The Joint Comprehensive Plan of Action (JCPOA) between Iran and the P5+1 world powers signed in Vienna on July 14, 2015 marks a historic turning point for the country. The deal creates the foundation for a new economic reality that will offer ample opportunities for domestic and foreign investors, although stakeholders will require time to adjust to the new investment climate. The much anticipated lifting of the sanctions on Iran pursuant to the JCPOA, the first phase of which was implemented on January 16, has sparked interest from a number of sectors and industries. This interest is particularly manifest in Iran’s oil and gas industry, given that, according to a recent report, the country holds the world’s fourth largest proven oil and the largest natural gas reserves. While the JCPOA has been generally considered a diplomatic triumph that will herald a new dawn for Iran’s oil and gas industry, some senior officials from the brokering states and business leaders doubt over the robustness and longevity of the deal, particularly in light of the unremitting geopolitical volatility in the Middle East.
The sanctions, via direct and indirect international measures, had a devastating impact on Iran’s oil and gas industry and severely hampered the country’s ability to exploit its hydrocarbon wealth. Following the introduction of the intensified sanctions in late 2011 and mid-2012, Iran’s oil production fell dramatically, from almost 3.7 million barrels per day (b/d) in 2011 to 2.7 million b/d in 2012. The further intensification of the sanctions by the U.S. prevented numerous states and companies from engaging with Iran, effectively bringing the country’s oil and gas industry to a standstill. Iranian companies struggled to raise finance from the international banking sector – which is expected to remain cautious post sanctions relief – due to the potential legal repercussions and reputational damage. Numerous projects were abandoned as the financial artery to Iran’s oil and gas industry ruptured, particularly impacting the upstream sector.
The JCPOA will not only enable Iran to attract considerable foreign investment and “reanimate its dormant oil fields,” for instance via the tender of approximately $30 billion worth of oil projects introduced at the Tehran Summit in November 2015, but will also encourage further exploration and development, for example in the Caspian Sea, which holds vast reserves of untapped oil. Iran has the world’s largest proven natural gas reserves according to a BP Plc report, yet this sector is very underdeveloped because of the sanctions. Iran has a high success rate in natural gas exploration, at 79 percent, compared to 30-35 percent for most other gas-rich nations. Exploration, however, is not a priority given that the country is home to large numbers of undeveloped and untapped known reserves.
Much like the oil sector, the gas sector has been hampered by sanctions and has the potential to grow significantly post sanctions relief, particularly as the South Pars offshore gas field, located at the center of the Persian Gulf, comes on-stream. This will significantly increase Iran’s gas production and turn the country into one of the world’s leading gas exporters. However, the infrastructure and know-how required to tap into and exploit these reserves are underdeveloped. Much investment is, therefore, required to modernize technologies and operational mechanisms to enable the country to compete with other sophisticated players in the oil and gas market, particularly with oil prices having descended to a 12-year low.
The JPCOA envisages a gradual lifting of the sanctions imposed on Iran as a consequence of its nuclear program, on the understanding that Iran will not “seek, develop or acquire nuclear weapons,” compliance with which will be tested via meticulous monitoring and inspections. The implementation mechanism under the JPCOA entails five key stages: (1) the signing of the deal, which took place on July 14, 2015 (the “Finalization Day”) and its subsequent approval by the UN Security Council via the adoption of Resolution 2231 and the commencement of monitoring by the International Atomic Energy Agency (the IAEA); (2) the start of preparation by the parties to the JPCOA for implementation of the deal, which took place on October 18, 2015 (the “Adoption Day”); (3) the commencement of phased sanctions relief upon verification by the IAEA that Iran has complied with its commitments under the deal, which occurred on January 16 2016 (the “Implementation Day”); (4) the termination or suspension of all outstanding EU and U.S. sanctions no later than eight years from the Adoption Day (the “Transition Day”); and (5) the termination of UN sanctions ten years from the Adoption Day (the “Termination Day”). It is, therefore, envisaged that all UN, EU and U.S. sanctions related to Iran’s nuclear program will cease no later than October 18, 2025 on the condition that Iran has kept its enrichment capacity below specified levels and complied with all its obligations under the JCPOA, or pursuant to a final determination by the IAEA that all nuclear material in Iran remains in peaceful activities.
The first significant stride toward sparking the development of the Iranian oil and gas industry was taken on January 16, 2016, which marked the extinguishment of the particularly stern sanctions imposed by the United States and the European Union and an estimated $100 billion of assets, some of which had been locked-up since the 1979 Islamic Revolution, were unfrozen from various countries around the world. Much of these unfrozen assets will be utilized, in conjunction with capital inflows from foreign investment, to boost Iran’s oil and gas industry, which desperately requires a capital injection for revival of dilapidated oil and gas fields, for instance by upgrading technologies and replacing aging machinery.
The JCPOA comes at a time when Iran is experiencing economic stagnation and is in dire need of economic stimulus, rendering a new regime for attracting investment from international oil companies (IOCs) ever more crucial. According to Moshtaghali Gohari, Deputy Head of the Integrated Planning Department of the National Iranian Oil Company, Iran intends to usher in a business approach that is in tune with the interests of both Iran and IOCs via the implementation of the Iran Petroleum Contract (IPC). The IPC is seen as a major milestone, moving Iran away from the buy-back contract, which discouraged investment in Iran’s oil and gas industry. Some details of the framework of the new flexible contract were unveiled in a two-day conference in Tehran in November 2015 (the “Tehran Summit”), which was attended by numerous government officials, including representatives of the British government and executives from various IOCs, including BP, Total, Royal Dutch Shell and Statoil. In addition, all major IOCs are expected to attend the much-anticipated Iran Oil and Gas Post Sanctions Summit scheduled to take place in London in late February, which will mark the international launch of the IPC. The London Summit is expected, consistent with the Iranian government’s intention to maximize the economic rewards of the JCPOA, to entail the announcement of the further details of “dozens” of oil and gas projects worth an estimated $30 billion. The inflexible buy-back contracts has made the Iranian oil and gas industry an unattractive place for IOCs to engage in business and as highlighted by Mehdi Hosseini, Chairman of Iran’s Oil Contracts Revision Committee, taking full advantage of the deal necessitates the participation of a wide range of IOCs in the projects to be offered under the new and more attractive IPC.
Iran’s constitution prohibits the granting of ownership rights over the country’s natural resources to foreign entities, thereby legally incapacitating IOCs from attaining ownership rights, such as under a concession agreement. This position, however, is not dissimilar to that of other resource-rich nations in the region and most IOCs were principally dis-incentivized by the nature of the buy-back contract, a form of service agreement offered by Iran that enables IOCs to engage in the exploration and development phases and relinquish ownership to the NIOC in the production phase. Under this regime, the NIOC utilized the proceeds of the production to provide IOCs with a pre-determined sum from the production volume, no additional compensation being payable to the IOC for boosting production. The viability of this structure for attracting investment was further undermined by the short duration of the contracts, availing IOCs a period of merely five to seven years to recoup their investment and accumulate profits. Further, the contract limited the profit that IOCs could recover, notwithstanding any increase in oil prices.
The IPC, the full details of which is expected to be revealed at the London Summit, ameliorates many of the concerns that IOCs had regarding the buy-back contract, in a bid to incentivize foreign investment and usher in much needed know-how and technology. While the IPC is not a production-sharing agreement, it has been described by some as a hybrid oil contract embodying some of the advantages of the “tried and tested” production sharing regimes used in the UAE and Iraq. The contract, which is expected to be offered for up to 74 oil fields nationwide, such as the Northfield and South Pars Field, will for the first time allow transfer of ownership rights to IOCs at specified delivery points, although IOCs “will not have any ownership rights over the project assets.” The IPC will allow joint ventures to be formed between IOCs, which will be granted a share of the output, and the NIOC or another Iranian partner, which IOCs can choose without interference from the NIOC. The contract will offer IOCs a better opportunity for cost recovery and profitability via significantly longer terms of 15-20 years, with the possibility of extension to 25 years, encompassing the production phase and extending to the enhanced oil recovery phase. While under the buy-back contract, stringent limits were imposed on the recovery of the costs of production and IOCs were limited to recovering costs up to a fixed sum specified in the agreement, the IPC imposes a more generous cap of 50 percent of total production in respect to the recovery of such costs. Further, the total compensation amount will not be fixed, but will rather be contingent upon the price per barrel, taking into account fluctuations in oil prices and the risk profile of the particular field to which the project relates. This compensation structure would ensure the profitability of IOCs in the case of a drop in oil prices and would assuage fears on the part of IOCs that a drop in oil prices, particularly given the current volatile nature of the crude market, would markedly reduce or wipe out their profitability. A key sticking point for IOCs will, however, remain under the IPC, namely that any dispute arising under the IPC will be subject to the exclusive jurisdiction of the Iranian courts.
Notwithstanding the pervasive interest in the Iranian oil and gas industry, a degree of uncertainty reigns. Indeed, much remains in the balance, given that the gradual extinguishment of sanctions under the JCPOA is contingent upon Iran’s compliance with its continuing obligations. The IAEA recently published a report on Iran’s nuclear proliferation status which, while clearing Iran of currently being engaged in nuclear proliferation with the intention of building a nuclear weapon, did nonetheless cast doubt on Iran’s commitment to transparency and honoring its obligations. The IAEA detailed experiments that Iran had conducted which were “relevant to a nuclear explosive device,” but it found no evidence that these succeeded in developing a complete blueprint for a nuclear bomb. While concerns as to Iranian compliance will pervade the discourse surrounding the deal, it is highly unlikely that the parties would take a step backwards, given that the deal has taken almost a decade to broker and marks a compromise that all parties accept.
Some commentators emphasize the risk of non-compliance on the part of Iran and the potential weakening of the commitment of a future U.S. and/or Iranian government to the deal given U.S. presidential elections scheduled for November 2016 and Iranian Parliamentary elections for February 2016. Still, future governments are likely adhere to the deal, not least due to the reassurance provided to the international community by the presence of claw-back provisions in the JCPOA, which allow for the re-imposition of sanctions in the event of significant non-performance by Iran of its commitments. However, the gradual and phased nature of sanctions relief under the deal and the risk of snap-back will make IOCs, investors, and international financial institutions cautious about doing business in Iran. Moreover, contrary to general perception, the JCPOA does not envisage a lifting of all sanctions imposed on Iran. The non-nuclear related sanctions, such as human rights-related sanctions and sanctions imposed pursuant to Iran’s alleged support for international terrorism, as well as U.S. primary sanctions prohibiting U.S. persons from dealing with the country, all remain intact.
Impact on Oil Prices
The volatile hydrocarbon market highlights a further dimension of the deal, namely its impact on oil prices as fears grow regarding the potential risk of a further drop of oil prices as a consequence of increased output of Iranian crude. Following Implementation Day, oil prices fell to below $28 per barrel and are expected to decline further to around $25 per barrel, as Iran seeks to increase its output by 500,000 b/d shortly following Implementation Day and by a further 500,000 b/d thereafter. However, as OPEC and non-OPEC oil producing states battle for market share, in a sudden policy shift, Iran has declared that it does not want to start a “price war” and intends to “gradually increase output.” While this goes some way towards reassuring the market that the potential of the JCPOA and Iran’s desire to return to the crude market has not blinded the country to plummeting oil prices, it is questionable at best whether such commitments will be observed in practice, at a time when exploitation of its crude wealth marks the most viable means for Iran to alleviate its economic stress. It also remains to be seen how OPEC will react to the further oversupply, of whatever degree, now that the first phase of sanctions relief has been implemented.
The JCPOA represents the fruits of a decade of political maneuvering and negotiation. Despite a degree of pessimism pervading the global discourse about the viability and longevity of the deal, it is unlikely that the international community will allow the progress to fall victim to internal politics. Iran is not only a potential key economic hub, it also has significant geopolitical leverage in the region, which ought to make the deal attractive in the eyes of the international community. Meanwhile, the JCPOA marks the cumulative result of more than a decade of diplomacy and outreach on the part of Iran, and holds the promise of an end to economic and political isolation and deep-rooted economic stagnation. The phased extinguishment of sanctions under the JCPOA, coupled with the new and more commercially viable IPC, has the potential to awaken a sleeping giant and make Iran a key participant in the global oil and gas market.
Shaheer Momeni is a Barrister-at-Law (Non-Practicing) and the President of British Chamber of Energy & Minerals (BCEM). Follow him on Facebook: www.facebook.com/ShaheerMomeniTotakhail/ Tamim Momeni is the Vice-President of British Chamber of Energy & Minerals (BCEM). Follow him on Facebook: https://www.facebook.com/tamim.momeni/