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Simon Watkins

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Iran Wants To Start Oil & Gas Production In This Disputed Hotspot

Given the array of sweetener deals in the oil and gas sector promised to Russia by Iran in the past year or so – suspended until public outcry over these bargain-basement giveaways has died down – Tehran is now sufficiently confident in its implicit support from Russia that it is going ahead with fully developing a long-disputed area of the massive Caspian Sea oil and gas reservoir: Sardar-e-Jangal.

The wider Caspian basins area, including both onshore and offshore fields, is conservatively estimated to have around 48 billion barrels of oil and 292 trillion cubic feet (Tcf) of natural gas in proved and probable reserves, on the basis of field-level data. Around 41% of total Caspian crude oil and lease condensate (19.6 billion barrels) and 36% of natural gas (106 Tcf) exists in the offshore fields, according to this data, with an additional 35% of oil (16.6 billion barrels) and 45% of gas (130 Tcf) estimated to lie onshore within 100 miles of the coast, particularly in Russia’s North Caucasus region.

The remaining 12 billion barrels of oil and 56 Tcf of natural gas are believed to be variously located further onshore in the large Caspian Sea basins, mostly in Azerbaijan, Kazakhstan, and Turkmenistan. The area accounts for an average of 17% of the total oil production of the five littoral states that share its resources, on average totalling 2.5-2.9 million barrels per day (mbpd).

Up until last year, OilPrice.com understands from a source who works very closely with Iran’s Petroleum Ministry, an informal agreement had been in place between the five littoral Caspian states of Russia, Iran, Kazakhstan, Turkmenistan, and Azerbaijan. This involved oil output targets for each country being set three months in advance, with all revenues - usually at least 95 per cent in U.S. dollars and Euros, but with some local currencies in the mix - paid into a central Caspian oil account. This was then split in equal proportions of 20 per cent between the five littoral states Related: How Tech Is Making Oil Work Safer

In this context, Sardar-e-Jangal was originally discovered in 2002 at a time when Iran’s total share of the Caspian gas take was assumed to be around 11 Tcf at best. The then-new gas field found at 700 metres depth off the shore of the northern province of Gilan in the Caspian was thought to contain total proven gas reserves of around 50 Tcf, around 10 times more gas than the Shah-Deniz field of Azerbaijan with which Iran has been locked in dispute for years.

In 2012, though, a routine exploration of the Sardar-e Jangal site led to the additional discovery of an oil layer slightly deeper – at 728 metres – that is now estimated to hold two billion barrels of quality crude, of which at least 500 million barrels is thought to be recoverable. Following the 2015 nuclear deal, Iran had hoped to license Caspian exploration blocks under its Iran Petroleum Contract (IPC) framework and pursue development of the Sardar-e Jangal field.

To this effect, according to the Iran source, Iran had already engaged high-powered lawyers in New York to challenge the 20 per cent share distribution agreement as it related to this field. According to Iran, the Sardar-e-Jangal field is located in Iran’s share so Azerbaijan had no claim at all on oil and gas coming from it. However, based on some previously reached agreements between Russia and Kazakhstan on dividing the basin by a line equidistant from the five coastlines, Azerbaijan claims that Sardar-e-Jangal is a shared field.

“Iran argued that the geology favours Azerbaijan having easier access to greater reserves,” the Iran source told OilPrice.com. “So, Iran was proposing that for two neighbouring states there should be a compensatory adjustment clause so that the one that has easier access to greater reserves should receive a maximum reduction of 2.5 per cent of the total value [which would have meant 17.5 per cent for Azerbaijan] whilst the neighbour received an extra 2.5 per cent [therefore, 22.5 per cent] for Iran,” he said.

“Azerbaijan’s view that the 20 per cent status quo should prevail was backed by its ally the U.S.,” he added. “Russia didn’t want to change it at that point either because it could lose its 20 per cent share and this, crucially, provided a large proportion of the only hard currency it is generating, given just the Crimea-related sanctions, even before the new U.S. sanctions were factored in,” he underlined. Related: How Accurate Were This Year's Oil Price Predictions?

Then came one of the greatest swindles in the entire history of the global oil industry (together with the exploitation of Middle Eastern oil by the ‘Seven Sisters’) - as analysed in depth in my new book on the oil markets – in the shape of the non-public part of the ‘Convention on the Legal Status of the Caspian Sea’ agreement signed in August 2018.

On the face of it, the agreement was a case study in dull, procedural legalese. It stated that the public agreement only stipulates that relations between the littoral states will be based on the ‘principles of national sovereignty, territorial integrity, and equality among members, and the non-use of threat of force’. Publically, it refrained from specifically going to details about share allocations in the resource, and although it referred to the Caspian as legally a ‘sea’, it also referred to it having provisions that give it ‘a special legal status’.

The actual agreement, though, saw Iran sold out on a massive scale by Russia. It is essential to understand that the original agreement regarding the Caspian Sea was made only between Iran and the then-U.S.S.R. and was a straight 50/50 split. Firstly, according to the very first agreement on the Caspian Sea resources made between Iran and the U.S.S.R. in 1921, this covered ‘fishing rights’ because that was the only resource of note thought to be in the Caspian at that point. In 1924, though, this 50/50 agreement between Iran and the U.S.S.R. was broadened out to include ‘any and all resources recovered’.

In 1991 when the U.S.S.R. broke up into its constituent states, including Kazakhstan and Turkmenistan, as well as Russia, Iran was perfectly within its legal rights to simply turn around to Russia and say something along the lines of: ‘As it is your country that has split up, each of the new countries can just take a share of your 50 per cent and we will keep our 50 per cent unchanged’. However, according to the Iran source, Tehran decided to “be generous for the sake of ongoing friendship with Russia, and do the 20 per cent-for-all split, which immediately meant 30 per cent less for Iran.”

Expecting any reciprocation of this goodwill to Russia, though, was a rookie mistake. Far from being grateful Russia saw this compassion as weakness and in the secret part of the ‘Convention on the Legal Status of the Caspian Sea’ screwed Iran into the ground. All disputes over the Caspian resources hinged on pinning down the exact legal definition of the Caspian as being either a ‘sea’ or a ‘lake’.

If it was designated a sea then coastal countries would apply the ‘United Nations Convention on the Law of the Sea’ (1982), in which event each littoral state would receive a territorial sea up to 12 nautical miles, an exclusive economic zone up to nautical 200 miles, and a continental shelf. In practice, this would mean that countries such as Turkmenistan and Azerbaijan would have exclusive access to offshore assets that Iran would not be able to access.

If it was designated a lake – and this was the informal designation before the most recent agreement – then the countries could use the international law concerning border lakes to set boundaries, by which each country effectively possesses 20 per cent of the sea floor and surface of the Caspian. 

In a brilliant move, Russia opened up the channel from the Volga River into the Caspian to prevent the levels dropping, meaning that the Caspian no longer conformed to the legal definition of a lake (which is that it is a localised water deposit standing independent of any river that serves to feed it), which meant that it was now a sea. With that done, Russia then additionally played upon Iran’s fear of bankruptcy in the fact of the U.S. withdrawal from the ‘Joint Comprehensive Plan of Action’ only a few months before, and new sanctions, to push it into agreeing a severe reduction in its share of Caspian revenues.

As it now stands, Russia’s major ally Kazakhstan has a 28.9 per cent share, its wished-for ally, Azerbaijan has a 21 per cent stake, Russia itself has 21 per cent and Iran just 11.875 per cent, with Turkmenistan (seen as largely irrelevant to Russia, holding the remainder). This switch from 50 per cent to just over 11 per cent means that Iran will lose at least US$3.2 trillion in revenues from the disputed and lost value of energy products going forward, according to the Iran source.

Given that Russia’s share from the Caspian whole is greater, and that its influence over the other Caspian littoral states is even more evident to each of them than before, it is all in favour of Iran fully developing the Sardar-e-Jangal field. According to a comment last week from Ahmad Shirzadi, exploration director at the Khazar Exploration and Production Company, his company is set to move ahead on the development of Sardar-e-Jangal and on exploration operations in the prioritised structures in the middle section of the Caspian Sea.

By Simon Watkins for Oilprice.com

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