Iran has surprised many global market experts with how rapidly it has increased crude oil production, following the January international agreement that lifted nuclear-related sanctions against the country. Production rose by 25% to hit the pre-sanctions level of 3.6 million B/D in April, shattering major analysts’ predictions that it would take a year to do so, and increased to 4 million B/D during the summer. Exports have doubled to more than 2 million B/D.
However, notwithstanding Iran’s early success, most market observers believe the country will be challenged to sustain a 4 million B/D output for the rest of the year. And for Iranian production to grow to 4.8 million B/D in 5 years, a goal that Petroleum Minister Bijan Zangeneh stated in June, the country will require a large infusion of capital from international oil and gas companies.
To keep its ambitions on track, Iran has set an objective of attracting USD 180 billion in international investment for its oil and gas sector. Of this amount, between USD 70 billion and 100 billion is needed for upstream projects, and Iran hopes to bring in from USD 20 billion to 30 billion of that for projects in its initial tendering round for licensing projects.
The Iran Petroleum Contract
Understandably, the global industry has been paying close attention to the Iran Petroleum Contract (IPC), the new framework approved by the Iranian government in early August for signing agreements with international operators to explore for and develop oil and gas resources in the country. While the framework was approved, questions remain over numerous details.
For priority projects under the IPC, Iran worked from a technical services contract model, under which an operating company bears all capital costs up to first production, or targeted incremental production, and begins to recover its costs from production proceeds. The percentage of proceeds from which costs can be recovered may be negotiated field by field but will not exceed 50% for oil fields and 75% for gas fields.
Previously, Iran used a system of buy-back contracts. Under these, the operator’s capital investment level and cost-recovery period were negotiated with the government and a fixed rate of return was set. If exploratory drilling led to a viable project, the operator’s capital expenditure for exploration and development was considered a loan to the state. The government compensated the company through annuity payments that began when production started, or a production target was met, and continued for the life of the contract.
Iran is likely to continue using buy-back contracts for lower priority projects. An important question is where it will draw the line between IPC projects and those on a buy-back or other contractual basis.
How Much Improvement?
“Although the IPC is likely to improve terms for foreign investors, still the question is by how much?” said Homayoun Falakshahi, Middle East and North Africa upstream research analyst at Wood Mackenzie. With new regions of activity and technology that has been developed, the industry is much more competitive than it was 20 years ago and has more global investment options, he said. Iran cannot afford to ignore today’s competitive landscape. However, the country offers low per-bbl development costs, low geologic risk, and high production volumes, which together have added attraction in the current low-price environment.
Before approval, the IPC framework was scrutinized by Iran’s Parliamentary Energy Committee, the National Audit Agency, and Supreme Leader Ali Khamenei, and was criticized for being too generous to foreign investors. As a result, the contract was revised to state clearly that foreign companies will not own any Iranian oil, and contracts established under the IPC are service contracts.
Iran is developing a list of international companies that will be eligible to participate in projects within the country. For eligible companies to invest in Iran’s oil and gas sector, they will need to form joint ventures (JVs) with local Iranian companies. In July, the government published a list of eight local companies that would satisfy the JV partner criteria.
The IPC framework stipulates that all decisions made by a JV will require approval by the National Iranian Oil Company (NIOC). This could slow the decision-making process. Ambiguity concerning the transition from an exploratory contract to the development phase is not yet resolved; no payment guarantee is offered to the international oil company (IOC); and the issue of the ownership of project assets could cause legal, insurance, and operational challenges.
“The IPC framework still holds serious ambiguities,” said Syd Nejad, chief executive officer and managing partner at NAFT Energy. “It is likely that the finalization of IPC terms will take place through bilateral negotiations with the very first bidding parties.”
Tenders Schedule Slips Back
Because of the extensive review the IPC received, and other reasons, the first round of international tenders (bids) under the IPC for participation in Iranian projects has been postponed several times and will take place this fall at the earliest.
With an eye toward next year’s presidential elections in Iran, the administration of President Hassan Rouhani is pushing NIOC to negotiate a few large projects with IOCs before the bidding round, Nejad said. If successful, this could give early impetus to Iran’s ambitious production expansion plans.
The delays in scheduling the IPC tenders have occurred “to make sure that all political parties in Iran are in support of the oil contract and to make final touch-ups on sensitive areas such as local partners, technology transfer, and the possibility of treating competitive-drainage fields [those producing in common with other countries] differently,” Nejad said.
Priority Fields
Production at the fields that straddle international borders fell as a result of the sanctions that were placed on Iran. These fields are capable of being returned to higher production relatively quickly, and Iran is giving them top priority for international participation.
Another factor that has delayed the bid round was the “poor engagement of the European banking system into the Iranian banking and financial sector,” Nejad said. To address such concerns, President Rouhani in July initiated a banking reform that enforces a single currency exchange rate, replacing a dual-rate system that discouraged foreign investment, and brings greater transparency to the country’s financial markets.
When the tendering does take place, Wood Mackenzie’s Falakshahi said, “We expect between 10 and 15 tenders to be put out for some of the priority fields—that is, fields that are shared with neighboring countries and possibly brownfield developments in need of IOR/EOR [improved oil recovery/enhanced oil recovery]. It would be difficult for the NIOC to handle more than this. These are likely to be offered under the IPC, while future tenders may only be offered under buy-back agreements or EPCF [engineering, procurement, construction, and finance] contracts.”
If tenders for nonpriority projects are offered under buy-back or EPCF contracts, it will be difficult for Iran to secure the level of foreign investment that it seeks, Falakshahi said.
First-Mover Advantage?
International companies interested in Iran are undoubtedly weighing how quickly to become involved. There could be a first-mover advantage for companies that sign relatively early IPC agreements. However, companies need to assess their competitive position and how well specific projects will fit their needs.
“For mid-cap companies, there could be a significant advantage in moving first, as it is more difficult for them to justify their competitive advantage to the Iranians,” Falakshahi said. “The European majors shouldn’t have this problem as Iran is trying to lure them. Nor should the Asian national oil companies, as Tehran is aiming to improve its ties with the main Asian crude- importing countries.”
Nejad emphasized the need for companies to start their study and analysis of Iranian opportunities early to formulate the right strategy.
“There are risks and advantages of being the first mover in the Iranian IPC,” he said. “The advantages are defined within each camp’s strategy, priorities, and risk profile. Front-runners might face lengthy clarifications on ambiguities that remain in the IPC. However, they might also be able to negotiate the gray areas in their favor. The contract will be more mature in later rounds, but by then the terms might be less favorable as the market becomes more competitive.”
Several IOCs have screened and engaged with Iran since 2014, before the agreement to lift international sanctions was signed, Nejad noted. These companies could be better prepared for early involvement in Iran.
“Mid-size IOCs need to aim for the right fit,” Nejad said. “So they have to be prepared for when their top three targets come to the table.
“Our advice to companies interested in the Iranian oil and gas sector and IPC projects is to start early so you can engage wisely. And by engagement, we mean risk assessment and market analysis.” Taking part in a bid round should be a separate decision, he said.
This article appears in the September 2016 issue of JPT.