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Pipeline economics

March 22, 2013

A GOOD deal of excellent comment has appeared recently on the geopolitics of the Iran-Pakistan (IP) natural gas pipeline. But what about the economics of it?

Contrary to most expectations, and after a delay of years, Pakistan and Iran have finally made significant headway in the Iran-Pakistan (IP) gas pipeline project. Despite strong and consistent opposition from the US, Pakistan has cited the so-called peace pipeline as vital to its energy security and needs, and is committed to seeing gas flow from Iran by December 2014.

The IP pipeline is slated to deliver 750 million cubic feet of gas per day (mmcfd) from the Iranian South Pars gas fields, to the Sui Southern Gas Company’s transmission and distribution network. Currently, Pakistan is facing a natural gas shortfall of nearly 1.5 billion cubic feet per day (bcfpd), which is expected to rise — without countervailing measures — to around 6-8bcfd by 2020.

Pakistan is actively seeking a multitude of diverse sources to meet its rapidly growing energy requirements, including import of liquefied natural gas and liquid petroleum gas, the Tapi project, import of electricity from Central Asia and, possibly, India, and greater exploitation of indigenous hydel, natural gas and coal resources.

The IP gas pipeline is thus one, albeit important, component of Pakistan’s overall energy requirement mix. Pakistan has earmarked the potential gas supply from the IP pipeline exclusively for generation of approximately 4,000 megawatts (MW) of electricity. Currently, the country is facing a power shortfall of approximately 4,000-5,000 MW, which peaked last year at around 7,000 MW.

Thus, the gas from Iran via the IP pipeline can not only wipe clear the power shortfall, but it can do so at a significantly reduced generation cost from the current fuel mix which is skewed towards furnace oil and diesel.

The direct economic cost to Pakistan emanating from the energy crisis amounts annually to around three to four per cent of GDP. The direct cost is mainly in the form of lost output/GDP. However, the broader macroeconomic collateral costs are substantial too, and include a decline in employment levels, lower incomes, lower government revenue, a decline in export orders, drastically lower fixed investment levels, and greater fragility of the banking system.

In addition, the persistent energy shortfall has burdened public finances through the provision of heavy subsidies via the budget, amounting cumulatively in the past five years to approximately Rs1.5 trillion, leading to a diversion of budgetary resources from development projects, and to a rapid build-up of public debt.

The build-up and persistence of the inter-enterprise circular debt in the energy sector has sapped the financial strength of energy companies, severely curtailed their operations and profitability, and drastically reduced new investment in upstream exploration and production activities, and in downstream projects such as installation of new generation capacity. Another important motivation for Pakistan to actively pursue the IP gas pipeline could include a strategic diversification of its energy sources.

Iran is currently under three layers of international sanctions targeting its alleged pursuit of “non-peaceful” nuclear activities — a unilateral sanctions regime imposed by the US in conjunction with the European Union, and a multilateral regime under the framework of the United Nations.

Broadly, US sanctions prohibit US nationals and entities from business and arms dealing with Iran, while also targeting Iran’s financial dealings with the rest of the world. Its ambit extends to non-US persons, however, in the case of re-export of sensitive US-origin goods, technology or services to Iran or the government of Iran.

The UN sanctions regime embargoes all dealings with Iran and designated Iranian entities that relate to “proliferation-sensitive nuclear and ballistic missiles programmes”. UN sanctions on Iran have been imposed via four binding Security Council resolutions, namely: 1737 (2006), 1747 (2007), 1803 (2008) and 1929 (2010).

Prima facie, transactions with the Iranian oil and gas industry that do not constitute investment in Iran’s energy infrastructure appear to be excluded from the ambit of the sanctions’ regimes of the US, EU and the UN. In addition, the US has provided a waiver to nine countries from its sanctions rules on import of, and processing payments for, Iranian oil.

For this reason, South Korea, Japan, South Africa, China and India continue to purchase crude oil from Iran — though at lower levels than previously — while Turkey continues to be supplied Iranian gas via pipeline. In fact, Iran’s crude oil exports rose 13 per cent in February from January to 1.28 million barrels per day (mbpd) — but down from an average of 1.5mbpd in 2012 and 2.5mbpd in 2011, according to the International Energy Agency.

However, under new US rules that took effect from February this year, the importers of Iranian crude are required to pay in local currencies kept in escrow accounts — or risk being debarred from the US financial system.

The purchase of Iranian natural gas does not appear to be “sanctionable” activity under current rules. However, even if it were met by the US “dialling up the pain” for Pakistan, economically or via other means, cold economic logic dictates that Pakistan should follow through on the pipeline. This is so since the annual cost of the foregone natural gas is around two to three per cent of GDP, at least, while the likely cost of US economic sanctions would be far below this level.

(As a relevant aside, fears of an economic “meltdown” in case of US sanctions are grossly exaggerated — and appear to be designed to foster and perpetuate a degree of dependency. “Noopolitik”?)

Pakistan should pursue deeper economic engagement with Iran as part of an expanded effort for regional economic integration which the US purports to support. Relations with Iran should not be viewed as a “zero-sum” game to any other set of Pakistan’s important bilateral relationships — in line with the US approach to Pakistan and India.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.