March 28, 2014

Oil and Gas in Iran – Do the easing of sanctions and introduction of new petroleum contracts herald

Co-authored by James Rudge.

With the world’s fourth largest proven oil reserves and reportedly the world’s largest natural gas reserves, there is no doubting the significance of the thawing of relations between Iran and the West.  As well as bringing much needed foreign currency to Tehran, these changes present a real opportunity for Western oil and gas companies.

From 20 January 2014 the terms of a Joint Plan of Action (“JPA”) were implemented, agreed between Iran and the five permanent members of the UN Security Council plus Germany. This agreement allowed for the suspension of many sanctions in relation to Iran’s petrochemical exports and associated services in return for the limiting of their nuclear programme.

Two months have passed since the implementation of these reliefs. It is therefore, a suitable moment to examine their impact and discuss the opportunities which have arisen and any complications which should be prepared for, by those willing to undertake business within the framework of the JPA.

The JPA suspended many sanctions against Iran for 6 months, from 20 January 2014 up to 20 July 2014. The most significant relaxation was in respect of Iran’s petrochemical exports, as well as relief from sanctions on associated services including insurance and transportation.

In the subsequent two months following these reliefs, there has been a significant increase in Iran’s oil exports. In financial terms, analysts project that the increased oil sales have already been worth $4 billion to Iran. China’s crude oil imports from Iran have risen 36.2% year-on-year, and the leading importers of Iranian oil have bought more than 1 million barrels per day (“bpd”) since November, making February the fourth straight month in which Tehran’s oil exports have increased. There has been an increase in shipments of around 100,000 bpd with increased shipments to Syria and China in particular.

However, a return to levels pre-2012 sanctions of exporting 2 million bpd is still a long way off and Western oil companies have so far steered clear of transacting with Iran.

Greater exports of Iranian oil will present opportunities in the shipping, finance and insurance markets.

The first point to note is that the JPA does not provide businesses with a free hand in trade relations with Iran. It is specific and identifies particular areas in which the sanctions are provisionally suspended. The JPA should be read as part of the wider context of Iranian sanctions and each party should ensure that the transaction or agreement is compliant with the JPA and all restrictions currently in force. This raises complex legal issues which should be addressed prior to entering into a transaction.

Secondly, it should be noted that the reliefs are currently due to expire on 20 July 2014.  Although there is the chance that the reliefs may be extended for another 6 months, to ensure that no breach is committed all business should be concluded before 20 July 2014.

Lastly, it is important to note that the reliefs are politically sensitive. They are dependent on Iran fulfilling their side of the agreement, and the political situation not destabilising further. Already, the US Congress is increasing the pressure to withdraw the reliefs and impose tougher sanctions on Iran. A growing concern is that current US and EU sanctions imposed on Russia has led to veiled hints that Russia could derail a permanent solution by way of retaliation. To reflect the ever-changing nature of the situation, contracts, policies and agreements should be drafted to provide for termination in the event that the proposed commercial activity becomes non-compliant due to the re-introduction of sanctions.

In the longer term, Iran’s oil and gas resources will have to be developed to meet increased demand. This presents opportunities for organisations wishing to explore potentially lucrative energy contracts with Iran. The chief executive of Total S.A. said in October 2013 that the company would be eager to return to Iran if sanctions were eased and Tehran made energy contracts more lucrative.

Iran is aware that foreign investment is crucial to maximising its energy resources. With this in mind, Iranian oil officials unveiled in February 2014 a new type of investment contract, the “Iran Petroleum Contract”. This aims to offer twin incentives, namely higher potential profits and lower investment risks.

In a different approach from the existing “buy-back” contracts, seen since the late 1990s which limited a foreign company’s involvement to exploration and development, the Iran Petroleum Contract proposes a joint venture between Iran and foreign companies for exploration, development and, importantly, production.  The companies will be paid for the work through a share of the field production.  The new contracts also reduce risk in respect of exploration projects as foreign companies will now be able to participate in other exploration projects if there are no results from the initial fields in which they invested. The new contracts are of much longer duration, lasting up to 20 or 25 years (almost double the length of buy-back contracts).

With these planned changes Iran is hoping to lure Western oil companies’ technical expertise in order to revitalise their sizeable but ageing oil fields as well as develop new ones once sanctions are permanently lifted.

A recent presentation in Davos given by the Iranian President and the Iranian Oil Minister and attended by ENI, Total, BP, Lukoil and Gazprom was a clear sign that Iran wants to develop closer commercial links with Western oil companies. Iran emphasised that the country was willing to open up to Western investments and technology, whilst also stressing the importance of fossil fuel, with global demand rising.

With oil field development in Iran currently being led by Eastern companies such as China National Petroleum Corporation which is developing the South and North Azadegan oil field, a full lifting of sanctions on Iran could be an opportunity for Western companies to enter and develop the market.

However despite the current reliefs from sanctions and new contracts, it is important to note that for Western companies, any future investment will be dependent on a permanent political solution being reached between Tehran, the EU and the US. Without this, fear of breaching international sanctions will keep investors away.

For more information on sanctions in Iran and elsewhere, see the Clyde & Co sanctions micro-site – http://sanctions.clydeco.com.