Iran’s new petroleum contract

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This January marks the first anniversary of the “Implementation Day”: the day on which nuclear-related sanctions against Iran were lifted under the Joint Comprehensive Plan of Action (“JCPOA”).

The lifting of sanctions has been particularly good news for Iran’s oil and gas industry which, according to reports, needs as much as US$200 billion in investment to reach its potential and to continue to be the driving engine in revitalising Iran’s economy.

Attracting investment

Over the last two years, the National Iranian Oil Company (the “NIOC”) has taken a number of important steps to prepare the ground for attracting foreign investment into the country’s oil and gas industry. This includes announcing a short-list of local exploration and production companies who are eligible to enter into joint venture arrangements with international oil and gas companies (“IOCs”) for investment in Iran, followed by the recent announcement of the 29 IOCs that have been pre-qualified to submit tenders to develop upstream projects.

The most important step taken by the NIOC has been to develop a more attractive investment vehicle, the Iran Petroleum Contract (the “IPC”). A major advance, in August 2016, was the approval of the by-law governing the IPC (the “IPC By-law”) by the Council of Ministers of Iran, which provides the legal framework for the IPC.

The IPC By-law

The IPC By-law is applicable to three categories of contract: exploration, development and production contracts; development contracts for existing fields or discovered reserves; and contracts for improving recovery rates for existing fields. Contract terms will be 20 years from the start of “development operations”, with the possibility of a 5-year extension. Consistent with the requirements of the Iranian Constitution, the IPC By-law provides that the NIOC will retain title over oil and gas produced as well as ownership of the well, and contracts will be governed by Iranian law.

The IPC By-law provides the parameters of cost recovery and incentives for the potential parties. The “Contractor” under the IPC includes the IOC and the local partner. However, the main responsibility for the financing and delivery of projects is placed on the IOC. Further, the Contractor bears the investment risks for:

(a) failing to make any discovery or commercially viable fields;
(b) failing to achieve the agreed production targets; or
(c) failing to achieve the production rate necessary to enable the amortisation of the cost of finance.

Under the IPC By-law, the Contractor will be remunerated for direct and indirect costs, finance costs and development costs through allocation of a portion of oil and gas produced from the fields above the agreed level, or revenues generated under the contract as a result of the sale of the product at market price. The Contractor’s entitlement to revenues will be capped at fifty percent (50%) and seventy five percent (75%) of revenues generated from oil and gas fields respectively.

Neither the Iranian government nor the Central Bank of Iran will issue any sovereign guarantee to the Contractor but in the case of IOR/EOR projects, if the Contractor is unable to recover its costs within the contract term, then this may be extended (with the approval of the NIOC) to allow for additional cost recovery.

Aims and objectives

The IPC By-law seeks to incentivise investment in projects with a higher level of risk and complexity by stating that remuneration will be dependent on project specific circumstances and the risk-taking appetite of the Contractor and also whether the Contractor has deployed modern technology. Further, the NIOC, in the prequalification application form, indicated that only companies with a certain level of experience will be able to bid for riskier and more difficult projects.

A key objective of the IPC By-law is to support local E&P companies: by requiring a joint venture company as the vehicle, the local E&P company will be given access to the new technology, know-how and training necessary to manage future projects in Iran and internationally. The NIOC’s list of local E&P companies eligible to enter into joint ventures with IOCs is dominated by state and semi state-owned companies previously known only for their engineering and services capabilities.

The IPC By-law also emphasises the Contractor’s “obligation to maximise” the use of local products and services: local content rules require that at least fifty-one percent (51%) of the value of the project, excluding the value of any immovable property, must be allocated to services and materials obtained from inside Iran.

Comment

The IPC By-law does not provide any details on the dispute settlement mechanism – which opens the possibility that parties can negotiate their own – but constitutionally the Council of Ministers and/or the Parliament must approve any arbitration clause in any contract that concerns public or government assets such as oil. Furthermore, the By-law does not deal with certain issues that could have a significant impact on any investment by IOCs in Iran. These include the potential re-introduction of nuclear sanctions (the so-called “snap-back” of sanctions) and changes in law.

There is also the wild card of President Trump, who threatened to rescind the JCPOA during his campaign. However, during their confirmation hearings, President Trump's choices for secretary of state, Rex Tillerson, secretary of defence, James Mattis, and Central Intelligence Agency director, Mike Pompeo, all testified that they would advise him to stick to the international agreement, but enforce it strictly.

The pre-qualified IOCs are currently in negotiations with the NIOC over heads of agreement. A formal tender is expected to be announced by the end of January or early February. In the meantime, the NIOC is finalising the IPC as it is ambitious to showcase its ability to attract investment into the country by signing a number of IPCs with IOCs prior to the presidential elections due to take place in May this year.