Economic Benefits Outweigh Sanctions For IP Pipeline

Iranian company Tadbir Energy is close to signing an engineering, procurement and construction (EPC) contract with Pakistan's state-owned gas import company Interstate Gas Systems for the 785km Pakistan section of the Iran-Pakistan (IP) gas pipeline. We believe the level of progress for the IP pipeline suggests that the economic benefits derived from the project are too tempting to resist for both countries, despite the economic sanctions placed by the US on Iran. However, we highlight that there are still several risks that could prevent the completion of the IP gas pipeline, namely with regards to financing and elections.

The EPC contract is expected to be signed this week (the Express Tribune reports), and comes after the Pakistani government approved the US$1.5bn deal for the project with the Iranian government on January 30 2013. The project is scheduled to be completed by December 31 2014, the dateline for the project as stipulated in a gas sales and purchase agreement signed by both countries in 2011. Once completed (Iran has so far completed more than 900km of the Iranian section of the pipeline), the proj ect envisages gas inflows of 21mn cubic metres per day (or 7.67bn cubic metres per year) to Pakistan by the end of December 2014.

Close To Implementation
Proposed Routes For Iran-Pakistan-India (IPI) and Turkmenistan-Afghanistan-Pakistan-India (TAPI) Pipelines

We believe these recent developments suggest that the IP gas pipeline is closer than ever to being implemented. Under the government-to-government agreement, Iran will provide a US$500mn, 20-year loan for the pipeline project, while the remaining funds will be raised by Pakistan's Gas Infrastructure Development Cess (GIDC) - a government levy on Pakistani gas consumers for the construction of gas pipelines. Meanwhile, under the EPC contract, Tadbir Energy is expected to complete the Pakistan section under two segments, as well as provide and assist in arranging financing for the project. Lastly, the detailed design for the Pakistan section of the pipeline is completed and under final review, thus Tadbir Energy should be able to start work in the first half of 2013.

Circumventing Sanctions

The ardent support for the project from both governments suggests to us that the economic benefits derived from the project are too tempting to resist for both countries. To carry out the project, both countries have actively sought ways to circumvent the economic sanctions placed by the US on Iran ( see our online service, March 15 2012, ' US Sanctions Deal Heavy Blow To Iran-Pakistan Pipeline' ). Tadbir Energy was selected as the EPC contractor because it does not face sanctions from any foreign government. The company is controlled by the Imam Khomeini Foundation, one of Iran ' s largest charitable groups, and will act as the lead contractor for the project, carrying out construction works through its local subcontractors. In addition, Iran would pay Tadbir Energy directly for the construction of the pipeline, negating the need for fund transfers between Pakistan and Iran, a problematic process due to the US' sanctions act on Iran.

Output/Exports Struggle Under Sanctions
Iranian Oil Production, Net Exports & Percentage Change y-o-y ('000b/d)

Economic Considerations

We believe that the economic benefits of the IP pipeline are indeed significant for both countries. The completion of the IP pipeline could ensure that Iran's revenues from hydrocarbon exports remain steady, allowing the government to continue to support spending in other areas of its economy. Ever tightening sanctions on Iran have made it difficult for the country to sell, ship, or receive payment for its hydrocarbon exports from foreign customers ( see 'Ambitious Goals Challe nged By Reality Of Sanctions', January 15 2013 ). This has had a discernible impact on Iran's government revenues. Platts reported in December 2012 that Iran was considering basing its FY2013 budget (beginning in March) on oil exports of just 1mn barrels per day (b/d), a significant drop from pre-sanctions exports in the area of 2.2mn b/d. Meanwhile, oil production has already fallen, with EIA reporting Q112 production of an estimated 3.4mn b/d falling to 2.6mn b/d by Q412.

Meanwhile, Pakistan is still facing chronic energy shortages that are disrupting industrial production and igniting popular discontent ( see 'Gas Shortage Keeps Looming On Long Term Outlook', January 15 2013 ). According to the government, Pakistan continues to experience an energy shortage of 4,000MW. Nameplate generating capacity in the country currently stands at 20,000MW, but Pakistan's state utility announced that they are only able to supply 13,000MW due to a lack of fuel. The IP pipeline could address this problem by providing the necessary fuel to boost electricity supply. In particular, the gas provided by the pipeline is projected to boost electricity generation by around 4,000MW in Pakistan.

We do however highlight that most of Pakistan's energy shortages are taking place in the northern regions, while the IP pipeline is currently designed to traverse the southern part of Pakistan. This means that Pakistan would need to increase the capacity of i ts domestic pipeline to fully benefit from the IP pipeline and it remains to be seen if that would be the case.

In Need Of More Gas
Pakistan's Gas Production, Consumption & Imports (bcm)

Risks To Execution

However, there are still several risks that could prevent the completion of the IP gas pipeline. Pakistan's ability to meet its full financial obligations for the IP pipeline is unclear. The Islamabad High Court recently declared the GIDC as illegal, and has directed the government to reimburse the funds collected to gas consumers. Meanwhile, US sanctions on Iran-related projects make it difficult for Pakistan to secure financing from international capital markets.

Additionally, Pakistan must hold its general elections by June 2013 at the latest, and the country's infrastructure plans could change should there be a change of government. Although we believe that the main opposition parties in Pakistan are not opposed to the IP pipeline project, a change in government has more often than not led to a review of infrastructure projects approved by its predecessor. This typically results in new feasibility studies and schemes being conducted and crafted respectively, which could lead to project delays, revisions or, at worse, cancellations.

This article is tagged to:
Sector: Oil & Gas, Infrastructure
Geography: Pakistan, Iran

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