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Iran’s new Petroleum Contract (IPC): what’s the deal?

Iran’s new Petroleum Contract (IPC): what’s the deal?

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Date: 8 December 2015 08:07

By Alice Drury, Sam Barden for Trend

What opportunities and risks should foreign investors expect from the new Iran Petroleum Contract (IPC)?

We assess the legal framework and language of the IPC, the political risk and dispute resolution process, and importantly, when foreign investors enter Iran, will they be able to exit?

The Iranians are looking for the IPC to generate appetite for foreign investment into Iran, so what’s the deal?

What is the IPC?

The IPC is a framework that lays out the basic structure -- and some details -- regarding all future petroleum contracts in Iran. As a Cabinet Resolution (which has similar status to a by-law) passed under the Petroleum Act (and a similar status to a by-law), it is by nature more open to legal and political challenge. The terms by which foreign companies will be permitted to exploit Iran's natural resources will be a politically sensitive issue in Iran for years to come, and in this framework not having not been subjected to rigorous debate in Parliament, this framework is leaves it more susceptible to controversy and, therefore, amendment. A complaint or argument could be put forward, or run, that a legally binding document of such significance falls outside the purview of the Cabinet's powers under the empowering provision. That said, at this stage there are no known challenges to the IPC.

But even if the IPC escapes controversy, it is also important to bear in mind that under Iran’s Constitution, the Iranian Parliament must approve any international agreements. Presuming (as it seems to) that this includes petroleum contracts with foreign oil companies, negotiations will be sensitive to the political realities in Iran.

IPC better than buy back

There is little doubt that the new IPC framework is an improvement on the old buy back system. The IPC is a service contract, or a “risk service” contract as Iranian officials describe it. The IPC is designed to spread investment risk on a sliding scale for the foreign investor, and offer more flexibility in terms of collaboration, competitive terms, pricing and booking of reserves to the foreign investor. With the prospect of 25-year service contracts and no capital expenditure ceilings, foreign capital will be able to enter Iran soon, but will they be able to exit?

Investment Entry and Exit

There is no doubt that Iran is getting ready to welcome foreign investment back into the oil and gas sector, and the Iranian Capital markets generally. Despite the lack of apparent banking and settlement capability, Iran intends for the new IPC to drive foreign investment.

The obvious risk in Iran is the banks. There are a lot of banks and not a lot of banking. The issue of sanctions on the banking sector, specifically US treasury sanctions, will mean the flow of funds in and out of Iran via the banks will be made more difficult. This naturally represents a risk to investors, despite the fact the Iranian Capital Markets and Exchanges are highly regulated by the Securities Exchange Organisation. Like many markets, they struggle for liquidity.

The Iran IPC certainly provides an investment opportunity, however it does not provide an instrument for investment. How will investors participate? They will either invest into the oil and gas company partnering on the IPC, such as BP, Shell, Gazprom for example, or perhaps the Iranian Government will issue some sort of bond against the hydrocarbon sector to encourage foreign investment.

Dollars and Euros

The issue still exists that Iran will be structurally short of euros and dollars, which they will presumably have to borrow either indirectly or directly to fund infrastructure investment into their hydrocarbon sector. The IPC on its own will not achieve this.

These dollars and euros will be “borrowed” against a low oil price, effectively devaluing Iran’s hydrocarbon Industry, simply because they will receive a lot less currency on sales internationally. Since the IPC does not have an instrument of investment, and as it stands foreign companies will have to rely on the government and Iranian banks to move funds. This makes an exit strategy much less clear for foreign investors, and thus greatly increases the investment risk to foreign funds.

What is missing from the IPC?

Until an authoritative copy is provided in English, we should proceed with caution in interpreting the IPC. A number of clauses, such as those relating to the form of and obligations arising from joint operating agreements and resolving disputes within the managing working group, remain ambiguous. Furthermore, defined terms are at times used inconsistently in the IPC, and clauses, which appear to relate to both oil and gas, on occasion only reference one. This lack of clarity in the details of the document when coupled with the style of legal drafting in Farsi, which tends to be more complex than in English, makes the risk of drafting a non-compliant contract higher. Foreign companies are well advised to employ reputable bilingual (preferably local) lawyers when reviewing any agreements against the IPC in its original (and authoritative) Farsi prior to signing.

Crucially, and more positively from the perspective of a foreign contractor, two important matters have not been addressed by the IPC: the law, which is to govern petroleum contracts and dispute resolution. Iran’s Parliament will want to maintain the maximum control possible over foreign petroleum contractors, while it will be crucial for foreign contractors that they ensure their petroleum contracts are governed by well-established international legal practice. The process and forum for dispute resolution is less controversial but nonetheless should be carefully negotiated and clearly articulated.

What does the IPC really mean for the foreign contractor?

The IPC does not represent a “free for all” when it comes to partnerships or fields for development. The first party to the contract will always be the National Iranian Oil Company (NIOC) and contracts will only be available for specific sites. Additionally, costs will be recovered from the production and sale of oil, however “cost” oil will be capped at 50%. In a low oil price environment, and with the possibility of cost overruns, foreign investors could be waiting a long time for a return on investment, even if it is only a service contract.

Similarly, the financial risk for any project lies with the contractor, or the foreign oil company. The issue of how to book reserves remains very unclear, and thus the ability to raise finance for production is made more difficult, as there is nothing to secure the loan against. The exit for investors when measured against the risk of investment looks to be high.

IPC’s significant points

The main points to consider in the IPC, and its significance for foreign petroleum companies, are as follows:

The NIOC shall be the contracting party on behalf of the Islamic Republic of Iran;

Initially, contracts will be granted in relation to specific sites already identified by the NIOC and awarded through a tender process;

Ownership rights in the oil or gas produced will remain with the state, and thus there is no prospect for a concession agreement;

Costs of production will be recovered from the oil or gas produced. Cost oil is to be capped at 50% of total production;

Profit is payable to the contracting party as a fixed fee earned per barrel produced;

The financial risk at each stage of production is borne by the contractor; and

Foreign contractors must commit to improving Iranian know-how and technology, and employ Iranian nationals to the greatest degree possible.

Oil as a service?

One important and defining point is that foreign contractors will be remunerated on a fee per barrel basis, not a profit sharing agreement. This is in line with statements made by the Managing Director of the National Iranian Oil Company, Roknedin Javadi, that the IPC facilitates a service agreement as opposed to profit sharing.

This represents a small step towards the view of “energy as a service”, as outlined by Chris Cook of Wimpole International, however as long as Iranian oil is priced via London and New York, Iran will have no control over pricing. Iran needs a regional pricing mechanism for their hydrocarbons.

Do I get my tools back?

There is no question of what Iran wants from the IPC. They want technology and knowhow to be transferred from the foreign contractor to the NIOC. This is a classic trade of intellectual property (IP) for oil. The natural, and much more valuable extension of this however, is the transfer of IP for Oil saved. That is essentially what Iran wants; the best possible value per barrel of oil or MMBTU of gas produced.

It seems that for foreign oil companies entering Iran, they will not be simply supplying knowledge and technology; they are also expected to bring their tools, and leave them there. Under the IPC, ownership of all installations and property on the contracted site will transfer to the NIOC. It is not clear if the ownership of materials and tools brought by the contractor will be transferred back to the contractor after completion of the contractual term.

Conclusion

The risk for Iran is that the IPC will not generate the tidal wave of investment from International oil and gas companies Iran hopes for. Upgrading Iran’s oil and gas infrastructure, applying new technologies and efficiencies will only come about from close collaboration and a large dose of trust between NIOC and the foreign partner.

However, the IPC is a positive and necessary first step toward opening up Iran’s petrochemical market to the world It does, however, present prospective foreign oil companies with some real challenges, the greatest of which being those associated with their closed banking system. Yet, with an overall reasonable framework for future oil and gas contracts coming from the IPC, we see reason for optimism.

Entry into the Iranian investment market looks easier than exiting, so the best advice for foreign oil and gas companies, is to prepare for a marathon, not a sprint, when investing in Iran.

About the Authors:

This article is produced on behalf of IranInvest.

Alice Drury:

Alice Drury is an Australian corporate lawyer, with experience in International Policy and advocacy. She is currently completing her Masters in Iranian Studies at the University of Tehran.

Sam Barden

Sam Barden is an Australian Citizen, and entrepreneur. He has spent 20 years in Emerging markets as a Trader and commodities expert.

* The Persian version if this article was published on Sharg Daily Newspaper.

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