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Sep 25, 2015 | 09:00 GMT

Iran's Next Challenge: Courting Oil Investors

Iran's Next Challenge: Courting Oil Investors
(ATTA KENARE/AFP/Getty Images)
Summary

Iran is preparing to formally open up its economy to Western investment, a prospect that has drawn the attention of the world's biggest oil companies. But Tehran may have more difficulty reviving its oil and natural gas sector than it hopes. On Sept. 24, the organizers of the Iran Oil and Gas Summit announced that the event would be delayed until February 2016. Originally set for Dec. 14-16, the London conference is important because it will officially mark the start of Iran's economic reintegration with the rest of the international community. At the summit, Iran plans to unveil the final draft of its new petroleum contract, which is expected to lay out significantly more attractive investment terms for international oil companies than seen in previous models.

The conference, delayed for the fourth time, will now align more closely with the expected timetable for the easing of sanctions outlined in the Iranian nuclear deal, known formally as the Joint Comprehensive Plan of Action, released in July. According to that schedule, sanctions will probably be lifted sometime during the first quarter of 2016. Because the sanctions have prohibited Western companies from participating in Iran's oil and natural gas sector for several years, their removal is key to Iran's goal of bringing its production and exports back online. But even if the West eases sanctions and Iran successfully attracts the interest of major international energy companies, as will likely happen, Tehran will struggle to meet its long-term goal of producing 6 million barrels of oil per day. 

Western oil companies' interest in Iran has been deteriorating since 1994, when the country first opened up its economy to Western firms with the offer of "buy-back" petroleum contracts. These contracts contained some of the harshest investment terms in the world, forcing Iran's foreign partners to assume all of the capital expenditure risk while offering no advantage in the event of high oil prices or surpassed production expectations. Despite the contracts' unappealing terms, Iran was able to attract the attention of companies like Eni and Total in the late 1990s. However, that interest quickly evaporated in the mid-2000s, when Iran's political climate changed with the rise of former Iranian President Mahmoud Ahmadinejad and when the European Union and United States ratcheted up sanctions on the country.

The Competition Heats Up

Today, things are changing. Tension between Iran and the West is subsiding, and a more open government has come to power in Tehran. With a climate more conducive to international cooperation, Iran is looking to regain the foreign investment it lost. But the Iranian buy-back contracts of the 1990s and early 2000s are outdated and uncompetitive. Over most of the past decade, investment terms became, on average, far more attractive for international oil companies as high oil prices made expensive projects located offshore, in deep waters, in unconventional plays, or in oil sands more economical. As a result, across the industry, even the most ultranationalist of oil producers have liberalized their investment terms. Iraq, Libya, Kuwait, Brazil, Mexico, China and even to some extent Saudi Arabia have adjusted their contracts with the hope of bringing in Western companies.

Simply put, Iran faces a much more competitive environment for attracting the attention of international oil companies. Tehran realizes that it must offer terms that are not only more lucrative than those of its old contracts, but also more enticing than those of its rival producers. Doing so will help offset the risk that Iran's political volatility continues to pose to foreign investors — a factor that hurt many of the country's previous investors when Ahmadinejad came to power.

In many ways, the parts of the new petroleum contract that Iran has revealed so far achieve these objectives. Iran will likely establish joint ventures between the state-owned National Iranian Oil Co. and foreign partners that could last 20-25 years beyond the lifetime of a field. Iran will also pay international oil companies in kind (with oil produced) or in cash, based on the price of oil, meaning foreign partners' compensation will more closely reflect the conditions of the global market. Finally, Tehran will offer firms higher compensation for fields that are more risky or more challenging to develop. Overall, this model will rival the contracts of competitors like Iraq, and in some ways surpass them.

Of course, Iran will remain a difficult place for Western firms to do business. Navigating the country's domestic political and economic environment is not easy, and Iran will likely include high local content requirements to facilitate domestic growth. There is also considerable debate among Iranian leaders regarding the details of the new contractual framework, including how strict local content regulations should be. Meanwhile, the contracts will prove difficult to implement on the ground as Iranian participants seek to carve out their share of any money flowing into the country. Each of these factors will limit Iran's attractiveness to foreign investors and the success of firms that choose to do business there.

Political and Investment Cycles

For the next six months, Iran will remain focused on ensuring that sanctions are ultimately lifted and that Western companies are allowed back into the country. The next important date on the Joint Comprehensive Plan of Action timetable is Oct. 18, when Iran is set to begin meeting its commitments under the deal to resolve any outstanding issues with the International Atomic Energy Agency over the military dimensions of Tehran's nuclear program. The IAEA, for its part, will begin preparing a report on Iran's compliance. Once the IAEA's Board of Governors approves the report after its release on Dec. 15, "Implementation Day" will take place, and the West will immediately begin easing sanctions. While Implementation Day could happen by the end of the year, it is far more likely to come in early 2016.

The delay of the Iran Oil and Gas Summit — originally set to take place before the Joint Comprehensive Plan of Action was even signed — is thus meant to bring the event in line with a more realistic timetable for sanctions relief. Throughout its history, Iran's oil industry has alternated between periods of openness to external actors and of shutting itself off to the rest of the world. These shifts typically align with the changing tides of Iran's political environment, as power changes hands from nationalistic governments to those more friendly with outside powers. Iran is currently entering a period of openness. But whether this state is sustainable remains unclear. Iran's new petroleum contract offers a 25-year investment cycle, which will almost certainly span beyond the current administration, and it is not unlikely that a more conservative successor could try to reassert a stronger influence over the country's oil and natural gas sector in the future.

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