Following the tentative start of lifting of international sanctions in early 2016, and the government’s announcement of a new tender round for oil and gas projects, Iran is once again demanding investment attention from the international oil and gas industry. Iran has the fourth largest proven oil (157.8 Bbo; BP Statistical Review) and the largest proven gas reserves in the world (1,200 Tcfg; BP Statistical Review). The country is looking for massive foreign investment to update its aging oil and gas infrastructure; this should enable a leap in production to service an increasing domestic demand for gas, and support a rapid rise in oil exports to fund a burgeoning economy.
The country has a long hydrocarbon history, with the first oil discovery in the Middle East made by the D’Arcy Company in 1908 in southwestern Iran (the giant Masjid-i-Sulaiman Field).
Following the 1978 revolution and the expulsion of the Shah, the rights to owning and producing natural resources reverted to the Iranian Government.
Thereafter, the only contracts that the National Iranian Oil Company (NIOC) ever offered were buyback contracts. These contracts are similar to service contracts and require the International Oil Companies (IOCs) to invest their own capital and expertise to develop an oil or gas field.
As per the buyback contracts, upon start of production from a field, operatorship reverted back to NIOC, which then used the revenue from sales to pay back the IOCs their capital expenditure for exploration and development.
The annual repayment rates to operators were based on predetermined percentages of production, as well as a predetermined financial rate of return. IOCs could not obtain any equity stake – this being a fundamental tenet (a philosophy which holds in many oil-rich countries)
Figure 1: Iran oil production and key events
The latest form of buyback contracts was applied in the 1990s and early 2000s, and attracted billions of dollars of foreign investment. But, when the EU and the US enacted sanctions measures in 2011-12, nearly all investors left the country, a move which affected the Iranian energy sector more profoundly than any previous sanctions. In particular, the EU oil embargo as well as sanctions against financial institutions and on shipping insurance affected Iran’s ability to sell crude to all of its customers. In addition, the exit of foreign investment, technology, and expertise limited the country’s ability to expand capacity at oil and natural gas fields and to reverse declines at mature oil fields. NIOC was forced to cut production and shut down some fields, with heavy oil and inefficient fields most affected. As a result, oil production fell from around 3.6 MMbo/d in mid-2011 to around 2.7 MMbo/d a year later, and stayed around the same level until 2015 (Fig. 1). According to the International Monetary Fund (IMF), Iran’s oil and gas export revenues dropped by 47% from US$ 118 billion in the 2011-12 fiscal year to US$ 63 billion in 2012-13.
Since the start of the lifting of sanctions in January 2016, Iran has managed to ramp up production to pre-sanction levels – much faster than many expected. However, it seems that output has hit a natural ceiling in the last few months, with production increasing at a slower pace. The initial rapid increase was attributed to fields and wells coming back online with high pressures, after having been shut-in for years. But the country will struggle to pump more, as undeveloped fields and many of the mature depleting fields need significant investment at a time when Iran remains cash-strapped and unable to finance development from internal capital resources.
Putting aside any OPEC deals with regards to freezing production, Iran’s sixth Five-year Development Plan targets oil production of 4.8 MMbo/d by 2021. In order to reach that goal, the country is hoping to develop oil and gas projects through attracting significant foreign investment under the new Iranian Petroleum Contract (IPC). The IPC was recently approved by Parliament, although this is but one stage in the gestation. In November 2015, Iranian authorities unveiled elements of the new IPC to potential investors at the Tehran Summit, in addition to showcasing 50 oil and gas projects and 18 E&P blocks (Fig.2). Projects presented include onshore and offshore, as well as early- and late-stage projects, with varying degrees of complexity. Proposed production from the development of these oil and gas projects could add around 1 MMbo/d, taking current production of around 3.7 MMbo/d, close to the declared target. According to Minister of Petroleum Bijan Zangeneh, NIOC will initially seek the development of shared fields along its borders (notably borders with Iraq, Kuwait, Qatar, Saudi Arabia and the UAE); also, the completion of the South Pars development project and West Karun oil fields are of top priority.
Source: Drillinginfo database
Figure 2: Map of Iran showing location of 18 E&P Blocks, 50 oil and gas projects and oil and gas fields
Although US companies will likely remain unable to get involved in Iran following the US senate’s decision to extend the Iran Sanctions Act by 10 years, a number of European and Asian IOCs have shown interest for investment. Several have signed Memoranda of Understanding (MoUs) for development studies for various fields, with a view to participate in projects if technical and financial conditions allow. Total has managed to go a step further, when in early November 2016 it signed a Heads of Agreement (HoA) with NIOC for the development of Phase 11 of the South Pars Field – the first such agreement following the signing in December 2015 of the Joint Comprehensive Plan of Action (JCPOA) to lift sanctions. Under the terms of the HoA, NIOC and the project partners (Total – op. 51%; Petropars 19.9% and CNPC 30%) will conduct exclusive negotiations to finalise a 20-year contract in accordance with the technical and economic terms established in the HoA, within the framework of the new IPC.
However, even with these strong signals regarding investment interest in the opportunities available in Iran, significant and wide-ranging challenges and risks remain, both above-ground and below-ground. These include remaining sanctions, banking and insurance issues, along with perceptions of corruption and lack of transparency (Iran is ranked 130 out of 168 countries in Transparency International’s 2015 corruption perception index). Political risks remain high too, with the country having poor relations with a number of neighbours in the Middle East, as well as further afield. Companies will have to assess how entering Iran might affect their business elsewhere. The principal risk for any company establishing operations in Iran, especially following the recent US elections, is the uncertainty surrounding future US-Iran relations and the potential for renewed sanctions under the snap-back provisions in the nuclear deal.
In any case, it remains to be seen how attractive the terms of the new IPC really are. The finer details are not yet available, but it is expected that the contract will be an improvement on the existing buybacks, hence presenting a new opportunity to the IOCs. Under the new contract terms, it is certain that companies will still be unable to own reserves; however they will be able to establish JVs with NIOC, or its subsidiaries, to manage the entire life-cycle of a project. Companies will have a longer time period, of between 20 to 25 years to explore, develop and produce from a field, with the possibility to extending it to the Enhanced Oil Recovery (EOR) phases. Fiscal terms are also understood to have been reworked.
Nevertheless, at the recent 4th Iran Europe Oil, Gas & Energy Summit in Berlin (attended by Drillinginfo), it was suggested that while improvements have been made, they might not be as advanced as many are hoping. The launch of the IPC has been postponed several times as rivals of President Hassan Rouhani resisted any deal that could end the buy-back system, and many minor and major changes have been made over the last year to appease political opponents.
Despite the investment difficulties, the opportunities in Iran make it compelling for Non-US companies to enter or re-enter the country. At a time when oil prices are down to levels not seen for a decade, IOCs need to look for exploration and production opportunities that require comparatively little capital and operational expenditure. As such, projects in Iran present great prospects – with costs to produce a barrel of crude in Iran estimated at around US$ 9 (Rystad Energy) compared to an average of around US$ 9 in Saudi Arabia, around US$ 35 in Brazil and around US$ 44 in the UK.
Thoughts? Comment below.
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