Pipeline to Nowhere?

The Iran-Pakistan pipeline may be the only way to go if Pakistan wants to continue using its gas transmission infrastructure and avoid fuel conversion expenses. But the option will not be easy to implement.

The pipeline was first proposed in 1994, and was supposed to extend to India. Eighteen years on, India has effectively bowed out, Pakistan’s energy crisis has assumed dire proportions, and Iran is facing crippling international sanctions as punishment for its purported nuclear ambitions. So where do things stand?

The government of Pakistan has come out strongly in support of the project, asserting in mid-February that the pipeline will go through, even as Iran is increasingly isolated in the international community.

As of August 2011, NESPAK had completed a reconnaissance survey of the 800km part of the pipeline that is to pass through Pakistan’s territory. It is currently preparing a feasibility study in collaboration with a German firm ILF. The government says the construction of the Pakistan section will be complete by December 2013. Iran has almost finished putting in the necessary infrastructure on its side of the border. Pakistan will have to start paying $2 million a day to Iran in penalties if it does not go through with the project.

Meanwhile, the pressure on Iran and on all parties who have any form of financial dealing with Iran is building up. Buyers of Iranian oil (most recently South Korea and India) are unable to repatriate payments to the country, as Iranian banks can no longer carry out transactions in dollars. The sanctions are aimed particularly at the energy sector (upstream, as well as on shipping of Iranian oil), and are leading to a withdrawal of international oil and gas companies from the country. Iran has the world’s second largest proven reserves of natural gas, and is part owner, along with Qatar, of the South Pars gas field, which is supposed to be the world’s largest field. This is also the field from which the Iran-Pakistan pipeline is supposed to originate. In spite of this endowment, Iran ranks only 25th in the international list of gas exporters, as it does not have the financial or technical resources to develop its fields. Qatar has become the world’s leading liquefied natural gas exporter using the same field, while Iran is facing a steady decline in its already relatively low level of exports.

For now, the biggest issue is financing. Inter-State Gas Systems (ISGS), the company handling the proposed project in Pakistan, estimates the cost of pipeline construction at $1.2 billion. It envisaged raising 30% (or about $373 million) of this in the form of equity, while the remaining would be debt. Of the total equity stakes, 51% are supposed to come from the public sector in Pakistan, while international investors are supposed to make up the remaining. The loans were, of course, to come from international financial institutions.

But as a result of the sanctions on Iran, Pakistan is having difficulty finding financiers. Even if the government manages to put up the 51% equity, getting the remaining funds will be a struggle. In January this year, the National Bank of Pakistan and the Oil and Gas Development Corporation (OGDC) decided to withdraw from the project for fear of repercussions on their international operations and withdrawal of foreign investment respectively. Most international banks will not touch the project. More worrying, China, which was long considered a supporter of the project, has gone silent in spite of the fact that the government of Pakistan appointed, in December 2011, the Industrial and Commercial Bank of China as the leader of a consortium that will act as financial advisors to the project.

Iran itself has offered to finance Pakistan’s share of the pipeline construction costs, but this is not a credible offer given its own straitened circumstances. Russia’s Gazprom has reportedly shown interest, which may be an option worth exploring.

So what are Pakistan’s options?

The cautious option is to just let the project die a natural death, while posturing valiantly in favor of Iran. The Iranian government can hardly blame any country for backtracking on any deal with it, in the current situation. Pakistan can cite extenuating circumstances and simply put the project on the back-burner for another (sunnier) day. There are indications that Pakistan may already be buying time. It has indicated that it wants to review the price – bringing it down from the currently agreed 78% of crude oil parity to 70% (something that Iran is likely to agree to readily in the circumstances). It has also, just before the recent heads of government meeting in Islamabad, asked Iran to have its reserves verified by the third party.

But Pakistan needs the gas for the longer term. The proposed TAPI pipeline which traverses Afghanistan is a non-starter. And while LNG imports from Qatar can help fill the gap at least for power generation, it is not a substitute for a long-term supply of natural gas, which is expected to generate up to $100 billion in savings over 25 years. There is the issue of the reparations that are to be made to Iran if Pakistan backs out. There is the issue of not really having any viable alternatives – the US for all its huffing and puffing hasn’t put anything concrete on the table and is unlikely to do so, given how hostile the US Congress is becoming towards Pakistan. And lastly, there is the issue of saving face – Pakistan has really gone out on a limb to support Iran in its current crisis. Having taken on the US and others so boldly, can it now just backtrack? Alternatively, can it afford to take on a fight with yet another neighbor?

Even if everything goes on schedule, the pipeline will not be in place for another three years. A lot can change in that timeframe. For now, it appears to be in Pakistan’s interests to continue to pursue the project as best as it can, without being overtly aggressive towards the international community. There may well be wiggle room that will allow Pakistan to proceed without necessarily being on the wrong side of international law. No payments are being made to Iran just yet, and in any case, the bilateral agreements on the pipeline pre-date the latest Security Council sanctions that seek to limit trade with Iran. Pakistan should avoid making grand or provocative gestures, but financing options should be explored in earnest, and the project should not be abandoned....