Sanctions imposed on Iran at the start of 2012 by EU countries against importing crude oil from Iran coupled with an embargo imposed by the U.S. have inevitably strangled the Iranian economy. The gradual lifting of sanctions following last year’s landmark nuclear deal have created hope for Iran’s ailing economy to such a degree that the incumbent government has revealed a new model of petroleum contract to create an environment to lure back foreign investment especially for the oil and gas sector. Given the current oil price slump, Iran’s petroleum sector would likely face a hard time winning back International Oil Companies’ (IOC’s) interest in its oil and gas industry, which has remained fragile and in dire need of technology and capital to move from a condition of ‘fragile to agile.’
In 1991, with the aim of opening up the Iranian oil and gas sector which was in need of substantial investment as it was falling far behind international standards, the buy-back scheme was introduced to revitalize the industry. The first buyback contract for the development of South Pars Gas field was signed between American Conoco and the National Iranian Oil Company (NIOC), and later in 1995 with French Total.
To bridge the gap, the shift towards reducing Iran’s international isolation through attracting international investment in the oil and gas business proved ineffective. This was due to several flaws stemming from the scope of the buyback contracts. Some unattractive conditions in the scheme worked as a deterrent and remained unpopular among the IOC’s. Rumor has it that the buy-back scheme, even prior to EU and U.S. sanctions, acted as a disincentive for investors by forestalling foreign companies from booking reserves and obtaining equity stakes in Iranian companies.
The time period of the buy-back contracts were between five to twelve years and by the time oil or gas assets reached their targeted amount, the contracts were handed over to the NIOC. This contract length was too short for participating companies and resulted in heavy reliance on the NIOC for their operations. When the contractor produced more than the previously agreed volumes, no compensation was paid for extra production.
The buy-back scheme was amended over time, however, due to the contract’s inflexibility along with relatively limited returns, potential losses incapable of being recovered emerged. Despite three generations worth of experience in the buy back scheme in the upstream oil & gas sectors, the contracts had many deficiencies that were unfavorable for IOC’s. Attracting investment through this channel has not delivered the expected results, and has paved the way for another contract model with more attractive and acceptable terms.
To facilitate the inflow of IOC’s investment, the Oil Ministry introduced a contract named the ‘Iran Petroleum Contract’ (IPC) in 2015, which put an end to the two-decades-old buy-back scheme. The aim of the IPC is to attract foreign investment for the further development of existing and newly developed oil and gas fields at maximum efficiency and at the lowest cost possible. Iran’s new contract model also targets the fulfillment of localization through acquiring local skills and know-how and accelerating much-needed technology transfer to boost production to reach pre-sanction levels.
The most important improvement in the new contract model came with its duration, which can be extended to twenty to twenty-five years - twice the time given through the buy-back contracts. After first production in the new contract model, this extended period of time would ease the IOC’s cost recovery.
Another improvement in the new model is in its provision to potentially form partnerships with other Iranian companies, covering exploration, development and production.
Since the government unveiled the IPC, the opposition has attacked it. The conservative group in Parliament, who criticized the general terms of the IPC contract, claim that the IPC will create conditions for the transfer of excessive payment amounts to IOC’s while they are empowered to have greater clout in the industry. They claim that such conditions are against the ground rules of the Constitution. The government, however, have rejected the opposition’s claims and assert that they support the idea of ownership of commodities remaining firmly with the Oil Ministry.
The change brought to a number of key areas with the introduction of IPC is likely to appeal to the IOC’s, particularly when compared with the unfavorable terms created by the buy-back contracts back in 1990s. Given the low cost of production at around US$5 to $8 per barrel, along with the advantages of greater security in the region and the ability to locally manufacture equipment, Iran has been placed ahead of the competition.
Commenting on the vast possibilities that Iran offers, Financial Times Nick Butler notes that, “the international oil companies see Iran as their last great hope of getting access to large-scale reserves of oil and gas”, therefore, “Iran is almost a dream destination for companies, especially for the majors which have been finding it so difficult lately to replace their production with new reserves”.
However, it should also be noted that the plunge in oil prices since June 2014 has already put further strains on the struggling oil and gas sector in Iran. The failure of yesterday’s Doha meeting on freezing output at January levels is likely to push current oil prices further down to a level in which the future of IPC would remain ambiguous until the oil price rebalances.