Tuesday, 7 July, 2015
by Michele Delera
Last month Mr Rouhani’s cabinet raised domestic fuel prices by 40 percent, and gas prices to households and commercial consumers by 15 percent [1]. The move comes as part of a wider government effort – which also includes a planned depreciation of the official exchange rate, by 10 percent – to bring some relief to the country’s strained public finances. Already severely affected by years of international sanctions – oil and gas export earnings have dropped from $118bn in 2012 to $56bn in the latest financial year – Iran’s position is now exacerbated by the drop in the global oil price. The country’s economy may appear relatively diversified when compared to other oil producers across the region. In fact, however, its hydrocarbon sector remains the main source of foreign exchange earnings and fiscal revenue. With a break-even oil price – set by the IMF at $102 – well above current prices for Iranian crude, the country’s fiscal deficit is on the increase. It is estimated to reach just under 3% of GDP by 2015.
To make matters worse, in spite of its rather long resource horizon – Iran is home to the world’s second largest gas reserves and fourth biggest oil reserves – the country’s hydrocarbon sector is in a dire state. Virtually off-limits for US companies since the 1979 Islamic Revolution, and for their European counterparts since the inception of EU and UN sanctions in 2007, the industry is lacking in technology and managerial know-how. Crude production is just over 2.8mn b/d, down from around 4mn b/d in the mid-2000s [2], and much more needs to be done to tap into the country’s gas reserves. Yet upstream investment has been notoriously slow over the past few years, with the recent delays witnessed in the development of the South Pars gas field – expected to turn Iran into the region’s top producer by 2020 [3] – being the latest prominent instance.
Prospects for the sector largely depend on the aftermath of the nuclear talks, recently delayed to July 7. In all likelihood, the inflow of a much-needed $100 bn in foreign investment – as recently estimated by Iranian officials – will depend on a renegotiation of the country’s gas and oil contract. Highly critical of the old ‘buyback’ – a technical service agreement which viewed foreign companies as contractors, and confined ownership of the reserves to the government – oil companies’ executives are encouraging the cabinet to settle on more favourable terms [4]. Negotiations, however, may prove tricky. Proposals for the new Iran Petroleum Contract (IPC) to be showcased in London next autumn seem to go a long way to meet foreign investors’ demands. But the government is likely to encounter significant opposition at home, where the ownership of natural resources – a prerogative of the state, according to Shari’a law – is a contentious issue.
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Fig. 1 – Iranian oil exports, million barrels per day. Source: OPEC
The Islamic Republic is hardly alone in struggling to balance its budget following years of expansionary policies and the collapse in oil prices, but it does not have the same financial buffers of the other hydrocarbon-dependent economies in the Gulf. This has much to do with the effects of restrictions on international financial transactions, with the authorities now hoping to receive some relief in the shape of $100-20 billion in frozen assets should the country and the P5+1 group manage to seal a final nuclear deal [5]. There is another reason. Unlike some of its equivalents across the region, Iran’s sovereign wealth fund (the National Development Fund), which receives 32 percent of projected oil and gas export revenues based on an assumed oil price ($95 a barrel for 2013-14), is insulated from government intervention. As such, it cannot be relied upon to provide budget support. Hence the need for greater spending efficiency.
Fig. 2 – Fiscal cost of fossil fuel subsidies, as of 2013. Source: IMF
Contrary to expectations, the fuel and gas price hike announced last month has been met with little contestation from the public, although the opposition has criticized it harshly in the media. One wonders what may have changed since 2007, when people took to the streets following a similar attempt by government to curb domestic fuel consumption and cut subsidies. Perhaps the answer lies in the persistence of high explicit subsidies – in the form of monthly cash-handouts to a large part of the population, now reportedly undergoing reform – introduced shortly after the political turmoil of 2009-10. Yet the decision to trim the country’s energy subsidy bill – estimated by the IEA to be amongst the highest in the world (see figure 2 above) – still appears somewhat praise-worthy. With substantial financial reserves at their disposal, other governments in the region may prefer to delay long-awaited reforms for fear of political backlash. Albeit timid, Iran’s fiscal consolidation strategy might be a step in a more sustainable direction.
[1] Middle East Economic Survey, 29 May 2015.
[2] Middle East Economic Survey, 5 June 2015.
[3] Middle East Economic Survey, 12 June 2015.
[4] Middle East Economic Survey, 3 July 2015.
[5] Middle East Economic Survey, 29 May 2015.