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Oil + Gas E1:R2

Oil + Gas E1:R2

Key Developments

◢ Growth in exports has been sustained, rising to 2.5 m/bdp. But challenges in marketing and financing Iran oil trade may limit exports in the near term. 

◢ The Ministry of Petroleum unveiled the long-awaited IPC contracts, but amendments were quickly made to address a flurry of criticism


 

Oil Market Share Reaches 80% of Pre-Sanctions Level

Over the past weeks, Iran has continued in its efforts to regain its share of the oil market lost in the sanctions period. The country marked a significant milestone when it was announced that the 80% of pre-sanctions marketshare had been restored. On the same front, Iran moved closer to the implementation of a new format of oil sector contract, known as the Iran Petroleum Contract (IPC), that envisages a long-term partnership between international oil companies (IOCs) and local players. The Ministry of Petroleum has identified eight domestic companies which can be considered suitable joint-venture partners for IOCs. Notably, Iran has been using a  variety of currencies to facilitate oil transactions. Officials have announced that oil-related banking and insurance issues, which have hampered exports for the last several years, have now been resolved. 

Momentum in Exports

In the Iranian calendar month of Khordad (21 May-June 2016), Iran continued in its efforts to increase the production and exports of oil. The country’s production reached over 3.8 million barrels per day (m/bpd).  Exports, which had already reached over 2 m/bpd, increased to over 2.5 m/bpd. In it latest report on the global oil market, the Energy Information Administration (EIA), announced that the majority of the expected increase in OPEC production would come from new supplies from the Islamic Republic. The EIA report shows that Iran’s average oil production in the second quarter of 2016 stood at 3.58 m/bpd, an increase of over 27% compared to the same period in 2015.  Iran’s oil exports before sanctions stood at over 2.5 m/bpd; this declined to around 1 m/bpd during the sanctions period.  

Iran’s rapid return to the oil markets came on the back of successfully negotiated contracts with many of the world's largest oil traders. Europe is currently importing around 600,000 bpd of oil from Iran. This is about a quarter of the Iran's total oil exports.  Iran has not sealed new contracts with its Asian clients but has nonetheless been able to increase its oil exports to Asia.  For example, Iran’s oil exports to Japan, which had declined over the past few months as a result of problems around the insurance of tankers, recently recovered to reach 200,000 bpd.  Iran’s goal is to increase oil exports to 4 million bpd within the next few years.

 
 

However, a look at the latest figures on Iran’s oil production shows that the country faces some serious challenges in its plans to increase the production and exports of oil.  Based on the latest reports, Iran’s exports in the first three weeks of June decreased by 20%. The country was able to compensate for this in the last days of June and continue with the rise in its production/exports of oil. Nevertheless, some longstanding clients of Iran’s are still refusing to resume purchases of crude from the Islamic Republic.  Other challenges include Iran's inability to perform dollar-based transactions and a lack of banking mechanisms to facilitate trade including limited provision of L/Cs. Internally, analysts also cite the persistent delays in the finalization of the IPC and poor marketing by the Ministry of Petroleum as additional challenges. 

Amendments to Iran Petroleum Contracts

The Ministry of Petroleum has finally unveiled the Iran Petroleum Contract (IPC), which has taken nearly two years to prepare. There remain, however, some serious reservations regarding the new IPCs in certain corners of the Iranian establishment. This led Iran’s First Vice President, Es’haq Jahangiri to urge Petroleum Minister Bijan Zangeneh to order a review of the IPCs, taking into consideration the points that critics have raised. President Rouhani’s cabinet eventually approved the draft for the IPCs with minimal changes. However, several key amendments were made which many believe strengthened the IPC. 

First critics had stated that each reservoir is unique and thus needs its own specific contract that would address the peculiarities of the project at hand. Furthermore, companies have specific expertise and cannot therefore be assigned to develop Iran’s oil fields through a single universal construct.  Language was added into the most recent version of the IPC to account for these points. 

Second, in the original draft of the IPC, there was no production ceiling for projects. In the final draft that was approved by the cabinet, there is a production ceiling of 1 million bpd and 250 million cubic meters of gas. The priority in this production ceiling has been assigned to shared oil fields, the management of which many have suggested is a strong point of the IPC model. Nevertheless, the priority given to shared fields has led to concern that a key these fields will be favored. 

The third key amendment made to the IPC concerns the authority of the NIOC over foreign contractors working on the development of a field.  The original draft of the IPC emphasized that the NIOC and its subsidiaries would need to implement whatever the second party to the contract (the IOC) stipulated. Failure to do so would amount to an intentional breach of contract. However, an amended version of the IPC emphasized that all measures need to be approved by the NIOC.  This amendment itself has raised concerns that NIOC will meddle in the rollout of projects, putting off IOCs. 

Despite these amendments, the IPC contracts have become a matter of debate between the Rouhani Administration and the parliament. At stake is the issue of sovereignty. The IPC enables foreign companies to take charge of production at fields.  Moreover, the foreign contractor will be party to the project for 32 years. Both details are in line with international norms for such contracts, but they strike a chord with Iranian politicians who are sensitive about control of natural resources. 

Another concern is the that the IPC contracts move away from the buyback model previously used towards a model with open capital expenditure. The buyback format of contracts always included a ceiling for the costs of the project which increased or decreased only under special conditions.  Buybacks determined a fixed capital expenditure from the beginning that would be approved through Iran’s national budgets.  The IPC has no such ceiling, and some have cited the potential for runaway project costs. 

As for selecting the Iranian partner firms, there is no set model within the IPC or related regulations that explains how the Ministry of Petroleum or the National Iranian Oil Company (NIOC) will vet local firms. The NIOC has nonetheless announced a list of companies that it has approved as potential partners for IOCs entering Iran.  But the lack of a clear selection framework has led to speculation that the shortlisted companies paid for the privilege. 

Finally, key financial details like indirect income, profit calculations, and taxation are still undefined. This lack of clarity has led some international oil executives, such as the CEO of Austria's OMV, to declare that the contracts are not up to an acceptable standard. 

MoP Responses to Criticisms

In the face of this criticism, the Ministry of Petroleum has defended the IPC and the amendments it has made.  It has emphasized that experts spent over 30 hours negotiating amendments to the IPC. Iran’s Petroleum Minister, Bijan Zangeneh, has highlighted several key legal points that have been addressed in the IPC:

  • An article that envisaged awarding another exploration target to the contractor in the same block if it failed to find oil over the original target has been removed.
  • An article has been added to specify that the government of Iran is the owner of the reservoir.
  • A mechanism has been created to make sure the decisions made by the Joint Management Company – the company established between the foreign company and its local partner – are approved by the NIOC.
  • Operating technicalities also need to be approved by the NIOC. 
  • The IPC has also been amended to allow IOCs to use the buyback mechanism when developing green-field projects.

Criticism of the contracts is bound is continue, but the Rouhani administration needs to press ahead as the contracts will underpin the long-term recovery of Iran's oil industry.  Accordingly, the Ministry has announced that the new, amended format of the IPC contract has no outstanding issues and will be implemented within the next six months.

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