Big Oil Eyes Upcoming Auction In Iran

Iran, a country boasting the fourth largest oil and the second largest gas reserves in the world, has become one of the most prominent topics in the news – for example, today’s election news affirming the shifting of political power to the moderate and reform candidates.

From the oil and gas industry point of view, the lifting of international sanctions provides the country, as well as International Oil Companies (IOCs), with opportunities at a time when oil prices are down to levels not seen for a decade. Although there is every likelihood that prices will rebound, the drivers of demand and supply indicate that this may not happen for some time.

The IOCs are hurting, reflected largely by their cut back in dividend as well as profit falls and job cuts. Under these circumstances, IOCs need to look for exploration and production opportunities that require comparatively little capital and operational expenditure. As such, Iran presents itself as a great opportunity – with costs to produce a barrel of crude in Iran estimated at around US$ 12 compared to an average of around US$ 9 in Saudi Arabia, around US$ 36 in the USA and around US$ 52 in the UK. Provided the IOCs are willing to accept the risks and challenges that arise with investing in Iran, the offering of about 18 E&P blocks and 50 oil and gas projects worth US$ 185 billion by 2020 under the new ‘Iranian Petroleum Contract’ (IPC), might just be the need of the hour.

On the other hand, Iran itself seems anxious about the incoming investment, as it is looking to update its aging oil & gas infrastructure, in order to increase production to meet the rising local demand alongside helping fund government spending. An initial foreign investment of around US$ 25 billion is targeted and several leading European E&P companies (BP, Eni, Repsol, Shell, Statoil, Total) are believed to have been in discussions. In late September 2015, the Minister of Petroleum, Bijan Zangeneh, declared the path chosen by the country by announcing that Iran will not hold back its oil production once economic sanctions are removed and that the country’s crude output will reach an ambitious 4.2 MMbo/d by the end of 2016. Crude oil production currently stands at around 2.85 MMbo/d and in an effort to reclaim its lost share of exports, Zangeneh anticipates the country taking back a market share of more than 1 MMbo/d. More conservative estimates, however, suggest an increase in production of between 600,000 bo/d and 1 MMbo/d within six months of the lifting of sanctions – subject to the negotiations ongoing for freezing oil production.

(Click to enlarge)

Map of Iran showing location of 18 E&P Blocks, 50 oil and gas projects and oil and gas fields (Source: Drillinginfo database)

The country has gone through a series of tumultuous events, the more notable being the CIA’s 1953 coup displacing the democratically elected Prime Minister Mohammad Mosaddeq, followed by installation of Mohammad Reza Pahlavi (Shah of Iran) which ultimately led to the Iranian Revolution in 1979, followed by an eight-year-long war with Iraq and various sanctions, which hit the country worst in 2011. Having faced such, it is surprising for many to see the country still being a dominant player in the Middle East and competing with Saudi Arabia. This very point makes the country hugely important – not only regionally but internationally – because a freely trading Iran, which will ultimately make the country financially secure, can reasonably change the power dynamics of the region, the dominance of Saudi Arabia and the fundamentals of relative stability left in the region.

Iran has a long oil history – the first oil discovery in the Middle East was made by the D’Arcy Company in 1908 in southwestern Iran (the Masjid-i-Sulaiman Field). Following the revolution, the right of producing and owning natural resources was given to the Iranian Government and the only contracts that the National Iranian Oil Company (NIOC) ever offered were buyback contracts. These contracts were similar to service contracts and required the IOCs to invest their own capital and expertise to develop an oil or gas field. As per the buyback contracts, upon commencement of production from a field operator-ship reverted back to the NIOC, which then used the revenue from sales to pay the IOCs back their capital expenditure. Additionally, the IOCs did not get any equity in the fields and the annual repayment rates to the companies were based on predetermined percentages of the field’s production, as well as the predetermined rate of return.

(Click to enlarge)

The new Iranian Petroleum Contract (IPC), which contains terms similar to a Production Sharing Agreement (PSA), was unveiled at the Tehran Summit in November 2015. With the new IPC, the Government is trying to increase the country’s attractiveness to foreign investment in the industry, in order to develop infrastructure and to boost production.

Although the finer details of the IPC are yet to be finalized, it is expected that the contract will be an improvement on the existing buybacks, presenting a new opportunity to the IOC’s. Under the new contract terms, companies will remain unable to have ownership of reserves, but will be able to establish JVs with NIOC, or its subsidiaries, to manage the entire life cycle of a project. Companies will have a longer time period of between 20 to 25 years to explore, develop and produce from a field, with the possibility to extending it to the Enhanced Oil Recovery (EOR) phases. Fiscal terms are also understood to have been reworked.

The auctioning of 50 oil and gas projects and 18 E&P blocks – aimed at doubling the country’s crude oil output from 2.85 MMbo/d to 5.7 MMbo/d – is expected to be held in May 2016 and will provide IOCs with an opportunity to help re-balance their portfolios and books and to remain competitive in a low oil price environment. The licensing round will include onshore and offshore, as well as early and late stage projects, with varying degrees of complexity.

At a time when companies are looking to cut capital and operating expenditures, the low-cost barrels that are going to be available make an entry / re-entry in Iran look very attractive. However, entering Iran will require careful consideration of the challenges and risks, below, as well as above ground. Political risks remain high too, with the country having poor relations with a number of neighbors in the Middle East, as well as further afield. Companies will have to assess how entering Iran might affect their business elsewhere. However, the major risk for any company establishing operations in Iran is the potential of renewed sanctions, should the country fail to adhere to the agreements made regarding its nuclear program.

By Johannes Sobotzki and Pavel Sharma via Drillinginfo.com