The need for Iran to invest in its oil and gas sector to maintain and boost output is obvious. In a bid to create an environment more conducive to attracting foreign investment, the oil ministry has started working on a new contract model for international companies seeking to become involved in domestic oil field developments.
The Iran Petroleum Contract (IPC) is set to replace the traditional buyback scheme, which was first introduced in the 1990s in an attempt to bridge the gap between the country’s need to attract foreign oil and gas investors, and a ban on private and foreign private ownership of natural resources under the Islamic republic’s constitution.
The scope of Iran’s buyback contracts covers both field exploration and development. They are essentially risk service contracts, under which the contractor is paid back by being allocated a portion of the hydrocarbons produced as a result of providing services. The pay-back period tends to be short, ranging between five to seven years, after which a developed field will be handed over to NIOC. Buyback schemes are based upon a defined scope of work, a capital cost ceiling, a fixed remuneration fee and a defined cost recovery period.
Although Iran has updated the buyback model twice since it was first introduced the contracts have been widely unpopular with IOCs due to their inflexibility and limited returns. According to a note published by legal firm Clyde & Co. in May , “the IOCs feel that the buyback model is prone to huge potential losses because the IOC has very limited options to put a ceiling on its capital costs. Additionally, the way that the contracts are structured means that at the time of signing, long term pre-defined operating targets are set that do not take account of prevailing market conditions, new drilling plans, reserve estimates, financing costs, etc.”
New Contract Model
The IPC will do away with many of these criticisms. Mohsen Shoar, Managing Director at Dubai-based Continental Energy DMCC and an expert on Iranian energy, says the new IPC model varies markedly from the existing buyback schemes in that it proposes the establishment of a joint venture between NIOC (or one of its subsidiaries) and a foreign partner for field exploration, appraisal, development and—for the first time since 1979—production.
There will also be a provision for the IPC to extend into enhanced oil recovery (EOR) phases . According to the EIA, “this modification aims to rectify issues with field decline rates by including the IOC in the production and recovery phases, while optimizing technology and knowledge transfers.”
Unlike the short nature of the buybacks, the IPC model will offer extended contract duration of 20-25 years, allowing for much longer cost recovery after first production. On top of this, there will be a risk-reward element linked to the complexity of fields that pays companies higher fees for ‘very high risk’ on- and offshore fields compared with ‘low-risk onshore’ fields.
The IPC is also designed to take advantage of foreign companies’ marketing expertise and give Iran access to their supply network to find an export market, according to Clyde & Co, in particular at a time when the Islamic republic has lost some market share.
“This is important at this time as the global energy market is expected to face oversupply in the mid-term due mainly to the discovery and harnessing of shale gas in North America. Thus, having the assistance of an international company and its networks around the globe will become an increasingly important resource for Iran.”
While IOCs won’t be able to book reserves under Iranian law, it is understood that the IPC will make some provisions allowing investors to incorporate revenues generated from Iranian oil and gas resources in their financial reporting, which for stock market-listed companies in particular would be an important incentive when mulling involvement in the country.
Other significant amendments versus the buyback model include an ‘annual work program and budget’ to be approved by a joint venture development committee (JDC) made up of officials from the partner companies, says energy expert Shoar. This is an important change as the fixed cost approach under the buyback model meant that cost for projects going above budget couldn’t be recovered, thus eroding profitability.
Overall, the increased flexibility and improved terms offered under the IPC will provide some incentive for foreign investors to consider a return to Iran’s oil and gas sector if and when sanctions are lifted. However, challenges remain. Continental Energy’s Shoar says, among other issues, IOCs may be concerned over too much interference into operations by the local joint-venture party, in particular when the foreign partner shoulders all project-related risk.
“Under the IPC, a foreign partner will be required to meet the Iranian local content requirement which will be 51% of the contract. This is, however, unlikely to deter too many foreign investors who are used to working in the region,” according to Clyde & Co.’s legal note. “Another potential sticking point for international oil companies may be the fact that any dispute arising under the IPC will be subject to the exclusive jurisdiction of the Iranian courts. Many international companies may not feel comfortable with this and would probably prefer international arbitration.”