Published 12 September 2015

Iran Going The Extra Mile
With New Oil Contracts

Desperate to attract technology and investment back to its stalled oil and gas sector, Iranian officials are pushing the limits with the terms they will offer IOCs in any post-sanctions opening. They face not only skepticism from the firms themselves but also a backlash from conservative factions in Tehran.

Iran’s Oil Ministry this week welcomed executives from several foreign oil companies to Tehran for further discussions about the Iran Petroleum Contract (IPC) – a new generation of upstream investment contract the country has been developing over the past 18 months, as part of the current administration’s push to breathe new life into its oil and gas sector.

After close to a decade of rampant mismanagement, corruption and sanctions-related under-investment, President Hassan Rohani made the rehabilitation of the oil and gas sector, the lifeblood of the Iranian economy, one of his government’s top priorities. Many believe the eight years in which Mahmoud Ahmadinejad was in office put the country on the path to economic ruin and confrontation with the international community; it has been up to the Rohani government to pull it back from the brink.

Of course, key to whether the Rohani administration succeeds or fails, are the ongoing nuclear talks – set for an end-June denouement, though an extension would surprise no-one – and the hoped-for resultant easing of economic sanctions. This is, of course, a necessary precondition for the hoped-for flood of western investment in the Iranian oil and gas sector. But it is not sufficient. Crucial also is the revision of Iran’s upstream contracts in a bid to make the terms more attractive for international oil companies (IOCs) than those of the preceding much-maligned ‘Buyback’ contracts.

IMPROVED TERMS NEEDED           

The Iranian oil and gas sector badly needs the investment, technology, managerial prowess and know-how that Western IOCs bring to the table. As Eni CEO Claudio Descalzi made clear at the International Opec Seminar in Vienna earlier this month, a lifting of sanctions alone will not be enough to lure them back. Eni lost “so much money” under the previous contract regime, he says. “You can be sure that we will not go back…with this contract” (MEES, 5 June).

WAVE OF INTEREST

With the 30 June deadline for a final agreement on Iran’s nuclear program fast approaching, and prospects good that a deal could be struck, IOC interest in Iran is again on the rise – just as it was some 12 months ago in the run-up to the first, ultimately missed, deadline of 20 July 2014.

Just last week a delegation from Anglo-Dutch major Shell arrived in Tehran to discuss future opportunities in Iran’s petrochemicals sector. This latest visit, confirmed in the local media by Mehdi Hosseini, head of the government committee tasked to lead the reformulation of Iran’s upstream contract, is just the latest example of the recent uptick in engagement between foreign oil companies and Iran’s oil industry top brass. Earlier this month, Iran’s Oil Minister Bijan Zanganeh and the heads of Eni, Shell, Total and Lukoil held talks while in Vienna for the Opec seminar (MEES, 5 June).

Iran holds the world’s largest gas reserves, and the world’s fourth largest oil reserves according to the latest BP Statistical Review (see table), and thus has no shortage of interest should the terms suit.

“The talks between Iran and the European IOCs have been entirely at expert-level, and have been removed from the politics,” Mr Hosseini said of this week’s discussions. “In these talks the foreign parties are after a better explanation of the new model of oil contracts. The Iranian team is available to answer all of their questions,” he was quoted as saying by the oil ministry’s Shana news service.

IPC TAKING SHAPE

The first draft of the IPC was unveiled in Iran in February 2014. But the oil ministry’s contracts revision committee has continued to work and rework the contract since, in an effort to build on the feedback it was receiving in its regular discussions with both IOCs and local experts. The Iranian oil ministry has made a concerted effort to involve IOCs in the development of its new contracts in order to gauge their perspectives at every step of the way. This, it hopes, will ultimately boost Iran’s chances of attracting the caliber of companies it most wants to see active in its oil and gas sector. Companies that have been in touch with the Iranian oil ministry in this capacity include Shell, Total and BP, MEES understands.

More than one year on, the IPC appears to have finally taken shape (see table), with one consultant with close ties to the contract revisions committee suggesting that further changes to the framework at this point are highly unlikely: “These are the very broad terms that will all make it to the final version,” Elham Hassanzadeh, managing director of the Iran-focused Energy Pioneers consultancy said at an Iran Briefing in London on 15 June. This latest version of the IPC is currently still being reviewed by the office of the Vice President for Legal Affairs Elham Aminzadeh, before it gets sent to the President’s office for final approval.

At least for now, the objections of hardline conservative elements within the government to any relaxation of the terms offered to IOCs appear to have been sidelined. The IPC does not need further approval from parliament, one less hurdle to overcome. However fears in Iran of giving away the ‘crown jewels’ too cheaply go back a long way, to the days of Anglo-Iranian Oil, the forerunner to BP: it is not hard to imagine such voices gaining in strength if IOCs queue up to enter the country, never mind brag of the money to be made.

‘BETTER THAN IRAQ’

Throughout the IPC’s development, and long before its finalization, one element that most Iranian oil officials could agree on – irrespective of their familiarity with the framework – was how it would ultimately stand up against its Iraqi counterpart, the technical service contract (TSC): there is no question, Iranian officials have repeatedly said. The Iranian contract will offer a better deal to IOCs.

And though there undoubtedly was a big element of nationalistic bias in these statements early on in the process, one look at the all-but-complete IPC’s main elements justifies these claims. The IPC, according to those designing it, is a hybrid contract. So while it does have some terms that are similar to those of the Iraqi TSC, Iran argues that the IPC is even broader than the Iraqi model as it includes some elements of the more favorable production sharing contract (PSC).

WORLD GAS RESERVES BY COUNTRY (TCM)   
SOURCE: BP STATISTICAL REVIEW, 2015
2014% of total20102000
Iran3418.20%33.126
Russia32.617.40%31.530.6
Qatar24.513.10%2514.4
Turkmenistan17.59.30%10.22.3
Saudi Arabia8.24.40%7.96.3
UAE6.13.30%6.16
Venezuela5.63.00%5.54.2
Nigeria5.12.70%5.14.1
Algeria4.52.40%4.54.5
Australia3.72.00%3.72.2
Iraq3.61.90%3.23.1
China3.51.80%2.81.4
Indonesia2.91.50%32.7
Canada21.10%21.7
Norway1.91.00%21.3
Egypt1.81.00%2.21.4

This will no doubt please Total chief Patrick Pouyanne who just two weeks ago said that the terms Iran offers would have to be a clear improvement on those in Iraq for Total to re-enter Iran. If not, “I’m not sure we can be a part of that,” he said in Vienna.

BOOKING RESERVES A POSSIBILITY?

In the IPC, the ministry has developed a contract which has done away with most, if not all, of the Buyback contracts’ shortcomings, Mr Hosseini has said.

As per comments made by Mr Hosseini and his colleagues over the past 12 months, several elements of the IPC have become clear. In contrast to the Buyback contracts, the IPC will integrate all three stages of exploration, development and production under one contract, offering smoother transition from the exploration to the production phase should a commercial discovery be made. As a result, the duration of the IPC will be longer: up to 25 years, versus 5-7 in the first generation of Buybacks, and 8-12 in the second and third generations.

The IPC also has a mechanism by which the terms and rate of return for oil companies will be flexible, depending on the complexity and risk factor of the project. Should a company fail to make a commercial discovery at the field it is originally contracted on, it could be given the opportunity to explore at another nearby field, if it so wished. Where the biggest interest lies, however, is in the possibility of booking reserves – a highly contentious issue in Iran given the constitutional rule that ownership of reserves in Iran is always with the state. “This is not only a constitutional requirement, but at the same time is also under Sharia law that says the state is in charge of public resources,” Dr Hassanzadeh says. “Only the state should exploit those resources, and share the rents with the nation.” Under the Buybacks, ownership of the reserves in every instance was exclusively confined to the government.

But while the same principle exists under the IPC, the team designing the new framework has more recently introduced some exceptions or conditions, under which booking of reserves could be permitted – namely in contracts for the more risky and high priority projects.

“As a foreign investor – an international oil company – you cannot and do not have the right to claim ownership of the reserves,” Dr Hassanzadeh says. “But booking reserves is possible for some special projects. Those projects for which the operation and/or development includes very high risks for the foreign investor, or at joint fields, where time is of the essence for the Iranian government,” she says. For such projects “the government would be prepared to offer reserves booking.”

What this does not mean however is also an entitlement to the reserves, she warns, stressing it is purely about declaring an asset under the company’s management so as to impact the price of its stock. “There is no right for you as an investor to claim ownership,” she says.

GOOD IOC RESPONSE

From the companies that have been kept up to date with the IPC’s development, the feedback has largely been positive, Dr Hassanzadeh says, echoing comments made by Mr Hosseini some weeks ago (MEES, 1 May). “They are very excited,” she told the London briefing on 15 June. “They think these are very interesting and lucrative terms… [the terms] have definitely attracted their attention.”

IRAN'S OLD 'BUYBACK' CONTRACT AND THE NEW 'IRAN PETROLEUM CONTRACT': KEY DIFFERENCES
SOURCE: ENERGY PIONEERS.
BUYBACKIRAN PETROLEUM CONTRACT
Field OwnershipNIOCNIOC. Under 'special conditions' companies can book reserves. Reserve ownership only available for high-risk exploration/development, ie joint fields, Caspian drilling etc.
Crude Output OwnershipNIOCIOC/ NIOC partnership. Resembles a PSA.
OperationIOC in exploration, development. Hands over to NIOC once development complete.Exploration by IOC; Development & production by IOC, NIOC partnership. Integration of exploration, development & production phases under same contractual framework ensures IOC involvement throughout life of field.
IOC Cost RecoveryFixed capex ceiling; Interest on investment costs; Limited amortization period.Capex, non-capex, bank charges recoverable. No capex ceiling. Cost recovery for exploration from start of production. Cost recovery cannot exceed 50% of total production/revenue. No interest paid on investment costs. If costs less than planned portion of savings to be paid to IOC as additional remuneration. Possibility to renegotiate terms if 'environment' changes.
RemunerationFlat, inflexible cash fee based on percentages of production and agreed fixed rate of return.Exploring IOCs remunerated with share of output; rate of return proportionate with risksÊ taken (field's development risk classified as low, medium, high or very high). Greater risk-reward element: $/B fee for oil, $/mn m_ for gas; fees based on international prices and sliding scale. Remuneration based on R-Factor;Ê Risk classification can be revised over time.
Payback PeriodCost recovery, remuneration through project operation life.Cost recovery 5-7 years after first production; remuneration throughout life of project.
TaxTheoretical only (IOC taxes were reimbursed).Tax rate of 30-35% (not final).
Signature BonusNo.No.
RisksIOC bears full risk of cost overrun; NIOC bears oil price risk; IOC bears risk of exploration failure.IOC bears exploration risk; if exploration fails, can be offered alternative nearby exploration acreage.
Contract Length1st generation: 5-7 years; 2nd, 3rd generation: 8-12 years.25-30 years (7-9 years exploration; 15-20 years development, production).
IOC, NIOC RelationshipIOC purely contractor.JV partnership between NIOC, IOC ensuring technology transfer, managerial skills, investment.

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