IHS Global Insight Perspective
The agreements have been driven by Pakistan's growing domestic supply shortages of gas, which are having increasingly serious repercussions on power plants, some of which are reverting to burning expensive fuel oil.
Pakistan estimates that gas from Iran could support supplies for 5,000MW of generation capacity. However, the slow pace of development of Iran's South Pars field, coupled with funding and technology shortages in the country's energy sector and its growing domestic demand for gas, could impede the project schedule.
Pakistan plans to launch a feasibility study on its pipeline section with a view to completing construction by 2014, although a reliance on uncertain internal financing sources and a volatile security situation in Baluchistan are formidable hurdles to the project schedule.
Some 12 months after deciding to proceed with a gas pipeline project without India, Iran and Pakistan yesterday signed the last of five contracts on the project. The agreement ended the paperwork on the pipeline and followed the signing of a pipeline accord in March 2010—dealing with operational transit issues—and a gas sales and purchase agreement (GSPA) initially signed in June 2009. The current agreement signed by the National Iranian Gas Export Company (NIGEC) and Pakistan's Inter State Gas Systems (Private) Limited (ISGS) was to exchange the sovereign guarantee agreement on the pipeline and formally record the effectiveness of the Iran and Pakistan GSPA. Following the signing, Iran's deputy oil minister Javad Owji stated that the Iranian portion of the pipeline will have an initial capacity of 110 mmcm/d, of which almost 50–60 mmcm/d will be used by Iranian industries alongside the pipeline route to the Pakistani border. The additional gas volumes of between 60 mmcm/d 70 mmcm/d would then be exported to Pakistan.
Around 907 km of the pipeline on the Iranian side has already been constructed, and a feasibility study on the second 300-km section on the Iranian side of the border is now under way with a tender planned over the coming months. Construction of the 750-km section on the Pakistani side of the border, however, has not yet commenced, although a feasibility study is due to launch this year.
An Unattractive Iranian Proposal
Iran has been pursuing the strategic "peace pipeline" project since the early 1990s, with the aim of building a long-term energy supplier relationship with its two large eastern neighbours. Like the rest of the Islamic Republic's gas export ventures, however, the project has become entangled in lengthy delays, with Iran's increasing international isolation being only one of the problems. Indeed, extending the pipeline to India has been seen as of core interest from Iran's side, as such a long-term supplier relationship holds the promise of high-level Indian support for Iran. Nonetheless, this strategic goal was not strong enough to cause Iran to give way on its notoriously price-hawkish energy policies, which embroiled Iran and India in a long-running and ultimately—it seems—fatal dispute over the gas prices demanded by the Islamic Republic. India's reluctance naturally had a lot to do with the still quite adversarial relationship with Pakistan, and its distrust of Pakistan's ability to secure the pipeline from military threats in its Baluchistan province. In the end though, it was Iran's unwillingness to offer prices that India thought reflected the risks involved, or to accept long-term market fluctuations, that caused the deal to lose its lustre.
The politicised energy environment in Iran means that the Islamic Republic has largely destroyed what reputation it might once have had as a stable long-term energy provider. While often mentioning its track record as a stable crude provider to the global markets, selling oil under term or spot contracts to a wide variety of clients is one thing, while entering long-term gas contract negotiations—reaching deals on the sale of a less spot-traded commodity—is an entirely different proposition that the country's highly resource-nationalist parliament has proved unwilling to countenance. With parliament having the power to review individual large-scale contracts, its threat of retroactive renegotiations has also soured the deal and delayed progress.
The largest reason for the slow progress of the pipeline, however, is the continued doubts about Iran's ability to export the gas in question. Iran sits on the world's second largest gas reserves, but some of the world's highest and most wasteful gas consumption patterns (fuelled by subsidies), as well as increasing inertia in the oil and gas industry—as international isolation has caused rising technology and finance shortages, as well as worsening brain-drain—has actually led the country to suffer seasonal gas shortages over the last several years. Its funding problems and its difficulty in sourcing production technology, as well as materials, mean that not only have its upstream projects often faced years of delay, but they also been developed to production capacity levels below similar projects previously developed by international companies. Meanwhile domestic demand has continued to spiral, with consumption growth rates over the past decade being firmly in the 7–11% span every year. This has still not been reined in, and the government's plans to cut gas and electricity subsidies are still uncertain to be followed through, rendering Iran's actual capacity to deliver stable quantities very uncertain.
Iran has already constructed the main trunkline taking gas from its prolific offshore South Pars gas field to the south-eastern Iranshahr hub, in order to provide its petrochemical industries—and power consumers—with feedstock. Hence, on its side, only a further 300-kilometre link to the Pakistani border remains to be constructed.
Pakistan—in Need of Gas
Pakistan's increasingly severe gas supply shortage, resulting in massive problems for the domestic generation sector, has been a major factor pushing forward agreements on the pipeline project over the last year. Pakistan is now exploring multiple options to boost supplies, including: pushing forward plans for development of LNG receiving capacity; looking at rental power plants that can run on fuel oil to substitute dwindling gas production; and importing piped gas from Iran. The entire volume of gas imported from Iran will be given to Pakistan's power sector and is expected to support approximately 5,000MW of generation capacity, which is likely to reduce generation costs in comparison to expensive imported fuel oil. Unlike on the Iranian side, however, construction of the 750-km Pakistani section has not yet commenced. A year is needed to carry out the feasibility study, and around three years estimated for construction. Both sides are targeting pipeline connection and gas transmission from 2014, under a 25-year agreement.
Outlook and Implications
While Pakistan is keen to move forward with the pipeline, it faces a number of potential hurdles. Foremost among them is how to finance its section of the pipeline. Previously Pakistan had been investigating the option of extending the pipeline to China, perhaps in return for getting Chinese financial backing for the project, although China National Petroleum Corp. (CNPC) recently appeared to turn away from the project to concentrate instead on building a gas pipeline from the western coast of Myanmar to south-west China. Neither is the United States supportive of the pipeline project given that it undermines the sanctions regime against Iran, and it is thus unlikely to provide financial assistance. Instead the United States is reportedly supportive of Pakistan's efforts to develop LNG receiving capacity.
Pakistan previously stated that the capital cost of its pipeline section could be around US$1.65 billion, and the government was previously looking at establishing a public private partnership to fund the project. This would have a debt equity ratio of 70:30 under which the Pakistan government will provide 51% equity. Reports suggest this equity financing would be provided upfront through selected public sector entities such as OGDCL, Pakistan Petroleum Ltd, Government Holding Private Ltd, and State Life Insurance Corp. Upstream energy companies in Pakistan already encounter difficulties in meeting their current investment commitments, with risks compounded by having to take on acreage in more volatile and less explored areas of the country, from which foreign companies generally shy away. Although they are in far better shape than their downstream equivalents there are uncertainties in relying on these companies for financing. Reports suggest that debt will be sourced from the market, backed by government guarantees, for the transportation tariff.
Further issues relate to the security situation in Baluchistan, through which the pipeline will pass. There have been numerous attacks on gas pipeline infrastructure on the Pakistani side of the border and while these are generally not too serious, only knocking out supplies for hours or a day at a time, they could increase operational costs for a government already short of money, while raising the need for 24-hour patrols on some sections of the pipeline.If all those hurdles can be scaled, the doubts about Iran's capacity to deliver will still have to be dispelled, given that right now they rest on Iran being able to rein in domestic demand growth by sufficient cuts in its gas subsidy regime—a highly controversial political reform in the country. Over the last few years Iran has become a net gas importer, and signs throughout its oil and gas sector imply that it will struggle to raise the speed of its upstream development. This fact is not officially acknowledged, but has nevertheless forced Iran to take steps over the past year to radically expand its gas import capacity from Turkmenistan in preparation for the late-year winter demand hike. Hence, the strategic will to build a Pakistani—and if possible Indian—gas export link might not be possible to match with the necessary real upstream developments given the Iranian domestic political cost.