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 [...]]]>
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 Carbon. Email him or follow him on Twitter.
]]>by Robin M. Mills
Hassan Rouhani is known as a man who sprays air-freshener in the room before a meeting. When it comes to Iran’s oil industry, Iran’s fastidious president-elect may have a great deal of spring-cleaning to do.
Much outside attention has been paid to the impact of sanctions on Iran [...]]]>
by Robin M. Mills
Hassan Rouhani is known as a man who sprays air-freshener in the room before a meeting. When it comes to Iran’s oil industry, Iran’s fastidious president-elect may have a great deal of spring-cleaning to do.
Much outside attention has been paid to the impact of sanctions on Iran and global oil markets. There has been less discussion of what Iranian policymakers should be doing with their oil, and what effect different policies would have within the country. Turning around the petroleum sector is crucial to Iran’s economy, and in turn, to the success of the centrist-reformist current that the pragmatic Mr. Rouhani is now representing.
During the phase of post-war reconstruction under Akbar Hashemi Rafsanjani, oil production rose by more than 3 percent annually and grew by more than 1 percent per year under Mohammad Khatami as major foreign investment flowed in from European, Russian and Asian companies. In 1995, Bill Clinton vetoed a contract for US oil company Conoco to develop the offshore Sirri fields, which allowed France’s Total to step in. The National Iranian Oil Company (NIOC) as well as domestic engineering and service companies also significantly improved their technical capabilities.
In contrast, the economic consequences of Mahmoud Ahmadinejad were oddly similar to those of Hugo Chávez in Venezuela — the replacement of skilled oil technocrats by less qualified allies, leading to stagnant output. Two giant oil field discoveries of the early 2000s, Azadegan and Yadavaran on the Iraqi border, have barely been developed.
Driven by South Pars, the world’s largest field — shared with Qatar — natural gas production continued to rise impressively under Ahmadinejad, albeit at a slower rate than with his predecessor. But with lines being drawn all over the map like spaghetti, minimal progress was made on gas export plans — to Turkey and Europe; Pakistan and India; the UAE, Bahrain, and Oman — and as liquefied natural gas. The country that, according to British Petroleum, now has the world’s largest reserves, is barely a net exporter of gas.
Development of the oil sector was, of course, hampered by increasingly tight sanctions. Western companies essentially suspended new activities by 2008, while Chinese and Russian firms did no more than keep a foot in the door. But bigger barriers — already apparent during Khatami’s second term — were unattractive contract terms, interminable negotiation periods and decision-making paralysis.
Three of Ahmadinejad’s nominees for oil minister were rejected by the Majlis in 2005; in 2011 he attempted to act as his own oil minister, again ruled out by parliament. As Kevan Harris has documented, from 2006, Ahmadinejad accelerated a process already underway since the 1990s — the pseudo-privatisation of a wide range of state-controlled entities, including oil development and engineering companies and petrochemical plants. In a process reminiscent of the “nomenklatura capitalism” of post-Soviet Russia, many of these companies have fallen under the control of regime insiders and government bureaucrats.
High and rising oil prices permitted complacency as Iran received more oil revenues than in the entire previous century of production during Ahmadinejad’s two terms as president. An increasingly overvalued exchange rate made domestic industry uncompetitive and attracted a flood of cheap imports in a vain attempt to keep down inflation sent soaring by excess liquidity. In a curious reversal of monetary orthodoxy, Ahmadinejad insisted that interest rates not exceed the inflation rate.
The main positive achievement of Ahmadinejad’s administration was reforming Iran’s ruinous energy subsidy scheme, which was replaced by direct cash payments to families. The plan was conceptually sound and surprisingly well-executed; consumption fell and the basic income provided made a substantial difference for poorer Iranians. But the scheme stalled as a result of further infighting between the Majlis and president, the sanctions-induced collapse in the rial, severe inflation and the failure to compensate affected businesses.
The administration did not anticipate how successful the US would be, from early 2012 onwards, in cajoling both allies and rivals to eliminate or cut oil purchases from Iran, as well as targeting insurance, shipping, financial transactions and exports of other Iranian products. Iran’s oil sales fell by a million barrels per day, while increased output from Saudi Arabia and from the US itself prevented global prices from rising too far.
The path of Iran’s oil industry under Dr. Rouhani will depend on progress made in nuclear negotiations and the easing of sanctions, as well as his administration’s domestic policy choices. A military conflict with the US and/or Israel would have highly unpredictable but damaging effects on Iran’s oil industry and possibly those of its neighbours.
If the current sanctions regime remains in place, Iran’s new administration will have to do its best to survive on a severely diminished income. As the Mossadegh government did in the early 1950s under somewhat similar circumstances, it can reorient the economy further towards domestic production and consumption, eliminating the luxury imports that boomed over the past decade. Better management and tackling corruption would reduce the social impacts and inequality — at the potential cost of harming some leading regime figures.
Bringing back Iran’s capable technocrats — and some of its talented diaspora, with more relaxed social conditions, as under Khatami — would keep oil production steady. Two candidates helped manage Rouhani’s campaign – former deputy oil minister Akbar Torkan and former refining and petrochemical chief Mohammad Reza Nematzadeh. Discounts, loopholes and disguised shipments can maintain exports, even at a reduced level. Over time, the enforcement of the sanctions can be eroded.
But, with the demand for OPEC oil set to be stagnant or falling over this decade, the prospect of lower oil prices, and Iraq’s taking an increasing share of the pie, the path ahead could be hazardous. Iran’s purported ally Russia has no interest in encouraging a competing oil and gas exporter. Given the Islamic Republic’s paranoid (if not unjustified) suspicion of the West, it would be ironic if it ended up yet more dependent on the Kremlin and China.
In the event of a breakthrough on the nuclear issue, and a lifting of most oil-related sanctions, the stage would be set for a pragmatic, Rafsanjani-style reconstruction. If the shutdown could be managed correctly, oil production could bounce back to near pre-2012 levels quite quickly.
But fully realising Iran’s petroleum potential requires foreign investment and expertise, ideally including Western companies. This will have to be under better contractual terms than the “buybacks” offered in the early 2000s that provoked so much nationalist debate within Iran.
Giving international companies a long-term stake in fields can be done with modern contracts that still provide Iran with full sovereignty and control over its industry. This would achieve two objectives. First, it would ensure efficient operations and maximum recovery from the country’s mature fields while encouraging technology transfer. Second, it would give momentum to the removal of remaining sanctions and create a barrier against their reinstatement.
In the same way, gas exports — to the GCC, Turkey and Pakistan — would anchor Iran more tightly within the regional economy and make it indispensable to its neighbours. The window for major exports to Europe has probably closed, with Azeri and Iraqi Kurdish gas set to flow. But Iran could still resurrect its liquefied natural gas plans, where it has fallen infinitely behind Qatar.
Domestically, Iran’s subsidy reform needs to be revived — more propitious when the economy is growing and government finances are increasing. The web of pseudo-privatisation also needs to be untangled and replaced by a balance of true private investment and commercially focused state enterprise.
The sine qua non is a resolution to the nuclear issue and an end to the major sanctions. A whole-hearted pursuit of these policies would amount to a revolution in Iran’s energy affairs — likely to provoke major domestic opposition and run into significant international hurdles. But even a pragmatic, technocratic house-cleaning of Iran’s oil sector would help set the economy on a path to recovery and give hope for the success of Dr. Rouhani’s tenure.
– Robin M. Mills is Head of Consulting at Manaar Energy and author of The Myth of the Oil Crisis and Capturing Carbon. Email him or follow him on Twitter.
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