Comment: Iran - A promise or a pitfall?

Experts from the law firm Dentons explore the opportunities for growth and some of the constraints that still face foreign businesses within Iran's energy sector

Alistair Black and Humphrey Douglas are partners in Dentons' energy, transport and infrastructure practices in London, and Chris Thomson is a managing  associate in the same practices.
Alistair Black and Humphrey Douglas are partners in Dentons' energy, transport and infrastructure practices in London, and Chris Thomson is a managing associate in the same practices.

There is still significant political uncertainty around the position of Iran in world energy markets, but international interest is high, with some early inward investment now evident.

Potential hydrocarbons superpower

Iran’s proven reserves of oil exceed those of Russia and the US combined, but its production of crude oil and other liquids in 2015 was less than a third of that produced by either of those countries individually.

When it comes to natural gas, Iran may actually have the world’s largest reserves. If not, it runs a close second to Russia. Yet its annual gas production in 2015 was less than half of Russia’s and barely a quarter of that of the Americas. The majority of its recoverable reserves are yet to be exploited.

In the recent oil price environment, maximising production from relatively low-cost basins like Iran is the key to success. Moreover, if global oil demand peaks by 2030, as some predict, and the drive to reduce global CO2 emissions continues to favour a shift to gas as a fossil fuel for power generation, Iran needs to develop and exploit its hydrocarbon resources more effectively and rapidly, and it will need international capital and know-how to do so.

Sanctions

Many US and EU sanctions against Iran were relaxed under the Joint Comprehensive Plan of Action (JCPOA) agreed by the five permanent members of the UN Security Council and the EU. However, it is important to note that sanctions could snap back, and to be aware of other techniques for mitigating other political risks.

Any party to the JCPOA can refer another to the Security Council if it thinks another party is not meeting its JCPOA commitments and the Joint Commission provided for under the JCPOA dispute resolution procedures does not resolve it in 30 days.

On such a referral, sanctions will snap back unless the Security Council positively votes to continue to lift sanctions.

Snap-back does not invalidate contracts already entered into as such but, if the contract is with a previously sanctioned entity such as NIOC, it can freeze performance of the contract.

Contracts need to make careful provision for these possibilities.

There may also be a need to protect against other aspects of Iranian political risk. Bilateral investment treaties are one way of doing this if one of the counterparties comes from a country that has such a treaty with Iran. They give investors the opportunity to appeal against unfair treatment to an independent arbitral tribunal applying international law principles.

Domestic Iranian legislation (such as the Foreign Investment Promotion and Protection Act) and enforcement considerations are also highly relevant.

The Trump factor

In the US, Iran-related sanctions applying to US persons remain in place, and parties are unable to clear US-dollar denominated funds in connection with Iranian transactions. The US position has had a broader inhibiting effect on potential transactions because it has affected the appetite of many non-US financial institutions to lend money to Iranian projects, and the availability of reinsurance coverage for them is also limited.

More fundamentally, Donald Trump has been highly critical of the JCPOA and has recently tasked US government agencies with reviewing whether suspending Iran sanctions pursuant to the JCPOA is vital to US national security interests. Some may regard this as a policy hardening following earlier electioneering that, although critical of the deal, focused on enforcement rather than questioning the basis of the agreement.

The significance of this review is that under US law, the suspension of US sanctions only remains in place if President Trump certifies to Congress, every 90 days, not only that Iran is complying with the JCPOA but also that continued suspension is vital to US national security interests. If he were to conclude that it is not, there is a legislative mandate for legislation re-imposing the suspended sanctions to be fast-tracked through Congress.

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Although President Trump certified Iranian compliance with the JCPOA in April, there can be no guarantee that he will do so again in July, or that he will not impose some additional, not specifically nuclear-related, sanctions, using the room for manoeuvre that the US is allowed under the JCPOA itself.

Upstream oil and gas: Total leads the way for returning IOCs

Uncertainty around the sanctions deal is nothing new. It is also not just a matter of US politics: the outcome of May’s elections in Iran is uncertain, and could result in a more hard-line regime in Tehran, meaning that contractual protections against changes to Iranian law are particularly sensitive topics of negotiation.

But in the meantime, at least for non-US companies, the potential opportunities of Iranian oil and gas are too good not to explore. For example, on 8 November, 2016, it was announced that Total, China National Petroleum Corporation and the National Iranian Oil Company (NIOC) had signed heads of agreement to develop Phase 11 of the 24-phase South Pars Gas Field – the largest in the world. The project is expected to produce 1.8 billion cubic feet, or 370,000 barrels of oil equivalent, of condensate per day.

Other companies on the list of those qualified to bid for new Iranian oil and gas contracts published by the NIOC in January 2017 include CNOOC, ENI, Gazprom, KOGAS, Lukoil, Maersk, Mitsui, OMV, ONGC Videsh, Perenco, Pertamina, Petronas, PGNiG, Schlumberger, Shell, Sinopec and Wintershall.

A further encouragement came on 26 November, 2016, when Iran signed the International Energy Charter declaration, paving the way for foreign investors in the Iranian energy sector to enjoy the investment protections offered by the Energy Charter.

Iran’s sixth Five-Year Development Plan is explicit about its ambitions for the oil and gas sector, and the need for foreign, private sector investment to achieve them. Amongst the priorities it outlines are:

- developing new fields and rehabilitating old ones (more than a half of the country’s output comes from 70-year-old fields, the output of which is shrinking by 10% annually);

- increasing crude oil and gas exports by more than 80% overall between 2014 and 2020; and

- reducing associated gas flaring (Iran is currently the world’s third largest flarer of associated gas).

In addition to heads of agreement to negotiate substantive investment, there have been a number of other recent deals reported involving oil pre-payment structures for crude sales.

What to do with all that oil and gas?

There is plenty of scope for more gas to be consumed in Iran’s domestic market. Approximately 80% of Iran’s electricity comes from fossil-fuel plants, with demand for power in the country growing by more than 5% a year. The government wishes to increase installed generating capacity by some 33% over the next five years.

Much of this will be achieved by improving or replacing existing gas-fired power stations or constructing new ones. But the real prize, and a major infrastructure investment challenge, is to facilitate exports by pipeline and – if LNG capacity can be developed in Iran – potentially much further afield.

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