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Iran has high hopes for slick new oil contract model

Iran's soon-to-be unveiled oil contract is designed to attract foreign investment amid the toughest investment climate in years, but what distinguishes it from the current model contract?

Iran has devised a new contract model — designed to benefit both the National Iranian Oil Company and international contractors — that it hopes will bring in billions of dollars in investments.

Unlike some other countries, Iran's oil rights can't be transferred to international oil companies. Iran has been using a unique model of buy-back contracts designed to attract international companies to invest in its oil and gas industry, but the model has not been very successful due to its limitations. So to gain access to advanced technology and international investments, Iran will soon unveil a new plan.

The new Iran Petroleum Contract (IPC) is to be presented officially in Tehran and London the week of Nov. 28-29. However, Oil Ministry officials have already explained the plan's details to Iranian MPs, experts, scholars and even the public through interviews and speeches. Mehdi Hosseini, secretary of the Iranian oil contracts revision committee, has held almost 80 meetings in parliament on the matter. Moreover, President Hassan Rouhani's administration formally adopted the contract in late September, and Vice President Es’haq Jahangiri announced its details in late October.

The IPC was developed to address shortcomings of the present buy-back model, and it is slated to replace it. Iran expects to be free soon of financial, banking and oil sanctions and hopes to attract $185 billion in investment in its oil and gas sectors during the next five years via initiatives such as the IPC.

The contract is significantly different in legal and financial aspects from the present buy-back model, which has been in use for decades. The new contract, which was approved Sept. 30 by the Iranian government, has two main goals: to protect the Iranian state’s rights to its oil and gas resources through the Oil Ministry and to avoid having to guarantee contracts through the Iranian Central Bank or government financial institutions.

The major difference between the IPC and the present buy-back model is in their sections on legalities, where the interests and commitments of the parties — an international oil company and a national oil company (NOC) — are laid out with the intention of protecting and increasing the interests of the Iranian side, while aligning them with those of the international side.

As with other oil contracts, the IPC model includes four phases: exploration, development, production and enhanced/improved oil recovery.

According to the legalities of the newly devised model, an NOC or its subsidiaries, along with international investors, will form a joint company to carry out any of the three phases of exploration, development and production. The joint company will only be responsible for developing the fields as a consultant, with all exploitation rights reserved for the Iranian side — the NOC. However, the joint operating company can take charge of the enhanced oil recovery phase in collaboration with the joint development company in order to strengthen its technical and financial capacity.

A positive change seen in the contract is the longer duration of stay for international companies. The new contract will last 15-20 years, providing foreign firms with better continuity for the exploration and development phases. In contrast, the present buy-back contract provides for a typical life cycle of only five to seven years.

Moreover, under the IPC, the investor company will finance the joint company and the required technology will be sourced in Iran, if possible. Furthermore, monetary compensation and taxation policies are based on full recovery of costs, remuneration fees and incentives for the investor to lower costs and increase production while protecting oil resources.

In this type of contract, 50% of the income from sales is allocated as “cost oil” for full cost-recovery purposes. To create incentives to drive down costs, a proportion of the saved cost, based on a defined Cost of Savings Index, will be paid to the investor in rebates. This will amount to as much as 5 to 10 barrels of oil, for savings equal to the cost of 1,000 barrels, according to Hosseini. There is also an incentive mechanism to encourage the investor to stick to the maximum efficient rate of the reservoir.

The IPC model also allows the investor to benefit from possible increases in oil prices over the span of the contract. In buy-back agreements, the contractor’s remuneration fee is set based on the project’s rate of return, which is also defined in the contract. In contrast, IPC does not set a return rate. It only indicates remuneration and payment conditions. In other words, instead of a constant figure as payment amount to the contractor, IPC allows payment to increase based on the geographical conditions of the field or even the oil market. This change, in particular, is in the interest of international contractors and encourages them to invest in Iranian oil and gas fields.

Under the IPC model, the investor’s income is directly related to risk. For instance, production operations in southern fields with relatively easier conditions will be rewarded with different income and benefits than operations in the central deserts or the complicated region of the Caspian Sea. Moreover, the investor’s profit is no longer linked to its costs, but to production levels. Instead of getting paid directly by NOCs, the investor will earn income through the oil field in question. In other words, more production will result in more income. However, to protect oil fields against possible damage due to overproduction, the contract life cycle is limited to 15-20 years and contractors are legally bound to preserve the fields.

Moreover, under the IPC, a management committee consisting of representatives from both the contractor and the employer will supervise the contract's implementation. The committee will assess plans, budgets and progress of the contract — for instance, the number of wells, excavation methods and progress, rig building and the oil market. This means that even though the contract runs for 15-20 years, plans will be assessed and revised annually based on the conditions of the field and the oil market. In contrast, under buy-back contracts, investors are not remunerated unless they meet the expected production rate. In such situations, the contractor would typically try to reach the target for at least one month to receive full payment. However, not only would the production rate plummet immediately after this period, but the field could be damaged.

The IPC also changes dispute resolution regulations. Nevertheless, Iranian local laws will still govern the contracts, and Iranian courts will handle disputes.

Hosseini said Iran's ultimate objective is to own oil companies active at the international level by the end of the new round of contracts. Whether the IPC will achieve this ambitious objective is far from clear. What is clear is that the IPC has the potential to fundamentally redefine the Iranian energy industry.

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