Summary: Oil is the most politically and economically sensitive mineral; all lines cross in the oil markets. Here Stratfor discusses how the Iran deal will affect oil prices, which will affect everybody.
How the Iran Deal Will Affect Oil Markets in the Long Term
Stratfor, 17 July 2015
Forecast
- Iran will offer joint venture contracts to attract international energy companies, which will give the country some advantage over Persian Gulf producers.
- Tehran will need more than five years to achieve its goal of producing 6 million barrels per day.
- Legal requirements imposed on foreign firms in Iran will still make operating in the country less cost-effective.
Analysis
Iran was once one of the world’s largest exporters of oil. But ever since Western powers imposed sanctions on the country, a shortage of foreign investment has crippled what is now a corrupt and mismanaged energy sector.
With the announcement of a nuclear deal with the West, and the prospect of some sanctions relief within a year, Iran is now looking to revitalize its oil and gas industry. Tehran wants to increase its oil production from its current level of about 3 million barrels per day to 4 million barrels per day within six months of sanctions removal. And its longer-term goal is even more ambitious: By 2020, Tehran hopes to raise its production levels even higher than they were prior to the sanctions — roughly 6 million barrels per day.
Iran will likely need much more time to achieve that level of production. To develop new oil fields and new technology, Tehran needs access to more than $100 billion of investment — funds that the government is hoping to get from foreign investment. And while relaxed sanctions may open the country up to more outside funding, Iran also needs international oil companies to actually set up operations on Iranian soil. This could be a challenge; burdensome regulations have historically made it difficult for energy firms to operate in Iran despite the country’s ample reserves.
A Competitive Advantage
In November, Iran will unveil a new contract model designed to make it worthwhile for international oil companies to enter joint venture projects in Iran. Under the new Iranian Petroleum Contract, a foreign company would have several years to explore and develop fields followed by 15 to 25 years of production rights. During that time, the state-owned National Iranian Oil Co. would pay the firm based on the complexity of the field, the production volumes and the price of oil.
A contract model of this type differs significantly from the buyback contract model that Iran has used for the past two decades. Under the buyback contracts, a foreign oil company funds the initial investment for the energy project, and the National Iranian Oil Co. then reimburses the foreign firm in cash for its operating costs. Then, after a negotiated period, the National Iranian Oil Co. takes over operations entirely.
Such contracts are largely uncompetitive for international oil companies. Because the amount the companies receive from the Iranian government is dictated by the terms of the contract, rather than the number of barrels sold, foreign firms do not benefit from growing production levels or rising oil prices, and they have no opportunity to recoup any lost capital if costs surpass their original budget.
Under the new terms, the amount the Iranian government pays foreign energy firms would be based on the price of oil and the amount of oil produced, which would incentivize the firms to increase production and even exceed target rates of output. If firms go over budget in developing and operating fields, they have a chance to regain some of that capital from sales. And the more technologically complex the project, the more likely it will be to yield higher revenue. So even if it requires more up-front investment, it will pay larger returns. The long period the new terms give the joint ventures would also incentivize raising production, managing reservoirs and investing more in later stages of development.
The new contract model would also change the relationship between foreign companies and oil reserves. Under the old model, international oil companies cannot claim rights to reserves because the Iranian Constitution requires that the state retain ownership of oil reserves until they are actually extracted. This is important because international oil companies boost shareholder confidence by showing they have rights to a particular field. The new terms may work around the constitution by designating oil it plans to extract “produced oil” and allowing foreign firms to lay claim to it.
The new Iranian Petroleum Contract may give Iran an advantage over its competitors in the region — none of the Gulf states offer similar joint venture models. Already several international oil companies have expressed interest in the new terms. Executives from Royal Dutch/Shell, France’s Total and Italy’s Eni have been in Tehran over the past three months to discuss potential investment opportunities. In the first years of Iran’s freedom from sanctions, European firms will likely be the first to enter the country. They have the most recent experiences dealing with the Iranian regime, and they will be comparatively less inhibited by their governments back home — European countries will likely do less than the United States to discourage investment in Iran.
Lingering Challenges
The success of the Iranian Petroleum Contract model will depend on the specific fiscal terms of the deal, which have not yet been finalized or announced. And even if Iran does manage to sign new contracts with foreign energy companies, those firms will still face tough hurdles when it comes to actually investing and working in Iran again.
Not least of these is Iran’s obligation to supply a domestic market. Any firms operating in Iran will likely be required to sell at least some percentage of their output to Iran itself — at lower prices than they could get on the global market.
Tehran would also require firms to use Iranian service companies, contractors, employees and equipment. Since the Iran-Iraq war and the reconstruction that followed, the Islamic Revolutionary Guards Corps has become a powerful economic force within the country. The IRGC now dominates Iran’s construction and petroleum sectors. Tehran will no doubt want its state-owned firms to be involved in any new energy projects, but that will make operating in Iran more difficult for international companies.
Iran may eventually return to the levels of production it had prior to sanctions, but it will likely take much longer than the promised five years. Ultimately, the fiscal terms that Iran offers foreign energy companies under its new contract model will have to be appealing enough to outweigh the significant challenges that come with operating in the country.
This is Part 2 of a two-part analysis on energy implications of the July 14 nuclear agreement between and Iran and six world powers. This focuses on the long-term effects of Iran’s return to the global oil market while Part 1 focused on the short term effects.
How the Iran Deal Will Affect Oil Markets in the Long Term
is republished with permission of Stratfor.
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About Stratfor
Founded in 1996, Stratfor provides strategic analysis and forecasting to individuals and organizations around the world. By placing global events in a geopolitical framework, we help customers anticipate opportunities and better understand international developments. They believe that transformative world events are not random and are, indeed, predictable. See their About Page for more information.
For More Information
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Come on FM, don’t waste your time with “analysis” from Stratfor. Stratfor consists of a few people sitting around in a half abandoned strip mall in Texas pretending they have contacts and knowledge about the world. They market their “product” to the credulous.
They proclaim that Iran could get a market advantage with “joint venture deals” with western oil companies. The Persian Gulf oil and gas business in the GCC countries overflows with joint ventures between western oil & technology companies.
Without American, European and Japanese engineers, there would not be one drop of oil coming from the Middle Eastern countries. The laughable “sanctions” against Iran and the pre-Iranian controlled Iraq are a hoot. The Italians and Russians were always there to make sure the oil kept flowing. The Italians are always the western world’s secret “go to guys” when sanctions need to be bypassed.
I lived and worked the gulf for many years and saw everything! Stratfor is a hoot!
Brian,
“The laughable “sanctions” against Iran and the pre-Iranian controlled Iraq are a hoot.”
Can you give us some evidence, a cite from the many sources watching Iran? There is a mountain of evidence that disagrees with your theory.
I’m fascinated by the prospect of seeing this play out–where will Iran end up? Will it shrug off some of its Theocratic baggage and become the modern, progressive society it might have been–or will it become another land of a wealthy, hedonistic oil aristocrats shielded by a curtain of extremism? Or will a civil war lead to cataclysmic nationalization? I’m so eager to see.
Chuck,
“the modern, progressive society it might have been — or will it become another land of a wealthy, hedonistic oil aristocrats shielded by a curtain of extremism?”
Great question! I will bet big that it will not follow the Gulf model.
Interesting. I also don’t know what to make of Stratfor. I did decide to read one of Friedman’s books.
OK FM, I will be less sarcastic. Off the shore of Ras al-Khaimah (UAE) in the gulf of Oman there is the worlds largest re-fueling station for large ocean going ships. Hundreds of oil tankers on any given day can be seen out in the gulf from the Ras al-Khaimah hills. I worked doing technical maintenance on these ships for years beginning in 1999. I would always ask crew members – where are you coming from? One common answer was – we are coming from Mina al-Bakr. That is Iraq’s main oil export terminal. I would ask – where are you going? The often and always astonishing answer was Corpus Christi Texas! That of course is the home of the US government’s Strategic Oil Reserve. But don’t you try doing any business deals with Saddam!
Many, many other tankers had left Iran’s Khark island oil terminal and were on their way to India, Pakistan, China and other Asian locations. India and Iran have had close relations for only about 4000 years now so I guess the Indians don’t really care about those western sanctions.
Western sanctions clearly hurt Iran and Iraq but did not remotely shut them down from doing business in the world.
I understand FM that I am not a billionaire or an important government official or even a “strategic analyst” so the observations of my suspect eyes and ears don’t mean much. I was just a worker
bee who had to get his hands dirty every day.
Brian,
(1) The limit on Iraq’s oil exports was raised to $10.53 billion/year. That’s a lot of tankers. In December 1999 Security Council resolution 1284 removed the limit on the amount of oil exported. (Wikipedia).
(2) Since 2010 we import about 100,000 b/day of Iraq oil (less in the past few years, as US production increased). But Iraq oil was not used to refile the Strategic Oil reserve. From 1998 – Dec 2009 that oil comes from the Gulf of Mexico (royalty payments owed to the Federal govt).
OK FM, I’m sorry. I like reading your blog and do not want acquire your ire. I am a very seldom commenter. Its just that at this stage of my life, it has become almost impossible for me to believe any statement put out by government (republican or democrat) or by the sovietized corporate media.
Saddam has weapons of mass destruction!
Bin Laden and his gang have a sophisticated network of caves & tunnels in Afghanistan with HVAC!
Bin Laden is dead! Who can possibly know?
I did not have sex with that… that woman!
My private email server was legal and secure!
If you like your health care insurance, you can keep it!
The hack of OPM & losing 22 million personnel records is just small potatoes!
Voting into office a Republican house and senate will change things!
There were 2 million boxcar unloadings in Duluth last year!
There were 15 million pork bellies processed in Kansas City last year!
Jeb Bush says Kate Steinle was murdered out of “love!”
Again, I am sorry and will leave you alone for a while.
Brian,
I have often written posts making the same points. With the government so often lying, who can tell the truth? But not believing anything makes us chaff in the wind.
My point about the oil was that the oil exports you saw did not violate the sanctions. As for the filling of the Strategic Oil Reserve, we know where the oil came from. Again, no skepticism required. This is the sort of exercise required to separate fact from fiction. It’s not easy.
“Come on FM, don’t waste your time with “analysis” from Stratfor. Stratfor consists of a few people sitting around in a half abandoned strip mall in Texas pretending they have contacts and knowledge about the world. They market their “product” to the credulous. They proclaim that Iran could get a market advantage with “joint venture deals” with western oil companies. The Persian Gulf oil and gas business in the GCC countries overflows with joint ventures between western oil & technology companies.”
Spot-on, 1,2,3. Editor, check the WL stratfor files. Come on.
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