The Fuse

Soap Opera Surrounding New Iran Contracts Enters Final Act

August 23, 2016

Guest Post by Matthew M. Reed | @matthewmreed

Matthew M. Reed is Vice President of Foreign Reports, Inc., a Washington, DC-based consulting firm focused on oil and politics in the Middle East.

The drama surrounding Tehran’s new oil contracts is coming to a head. After many delays and postponed conferences, the new terms were officially unveiled in Tehran last November. But it wasn’t until this month, six months after the toughest oil sanctions were lifted, that President Rouhani’s cabinet approved the new contract model. The last major obstacle is a high-level implementation board, overseen by the speaker of parliament, which will decide whether or not the terms are consistent with the country’s national interest. That decision could be announced in the coming weeks. Assuming the terms are endorsed, Iran can start issuing tenders later this year.

Assuming the terms are endorsed, Iran can start issuing tenders later this year.

Nothing about this was straight-forward. There have been countless false starts and much wrangling behind-the-scenes. The Rouhani government is proceeding carefully in order to deflect the wrath of hard-liners opposed to his agenda and re-election. In response to critics, officials have argued that foreign investment is a necessity, local content requirements will promote domestic industries, and joint oil projects can protect Iran from new sanctions. But the showdown isn’t over yet. Oil Minister Bijan Zanganeh is still responding to critics on a daily basis. He’s giving the impression that the new model will be finished soon, although this week Vice President Eshaq Jahangiri ordered the finance and oil ministries to proceed as if it was.

Oil officials have made it clear that Iran needs foreign expertise to revive aging fields and ramp up production. “Some companies think we want money from them,” Zanganeh said last year. “No, our problem is not only money. Our most important need is technology.” Iranian production—reported to have hit 3.85 million b/d—is up this year by some 750 thousand b/d according to official data. Exports are above 2 million b/d. In spite of these gains, it’s questionable whether or not today’s volumes are sustainable.

Oil Minister Bijan Zanganeh is still responding to critics on a daily basis. He’s giving the impression that the new model will be finished soon, although this week Vice President Eshaq Jahangiri ordered the finance and oil ministries to proceed as if it was.

Other officials praise local content provisions which will require foreign companies to partner with Iranian ones. Zanganeh has said he wants to build up Iran’s manufacturing base by licensing foreign equipment, building it inside Iran, and using it for new oil projects. There’s nothing controversial about that. But in an interview last year, Zanganeh took it a step further when he described a “market-for-market” arrangement. This scheme would force foreign companies to source equipment from Iran in exchange for upstream access, only to then grant Iranian manufacturers the exclusive right to sell that equipment to regional markets using the foreign brand name. Zanganeh called this a “key point” last summer. It may prove to be a “key sticking point” for IOCs, since they’d be asked to forfeit business elsewhere.

Another popular argument among officials is that foreign investment will protect Iran from aggression. If you invite European, Chinese and Russian companies to do business inside the country, the thinking goes, it’s a safe bet those companies will pressure their governments on your behalf. Officials also plan to prioritize those fields that Iran shares with neighbors. In theory, this will promote Iran’s regional integration and the normalization of relations with neighboring Arab states, among others. Defenders of the new framework say future deals are a kind of insurance policy because they give foreigners a stake in Iran’s security and prosperity.

Another popular argument among officials is that foreign investment will protect Iran from aggression. If you invite European, Chinese and Russian companies to do business inside the country, the thinking goes, it’s a safe bet those companies will pressure their governments on your behalf.

For critics of Rouhani and Zanganeh, there are no good options for killing the new terms. After Rouhani’s cabinet approved the framework on August 3, some members of Iran’s parliament—the Majlis—demanded that a vote be held; others have called for the model to be abandoned and Zanganeh to be impeached. Yet Majlis Speaker Ali Larijani and the Head of the Majlis Energy Committee, Fereydun Hasanvand, agree no parliamentary vote is required by law. Zanganeh, who has briefed Larijani and Hasanvand several times this summer, says only a few more changes are to be made. He wants to start issuing tenders as soon as possible.

New deals, some details of which were published last November, are to be considerably more flexible than the old buy-back contracts, which were notoriously rigid and short-term. By contrast, new deals are to be 15-25 years in length. Fixed per-barrel fees are to be replaced with more flexible compensation rates that account for changes in the price of oil as well as geological complexities that can lead to delays and cost overruns. IOCs could recover costs more quickly as a result; delays would be less problematic because of the term length.

It’s worth noting that these terms were first published almost a year ago. Since then, dozens of changes have reportedly been made following internal government discussions. Supreme Leader Ali Khamenei warned last month that the contracts still needed some tinkering. Are these changes big or small? We don’t know. Recently, Zanganeh assured lawmakers that IOCs will not be allowed to book reserves. He also promised that all arbitration will be handled by Iranian courts. As with any “market-for-market” scheme, this too will give foreign companies pause.

Recently, Zanganeh assured lawmakers that IOCs will not be allowed to book reserves. He also promised that all arbitration will be handled by Iranian courts. As with any “market-for-market” scheme, this too will give foreign companies pause.

If the political soap opera is entering its final act, then the tendering process will be the finale for this tortured oil story. The oil ministry wants to attract $150 billion over five years. But doing business with Iran is still tricky. Reliable banking channels will have to be made available. For banks and IOCs, due diligence is a nagging concern because they have minimal confidence in Iran’s corporate registries (proving ownership, etc.) and worry about the prevalence of front companies and the pervasive influence of the Iranian Revolutionary Guard Corps. The IRGC-run Khatam al-Anbiya engineering firm was one of eight companies approved by Tehran to partner with foreign companies when the time comes. It remains sanctioned.

These issues aside, Iran’s appeal will also depend on whether or not the market outlook warrants big commitments when the industry is on track to cut investment by $1 trillion from 2015-2020.

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