The following article was written for MEES by Dr Kneissl, an independent writer on Middle East affairs in Vienna who teaches international relations there and in Beirut. She recently revisited Iran.

Iran is not in a hurry. The Islamic Republic appears comfortably placed, despite the tremendous domestic problems such as unemployment and general dissatisfaction with a failed economic system based on the Islamic revolution. And the explosive mix of repression and desire for change could spark off internal unrest. Nevertheless, the common aim of all layers of society is to change the country from within, and certainly not via outside intervention. The government’s handling of the nuclear crisis is ensuring it of popular support. Sanctions against Iran would strengthen solidarity with it.

On a wider diplomatic level, Tehran has attractive cards in its hands. Its quest for leadership in the Islamic world, the aim of Shah Reza Pahlavi until his fall in 1979, has become more marked under the populist revolutionary Mahmoud Ahmadinejad, in power since August 2005. Regardless of its leadership, Iran will always behave like an empire and want to be treated as such. Dealing with the EU-3 (UK, France and Germany) in order to tackle the nuclear issue has been a useful tool to keep a dialogue going. But in the end, the Iranian “empire” wants a deal on an equal footing with the other “empire”: the US. Washington could benefit from dialogue with Tehran over the the US’s envisaged plans to withdraw from Iraq and Afghanistan where Iranian spheres of influence have significantly grown in the aftermath of the respective invasions in 2001 and 2003. Unexpectedly high oil and gas export revenues are providing Tehran with opportunities to experiment in domestic and foreign politics. Iran feels strong, and is convinced that it can set the rules of the game.

Europe Seeks Energy Partnership
 

Europeans are aware of Iran’s significance – not least as an oil/gas producer. Power cuts in Europe in January this year because of the Russian-Ukrainian price dispute increased calls for a new energy partership with Iran. Echoing Winston Churchill’s plea for “safety in variety”, the EU is again courting Iran as one of the partners in diversification. Investment opportunities in Iran are not that tempting for Western companies. “But if they consider the draft contracts unsatisfactory, then Iran simply proposes them to China and India,” says Bijan Khajehpour, Chairman of the Atieh Group, a consultancy business based in Tehran. Iran seems to be in the comfortable position of being able to decide with whom to do business, be they Western or Asian partners. The prevailing consideration is obviously that investors will accept the Iranian terms if this is the only way to get into Iran. Can it work?

As far as hydrocarbon reserves are concerned, Iran holds 137bn barrel of oil and gas liquids, accounting for 11.6% of world’s total proven reserves, and up to 29 trillion cu ms of natural gas, 15.3% of the world’s total reserves. That may not be all, for large parts of Iranian territory, especially the northern half the country, have not been explored for fossil fuels due to geographic proximity to the Soviet Union in the Cold War era. “More than 60% of Iranian gas reserves are located in non-associated fields and have so far not been developed,” says Hossein Adeli, Chairman of the Tehran-based Center for Economic and International Studies.

There is huge need for investment. According to a Ministry of Petroleum estimate, an annual investment of about $10bn between 2005 and 2010 is necessary. One of the impediments for foreign investment is the buyback agreement – a short-term risk service-contract between the National Iranian Oil Company (NIOC) and an international oil company (IOC) for petroleum exploration and/or production rights. The IOC is a contractor to the NIOC and is reimbursed in cash after completing an agreed scope of work without obtaining equity rights in crude oil. The reimbursement includes cost recovery and an agreed rate of return. The main problem for IOCs is the very short time-frame. Compared to respective offers in Qatar, say, or Algeria, the buyback regime is simply not attractive.

Difficult Decision-Making Process
 

The ongoing review of the buyback formula reflects the difficult decision-shaping process in Iran. The Ministry of Petroleum seems to be alone in pushing for reforms in foreign investment and for more transparency in highly subsidized energy prices. But the power of the Iranian parliament (Majlis) should not be underestimated. Parliamentary filibustering on contracts with foreign investors is common and landed former oil minister Bijan Zanganeh in trouble. The Fourth Development Plan presented by the government underwent numerous amendments and was finally passed by the Majlis in the fall of 2004. Obviously the Majlis was keen neither on the initially promoted “open doors” policy nor on a reduction of the state’s role in the national economy. However, in early July 2006 privatization plans were boosted. The Expediency Council, the top legislative body between the Majlis and the Guardian Council, and headed by former President Ali Akbar Hashemi Rafsanjani, ruled that the government’s role would shift from direct involvement in ownership and running the large companies to supervising and guiding different sectors of the economy. With regard to the oil and gas sectors, the order specified that the downstream would undergo privatization, but not the upstream. This new course is based on an executive order by Ayatollah Khamenei passed on 2 July 2006. It is intended to support the targets envisioned in the 20-year strategy for economic, social and cultural development and at the same time bring about social justice and eliminate poverty (MEES, 10 July).

Companies ready to enter the Iranian market should be patient. And those which finally opt for Iran – small and medium-size companies tend to find the decision easier than the large IOCs – the thinking is clear: they do so because they find investment opportunities that they cannot encounter elsewhere. According to Mr Khajehpour, it is all about long-term contracts. The crucial point in the review process of the buyback scheme is the time-frame. Iranians dislike long-term contracts for historical reasons, remembering the concession regime. But it might prove difficult othewise to specify the indicators of the rate of recovery, or how to obtain better technology at a better price. Many questions remain, aside from the extremely volatile geopolitical situation in the region. The fundamental question for Iran remains: does it wish to attract real investment or is it simply about a  buyer-seller relationship? The International Energy Agency stated in its World Energy Outlook Through 2030 that, “Iran has immense oil and gas reserves, but it is less able than other Middle Eastern countries to capitalize on them because of barriers to foreign investment and heavy subsidies”.

IOC Interest
 

Nevertheless, various IOCs have ventured into Iran. Conoco did so with the silent blessing of the Clinton administration, only to be replaced by Total. And Iran demonstrated to the world that it could even sign a contract with Shell. And, according to an experienced oil engineer, the Iranian view is that “if the West does not accept the deal, we will work with the Asians.” One inherent problem of negotiations seems to be more psychological than anything else: Iranians are convinced that a good deal can only be one in which the other side looks like a loser. The idea of a win-win balance seems not to be widely accepted.

But Europeans generally seem keen to pursue an energy dialogue with Iran – which enjoyed some institutionalization until its termination in 2002. The idea to open an EU energy office in Tehran, however, lacked a legal basis and was abolished by the European Court of Justice. Even though the EU must have felt at various instances undermined by an often unpredictable Tehran in the course of the EU-3 negotiations on the nuclear program, the aspirations of the EU to do energy business with Iran have increased since the beginning of 2006. The Austrian EU Presidency which was not at all prepared to tackle the long-announced crisis between Russia and Ukraine on gas prices, hastily put energy on the agenda and lobbied for the Nabucco project on all possible occasions. So, is Iran the reliable option for diversification?

Europeans Court Tehran
 

The Italian group Eni/Agip is the largest investor in Iran, followed by various other European companies of different sizes. “However, many more investors would come if they did not have to fear some sort of US-bashing because of their business in Iran,” says Rocky Ansari of the investment group Cyrus Omron Int. Of course, Russia does not appreciate such moves, wishing to preserve and enlarge the European market for its own companies, he adds. Potential rivalry with Europe in the energy business is counterbalanced by Russian diplomatic support for Iran in the UN-Security Council and Russian arms supplies. In Moscow’s logic, the Iranians would be better supplying gas to India and China, rather than central Europe via the Nabucco project.

In January 2004, Austria’s OMV and the National Iranian Gas Export Company (NIGEC) signed a memorandum of understanding regarding exports of Iranian gas to Europe through the proposed Nabucco pipeline from Turkey to Austria. It would take gas from Turkey to Austria via Bulgaria, Romania and Hungary – a venture being planned by OMV and partners BOTAS of Turkey, Bulgargaz, MOL of Hungary and Transgaz of Romania. Proposed pipeline capacity is 20-25bn cu ms/year, with potential gas sources including Russia, Turkmenistan, Azerbaijan, Egypt and Iran (MEES 9 February 2004).

Austria is keen to get the Nabucco project under way, while Iran seems less enthusiastic. Is Tehran taking Russian sensitivities into account? This might be part of the answer. But the main problem lies in intrinsic Iranian deficiencies such as fragmented decision–taking, the absence of a coherent energy policy and hesitation about what to do with its natural gas reserves. The key question is: will there be sufficient reserves to meet all the demands of potential as well as current clients? If the gas pipeline project with India turns into reality, there will definitely not be enough gas for Nabucco. Domestic demand, increasing by 10% annually, poses a huge challenge. Some insiders speculate that Iran might lack gas by 2010 and would then have to enter some sort of arrangement with Turkmenistan.

Data/Reserves Caution
 

As is the case elsewhere, data on oil and gas reserves in Iran have to be taken with caution. For example, all gasfields, associated and unassociated, are put into one basket. And their life expectancy is often vague due to bad exploration methods. “Regarding the South Pars field, its best part is done,” says Paul Graf, oil engineer and consultant. In his view, the remaining exploration might be of far inferior quality. Such uncertainties and the difficulties with the investment scheme and the available engineering in Iran confront investors with various problems.

Attractive Asian Option

While the West has a strong tendency to patronize Iranians and colonialism is part of the collective Iranian memory, the Asians seem much easier partners. It is all about business and not human rights when it comes to China. That means no interference in domestic affairs. China has for some years been fostering strategic and energy ties with Iran, signing a preliminary deal in November 2004 to develop the Yadavaran, one of the world’s largest oilfields.

Interesting to note in the context of the developing China-Iran relationship is the rising importance of the Shanghai Cooperation Organisation (SCO).  The emergence of countries like Iran, India, Pakistan, Afghanistan and Turkey with observer status dramatically changes the outlook, perception, and international dynamics of the SCO. It renews questions on how a supposedly uni-polar world order has changed. According to ex-diplomat Dr Adeli, an Asian identity ties countries like Iran to India and China, for an Asian identity evolves which prevails over specific Islamic, Hindu or other religious identities. The SCO is significant enough for being led by China and Russia, both Permanent Members of the UN Security Council and very large countries with increasing international stature in their own right. The high-profile attendance of Iran at a sensitive time of international concern about its nuclear intentions immediately sharpens the mind. A central objective of the SCO is energy cooperation, so it easy to see why an energy-hungry China should conceive the organization as an important link with the world’s main supply lines.

Cooperation with India is particularly attractive, given the historic and ethnic links between the two countries. In 1993 the idea of an Iran-India gas pipeline through Pakistan was first proposed. But despite Iranian fostering and an “all-gain” project, politics for long cast shadows over economics. Finally things started to move. Recently India, Pakistan and Iran have agreed to appoint consultants in a bid to solve the issue of pricing over a proposed gas pipeline. The project would carry natural gas more than 2,500km from Iran to India. But India and Pakistan cannot agree with Iran on the price of the gas. Iran wants it to be fixed to international market prices while India and Pakistan want a fixed price. The dispute continues to hold up the $7bn project.

Dealing With Iran
 

“We have to talk to Tehran” – a call voiced by various top European diplomats and also by some US veterans like former Assistant Secretary of State Richard Murphy. High-ranking US and Iranian officials met privately near Vienna in late 2005 to test the ground. So far, limited European-Iranian dialogue is limited to the nuclear issue. In general, Iran displays rigid self-confidence – feeling that its ambition to become the champion in the Islamic world is within reach. The Palestinian cause has been on the Iranian agenda since the early revolutionary days of Ayatollah Khomeini. It could be that the Shi΄a political dominance from Tehran via Karbala to Beirut comes to the rescue of the Palestinian cause. Already the Iraq war has strenghtened Iran, an outcome expected by sober analysts, but certainly miscalculated by those in favor of dismantling the Ba΄th regime.

How to deal with Iran in an emerging multi-polar world will be a harsh test for the West. Energy needs and the desire to pacify the Middle East logically offer Tehran an important position that should be used wisely. In 1906 Iran adopted its first constitution; a century later Iran could gain more from acting in accordance with international law. Even though the perspectives for the region look gloomy, there is still room for some hope: US and Iran have, to a certain degree, reciprocal interests. There is even some symmetry. As one Iraninian diplomat said: “I am confident that when President Ahmadinejad and Bush eventually sit down together, they will have a perfect understanding, for they both met God.”