THE CVAR ANALYSIS FOR THE MANUFACTURING AND MINING SECTORS 171

171

imports was destined to the manufacturing sector. Given the import substitution policies pursued for most of the years under study, the low size of export ratios may seem unsurprising.

6.5.4. THE CVAR ANALYSIS FOR THE MANUFACTURING AND MINING

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Table 6.6 Manufacturing and mining sectors’ fully-identified long-run structures (1974-2011)

Note: the analysis is conducted employing WinRATS Pro8.1 software.

MANUFACTURING AND MINING SECTORS (1974-2011) (t-values in parentheses)[p-values in brackets]

OVER-IDENTIFIED VECTORS - χ2(1) = 0.044 [0.834]

r = 2 i_tManuf acturing y_tManuf acturing c_tManuf acturing ln(δ + g^k)_tManuf acturing dp_t orev_t T(1988:01) trend β1Manufacturing

1.000 (NA) -0.593 (-6.464) 2.905 (4.477) 0.000 (.NA) 2.369 (3.484) -0.080 (-2.172) 0.059 (5.629) -0.069 (-7.379) α1Manufacturing

-1.214 (-3.582) -0.475 (-3.599) -0.621 (-5.311) -1.197 (-3.508) 0.614 (4.244) - -

-β2Manufacturing

0.000 (.NA) 0.000 (.NA) 3.348 (3.353) 1.000 (NA) 5.313 (5.295) -0.299 (-4.205) 0.131 (6.488) -0.097 (-6.013) α2Manufacturing

-0.433 (-1.635) 0.009 (0.092) 0.514 (5.625) -0.520 (-1.949) -0.564 (-4.990) - -

-173

The over-identified structures specify two interpretable irreducible long-run relations based on χ2(1) = 0.044 [0.834]. The first relation describes the investment equation. As predicted by the theory, the relation between investment and output is positive with a coefficient magnitude 0.59.

Also, consistent with the theory, investment is strongly and negatively related to the user cost of capital with a coefficient equal to -2.90. Furthermore, investment in the sector is found to be a negative function of inflation in the long-run with the latter’s coefficient equal to -2.36. In the long-run, however, the relation between investment and ln(g^k + δ)tManufacturing

appears to be statistically insignificant.

Notably, investment is a positive function of oil revenues with an estimated coefficient equal to 0.08, indicating a positive relation between investment and the availability of oil income in the country’s manufacturing and mining sectors in the long-run. This relationship, however, is inconsistent with the predictions of the Dutch Disease theory in terms of the sign of the coefficient on oil revenues for the non-booming tradable sectors of manufacturing and mining.

The estimated α loading coefficients show that investment, output and the user cost of capital are all error correcting to the first long-run equilibrium relation, with respective adjustment coefficients of 1.21, 0.47 and 0.62. However, the estimated α coefficient on inflation for the first relation suggests that in the short-run the highly persistent inflationary pressure in the Iranian economy is error increasing with a coefficient magnitude 0.61. The second relation describes the capital growth equation. Expectedly, in the long-run, the growth rate of capital stock is a positive function of oil revenues with a coefficient of 0.29, and a negative function of the user cost of capital and inflation with respective coefficients equal to -3.34 and -5.31. Inflation and ln(g^k + δ)tManufacturing are both adjusting with error correcting coefficients of 0.56 and 0.52, indicative of the significance of these variables in the short-run for the second cointegrating relationship.

Overall, the manufacturing and mining sectors’ investment pattern largely corresponds to the theoretical framework of the neoclassical-accelerator type models of investment, i.e. a long-run positive relationship between investment and output, and a long-run negative association between investment and the proxies of the user cost of capital. Interestingly, there exists a long-run relationship between investment activities in these sectors and oil revenues suggesting that they benefited from investment spillovers (facilitated by the government’s decision to promote industrialization) fueled by the availability of oil income. Nevertheless, the contribution of the

174

manufacturing and mining sectors in GDP and employment could have been greater given the diversity of the manufacturing activities as well as the quantity and quality of the proven mineral deposits in country.

6.5.5. OIL SECTOR: OVERVIEW

Iran was the first country in the Persian Gulf which discovered oil in 1908. Since the 1920s, the country’s economy became increasingly reliant on the oil sector, and oil revenues accounted for about 65 percent of the government’s revenues during 1970-2010. Yet, in total GDP, the value-added of the oil sector contributed only 19 percent on average per annum over these years. The country holds the fourth largest proven crude oil reserves and the second largest natural gas reserves in the world. The country ranks among the world’s top 10 and top 5 crude oil and natural gas producers, respectively, and is blessed with about 10 of the world’s and 13 percent of OPEC’s crude oil reserves (EIA, 2014). About 70 percent of the country’s crude reserves are located onshore mostly in the Luristan-Khuzestan basin in the Southwest near the Iraqi border, with the rest located offshore in the Persian Gulf as well as the Caspian sea.⁹⁷ The country further shares several onshore and offshore fields with its neighboring countries including Iraq, Qatar, Kuwait and Saudi Arabia. Figure 6.6 maps the major crude oil and natural gas infrastructure and facilities in the country.⁹⁸

97 Iran's largest producing oil fields are the onshore Ahwaz-Asmari, Marun, and Gachsaran fields, all of which are located in the Khuzestan Province.

98 Iran’s major crude oil terminals are Kharg (with a capacity of 5.0 million barrels per days), Lavan, and Sirri Islands, all of which are located in the Persian Gulf. In addition, the country has two small crude oil terminals at Cyrus and Bahregansar, one terminal along the Caspian Sea, and other terminals that handle mostly refined product exports and imports. Condensate from the South Pars natural gas field is exported from the Assaluyeh terminal.

175 Figure 6-6 Map of key petroleum facilities in Iran

Source: Parstimes, Iran oil and gas resources: key petroleum facilities [Online]. Available at:

http://www.parstimes.com/ioil.html [Accessed 30 July 2014].

The Supreme Energy Council, established in 2001 and chaired by Iran’s president, consists of various ministries including the Ministry of Petroleum, and oversees the energy sector in the country. The Ministry of Petroleum supervises the enterprises of the National Iranian Oil Company (NIOC), the National Iranian Gas Company (NIGC), and the National Petrochemical Company (NPC), all of which are state-owned.⁹⁹ NIOC and NIGC through their subsidiaries, listed in Table 6N1 (Appendix 6N), control upstream oil and natural gas activities and downstream natural gas activities (incl. pipelines, city natural gas networks and gas processing plans), respectively.

The country’s proven oil reserves grew by a total of about 160 percent from 57 thousand million barrels in 1980 to 151 thousand million barrels in 2010 (see Table 6N2 in Appendix 6N). The country’s crude oil production increased from 3.8 million barrels per day in 1970 to 4.3 million barrels per day in 2010, illustrating a total growth rate of 12 percent over these years. During this period, the amount of the country’s oil production greatly varied. For instance, during

99 NPC accounts for approximately 90 percent of the country’s total petrochemical production and exports through its subsidiary, the Iran Petrochemical Commercial Company (Source: National Iranian Oil Company. [Online].

Available at: http://nioc.ir [Accessed 28 July 2014].

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1975, the crude oil production was at its highest averaging 5.1 million barrels per day, while this figure registered its lowest and averaged 2 million barrels per day during the early years of the war with Iraq from 1981-1985. The share of value added of the oil sector in total GDP declined from 46.6 percent in 1970 to as low as 8.7 percent in 2010. Despite its declining share of value-added in total GDP, during 1972-2007, the oil sector’s share of export in total export averaged as high as 78 percent on a yearly basis, while that of the non-oil sector recorded merely 22 percent. The panel on the left in Figure 6.7 graphs total and non-oil exports during 1973-2010.

Currently, the largest buyers of Iranian crude oil are China, India, South Korea, and Turkey (EIA, 2014). The panel on the right in Figure 6.7 shows the geographical distribution of Iran’s oil exports during 1973-2009. During 1965-2006, there has been a significant shift away from Europe with a declining rate of 20 percent towards Asia and Far East (see Table 6N3 in Appendix 6N).

Figure 6-7 Total exports, oil exports and non-oil exports

Total and non-oil exports Distribution of oil exports

Note: Constructed based on data in billion Rials at constant 2004/05 prices. Source: CBI.

Figure 6.8 plots the oil production quota designated to Iran by OPEC against the amount of Iran’s oil output. The quota for Iran increased from 1.2 million barrels per day in 1982 to 3.8 million barrels in 2010. However, the output of the oil sector grew from 2.3 million barrels in 1982 to 4.3 million barrels in 2010. Although the amount of production exceeded the allowed quota, the growth rate of oil production remained lower than that of the quota. This could suggest that the low growth of oil output was due to the sector’s limited capacity rather than the designated oil quota.¹⁰⁰

100 Nevertheless, exceeding the quota by a large margin may not have been possible as it would have caused disturbances within OPEC.

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000

1975 1980 1985 1990 1995 2000 2005

Non-oil exports (billion Rials) Total exports (billion Rials)

0 10 20 30 40 50 60 70

5 10 15 20 25 30 35

 Africa (%) 

 Asia & Far East (except Japan) (%)   Europe (%)

 Japan (%)   Other Areas (%) 

177

Figure 6-8 OPEC quota and oil production in Iran

Source: CBI.

The oil industry in the country has been challenged by a number of structural problems such as financial constraints and the consequent underinvestment. Others include sanctions by the US and the West, technical shortages, and increasing demand and consumption due to heavily subsidized energy prices and the growing population. In 2012, for instance, oil and natural gas accounted for about 37 and 61 percent of the country’s total energy consumption, respectively, with a minimal contribution from hydropower, coal, nuclear and non-hydro-renewables (EIA, 2014, p.4). Iran is the second largest oil consumer in the Middle East, after Saudi Arabia. The domestic oil consumption mainly includes gas oil, gasoline and fuel oil (see Figure 6.9). In order to meet the domestic demand and due to limited domestic oil refining capacity, Iran has relied on imports of refined products, particularly gasoline, and the country’s import of oil products illustrated a substantial growth during 1978-2010 (see Table 6N2 in Appendix 6N).¹⁰¹

About 80 percent of the crude oil reserves in Iran were discovered before 1965. Since 2007, no new oil field has entered into production. Table 6N4 in Appendix 6N illustrates the declining development of refinery activities in the country during 1986-2007. Relatively low cost and highly productive oil fields are declining by about 2-2.5 million barrels per day (Ghanbari, 2012, p.130). Also, the country’s oil fields have high annual natural decline rates of 8-11 percent and low recovery rates of 20-25 percent (EIA, p.11). The sanctions and the consequent lack of international participation have adversely affected the Iranian oil sector’s activities of particularly upstream projects through affecting the availability of technology, expertise and

101 Iran’s energy prices, in particular gasoline prices, have been substantially subsidized. In 2010, the government initiated subsidy reform and lowered the subsidies on energy prices in order to discourage wasteful energy use.

Since 2010, the import of oil products and mainly gasoline fell due to subsidy cuts.

0 1,000 2,000 3,000 4,000 5,000

82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

OPEC quota (thousand barrels per day) Oil production in Iran (thousand barrels per day)

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investment leading to postponements or even annulments of some of the projects.¹⁰² The development of only a few projects still continues, although at a slower pace than initially planned. Table 6N5 in Appendix 6N presents a selected number of new upstream oil projects in Iran and their status. Although there are a few Chinese and Russian companies involved in the country’s oil sector, the activities of all western companies have been stopped.¹⁰³

Figure 6-9 Oil products consumption (thousand barrels daily)

Source: CBI.

In addition to its considerable proven oil reserves, Iran holds the second largest proven natural gas reserves after Russia and more than a third of OPEC’s reserves. The country’s proven natural gas reserves grew from 494 trillion cubic feet in 1980 to 1165 trillion cubic feet in 2010, and natural gas production increased from 1.2 billion cubic feet per day in 1970 to 14 billion cubic feet per day in 2010 (see Table 6N2 in Appendix 6N). The South Pars field, discovered in 1990, is an offshore gas field located in the Persian Gulf and the largest gas field, accounting for about 40 percent of the country’s gas reserves.¹⁰⁴ The country is also estimated to hold 2 trillion cubic feet of proven onshore and offshore natural gas reserves in the Caspian basin. In recent

102 The contracts with CNPC for the development of Phase 11 of the South Pars natural gas field and the South Azadegan field were cancelled in 2012 and 2013, respectively, due to project delays.

103 Further, according to the Iranian Constitution, the private or foreign ownership of natural resources and any kind of production-sharing agreements are not permitted. Instead, unattractive buyback contracts are allowed based on which an International Oil Company (IOC) enters into exploration and production activities via an Iranian subsidiary.¹⁰³ The contractor invests its own capital and expertise for the development of oil or gas fields. However, when the field is developed and production has begun, the field is given up to the NIOC or one of its agents. The IOC gets its capital costs back from a pre-determined percentage of the field’s production and rate of return which varies between 12 and 17 percent within a five to seven years payback period, presuming the field generates an agreed upon amount and the international energy prices are high enough (Van Groenendaal and Mazraati, 2006).

104 See Oil and Gas Journal (January 2014) for details. South Pars has a 24-phase development scheme, shown in Table 6J.3 in Appendix 6J, with a total cost expected to exceed 100 billion US $. The entire project is managed by Pars Oil and Gas Company (POGC), a subsidiary of NIOC. Production from phases 1 to 10 was originally designed to be allocated for domestic market consumption and reinjection. Production from the remaining phases is planned for export via 26 pipelines and liquefied natural gas (LNG) and/or used for proposed gas-to-liquids (GTL) projects (EIA, 2014). Other gas fields in Iran are Kish, North Pars, Tabnak, Forouz and Kangan.

0 100 200 300 400 500 600

1975 1980 1985 1990 1995 2000 2005 2010

LPG Kerosene Gasoline

Gas oil Fuel

179

years, there have been substantial gas discoveries in the country yet most of the natural gas fields are underdeveloped because of a range of constraints such as financial and technical as well as contractual barriers.

Figure 6-10 Iran’s natural gas imports and exports

Source: CBI.

Despite holding 17 percent share of the world’s natural gas reserves, the country has relied on imports of natural gas due to high domestic needs.¹⁰⁵ Figure 6.10 graphs Iran’s imports and exports of natural gas during 2001-2007. The imports and exports of natural gas respectively grew from 158.92 and 17.657 billion cubic feet in 2001 to 218.95 and 197.76 billion cubic feet in 2007 (see Table 6N2 in Appendix 6N). Natural gas has been used domestically for residential, commercial, industrial and transportation sectors, for electric power and for reinjection into oil fields to boost crude oil production through enhanced oil recovery (EOR) techniques. The country’s natural gas consumption grew from 0.89 billion cubic feet in 1970 to 13.9 billion cubic feet in 2010. Figure 6.11 depicts the development of natural gas production and domestic consumption (the panel on the top left) and the share of domestic natural gas consumption in total gas production (the panel on the top right) during 1973-2007. At large, both natural gas production and domestic consumption increased on average by 5.6 percent and 10 percent per annum, respectively, suggestive of the higher growth rate of domestic consumption compared to that of production. Over the same period, the share of domestic gas consumption in total production increased from 25 percent in 1973 to 85 percent in 2007.

105 The majority of the country’s natural gas imports come from Turkmenistan and the remainder from Azerbaijan.

The country also exports gas mainly to Turkey and to a lesser degree to Armenia and Azerbaijan Iran exports natural gas to Nakhchivan in Azerbaijan through the Salmas Nakhchivan pipeline. In return, Azerbaijan exports natural gas to the Northern provinces in Iran through the Astara-Kazi-Magomed pipeline. The NIOC started construction projects in the past to build an LNG export plant, but it has not yet built a liquefaction facility mainly due to the lack of technology and finance stemming from international sanctions. The proposed regional gas pipelines include Iran-Iraq pipeline, Iran-Oman pipeline, Iran-Pakistan pipeline and Iran-UAE gas contract.

0 40 80 120 160 200 240

2001 2002 2003 2004 2005 2006 2007

Natural gas exports (billion cubic feet) Natural gas imports (billion cubic feet)

180 Figure 6-11 Natural gas production and consumption

Natural gas production and domestic consumption Natural gas consumption in total gas production

Note: Constructed based on data in billion cubic meters. Source: CBI.

During 1970-2010, the oil sector’s value added and investment recorded average annual growth rates of 2 percent and 10 percent, respectively, indicative of investment inefficiency in the sector given the higher growth rate of the latter compared to that of the former (see Appendix 6N Table 6N2). The share of the oil sector’s value-added in total output, shown in Figure 6.12 (the panel on the top left), fell by an annual average rate of 2 percent during 1970-2010. The share of the sector’s investment in total investment, illustrated in Figure 6.12 (the panel on the top right), highly fluctuated and grew on average only by 3 percent per annum over the same period.

Figure 6-12 Oil sector’s output and investment shares

Share of oil real output in total output (%) Share of oil real investment in total investment (%)

Oil real output and real oil revenues (billion Rials)

Oil real investment and real oil revenues (billion Rials)

Note: Constructed based on data in billion Rials at constant 2004/05 prices. Source: CBI.

0 20 40 60 80 100 120 140 160

1975 1980 1985 1990 1995 2000 2005

Domestic gas consumption (billion cubic meters)  Gas production (billion cubic meters) 

20 30 40 50 60 70 80 90

1975 1980 1985 1990 1995 2000 2005

0 10 20 30 40 50

1970 1975 1980 1985 1990 1995 2000 2005 2010 0

2 4 6 8 10 12

1970 1975 1980 1985 1990 1995 2000 2005 2010

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000

1970 1975 1980 1985 1990 1995 2000 2005 2010

Oil revenues (billion Rials) Oil real output (billion Rials)

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000

1970 1975 1980 1985 1990 1995 2000 2005 2010

Oil revenues (billion Rials) Oil real investment (billion Rials)

181

The bottom left and right panels in Figure 6.12 plot the development of the oil’s output and investment against the movements of oil revenues, respectively. The former appears to co-move closely with the movements of oil revenues. This is not surprising as oil revenues are a function of oil output and oil prices. However, unexpectedly, yet consistent with the empirical findings, investment in the oil sector does not appear to follow the movements of oil revenues, with the exception of a small rise in investment in the sector after the first oil shock. Over these years, the oil sector’s share of investment in total investment averaged merely 4.7 percent.

Figure 6-13 Government’s revenues and expenditures

Oil revenues and government’s public expenditure Oil revenues and government’s payments

Note: Constructed based on data in billion Rials at constant 2004/05 prices. Source: CBI.

At first, the non-trending pattern of the sector’s investment with oil revenues and its low share of investment seem puzzling given the oil-driven nature of the Iranian economy as well as the country’s abundant oil windfalls during these years. There are, however, some major underlying factors which contributed to this pattern. During the period under study, the government over-relied on oil income to finance its public expenditure. The co-moving pattern of oil revenues and the government’s public expenditure between 1970 and 2010 is depicted in Figure 6.13 (the panel on the left). In this picture, the share of the government’s current expenditure amounted to 72 percent of total expenditure. This, in return, adversely affected the government’s budget available for development and capital spending in various economic sectors. Particularly the share of investment in the oil sector reduced to a very low level. Even the National Development Fund (NDF), which was introduced in 2009 to replace the country’s Oil Stabilization Fund (OSF), allocated merely 14 percent to the National Iranian Oil Company (NIOC).¹⁰⁶

106 According to the rules of the NDF in 2009, 63.5 percent of oil and gas are allocated to the national budget, 20 percent to the NDF, 14.5 percent to NIOC, and 2 percent to impoverished and oil-based regions (IMF, 2011, p.8).

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000

1970 1975 1980 1985 1990 1995 2000 2005 2010

Real government's public expenditure (billion Rials) Real oil revenues (billion Rials)

0 20,000 40,000 60,000 80,000 100,000 120,000

1970 1975 1980 1985 1990 1995 2000 2005 2010

Real government's total payments (billion Rials) Real government's current payments (billion Rials) Real government's development payments (billion Rials) Real oil revenues (billion Rials)

182

A sizable part of the government’s current expenditure was spent on subsidies including domestic energy subsidies, accounting for about 15 percent of the government’s national budget.

In short, the oil sector seemed to have been caught in a vicious circle. During most of the years under consideration, the imposed sanctions against the Iranian oil sector and the resulting insufficient foreign investment, expertise and technology coupled with the maturity of existing oilfields undermined the production capacity of this key sector in the Iranian economy.

In document Economic Determinants of Domestic Investment in an Oil-Based Economy (Sider 189-200)