Moscow to Gain from Iran's Oil, Gas: Sources

Reports of last week's visit to Moscow by Iranian president Hassan Rouhani cited security co-operation generally and in Syria specifically as the main subject.

However, energy co-operation agreements were also reported, which according to sources, represent a fundamental shift in Iran's energy diplomacy and economic strategy. 

According to one source, Iran has essentially agreed nothing less than that Russian international oil companies (IOC's) such as Rosneft and Lukoil would in future act as lead developers of Iranian upstream oil & gas assets. In that role they would have priority in investment of finance capital and technology and would choose which western IOCs would be allowed to participate.

According to this source, Russia will decide “...how much oil and gas is pumped from each field it's involved in, where it is sold, and at what price.”. As the source continued, what happened last week was nothing less than a shift by Iran “..... into the Russian (and Chinese) camp entirely”.

Dollar Addiction

Iran has long been addicted to the US dollar, which despite long-standing US/Iran hostility and the best efforts of the EU and European Central Bank, remains Iranians' currency of choice, being trusted and used by Iranians in preference to their own riyal.

Iran's hopes that the US Donald Trump administration would act to enable access to dollar finance via western international oil companies' investment have recently been dashed by crude pressure from the US State Department and Treasury which has made impossible participation in Iran by banks and IOC's wishing to do business in the US.

So if the financial heroin of the dollar can no longer feed Iran's addiction, perhaps the euro can act as a substitute financial methadone. Since the JCPOA 5+1 agreement on the Iranian nuclear programme was signed over a year ago – if not before – Germany and France have been pushing technology and services on Iran funded by euro-denominated debt. It is no secret that these founders of the euro have aimed since the start for euro debt to be secured against oil and gas so that the petro-euro can supplant the petrodollar.

However, what little confidence Iranian decision makers had in the sustainability of the euro in its current form has been destroyed by the UK Brexit decision to leave the EU. So there is no Iranian desire to back the euro with Iran's sovereign resources of oil and gas. Although neither dollar nor euro finance capital are feasible, the announcement in Moscow that Iran and Russia will accept each other's currency in payment for transactions does nothing to help resolve the investment issue Iran and Russia face in funding implementation of new oil and gas development agreements.

So how may Iran recover from the pain and discomfort of a long period of forced withdrawal – “Cold Turkey” from dollar addiction?

A Two-Tier Market

Before addressing the question of funding there is also the matter of the oil market itself. I have often written of the evolution of commodity markets into financial asset markets since the financial crash of 2008. This in turn led to the evolution of a two-tier market in oil whereby the US has been able to use Saudi capital to manipulate the physical oil market price and thereby fund the creation of new shale oil reserves.

Meanwhile major oil traders, banks and IOC's have profited as middlemen from a hugely profitable market platform which they own and operate at the expense of producers and consumers alike. I have warned Iran's decision-makers of the need to create a new and neutral market platform since June 2001, but unfortunately only cosmetic action has ever been taken.

I was recently struck by finding how severely Iran's lack of market power affects the actual prices obtainable from selling oil as a commodity to independent refiners. Russia is similarly placed so we see Urals crude oil sold at substantial discounts to the UK North Sea Brent/BFOE global benchmark price which is the tail that wags the oil market dog. While Russian and Iran would both benefit from the new regional oil commodity market platform I first recommended in 2001, Russia is unlikely to risk massive investments from US and other upstream oil and gas investors purely to promote relatively small investments in Iran.

Transition through Gas

One of Russia's principal strategic energy policies has always been to prevent Iranian gas competing with its lucrative European market.  However, Iran's own strategic energy policy has for decades been to use gas to displace the use of oil and oil products: by way of example, Iran's taxi and commercial transport fleets have long used compressed natural gas (CNG) instead of diesel fuel, while Iran's new petrochemical complexes were built to use natural gas as a feedstock rather than naphtha refined from crude oil.

The fact is that to move natural gas over long distances, whether by pipeline or by liquefaction into transportable LNG, carries massive energy costs. Since late 2014, when first referred to in Ashgabat by National Iranian Gas Exports Company chairman Dr Ramazani, the principle of 'least carbon fuel cost' is increasingly being incorporated into Iranian energy strategy. Moreover, the more expensive natural gas becomes in dollar or euro terms the more profitable it becomes to save it in accordance with this principle. The clear economic rationale for energy efficiency is supported by massive Iranian budgeted expenditure under Article 12 of Iran's Economic Plan.

Competition in relation to crude oil production and marketing – combined with insufficient market share – prevents a joint Russian/Iranian oil market initiative. However, since Iran and Russia command well over half of the global natural gas reserves, Iran's openness to cost-sharing opens the way to a new global gas market paradigm, beginning in the Caspian region where the two countries have converged for centuries.

Caspian Energy Grid

Energy users do not use raw energy such as oil and gas but actually use forms of energy as a service such as heat/cooling, power and transport. A market in energy services may simply be achieved through swaps of flows of energy such as gas for power; fuel for transport; and even technology use for energy use (eg solar as a service). The funding instrument necessary to directly monetise these energy flows is simply a promise or credit issued by energy producers in exchange for value received by an acceptor, and which the producer will then accept in payment for energy supply instead of dollars or euros.

In order to create a market in energy as a service, both energy service providers and users are required. The obvious regional candidate here is Turkey, who not only has borders with both Russian and Iran, but also an immense capacity to reciprocate energy supply through providing valuable goods and services.

At the 2016 World Energy Congress in Istanbul the participation of Turkish and Iranian power grids in the proposed Caspian Energy Grid initiative was discussed at a meeting convened by the Energy Charter Treaty and also raised at the private sector Bosphorus Energy Club.

Finally, there is the matter of energy transit, and the needs for a regional neutral energy hub and pricing point, where Baku is an obvious pricing point for a regional energy market.

Cold Turkey

So perhaps Moscow and Tehran's withdrawal symptoms from dollar addiction and Istanbul's need for secure energy supply could all be met through creating a new regional energy-as-a-service market beginning perhaps with proof of concept regional projects probably at border crossings and free zones.

In this way all three nations could avoid Cold Turkey through new physical Caspian Energy Grid and regional financial Energy Clearing Union and investment networks. Such networks could be organically extended to the EU and China to create new Eurasian energy and financial market infrastructure.

Chris Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and a commentator.