Iran out of ideas

Sanctions may or may not hit Iran’s oil industry hard, that remains to be seen. According to some their impact so far has been devastating; others have called them ineffectual and misguided. In fact, though, they may represent simply the last wave of a perfect storm of factors hampering the growth of an industry the whole Iranian economy and 70 million people rely on. Because, before you get to sanctions, there’s the whole ideology of the Islamic republic towards foreign investment, especially in the oil sector. And the fact that depletion of Iran’s ageing fields makes such investment an ever more pressing need. Iran has joined the growing list of “mature”producing countries that invest more and more just to get the same results.

Quite apart from the nuclear issue itself, the Western-Iranian conversation on oil plays something like: West “We don’t like how you do, so we’re out”. Iran: “Fine. We never liked you anyway.”

Viewed from history, Iran’s latest careful ruminations about how to reconcile national ownership and sovereignty, the old and understandable Iranian obssession, with foreign capital and global markets are just the latest stage of a debate that is now a century old and shows no sign of being resolved. Since 1908 Iran – then Persia – has been through just about every configuration of fiscal and regulatory regime imaginable – concessions, PSCs, service contracts, buy backs. But it still doesn’t know where its oil head is, so to speak.

Engagement with foreigners has been a contentious issue in Iran dating at least to the 1950s, when it curbed its traumatic relationship with the Anglo-Persian Oil Company after a half century of occupation and exploitation. Since it nationalized its oil industry in 1951, Iran has committed three petroleum laws and the 1979 constitution to freeing itself of dependence on foreign money and expertise. Today though, Iran’s economy is stretched thin, oil production is in decline and the need for investment is as critical as ever.

Expanded US and EU sanctions limiting foreign involvement in Iran have compounded these troubles, loath as its oil ministers and political leadership are to admit it. As they continue to stress both the importance and feasibility of achieving self-sufficiency in oil it is increasingly clear, a century after Iranian crude first hit world markets, that Iran seemingly still doesn’t know what it wants from its oil sector, nor does it know how to get it.

Iran’s legislative history since the 1950s shows a progression away from foreign and toward domestic investment and control, especially in the petroleum sector. Aversion to foreign involvement in the oil sector is understandable, thanks to a history littered with events that seem to legitimize Iran’s chronic suspicion of foreign interests.

In 1952, after nationalization, Prime Minister Mohammad Mossadegh shrugged off British and American advances to get Iranian oil flowing due to their failure to draw up a sufficiently favorable deal. A year later, due in part to his intransigence in negotiations with the US and UK, Mossadegh was gone, overthrown in a coup backed by the CIA and MI6.

Since then, Iran has used almost every contractual mechanism at its disposal to maximize its share of profits from oil extracted within its borders. This progression of legal regimes toward increasing state control has not been linear by any means; rather, it is rife with inconsistencies and reversals of policy that have come in response to national and global necessities. Nevertheless, the historical contradictions in Iran’s petroleum policy give the sense that Iran itself doesn’t know what it wants its oil reserves to achieve.

Between the discovery of oil in 1908 and the nationalization of the industry in 1951, Iran had a concessionary contract system in place, by which foreign companies owned all the oil in a prescribed area and the Iranian government received a royalty for allowing its extraction. The Anglo-Persian Oil Company (APOC), which became BP in 1954, dominated with a virtual monopoly over the exploration, production, refining, transportation and export of Iranian oil. Because Iran lacked the legislative framework to govern the activities surrounding the exploitation of its oil, APOC was able to take advantage of a relative state of lawlessness and negotiate exceedingly favorable contracts with the government in Tehran.

The company was officially kicked out of Iran by nationalization in 1951. But it returned in 1953, camouflaged within a larger consortium of Western companies. Nationalization had made oil in the ground the property of the Iranian government; but under the new consortium agreement, title to the oil was transferred to the consortium once the oil reached the well-head – making the government the owner of the oil with effectively no rights.

Iran’s first petroleum law, enacted in 1957, remedied this to some degree by making possible Joint Ventures, by which the government and private companies shared ownership of the oil in a 75-25 percent split for the government. The 1957 law, however, applied only to areas outside the territories controlled by the consortium, which remained in force and unaffected by parliamentary legislation until the 1979 revolution. In effect, this meant that Iran had two parallel contractual regimes: one through which it could negotiate with foreign entities on its own terms, and a second, with the foreign consortium, over which it exercised minimal control.

It wasn’t until 1979 that Iran abolished this awkward system of parallel contractual regimes and took nationalization to its logical end. The new constitution of that year and, subsequently, the 1987 petroleum law, forbade foreign investment of any kind and established the government’s annual budget as the only mechanism for financial investment in oil. The constitution regarded all natural resources as Anfal, an Islamic concept meaning public wealth and property which cannot be sold or transferred to anyone; and the terminology thus created a grave impediment to any foreign entity seeking ownership of Iran’s oil wealth.

A few years later though in 1994, as investment in the oil sector began drying up, Iran’s leadership reversed course and re-opened the door – albeit just a crack – for foreign participation through so-called ‘buy-back’ agreements. Buy-backs, also known as risk service contracts, allow international contractors to search for oil and gas at their own risk and receive remuneration for any they find, without gaining ownership. Making an exception to the foreign investment ban through buy-back agreements probably made Iran’s hard-line leadership cringe; but it was necessary because the trend toward increasingly isolationist oil policy had become economically unsustainable.

In recent years, the buy-back mechanism has itself failed to satisfy Iran’s critical investment needs, and the recent ramping up of sanctions on Iran has made the predicament even more dire. Iran has already produced about 75 percent of its total reserves and its mature oil fields are rapidly depleting, reflected in base production declining by about four percent every year. Oil and gas reserves are becoming harder to reach across the globe – total investment in exploration and production globally is about five times what it was in 2000 – and sanctions, with their stated goal of choking off investment that Iran’s oil sector desperately needs, make Iran’s prospects for attracting that investment from foreign entities rather dim in the near-term.

Not that Iran’s leadership will admit that this is a problem. The sanctions, coming after a century of effectively colonial relations with the West, have only hardened the attitude of Iran’s political elite toward meddling foreign powers. Not only Iran’s politicians, but also its oil deputies have been vocal about their intentions to be totally financially self-sufficient in oil matters by 2015 at the latest.

But one wonders if this confidence is well-founded. Compounded by sanctions, the current legislative framework will struggle to lift Iran’s production levels to anything close to their peak of nearly six million barrels of oil per day in the 1970s. With oil production in mid-2011 averaging around 3.7 million barrels per day (mbpd), Iran’s deputy oil minister warned that output would fall to 2.7 mbpd by 2015 unless the sector received at least $32 billion in investment by that year. And it is unlikely that Iran’s leadership will sign contracts allowing foreign ownership without facing formidable political opposition at home.

Perhaps Iran will reverse course again and eventually allow foreigners into the industry on which its economy so thoroughly depends. Sanctions make this impossible in the near term; they have already made a reclusive state even more wary of foreign engagement. But, bitter pill though it may be, Iran’s cash-strapped leadership will eventually need to open its doors to sustained foreign investment – or resign itself to the oil sector’s continued decline.

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