Iran seeks to reverse declines

Iran, holder of the world's fourth-largest proved oil and the second-largest proved natural gas reserves, has been hard hit by UN and international bilateral sanctions imposed on the country in 2006 and 2010 on top of existing US sanctions. But it was the latest set of even more stringent measures enacted by the US and the European Union in late 2011 and 2012 that had the most devastating impact on the local economy.

According to the International Monetary Fund, the sanctions have had a contractionary impact on the economy, with real gross domestic product declining by nearly 6% in 2012/13. During the first half of 2013/14, real GDP was estimated to have declined by about 2.5% compared with the same period in the previous year. Between June 2012 and February 2014, Iran recorded negative GDP growth for seven consecutive quarters.

The Islamic Republic's energy sector has been among the most severely affected by the various embargoes in recent years. Since first imposed in 2006, UN sanctions have prevented Iran from securing much-needed foreign investment, technology and expertise for its energy sector, stymieing developments especially in upstream oil and gas and downstream refining. A large number of projects has either been cancelled or delayed. As a result, the country has struggled to expand production capacity at its oil and gas fields, and to halt and reverse declines at its mature fields.

Since another round of stringent EU and US sanctions was levied on Tehran in late 2011 and 2012, the country's economic situation has dramatically worsened. Aimed at impeding Iran's ability to sell oil, the sanctions led to a one million barrel a day (b/d) drop in crude and condensate exports in 2012 versus the previous year. Once OPEC's second-largest oil producer, Iran now ranks behind Iraq in terms of oil and liquids production, averaging only about 3.2 million b/d in 2013, compared with about 4.2 million b/d in 2011.

The economic price of falling oil production and exports in particular has been hefty. According to IMF figures, Iran's oil and gas export revenues slumped by 47% to $63 billion in the 2012/13 fiscal year from $118 billion a year earlier. The IMF estimates that oil and gas export revenues declined by another 11% to $56 billion in the 2013/14 fiscal year, which would have plunged by another 50% over the last year with collapsing oil prices.

The crippling effect of the latest round of sanctions, combined with the election of moderate Hassan Rouhani as Iran's president in June 2013, is widely considered to have played an important role in Tehran's decision to agree to the establishment of a Joint Plan of Action (JPA) with the P5+1 in November 2013.

With more than 100 years of experience, Iran has one of the world's most mature oil sectors and the energy infrastructure that has been built up since is extensive. Today, Iran's conventional proved oil reserves stand at 157 billion barrels. The country has 10 refineries, extensive pipeline networks, oil terminals, and ports along the Gulf coast, and a large petrochemicals industry.

Several large refinery upgrades were stopped in their tracks when sanctions hit, which could present international oil services companies with opportunities to win contracts worth tens of billions to repair and modernize Iran's oil refineries once sanctions are removed. Iranian Petroleum Minister Bijan Zangeneh recently said that the Islamic Republic planned to invest $80 billion over the next 10 years to upgrade and expand its petrochemical sector.

Few would disagree that Iran has the potential to reclaim its status as an energy giant. But it won't be an easy task. The sector's infrastructure is in dire need of rehabilitation and upgrading worth tens of billions of dollars after years of underinvestment. Moreover, decline rates at the country's oil fields are relatively high, ranging between 8% and 11%, while recovery rates are quite low at 20% to 25%, according to energy consultancy FGE and the Arab Oil and Gas Journal.

With hopes high that the sanctions on Iran will start to be lifted over the coming months now that US President Barack Obama has secured the support he needs to ensure the accord will not fail in the US Congress, technocrat Zanganeh will move swiftly to finalize the framework of a new oil contract model that will replace the unpopular buyback schemes. Aimed at drawing more foreign companies to invest in and develop Iranian hydrocarbon reservoirs, the new, so-called Iran Petroleum Contract (IPC) is still being finalized but indications are that it will be a major improvement on the old buyback model and will be unveiled at the Iran Oil & Gas Summit in London this December.

The need for Iran to invest in its oil and gas sector to maintain and boost output is obvious. In a bid to create an environment more conducive to attracting foreign investment, the oil ministry has created a new contract model for international companies seeking to become involved in domestic oil field developments.

The IPC is set to replace the traditional buyback scheme, which was first introduced in the 1990s in an attempt to bridge the gap between the country's need to attract foreign oil and gas investors, and a ban on private and foreign private ownership of natural resources under the Islamic republic's constitution. They are essentially risk service contracts, under which the contractor is paid back by being allocated a portion of the hydrocarbons produced as a result of providing services.

Mohsen Shoar, managing director at Dubai-based Continental Energy DMCC and an expert on Iranian energy, says the new IPC model varies markedly from the existing buyback schemes in that it proposes the establishment of a joint venture between NIOC (or one of its subsidiaries) and a foreign partner for field exploration, appraisal, development and-for the first time since 1979-production.

The IPC is also designed to take advantage of foreign companies' marketing expertise and give Iran access to their supply network to find an export market. This is important at this time as the global energy market is expected to face oversupply in the mid-term due mainly to the discovery and harnessing of shale gas in North America. Thus, having the assistance of an international company and its networks around the globe will become an increasingly important resource for Iran.

"I would also expect strong Chinese and Indian interest," says Shoar, adding that ultimately energy companies across the board are likely to seek involvement. "Iran needs huge investments and the potential for rewards is huge, especially in the longer term. There is, for example, a lot of stranded and non-associated gas in Iran, so there is a lot of potential for gas projects in the form LNG and pipelines for example."

Despite the recent history of sanctions and the withdrawal of Western IOCs such as Shell, Total, Statoil, and Repsol, Iran has sought and secured expertise and financing from willing Eastern firms.

In 2004, NIOC signed an estimated $2 billion deal with China Petroleum & Chemical Corporation (Sinopec) to develop the large Yadavaran oil field, while China National Petroleum Corp. (CNPC) in 2009 signed two separate contracts valued at a combined $6 billion to develop the massive North and South Azadegan oil fields. CNPC is also involved in the Masjid-e Soleiman oil field development. In 2002, NIOC awarded an Indian consortium led by ONGC Videsh Ltd. (OVL) the contract to develop the offshore Farsi gas block. In addition, deals have been signed with Russia's Gazprom.

However, all these projects have suffered delays or cancellations. Last year, Iran's oil ministry cancelled CNPC's South Azadegan deal due to lack of progress by the Chinese national oil company (NOC), which continues to work on the field's northern portion, where progress also hasn't been satisfactory according to a statement by Zanganeh in May.

In 2013, Iran cancelled CNPC's contract to develop Phase 11 of the South Pars natural gas field, also over persistent delays. And, in the same year, it reportedly awarded the development of the OVL-led Farsi gas block to a local company after the Indian state-run consortium dragged its feet on operating the project.

There can be little doubt that interest among international firms in developing Iran's hydrocarbon resources post sanctions is enormous. To be sure, the risks and challenges associated with becoming involved in Iran's energy sector would still be large - but likely to offer sufficient upside to attract international interest.

ABOUT THE AUTHOR

Thangapandian Srinivasalu, executive director of Gulf Petroleum Group, has more than 30 years' experience in sales, marketing, and trading of petroleum products from India to Nigeria. Before joining the GP Group, he served as CEO - Marketing and IST at Essar Oil Limited. He established PetroFina in India and was part of the team that launched Gulf Oil in India after the opening of the market there.