Exploring the Iran-Russia mystery deal [Gas in Transition]
In July Gazprom and Iran’s NIOC signed a memorandum of understanding (MoU) on multiple projects with a total reported value of $40bn. The MoU has not reached the public domain, but its size begs a large question as to what its contents might be. The few public details announced (a few field developments and some tinkering with gas reservoir pressures) cannot account for more than one or two per cent of the total, so what is the rest of the deal about?
Some clues to its likely contents, might be found by looking at the interlocking agendas of Iran, Russia and their respective energy customers and geopolitical competitors.
Oil production issues are too small and too cheap to be the heart of the deal
First, the deal probably has little to do with oil production or marketing. Iran and Russia are essentially competitors in the oil export market, with a combined potential 11mn barrels/day of exports (limited by sanctions) looking for customers. They might well cooperate to manage customers and prices, but that won’t demand much investment capital. No. This deal has to be a gas deal.
On the gas supply side Russia’s present export capacity is some 250bn m3/year. Proven reserves provide for seventy years of total production, and reserves yet to be explored will undoubtedly add substantially to that.
Iran’s export capacity is much smaller at about 17bn m3/yr, to Iraq and Turkey when they find the cash to pay their bills. Proven reserves are sufficient for 140 years (the data is out of date, but close enough for this big-picture view).
Neither country is in a big hurry to develop new reserves, so the deal is unlikely to be aimed at that either. Gas market access is another question. Here Iran and Russia have complementary problems. Russia is likely to lose its main export customer (Europe) permanently due to a combination of NATO sanctions and the European Commission’s desire to decarbonise Europe’s economy. Iran, meanwhile, is physically close to two significant and rapidly growing sources of gas demand much too large for its surplus production – in Pakistan and India.
Russia’s exports to China will be capped by China’s own diversification strategy
Russia’s first choice to replace European demand is China, which imports around 140bn m3/yr, but China is not an ideal additional market for Moscow. First, Beijing is acutely aware of the risks of sole-sourcing hydrocarbon imports, and therefore has long had a core strategy of diversifying suppliers, routes and formats as much as it can.
Imports from Russia are strategically valuable because they cannot be blockaded at sea, an environment in which China is at a significant disadvantage against the US and its allies and friends, but Beijing is highly unlikely to allow itself to become dependent on Russian gas. It will probably accept some increase because of reliability of both the route and the supplier, probably via Power of Siberia 2, but that is some way off. (even the basic route is still under discussion). Moscow, too, has probably become acutely sensitive to the benefits of market diversification. Moscow has already learnt that China drives a hard price even with its friends – reports suggest that this year’s 10 bcm per year uplift to Power of Siberia contract was priced at “around the same level” as the current 30 US cents per metre, while gas in Europe is selling at seven times that level.
China may be a safe and friendly long-term market but it is not a wildly profitable one, and will not soak up even half of Russia’s export capacity. And that is where the deal with Iran may fit in.
Pakistan is the first big market opportunity
The analysis starts with Pakistan, with gas production of 38bn m3/yr from reserves with a fifteen-year life, and present imports of 11bn m3/yr. At present Pakistan meets its entire import needs with LNG – expensive, vulnerable to blockade, and sourced from a worryingly small number of suppliers whose agendas might easily change under pressure. As the balance between rising demand and falling production worsens Pakistan’s strategic gas problem also grows.
At first sight Pakistan (extremist Sunni) and Iran (extremist Shia) may not look like ideal strategic energy partners. To sour the pot Pakistan’s main strategic ally and supporter has historically been the USA – Iran’s most active opponent. But the two countries share a 500 km border, and the straight-line distance from Iran’s gas reserves to Pakistan’s CCGT plants is a scant 2,000 km, with a pipeline already part-built across Iran.
In spite of the potential antagonistic aspects of their strategic relationships Iran and Pakistan have maintained a reasonably relaxed peace for the nearly three generations since Pakistan’s birth. If Iran had the spare export capacity, then feeding an 11bn m3/yr pipeline to Pakistan (with capacity to scale to 20bn m3/yr and higher over time) would make plain economic sense.
And Pakistan may be open to a new relationship
Now might be a good time to push. Pakistan’s relationship with the US is far from stable. Islamabad’s poltical and military elite appear content to work hand in glove with Americans, but the mass of Pakistan’s population are much less happy, seeing the US (correctly, it is arguable) as no friend of Islam. Beijing has inserted itself into that gap under the label of the China Pakistan Economic Corridor (CPEC), and with the construction of a large new port at Gwadar that has ample potential for projecting military power into the Gulf. Pakistan’s relationships are drifting away from the US towards its neighbours.
CPEC’s grand plan is for $50bn of investment in roads, railways, ports, pipelines and power plants. Some of these exist or are in hand. The plan includes the construction of the Pakistan portion of the Iran/Pakistan gas pipeline. Until now Islamabad has appeared unwilling to provoke a hostile US reaction by completing a gas supply deal with Iran but that is likely to change as the large flow of capital from Beijing pushes US influence off Pakistan’s analytical map. However, the problem of where to find that 10-20 bcm of gas remains, alongside Pakistan’s acute economic problems which Russia may be more willing to help solve than the US.
Pakistan is the starter, India the main course
A few hundred kilometres east of Pakistan lies an even larger gas export opportunity, in India. Here annual production of 28 bcm (from 50-year reserves) lags consumption by 34 bcm. At present India fills the gap with expensive LNG, but is likely to look kindly on a reliable, long-term and cheap pipeline supplier to replace that expensive habit.
Talks on a pipeline via Pakistan had little chance of success given the antipathy that India and Pakistan share for each other, but a subsea pipeline bypassing Pakistan could solve that problem. It doesn’t, though, solve the lack of export capacity in Iran, or Indian concern about US sanctions. However, this year’s geopolitical tectonics have moved India away from the US and towards Russia, marked by the sale of discounted Russian oil to India and by generally warm relations in spite of the Ukraine war.
A back-door route into China too
Iran’s geography offers another export route eastwards. China and Pakistan share a short border over the Karakoram mountains, but one long enough to accommodate an overland pipeline bringing Iranian gas (or Russian gas carried across Iran) into western China. From there it would have a couple of thousand kilometres to travel to China’s gas consumers, but over Chinese territory.
When we combine these three demand opportunities they potentially generate sustained contracted demand for something between 30 and 40 bcm per year (allowing for each buyer’s natural desire to diversify sources and capacities). But where would the gas come from?
One option is for Iran to develop its own ample reserves – a slow and expensive prospect made slower and more expensive by US unilateral sanctions. It would be quicker and cheaper to connect those markets to Russian production and so take advantage of spare Russian export capacity. That may be what the Memorandum of Understanding is all about.
A southern export route from Russia is surprisingly practical
Connecting up Russian production and Indian Ocean consumers is a smaller challenge than appears at first sight.
The Brotherhood pipeline, Russia’s oldest gas export line to Europe, already has a capacity of some 30bn m3/yr.. A spur leaves that line heading south to form Blue Stream (to Turkey). It would not be a complex or slow job to add a new spur to take Brotherhood gas south to Iran, either through Turkey (which would be grateful for the transit fees and some cheap supply along the way) or through Azerbaijan (less friendly to Russia, but easier to dominate), or even across the bed of the Caspian Sea (subject to complex approvals from Caspian sea states).
All three options imply a new pipeline build of about 2,500 km (straight-line distance) to the area around South Pars. Within a few short years Russia could establish three new export markets of 30-40bn m3/yr, to Pakistan, India and China. Four new pipelines would be needed – the first joining Brotherhood to the Iranian gas system (2,500 km straight-line), the second completing the Pakistan line (1,000 km), the third into India (1,500 km subsea) and the fourth extending the Pakistan line to the border with China (1,000 km, plus the Chinese element). Total pipeline builds would come out at somewhere around 6,000 km straight-line, mostly overland. The projects together would come in at around $20bn.
A new Asian gas map might emerge
That plan would dramatically alter the global gas map in Russia and China’s favour. For starters it would position Russia as a major long-term strategic energy partner for India and Pakistan – two significant participants in the Global South. Both would reduce (or even escape) a significant strategic vulnerability – the threat to seaborne LNG flows posed by the United States and its allies. That threat – never stated in public but real nevertheless – is at present a significant potential US hold over Indian and Pakistani foreign policy.
China would be equally happy to see another source diversification, with perhaps 10bn m3/yr coming in overland via Pakistan – a state in which it has a rapidly growing influence. The diversification would be less secure if that pipe was carrying Russian gas, but over time and with investment Iran’s own export capacity will grow, allowing the Chinese import element to be joint-sourced from Iran and Russia. Later on it might even take in gas exported from Iraq.
Diverting the Brotherhood gas flow south not only replaces a large slice of European demand for Russian gas but would have the bonus prize that Russia could reduce supplies to Ukraine over time, throwing Ukraine’s import requirement and its perennial inability to pay for around 10bn m3/yr onto Europe’s shoulders.
Turkey may like the outcome as well
Other prizes are on offer. Brotherhood gas flowing through Turkey could replace Iran’s current exports to Turkey, which could be turned around and head east. That would deepen the relationship between Russia and Turkey and provide Iran with more reliable customers in Pakistan and India (Turkey’s payment record is spotty, and likely to grow worse). As Turkey develops its own domestic gas production in the Black Sea (and later the East Mediterranean) more Brotherhood gas would flow east. It may be significant that President Erdogan was present for the talks that led to the MoU, and that Presidents Putin and Erdogan met for an extended session in Sochi in early August.
The plan described here accounts for only half of the headline amount of the MoU. The balance might be allocated to the development of a set of LNG liquefaction trains on Iran’s southern coast (well outside the Hormuz trap). There is gas production to cope. In 2021, Russia exported 151bn m3 of gas to Europe, but the possible plans I’ve outlined here only consume export flows of about 90-100bn m3/yr. If another 50-60bn m3 of Russian gas arrived on the world market as LNG it would put Russia in the top five club of LNG exporters worldwide, when added to existing capacities, where it could either enjoy the super-margins available today, or undermine those of its competitors and win strategic friends in the LNG importing world (including, ironically, Europe).
The scale of the prize is enormous, but so is the scale of the investment. 60bn m3/yr of gas would demand a half dozen 4mn metric ton/yeari liquefaction plants and a fleet of new LNG carriers. That plan would comfortably account for the missing balance of the MoU headline figure.
Some clues in the detail
One report of the MoU’s shape seems to corroborate some of this logic. NIOC’s CEO Mohsen Khojastehmer has been quoted saying “The [MoU] includes six axes, which are investment in the development of oil and gas fields, investment to complete the half-finished Iran-LNG project, definition of new floating LNG (FLNG) and small-scale LNG (mini-LNG) projects, gas swap, oil product swap, construction of high-pressure export lines and technology transfer.”
None of this would require Iran to invest a penny in new gas production, releasing scarce Iranian investable capital for development of its oil production and downstream plants. A plan on these lines would also demand little investment from Iran in gas pipelines or associated infrastructure. In fact the cash flow would be the other way – with large sums spent on Iranian labour, and larger sums arriving as transit fees. A deal might include a gradual substitution of spare Iranian gas production for Russian gas as and when future investments make that available.
In the short term Iran would trade geography for cash. It has little cash and ample geography to spare.
A military sting in the tail?
A final part of the MoU may be military rather than economic. With billions of dollars of capital invested in pipelines and LNG plants in Iran, Russia is likely to seek a substantial naval base facility somewhere on the Iranian coastline, probably outside Hormuz, to protect its assets. Relationships between the two navies are already under construction – two Iranian warships took part in 2021’s naval review in St Petersburg – and Iran already uses naval weapons and platforms supplied by Russia. Russia’s new Naval Doctrine adopted at the start of August states that Russia has “…[the] ambition [to become] a “great maritime power” which extends over the entire world”. So far Russia lacks a base presence in the Indian Ocean, which Iran might provide, and which would be an essential asset in that doctrine.
Washington will not be happy. In late July Robert Malley, the US envoy to Iran, said in a CNN interview that the Iranian regime is facing a choice between renewing its nuclear deal with the US and siding with the Russians – “[Iran] can opt for a position of relative dependency on Russia, which itself is isolated internationally…or it can choose to come back into the deal that’s been negotiated…and have normal economic relations with its neighbourhood and with Europe and the rest of the world”. The $40bn MoU may well mark the moment when Iran makes that choice.