Global Investing Hot Spots

The billion-dollar gold rush to tap into Iranian oil

A gas flare on an oil production platform in the Soroush oil fields is seen alongside an Iranian flag in the Gulf.
Raheb Homavandi | Reuters

The chase is on for some of the most prized oil and gas assets in the world, following the lifting of sanctions on Iran earlier this year. The historic deal paved the way for the country to rebuild its lost production capacity and fight for market share.

If all goes as planned, Tehran's oil officials will attract roughly $200 billion in new oil and gas investment, but the path to that target is fraught with obstacles.

In October the National Iranian Oil Company, or NIOC, began taking applications from foreign firms for some 50 crude and natural gas projects around the country. While details are not available, these include deals from European giants Royal Dutch Shell, France's Total and Italy's Eni, as well as Russian and Chinese drillers, according to NIOC.

U.S.-based oil majors, like Exxon and Chevron, are restricted from bidding by American sanctions on Iran.

The stakes are high. Iran is home to the world's fourth-largest reserves of crude oil and second-biggest deposits of natural gas, and much of it is relatively cheap to extract. Its energy assets are staggering; the Persian Gulf nation has 158 billion barrels of oil and 1.2 trillion cubic feet of natural gas.

But the country's production has been stymied by international sanctions that strangled its energy sector in recent years.

Figures show Iran's September production rate at 3.7 million barrels a day and exports at about 2.6 million barrels a day, up from a recent low of 1.1 million barrels a day in 2013.

"All the big players are hovering around Iran, but in the shadows," said Chris Weafer, co-founder of consulting agency Macro Advisory Partners.

"We are absolutely aware that everybody is engaged at some level. It's because the prize is too big not to be engaged," he said, adding that no one wants to give up ground to competitors.

NIOC says the proposals under consideration include Total's submission for South Azadegan, a field bordering Iraq that contains an estimated 5 billion barrels of recoverable reserves.

Total, along with Eni and Hyundai, also proposed developing the South Pars field, one of the world's largest natural gas prospects. Shell and Sinopec, meanwhile, have their eyes on assets in the Yadavaran Field, another multibillion-barrel oil play, NIOC said.

The Russia-China nexus

Investors in Iran's energy sector face huge challenges. One is competition from Russia and China.

Already, Russian oil firms, like Lukoil and Tatneft, have signed oilfield deals with Iran.

Meanwhile, Chinese energy giants, like Sinopec and China National Petroleum, are also getting back into the game. The companies never truly left Iran, because they were protected by a provision of the sanctions regime that allowed companies to invest less than $20 million per year into Iran's oil and gas industry.

In September the Tehran Times reported that Sinopec and the Iran Oil Ministry finalized an agreement worth $1.2 billion to renovate and improve production at Abadan, the nation's largest refinery. Work is expected to begin this month.

Experts say competition from China poses a real risk to Western oil companies. Given that China's domestic production is declining as the nation's producers cut capital spending in the face of persistently low oil prices, the Chinese energy giants may be "extra motivated" to look for international opportunities, Cowen & Co. analyst Sam Margolin said.

Iran, Iraq refuse to freeze output - DJ
Iran, Iraq refuse to freeze output - DJ

Another obstacle is Iran's new model oil contract. Iran's oil ministry took more than two years to draft the new model, which continues to face political opposition from conservative hardliners.

Up until now, investors have operated under short-term, fixed-fee contracts called buybacks that give them no share in the profits.

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The new system allows foreign oil majors to form joint ventures with Iranian companies and participate in production activity. They were previously limited to exploration and development. The change gives foreign firms the opportunity to improve ultimate recovery and reap higher returns by coordinating early stage output and using advanced methods to squeeze oil and gas from maturing fields.

While the new contract structure looks more favorable, it is studded with caveats.

The state is encouraging local partners to put up 25 percent of the investment, but there are few Iranian companies capable of doing so, according to Scott Modell, managing director at The Rapidan Group and a former CIA officer.

These partners are likely to offer oilfield services to compensate, but international firms prefer to use their own service companies, not only because they believe they're more capable but to avoid dealing with bureaucracy, corruption and sanctioned Iranian entities, he added.

Another issue: Iran's network of security and intelligence officials aligned with Supreme Leader Ayatollah Ali Khamenei has become more entrenched in the economy in recent years, creating a minefield for oil majors. The best known player at the nexus of security and the economy is the Islamic Revolutionary Guard Corps, an ultra-loyal military force that has been targeted by U.S. sanctions.

In working with the eight approved Iranian oil and gas companies, Western oil majors face the very real threat of getting tied up with this so-called deep state, according to Greg Priddy, director of energy and natural resources at Eurasia Group.

The contract that they're rolling out that they're calling the IPC is really just a modified buyback contract.
Greg Priddy
director of energy and natural resources, Eurasia Group

Further, hardliners have stripped out many of the forward-looking elements from the new contract structure, and the conservatives have largely won for the time being, in his view.

"Over the last year, everything has shifted in a much less reform-oriented direction. The contract that they're rolling out that they're calling the IPC is really just a modified buyback contract," he said.

In his view, international oil companies will have a hard time achieving greater returns than those the old buyback deals yielded. The firms can only realize significant upside if they exceed their production goals, he said.

Ultimately, Priddy believes many of the Western oil giants could walk away from the table.

Iranian President Hassan Rouhani (L) and IRGC Major General Mohammad Ali Jafari (R) attend the 21st Nationwide Assembly of the Islamic Revolution Guards Corps (IRGC) Commanders in Tehran, Iran on September 15, 2015.
Iranian Presidency Press Office | Anadolu Agency | Getty Images

A major political challenge to the continued easing of sanctions will come next spring, when Iranians are scheduled to head to the polls. The contest pits moderates represented by President Hassan Rouhani against conservative hardliners who are intensely wary of foreign involvement in the energy sector.

The hardliners have tried to make the case that the American government has not held up its end of the bargain in exchanging sanctions relief for international oversight of Iran's nuclear program.

In September, the U.S. Treasury Department advanced the deal forward by granting Boeing and Airbus licenses to sell Iran commercial airliners. That marked a coup for Rouhani and reformists eager to show tangible benefits of the nuclear accord. Iran's aviation industry was the only major capital-intensive sector allowed to purchase directly from U.S. businesses as part of the nuclear deal.

It remains to be seen how Iran will finance the multibillion-dollar purchases, but executives in other industries see the airline transaction as a critical test case, according to Weafer.

"You're going to have a queue of oilmen forming the next morning" at the Treasury Department if the airline transactions are successful, he said.

The barriers will remain high for U.S.-headquartered oil and gas companies, because the United States prohibits them from doing direct business with Iranian companies or individuals, due to the government's alleged human rights abuses and support for U.S.-designated terror groups.

The Revolutionary Guards' penetration of the economy assures that the issue of American businesses reentering Iran will remain a political hot potato. The Guards support Lebanon's militant anti-Israel group Hezbollah and recruit foreign fighters to back Syrian President Bashar Assad in his country's civil war with U.S.-backed rebels.

That allows American politicians opposed to rapprochement with Iran, primarily Republicans, to draw a relatively straight line between increased Iranian business activity and financial support for terrorism and U.S. adversaries.

Richard Nephew, a former lead sanctions expert for the State Department, said it could be years before it becomes politically viable to broach the subject of rolling back sanctions to allow U.S. companies to do business in Iran.