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Iran offers new terms for oil contracts

Although international sanctions are still in place pending the outcome of the nuclear talks, Iran is proposing new investment contracts to raise profits and reduce risks to attract international companies to its energy sector.
Iranian Oil Minister Bijan Zanganeh talks to journalists before a meeting of OPEC oil ministers at OPEC's headquarters in Vienna December 4, 2013. Zanganeh said on Wednesday he expected Iranian oil output to reach 4 million barrels per day at the end of next year. REUTERS/Heinz-Peter Bader  (AUSTRIA - Tags: POLITICS ENERGY) - RTX1635R

Iranian oil officials introduced a new type of investment contract for its upstream energy industry at a two-day conference in Tehran on Feb. 23. The new Iran Petroleum Contract will offer greater incentives to international oil and gas investors by offering higher potential profits and lower investment risks. The goal of contract is to attract investment and technology to the Iranian oil industry and to increase the industry’s overall crude oil and natural gas production.

Over the past decade, international sanctions have thwarted the required (and necessary) levels of investment and technology for Iranian oil and gas fields. Sanctions reduced Iranian oil production capacity from over 4 million barrels a day to around 3.5 million to 3.7 million. Iran possesses the second-largest natural gas reserves in the world, but has less than 1% of global market share. Iran still might not be able to gain any new oil and gas investment contracts — largely due to sanctions still in place — until it reaches a complete agreement with the West on its nuclear program. Only then, by offering more flexible terms, could Iran once again draw investors’ attention toward potential exploration and development projects.

From buy-back to Iran Petroleum Contract

After the Islamic Revolution in 1979, Iran revised its policies toward international investors in the energy sector. In the 1990s and early 2000s, Iran introduced buy-back contracts (a kind of service contract) to international investors for the first time. At that time, buy-back contracts allowed investors to participate in developing old oil fields with the aim of increasing their recovery factors. Later on, Iran extended the terms of buy-back contracts to exploration projects. Similarly, this allowed investors to work on green fields and sign exploration projects.

Buy-back contracts were revised for a third time to reduce investment risks, by offering more flexibility in investment costs. But it was not successful at keeping international companies such as Total and Eni in the country. This was further compounded by Iraq’s situation in 2004 and 2005, since the country offered more flexible investment models, a new market and heightened competition in the region.

Bijan Namdar Zanganeh, the former (and current) Iranian petroleum minister, introduced the buy-back contracts in the late 1990s. Now, he has assigned a committee to revise oil investment contract models to increase Iran’s natural gas and crude oil production capacity, with the ultimate aim of regaining its lost market share and position.

The sanctions noose has increasingly tightened around the neck of Iranian energy since 2003. But, it should be remembered, this is not Iranian officials’ first attempt to attract international investors by offering better incentives. In 2013, for the first time, Iran offered production-sharing contracts for investment in upstream energy fields. These contracts theoretically allow oil companies to recoup their investment expenses quicker than under buy-back agreements. The National Iranian Oil Company offered this contract to an Indian consortium of three companies to develop the offshore Farzad B gas field, which is located in the Farsi block of the Persian Gulf. Negotiations over developing the Farzad B gas field had been in progress with the Indian consortium since early 2009. Even though sanctions on investment in the Iranian energy industry are much tighter than in 2009, Indian companies still seem to be interested in inking a deal with Iran under production-sharing contract rubric. Indian officials have been quoted as saying, “Why should we leave this offer for others?”

Zanganeh, however, has run into a constitutional roadblock. According to Iran’s post-1979 constitution, ownership of land and resources is vested in Iranian nationals. Assigning ownership of fields and reservoirs to foreign nationals would, technically, be against the law. Nevertheless, the buy-back system is a rather uncommon type of agreement for high-risk upstream energy investments. Though sanctions and the legal dubiousness of the proposal qualify such investments as risky, the potential is there.

According to Iranian officials, in more than 15 years, buy-back contracts have attracted up to $50 billion for Iran’s energy industry. Yet, when one combines the buy-back contracts’ higher risks and lower profits with the pervasive pressure of international sanctions, this makes for a fairly dysfunctional arrangement for Iran’s energy industry.

Iran Petroleum Contract terms

The Iran Petroleum Contract seems to be an altogether different approach, which proposes a joint venture with international companies for exploration, development and production projects. Marking a major change is the contract’s involvement of foreign companies in the actual production process, whereas previously, international companies were only involved in exploration and development. Under the contract, though, foreign investors will have an actual hand in production — something unseen since the 1979.

According to Iranian officials, this helps Iranian companies gain technology and expertise in developing fields. Based on this agreement, the foreign partner will be paid for the work with a share of the field production. This will particularly help Iran take advantage of foreign companies’ marketing expertise and give Iran access to their supply network to find an export market for the field’s production. Iran lost some of its market share due to sanctions and limitations on its oil exports.

Yet, the global energy market is expected to face oversupply in the mid-term due mainly to the shale revolution in North America and new Iraqi supplies. Seen from this perspective, having international partners as joint producers and market conduits for its oil would be of immense help to Iran.

The other major change in the Iran Petroleum Contract is with regard to exploration. Previously, under buy-back contracts, investors would not be paid if they failed to discover any usable fields. The new petroleum contract allows the investor to participate in other exploration projects if there are no results from the initial fields in which it invested. According to Seyyed Mehdi Hossein, head of the committee that revises oil investment contract models, “The ownership of the reservoir belongs to the people and cannot be transferred.” But the new type of contract allows international investors to include their revenue from Iranian hydrocarbon resources in their annual financial and monetary reports — their bottom line. So, the petroleum contract makes ownership, in the legal and technical sense, less of a debilitating factor than it might otherwise be.

Yet, the new Iran Petroleum Contract has a cost-benefit. The new contracts’ duration is much longer, lasting up to 20 or 25 years, almost double the length of buy-back contracts. Previously, international investors had to leave the field within three to five years after completion of work. Iran hopes to increase the quality of its work and protect the reservoir by involving investors for longer periods of time and giving them a more vested stake in the field. This factor could have a political advantage for the Iranian side, as international partners would have shared profits and interests in Iran for longer.

The proposed terms in the new Iran Petroleum Contract are much more flexible and have greater incentives than buy-back contracts. Iranian officials are hoping to once again attract and motivate foreign investors to invest in their energy industry by changing their upstream investment model. However, current sanctions on Iran’s energy industry are still in place and play a major role in preventing the transfer of crucial investment and technology. Therefore, reaching a final agreement with the P5+1 group over Iran’s nuclear program seems to be the main game changer, along with more attractive terms of investment for the country’s energy industry.

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