Pipelines and the Challenges of Energy Integration in the Middle East

This article is part of a series exploring regional energy cooperation in the Gulf and is published in cooperation with Istituto Affari Internazionali.

Energy cooperation in the Middle East has long been pursued through the establishment of petroleum pipelines, built with the goals of connecting to energy markets in the broader Eurasian context, diversifying oil export routes, and reducing vulnerability. After several years of renewed regional diplomacy in the Gulf and an increase in the level of regional trade and investment, energy integration is once again on the agenda in bilateral and multilateral forums.

However, in a region characterised by both internal instability and external threats, most intra-regional energy trade agreements have been short-lived. The legacies of the Middle East’s major oil and gas pipelines offer important lessons for regional leaders hoping to integrate energy markets and infrastructure.

The region’s seven major pipelines have existed for a cumulative 445 years. But they have only been active for 168 of those years. In other words, the seven pipelines have been operational for just one-third of their lifetimes. Every international oil pipeline in the region has also shut down at least once, and the majority remain closed today.

Political conflicts within producing and transit countries, as well as interstate disputes, remain the primary reasons for pipeline shutdowns. While the mutual dependency stabilising factor ensures continued oil supply from the region, short-term interruptions persist due to geopolitical tensions. Historical events like the Arab oil embargoes and international sanctions against Iraq and Iran underscore the region's susceptibility to temporary disruptions. The military attacks during the eight-year war between Iran and Iraq (1980-88) prompted a reconsideration in pipeline strategies in the region as the conflict both underscored the vulnerability of the infrastructure to military attacks, but also their potential in assisting countries at times of isolation.

For example, Iraq, whose meagre Gulf coastline was blocked during the war and its export outlets through the Mediterranean (Syria and Lebanon) were shut down, sought to diversify its export channels through pipelines with Turkey and Saudi Arabia. Iran, on the other hand, facing security concerns due to sporadic Iraqi air strikes on its territories, also explored pipeline options to bypass vulnerable terminals. But the 1986 Iraqi strikes on Iran’s Larak and Sirri terminals raised doubts about the security and usefulness of such infrastructure, resulting in the postponement or cancelation of many pipeline projects.

In the 1980s, to reduce  dependence on the Strait of Hormuz and vulnerability to Iranian threats, Saudi Arabia built its main export pipeline “Petroline” from the oil-producing Eastern Province to Yanbu on the Red Sea. Yet, liftings at the Red Sea must transit through the Suez Canal which is controlled by Egypt or through the Strait of Bab Al-Mandeb which is controlled by Yemen. Oil could also be piped through the Sumed pipeline which links, within Egypt, the Gulf of Suez to the Mediterranean, or through the Eilat-Ashkelon pipeline in Israel. But these avenues pose their own challenges.

The Eilat–Ashkelon pipeline has recently gained attention, with press reports of the UAE considering it for transporting crude from the Red Sea to the Mediterranean. Interestingly, this pipeline was built in 1968 as a joint-venture between Israel and Iran to transport Iranian crude oil to Europe. However, Iran ceased using the pipeline following the 1979 Revolution and the subsequent nationalisation of the pipeline by Israel. Today, with the ongoing war in Gaza and the fate of Arab-Israeli normalisation agreements mean the future of this pipeline is uncertain.

Limited Success in Gas Cooperation

In the realm of gas pipelines, the Middle East has seen some limited success, but only few interstate gas pipelines have been built. The first interstate gas line in the region was built in 1986 linking Iraqi fields to Kuwait. This short-lived pipeline closed after the Iraqi invasion of Kuwait and switched to supplying water for Iraqi troops. Around the same time, a small gas link was constructed between Oman and the UAE’s emirate of Ras Al-Khaimah. That link later expanded and became the much larger Dolphin pipeline which came on stream in 2007, supplying Qatari gas to the UAE and Oman.

In the Eastern Mediterranean, a gas pipeline linking Egypt and Israel was initially built to channel Egyptian gas to Israel, before reversing its flow to supply Israeli gas to Egypt. On a more regional scale, the Arab Gas Pipeline (AGP), built in 2003, has been linking Egypt, Jordan, Syria, and Lebanon, and has plans to connect to the European network in Turkey. However, the AGP has faced serious challenges since its inauguration, including the acute shortage of gas feedstock from Egypt.

The development of liquified natural gas (LNG) has also dealt a blow to the prospects of increasing gas pipelines around the Middle East. In fact, Bahrain, the UAE, Kuwait, and Jordan are already operating LNG import terminals, while Oman, Saudi Arabia, and Lebanon are pursuing the same strategy as well. The LNG option has been favoured over gas pipelines as a result of many factors, including the security related factors as well as the competitive costs and prices for building the different parts of its chain, i.e. the liquefaction plants, transport vessels, and regasification units.

Revitalising Pipelines

Despite persistent challenges, international pipelines are needed in the region and they can be an efficient and secure way of energy trade, if operated properly. To turn a new page, addressing various issues is crucial. First and foremost, the issue of transit fees must be clearly resolved, especially if a third country is involved in the transit. Those fees, returned in cash or commodities, could well affect the entire economic feasibility of a pipeline network project.

Adherence to World Trade Organization (WTO) agreements is also a significant challenge. In fact, each member of the WTO has to give the owner or operator of any pipeline passing through its territories full and free access to its own domestic market. That right for market access has not always been admitted by all Middle Eastern countries.

There is also the question of “energy independency” which needs to be addressed. In the Gulf and the broader region, governments are hesitant to depend on neighbouring countries for their fuel supplies. At the same time, the psychological desire among oil-producing countries for self-sufficiency also promotes a greater willingness to burn more liquid fuels than import gas, despite their higher relative and opportunity costs and the damage they induce on the environment.

Trust building measures and gradual expansion of bilateral and multilateral engagements could contribute to increasing energy cooperation, in addition to increasing the interdependency between the countries along the routes of pipelines through transit fees and large reliance on the pumped supplies.

Gas pricing is a challenge which is further compounded by the fluctuations in demand throughout the year. Demand for electricity, and consequently for natural gas, peaks in the summer for the majority of countries in the region, and consequently gas sales fall in the winter. To offset these challenges, regional countries could either create storage facilities at the upstream producing end or at the downstream consuming side. This requires much closer regional cooperation on gas.

While the challenges are evident, the pursuit of energy cooperation through pipelines in the Middle East remains a complex yet vital endeavour, requiring continuous adaptation to geopolitical realities and global market dynamics. Despite the current favouring of LNG over gas pipelines, policymakers must keep the idea of building a regional gas network on the agenda.

Regional players need to learn from past failures and match infrastructure with institutions to provide platforms for dispute resolutions and enhanced cooperation. Such a way forward could bolster regional economic development, enhance intra-regional trade, and contribute to long-term political cooperation and economic integration in the broader region.

Photo: Aramco

As Iran Sells More Oil to China, the U.S. Gains Leverage

A new report from Bloomberg, citing data from Kpler, an analytics company, claims that Iranian oil exports to China will reach 1.5 million barrels per day this month, the highest level in a decade. The report has led to a flurry of criticism from hawks that President Biden is failing to enforce U.S. sanctions on Iran’s oil exports and thereby gifting Iran billions of dollars in oil revenue. But in reality, Iran appears unable to spend most of the money—a situation that is giving Biden leverage he can use in future negotations.

Iran’s resurgent oil exports are earning the country a lot of money. The crude oil price is currently hovering at around $80. Iran discounts its oil for Chinese customers, so the actual selling price is probably closer to $74 dollars per barrel. At this price, Iran’s 1.5 million barrels per day of exports are earning the country around $3.3 billion per month.

These back of the envelope calculations are necessary because China’s customs administration stopped reporting the value and volume of oil imported from Iran back in May 2019, when the Trump administration revoked a series of waivers permitting limited purchases of Iranian oil by select countries. When looking to the Chinese data alone, Iran’s export revenue appears much smaller than it is, hiding the true trade balance.

In the most recent three months for which we have customs data, Iran’s imports from China averaged $826 million. In the same period, Iran’s non-oil exports to China averaged $357 million. When not counting Iran’s oil exports, Iran appears to be running a trade deficit with China of around $469 million. But when adding the reasonable estimate of $3.3 billion of oil exports, the monthly trade balance swings dramatically in Iran’s favor. In recent months, Iran has likely run a trade surplus with China of around $2.8 billion per month.

In other words, Iran is earning billions of dollars it appears unable to spend. After all, Chinese goods, especially parts and machinery, are a lifeline for Iranian industry. If Iran was able to buy more Chinese goods, it would be doing so. Two other data points confirm this interpretation. Exports from the UAE to Iran remain depressed, so Chinese goods are not arriving in Iran indirectly. Purchasing managers’ index data for the manufacturing sector also indicates that Iranian firms continue to struggle with low inventories of raw materials and intermediate goods. Moreover, Iran is continuing to doggedly pursue the release of its frozen assets, including $6 billion that will be made available for humanitarian trade as part of the recent U.S.-Iran prisoner deal. Iran would not be so desperate to strike such deals were its oil revenues in China readily accessible. In short, Iran is selling its oil and earning money, but it is not getting the full economic benefit from the surge in oil exports.

Chinese exporters and their banks remain wary of trading with Iran, where entities and whole sectors remain subject to U.S. secondary sanctions. For most Chinese multinational companies, trading with Iran is not worth the risk. In the first six months of this year, Chinese exports to Iran averaged $898 million per month. Exports remain 35% lower than in the first six months of 2017, the most recent year during which Iran enjoyed sanctions relief.

It remains to be seen whether Iran can sustain this new, higher level of oil exports. Oil markets can be fickle, and China’s economic wobbles could depress demand. But for now, Iran’s significant trade surplus with China also means that its renminbi reserves must be growing. This is a novel situation. Historically Iran has run a small trade surplus with China. Between January 2012, when the Obama administration launched devastating financial and energy sanctions on Iran, and January 2016, when the implementation of the nuclear deal granted Iran significant sanctions relief, the average monthly trade surplus was just $511 million (China’s purchases of Iranian oil are reflected in customs data for this period). In other words, assuming its oil revenues are stuck in China, Iran’s reserves are now growing four times faster than in that period.

At first glance, this might look like a major failure for the Biden administration. Biden purposefully maintained the “maximum pressure” sanctions imposed by Trump in an effort to sustain leverage for negotiations and Iranian oil exports remain subject to U.S. secondary sanctions. But those who claim that Biden is failing to enforce his sanctions are failing to see the wisdom of the current U.S. enforcement posture.

First, Biden is loath to deepen already heightened tensions with China. Sanctioning Chinese refiners for their purchases of Iranian oil, thereby targeting China’s energy security, would be a dramatic escalation in the growing economic competition between Washington and Beijing. Second, such escalation would be entirely pointless given the circumstances around Iran’s oil exports—namely that Iran is not getting the normal economic benefits. Given that Iran is earning more money but cannot spend it, the U.S. is actually gaining leverage for future negotiations.

Unlike Trump, Biden has made a serious effort to engage in nuclear diplomacy with Iran and is likely to continue those efforts if there is a reasonable opportunity to achieve a new diplomatic agreement that contains Iran’s nuclear program. But U.S. negotiators have struggled to make a compelling offer to their Iranian counterparts. Many Iranian policymakers felt the promised economic uplift of sanctions relief would be too small. Iran’s opening gambit in the negotiations with Biden included the claim that sanctions had inflicted $1 trillion of damage to Iran’s economy and that Iran was owed compensation.

With its oil exports significantly depressed, Iran has been unable to significantly grow its foreign exchange reserves, which the IMF estimates at around $120 billion. If Iranian officials believe that they need to remediate $1 trillion of economic damage, the windfall represented by the unfreezing of foreign exchange reserves does not count for much.

The longer the sanctions remain in place, the more money will be needed to undo the cumulative effects of U.S. sanctions, which have now hobbled Iran’s economy for over a decade. It is politically impossible for Biden to promise any kind of compensation for Iran—the best that the U.S. can do is promise to once again unfreeze Iran’s own money as part of a new diplomatic agreement.

For this reason, it is a good thing if Iran’s reserves are growing. Iran’s oil exports to China are kind of like payments made as part of a deferred annuity insurance contract. One day, Iran will be able to cash out on that policy. But it can only cash out if it meets the conditions set by the U.S. In other words, every barrel of oil Iran is currently selling to China is increasing U.S. leverage for future talks. It would be wise to let the oil flow.

Photo: Canva

Cañete to Discuss Vital Central Banking Solution on Iran Visit

In a statement released Friday, European Commission president Jean-Claude Juncker declared that the Commission has a “duty… to do what we can to protect our European businesses, especially SMEs.”

As Europe steps-up its efforts to fulfill that duty, the commission took two concrete steps, launching the formal process to revive the blocking regulation that will prohibit EU companies from “complying with the extraterritorial effects of US sanctions.” The regulation also “allows companies to recover damages arising from such sanctions from the person causing them.”

The European Commission also launched the formal process to enable the European Investment Bank (EIB) to finance activities in Iran under an EU budget guarantee. Helga Schmid, Secretary General of the European External Action Service, first announced that EIB would be receiving such a mandate, at the Europe-Iran Forum, a business conference organized by Bourse & Bazaar, in October 2017.

Friday’s statement further highlighted the pending visit of Europe’s Commissioner for Climate Action and Energy, Miguel Arias Cañete, to Tehran. The visit, which will take place over the weekend, is a continuation of a program of “sectoral cooperation” launched in 2016.

But the most significant announcement was the news that the European Commission is “encouraging member states to explore the possibility of one-off bank transfers to the Central Bank of Iran” in order to assist Iran in receiving “oil-related revenues, particularly in case of US sanctions which could target EU entities active in oil transactions with Iran.”

Experts have pointed to the creation of channels for such transfers as an important short-term measure. A report published earlier this month by International Crisis Group, suggests enabling “pertinent European central banks to process related payments” as a means of “empowering those in the Iranian leadership who advocate continued compliance with the deal.”

Speaking on background, an EU official confirmed that Cañete’s visit would include “discussions on how the mechanics of all of this would work.” European authorities have identified two priorities: “One is to work out how you can facilitate payment of Iran for imports of oil to the European Union. But, secondly and equally importantly, the repatriation of Iranian funds that are currently in the European Union.”

The emphasis on repatriation is especially important as Iran seeks a route to sustained economic growth despite the snapback of primary and secondary U.S. sanctions. Economists have identified that increased public investment could help Iran achieve growth in the absence of the foreign investment that had been expected to follow the lifting of sanctions in 2015. Typically, half of Iran’s oil revenues are earmarked for the government budget, and a just under a third of revenues are allocated to the National Development Fund.

During recent consultations, experts from the International Monetary Fund implored Iranian authorities “to explore the scope to use oil revenues to fund bank recapitalization, and noted the importance of replenishing the Oil Stabilization Fund to provide the budget a buffer.”

Seen in this context, oil revenues are a lifeline for the Iranian economy. As Iran’s economy begins to lose momentum in advance of full sanctions snapback, Iranian business leaders and consumers will be watching intently to see if Europe can keep oil flowing in and revenues flowing out. 

Photo Credit: Wikicommons