Uncertainty undermines opportunities for Iranian energy sector

Uncertainty undermines opportunities for Iranian energy sector

The Iran nuclear deal opens up billions of dollars in investment opportunities in the country’s energy sector. But uncertainty remains about the stability of the deal, the end of sanctions, and how accommodating the industry will be to the needs of foreign investors.

In a deal reached between Iran and the five permanent members of the UN Security Council and Germany (the P5+1), the Islamic Republic agreed to curbs on its nuclear program in exchange for relief from economic sanctions. The most punishing of these sanctions target Iran’s oil and gas sector and since 2011 they have prevented the export of petroleum products to most of the industrialized world, hindering the modernization of the country’s energy sector.

The sanctions have devastated Iran’s economy. 20% of GDP came from the export of petroleum products in 2011. According to the US Energy Information Administration, revenue from oil and natural gas exports fell 47%, from $118 billion in FY 2011/12 to just $63 billion in FY 2012/13. This contributed to a more than 8% drop in Iran’s GDP from 2011 to 2013, according to the most recent IMF data.

But while the prospect of lifting sanctions means that oil and gas could start flowing abroad once again, a number of barriers prevent investors from taking full advantage of Iran’s re-opening. For one thing, the timeline for relief is still unclear. The agreement with the P5+1 states that the UN will not lift sanctions until the International Atomic Energy Agency verifies that Iran has complied with its initial set of conditions. US Secretary of State, John Kerry, estimated that this “implementation day”, named in the agreement, could be six months away.

Iran could then immediately repatriate about $100 billion in oil sales to China, India, Japan, South Korea, and Turkey held in escrow accounts until sanctions are lifted. At least another 20 million barrels are already on hand to sell, perhaps at a significant discount. But as a number of recent analyses have already made clear, Iran cannot simply “turn on the spigot” once sanctions are lifted.

Despite the Petroleum Ministry’s claim that it could ramp up production by one million barrels a day within a few months by re-activating idle wells, industry experts predict that the number is probably between 100,000 and 400,000. Production could increase further, by between 400,000 and 600,000 barrels a day, by the end of 2016.

Driving any more production out of Iran will require investment and expertise that can only come from global oil companies. Iran’s oil ministry wants to regain its place as the world’s fourth-largest oil producer, and may be prepared to offer contracts to foreign investors worth up to $100 billion for as many as 50 projects to develop and modernize Iran’s stalled energy sector.

That opportunity is already attracting Western energy companies: executives from the Dutch oil company Shell, Italy’s ENI, and France’s Total each met with Iranian officials prior to the July nuclear deal, and German Vice Chancellor, Sigmar Gabriel, also the economy and energy minister, headed a delegation of business leaders to Tehran on Sunday.

American oil companies appear stuck on the sidelines while these negotiations take place. This is because most of these companies are still limited in their ability to do business in Iran due to additional US sanctions related to terrorism support and human rights issues, putting American companies at a disadvantage to their European competitors.

Another challenge is that the deal still has yet to be officially adopted; Congress has 60 days to review and vote on the resolution, the result of which the President can then sign or veto.

Even though the agreement is expected to pass, many US companies will be hesitant to make significant investments due to uncertainty about the stability of the deal. The nuclear agreement allows for sanctions to “snap back” into effect should Iran not fulfill its side of the bargain.

Firms accused of violating these sanctions have been punished harshly in the past, such as when oil-field servicer Schlumberger Ltd. was forced to pay $232.7 million in a settlement with the US Justice Department. Writing for Foreign Affairs, Eric Lorber and Elizabeth Rosenberg call for US officials to clarify the rules for investors, claiming that “the U.S. Treasury Department has offered little guidance for companies on how to navigate Iranian sanctions in the past.”

Yet another barrier to foreign investment is the nature of the energy industry itself: Article 153 of Iran’s constitution forbids foreign ownership of natural resources, so the National Iranian Oil Company and two other state-owned enterprises manage Iran’s energy sector, including all oil and natural gas production projects. Foreign companies are permitted to participate in exploration and development phases, but only by entering into contracts with Iranian subsidiaries.

The key question for foreign investors is whether Iran will establish a new framework for petroleum contracts that allows international oil companies to participate in all stages of production. Emerging contract details would give foreign companies a greater role in production, would be longer-term, and would have a more flexible fee structure, promising a bigger return on investment. Iran’s Ministry of Petroleum is expected to reveal the final details of those contracts in the near future.

On paper, Iran’s agreement with the P5+1 offers the prospect of a potential bonanza for foreign investment in Iran’s energy sector. But political uncertainties stemming from both sides, coupled with ambiguity about the emerging framework for doing business in Iran, will make investors hesitant to commit to these high-risk projects in the short run—while those in the US will likely be shut out altogether.

About Author

David Wille

David Wille works for a research center affiliated with George Mason University, where he is pursuing an MA in economics. Prior to graduate school, David was a retail banking research analyst at a Virginia-based consulting company and was a Fulbright Scholar in Egypt until 2011. He writes about the political economy of the Middle East.