The Fuse

Political Risks Cloud Iran’s Efforts to Entice Western Oil Firms

by Matt Piotrowski | February 11, 2016

Although Iran has diligently reformed its petroleum contract to attract international oil companies (IOCs), the OPEC country is still dealing with a volatile political and economic environment that could delay and possibly undermine new and longer-term investment.

International sanctions against the Islamic regime have been lifted and the country has gone through a political sea change, but there are still ongoing political risks that could cause IOCs to balk on returning to Iran despite sweeter terms.

Although Iran has diligently reformed its petroleum contract to attract IOCs, the OPEC country is still dealing with a volatile political and economic environment that could delay and possibly undermine new and longer-term investment.

Iran still has a “testy” political situation which is “deeply unstable,” said Suzanne Maloney, Deputy Director, Foreign Policy Program at the Brookings Institution, at the Atlantic Council Global Energy Center’s event this week on the Iran Petroleum Contract (IPC). In the current circumstances, foreign companies “will have to proceed carefully.” During the talk, Maloney emphasized the “arbitrary” judicial system as a possible deterrent to investment.

Despite the transformation of political viewpoints under President Hassan Rouhani, “there won’t be a quick fix,” which will force IOCs to proceed carefully even when they return: There will always be the possibility that Iran could revert to being hostile to foreign investors. “There is the potential for political shifts that would change the investment environment,” Maloney said. Under the new IPC, which has yet to be formally released, IOCs will have the opportunity to sign long-term deals. When considering investment in Iran, companies will have to consider not only the oil price outlook, but also the geopolitical risks and domestic political environment for the next two decades.

Iran

The thorny issue of foreign investment in Iran stems from the country’s economy being very political. And since oil is important to the economy, oil is therefore very political and always will be. There are still hardliners who are pushing back against foreign investment, and resource nationalism has always been very strong in Iran. But sentiment has shifted sharply, not least because of the severe hit to the economy and the country’s oil and gas infrastructure from sanctions. Maloney said there is less anxiety about outside investors because years of sanctions “reinforced a consensus around a need for foreign investment.” She added that sanctions “punctured the notion among conservatives that Iran didn’t need the West.”

The new contract

Iran is making the terms of the IPC as attractive as possible while also looking after its own economic interests.

Iran is making the terms of the IPC as attractive as possible while also looking after its own economic interests. The new contract has not been officially unveiled and has been postponed a number of times, with the London conference scheduled for the third week of February being cancelled. The IPC has been delayed due to inter-agency rivalries, the country’s arbitrary legal system, and the need to iron out ambiguities. The process has been slowed by the fact that the country doesn’t have an energy regulatory body.  The panelists at the Atlantic Council event reinforced the notion that it is important the country gets the terms right before the contract is unveiled, because it sets the groundwork for individual agreements that will be negotiated with firms.

Despite the setbacks and delays, Tehran is on the right path in its contract terms, according to the panelists.

“NIOC clearly understands the expectations of IOCs,” said Guly Sabahi, a partner of the energy sector team at the law firm Dentons, referring to the National Iranian Oil Company. The IPC is trying to “strike the right balance” between the government wishes and the goals of the IOC, Sabahi said.

atlanticevent

The IPC will be fundamentally different than the previous system which consisted of a buyback scheme. Important details of the new contract include:

  • A production sharing process. Firms will be involved in production and not just marketing crude.
  • The duration of contracts will be longer than before. Instead of contracts lasting 5 to 7 years, their duration will be for 20-25 years in an attempt to provide stability for the fields and investors.
  • Fee per barrel based upon risk factors. The higher the risk factor, the higher the fee per barrel, with the largest fees for deepwater and shared fields with other countries.
  • IOCs can’t book reserves in the traditional sense, but the IPC does provide flexibility in this regard. Investors will be able to show revenues from Iranian oil and gas resources in their financial reporting, which is crucial for publicly traded companies.

Low oil prices, no problem

The weak price may actually help Iran attract investment.

With oil prices now around $30 per barrel and OPEC countries pumping at a very high level, it’s obvious the current environment is a tough time for Iran to increase its exports and try to lure foreign investors. The weak price may actually help Iran. Sara Vakhshouri, the founder and president of SVB Energy International, said that the low oil price is actually a “lucky charm” for Iran given its low-cost production.

With oil prices at current levels, investment in Iran becomes more attractive for IOCs as they search for low-cost opportunities. Moreover, Vakhshouri noted, the fee per barrel will rise with the price. “First production from fields won’t be for five to seven years, when prices are higher,” said Vakhshouri, who also noted that countries are more interested than companies in putting together deals with Iran, which does the largest amount of non-dollar oil sales of any country.

Optimistic future, lots of risks

Tehran has been in ongoing talks with IOCs to determine what terms are amenable to them. Many are eager to take advantage of the country’s untapped resources, especially given how vast they are and the low cost of production. Any political instability, however, could slow down or halt the ambitions of both Tehran and IOCs.

 

 

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