Commodities, Energy, Frontier Markets

How The Iran Deal Will Affect Oil Markets In The Long Term

By Stratfor Global Intelligence

  • Iran will offer joint venture contracts to attract international energy companies, which will give the country some advantage over Persian Gulf producers.
  • Tehran will need more than five years to achieve its goal of producing 6 million barrels per day.
  • Legal requirements imposed on foreign firms in Iran will still make operating in the country less cost-effective.

Iran Oil2Iran was once one of the world’s largest exporters of oil. But ever since Western powers imposed sanctions on the country, a shortage of foreign investment has crippled what is now a corrupt and mismanaged energy sector.

With the announcement of a nuclear deal with the West, and the prospect of some sanctions relief within a year, Iran is now looking to revitalize its oil and gas industry. Tehran wants to increase its oil production from its current level of about 3 million barrels per day to 4 million barrels per day within six months of sanctions removal. And its longer-term goal is even more ambitious: By 2020, Tehran hopes to raise its production levels even higher than they were prior to the sanctions — roughly 6 million barrels per day.

Iran will likely need much more time to achieve that level of production. To develop new oil fields and new technology, Tehran needs access to more than $100 billion of investment — funds that the government is hoping to get from foreign investment. And while relaxed sanctions may open the country up to more outside funding, Iran also needs international oil companies to actually set up operations on Iranian soil. This could be a challenge; burdensome regulations have historically made it difficult for energy firms to operate in Iran despite the country’s ample reserves.

Image courtesy of Stratfor

Image courtesy of Stratfor

A Competitive Advantage

In November, Iran will unveil a new contract model designed to make it worthwhile for international oil companies to enter joint venture projects in Iran. Under the new Iranian Petroleum Contract, a foreign company would have several years to explore and develop fields followed by 15 to 25 years of production rights. During that time, the state-owned National Iranian Oil Co. would pay the firm based on the complexity of the field, the production volumes and the price of oil.

A contract model of this type differs significantly from the buyback contract model that Iran has used for the past two decades. Under the buyback contracts, a foreign oil company funds the initial investment for the energy project, and the National Iranian Oil Co. then reimburses the foreign firm in cash for its operating costs. Then, after a negotiated period, the National Iranian Oil Co. takes over operations entirely.

Such contracts are largely uncompetitive for international oil companies. Because the amount the companies receive from the Iranian government is dictated by the terms of the contract, rather than the number of barrels sold, foreign firms do not benefit from growing production levels or rising oil prices, and they have no opportunity to recoup any lost capital if costs surpass their original budget.

Under the new terms, the amount the Iranian government pays foreign energy firms would be based on the price of oil and the amount of oil produced, which would incentivize the firms to increase production and even exceed target rates of output. If firms go over budget in developing and operating fields, they have a chance to regain some of that capital from sales. And the more technologically complex the project, the more likely it will be to yield higher revenue. So even if it requires more up-front investment, it will pay larger returns. The long period the new terms give the joint ventures would also incentivize raising production, managing reservoirs and investing more in later stages of development.

The new contract model would also change the relationship between foreign companies and oil reserves. Under the old model, international oil companies cannot claim rights to reserves because the Iranian Constitution requires that the state retain ownership of oil reserves until they are actually extracted. This is important because international oil companies boost shareholder confidence by showing they have rights to a particular field. The new terms may work around the constitution by designating oil it plans to extract “produced oil” and allowing foreign firms to lay claim to it.

The new Iranian Petroleum Contract may give Iran an advantage over its competitors in the region — none of the Gulf states offer similar joint venture models. Already several international oil companies have expressed interest in the new terms. Executives from Royal Dutch/Shell, France’s Total and Italy’s Eni have been in Tehran over the past three months to discuss potential investment opportunities. In the first years of Iran’s freedom from sanctions, European firms will likely be the first to enter the country. They have the most recent experiences dealing with the Iranian regime, and they will be comparatively less inhibited by their governments back home — European countries will likely do less than the United States to discourage investment in Iran.

Map courtesy of Stratfor

Map courtesy of Stratfor

Lingering Challenges

The success of the Iranian Petroleum Contract model will depend on the specific fiscal terms of the deal, which have not yet been finalized or announced. And even if Iran does manage to sign new contracts with foreign energy companies, those firms will still face tough hurdles when it comes to actually investing and working in Iran again.

Not least of these is Iran’s obligation to supply a domestic market. Any firms operating in Iran will likely be required to sell at least some percentage of their output to Iran itself — at lower prices than they could get on the global market.

Tehran would also require firms to use Iranian service companies, contractors, employees and equipment. Since the Iran-Iraq war and the reconstruction that followed, the Islamic Revolutionary Guards Corps has become a powerful economic force within the country. The IRGC now dominates Iran’s construction and petroleum sectors. Tehran will no doubt want its state-owned firms to be involved in any new energy projects, but that will make operating in Iran more difficult for international companies.

Iran may eventually return to the levels of production it had prior to sanctions, but it will likely take much longer than the promised five years. Ultimately, the fiscal terms that Iran offers foreign energy companies under its new contract model will have to be appealing enough to outweigh the significant challenges that come with operating in the country.

Courtesy of Stratfor Global Intelligence, © 2015 Stratfor
Stratfor is a geopolitical intelligence firm that provides strategic analysis and forecasting to individuals and organizations around the world.  For more information, please visit Stratfor Global Intelligence


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