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India can drive a hard bargain on the IPI Pipeline

Rohit Pattnaik was a Visiting Scholar at the Institute for Defence Studies and Analyses, New Delhi.
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  • February 23, 2007

    The general impression is that Iran has gained tremendously from rising oil prices, fuelled by its vast oil wealth. In reality, however, given increased domestic consumption coupled with inefficient usage and subsidies, Iran is actually struggling to produce enough oil and gas for export. Without substantial upgrades Iran's oil production is expected to go through a gradual decline. Though Iran has abundant oil reserves, estimated at around 137 billion barrels, it has not even been able to generate its OPEC quota due to lack of technical expertise and skills. Nothing illustrates this better than the fact that while before the Islamic Revolution Iran pumped 6.1 million barrels of oil a day, today it produces only 3.9 million barrels a day.

    Iran's whimsical policies have led to a situation where its crude exports - its basis for geopolitical muscle - could effectively come to a nought in a decade. This crisis is due to under-investment and years of neglect. Domestic consumption outstrips supply and Iran has been forced to import US $5 billion worth petrol last year. Its oil imports amount to a third of its energy needs. Domestic subsidies are costing Iran roughly 15 per cent of its GDP. The government has for the first time started a rationing plan for gasoline to curb inefficient energy consumption. With double-digit unemployment and inflation, the times ahead are bound to be difficult for ordinary Iranians. The country's $60 billion foreign exchange reserves are misleading since Tehran has used money set up for a stabilization fund in political projects. It is expected that without a large stabilization fund for the rainy day, Iran will be forced to obtain loans when oil prices slide further.

    Fears about Tehran blockading the Straits of Hormuz and suspending its oil exports are not therefore realistic given that Iran's economic conditions are not as healthy as assumed. Oil exports amount to between 80 and 90 per cent of state revenue and between 40 and 50 per cent of the budget. Any reduction in revenue would affect social spending and lead to domestic unrest given the high unemployment rates.

    While the US is mounting diplomatic pressure on Iran to compel it to forego its nuclear ambition, a more interesting development is taking place in the energy sector. Washington is seeking to squeeze the oilfields that are Iran's lifeblood. The oil industry has been targeted specifically in terms of financing for oil and natural gas development projects, which poses a threat to Iran's ability to expand its oil and gas fields. IAEA estimates that Iran will need $165 billion to meet its energy production goals set for 2030. Tehran has failed to attract newer investments due to the fear of a potential showdown with the US and the regime's non-pragmatic terms. Due to the lack of newer investment opportunities, Iran is now actually a net importer of gas, something it will continue to do until the end of this decade. Tehran has signed a spate of energy deals with Kazakhstan, China and is keen on signing the deal with India for gas to hedge against its vulnerability to sanctions. Washington has warned China about being held accountable under US laws if it proceeded to develop the North Pars gas field and the Yadavaran field.

    In the case of the proposed India-Iran pipeline project, it is Tehran's slow pace of negotiations that has led to the current stalemate. Foreign Minister Pranab Mukherjee's statement during his recent visit to Tehran indicates the importance that India places on Iran as a source of energy, and this despite Washington's public and unfavourable articulations on this aspect. However, India's nuclear deal with the US will have an impact on the outcome of its ongoing negotiations with Iran on energy co-operation.

    The Indian team involved in price negotiations for the IPI pipeline would do well to adopt a cautious stance in spite of the fact that Pakistan has broken ranks and sided with Iran. The pressure being applied on India to sign an agreement should be resisted and the pipeline, though important, should be put on hold if terms are not favourable. The point of contention is the price of gas. India is looking to have the gas priced on the basis of the LNG Japan prices, which takes into account the cost of transportation, while Iran wants it linked to the Brent crude index. International consultants appointed to examine the feasibility of the pipeline have recommended linking the gas price to the average of the six-month Japanese crude, preceding the month of delivery. India has sought a lower price, with the pricing based on a five-year average, as against Iran's offer of a 10-month average. Also, Iran's insistence on a 25-year sales purchase agreement would be too long considering the possibility of domestic availability once gas finds on India's east coast are brought onshore.

    Gas from Iran through the IPI pipeline could prove a success story in terms of integration of the economies of the three countries. The pipeline could also be networked with pipelines from Central Asia to deliver oil and gas to India. However, given the ongoing crisis over Iran's wish to enrich uranium, it makes sense for India to adopt a pragmatic policy and hedge till the nuclear issue is resolved. Apart from the security of the pipeline in Pakistan, the ability to turn off gas if relations deteriorate between either of the countries cannot be ruled out. Russia turning off gas to Ukraine when bilateral relations nose-dived is a telling reminder in this regard. As India looks to expand it energy supply base for its rapidly growing economic needs, it will have to increasingly participate in the geopolitical melee to dictate favourable conditions in the oil exporting nations of the world.