IRAN'S ENERGY CRISIS

Number 09● 29 January 2007

Although Iran is one of the richest countries in the world in terms of hydrocarbon resources, it is suffering a major energy crisis. It has the world's second largest oil reserves, after Saudi Arabia, and they will last over 90 years at current levels of production. In 2006, it produced 3.8-3.9 million barrels of oil a day (mb/d), five percent less than its OPEC quota and some 300,000 barrels less than in 2005. In 1974, it produced 6.1 mb/d. In 2005, Iran produced 5.1% of world oil output and was the third largest producer after Saudi Arabia and Russia. It also has, after Russia, the world's second largest natural gas reserves: 26.74 trillion cubic meters. In 2005, its production of gas was 87 billion cubic meters and was the world's fourth largest producer.

The reason for the crisis is that domestic demand for energy has risen sharply while supply has been severely constrained. Demand has risen because the economy is growing, mainly as a result of the extra income yielded by high international oil prices. The growing demand for oil and gas has been the result of real economic growth and huge implicit subsidies. As the government charges Iranian consumers much less than the international price, the price mechanism did not constrain demand when international prices rose. Heavily subsidized hydrocarbon prices are common in Middle

East countries, but the subsidies are larger in Iran than anywhere else in the region. As a result fuel prices in Iran are a fraction of their world level; in early 2006, the price of gasoline was just $0.09 per liter ($0.34 per US gallon). These subsidies cost some $7 billion or 16% of government spending.

In addition, Iran has a thriving automobile industry and there are reports that up to one million new cars are produced a year. The government is keen for the economy to grow because this is a way of coping with large-scale poverty and the fact that one million young people are entering the labor market a year. Finally, oil and gas are used to produce electricity that is sold to consumers at prices that do not cover costs. Between 1982 and 2004, the population rose by an annual average of 2.3%, GDP by 2.7%, but electricity consumption increased by 5.9%. The result has been shortages of both oil and gas, and reserves are being used faster than the government wishes. This is the reason given for the nuclear program.

In 1995, domestic consumption of crude oil was 1.23 mb/d; by 2005, it had reached 1.66 mb/d, a rise of 35%. During those years, Iran's oil production rose by only eight percent and its exports fell by 2.5%. In 1995, the domestic market consumed 33% of total production, in 2005, it accounted for 41% of total production. Iran's oil and gas exports have been limited by domestic demand.

On the supply side, the crisis is the result of years of neglect and underinvestment in the hydrocarbon sector. In September 2006, the oil minister, Kazem Vaziri-Hamaneh, suggested that with no new investment, Iranian oil output could fall by 13% a year, twice the rate that outside oil experts had expected. The government uses the oil industry as a source of funding for social programs while allocating only $3 billion a year for investment, less than a third of the sum needed to increase production. US sanctions have also had a major effect by reducing the willingness of Western firms to invest in Iran. This has denied Iran access to technology as well as finance.

As a result, despite being a major exporter of crude oil, Iran has imported refined oil products since 1982, and in recent years these have increased rapidly. In 2005, imports of gasoline came to 170,000 barrels a day (b/d), at an annual cost of $3-4 billion. In 2006, they were estimated at 194,000 b/d, some 42% of domestic consumption. Plans to introduce a form of rationing, under which consumers could buy only a limited amount of gasoline at a subsidized price, have been proposed, but not yet implemented.

In the first half of the Iranian year 2005/06 (April-September 2005), oil and gas revenues accounted for 75% of government revenue and 86% of total exports. The hydrocarbon sector that includes crude oil production, gas, refining and petrochemicals accounted for 28% of GDP in the first half of 2005/06. Iran is therefore completely dependent on exports of oil and gas and dependent on imports for nearly half of its gasoline needs.

Ironically, demand for oil and gas has increased largely because the government has had access to higher oil incomes. The latter was due to the rise in international prices that more than outweighed the effect of Iran's declining volume of exports. The mechanism that facilitates this is the massive subsidy given to consumers. A significant fall in international oil prices or in revenues for some other reason would cause this system to collapse and that could force a resolution of Iran's energy crisis!

The Alliance Center for Iranian Studies (ACIS)

Tel Aviv University, Ramat-Aviv 61390, Tel Aviv P.O.B. 39040, Israel

Email: IranCen@post.tau.ac.il Phone: +972-3-640-9510 Fax: +972-3-640-6665

Iran Pulse 9 ● January 29, 2007 © All rights reserved.