ECONOMIC IMPLICATIONS OF SOVIET-IRANIAN AGREEMENTS INVOLVING OIL AND GAS (RR IM

Created: 6/1/1967

OCR scan of the original document, errors are possible

Intelligence Memorandum

Economic Implications

of Soviet-Iranian Agreements Involving Oil and Gas

CO"'* NO.

RR?

CENTRAL INTELLIGENCE AGENCY Directorate of7

INTELLIGENCE MEMORANDUM

Economic Implications of Soviet-Iranian Agreements Involving Oil and Gas

Summary

The USSR and Iran have entered into cooperation agreements that will have beneficial economic results for both parties. Under terms of an agreement ofhe USSRredit9 million to be used for the construction in Iranteel milleavy machinery plant,as pipeline. In7 the USSRredit0 million to be used for the 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 ihe principal provisions of these agreements are fulfilled. Iran will have (II improvedts industrialepaid all of its debt to the USSR andredit of more0 million on Its

This memorandum was produced solely by CIA ll was prepared by the Office of Research and Reports. The estimates and conclusionsnt bi?si judgment of thc Directorateintelligence.

account with theeveloped an export market for its 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, and 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 sale of gas will representmall part of Iran's total importi and will not significantly change its Western 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 is analogous to the import of Canadian gas into the US Pacific Northwest, attractive and convenient. It is unlikel that the planned import of Iranian gas would give the USSR any important addir:onal capability io exports or oil.

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

A communiquefollowing thcigh-level Soviet trade delegation and Iranian officials in. described 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 (or expansion of the pipeline. The USSR offered to purchase an additionalillion cubic meters of gas, but the Soviet Union docs notlear neen Cor thisfas. and its delivery wouldc-cond pip-lint, which naithur the USSR nor Iran is yet willing lo finance and construct. The Soviet delegation also offered t" "cooperate" in ihe search for oil in the "free of Irani presumably the parcel* recently relinquishedthe Consortium. Soviet'it these areasdepend on whether Iran changes its policy and agrees to pay at least part of the cost ol exploration or on whether Ihe USSR cli.ingos its policy and hears all the risk oi foreign exploration.

I. tor years Iranians have been annoyed by the sight of vast quantities of natural gasroduced 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 the same time. Iran has long dreamed ofomestic iron and steel industry, and first 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.

USSR has now agreed to buy thegas and toteel mill and otherIran in exchange. Inanscaucattue (theArcrbaydzhan. Georgia, andn areato Iran, gas supplies produced in associationoil (particularly in the old Baku oilfields) arefor local needs, and supplies areIran has available groat quantities of gas andhas the capability to provide capital and othercoincide with Iran's development needs, theconcluded wfeat appears toutuallyand technicalation agreement on 16 Subsequently. inhey concludedwdortbv [ran woulde USSR.

c!ving lumin Ga>

USSR hafotal7 milliontoiis ofillion andcredit o'0 Alle military

illion oi th*rdit* wili b* repaid in Iranian>. T<rwiil helpteel mill complex including vol *nd or* mine* and wi;or

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

4. Information is not available on thc total cost of each of tho 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 thc exports plannedill require the expansion of gas gathering facilities and an increase in the number of compressors for the line at an additional cost0 million.

5- The totol 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, prob* ably Western countries. Credits0 million apparently have been obtained frcm50nd5 million) banks.

6. Under the tr.rms of th* gis supplyI*.rough the proposcii pipol.no over aperiod beginning0 a>nnual rate of 6meter? O billion cubic metersthe Utter ratebe maintained of the ga| is sethousand cubicescalator in the contractariablethe price tord priceat Abadan. but

no significantn the pile* ri fuel oil or gat ia expected during ihe period of 'he contract, ran

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will 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 the 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 of 18 billion cubiche following tabulation presents tentative estimates of Iran's production of oil and gas and Iran's consumption of gas for selected years:

arrels

Ci,z'>

Gas (Billion Cubic Meters cer Year)

of Gas a/ (Billion

Cubic Meters per Year)

A

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-<

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c

the prspsMd Shapoure Allied Chemical Caapany sulfur/fertilizer plant.

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

Iran has adequate reserves of non-associated gas to insure the continuous flow of gas through the pipeline in the event that crude oil production fluctuates or is interrupted to thc point that sufficient associated gas is not available, but these reserves are not now being exploited. The Pazanan gas deposit in the vicinity of the producing oilfields in the southikely source ofgas (see the map). However, payment for the cost of developing the Pazanan gasficld would have to be negotiated between the Consortium and Iran.

Some gas deposits in Iran occurdome"the oil and Ihe surface of the ground. Exploiting gas in these domes poses tricky technical problems, and exploitation might adversely affect the production of oil from the reservoirs beneath. However, production of gas in association with crude oil and from Pazanan can be accomplished without these difficulties.

Recent Proposals by the USSR

joint communique issued onprilcompletion of preliminary discussions inthe high-level Soviet delegation and the Iranians

has been described as deliberately vague and confusing. It appears that thc Russians made grandiose proposals to the Iranians to expand the existing technical andooperation agreements between the two countries. Thc communique, while it did not explicitly mention acceptance or rejection of any ol the proposals, did indicate aby lian to examine the Soviet proposals.

fa) To Speed Up Gas Deliveries

L'SSR suggested that Che delivery of gattatc ofillion cubic meterslanned formoved up Gas production now forecast lor

Iran would support the revised delivery schedule. in order to provide sufficient transmission capacity tor the pipeline lo carryillion cubic meters0 rather thanran would have to provideillionour years sooner than would otherwise be 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 ol the designed capacity of aboutillion cubic meters, industry experts agree that thc movement ofillion cubic meters wouldecond pipeline of essentially the same design and capacity as the first.

Thc 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 itself probably cannot proceed without subMUnlidlfrom outside sources, and it is highly improbable that the USSR would, or could, construct the second line

" -j, i.

of crude oil production suggest that 'j..asocia;ed gas outputufficient to provideillion Cubits for the USSR sometiire

Although thc output ofran would be ample todomestic demand and to exportillion cubic metershc unwillingness of Iran, and thc inability of the USSR to construct the necessary second pipeline in the near future, suggest that this proposal may doomed.

{c> To Explore the "Free Areas"

1 5. 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 thc USSR probably meant the three parcels of landotal of0 square milesn southern Iran recently relinquished to the government of Iran by the Consortium from itsArea" (sec the map). The USSR probably intended to include the offshore areas 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

assi stance to other countries in thepetroleum traditionally involves no risk of The host country must insure payment ofcosts, whether Or not petroleum is found, andis repaid for its costs of exploration fromcredits or in petroleum. Western oil operators.

on thc other hand, accept the financial risks involved in exploration, and the host countrv* has no obligation to reimburse the operator if petroleum is not found.

areas in thc south relinquished byare parcels that were the leastThe Agreement Area; otherwise the Consortiumexploited them or have relinquished other land.

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ing to provide risk capitalenture in these areas, which are remote from the principal Soviet domestic and export markets.

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 the 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.

From the Iranian point of view, there areagainst accepting the Soviet terms for exploration in the south. Proved oil reserves in Iran are adequate for foreseeable needs, and it is questionable whether Iran should provide risk capital for exploration where prospects are less favorable than elsewhere. if Iran should Open the relinquished areas to bids, there probably are Western oil interests not included in the Consortium that would be willing to risk capital and, possibly, lo payonus for the opportunity tofor oil.

Economic Advantages lo Iran

21. Examinatione tfirms of existing agreements betweenSR and Iran involving Oil and gas suggests that significant economic gams will accrue to both parties, and that Ihe nei ecusnmic advantage probably lies with Iran. During theear* ofupply contract with the USSR, Iran willeturn of almostillion On the export of gas. It is unlikely that the Consortium

or Iran could have provided any other market (or an equivalent high level of production and the gas would have been flared. In exchange for thisran will have repaid tho loans obtained from the USSR to finance the steel mill complex, the heavy machinery ^lant, 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.

ay b<ll of these c

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 millionffected. In three or four yearsqual the foreign exchange borrowings (or apital expansion projects. Iran's foreign exchange borrowings to support the existing agreements appear to he insignificant, .ilao, in terms of itsearnings from oil exports. ran will earn Ihe equivalent o!0 million0 million from oil sales: by the mid-earnings probably will exceedillion per year.

vent that Soviet gas or oil equal to the Soviet imports o

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

billion cubic meters of 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 thc 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 lossercent of Western Europe's total oil import demand. Should the gas deliveries to the USSR beillion cubic meters parhe snare 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 Iron, would presumably be affected.

agreements may form the basis forperiod of amicable relations between Iran and The USSR, Iran, and tho Consortiumone another's importance. Iran's credit inmarkets is dependent on its continued exportthrough the marketing apparatus of thc 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 of oilrecondition of gas production. For these reasons the Iranian-Sovietcould represent security for thc Consortium.

Economic Advantages to the USSR

economic advantages to the USSR ofagreement appear not to be as great asto Iran. It lb not possible to assess theof Soviet political motivation, but theof Soviet activities oi this type indicates thatrarely, if ever, ncgotiattc solely for political There is 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 that part of 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 of gas would 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

^scd elsewhere in the USSR, thus providing greaterto the Soviet distribution system.

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

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

thc demand for gas increases inordinately in thc next few years, the USSR probably does notomestic need for theillion cubic meters it has offered to accept. However, having access to that gas, thc 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 (wo markets. ultibillion 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 thc European USSR but has sufficient additional capacity to serve export needs.

29. The Soviet offer to explore and exploit oil resources in thc "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 Europn 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 the 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 tne USSR will continue to supply oil to the Ccrnmunrst countries of Eastern Europe. There is evidence, howtrvtr, that these countries plan to supplement their supplier ofm with imports from Free World sources. Some ofupplementalcould he supplied by Iran.

30. ?i'-.': in optionart of itshe Consortium inl in accordance with the following schedul-*:

-SKGRET

Iran 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 list of export markets.) Oil that the USSR could acquire from Iran might indirectly compete with oil that Iran could itself market in Eastern Europe.

growth of Soviet oil exports to Freehas leveled off in recent yearsarietyincluding competition and reluctance ofconsumers to buy Soviet oil. representedercent of the totalFree World countries other than the Unitedcorresponded to aboutercent of gross crudein the USSR. To maintain its sharehe USSR would have to exportof aboutercent of its anticipatedproduction. The USSR probably could importmoderate quantities of Iranian oil to maintainposition in Western markets and could dodisplacing Iranian oil from its

ter

USSR may find it advantageous tooil in Iran. Costs of oil production in the USSRin recent years as exploitation of lesshas become necessary. Access to oilproducing areas in Iran would give the USSRflexibility in world markets. This wouldtrue if the Oil could be obtained at lowwithout risk of Soviet capital.

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