Gradual Decoupling of Oil Revenues

Gradual Decoupling of Oil RevenuesGradual Decoupling of Oil Revenues

One of the most honest and direct announcements regarding the oil industry was made on Dec. 31 by Mohsen Qamsari, director of the International Affairs Department of the National Oil Company. He argued that in 2015 the oil price would reach a maximum price of $60 pointing out that “in my opinion, if we base the [government’s] budget on a lower oil price, we won’t bring in a deficit. And if the price of oil would increase, we can reap its benefit by saving the money in the National Development Fund (NDFI) and use it for the country’s development.”

Indeed, the budget bill for the next fiscal year was sent to the parliament just when global oil prices were coming down hard. Although the government first wanted to base budget on a much higher oil price, last minute estimation made them argue for an average oil price of $72/bbl. Their estimation was based not so much on scientific prediction, as it was a reflection of oil prices at the time.

In the meantime, however, oil has plunged even more. Trading in Brent Crude closed at $50/bbl on Jan. 7 after resting below the $50 mark for a few hours. While it was still controversial in late October, analysts seem to increasingly approve of the prediction that oil prices could stay below $50/bbl for quite some time. Saudi Arabia has repeatedly stated that it will continue to pump at current rates; Russia has recently reported that it had reached record oil production in 2014; the US shale revolution continues to develop, and Chinese and Indian demand are not expected to flip around the demand/supply balance significantly next year.

However, in the long run, the government should go beyond the recommendations of Qamsari regarding the prudential prediction of oil prices towards the gradual de-coupling of the oil budget from the fiscal budget. Such action would require bold action and reform.

An independent oil sector is nothing entirely new and to a large extent is already implemented in advanced social welfare economies like Norway. However, in Iran, such a policy would be difficult to implement in the short run, given the centrality of oil in government expenditure; nevertheless, it would become significantly more feasible from next year onward. Not only are oil revenues predicted to make up only 31.5 percent of the fiscal budget, but in light of the government’s recent overestimations, even this number might slightly come down further.

A situation in which oil revenues are independent from direct government expenditure would have several key advantages.

Most importantly for the oil industry itself, physical capital used to pump up the black gold is heavily outdated. The administration of President Hassan Rouhani has taken steps to revise the Iran Petroleum Contract - a new contract model aimed at attracting foreign oil companies with 25-year deals. In fact, it now offers unprecedented terms, aimed at being on par with Iraq’s investment climate for major international oil companies.

Mansur Moazami, deputy oil minister for planning and supervision, recently pointed to the sums of money the oil ministry has been allocating directly to the subsidy reform plan. Since windfall oil revenues between 2005 and 2010 were combined with former president Mahmoud Ahmadinejad’s controversial policies, oil revenues have been used to extend subsidy reforms. Although the Rouhani administration has been trying to gradually perk in and rationalize the subsidy plan, oil revenues remain deeply attached to redistribution.

  “A Huge Amount”

According to Moazami, “37.5 trillion rials, equivalent to $1.2 billion, has been transferred on a monthly basis by the oil ministry for the payment of cash subsidies.” This is a huge amount, which Moazami rightly believes could partly be used to replace outdated capital and invest in new technologies.

It is expected that next year’s oil price would stabilize at $50/bbl and the government continues its export of over one million barrels per day.

According to CNBC, it costs the National Iranian Oil Company between $10 and $15 to produce one barrel of oil. Indeed, in neighboring Iraq and also in Saudi Arabia, this cost runs at below $10. Investing in technology could bring costs down and increase revenues. On the other hand, Iran’s pumping capability is much lower than those of its neighbors. As a result, some shared oilfields such as the Nosrat oilfield, shared with the UAE, are depleted unequally against the odds of Iran. Improving storage and drilling capacity would thus improve the balance sheet of the oil industry considerably.

While privatization programs have been quite effective in reducing the size of the government, Moazami points out that many of these privatization efforts have led to creation of semi-private companies, with informal networks still connecting the government to the newly privatized shares. According to him, particularly large industrial privatizations such as the privatization of the petrochemical industry have been examples of this trend.

Additionally, oil, as stated by different governments, should belong to the people and in that sense the government could play a more central role than private companies. So, while privatization of oil should not be considered, radical overhaul of the oil industry should be on the table.

The gradual de-coupling of oil revenues from state expenditure would expand Iran’s sovereign wealth fund, the NDFI, and provide viable alternatives to oil for the country’s future development.