The Iranian cabinet has just approved new contracts for petroleum exploration, hoping to attract foreign capital and technology to boost production (and revenue). Some uncertainty remains about the precise nature of the contracts and whether or not it will be necessary to submit them for Parliamentary approval. Although there is a lot of interest in developing Iranian oil resources, entering the sector will not be for the faint of heart.
The biggest change is apparently a switch from buyback to production-sharing contracts. The former is disliked by the industry and often seems to result in poor returns, at least according to European firms that operated in Iran in the 1990s. Production-sharing contracts are the preferred model throughout most of the world, but are apparently somewhat controversial in Iran, judging from the 2-year debate and 150 amendments.
The battle over the contract structure resembles many other struggles in Iran, essentially between so-called hard-liners and reformers. The former are strongly xenophobic and have blocked many of the initiatives of the Rouhani government, which is attempting to reform both the government and the economy. The situation is complicated even more because many of the hard-line elements, notably the Revolutionary Guards, control large segments of the economy.
Perceptions are often a major part of the problem. To some politicians, most notably nationalists and populists, the presence of foreign companies (and foreign workers) is undesirable, especially if the companies are large, powerful and American. The implied economic imperialism, as described by dependency theory, makes some governments certain they are being exploited and that their control of their own resources is diminished. Before World War II, such fears were well-founded as many oil exporting nations did not have the expertise to operate a large oil producing system; such is much less the case now, given higher levels of education globally but also the availability of many service firms.
And Iran in particular shows how the balance of power has changed over the decades. When British Petroleum’s Iranian operations were nationalized in 1951, they successfully blocked Iranian exports of oil on the grounds that contractually, the oil belonged to BP . Later, Iraq overcame this legal obstacle following its nationalization by swapping its oil with the Soviet Union. Soviet courts were obviously not amenable to western oil companies’ lawsuits. Now, of course, there are so many markets for oil: in 1970, 75% of the world’s oil was consumed in OECD countries; now it’s less than 50%.
And the many nationalizations and contract abrogations over the past several decades have seen few if any cases where courts were willing to rule against sovereign nations, although companies have sometimes been able to gain recompense through arbitration. And there are governments that have voluntarily given foreign or private operators compensation for their losses, although often, as in the recent example of Argentina renationalizing YPF , it is because the government doesn’t want to antagonize potential investors.
Which suggests that Iran doesn’t have as much leverage as it did twenty years ago, given the country’s dire need of oil revenue. Anything which would discourage foreign companies from entering Iran’s upstream sector should, theoretically, be assiduously avoided. However, recent legal actions, including claims of espionage, imply that hard-line elements in the government remain willing to behave in ways that will discourage foreign participation in the Iranian economy, possibly with the explicit attempt to damage the economy and thereby the government. Because the rule of law appears to be very weak in Iran, the risk that any company seeking to operate in the country will see its personnel and operations disrupted is very real.
Still, as one colleague once remarked, political risk is the mother’s milk of the oil industry. As an example, in 1905, young Iosif Djugashvili was the chief labor organizer in the Baku oil fields for the Bolsheviks. He was later better known by the nom du guerre Joseph Stalin and he was probably less than commodious to his industry counterparts. Today’s Revolutionary Guards are, by comparison, weak beans.
The upshot is that investing in Iran’s oil sector is riskier than in most (but not all) countries and not for the faint of heart (or undiversified), but no doubt money will flow into the country and, presumably, out.