ECONOMIC IMPLICATIONS OF SOVIET-IRANIAN AGREEMENTS INVOLVING OIL

Created: 6/1/1967

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DIRECTORATE OF INTELLIGENCE

Memorandum

Economic Implications

of Soviet-Iranian Agreements Involving Oil and Gas

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CENTRAL INTELLIGENCE AGENCY Directorate of7

INTELLIGENCE MEMORANDUM

Economic Implication* of Soviet-Iranian Agreements Involving Oil and Ga*

Summary

The USSR and Iran have entered into cooperation agreements that will have beneficial economic results for both parlies. Under terms of an agreement ofhe USSRredit9 million to be used for the construction in Iranteel milleavy machinery plant,as pipeline. In7 tha USSRredit0 million to be used for tbe purchase by Iran of military goods. Both of these credits, with interest, are to be repaid by exporting natural gas to the USSRyear period ending

When the principal provisions of these agreements are fulfilled, Iran willmproved substantially its industrialepaid all of its debt to the USSR andredit of more0 million on its

NOTE; This memorandum was produced solely by CIA. It was prepared by the Office of Research and Reports. The estimates aad conclusions represent the best judgment of the Directorate of Intelligence.

account with theeveloped an export market for ite natural gas,cquired an integrated gas transmission system to serve both that export market and domestic gas consumers. The gas to be exported to the USSR willotal value of aboutillion, snd is now being produced in association with crude oil and burned as waste (flared) in volumes adequate to meet the scheduled export demand. Iran must borrow0 million0 million in foreign exchange from Western sources to complete the Soviet projects. Repayment of these loans will be made from Iran's anticipated earnings of more thanillion per year from oil exports by thes.

The Soviet credits will not require the USSR to use its hard currency reserves, and the goods and services to be provided to Iran are well within Soviet capabilities. The USSR willmall captive market in Iran for Soviet goods and services, although0 million favorable balance Iran will acquire through the aale of gas will representmall part of Iran's total imports and will not significantly change its We stern orientation.

Gas production in the USSR,illion cubic meters per years adequate for its overall current needs, but there are potential local markets for Iranian gas. The demand for gas in the Transcaucasus contiguous to Iran is increasing in the face of dwindling local supplies. Theillion cubic meters of gas imported annually from Iran would supplement local supplies, and any excess, presumably small, could be moved north in the direction of Stavropol in the North Caucasus, where gas production already has reached its peak. The import of Iranian gas into the Transcaucasus ia analogous to the import of Canadian gas into the US Pacific Northwest, attractive and convenient. It is unlikely that the planned import of Iranian gas would give the USSR any important additional capability to export Soviet gas or oil.

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The existing agreements almost certainly will not give cither party economic leverageis the other, and mightorce for stability in the area. Iran, the USSR, and the Iranian Oil Participants Limited (Consortium) surely recognize the interlocking mutual interests involved in these agreements. Iran knows that under presentthe uninterrupted production of crude oil by the Consortium is necessary for the production and export of gas. The output of crude oil in quantities sufficient to provide the necessary gas is dependent on large sales by the Consortium of oil that neither the USSR nor Iran could sell independently. The USSR and Iran know, also, that implementation of the Soviet projects depends on Iran's ability to service its foreign exchange borrowings in the West by means of hard currency revenues from oil sales.

A communique issued following theigh-level Soviet trade delegation and Iranian officials inescribed as deliberately vague and confusing, discussed possible additions to the original agreement The USSR suggested that the delivery rate for gas now scheduled4 be advanced Iran could do this if it is willing to spend an0 million four years sooner than otherwise would be necessary for expansion of the pipeline. The USSR offered to purchase an additionalillion cubic meters of gas, but the Soviet Union does notlear need for this additional gas, and its delivery wouldecond pipeline, which neither the USSR nor Iran is yet willing to finance and construct. The Soviet delegation also offered to "cooperate" in the search for oil in the "free areas" of Iran, presumably the parcels recently relinquished by the Consortium. Sovietol these areas will depend on whether Iran changes its policy and agrees to pay at least part of thc cost of exploration or on whether the USSR changes its policy and bears all the risk of foreign exploration.

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For years Iranians have been annoyed by Ihe sight of vast quantities of natural gas produced in association with crude oileing burned as waste (flared) in theoperated by the Consortium. The government of Iran, through its National Iranian Oil Companyas pressed the Consortium unsuccessfully toarket for this valuable natural resource. At thc same time, Iran has long dreamed ofomestic iron and steel industry, and firat attempted toteel milleasibility studies by US, German, Swedish, Belgian, and French experts generally concludedill, asby Iran, would be uneconomic. Thus no capital could be obtained for this project.

2. The USSR has now agreed to buy the unused Iranian gas and toteel mill and other projects to Iran in exchange. In the Transcaucasus (the Republics of Axerbaydzhan, Georgia, andn areato Iran, gas supplies produced in association with crude oil (particularly in tho old Baku oilfields) arefor local needs, and supplies are dwindling. Because Iran has available great quantities of gas and the USSR has the capability to provide capital and other goods which coincide with Iran's development needs, the two

parties concluded what appears toutually advantageous economic and technical cooperation agreement on Subsequently, inhey concluded an

additional agreement whereby Iran would purchase military

goods from the USSR.

Soviet-Iranian Agreements Involving Iranian Gas

3. The USSR hasotal7 million in credits to Iranconomic credits7 millionilitary credit0 million. All of the military credit9 million of the economic credits will be repaid in Iranian gas. The latter credit will helpteel mill complex including coal and ore mines and water

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controleavy machinery plant,as pipeline. (The locations of tho proposed capital projects are shown on the accompanying map.) illion of economic credits not scheduled to be repaid in gas are to be used for the Aras River Dam, an electricplant, grain silos, and tractors.

4. Information is not available on the total coat of each of the projects to be financed from9 million credit. illion has been earmarked for engineering services and compressors for the gas Available information indicates that the total cost of constructing the first phase of the pipeline, to provide capacity to move the exports plannedill0 million. The second phase, to provide capacity for the exports plannedill require the expansion of gas gathering facilities and an increase in the number of compressors for thc line at an additional cost0 million.

5. The total cost of the three development projects probably will be on the Order0 million. Deducting the Sovietillion) and local funds to be used, Iran probably will have to obtain0 million0 million in foreign exchange from other sources,Western countries. Credits0 million apparently have been obtained from50nd5 million) banks.

6. Under the terms of the gas supply contract. Iran will export gas through thc proposed pipelinei lyear period beginning0 at an annual rateillion cubic meters, increasing toillion cubic metershe latter rate to bo maintained The price of the gas is seter thousand cubic meters. (An escalator clause in the contractariable portion of the price to the posted price of fuel oil at Abadan, but no significant variation in the price of fuel oil or gas is expected during the period of the contract.) ran

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have repaid the credits withercent per year) and will haveredit on its account with the USSR of more0 million. On an average annual basis, this amounts to lessduring the period of the contract, insignificant in terms of Iran's total foreign trade and revenues from other sources. Iran could easily absorb an equivalent value of goods from the USSR including, but not limited to, maintenance and spare parts for the capital projects to be built to Soviet design.

Iran's Capability to Meet Its Obligation Under thc Agreements

7. Huge quantities of gas are produced inwith the extraction of crude oil in Iran. Less thanercent of the current output of associated gas is used locallyource of energy; the remainder is flared. (Inas was flaredaily rateto an annual rate ofillion cubiche following tabulation presents tentative estimates of Iran's production of oil and gas and Iran's consumption of gas for selected years:

These data indicate that Iran will be able to meet the requirements oi the gas supply contract.

has adequate reserves of non-associatedinsure thc continuous flow of gas through the pipeline

n the event that crude oil production fluctuates or is interrupted to the point that sufficient associated gas is not available, but these reserves are not now being exploited. The Paranan gas deposit in the vicinity of the producing oilfields in the southikely source ofgas (see the map). However, payment for the cost of developing tho Pazanan gasfield would have to be negotiated between the Consortium and Iran.

gas deposits in Iran occurdome"the oil and the surface of the ground. in these domes poses tricky technical problems,might adversely affect the production ofthe reservoirs beneath. However, production ofassociation with crude oil and from Pazanan canwithout these difficulties.

Recent Proposals by the USSR

10. The joint communique* issued on7 following completion of preliminary discussions in Teheran between the high-level Soviet delegation and the Iranians has been described as deliberately vague and confusing. It appears that the Russians made grandiose proposals to the Iranians to expand the existing technical and economic cooperation agreements between the two countries. The communique, while it did not explicitly mention acceptance or rejection of any of thc proposals, did indicate aby Iran to examine the Soviet proposals.

(a) To Speed Up Gas Deliveries

hc USSR suggested that the delivery of gas at tho rate ofillion cubic meters now planned4 be moved up Gas production now forecast for

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Iran would aupport the revised delivery schedule. in order to provide sufficient transmissionthe pipeline to carryillion cubic meters bythanran would have to provideillionour years sooner thanbe necessary. The requisite foreign exchange

probably could be obtained, through borrowing, but there is no evidence that Iran is willing to seek it. There are no short-term advantages to Iran from speeding up gas deliveries. In the long run, under the accelerated schedule of gas deliveries, Iran would accumulateredit balance equivalent to0 million, rather than the more0 million foreseen under the original

(b) To Increase Gas Deliveries

The Soviet delegation proposed that gasbe doubled toillion cubic meters per year at some unspecified period0lthough the gas pipeline as now engineered could be operated in excess of the designed capacity of aboutillion cubic meters, industry experts agree that the movement ofillion cubic meters wouldecond pipeline of essentially the same design and capacity as the first.

The Iranians have indicated that they would not finance the constructionecond pipeline. The USSR has given no indication that it would financeine. The program for pipeline construction within the USSR

(probably cannot proceed without substantial assist-

ance from outside sources, and it is highly improbable that the USSR would, or could, construct the second line in Iran.

of crude oil production suggestgas output will be sufficient to providecubic meters for the USSR sometime

Although the output of gas in Irsn would be ample todomestic demand and to export ZO billion cubic metershe unwillingness of Iran, and the inability of the USSR to construct thc necessary second pipeline in the near future, suggest that this proposal maybe doomed.

(c) To Explore the "Free Areas"

The Soviet delegation offered to "cooperate in activities concerning exploration and exploitation" of oil resources in the "free areas" of Iran. The "free areas" were not identified, but the USSR probably meant the three parcels ofotal of0 square miles in southern Iran recently relinquished to the government of Iran by the Consortium from itsArea" (see the map). The USSR probably intended to include the offshore areaa of Iran in the Caspian Sea, where Soviet technicians, acting as contractors for the NIOC, currently are conducting seismographic tests. It is estimated that such tests may continue untilf exploratory drilling is justified, as seems likely, NIOC must negotiate an agreement for exploration and marketing.

Soviet assistance to other countries in the search for petroleum traditionally involves no risk of Soviet capital. The host country must insure payment ofcosts, whether or not petroleum is found, and the USSR is repaid for its costs of exploration fromcredits or in petroleum. Western oil operators,

on the other hand, accept the financial risks involved in exploration, and the host country has no obligation toreimburse the operator if petroleum is not found.

areas in the south relinquished byare parcels that were the leastthe Agreement Area; otherwise thc Consortiumexploited them or havo relinquished otherUSSR, recognizing this, probably would not beto provide risk capitalenture in thesearc remote from the principal Soviet domesticmarkets.

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The Soviet position with respect to the costs of exploration offshore in the Caspian, and repeated in connection with its offer to explore the "freeollows thc traditional Soviet pattern of requiringeven if oil is not found. Iran, guided by its experience with Western operators, insists that the USSR accept the risks of exploration.

It is unlikely that any Western oil operator would risk capitalearch for oil offshore, or even onshore, in the Caspian area because of the difficulty

of moving oil from that remote area to Western markets. The USSR, however, if convinced on the basis of its reportedly favorable seismographic test results that exploration did notisk, might retreat from its current position and agree to provide risk capital for the venture. The Caspian area is much closer to Soviet than to Western markets.

thc Iranian point of view, there areagainst accepting thc Soviet terms forthe south. Proved oil reserves in Iran areforeseeable needs, and it is questionableshould provide risk capital for explorationare less favorable than elsewhere. if Iran should open the relinquished areas toprobably are Western oil interests not includedConsortium that would be willing to risk capitalto payonus for the opportunity tofor oil.

Advantages lo Itau

of the terms of existingthe USSR and Iran involving oil and gassignificant economic gains will accrue to boththat the net economic advantage probably lies During theears of the gas supply contractUSSR, Iran willeturn ofhe export of gas. It is unlikely that tho Consortium

or Iran could have provided any other market for an equivalent high level of production and the gas would have been flared. In exchange for thisran will have repaid the loans obtained from tbe USSR to finance the steel mill complex, the heavyplant, the military goods, and the gas pipeline, and will have accumulated0 million in credits with the USSR. The completed facilities willtrong base for Iran's industrialization program, particularly in the central provinces; will facilitate exploitation of Iran's natural resourcesoal. Iron ore, lime, hydro-power, and natural gas; and will provide employment for an unspecified, but presumably large, number of persons during the construction period and indefinitely beyond. Moreover, Iran will have diversified its markets forin much the same way that Western oil operators have diversified their sources of supply.

22. Iran will have to obtain0 million0 million to supplement the Soviet credit and local financial resources in order to construct the steel mill complex, the heavy machinery plant, and the gas pipeline. However, if the steel mill complex operates at its designed annual capacity ofons andsteel products to meet all of Iran's needs, as claimed, foreign exchange savings up0 million per year may be effected. In three or four years these savings would equal the foreign exchange borrowings for all of these capital expansion projects. Iran's foreign exchange borrowings to support the existing agreements appear to be insignificant, also, in terms of itsated earnings from oil exports. ran will earn the equivalent of0 million0 million from oil sales; by thes, earnings probably will exceedillion per year.

23. Iran's exports of oil might be competing in world markets against oil or gas released for export from the USSR by Soviet access to gas from Iran. In the unlikely event that Soviet gas or oil equal to the Soviet imports of

billion cubic meters oi Iranian gas should find its way into Western European markets, the maximum amount of

that might be displaced (based on energy content of

oil and gas) would be the equivalent ofarrels per day (bpd). estern Europe's demand for oil imports will be aboutillion bpd, and the additional Soviet gas or oil would represent lessercent of Western Europe's total oil import demand. Should the gas deliveries to the USSR beillion cubic meters perhe share would still be insignificant in terms of Western Europe's import demand. To the extent that any oil would be displaced in Western Europe, all oil suppliers, not only Iran, would presumably be affected.

agreements may form the basis forperiod of amicable relations between Iran and The USSR, Iran, and the Consortiumone another's importance. Iran's credit inmarkets is dependent on its continued exportthrough the marketing apparatus of the membersConsortium. The USSR knows that theof the capital projects to which itarty

is dependent on Iran's ability to obtain supplementary foreign exchange. Both the USSR and Iran know,that the successful fulfillment of the gas supply contract under present circumstances depends on the uninterrupted production ofa precondition of gas production. For these reasons the Iranian-Sovietcould represent security for the Consortium.

Economic Advantages to thc USSR

economic advantages to the USSR ofagreement appear not to be as great asto Iran. It is not possible to assess theof Soviet political motivation, but theof Soviet activities of thie type indicates thatrarely, if ever, negotiated solely for political There ie clear evidence that the USSR doeshard-headed economic considerations in its foreign

trade activities. For example, during recentinvolving the possible sale of Soviet gas to Italy, the USSR departed from an earlier offer to accept Italian goods in exchange for gas and indicated thatf the payment for the gas must be made in hard

The credits extended to Iran by the USSR will not require the use of any Soviet hard currency reserves, and the technical services and equipment to be provided to Iran are well within Soviet capabilities. The industrial projects now planned for Iran willarket for future Soviet exports of maintenance and replacement parts. Moreover, Iran willaptive market for Soviet exports to the extent of the credits that Iran accumulatesesult of the gas sales.

The USSRegitimate but not essential need for Iranian gas. Production of gas in the USSRillion cubic metersnd the planned imports ofillion cubic meters will representmall part of the total gas supply of the Soviet Union. However, growing demands and dwindling local supplies of gas in the Transcaucasus make the imports from Iran attractive and convenient for that area* in much the same way that Canadian gas imported into the United States is attractive to the Pacific Northwest. Supplemental supplies ofould otherwise be moved south from Stavropol where local production probably also will decline in thefuture. Imported Iranian gas in excess of local

, .demand could enter the Soviet gas net at Stavropol and be used elsewhere in the USSR, thus providing greaterto the Soviet distribution system.

* Gas transmission facilities in the Transcaucasus and north to Stavropol now are inadequate to handleillion cubic meters per year, but probably will be expanded as necessary.

is not known why the USSR would needillion cubic meters of gas from Iran. Unless

the demand for gas increases inordinately in the next few years, the USSR probably does notomestic need for theillion cubic meters it has offered to accept. However, having access to that gas. the USSR might be able to export additional gas to Eastern Europe and to initiate gas deliveries to Western Europe. Whether or not Iranian gas is available, the USSR will have the capability of supplying those two marketsultibillion dollar gas supply system with an ultimate annual capacityillion cubic meters is now under construction. The system is designed primarily to distribute gas from Western Siberia to domestic gas consumers in tho European USSR but has sufficient additional capacity to serve export needs.

29. The Soviet offer to explore and exploit oil resources in the "free areas'* of Iran may have been motivatedesire to have access to foreign crude oil, which if consumed in the USSR would free Soviet oil for export to Eastern Europe and to Free World markets. The USSR now provides about three-quarters of the total oil supplies of the Eastern European Communist countries. Expansion of the capacity of the Friendship Pipeline from thc USSR to Eastern Europe and the supply of capital goods by Poland and Czechoslovakia for use in support of the Soviet oil industry indicate that the USSR will continue to supply oil to the Communist countries of Eastern Europe. There is evidence, however, that these countries plan to supplement their supplies of petroleum with imports from Free World sources. Some of this supplementalcould be supplied by Iran.

30. Iran has an option to take part of its royaltyfrom the Consortium in crude oil in accordance with the following schedule:

bpd (saxlmuir.)

bpd

bpd

pd

pd

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stipulated that sales of this oil would be made only to Bulgaria, Czechoslovakia. Hungary, Poland, and Rumania. (Iran indicated subsequently that it wanted to add East Germany to the agreed Ust of export markets.) Oil that the USSR could acquire from Iran might indirectly compete with oil that Iran could itself market in Eastern Europe.

31. The growth of Soviet oil exports to Free World countries has leveled off in recent yearsariety of reasons including competition and reluctance of many Western consumers to buy Soviet oil. uch exports representedercent of the total demand of Free World countries other than the United States and corresponded to about IS percent of gross crude oil production in the USSR. To maintain its share of that markethe USSR would have to export the equivalent of aboutercent of its anticipated crude oil production. The USSR probably could import and

use moderate quantities of Iranian oil to maintain tho Soviet position in Western markets and could do so

without displacing Iranian oil from its established

markets.

32. The USSR may find it advantageous to explore for oil in Iran. Costs of oil production in the USSR have increased In recent years as exploitation of less favorable deposits has become necessary. Access to oil from new producing areas in Iran would give the USSR greater bargaining flexibility in world markets. This would be especially true if the oil could be obtained at low cost and without risk of Soviet capital.

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