via LobeLog

by Robin M. Mills

Iran’s new oil minister, Bijan Zanganeh, cancelled plans to attend September’s United Nations meeting in New York. But the much-heralded thaw in US-Iranian relations has led to a remarkably quick revival in Western oil companies’ interest.

At least one large European firm is already rumoured to be looking at re-opening its Tehran office, and “There is no embargo on talks,” one European oil executive told Reuters.

The oil companies’ memories may be short. In the late 1990s, beset by low oil prices and outmoded technology, Iran sought to sidestep constitutional restrictions on foreign investment to bring in international oil companies (IOCs).

Under Zanganeh’s first tenure as oil minister, from 1997-2005, France’s Total, Anglo-Dutch Shell, Norway’s Statoil, ENI of Italy, Spain’s Repsol, Petronas from Malaysia, Gazprom from Russia and others came in to work on major oil fields, conduct new exploration, and develop South Pars, Iran’s sector of the world’s largest gas field, which it shares with Qatar.

But the biggest prize was lost when US corporation Conoco had to withdraw from a $1 billion deal to develop the Sirri offshore fields after being blocked by president Bill Clinton’s executive order. Total stepped in instead, and a chance of US-Iranian engagement was forfeited.

The international companies did not find the going easy. The Iranian constitution was interpreted as banning foreign ownership of hydrocarbon reserves or even a contractual right to a portion of oil and gas a company extracted — the “production sharing contract” (PSC) used by Qatar and many other major producers.

Instead, Iran devised its own formula, the “buyback”, where the contracting company committed to delivering a set development plan for a fixed price, receiving a defined profit margin, and then handing over the field to the National Iranian Oil Company (NIOC).

A more lose-lose formula could hardly have been devised. According to those terms, the international company assumed all the risks of cost overruns and technical problems without any share of a potential upside from larger reserves or higher prices. The Iranians meanwhile missed out on a transfer of skills and a chance to optimise development or operations as the international operator learnt more about each field’s geology. Each contract took years to negotiate, trying the patience of IOCs who saw more attractive opportunities elsewhere as oil prices recovered.

The buybacks were attacked on nationalist grounds, and Zanganeh and his associates were accused of corruption. Their quasi-privatisation of parts of the oil industry into companies such as PetroPars and PetroIran — in fact controlled by government organs — was problematic. Nevertheless, oil production increased from 3.8 to 4.2 million barrels per day, and gas output more than doubled. Iran developed a substantial, if rather expensive, domestic oil engineering capability.

But under the Ahmadinejad administration — amid an increasingly politicised oil ministry and NIOC, a hostile Majles, and ever-tighter international and US sanctions — progress ground to a halt. In 2010, Shell halted new business development in Iran and finally gave up on its “Persian LNG” (liquefied natural gas) joint venture with Repsol. Some other oil companies, particularly Chinese ones, continued operations at a low level but did not make major new commitments.

If Western oil companies are to return to Iran, the prerequisite will be a relaxation of many of the US and EU sanctions on oil trade, investments in the energy sector and financial transactions. The Europeans, at least, could operate with some continuation of the much milder sanctions of the early 2000s, which mostly affect technology transfers. But to make large investments, these companies would have to be confident that harsh sanctions would be unlikely to return.

Just as importantly, IOCs would have to be confident that contractual terms will be reasonably attractive and balanced. They will want to negotiate contracts within reasonable time frames.

The competitive landscape for Iran is much tougher than during its last opening. Lucrative — albeit high-cost — investment opportunities have sprung up in North American shale oil and gas. Next-door Iraq also offers access to giant, low-cost fields — though on tough terms and with serious political and security risks. The sector of the Zagros Mountains in the Kurdistan region of Iraq shows just how successful modern exploration techniques can be. And the gas market is much more crowded, with the US, East Africa and Australia all seeking to rival Qatar as global LNG giants.

Zanganeh’s deputy, Mehdi Hosseini, is well-known to Western IOCs. But he has praised Iraq’s service contracts, which will not excite them. Production sharing contracts seem still to be off the table, for now — though there was talk earlier this year about using them for an Indian consortium’s offshore field.

More feasible would be a contractual form that mimics the financial returns from a PSC while honouring nationalist sensitivities. IOCs would like to be able to book reserves but can manage without this if profits are sufficient. The key is to give international companies a long-term stake in fields that encourages them to bring their best technology, maximise recovery in Iran’s mature oil-fields and explore new prospects. In gas, Iran can use the commercial skills of IOCs to develop exports to its neighbours, which will re-integrate it into the regional and global economy.

If the political stars align, the return of Western IOCs to Iran can bring them benefits while also benefiting Iran and the global economy. Zanganeh and his team have learnt lessons from their successes and failures in the early 2000s. But domestic realities on both sides may mean it’s a long time before ExxonMobil and Chevron are drilling just over the border from their Iraqi operations.

– Robin M. Mills is Head of Consulting at Manaar Energy and author of The Myth of the Oil Crisis and Capturing CarbonEmail him or follow him on Twitter.