What next after Iran’s nuclear deal?

The date of 14 July 2015 marked a pivotal moment in the relations between Iran and the international community. After countless failed attempts to broker a deal regarding the Iranian nuclear programme, the five permanent members of the United Nations Security Council (China, France, Russia, the United Kingdom and the United States) as well as Germany, the European Union and Iran, managed to broker the much anticipated Joint Comprehensive Plan of Action, or JCPOA.

A few moments after reaching the deal, the EU High Representative, Federica Mogherini, and Iranian Foreign Minister, Mohammad Javad Zariff, announced it was “the result of a collective effort” and was a “historic day also because we are creating the conditions for building trust and opening a new chapter in our relationship”. Given the thorny path of the previous talks, such statements inevitably raise two basic questions. Why has the agreement come about only now, and can the parties create enough momentum to cooperate on other future issues, ones that go beyond the Iranian nuclear programme?

Despite the fact that the core US and EU sanctions blocking Iranian imports still remain intact, the utility of a negotiated solution became already clear since the interim agreement was announced in early April 2015. On one side, Iran has already benefited from an estimated $7 billion in sanctions relief. On the other, its foreign trading partners are also anticipating high returns from a post-sanctions environment. For instance, Germany (which in 2012 exported to Iran nearly $3.86 billion in goods and services) is likely to reach over $11 billion in exports per year, if and when sanctions are lifted.

To understand the opportunities available in the near and distant future for further cooperation, as a result of the negotiation process, requires an investigation of the economic sources of national pain and potential gain which led the parties to ultimately strike an accord. The expected benefits from further cooperation are one side of the coin of the calculated decision that led the parties to negotiate a mutually acceptable agreement. The other side of that coin mirrors an environment of growing pain and unease with the present situation from which the parties try to uncouple themselves.

One such specific factor was Russia’s monopolistic position of gas supplier across the EU, and the EU’s desire to detach itself from such entrapment. This sentiment has only intensified since the rapid deterioration of Euro-Russian relations in the aftermath of Moscow’s decision to annex Crimea, parallel destabilization of the situation in Ukraine, and the subsequent imposition of restrictive EU measures against the Russian Federation. A closer look at Germany, the oft-cited economic locomotive of the European Union and role model for long-term sustainable growth, which was also a member of the E3/EU+3 negotiation team, may provide important clues as to how the pain experienced by the EU at the time the agreement was reached has been considerably worse than commonly understood.

Germany’s natural gas lifeline

For the time being, Russia maintains a strong grip on Germany’s gas balance, providing up to 40% of natural gas supplies. Berlin’s decision to end all domestic nuclear energy production following the environmental backlash of the 2011 Fukushima incident, will most likely induce Germany to meet even more of its energy demand with natural gas from Russia as opposed to polluting coal from other Eastern European countries. If Russia hypothetically chose to impose a complete gas embargo, Germany would only have a nine-month grace period before fully depleting its domestic gas reserves.

Germany has been on the edge of a major gas-supply shortage several times over the past couple of years. Historically, extreme cold periods, supply interruptions, inaccurate gas-storage forecasts and regional bottlenecks in the transport system have often occurred simultaneously. For instance, in January 2009 the escalating Russian-Ukrainian gas dispute, which disrupted steady import flows, coincided with an extreme cold spell in Western Europe. The limited range of Germany’s physical gas-storage facilities, which are largely based in northern Germany, left the rest of the country under-supplied and vulnerable to external shocks.

To make matters worse for Germany, the market value of storage capacities has decreased by more than 80% over the past decade and is facing a similarly poor outlook over the next five years. With a continued pressure to reduce gas-storage fees, many operators have started decommissioning their assets. Germany is on its way to jumping out of the frying pan into the fire, leaving physical gas-storage providers with zero commercial incentive to provide the nation with a secure gas supply. Without action on the part of the German government to forward the diversification of gas supplies, for Europe’s anchor of economic stability the next gas crisis will not be as easily avoided.

Is Iran the way out?

Iran’s untapped energy reserves represent some of the most attractive opportunities, both for leaders in Tehran and European businesses. With gross natural gas production of almost 8.2 trillion cubic feet per year, Iran is the world’s third-largest producer after Russia and the US. Despite its vast resources, Iran only accounted for 1% of global gas trade in 2012.

Iran seems to hold the key to easing Germany’s (and the EU’s more broadly) gas supply and storage dilemma, potentially encouraging cooperation between two sides over the long term. In fact, soon after the JCPOA was signed, Vice President of the European Commission, Maroš Šefcovič, stated: “The return of such a big player to the global energy market will clearly have implications on the global oil and gas market. It fits very well with the diversification strategy of the European Union and the energy union.”

The prospect of distributing Iranian gas to the EU has the potential to foster cooperation between the two sides over the long term. This strong incentive was missing from the previous bargaining process. In fact, in the previous rounds of negotiations, prior to the fall of 2014, the E3/EU+3 devoted too much attention to the punitive aspect of sanctions as a response to Iranian non-cooperation. By September 2014, the EC had started increasing the urgency of importing Iranian oil. Also, with oil prices currently falling below the benchmark price required for the Iranian government to balance its federal budget, a window of opportunity had opened for the two counterparts, Iran and the EU, to find a way out of their impasse, particularly as US sanctions depressed the Iranian economy to a 6% GDP deficit in 2013 and fully restricted the sale of petroleum products.

Iranian decision-makers can offer two options in terms of gas supply routes to the European market as part of building momentum toward future cooperation. The first is to route gas through pipelines on its territory, an option that is cheaper but involves a greater commitment over the lifetime of the project and potentially more players (transit countries). The second is to transport liquified natural gas (LNG), which is more costly but gives the exporter more flexibility and involves less obtrusive production.

The LNG option offers Iran and its European counterparts more flexibility in the early stages of testing their relationship. An initial agreement could propose small gas volumes of 5 million tons per year, which could be incrementally increased to 1 Bcf/day (or billion cubic feet per day) over a 10-year testing period.

From a cost perspective, both gas transportation options to European markets would be well below current Russian gas sales prices to both European and former Soviet countries. Development costs of Iranian LNG – which include the cost of production, liquefaction, shipping and re-gasification (ranging from $2.60 to 5.00 per million cubic feet) – would be very comparable to the cost of shipping Iranian gas via the Persian Pipeline to Europe (2.12-5.00 $/MMCF). Compared to the 2012 EU sales prices of Gazprom, Russia’s largest gas exporter (10.78-13.59 $/MMCF), the Iranian option (either LNG or pipe) would leave considerable room for Europe to negotiate improved prices with Iran.

Just the beginning

In the case of the JCPOA agreement with Iran, there appears to be a great deal of room for future cooperation between Europe and Iran that transcends the narrow scope of the explicitly agreed terms. For the EU, future cooperation rests on the expectation that a steady supply of comparatively attractively priced Iranian gas may allow it to diversify its gas imports. That would also have potentially significant geopolitical ramifications. The option of exporting its surplus gas supplies would facilitate quicker economic development in Iran, after suffering under the existing sanctions regime.

The fact that the existing pipelines cannot meet Europe’s growing demand for gas may be a blessing in disguise. The gradual and coordinated dismantling of sanctions called for by German Chancellor Angela Merkel could represent an opportunity to test the willingness of both sides to cooperate. If it proves its utility, this could further expand to include arrangements for building pipelines and a more robust distribution of gas to Europe. The JCPOA could open the door to a more mutually beneficial rapport between Iran and the West. With the opportunity present, the challenge remains to make use of it.

Have you read?
Why Europe backs the US on Iran
Why was the Iran deal not struck a decade ago?
What we can learn from the Iran negotiations

Authors: Dr. Tara Shirvani (@Tara_Shi) currently works for the Energy and Transport Unit of the World Bank Group. In 2012 she was nominated as a World Economic Forum Global Shaper in the field of energy policy and sustainability.

Dr. Siniša Vukovic is Assistant Professor at Johns Hopkins University’s School of Advanced International Studies (SAIS).

The views expressed in this article are solely those of the authors and do not express the views of the World Bank, its board of executive directors, or the governments they represent.

Image: A general view shows a unit of South Pars Gas field in Asalouyeh Seaport, north of Persian Gulf, Iran November 19, 2015. REUTERS/Raheb Homavandi