Why Iran's New Oil Contract Won't Change a Thing

Iran yesterday announced a list of 29 international oil companies that have been approved to bid for oil and gas projects under a newly redesigned version of the Iran Petroleum Contract (IPC).

But despite what today's drop in the price of oil may make you think, this is not a sign that Iran is about to massively increase its oil production and scuttle the Vienna Accord that's pushing oil prices up.

Here's why...

Companies Are Still Concerned About Sanctions

The list of 29 companies does not include any U.S. companies, and UK major BP plc (BP) has decided not to participate. In both cases, the status of U.S.-UK sanctions on Iran and threats by U.S. President-elect Donald Trump to scrap the Iranian nuclear accord are preventing involvement by American and British companies.

In the U.S., additional Congressional prohibitions against companies working in the Iranian hydrocarbon space are also still on the books.

Meanwhile, the primary problem facing Tehran is the way in which international companies can work in the country. This issue has been exceptionally contentious for some time among Iranian leaders.

Unfortunately, the media continue to confuse the real issue here...

Iran's Old Contract Scheme Was a Failure

Reports still attempt to pit Iran's President, Hassan Rouhani, against the country's religious hardliners. Actually, there is widespread agreement up and down the domestic political spectrum on the limitations imposed on outsiders. On this, virtually all political and religious leaders agree.

And that continues to be the problem when it comes to attracting investment to Iranian oil and gas projects.

Both the 1979 Constitution (the one written after the revolution led by Ayatollah Khomeini) and subsequent legislation prevent foreigners from either owning land or raw materials inside Iran. That prevents the use of joint ventures or similar arrangements, which are typical for foreign investment in other oil- and gas-rich countries.

That also means international companies cannot "book" any reserves found in Iranian fields, preventing them from using the production to enhance their production figures (as well as their equity value).

Instead, Iran came up with a "buy-back" scheme.

Under this contract, the outside company provides all of the development capital and operational responsibility, subsequently transferring the project to the National Iranian Oil Company once production has reached a contracted level. In return, the outside company is paid back in kind (i.e., in oil) for both the project expense and a previously agreed to portion of the "profits."

Now, Iran may have reserves that rank among the largest in the world. But even before the country was hit by sanctions and nuclear concerns, this buy-back approach was universally considered the most difficult approach to negotiate.

It's a drawn out and frustrating process. A "price" for the oil had to be agreed upon at the outset. Even if market situations changed, the project hit unanticipated cost overages, the oil turned out to require additional treatment, weather or other external events impeded the schedule, or anything else, this "exchange-rate" between money and oil couldn't be changed.

Tehran has now revised the scheme in an attempt to get around some of these obstacles. Sources have confirmed that the new arrangement provides some flexibility for operating companies, and will account for project problems and market fluctuations.

But one thing will not change...

The New IPC Doesn't Look Much Better Than the Old One

The new contract will continue the policy of not allowing foreigners to own any part of the oil outright, or to consider any portion of the reserves as bookable. It appears that the resulting situation will provide no better working environment than the service contracts offered by Baghdad across the border in Iraq.

There, international oil companies also cannot consider any of the oil lifted as their own. Instead, the arrangements amount to glorified service contracts where companies receive a contracted per barrel payment once daily production reaches a specified level.

The oil or gas field, however, remains the property of the national oil companies or one of its regional affiliates.

In both Iraq and Iran, companies ready to brave these contracts face two additional obstacles. In Iraq, those are 1) an often intransigent central bureaucracy, and 2) ongoing security concerns and domestic sectarian disagreements. In Iran, the dual nature of the threat involves 1) the possibility of renewed sanctions and 2) internal restrictions on company operations.

As I have noted here in Oil & Energy Investor on several occasions, Iran is facing major problems in its fields, some of which rank among the oldest in the Persian Gulf. In addition to an immediate need for working capital, it also desperately requires access to foreign expertise and technology. Meanwhile, the broader support and delivery infrastructure is beginning to collapse.

These are the real reasons why Iran finally agreed to cap production at October levels and enter the OPEC production revisions (the so-called "Vienna Accord" signed at the end of November and set to take effect this month).

Officially, it wanted to return to pre-sanction oil extraction levels. Realistically, however, the country cannot sustain them given the current state of its oil sector.

And now yet another impediment is emerging even before the specifics on projects going up for bid are released...

You'll Get the Inside Scoop on Iran's New Contract Right Here

The Majlis (the Iranian parliament) is not pleased with how the new contract relaxes restrictions against foreign companies. And then there is the all-important position of Iran's current Supreme Leader, Ayatollah Ali Khamenei.

Khamenei succeeded Ayatollah Khomeini upon the latter's death in 1989 as the second post-revolutionary religious head of the country. He has more power than the president and parliament combined. Khamenei has no love for foreigners or their money, and could stop the new approach in its tracks with a single word.

All of which means yesterday's announcement of approved bidders for the new IPC is but the first step in a tortuous process. Much more than oil is at stake here. Massive natural gas deposits and liquefied natural gas (LNG) export possibilities are also in the offing.

But I'll be able to determine if this is a genuine departure from the old, unpopular way of doing things, for myself. I am scheduled to meet with Iranian officials in Frankfurt the middle of next month, followed in May by my attending the annual Iranian oil summit... in Tehran.

I'll be taking you along to both, right here in Oil & Energy Investor. This is about to get real interesting...

The post Why Iran's New Oil Contract Won't Change a Thing appeared first on Oil & Energy Investor by Dr. Kent Moors.

About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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