Iran holds back on new oil contracts: foreign investments at risk

Iran holds back on new oil contracts: foreign investments at risk

Simone Cantarini (Agenzia Nova)
Foreign oil companies could even wait several months before being able to launch investment plans in Iran. The Tehran government has announced, several times, the adoption of a new contractual model, closer to international standards, however the project is still under examination and new contracts will have to wait

The new director of the National Iranian Oil Company (NIOC), Ali Kardor, confirmed in recent days that, at least in the short term, the previous contractual model, known as a "buy-back" model, in force since the ’90s and considered particularly risky by the major international oil companies, will be maintained. Kardor ha specified in a press conference that the future development of the Iranian oil fields will take place via the use of 3 agreement models: the classic buy-back model, the so-called EPCF (Engineering Procurement Construction and Financing) contract which requires companies to construct, develop and finance the project, and the new contractual model that is still being examined known as the IPC (Iran Petroleum Contract). Kardor has not provided any further details on the IPC and which conditions will be applied to it, apart from stating that "the common fields", that is the oil fields shared with countries, will be able to see the first use of the new contract type. The vague tone used by Kardor was interpreted by analysts as a freeze of the reform, due to the pressures of the most conservative fringes: a development that could slow down expected future investments and therefore oil production.
Kardor’s statements are also at odds with the statements made on June 27, 2016 in an interview with the Iranian press agency "ISNA" by Iranian Oil Minister Bijan Zangeneh himself, according to whom the country was planning to launch a series of bids for the development of its oil fields this summer, revealing the intention to implement the IPC contract as soon as possible. In the interview, Zangeneh provided various details on the matter, stating that the authorities had the intention of developing the first oil fields along the borders, including the southern Azadegan oil field, near Iraq, revealing the possibility of bids also in the field of exploration. The minister emphasized: "One of the most important challenges is to benefit from the shared fields. Iran needs to increase the amount of oil it can produce and needs technology, for better management and more funds. For this reason, we have prepared new contracts". Zangeneh had also revealed that the submission of bids to develop 10 to 15 oil and natural gas fields would be set by July, specifying, as priorities for development, phase 11 of the natural gas field of South Pars and the respective Farzad oil and gas fields. The minister had finally concluded by reiterating that Iran’s primary goal is to produce approximately 4.8 million barrels of oil per day and approximately 1 million barrels of condensate in the next 5 years.

The necessary participation of international companies

In May, Iran’s oil production amounted to 3.8 million barrels of oil per day while exports increased from 970,000 barrels in 2014 to 2 million in May. The rate of increase in output has surprised industry analysts, including the International Energy Agency, which had underestimated Teheran’s capacity to increase production just 6 months after the implementation of the Joint Comprehensive Plan of Action (JCPOA) which led to the lifting of the economic sanctions linked to the Iranian nuclear program. However, the level of production was reached by bringing plants up to their maximum capacity, making further substantial increases over the coming months impossible. To reach the amount of 4.8 million barrels within the next 5 years, Tehran has the absolute need to attract up to $200 billon of investments to develop obsolete extraction plants. Such a huge investment is only possible through the involvement of international oil companies which, however, refuse to invest in the country on the basis of "buy-back" contracts.
The main international oil companies active in the Iranian market prior to the sanctions have recorded substantial losses due to the conditions imposed by the contracts, the effects of which came to light following the decision of the International Community to impose restrictions on the Iranian economy. Despite the visits made by the western company leaders in Tehran, a year after the agreements on the nuclear issue were signed, the idea to begin investing again in Iranian oil fields remains linked to the application of new IPC contracts. The issue of new IPC contracts looks increasingly like a political, as well as economic, problem. The supporters of Iran’s opening to the international markets and its rules are, firstly, President Hassan Rohani’s followers who gained acclaim in the latest parliamentary elections last February, thanks to the prospects of the Iranian nuclear agreement, including the return of foreign investors. Iran’s political structure, which is dependent on the final judgement of the Council of Experts and the supreme leader, Ali Khamenei, as regards the reforms in strategic sectors such as energy, therefore results in an advantage of the exponents of the radical line, whose followers hold various prestigious positions in the main sectors of the Iranian economy.

How the IPC functions

The new contract model was proposed in November 2015 in a conference in London, during which, however, only the general sections were revealed. On that occasion, Zangeneh had assured that the official approval would take place within 6 months. The IPC contract is essential for achieving the development of the entire sector and for being able to compete on par in the medium term with competitors such as Saudi Arabia, Iraq, Kuwait and the United Arab Emirates. The new contractual model provides for the establishment of a joint-venture between foreign companies and the state company NIOC, which will own 51%. The national company will participate in the exploration, development and production phases. The contracts between foreign companies and NIOC will last from 20 to 25 years and will offer a flexibility of payment on the risk assumed for explorations and the development of oil fields with high investment costs. Once production starts, the foreign company will receive a payment for its service and for exploration and development costs. A management committee of the joint-venture comprising members of the foreign company and the NIOC will examine the costs of the exploration and development phase in order to approve any overspending compared with the initial budget.
The new oil contract under scrutiny in parliament is a modified form of the so-called "production sharing" agreement, in order to respect the Iranian Constitution, which does not allow the sharing of oil production with foreign entities. The sharing agreements are currently in use in Iraqi Kurdistan, Oman and Egypt. As regards the agreement proposed by Iran, costs relating to development are 50 percent covered by the annual output of the joint venture, while the cost of the service is paid through production volumes.
The formula designed by Tehran is not, however, without faults: ambiguities on base fees paid by the state-owned company to the foreign company; oversight and accountability of the joint venture management committee; lack of clarity on the independent sale of oil production and on the possibility for foreign companies to place oil reserves in the budget. The latter aspect is particularly important as it would offer companies the possibility of exploiting the reserves for financing the project. However, according to the Iranian Constitution, all of the country’s energy reserves belong to the state, even if the agreement seeks to circumvent the rule, by using long-term production agreements.