Iran’s Oil Industry: A House of Cards?

At first glance, Iran looks like an energy superpower. It is the second largest oil producer in the Organization of Petroleum Exporting Countries (OPEC). It owns 11 percent of the world’s conventional oil reserves, second only to Saudi Arabia. It also sits on 16 percent of the world’s gas reserves, the largest reserve after Russia. With rising oil prices, Iran’s oil export revenues have increased steadily, from $32 billion in 2004, to $47 billion in 2006. Finally, its geographic position on the world’s most important energy corridor, the Strait of Hormuz, through which 40 percent of the world’s oil traffic passes, gives Iran the ability to disrupt the flow of oil to global markets.

A closer look, however, reveals that Iran’s energy sector is a house of cards.
It is neglected, crumbling and underinvested. Many of its oil and gas fields are in dire need of foreign technical expertise to help reverse their natural decline. An analysis published last year in Proceedings, a journal of the National Academy of Sciences, asserts that, “Iran is suffering a staggering decline in revenue from its oil exports, and if the trend continues, income could virtually disappear by 2015.” Iran’s deputy oil minister, Mohammed Hadi Nejad-Hosseinian, confirmed recently that, “if the projects for increasing the capacity of the oil and protection of the oil wells will not happen, within ten years there will not be any oil for export.”

Oil may be Iran’s greatest strength, but it is also Iran’s greatest weakness. As such, the debate in the West on how to prevent Iran from developing nuclear weapons should focus less on the risky military option, or the seemingly ineffective diplomatic option, and more on a comprehensive economic warfare strategy that targets Iran’s energy sector. With oil exports accounting for half the government’s budget and around 80 to 90 percent of total export earnings, the surest strategy to bring down Tehran’s Islamic regime is to break its economic backbone.

In the mid-1970s, with a production level of more than 6 million barrels per day (mbd), Iran was one of the world’s leading energy producers. After the 1979 revolution, Iran’s fortunes reversed. Production plummeted to 1.5 mbd, and during the subsequent eight-year war against Iraq, Iran’s oil infrastructure was crippled further. Today, if Iran were to try to match its pre-1979 level, it would require at least $80 billion in investment. Moreover, its gas industry would require an extra $85 billion by 2030.

U.S. sanctions have ensured that Iran’s oil sector would not recover. President George W. Bush has renewed sanctions first imposed in 1995 by President Bill Clinton, citing the “unusual and extraordinary threat” to U.S. national security posed by Iran. These sanctions prohibit U.S. companies and their foreign subsidiaries from conducting business with Iran, while also banning the financing of development of Iranian energy resources. In addition, the 1996 Iran-Libya Sanctions Act (ILSA) imposes sanctions on non-U.S. companies investing more than $20 million annually in the Iranian oil and natural gas sectors. The 2006 Iran Freedom Act (IFSA) extended ILSA until December 2011. Thanks to these sanctions, investment has plummeted. Today, Iran produces only 4 mbd and exports 2.34 mbd, about 300,000 barrels below its OPEC quota. This shortfall represents a loss of about $5.5 billion a year.

The decline in oil and gas export revenues is amplified by growing domestic energy demand. To keep 70 million Iranians content, Tehran annually spends about $20 billion, or 15 percent of its economic output, to subsidize gasoline, natural gas, kerosene and electricity prices. These subsidies have spurred rapid growth in consumption, prompting 15 percent to 30 percent inflation, and sparking a full-blown financial crisis.

Iran’s dire economic situation has also impacted its lack of refining capacity to meet domestic need for gasoline and other essential refined petroleum products. Gasoline production stands at 10.5 million gallons a day, compared with a daily demand of 18.5 million gallons. With 43 percent of its gasoline imported, Tehran plans to curb demand by launching an unpopular, and potentially explosive, rationing system this year. For a regime that promised to bring oil revenues to every family, eradicate poverty, and reduce unemployment, the decline in oil revenues, coupled with austere gasoline rationing measures and the eradication of energy subsidies, could be dangerous for the survival of the Mullahs’ regime.

The economic crisis brewing in Iran is an opportunity for the West. Should the West decide to exploit this situation and ratchet the pressure on Iran’s crumbling energy sector, Tehran’s house of cards could eventually collapse.

Institute for the Analysis of Global Security