On 1 July 2010, U.S. President Barack Obama signed into law the Comprehensive Iran Sanctions Accountability and Divestment Act, further extending U.S. economic sanctions against Iran. The Act targeted Iran?s petroleum resources with a threat of sanctions against U.S. and foreign companies that invest Iran?s domestic production of refined petroleum products in excess of $1 million (or $5 million over the course of 12 months). It also sanctions companies that sell refined products or provide goods, services, technology or other support that contributes to Iran?s ability to import refined petroleum products in excess of $1 million (or $5 million over the course of 12 months).

CISADA added to the weighty list of sanctions against Iran, all of which have taken their toll on the economy, the base oils and lubricants sector being no exception. Undoubtedly, Iranian lubricant manufacturers have had to adjust by turning to new supply sources as well as seeking out new customers in the face of the embargo.

Largest Lube Market in the Region

Not many countries are potentially as enticing to international oil companies as Iran. Yet, Iran?s base oil and lubricants market is fundamentally opaque and, as sanctions have tightened, sources of credible data have diminished.?

Pars Oil Co., founded in 1959 and claiming to be the oldest base oil refiner in the country and the first not integrated into a fuel refinery, closely monitors the base oil and lubricants market. Majid Safdari, planning manager at Pars, said he estimates the total lubricant market to be 540,000 metric tons per year and the largest in the Middle East.

The automotive sector, which includes two-wheel and so-called driveline type vehicles, accounts for the bulk of the market, consuming approximately 420,000 t/y. Iran is overwhelmingly an API Group I base oil market; Group I accounts more than 95 percent of the total market according to Pars. Safdari said consumption levels of Group II are less than one percent while Group III and nonconventional synthetics account for three to four percent of the total market.

The heavy skew to Group I base oils shows that the Iranian market is a low-quality market in relative terms, although Iranian producers are attempting to convert the market to higher specification lubricants. This is all well and good, but the harsh reality of sanctions is likely to constrain those efforts for some time to come, analysts say.

The preponderance of Group I products comes down to two major issues: the languid pace of vehicle fleet modernization and a lack of awareness by consumers of the higher costs associated with using lower quality lubricants. For all that, it is also as much about the limited purchasing power of consumers grappling with a harsh domestic economic environment.

At the ICIS Middle Eastern Base Oils & Lubricants Conference in Dubai last October, Mojtaba Arabi Anaraki, dewaxing expert at Sepahan Oil Co., described the main drivers of the Iranian finished lubricant market. First, ?Iran?s auto sector is the second most active industry in the country,? he said, ?and Iran has become the largest vehicle producer in the region, producing 46 percent of all cars produced in the Middle East.? He noted that the country?s auto production increased 445 percent between 1998 and 2008.

Given Iran?s industrial legacy, it is no surprise that the industrial sector is an important consumer of lubricants, using 100,000 t/y, primarily hydraulic oils, compressor oils, turbine oils and metalworking fluids. The grease market is estimated to be 20,000 t/y.?

Pars added 2,000 t/y of grease capacity at its existing plant, which it says is running at full capacity. This increases the company?s total grease production capacity to 12,000 t/y. Applications for grease include the automotive aftermarket, bearings, pumps and electromotors in a number of different industries.

Dealing with Quality

With the economy under pressure, getting consumers to switch to higher grade lubricants is a challenge. But, according Ali Sadgehi, chief executive of Pars Oil, they and other Iranian producers are pursuing a dual track strategy, educating consumers as well as using advertising and distribution incentives.?

Another qualitative characteristic of the Iranian market is the widespread use of recycled oil. A nationwide network of factories, most of which operate at less than full capacity, recovers used oil from the market. According to Safdari, ?Almost all used oil in Iran is collected, however [there is] no data regarding top-up or make-up.? The yield obtained from recycling used oil is around 65 to 70 percent per barrel, most of which is destined for export.

[The] share of recycled [oil] is not much [in the] local market, reaching a maximum [of] 8 percent. A close estimate would be around 150,000 to 170,000 t/y of production [with] 100,000 to 130,000 t/y exported,? Safdari said. Recycled oil is prevalent in East and West Africa, according to analysts, causing a lag on the adoption of more technologically advanced lubricants.

The complexity of the market in Iran is evidenced by some startling statistics. According to Pars, base oil production costs for solvent neutral 150 have tripled since 2007, and domestic feedstock prices have nearly quadrupled in local currency terms since 2009 to approximately 9 and 9.5 million Iranian rials per metric ton, respectively following a reduction in government subsidies. However, major lube refiners were granted authorization to increase prices in March 2012 from the Consumer Manufacturers Rights Support Organization, a regulatory body set up to monitor and set prices for consumer products.?

According to Safdari, the controlled pricing formula has resulted in price increases in lubricants of up to 30 percent. ?This has considerably increased the earnings per share and market value of such companies on the Iran stock market,? he said. Iran?s large domestic supply of feedstock ensures that it will long continue to be a major producer of base oils, but it needs investment equally. Five Iranian refineries supply feedstock, but only one produces a full range of viscosity grades, and three supply only one feedstock grade.

Sanctions, What Sanctions?

Some producers in Iran offer products blended with Group II/III, which begs the question how the Group II/III products are imported in light of the panoply of sanctions. According to Safdari, they are sourced through intermediaries who buy from suppliers in Southeast Asia.?

An executive at a lubricants company in the United Arab Emirates, who asked not to be identified due to the sensitivity of the matter, says it is a similar situation with additive technology. ?It is sourced through some companies in the Gulf, and then sent on to Iran. It is a well-known fact.??

Many intermediary companies have also set up in the bustling free trade zones of the U.A.E., which permit 100 percent foreign ownership and operate as an offshore hub to effectively cloak the final destination. Further afield, China?s gain from the embargo is described as ?huge? according to a source at a major oil company.

Safdari echoes the fact that the impact of sanctions has been limited. Consumption has fallen, but that is due to the domestic economy. ?The lube market has not been noticeably affected on the supply side; however, macroeconomic factors, inflation and negative growth rate have hit the demand side.? He cites no hard data, but the consensus is around a 10 percent reduction in demand, mainly of industrial lubes.?

Iran exports sizeable volumes of base oils to India as well as Africa. Many of these countries are outside the sanctions net and, therefore, are a naturally attractive haven for Iranian exports.

Stability has also returned to the currency market after a significant fall in the currency and the fact that Iranian companies no longer have to use the exchange rate set by the central bank. Pars switched to the so-called free exchange rate over a year ago. Consequently, profits on base oils and lubricants have risen sharply as the cheap Iranian Rial has boosted export revenues. In international markets, that has kept a lid on base oil prices.

The Game Changer

Iran?s potential reentry into international markets could radically shake up the status quo both in the region as well as globally. Refiners including Enoc or Adnoc in the UAE and Petromin in Saudi Arabia face a threat of greater competition from their neighbor across the Strait of Hormuz. Undoubtedly, that could force a rethinking of investment and expansion plans that have flourished during sanctions.?

That is why any suggestion of
an easing of the embargo leaves many uneasy at the prospect and
the potential for a sudden adverse impact on global base oil prices. According to analysts, it could also pit regional refiners against their global counterparts. The former wanting to protect market share; the latter excited by the investment opportunities Iran offers.?

Whatever the outcome of the negotiations, it is likely international oil companies will face a much different Iran than in recent memory. For all the talk of reform, Iran?s intrinsic complexities and the intertwining of other superpower interests notably China and Russia, will be a challenge even for the most ardent of negotiators.