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Iran's Plan to Lure Big Oil

Amir Handjani is a lawyer and former energy executive and trader. He is a board member of the Atlantic Council and a fellow with the Truman National Security Project.
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Far away from the bloody Syrian conflict and continuing rancor of the Iran nuclear deal, influential policymakers in Tehran are debating the future of the country’s energy resources. They know Iran needs vastly increased foreign investment to revive its ailing economy after years of international sanctions and economic isolation.

President Hassan Rouhani and his oil minister, Bijan Namdar Zangeneh, have come up with a master plan to reverse decades of indifference from Western majors. But the question for them, and the giant global oil companies they want to entice, is whether pressure from Tehran's hardliners and potential blowback from the U.S. government will make investing in Iran's oil fields too risky a bet for foreigners to undertake.

Rouhani's government has set an ambitious target: boosting Iran’s oil production by 20 percent by 2021 -- from 3.8 million barrels a day to 5 million. To accomplish this, Tehran is looking for $200 billion in foreign investment over the same period. It's an eye-popping amount, especially in the current climate of flat oil prices and surplus production. It will require Iran to offer commercial terms to international oil companies that are far more favorable than what it has done in the past.

The key to the Rouhani plan is a new contracting model, officially the Iran Petroleum Contract, which was approved at a cabinet meeting in August and appears to have the support of Supreme Leader Ayatollah Ali Khamenei. In this new legal regime, Iran will do away with the old “buy-back” contracts that have defined the relationship between the National Iranian Oil Company and international oil companies for decades. Those contracts were maligned by the majors because they do not have the features of the production-sharing model they favor -- particularly when it comes to booking crude reserves, the process by which oil companies hold title to a percentage of hydrocarbons they produce. 

Buy-back contracts treat foreign firms more or less as subcontractors. Their terms are much shorter than those of production sharing agreements; usually between 7 to 10 years as opposed 20 to 25 years. Buy-backs typically give little authority to foreign firms on how to manage reservoir development and oil field production once it begins, and places those decisions squarely in the hands of Iran's state owned company.

The new contract will address these issues. For instance, it will allow foreign companies to establish joint-venture partnerships with Iranian companies in which they will manage production and reservoir development. More specifically, it will allow lengthier contract periods (up to 25 years and perhaps longer in certain instances) and permit the global oil companies to have significant input in budget and work programs of projects. Foreign firms will also have full cost recovery --which means they will have the ability to recover their investments in exploring, discovering and developing a given field, if they are commercially viable. They will also have incentives for coming in under budget for a given project.

In theory, this new contractual paradigm brings an equitable distribution of risk and reward between international firms and their Iranian partners. Perhaps more importantly for Iranians, much-needed foreign and technical expertise could start coming back into the country after three decades of isolation.

Control over Iran’s oil wealth has been a hotly contested issue among its people for the last 100 years. They remember when the British government, through its ownership of Anglo-Persian Oil Company, effectively controlled its production. Zangeneh, the oil minister, has had to pledge to hardliners that Iran’s sovereignty over its energy resources has been preserved by the new contract, and yet provide enough incentive to foreign companies to assure them that they would be treated as partners and not as contractors with no skin in the game.      

Despite this balancing act and careful planning by Rouhani's government, many questions remain unanswered. First, what will happen if sanctions on Iran’s nuclear program snap back as a result of Iranian noncompliance with the nuclear deal? Second, Iran is about to enter into an election cycle; if Rouhani is not re-elected, will his successor continue on the path of energy-sector reform?

But perhaps the biggest issue is that, despite nuclear-related sanctions being lifted on Iran, prime European banks such as BNP Paribas, Deutsche Bank and UBS have been skittish about financing projects for fear of falling afoul of remaining secondary U.S. sanctions on Iran's economy and banking sector. Will these injunctions have a similar chilling effect on energy majors such as Shell, BP and Total?  Will the risks associated with investing and working in Iran be worth the reward?

Certainly, Iran thinks the allure holding 10 percent of the world’s proven oil reserves, as well 15 percent of the world’s gas reserves, will be too much for energy majors to pass up. But it's unlikely that that European conglomerates will go in with full force unless they get guarantees from the Washington that there will be no repercussions on their U.S. operations. Perhaps the question for the next presidential administration will be whether a flourishing Iranian oil sector will be more likely to lead to economic and political reform, or if it will it lead to further clashes between reformers who favor more engagement with the West and hardliners who don’t.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Amir Handjani at ahandjani@gmail.com

To contact the editor responsible for this story:
Tobin Harshaw at tharshaw@bloomberg.net