Developing the refining sector critical to maintain Iran's remarkable return to oil markets

Eighteen months after the removal of international sanctions against Iran, the country has made a remarkable return to international oil markets. Its crude oil exports are estimated to have grown 77% year-on-year to reach 1.9MMb/d in 2016, with both Europe and Asia featuring prominently in Iran's plans to regain crude market shares. Similarly, Iran has also been successful in re-establishing export markets for its product surpluses. While some countries continued to import small volumes of Iranian oil products, the government-controlled National Iranian Oil Refining and Distribution Company (NIORDC) generally had great difficulty in marketing these surpluses under sanctions. In 2015 the country exported 514,600 b/d of products, all of which went to Asia - accounting for 5% of Asia's total oil product imports. By comparison, in 2016, Iran's total product exports, still entirely directed to Asia, reached 889,400 b/d, making Iran the largest exporter to the region among OPEC countries with a 26% market share of total OPEC oil product exports, a level surpassing the estimated 734,000 b/d that Saudi Arabia sent to Asia in 2016.

However, while Iran did succeed in regaining market share, oil product exports in 2016 would have been significantly lower if the country had not accumulated significant quantities of fuel oil in floating storage during the sanction years. With these volumes successfully cleared, product exports should be lower in 2017. Consequently, Iran's future export growth will depend heavily on the country's ability to deliver on its plans to build new refineries and upgrade existing plants.

Plans to modernize Iran's ageing refining sector gaining traction

Iran's refining sector, encompassing nine refineries with a combined distillation capacity of 1.8 MM b/d, is in dire need of investment after years of insufficient maintenance due to restricted access to technology, equipment and funds. Most of the country's refineries are antiquated and of relatively low complexity leading to a national average Nelson Complexity Index of only four. This results in large fuel oil and high-sulfur gasoil production and leaves refining output misaligned with both domestic and external market requirements.NIORDC has sought to initiate numerous refining upgrade projects over the past decade, and since the removal of sanctions, the government has multiplied

calls for foreign investment and reportedly advanced talks with international companies, mostly from Japan, China and South Korea for planned modernization work at five existing refineries.

In early-2016, a significant upgrade project was completed at Iran's largest refinery in Isfahan that included the installation of isomerization and reforming units. The 370,000 b/d refinery is also earmarked for further investment for which a contract was granted to South Korea's Daelim. However, the country is still facing challenges despite the removal of sanctions, primarily related to financing in the low oil price environment, an issue that has stalled enhancement work at three refineries, namely the Tabriz refinery for which Iran was reportedly in talks with Italy's Saipem, the Abadan refinery about which NIORDC has held discussions with unnamed Chinese companies, and the Tehran refinery project that was announced in 2015 for which the prospects for materialization in the medium term is viewed to be low.

With gasoline accounting for just 20% of total refining output, maximizing gasoline yields is at the heart of plans to modernize the county's refineries. Iran has historically been highly dependent on gasoline imports; when the country was unable to procure gasoline from international markets under sanctions, it was forced to command the large-scale production of highly sulfurous gasoline at its petrochemical plants. While gasoline production in petrochemicals facilities is likely to cease due to high costs, environmental concerns, and the maximization of high-value petrochemicals exports, Iran's total gasoline output is expected to increase following the completion of upgrades and the streaming of the first phase of the greenfield Persian Gulf Star refinery by end-2017. Nevertheless, sustained demand growth will leave Iran a net gasoline importer. Iran's deficit is predicted to resume growth in 2018, highlighting the need for further upgrades.

The International Maritime Organization's (IMO)decision to reduce the maximum sulfur content of marine bunker fuel from 3.5% to 0.5% by 2020 will also require additional changes in Iran's refining sector. The regulation will result in an estimated ~500,000 b/d of demand destruction for HFO in 2020. While exhaust gas scrubbers are expected to be the solution of choice over the long term, investments are unlikely to be in place before the 2020 implementation date. In the meantime, refiners will need to make changes in order to meet growing demand for low-sulfur bunker fuels and avoid unwanted residue.

In the case of Iranian refineries, residual fuel oil is estimated to account for about 63% of oil product export capacity in 2017, much of it high in sulfur. Investments in conversion capacity to transform high-sulfur fuel oil into lighter streams, which can be more easily desulfurized,are therefore all the more critical for Iran's oil product export capacity.

Iran's long-term refining expansion strategy still on hold but critical to secure crude outlets

Driven by both a need to ensure adequate supply for growing domestic consumption levels and a grander ambition to become a significant exporter of oil products, Iran is planning to build eight new greenfield crude and condensate refineries that would increase its refining capacity by more than 1.5MMb/d. Despite the country's renewed focus on its downstream sector, a majority of the numerous projects to build greenfield refineries that have been in the cards for some time are still on hold, with no official deal signed. The 360,000 b/d Persian Gulf Star Project, designed to process South Pars Condensate, is the only project that has made some progress, although it remains far from full completion as only the first phase of the project that will add 120,000 b/d of refining capacity is predicted to be streamed by end-2017.

The need to secure a long-term outlet for its crude,against the backdrop of rising global supply and weak demand growth in major export markets, as well as a desire to add value to its crude and to create employment for the local population, will also drive Iran's downstream push. Iran will attempt to replicate the strategy implemented by its regional rival, Saudi Arabia, which has substantially expanded its refining capabilities in recent years, becoming a refiner of significant global importance. Iran has also clearly stated that it wants to attract foreign partners to help develop its projects, as domestic companies lack the expertise and technological capabilities to build sophisticated, complex refineries. A significant expansion of the Iranian refining sector remains a long-term goal for now, as government priorities will be first geared toward developing the country's oil and gas fields and revamping its existing refineries. Nevertheless, this is a goal that Iran is likely to continue to pursue with renewed vigor, as it remains critical for the country to establish a strong global oil product export role and add value to its crude in a more competitive oil market.