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Tehran moots contract changes to attract IOCs

Iran is preparing for a complete overhaul of its contract model, confident that the improved political atmosphere in light of the P5+1 deal will attract major international firms – so long as the terms are sufficiently inviting, reports James Gavin

Nearly 16 years on from the launch of Iran’s unloved buy-back contracts, the Islamic Republic is preparing once more to spruce up commercial terms in a renewed bid to entice international oil companies (IOCs) back to develop oil and gas blocks – capitalising on the positive momentum injected by the P5+1 deal that envisages Iran scaling back its nuclear enrichment in return for a gradual relaxation of sanctions on the Islamic Republic.

Optimism in Tehran is high that the political atmosphere will be more supportive than the previous, and largely abortive attempt, to attract IOC interest in Iranian hydrocarbons.

Plans are afoot for oil minister Bijan Zanganeh to unveil the new contracts – promising much-improved terms – at a London conference scheduled for March 2014.   

Zanganeh was also the minister who first foisted buy-back contracts – essential service deals in which the contractor is paid in oil or gas before handing back the project to the client – on an unsuspecting world back in early 2008.

Given the dismal returns Iran has received from buyback, Zanganeh must hope this is not a case of history repeating itself. The experienced minister, brought in by president Hassan Rouhani to re-engage Western IOCs, has laid out an ambitious schedule to drag Iran’s oil sector out of its rut. He has discussed plans to restore crude production capacity to 4 million barrels a day (b/d) within months, compared to the 2012 average of 2.9m b/d.

Only the sketchiest details have emerged of Zanganeh's intentions over his promised overhaul of contract terms. However, the dispatch of the experienced and Western-friendly Mehdi Hosseini, a senior adviser to the minister, to head a newly formed committee charged with designing a new model contract, is seen as a positive signal of intent.

Hosseini was the architect of the buy-back programme. This has its drawbacks, notes one IOC strategist familiar with Iran. “There are pros and cons, the chief con being that he may have an inbuilt bias towards buy-backs, and might find it difficult to develop alternative models that would amplify buy-back's failure,” he says. “The pro is that he knows buy-backs better than anyone and therefore what politically is acceptable.”

So far, Hosseini has only said that the current system would be scrapped in a bid to attract $100 billion of investment into Iran over three years.

The rumour mill in Tehran has been grinding hard for the past couple of months, with suggestions that some form of equity participation is on the agenda, though likely to fall well shy of full production sharing contracts.  That would require an amendment to Iran’s constitution – which would entail a complex domestic political negotiation with the different stakeholders inside Iran.  

One theory that has gained airplay is for use of a production-sharing style deal on Iran’s shared fields, which are deemed to be more at risk of depletion due to neighbours’ advanced drilling activities, such as in the shared North Field/South Pars gas deposit, shared with Qatar.

Tapping Western IOC capital and technology in order to stem field declines on these blocks would serve a nationalist agenda and prove an easier political sell. Successful deployment could set a template for their use in other fields.

Well-placed analysts give this idea short shrift, while allowing that some form of ownership could be plausible. Houman Dolatshahi, of Tehran-based Atieh Bahar Consulting, says what will likely emerge is a hybrid form of contract, sufficiently distant from buy-back to be worth a second glance from IOCs. “They could allow foreign companies to have a share in oil projects, possibly by investing in a company rather than owning oil in the ground,” he said.

But the idea that Tehran’s need for IOC participation is so intense that it would make terms so attractive that oil company's would be wiling to bypass sanctions is far-fetched. “Unless they offer production-sharing deals for onshore fields with 30-year concession periods, and with $3 per barrel production costs – an unlikely scenario - oil companies are not going to take that risk,” says the IOC strategist. “There are so many restrictions in terms of access to capital and technology, that it wouldn't matter how attractive the terms would be."

Even so, the mood in Tehran is such that some kind of substantive reform is needed, particularly in the context of the maturing Iranian oilfields that are deemed unsuited to the buy-back model. Gholam-Reza Manouchehri, a member of the committee charged with revising the contracts, was quoted telling news agency Shan in late October that a share of the production had to be given to the contractor “to encourage them to keep working effectively on the project and to share some of the risk that the field might not produce as much as hoped in the long term”.

More plausible than production-sharing deals is for Iran to mimic its western neighbour and adopt a service contract model.

Siamak Adibi, an analyst at FG Energy, expects a revision of fiscal terms that would effectively turn them into Iraqi-style service contracts. “One idea is to increase remuneration fee based on production, like the Iraqi contracts, and make it longer-term in duration,” he said.  

Longer-term concession periods, and better rewards if the company improves production over time and ensures better reservoir management, would sweeten the pill for many IOCs. Improving the flexibility of terms so that better compensation is afforded when oil prices are high is another requirement, as well as to account for cost escalation on projects.

Zanganeh has other motivations to lure IOCs with a new improved contract model. The oil minister has also played a decisive diplomatic role, viewing negotiations with IOC executives as a means of encouraging them to apply pressure on their own governments to agree relaxations to the tough sanctions regime imposed on Iran.

He has form here. Back in 2000, he presented the newly discovered Azadegan oilfield to Japanese investors, hoping that they would then persuade their government to form closer ties with Iran on a political level.

Under the terms of the P5+1 deal, there will be a six- month freeze and partial rollback of Iran's nuclear programme, as a precursor to a long-term agreement.

If the P5+1 deal sticks – no foregone conclusion given US Congressional animus, Israeli opposition and disquiet among hardline circles back home – Zanganeh’s oil diplomacy may not be needed.

The next few months will shed light on the Western majors’ willingness to re-engage with a notoriously difficult partner, for all its promising hydrocarbons potential.

The likes of Shell, Total and Statoil have in the past shown they are prepared to play ball, investing in key phases of the South Pars gas development. The IOCs need strong terms crafted to the emerging opportunity set in Iran, one that will call for increased enhanced oil recovery activities. 

The Iranian leadership is impatient for change. Elected on a platform of improving the lot of the Iranian people, Rouhani's strategy is all about delivering on his promises, in sharp contrast to his detested predecessor Ahmadenijad.

Zanganeh aims by March 2014 to have a new model contract on the table, intended both as an enticement to foreign companies invest in oil and gas acreage and to further enmesh Iran into the international community. Those two tracks are designed ensure that the Islamic Republic’s last decade-plus of isolation and lost opportunity will be consigned to history.  

What is the P5 + 1?

The P5+1 is a group of six world powers which in 2006 joined the diplomatic efforts with Iran with regard to its nuclear programme. The term refers to the five permanent members of the United Nations Security Council (P5) – the US, Russia, China, the UK and France, plus Germany.

On 25 November 2013, the P5+1 struck an interim deal with Iran over its nuclear programme. Under the terms of the six-month deal, Iran and the P5 + 1 agreed to a series of steps to be carried out while a conclusive agreement is negotiated.

Key points of the deal

- Iran has agreed to a number of points, including:

- Halting enrichment of uranium above 5% purity;

- "Neutralise" its stockpile of near-20%-enriched uranium, either by diluting it to less than 5% or converting it to a form which cannot be further enriched;

- Not build any more enrichment facilities;

- Not increase its stockpile of 3.5% low-enriched uranium;

- Provide daily access to Natanz and Fordo sites to International Atomic Energy Agency inspectors and access to other facilities, mines and mills;

- The P5 + 1 has agreed to:What the world powers will do;

- Provide "limited, temporary, targeted, and reversible [sanctions] relief";

- Not impose further nuclear-related sanctions if Iran meets its commitments; and

- Transfer $4.2bn (£2.6bn) to Iran in instalments from sales of its oil.

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