Iran Petroleum Contract Bill: risks and benefits for foreign investors

Oil&Gas Materials 20 November 2015 10:04 (UTC +04:00)
The Government of the Islamic Republic of Iran defined and released the general structure of the upstream oil and gas contracts, Iran Petroleum Contract (IPC) Bill, in September 30, 2015
Iran Petroleum Contract Bill: risks and benefits for foreign investors

By Reza Yeganehshakib, for Trend Agency:

The Government of the Islamic Republic of Iran defined and released the general structure of the upstream oil and gas contracts, Iran Petroleum Contract (IPC) Bill, in September 30, 2015.

Although The Iranian Ministry of Oil officially put this into effect in November 14, 2015, President Rouhani and several other Iranian officials in the Ministry of Oil have already announced the conditions of the new upstream contracts since late 2013.

The new generation of the oil and gas contracts (the forth generation) will be still "buy-back" or "service contracts."

One of the differences of the forth generation of these contracts with their predecessors is to provide more incentives to the foreign contractors, especially in the form of rewards (Fee, according to Article 1, Section 20) paid to each excess barrel of oil, each 1000 cubic feet natural gas or each barrel of gas condensates produced in addition to the minimum agreed production amount.

The other incentive in these contacts, according to Article 2, Section 1, is that if a contactor is successful in finding a commercial-scale field or reservoir, the consecutive phases of the operation contracts including development and production will be given to him. According to Article 10, Section 1, the estimation of the Fee will be transparent and more accurate comparing to the three previous generations of contracts and will be paid to the second party (contractor/foreign investors) as soon as the production from the reservoir is started or reached to the excess production level.

Based on Article 1, Section 27 and Article 8, Section 5, these contracts are also Open Capex, which means there is no cap on the contractor's expenses in various phases of the operations. Another incentive, anticipated in these contracts is that according to Article 6, Section 2, Subsection 2, although the contractor (the second party) accepts all the risks of exploration, if the exploration is not successful in finding a commercial-scale field or reservoir, another exploration block will be assigned to him with the same conditions stated in the original contract.

As it is discussed in details in the article published in the Journal of Political Risk Vol. 3, No. 4, April 2015, these incentives make these contracts more attractive to the foreign investors comparing to the first three previous generations of Iran's oil and gas contracts. Yet, there are some issues that may impose a risk on the foreign investors' capital and future accumulated interests.

According to Article 3, Section 1, in all the contracts these principles should be followed: the government of the Islamic Republic of Iran 's right of ownership of the oil and natural gas resources and reservoirs, which is practiced through the Ministry of Oil. Article 11, Section 5, also clearly stated that the oil, gas or gas condensates or any material produced as a result of production operation is the property of the first party (the employer), which is Iran's Ministry of Oil.

Moreover, according to Article 3, Section 7, all the operations done by the contractor is under the supervision, ownership, and on behalf of the Iranian Ministry of Oil (First Party of the contract), and all of the assets such as buildings, goods, equipment, wells, and installations, including those over-ground and underground, belong to the Iranian Ministry of Oil since the beginning date of the contract.

This simply means, the contractor should heavily invest in all the operations from the preliminary phases of the operation (explorations) to the development and production stages but has no ownership right over neither equipment nor the produced oil and gas. Based on Article 3, Section 3, All the contractor's expenses (costs) including Direct Capital Cost (DCC), Indirect Cost (IDC), Cost of Money (CoM), Fees, and Operation Costs (Opex) should be covered from a fraction (Maximum 50%) of the produced oil and gas from the field or the profits made by the execution of the contract based on the actual price of the produced oil or gas at the time of payback.

This creates some issues for the investors, which are generally more interested in the value of the product rather than the product itself. As mentioned above not only the contractor's expenses will be paid back from a maximum 50% of the produced oil and gas but also the "fee" (reward) is determined based on the actual price of the oil or gas at the time of production.

The current trends in the global oil markets, especially the relatively higher supply and lower demand are indicators of fluctuations in the value of these resources based on which all the rewards and paybacks are calculated.

Particularly, with the Iranian oil entering into the global markets, if the other oil producers do not decrease their production and the demand does not increase, we should not expect any significant increase in the value of the produced oil and natural gas. This is one of the reasons that makes buy-back contracts relatively less attractive comparing to Production Sharing Agreements (PSAs).

One of the other issues is the way Joint Operating Company/Joint Operating agreement has been set up in Article 1, Section 21: Contractor (second party) has to have an Iranian subcontractor/partner with which he shall work in operational phases including development and production.

The foreign contractor also should gradually transfer the decision making process, while rotating management in early phases, along with the technology to the Iranian subcontractor/partner. However, this joint agreement is not going to reduce or eliminate any of foreign contractor's (second party's) responsibilities and he shall remain responsible for all of his obligations.

This regulation also defines when this third party should assume his responsibilities. According to: Article 11, Section 1, Subsection 1, if the employer (first Party/ Ministry of Oil), decides that it is necessary to employ an Iranian subcontractor which is an National Iranian Oil Company (NIOC)'s satellite company, during the production phase of any Brown Field or Brown Reservoir, a Production Agreement will be signed between the second party (contractor) and the NIOC's satellite company.

The purpose of this Operational Agreement is to assist the contractor in fulfilling his duties in the production phase. The NIOC's satellite company must follow all the contractor's operational guidelines and rules. If NIOC's satellite company violates any contractor's rules, this will be considered as the first party's (employer's) violation of the agreement.

According to these regulations pertaining Joint Operating Company/Joint Operating agreement, whenever the first party decides to enter a third party (his satellite company) into the operational phase, the contractor must agree and sign an agreement with the third party, even if the second party is not confident with the capabilities of the third party or do not wish to work with him.

In order to create an environment of confidence for a foreign investor, the law should bestow a power of decision making to the second party in this section; otherwise, any failure in the production operations caused by the third party, may have negative impacts on the second party's fulfillment of his responsibilities.

This has also benefits for the first party because after the foreign contractor's approval of the third party, any further failure in the production will be foreign contractor's responsibility, and not the result of an imposition of an NIOC satellite company that the contractor did not wanted to work with at the first place.

As mentioned above, the general structure of these contracts are service contracts or buy-back. The experience of several countries that went through these agreements, especially Iraq, proves that Production Sharing Agreements (PSAs) are better choices for the foreign investors.

Meanwhile, the Iranian law does not allow the government to sign these types of contracts since they create the right of ownership of the resources for foreign companies. According to the Iranian law, these resources are in the category of anfal which is the common property of the Muslim community (Umma).

The control of these properties/assets is in the hands of the leader of the Muslim society on behalf of the people of the faith. No matter what bills President Rouhani's government passes in order to make the oil and gas contracts more attractive to the foreign investors, the answer to the question of attractiveness is somewhere else: the parliament (majlis) and the guardian council (shoray-e negahban). These organizations should work together to present new interpretation of the law to separate oil and gas resources from anfal, at least under some conditions, for example a restricted amount of ownership for foreign investors.

Although the new generation of Iran oil and gas contracts is named Iran Petroleum Contracts (IPC), they are indeed another buy-back agreement with better incentives and more flexibility. Yet, under the very current regulations, Iran is able to mitigate the risk of new contracts' unattractiveness (comparing to PSAs) by investing on other products and sectors of energy such as LNG and gas condensates.

Iran should pay more attention to midstream and low stream sectors. More foreign investment should be attracted in expanding these sectors. This may also help the Iranian oil and gas to overcome the issue of a low demand market.

Dr. Reza Yeganehshakib is Iran expert in Corr Analytics, a New York-based political risk consultancy. He is also an adjunct faculty at Fullerton College teaching the history of The Middle East.