"There are very few places in the world that are entirely off limits to the western oil majors, a group who will literally go anywhere in search of crude. But Iran is the big exception. Thanks to US and EU sanctions, Iran is, for Big Oil at least, beyond the pale.
That may now be about to change. The recent charm offensive by Iran’s new president, Hassan Rouhani, has raised hopes of a diplomatic rapprochement between Tehran and Washington and an easing of sanctions. Iran has now gone further, suggesting it could offer more lucrative contracts to foreign companies prepared to invest in its oilfields.
In an interview with the Financial Times, Mehdi Hosseini, an adviser to the Iranian oil minister, said the government was working on scrapping the current system of “buybacks” – a kind of deal that has proven one of the most problematic in the oil industry – and replacing it with a new type of contract. It is part of a push to attract at least $100bn of investment into Iran over the next three years.
In principle, there could be a lot of interest. Iran, after all, does boast the world’s fourth-largest oil reserves and the world’s largest endowment of natural gas. Its South Pars natural gasfield, the biggest in the world, was once the hottest ticket in the global oil industry.
“Iran still has a number of very attractive opportunities,” says Alex Munton of consultancy Wood Mackenzie. He cites South Pars and the huge potential gains from using modern western technology to boost recovery from Iran’s mature oilfields, which peaked in the 1970s and are now in steep decline.
But the majors are sceptical. So many things have to change before they would even consider investing in Iran – not least an end to sanctions. And even then, success is not assured.
“Oil companies have a lot more opportunities now than they did even 10 years ago,” says a senior executive at one of the majors. “The world has changed – there is Africa, Latin America, US shale. In that context, Iran’s going to have to offer much more competitive terms if it wants to attract companies like ours.”
Still, Mr Rouhani’s election has brought a rare ray of hope. Industry experts were particularly heartened by his appointment of Bijan Namdar-Zanganeh as oil minister. A technocrat who occupied the same job between 1997 and 2005, under the reformist president Mohammad Khatami, he was instrumental in attracting billions of dollars in foreign investment into the oil sector. Nonetheless, he faces major challenges in reviving that interest.
The biggest problem is the buybacks, a type of contract first introduced in the early 1990s, under which foreign companies pay all the upfront costs of developing an oilfield and, over a fixed number of years, are allowed to recoup their costs and make a small profit – but at a specified rate of return.
Initially, the contracts were quite attractive, and companies like Total and Petronas won reasonable rates of return. But then, as resource nationalism took hold in Tehran, the Iranian parliament intervened to reduce the rates.
Despite the deteriorating terms, companies like Royal Dutch Shell were lured into Iranian ventures like South Pars. However, the Iran-Libya Sanctions Act, imposed by Washington to squeeze foreign companies out of Iran, achieved its purpose. In 2008, Total, one of the last foreign groups that retained a big interest in Iran, threw in the towel.
Ideally, investors would like to see buybacks replaced by the kind of production-sharing agreements, joint ventures and concessions seen in the more investor-friendly oil-producing countries. But that would bump up against Iran’s constitutional ban on foreign ownership of its oil and gas resources.
Mariam Al Shamma, a Middle East analyst at consultancy PFC Energy, says the outcome of Mr Hosseini’s reform efforts will probably be a type of service contract “with a high enough rate of return to attract the international oil companies”.
She says there is also a “remote possibility” of legislation that allows the majors to book oil reserves – thereby reflecting the potential value of the oil or gasfields in their accounts – without actually owning them.
Any hope of reviving Iran’s oil industry rests on its ability to attract foreign investment. “If there is no foreign involvement in Iran’s upstream, its [oil and gas] production will stay flat and could start declining in the medium to long term,” says Shapour Saba of Wood Mackenzie.
With so many other places to operate, oil companies need a lot of persuading to return to Iran. “If you want to compete for investment, you have to offer very attractive contracts,” says Salar Moradi, an oil market analyst at FGE."
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