The Fuse

Uncertainties Loom Over Iran’s Petroleum Contract Despite Revisions

by Mehrun Etebari | August 05, 2016

On Wednesday, the Iranian cabinet gave approval to revisions of the Iran Petroleum Contract (IPC), the model oil and gas field development terms that Tehran hopes will set the stage for large-scale investment by international oil companies in the Islamic Republic. Although revisions to the IPC, which are aimed at allaying the concerns of conservative elements of the Iranian government, raise questions about the attractiveness of Iran’s business climate for foreign companies, the approval represents a major step forward to opening Iran for business. Moreover, as the administration of President Hassan Rouhani, facing a re-election fight in less than a year, deals with increasing clamor from hardliners who claim the nuclear deal has brought insufficient economic benefits, the pressure on the Oil Ministry to land significant contracts is immense.

Although revisions to the IPC raise questions about the attractiveness of Iran’s business climate for foreign companies, the approval represents a major step forward to opening Iran for business.

On Monday, Supreme Leader Ali Khamenei publicly complained that Iranians have seen no tangible improvement more than six months after the implementation of the Joint Comprehensive Plan of Action (JCPOA) concluded between Iran and the P5+1 nations over its nuclear program. He said, “The JCPOA as an experience proved again the fruitlessness of negotiations with the Americans, their disloyalty and the necessity for distrusting the U.S. promises and showed that the way for the country’s progress and improving people’s living conditions is paying attention to the domestic potentials and not the enemies who are continuously rocking the boat for Iran in the region and the world.”

Oil exports surge

Such remarks no doubt add to the sense of urgency facing Rouhani, the catalyst of Iran’s diplomatic push, to deliver economic benefits. Rouhani, in a televised appearance on Tuesday, chimed in with blaming the U.S. for not fully following the agreement in good faith and holding back Iran’s economic recovery. But he also highlighted the progress Iran had made in ramping up oil exports and production numbers. He accompanied his defense with Oil Ministry charts showing total oil production, including condensate, of 4.15 mbd for the Iranian month ending July 21, with exports of 2.43 mbd, up from 3.5 mbd and 1.35 mbd respectively over the final ten months of full sanctions.

The current Five-Year Development Plan, running through March 2021, calls for crude oil production to rise to over 4.6 mbd by 2020 and for condensate to increase to 1 mbd from levels below 0.5 mbd during sanctions.

While June totals were a five-year record for Iranian crude oil output at 3.63 mbd (not including condensate), even ambitious government targets see the recovery only allowing Iran to reach 4.0 mbd in 2016. Beyond returning to pre-sanctions levels, however, the government’s aims for the next few years will require substantial investment. The current Five-Year Development Plan, running through March 2021, calls for crude oil production to rise to over 4.6 mbd by 2020 and for condensate to increase to 1 mbd from levels below 0.5 mbd during sanctions.

Western IOCs show interest

Representatives of Lukoil, Total, and ENI all met with Iranian Oil Minister Bijan Zanganeh during June’s OPEC meeting in Vienna, and Zanganeh has said Iran expected to sign contracts with all three. At the time, his comments pointed to the first contract being signed by September, although National Iranian Oil Company (NIOC) Managing Director Ali Kardor said this week that news on contracts will come in the next six months. Other companies that once worked in Iran, such as Royal Dutch Shell—which resumed oil purchases from Iran in June, are expected to show interest in the new contracts as well.

Despite the optimism from the Rouhani administration, the process of finalizing the contract terms has taken far longer than desired. Zanganeh said in an interview given to Reza Zandi of Iran’s Seda Weekly in June that delays should be expected, arguing, “Getting the contract approved takes time. It requires negotiations. It’s possible for a man to desperately want to become a father, but no woman can make a baby arrive in just a month.”

If the IPC is Zanganeh’s baby, its infancy will be critical to his efforts to rejuvenate Iran’s oil production. Assuming it is signed off on by the requisite parliamentary oversight committee and speaker Ali Larijani, the question will be whether the amended terms will attract sufficient investment to allow Iran to meet its output growth targets. After some domestic critics complained that the IPC gave unconstitutional levels of control over Iranian resources to foreign companies, Oil Ministry officials met with skeptics from different branches of the government and regulatory bodies. They made more than 150 revisions, including the addition of 4 articles to the previous 11.

NIOC given greater supervisory powers

The full text of the new model contract has not been released, but based on comments made by Zanganeh in his Seda interview, the substantial changes assuage concerns that too much control was being given to foreign companies. First, the updated IPC further clarifies and emphasizes that the oil in reserves remains the property of the government of Iran, not that of foreign firms extracting it. The NIOC is also given greater supervisory powers. If an NIOC subsidiary operating a field with a foreign company is instructed to perform any activity by a foreign entity as a result, it must be approved by the NIOC; similarly, it must also approve decisions of joint management committees set up with foreign companies. Further, regulators prompted the Oil Ministry to remove a clause facilitating the contracting of a nearby field to foreign companies who are unsuccessful in the exploration phase of fields they have successfully bid on.

Perhaps the biggest uncertainty arising from the revised IPC is that concerns about the increased control it would give to foreign firms. This question has forced the Oil Ministry to publicly state that it will not be the only contract used in the post-sanctions era. In certain cases, the NIOC will be able to use traditional pre-sanctions buyback contracts, which Zanganeh said will be considered “especially for greenfields.” The unpopularity of the buyback terms among IOCs in the pre-sanctions era could raise concerns about the long-term growth sought under the current five-year plan and beyond. While it appears that Iran’s most urgent efforts to expand production in the West Karoun fields near the Iraqi border, particularly the newly operational Yadavaran and North and South Azadegan fields, should use the more attractive IPC should a bidding round be opened, this change has not been confirmed.

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The IPC notably allows for foreign companies to operate Iranian oil and gas fields for a far longer time than under previous contracts—reportedly up to 20 to 25 years.

However, the IPC notably allows for foreign companies to operate Iranian oil and gas fields for a far longer time than under previous contracts—reportedly up to 20 to 25 years. What’s more, the traditional low cost of production of conventional fields in Iran may prove an attractive bet for IOCs wary of stubbornly low global prices, even if there is some uncertainty about Iran’s contract environment. Zanganeh told Seda that much of these concerns, and worries about political instability in an Iranian election year, should be ignored, as it is the product of domestic actors seeking to scare off investors to damage the Rouhani government’s reputation. “In my opinion, they have political motivations and are unable to comprehend the national interest,” he said.

Other obstacles

Further obstacles remain outside of the contract environment, however. Concerns about Iranian banks’ compliance with international standards and systems, and most importantly, with U.S. anti-terrorism sanctions that remain in force, have apparently scared many potential investors away from doing business in Iran (or scared international banks away from financing such investment). This phenomenon could well extend to oil sector investment. Questions remain about which domestic partners foreign oil companies will be able to work with—and with the approved partner list reportedly including US-sanctioned entities like the Islamic Revolutionary Guards Corps’ Khatam al-Anbia industrial conglomerate, navigating the partnership process will be a major concern for prospective investors as well. But if, as Zanganeh claimed, a new contract with a major IOC is imminent, this could set a positive example for wary parties and pave the way for the renewed investment needed for Iran to reach its long-term production goals—and perhaps bolster Rouhani’s case that the nuclear deal was in the best interest of Iran and its sanctions-ravaged economy.

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