Large Backlog Builds as NIOC Experiences Difficulties in Selling Iranian Heavy Crude

28 Million Takes Time

As Global Insight reported yesterday, Iran has been amassing very large crude carrier (VLCC) tanker capacity off its Kharg Island and Soroush oil loading terminals, for the storage of increased amounts of crude (see Iran: 8 May 2008: Iran Reported to Be Holding 28 mil. barrels in Floating Storage, Anticipating Demand Pick-Up). A Reuters report on Tuesday (6 May) assessed much of the stored crude, now climbing to around 28 million barrels, as coming from the Nowruz/Soroush fields in the Gulf, a suspicion corroborating an earlier Bloomberg report from 2 May. While sparse Iranian comments—mainly by the National Iranian Oil Company (NIOC)'s international affairs director, Hojjatollah Ghanimifard—have tried to portray the news as a result of seasonal offtake patterns resulting from refinery turnarounds in Iran's core export markets, the notion that a reported 200,000-b/d export shortfall over roughly the past three weeks and the coming week could lie behind a 28-million-barrel backlog does not add up.

The Nowruz/Soroush fields produce 180,000-200,000 b/d of heavy sour crude, with an API grading of 18.3-21°, although NIOC generally blends the crude with condensates to make it more marketable. Still, the number of refineries geared to handle this crude is low, and sales rely on transactions between a relatively small group of companies. With the vast majority of the 28 million barrels in storage being Iranian heavy and sour crude from the Nowruz/Soroush fields, it would have taken 140-155 days to form a backlog of the current size. This takes us back to very late December or early January, when the main taker of Iran's heavy and sour grades from these two fields, Indian refiner Reliance, announced that it was terminating term supplies of refined products to Iran due to its mainly French banks refusing to issue letters of credit (LCs) for transactions with the Islamic Republic (see Iran: 11 January 2008: Iran Forced to Source Fuel Imports from Spot Market as Indian Refiner Cuts Ties). This move had itself been prompted by the tightening of U.S. financial sanctions against Iran, isolating its financial industry sector.

So from this it would seem that at the same time Reliance also chose to sever its term-contract crude import relationship with Iran, halting dealings with the country and causing the floating storage backlog to start growing, amid hopes that the heavy sour crude market would pick up and a buyer would be found. A similar exercise was held in 2006, when Iran was reported to have stored well over 10 million barrels, at rising cost, in order to wait out a market glut (see Iran: 4 August 2006: Iran Palms Off Nowruz/Soroush Heavy Crude: Shell, India Reported Buyers).

Reliance's Reasons

While international financial sanctions have proven very problematic for Iran when trying to attract investments and move development projects forward, its crude sales and fuel imports have suffered only marginally, due to the market's high liquidity and the several different possible ways of structuring the deals in order to get around the LC issuing problems.

However, it appears that Reliance might have used the LC dilemma as an official reason instead, while quietly eyeing strategies to invest in the U.S. refining market through taking full or partial stakes in domestic U.S. refineries. An attempt to build up assets in the United States would have exposed the company to much tougher legal scrutiny of its dealings with Iran, and the decision to sever dealings with the Islamic Republic could be seen as a proactive policy to counter eventual opposition to Indian investment in the strategic refining business. Added to this, U.S. supermajor Chevron—which like other U.S. IOCs is careful not to deal with Iran—holds a 5% stake in Reliance as well as the option to raise its stake in Reliance's refining arm further.

Expensive Storage

Iran's continued inability to shift such a large—and growing—amount of sour and heavy crude might seem ironic given the tight market and spiralling crude prices, but shows the different situations reigning in the diverse segments of the world crude markets. As gasoline (petrol) and diesel demand is spiralling, seasonal demand for heating oil and fuel oil has been weak for some months. This means that the sour heavy crudes—which have lesser yields of high and middle distillates when refined than other lighter crude grades—have suffered a demand glut. Falling import levels from China's vast network of old micro-refineries, due to them being squeezed out of the market by the current low refining margins, have further exacerbated the problems for Iran, taking away potential buyers of Nowruz/Soroush production from the market.

The heavy oil discount on the global markets has already been growing, with the spread to WTI and Brent prices reaching very high levels. The discount for Iranian heavy crude relative to lighter Omani and Dubai oil was reported by Bloomberg at the beginning of the month to be US$3.25/b, compared with US$1.49/b in December. With news spreading about Iran's booming backlog of this particular crude, the discount it will ultimately have to offer buyers is set to grow unless it manages to outwait the glut.

Costs for the floating storage arrangements are, however, believed to be considerable. Although the National Iranian Tanker Company (NITC) is believed to be using nine of its own VLCC tankers in the operation, and chartering only four or five on the market, tying up a larger number of its own carriers will have forced the company to charter tankers on the open market for the portion of its normal exports that would otherwise use national tankers. Bloomberg reports that tanker charter rates for the region have more than tripled since 8 April on London's Baltic Exchange, with the benchmark tanker rental rate for voyages from the Middle East to Asia reaching US$148,000/day on 2 May, compared to US$44,300/day on 8 April. The number of double-hulled VLCCs available for rent within 30 days was also reported to have dropped from 56 to 28 over the past month.

In 2006, NIOC reported that the storage operation had cost the company US$243 million over eight months—a figure that, at today's rates, should easily have been surpassed by now (see Iran: 8 August 2006: Iran Breathes Sigh of Relief as Nowruz/Soroush Backlog Cleared).

The Jamnagar Chimera?

Many market actors and commentators have set their sights on the opening of India's new 580,000-b/d Jamnagar refinery in December 2008 (though it is now said to be coming onstream ahead of schedule, perhaps as early as July) as a possible solution for Iran's marketing problems. However, the refinery is owned by Reliance and Chevron has an option to take a large stake in the project, throwing Iranian term supplies to the new plant into question, in Global Insight's view. Compounding these doubts, the refinery's coking units are not expected onstream at the same time as the rest of the facility, delaying possible Nowruz/Soroush sales to Jamnagar till early 2009 at best.

Outlook and Implications

While Iran's sour and heavy crude will get sold at some point, it increasingly seems to be a question of how large a discount NIOC will be willing to give to shift it, as demand for it will continue to be low for some time yet, it appears. Although some sales might head towards the East Mediterranean following refinery turnarounds in that area, the sheer amount of heavy and sour crude on Iran's hands suggests that marketing might become increasingly difficult and a halt of production at the fields will have to be considered.

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