AN INDEPENDANT STUDY ON IRAN’S GAS BALANCE OVER THE NEXT 20 YEARS

Principal Author: Hatef Haeri

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Co-Authors: Farhad Hariri1, Khosrow Salour

1, Sahar Mozaffarian

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1. Idam Consulting Group (ICG)

Keywords: 1. Iran; 2. gas; 3. supply; 4. demand; 5. balance 1 Introduction/Background

Until recently, Iran was a country focused on the development of oil fields. However, with regards to the country's high oil dependency (close to 80% of GDP) together with recent skyrocketing crude prices in 2007-2008 and increasing domestic consumption, Iran is pursuing a policy to "free" internal consumption of the hydrocarbon by converting – where feasible – oil consuming industries to natural gas consuming industries. In addition, the government has recognized the economic and political benefits of utilizing natural gas for domestic consumption as well as export purposes – a fact clearly illustrated in the 20-Year Outlook Plan (2005-2025) – and has shifted its focus from oil to gas. However, one important factor must be taken into account. As opposed to plans in regards to the sale of oil, natural gas exports – whether in the form of LNG or via pipelines – require long-term planning as well as solid assurances from all involved parties.

The abovementioned issues have lead to an increased demand for this natural resource – the current production of which is limited (approximately 500 mmcm/d in 2008) as the majority of proven gas fields remain untapped. As a result, the country requires long-term strategic planning for its natural gas reserves and future production, the first step of which entails the evaluation of current natural gas demand on a sector by sector basis followed by future predictions in line with the aims of the Five-Year Development plans together with the 20-Year Economic Outlook Plan. The long-term strategic planning mechanism will also require a shift in policy for meeting with domestic natural gas demand – which until now has been to increase production parallel to hiking demand – and calculate natural gas demand as a portion of supply.

To date, many organizations have undertaken gas supply/demand studies. However, ICG has conducted its own independent study with the main aim to implement a dynamic study in which government policies are considered in both long-term and short-term forecasts in conjunction with a unique characteristic – recent government policies for combating high natural gas consumption via price shocks etc. and increasing efficiency has been taken into account. Based on over 15 years of experience in Iran's energy sector, ICG teamed up with 25 of the country's top economists and experts in various disciplines and conducted a study with the objective of assessing Iran's gas balance until 2025 and determining domestic gas requirements for various sectors of the economy and the extent of the country's potential to export gas. ICG's Gas Supply/Demand Study (GSDS) has taken over two years to complete and has resulted in a product we believe can be utilized as a strategic tool by Iranian authorities as well as foreign companies looking to invest in the country's economy – especially the natural gas sector.

2 Objectives of the paper The study to establish Iran’s gas balance over the next 20 years has been divided into two main sections, each of which has been further broken into sub-sections:

a) Supply Comprises associated, non-associated, gas produced from NGL plants and imported gas. The methodology utilized for assessing this section was bottom-up which involved reviewing of existing and future planned natural gas fields.

b) Demand This section has been assessed on a sector by sector basis and comprises residential & commercial, industry, power, petrochemical, transportation, gas export and gas injection for IOR and EOR purposes. ICG's team of experts determined the mentioned sector's behavioral study, determined by past data, and forecast results were assessed using two methodologies: Time series and panel data models together with bottom-up methodology.

For this purpose, ICG gathered historical data on 100 variables, from a vast array of official government sources, which include the Central Bank of Iran, the Ministry of Petroleum, the Ministry of Power, the Ministry of Industries and Mines and the Ministry of Economic Affairs and Finance. Our group of experts then identified the variables which had most impact on natural gas consumption and determined that the price of energy plays a major role resulting in ICG's reflection of government announced price shocks in the models.

The outcome of the model is a user-friendly computer interface, which enables users to easily change variables, modify and alter the completion date of projects and define numerous scenarios to forecast Iran's gas balance.

The study, which will be presented to you in this session, has been created using the GSDS model. We have concluded on a range of results, High, Medium, and Low, based on government policies of the 4

th and 5

th Five-Year Development plans, and the 20-Year Outlook Plan. The medium case

represents ICG’s most likely view of Iran’s future gas balance.

Pic1: ICG’s Methodology for the study

3 Development/Methods

a. Gas Supply

Iran's history of utilizing natural gas dates back to 1873 where it was used for fueling street lamps. However, the country has come a long way; the fossil fuel currently constitutes over 60% of the Iranian primary energy basket which the government plans to increase by 2025. With Iran having the world's second largest proven natural gas reserves – the bulk of which remains untapped – the country has huge potential for becoming a leading global natural gas producer. The government has also recently shifted focus from oil production to the development of gas reserves and increased production since it has recognized the economic and political benefits of utilizing gas for export via pipelines and LNG and has also identified it as a means for enhancing industrial development. With regards to the above mentioned together with the goals of the 20-Year Outlook Plan (2005-2025; a major economic plan clearly outlining the aims of each sector over the mentioned timeframe) which clearly envisages a major boost in natural gas production – the supply of gas has transformed into one of the most important issues concerning the country.

1) ICG’s Gas Supply Model

ICG chose the bottom-up methodology for identifying the amount of future gas supply as it provides the clearest and most accurate prediction for Iran's gas production. Data for the gas supply model has been gathered from numerous sources including: Institute for International Energy Studies (IIES) annual hydrocarbon reports, Iranian Central Oil Fields Company (ICOFC) reports and publications and the local media. The breakdown of ICG's Gas Supply Model is as follows:

i. Gas imports: Pre-determined gas import contracts Iran signed with Turkmenistan & Azerbaijan – a short-term swap contract. Gas imports from Turkmenistan started in 1997 at a rate of 0.36 Bcm which has increased by over 20 fold during the past 11 years and hit its peak of 6.31 Bcm in 1385 (March 2006-2007). Imports from Azerbaijan were initiated in 2002 at 0.04 Bcm and have increased by close to six fold during the past six years and stand at 0.23 Bcm/y according to the latest National Iranian Gas Company (NIGC) figures. In general, gas imports accounted for a little over 4.7% of Iran's gas production in 1386 (March 2007-2008).

ii. Non-associated gas fields: This section is divided into three sub-sections: Currently producing fields: Includes the official rich gas production rate of each field (according to the National Iranian Gas Company (NIGC)) as well as the depletion rate for future production of gas fields (ICG's independent view until March 2029) where available. The currently producing fields comprise SP Phases 1-5, Aghar, Dalan, Gavarzin, Gonbadli, Homa, Khouzestan, Mozdouran, Nar&Kangan, Sarajeh, Sarkhoun, Shanol, Shourijeh, Tabnak & Varavi and produced 120 Bcm of gas between them in 1386.

Future projects: This section comprises fields officially announced by the Ministry of Petroleum and its affiliates which are either undergoing development or are planned to in the future. The South Pars (SP) gas field is Iran's most important gas field with reserves amounting to 14.5 Tscm. This field has been divided into 24 phases – 19 of which have not yet started production. The phases which have been awarded and are undergoing development are SP Phases 6-10, 12 and 15-18 with a predicted combined gas production of 126 Bcm/y once fully operational. The remaining phases are either undergoing negotiations (Phases 11, 13&14 with a combined production capacity of 51.71 Bcm/y) or are on tender (Phases 19-24 with a production capacity of 43.83 Bcm/y once operational). In fact, the share of South Pars gas production compared to total gas production is expected to increase from 3% in 2005 to 48% in 2010 (according to ICG's medium case gas supply scenario). The government has also focused on the development of fields other than South Pars. In fact, the Minister of Petroleum, Nozari, mentioned 34 fields which have been prioritized for development during his inauguration speech which are predicted to produce some 157 Bcm/y of gas once fully developed. Of these 34 prioritized fields only five with a total production capacity of close to 60 Bcm/y have been awarded. ICG's data gathering also resulted in 17 non-prioritized fields – mostly in the jurisdiction of the Iranian Central Oil Fields Company (ICOFC) – with a combined predicted gas production capacity of 14.56 Bcm/y. Another subdivision included in our predictions is non-associated gas production from associated fields which comprises 14 fields with an estimated 63.18 Bcm/y production capacity.

Yet to Find: Since exploration operations in the country have been limited, ICG believes that

there is future potential for discovering further gas reserves. This category covers the latter and incorporates the amount of production from such reserves on an annual basis.

iii. Associated gas production: ICG has incorporated associated gas in the following three categories: gathered via gas gathering (flare reduction) projects, refined by NGL plants or flared. At present there are three operational gas gathering (flare reduction) projects with a combined gas gathering capacity of 2.1 Bcm/y – some 1.7% of Iran's total gas production in 2006. The Ministry of Petroleum announced plans for the construction of seven additional gas gathering (flare reduction) plants with a combined gas gathering capacity of 20.71 Bcm/y the majority of which are under construction. The amount of associated gas refined by NGL plants amounted to 25.4 Bcm and flared gas was reported at 11.4 Bcm in 2006 –

ranking the world's third largest following Russia and Nigeria. In general, associated gas production accounted for over 32% of total natural gas production in 2006.

2) Gas Supply Assumptions

Low Scenario: This scenario is based on the assumption that both foreign and domestic investment in the oil and gas sector remains low due to the continuation of economic sanctions against Iran. ICG has predicted that negotiations and awarding of contracts in the petroleum sector will continue at a slow pace, resulting in delays of awarding and subsequent completion of projects undergoing negotiations. We have also assumed that Iran's domestic oil and gas companies capable of developing gas fields – which are currently overloaded with projects (e.g. SP Phases 15-18) – will not have the extra capacity or resources to take on other fields in the near future. Therefore, large-scale gas projects (such as various South Pars phases) are destined to be implemented by foreign companies which, in this scenario, will invest to a very limited extent. Therefore, projects under negotiation (e.g. SP Phases 11, 13&14, North Pars) will incur lengthy negotiation periods and experience delays of an average four and a half years (compared to official announcements) while the completion of projects currently undergoing development will be delayed by an average of four years. This is due to the aftermath of economic sanctions including difficulties related to money transactions, importations of goods, US pressure on IOCs, etc.

Medium Scenario: This scenario is based on the assumption that foreign and domestic investment will remain low for the next four years but will increase thereafter due to a more favorable economic climate and eased sanctions against the country. ICG has predicted that negotiations and awarding of contracts in the petroleum sector will continue at a respectively faster pace compared to the low scenario, however, delays are inevitable. With regards to the abovementioned, ICG has considered an average delay of three years (compared to official announcements) for projects currently under negotiation and two and a half years for those undergoing development.

High Scenario: This scenario is based on the assumption that foreign and domestic investments will increase rapidly due to a sudden boost in Iran's economic and political climate resulting in a fast pace of awarding projects under negotiations and completion of ongoing ones.

The below graph illustrates the impact of ICG's assumption for the three scenarios. For example, in 2015, gas production in the high scenario is roughly twice that of the low scenario. In fact, predicted gas production figures for 2015 in low, medium and high scenarios are 300 Bcm, 400 Bcm and 560 Bcm while the rate in 2028 has been estimated at 600 Bcm, 670 Bcm and 680 Bcm respectively.

Natural Gas Low & Medium & High Supplies

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Graph1: Gas production low, medium and high scenarios 2000-2028

b. Demand

Many different energy consumption studies have been carried out for Iran, however, seldom focused on natural gas demand. This may be due to a number of reasons including the fact that natural gas consumption does not have a long-term history in Iran, and gas connectivity is not widely spread around the country. The methodology ICG has undertaken is a combination of the government’s policy towards gas distribution and consumers fuel substitution behavior. Their developments in various sectors and provinces have been seen in annual budgets together with the targets of plans which define the macro-economic policies of Iran (the Five-Year Development plans as well as the 20-Year Outlook Plan (2005-2025)). These plans have been incorporated in our models and forecast scenarios. The consumers' behavior has also been analyzed and studied extensively via historical data allowing ICG and our group of experts to predict an accurate estimate of future gas consumption trends. ICG has used a combination of top down methodology (econometrics models) and bottom-up methodologies for defining and cross checking future gas consumption in various sectors. The following graph illustrates total gas demand in the low, medium and high scenarios during the 2000 to 2028 time frame and clearly illustrates Iran's policies for increasing gas consumption in the future- an issue which has been elaborated in the various sections of ICG's Gas Demand Study.

Iran's Low, Medium & High Gas Supply; 2000-2028

Graph2: Iran's gas demand in low, medium and high scenarios from 2000-2008

i. Residential & Commercial Residential and commercial sectors’ natural gas consumption is often estimated together since most often separate data is not available. Consumers demand natural gas mainly for heating and cooking purposes. Demographic factors are important in the assessment of the energy demand of the residential/commercial sector. The below table shows the percentage of hydrocarbon fuel consumption by this sector in Iranian Year 1386 (2007-2008) and the chart depicts natural gas consumption in the residential and commercial sector from the year 1346 (March 1967-1968) to the year 1384 (March 2005-2006).

Hydrocarbon Energy Type Residential Commercial

Kerosene 20% 20%

Diesel 4% 3%

LPG 0 11%

Natural Gas 60% 60%

Fuel oil 16% 6%

Table1: Share of Energy in the Residential/Commercial Sector; Source IIES

ICG used several models to make a correct forecast for this important segment of the study and finally selected a time series model which is sensitive to GDP of the services sector, number of gas connections per annum and prices as the main external variables effecting natural gas demand in this sector. ICG has also cross checked the results with a separate study using the bottom-up methodology in order to verify the results. With regards to government policies for de-subsidizing gas prices for high consumers, ICG has divided residential/ commercial users based on their consumption volume with brackets 8-10 for high gas consumers and brackets 1-7 for low gas consumers.

1) Residential & Commercial Sector Assumptions The variables considered by ICG in the commercial and residential model are: • Service sector GDP • Population of natural gas consumers • Natural gas prices

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• Consumer price index • Gas price index

The three most affective variables have been further discussed here below: a) Service Sector GDP Assumptions

The sector's average growth for the past decade was an average 4.5%. The most significant growth of this sector was seen after the Iran-Iraq War when the country’s infrastructure and industrial base was devastated and the only economic activity left were retail sales and services. ICG has envisaged that the service sector has 20% share of total GDP and that the sector will show moderate growth in coming years. Noteworthy is that ICG has observed GDP in the services sector with respect to the two groups of low and high consumption consumers with the assumption that most new activities will be concentrated in services such as hotel and modern businesses which, ICG believes, is conducted by high income segments of the society, in turn falling under the high consumption category.

b) Number of New Gas Connection Assumptions

The National Iranian Gas Company's (NIGC) plan for gas connections –initiated in 1977 – has been an essential part of supplying energy to the residential/commercial sector and is one of the most important variables of our model. The current network covers 75% of the population with 6.2 million connections in 1386 (March 2007-2008). Connection to rural areas is the latest challenge of NIGC since 40% of the villages have yet to be connected to the natural gas network. NIGC planned 500,000 new gas subscribers per year during the 4

th Five-Year

Development Plan (2005-2010) and the company has matched this aim and even exceeded goals in 1386 by connecting 510,000 new subscribers. ICG's base case scenario predicts that some 300,000 new connections will be offered each year until everyone is connected 25% of which will be allocated to high consumers and 75% to low gas consumers.

c) Natural Gas Price Growth Rate ICG has predicted that Iran will access full membership to the World Trade Organization (WTO) in 2015, which itself requires the implementation of price liberalization policy. In line with government, MoP and NIGC policies, ICG has applied one large price shock for high gas consumers (brackets 8-10) of the residential and commercial sector before the end of the 4

th

Five-Year Development Plan (2005-2010) the base price of which is gas import prices from Turkmenistan (currently at US$75/1000 cubic meter and expected to increase to US$100/1000 cubic meter by 2009 and US$150/1000 cubic meter by 2015). Contradictory to high gas consumers, low consumption natural gas subscribers (brackets 1-7) will not experience large price increases. In fact, real price rates of low consumers in the medium scenario has been increased by 5.5% and if we consider that a portion of high consumers will also receive no subsidy in the future, real prices must be increased by 180% in 2010 as a single shock and 80% in 2015 to achieve a real rate equivalent to Turkmenz.

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Graph3: Natural gas demand in residential & commercial sector low, medium & high scenarios 2000-2028

ii. Power

Looking at historical data, the demand for electricity has grown at a rate of an annual 6.9% during the 1357 (1978- 1979) to 1386 (March 2007-2008) period. The growing industrialization and expansion of urban areas and development of rural areas has increased electricity demand. The current breakdown of power plant electricity generation is illustrated in the below graph:

Graph4: Breakdown of power plant electricity generation in 2007 The increasing demand for electricity consumption has lead to elaborate goals being set in the 4th Five-Year Development Plan (2005-2010). The plan envisages that the Ministry of Energy will increase the growth rate of more efficient gas and combined cycle power plants by 15.5% and old steam generator plants with an efficiency rate of 35% will go through revamping to change their fuel input systems to combined cycle in addition to the conversion of all steam power plants in the country to combined cycled by the end of 2010. In order to achieve this goal, the Ministry of Energy has predicted an US$8 billion needed investment. However, since government funding for the sector has been low – the development budget for the power sector in 1385 and 1386 annual public budgets combined was US$1.4 billion – the ministry had to engage in a plan to attract foreign investment under the Build, Operate and Transfer (BOT) and Built Operate Own (BOO) investment scheme. The ministry is planning to generate 12,000 MW under BOT and 18,000 MW under BOO by 2010 with main emphasis on the expansion of combined cycle, gas, hydraulic and renewable power plants. The main gas and combined cycle plants of the 22 projects have been listed below:

Power Plant

Capacity (MW)

Gas Consumption (cubic meter/h)

Investment (€ mln)

Ardebil CC

630 200,000 138

Ghaen 630 200,000 128

Kazeron 5,319 21,250,000 200

Kerman 12,319 30,000 250

Neka 4,457 10,000 75

Orumieh 630 200,000 139

Pareh Sar

926 200,000 200

Tabriz 1000 207,000 215

Yazd 3,283 11,250 71

Parand 945 300,000 213

Table2- Combined Cycle Power Plants Projects to be Constructed by 2010; Source: Tavanir Project Tracker Besides the abovementioned combined cycle projects, there are a number of gas turbine power plants such as Assaluyeh with 100 MW capacity, Jahrom, with 954 MW, Ferdousi with 795 MW, Chabahar with 477 MW and Roudeshor with 550 MW. The mentioned projects will be the corner stone in the country's future power supply. Together with renewable energy such as the 2000 MW Bushehr Nuclear Power Plant and numerous hydro power generation units, the ministry hopes to

cover rising demand. Until 2010, 60% of the sector's development activities will be related to combined cycle (12000 MW/hr) and hydro (9000 MW/hr) power plants. ICG's chosen methodology for the development of natural gas demand in the power sector model was time series methodology which allows the behavioral study of consumers in past situations based on fluctuations in historical data for different variables. In order to incorporate government policies in regards to de-subsidizing natural gas prices, the model has been revised so that it can simulate price shocks. ICG has predicted that provided a price shock is implemented to the three high consuming brackets (8-10), they will reduce consumption to an extent that the share of electricity expenditure to total expenditure will increase from 3% in March 2003-2004 to 7% in 2007. Efficiencies in the supply as well as demand sections of the industry have also been taken into account.

2) Power Sector Assumptions The variables ICG has taken into account while devising the power sector model are: • Total GDP (total value added) of the country • Non-labor population • Capital in building • Price of electricity deflated by an index for energy prices • Labor force • Efficiencies in both demand and supply sides • Natural gas share in the power sector to generate electricity

The three most affective variables have been further discussed here below: a) Assumption and Forecast for Growth Rate of GDP The GDP of the past 10 years averaged 5.2%, illustrating healthy GDP growth since 2001. Recent years have especially indicated a satisfactory performance due to high oil prices and high income generated from crude oil sales. In ICG's base case scenario, we have assumed that oil prices will remain relatively high in the short and medium run resulting in the stabilization of natural gas consumption to medium levels. The average GDP growth for the medium scenario has been set at 5.95%. b) Assumption and Forecast for Growth Rate of Prices ICG used CBI's energy deflator, for price conversion to real terms. The basket of energy deflator includes electricity and oil products, as well as natural gas. This deflator is part of the larger inflation measure, consumer price index (CPI). Since electricity prices have benefited from higher subsidies than fuel and natural gas, the price growth for electricity is assumed to be higher than other energy conveyers. ICG has envisaged a moderate price increase for low gas consumers (brackets 1-7), however this factor for high gas consumers (brackets 8-10) in ICG's base case scenario has been set two 250% price increases – one in 2009 and the other in 2016. c) Assumption and Forecast for Share of Gas as Fuel for Power Sector When reviewing power plant energy supply, the ratio of natural gas share is the most important primary energy used to generate electricity and has grown from 2% in 1971 to over 70% at present and is planned to increase to 80% within the next two years. However, ICG believes that NIGC will not have the ability to supply the complete amount of natural gas requested by power plants and will supply close to 78% (in the medium scenario). The remaining power generation fuel demand will be supplied from renewable energy (10%) including hydro and nuclear, and about 15% to 20% by oil products.

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Graph5: Natural gas demand in the power sector low, medium and high scenarios 2000-2028

iii. Industries The only sector exceeding economic growth to that of the industries and mines sector is the services sector. Increased oil revenue, liberalization of the trade system, subsidies on raw material and fuel and the availability of bank credits are part of the adopted policies creating growth in the Iranian industrial sector. The increase in foreign investment from 2000 to 2005 also boosted the sector's growth. The industrial sector is also the country's third highest fossil fuel consuming sector and growths have lead to significant energy consumption increases in recent years; in fact, in 1373 (March 1994-1995) the figure stood at 120 million barrels of crude oil equivalent and increased to 168 million barrels of oil equivalent in 1379 (March 2000-2001) and to 226 million barrels of oil equivalent in 1384 (March 2005-2006) for the industrial sector alone. The total production growth rate of industrial products stood at 32.6% in 1382 (March 2003-2004), 16.1% in 1383, 15.1% in 1384 (March 2005-2006) and 16% in 1385 (March 2006-2007). In terms of real value added of industries and mines segment of GDP growth stood at 10.1% in 1382, 11.9% in 1383, 7.2% in 1384 and 9.7% in 1385. Industries and mines contributed 24.7% of real GDP in1385. The breakdown of the energy sources used in the industrial sector is:

Graph6: Breakdown of energy sources in the industrial sector in 2006 Industries with the highest gas consumption are steel (20.4 million tons in 1386), aluminum (204 million tons in 1386) and cement (45 million tons in 1386). Steel, aluminum and cement production is growing at a positive pace since there are a number of projects planned by the Ministry of Industry and Mines which are coming on-stream soon. The cement industry's production has incurred significant growth since 1385, in turn resulting in an increase in natural gas consumption. In order to increase growth in the industrial and mining sector to levels that will boost Iran's economy to first in the region – part of the aims of the 20-Year Outlook Plan (2005-2025) – production from the cement industry is expected to increase to 70 million tons by 2010 following the renovation and construction of eight and nine plants respectively. The steel industry will see a production increase of 45 million tons following the implementation of 11 projects while the aluminium industry is expected to increase production by 819 million tons by 2010 with the inauguration of four new production units. In line with aims to mark Iran as the first in the region, a comprehensive privatization and price liberalization plan has been foreseen. The government plans to sell up to US$110 billion worth of

state assets over the next 10 years in line with the communication of Note "c" of Article 44 of the Constitution. Large industries such as Mobarakeh Steel Mill, SADRA Offshore Industries and Jajarm Aluminum Plant are offering shares at the Tehran Stock Exchange. Although the majority of ownership transfer has been made to state banks, welfare organization and pension funds, the management and financial organization of the newly privatized companies have been more incline to the free market mechanism. In line with ownership transfer, price liberalization is also on the agenda of Iran's economic planners. Price control measures taken by the government seem inadequate and will not keep inflation in check. The incentives that seem to be created for the private sector to expand their participation in the economy seem to cover the social benefits created by a subsidized commodity priced mechanism. In fact, from 1387 (March 2008-2009) all subsidies offered for raw material of industries have been reduced. The industries are permitted to calculate their sales price based on free market tools and drive demands. No government institution is allowed to interfere in the pricing of products. There are also plans to increase efficiency of energy consumption in the industrial and mining sector. The National Iranian Gas Company (NIGC) and the National Iranian Oil Refining and Distribution Company (NIORDC) – the main fuel suppliers of the country – are allowed to fine production units which do not comply with consumption standards by up to 20% in their utility bills. There are also financial incentives for plants which use sustainable energy systems and advanced technologies which take energy conservation in mind for their production lines. For the development of the natural gas demand model in the industrial sector, a time series model emphasizing on value added and prices together with a bottom up study was used.

3) Industrial Sector Assumptions

The variables ICG has taken into account while devising the industrial sector model are: • GDP (Industries Value added) • Natural Gas prices • Consumer price Index • Gas Price Index

The two most affective variables have been further discussed here below: a) Assumption and Forecast for Growth Rate of Industrial Sector GDP The average growth rate of the industrial sector over the past decade stands at 8.4 % and 25% of GDP is related to the industrial sector. For determining the growth rate of industrial sector GDP ICG took a number of factors into account including the fact that the Iranian industry is operating below capacity, there is room for foreign and local investment together with the fact that modern industries, such as nano and aerospace have yet to be broadly introduced in the country. For this reason, average GDP growth in the industrial sector has been set at an average 7.2% during the 2005-2028 timeframe. b) Assumption and Forecast for Growth Rate of Natural Gas Price The price increase in the industrial sector will not be as broad as the price increases envisaged for the residential and commercial together with the power sectors. A level of subsidies and price cuts will be applied to the industrial sector in the following manner:

• Industries with high value added to the economy will have gas price discounts • Real gas price increases will range from 40% to 80% in three price shocks in the medium scenario

over a 12 year timeframe.

Industries (Low & Meduim & High)

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Graph7: Natural gas demand in the industrial sector low, medium and high scenarios 2000-2028

iv. Petrochemicals

The petrochemical industry has proven to be one of the most active in the petroleum industry over past years. Investments exceeding US$15 billion has been made since 1996, the bulk of which (US$12.5 billion) was over the past three years resulting in hiking petrochemical production capacity. According to reports published by NPC, petrochemical production in 1379 (March 2000-2001) reached 11 million tons and increased to 18 million tons and 22 million tons in 1382 (March 2003-2004) and 1383 (March 2004-2005) respectively. In 1386 (March 2007-2008) alone, 12 plants with a combined production capacity of 9 million tons were inaugurated and petrochemical production capacity hit an all time high of 35 million tons. The Ministry of Petroleum (MoP) has set elaborate goals for the future of this sector and the Minister, Nozari, recently announced plans to increase petrochemical production capacity to 47 million tons by March 2009 – resulting in the increase of Iran's petrochemical share in the region from 25% in 1386 to 29% in 1387 (March 2008-2009). The Minister also stated that 24 petrochemical plants costing US$13.3 billion with a total production capacity of 31 million tons are under construction and will be inaugurated by March 2010. Goals of the 20-Year Outlook Plan are also very ambitious – 72 million tons per year production capacity for petrochemical products by March 2025 – over double the current figure. The plan also sees Iran as having a 25% and 6.1% petrochemical output share in the Middle East and world market respectively. In order to achieve this goal, the Ministry of Petroleum has envisaged the investment of US$30 billion which will be met via financial and technical cooperation. The plan also envisages the allocation of 12% of natural gas production and 46% of gas condensate production to the petrochemical industry by 2025. Another important development in Iran's petrochemical sector is privatization. According to former NPC Managing Director, Nejabat, 25 NPC subsidiaries were privatized by May 2008 and an additional 22 companies are set to be privatized. Furthermore, NPC and the National Iranian Gas Company (NIGC) plans both emphasize on the construction of petrochemical plants by the private sector. According to NIGC a mass of 100 mmcm/d of gas as feed and fuel has been envisaged for private sector petrochemical plants alone in 2025 – an increase of over 90 mmcm/d compared to current figures. However, reports suggest that no new private sector projects have been awarded and no authorization has been given to state companies to undertake plants, resulting in the country lagging behind its plans for future petrochemical production. The chosen methodology behind the module for gas demand in the petrochemical sector is bottom-up in which ICG looked closely at gas and ethane feed and fuel together with project startup dates in addition to actual petrochemical production. In addition to plants and project which have been

completed – and currently consume over 10 Bcm/y of natural gas – ICG has incorporated a complete list of ongoing, future and under study projects which have been officially announced by NPC in order to define future gas consumption of petrochemical plants. Following the study on actual production of petrochemical plants in 2006, ICG came to the conclusion that on average, plants produce at a rate of 70% of their production capacity due to a number of reasons including gas deficit during the course of the year, a number of plants are in their first year of commission and produce at 80% of their nominal capacities and a number of plants are faced with processing problems and also incur lengthy repairs. When the country is faced with gas deficits, the Iranian government's first priority for providing gas is to the residential and commercial sector, followed by gas exports, industrial and petrochemical sectors, power plants and gas injections into oil fields. In fact, during winter 2007 when Iran was faced with the coldest weather in decades, gas deficits reached all time high and although gas injections into oil fields were halted, power plants were fed by alternative fuel and gas feed to high consuming industrial plants was stopped, the country continued to experience gas shortages in the residential and commercial sector – Iran's first priority for providing gas. This lead to no alternative for the government but to halt gas feed to industrial and petrochemical plants as well as exports to Turkey. This issue was not taken lightly by petrochemical plant owners as gas interruptions would not allow them to preserve production levels, resulting in not being able to meet with internal and international commitments. However, once plant owners protested to NIOC regarding this issue, the company agreed to guarantee gas feed to petrochemical plants as of 2008. In order to determine the completion date of petrochemical plants in our medium scenario, ICG has predicted that projects with progress of over 70% will be completed with an average 1-year delay, projects in their initial stages of development will be completed with an average two year delay, and projects under study will be completed with an average four year delay. We have also assumed that in this scenario, problems related to procurement of plant feedstock will reduce and actual production will stand at 75% of nominal capacity. This figure for the low and high scenarios stands at 70% and 80% respectively. According to ICG's medium case scenario, natural gas consumption of petrochemical plants will reach over 40 Bcm/y by 2020, indicating an increase of over 400% compared to current figures. This figure for the high and low scenarios is 45 Bcm/y and 38 Bcm/y respectively.

The presentation of method 2.

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Graph8: Natural gas demand in petrochemical sector low, medium and high scenarios 2000-2028

v. Transportation

Iran’s automotive industry is the second largest enterprise after the national oil and gas industries, and has boomed in recent years to become one of the biggest sectors outside oil, accounting for about 4% of GDP. It is estimated that Iran’s automotive sector is the world's 16th largest with a combined output of over 1 million units of passenger cars, pick-ups, vans and trucks per year. There are approximately 16 major automakers in Iran manufacturing light and heavy vehicles mostly operating either independently or under license. The automobile factory’s output constitutes for almost 1.5% of global auto share. Iran Khodro and Saipa have the largest chunk of automotive production share accounting for over 90% of all vehicles produced in Iran.

Given the increasing demand volume, developing and implementing the scrapping programs for out of date vehicles and the introduction and implementation of sales and marketing initiatives such as leasing programs, through data collected by the Peugeot/Citroen group in Iran, it has been forecasted that the total demand volume will reach 1.5 million units in 2008.

An issue that greatly affects gas consumption in the transportation sector is the fuel rationing program – which started in spring 2007 – together with the government decision to cut down on the production of gasoline run units and increase production of dual-fuel cars on CNG with the aim of eventually cutting the annual US$10 billion gasoline subsidies. In 1385 (March 2006-2007) 110,242 dual-fuel vehicles existed which increased to 261,299 in 1386 (March 2007-2008).

For the initial development of the module, the total number of vehicles in different categories (i.e. vans and vehicles, taxi, trucks, intercity, urban buses and minibuses) was calculated with information being extracted from the Ministry of Industries and Mines, the Ministry of the Interior, the Ministry of Roads and Transportation, the Iranian Fuel Conservation Organization (IFCO), the State Taxi Fleet and United Bus Company.

For vans and vehicles, trucks and intercity buses and minibuses – based on historical data on production and import up to 2005, growth in the recent years and future plans announced by IFCO and other relevant organizations – ICG concluded an average rate for production and imports for every five years starting from 2006 based on the country's production capacity.

For taxis (excluding Paykans), the same method was used. However, in this case for the production rate, we used IFCO’s plans which stated taxis production in 2006 at 28295 and van taxis at 3900. We subtracted the total amount of taxis (including taxi-services, official taxis and non-official taxis) from the total amount of vans and vehicles. Since the fuel consumption of Paykan taxis is much more than other models, the consumption of was calculated separately taking the phased-out rate of these cars into account. The phase-out plan is not only for Paykan taxis. Based on IFCO statistics, 300,000 cars, 12,000 trucks, urban and intercity buses and minibuses should be phased out each year. However, the number of cars phased out last year was only 100000.

Growth rate for urban buses and minibuses has been estimated at 4%. This is to address government plans to develop the public transportation sector (taking into consideration the new policy for fuel rationing). The proportion of the number of CNG fueled buses to the number of CNG fueled minibuses in the urban part was estimated at a third based on IFCO’s data.

After the total number of vehicles in each category was calculated the next step is to calculate the number of dual-fuel cars in each section. For vans and vehicles and taxis, IFCO announced that they plan to convert 45% of cars to dual-fueled in 20 years, so we adjusted the convert rate per year in a way that resulted in 45% of the total cars converted to dual-fuel after 20 years.

For intercity bus, minibus and trucks, IFCO has announced their plan to convert 5% to dual-fueled per year so we applied this factor to the total number of trucks and intercity bus and minibus each year and sum it up with the number of – dual fuels last year. The number of dual-fuel intercity bus and minibus and trucks in 2006 were extracted from IFCO.

The number of urban CNG fueled bus and minibus in 2007 and 2008 were extracted from the United Bus Company and the growth rate of urban bus and minibus is 25% in 2008. This rate is going to increase to 50% by 2016, after which the rate will stay constant until 2024. Based on these assumptions we calculated the average conversion rates in each year up to 2016 by dividing the difference of the current rate and the target rate by the years which these changes will occur. By imposing these rates to the total number of urban bus and minibus in each year the total number of dual-fuel urban bus and minibus in the same year was achieved.

In the third stage, fuel consumption of vehicles in each type was calculated based on distance traveled per year by each car and the amount of its gasoline consumption per 100 km. For each type of cars and taxis, we obtained the traveling distance per year and the amount of its gasoline consumption per 100 Km from IFCO.

As per the below graph, natural gas demand in the transportation sector's medium case scenario will increase from 3 Bcm in 2007 to 7 Bcm in 2015 and 19.5 Bcm in 2028.

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Graph9: Natural gas demand in transportation sector low, medium and high scenarios 2000-2028

vi. Gas Exports

To date, Iran has two in-place gas export contracts – Turkey which aims at the export of 3 Bcm/y of gas which is set to increase to a plateau of 10 Bcm/y in the near future (the contract envisaged this plateau as of March 2007) and Armenia – started in 2007 at a rate of 3 Mcm/d and set to increase to a plateau of close to 6.5 Mcm/d.

However, as recently experienced over the past few years, Iran's domestic winter gas demand has been so high that although power plants shift to alternative fuels and gas supply to a number of high gas consuming industrial complexes are halted for short intervals, Iran still experienced gas cuts in the residential and commercial sectors, leaving the country no choice but to periodically halt gas exports. However, with regards to the development of a number of gas fields set to be completed by March 2009 (SP Phases 6-10), the government is optimistic that the country will not be faced with an internal deficit this year and that gas exports can continue as usual this winter.

The National Iranian Gas Export Company (NIGEC), a subsidiary of National Iranian Oil Company, has defined numerous gas export projects via LNG and pipelines and has also predicted huge amounts of gas exports in the coming years.

A total of six LNG projects with a combined gas consumption capacity of 67.85 Bcm/y have been identified together with 10 gas export via pipeline projects with a total 94.74 Bcm/y gas export capacity.

Of these pipeline projects, seven are related to neighboring countries – comprising Turkey, Armenia, Nakheijavan, Oman, Bahrain, UAE and Kuwait with an overall capacity of over 25% of total predicted gas exports while the remaining three comprise the Iran-Pakistan-India Pipeline Project (IPI Pipeline), gas exports to Europe (Nabucco Pipeline) and gas exports to Switzerland. The three mentioned projects have a combined gas export capacity of 57 Bcm/y – over 35% of NIGEC's

projected gas export capacity – and are regarded as the most prominent natural gas export via pipeline projects to date.

In the case of the IPI Pipeline, although negotiations have been ongoing for over a decade, a number of issues continue to stall the process which include Iran's proposed gas export price, US pressure on both Pakistan and India to abandon the project as well as India and Pakistan's long term conflicts regarding the Kashmir region. Regarding the Nabucco Pipeline and gas exports to Switzerland, negotiations have only recently started, however, as the pipeline is set to run through a number of countries negotiations are expected to be very lengthy. In addition to US pressure against the pipeline, Russia is not in favor of the gas export pipeline as it threatens to reduce its prominence in the region as Europe's sole natural gas provider. Also, as per the IPI Pipeline project, negotiations regarding the pricing strategy are also predicted to be lengthy.

The six defined LNG project comprise:

LNG Project Gas Feed From Production Capacity

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Golshan & Ferdowsi Golshan & Ferdowsi fields 20 Awarded to SKS

Iran SP Phase 12 10.5 Awarded to Petropars

North Pars North Pars field 20 Negotiations ongoing

Pars SP Phase 11 10 Negotiations ongoing

Persian SP Phases 13 & 14 16.2 Negotiations ongoing

Qeshm Kish field 2 Negotiations ongoing

Table3: List of planned LNG projects

As is illustrated in the above table, only two of the LNG projects have been awarded to date, indicating the fact that although Iran will not be a major LNG producer in the short run– there is huge potential for the country transforming to a major LNG player in the future.

For the construction of the gas and LNG export module, ICG used the bottom up methodology in which we took the planned gas export projects into account with the main variable being the startup date of the gas export contracts.

Since the majority of gas export projects have a specific designated field, ICG has delayed the project by the same extent that the field has been delayed. Information was gathered from the National Iranian Gas Exports Company's (NIGEC) reports and publications. The following graph illustrates NIGEC's plans for LNG and natural gas exports compared to ICG's medium case scenario for gas exports – which basically illustrates that Iran will have the potential to fulfill all planned gas export projects as of 2021.

Graph10: Natural gas & LNG exports NIGEC vs ICG's medium scenario 2001-2027

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vii. Gas Exports

The majority of Iran's producing oil fields are currently in the second half of their life span with an annual depletion rate of between 9% and 11% - resulting in an increasing need for EOR and IOR. This issue was repeatedly brought up by outspoken former Head of the Majlis Energy Commission, Kamal Daneshyar, one of the main oppositions to gas exports due to his belief that Iran should extract as much oil from fields as possible. In addition, various bodies within the Ministry of the Petroleum (MoP) and Majlis have suggested different figures in regards to the amount of required gas injections, the highest of which was made by the Majlis Research Center proposing close to 490 mmcm/d by 2025 – double that suggested by NIOC's corporate planning department (220 mmcm/d). During the 1996 to 2007 time frame, actual figures were roughly half that of plans – an issue that has been reflected in our scenarios. Additionally, if the ministry is to implement plans for a hike in gas injections, development of infrastructure and transportation of gas to the required oil field deems necessary. In other words, current infrastructure cannot support the injection of 200 mmcm/d of gas.

For the construction of a gas injection model, ICG gathered available data from NIOC and its subsidiaries in regards to the amount and start date of gas injection projects together with announced plans of the Ministry of Petroleum. The data ICG was able to accumulate has been illustrated in the below graph:

Graph11: Various official announcements regarding gas injection into oil fields

Once all the available data was gathered, the average plans of NIOC for gas injections was calculated and this information was put forward to a selected group of international oil companies who also provided us with key information. Following the above-mentioned, a model based on the injection for increasing recoverable reserves by between by 14 billion barrels and 16 billion barrels over a 20-year timeframe – equal to an annual recovery increase of 0.3% to 0.44% was constructed.

With regards to the available data, ICG calculated average gas injections over a five year period aimed at increasing recoverable reserves by roughly 3 billion barrels at 198 mmcm/d. There are two fundamental variables ICG has taken into account for devising the gas injection module; amount of gas injection and start date of gas injections. For the medium scenario, an average gas injection of 198 mmcm/d has been taken into account over the next 20 years.

Graph12: Gas injection into oil fields low ,medium and high scenarios 2007-2027

4 Results

With regards to all the above mentioned and with regards to the various models, assumptions and scenarios, the following charts are the extracted results of the model. Please be advised that ICG's consulting opinion is the medium case scenario in both supply and demand. Low Demand vs Supply

Graph18: Low natural gas demand vs Supply in three scenarios As can be seen in graph 18, if Iran's gas demand were to maintain low levels and prevention measures for curbing excessive consumption were to be implemented to the extreme, the country will experience surplus gas production as of 2013 (ICG's medium case supply scenario). The amount of excess gas in the low, medium and high supply scenarios will reach 45 Bcm, 155 Bcm and 300 Bcm in 2015 and 260 Bcm, 320 Bcm and 330 Bcm in 2025 respectively.

Medium Demand vs Supply

Graph19: Medium natural gas demand vs Supply in three scenarios The medium demand scenario is ICG's base case. Graph 19 clearly illustrates that if Iran's gas demand were to increase at a moderate pace, and prevention measures will be implemented in line with meeting the goals of the 4

th Five-Year Development Plan (2005-2010) and the 20-Year Outlook Plan (2005-2025) the country

will experience surplus gas production as of 2014 (ICG's medium case supply scenario). The amount of excess gas in the low, medium and high supply scenarios will reach 0 Bcm, 155 Bcm and 270 Bcm in 2015 and 115 Bcm, 210 Bcm and 230 Bcm in 2025 respectively.

High Demand vs Supply

Graph20: High natural gas demand vs Supply in three scenarios The high demand scenario is based on the assumption that the government does not implement any serious prevention measures and gas consumption will increase at a fast pace over the next 20 years. Graph 20 clearly illustrates that if Iran's gas demand were to increase at a high pace, the country will experience surplus gas production as of 2014 (ICG's medium case supply scenario). The amount of excess gas in the low, medium and high supply scenarios will reach 0 Bcm, 50 Bcm and 205 Bcm in 2015 and 65 Bcm, 120 Bcm and 140 Bcm in 2025 respectively. References [1] Iran Energy Balance published by Ministry of Energy 2006 [2] Iran Hydrocarbon Balance published by IIES 2006 [3] Petroleum and Development no 3,4,5 published by NIOC [4] NIOC and NIGC website [5] NIGC Monthly & Annual Reports [6] NIGC Detailed Statistics [7] All macroeconomics data and time series prepared from Centre of Statistics and the Central Bank of Iran (CBI)