Iran Faces a Bumpy Road back to Global Energy Markets

President Rouhani’s attempts to reform the oil sector in Iran are essential for the Iranian economy, but are facing steadfast opposition.

On January 30, hardline students gathered outside the Iranian oil ministry in Tehran to protest against a proposed new legal framework for the Iranian oil industry.

At the end of November, President Hassan Rouhani’s government proposed extensive changes to the regulation of oil production, seeking to make investment in Iran more attractive to international companies.

The students, along with many in the political opposition, accuse Rouhani of going against the constitution, which strictly prohibits foreign ownership of the country’s natural resources.

The Iranian constitution, which was adopted after the Islamic Revolution of 1979, states that “public wealth and property, such as uncultivated or abandoned land, mineral deposits, seas, […], shall be at the disposal of the Islamic government for it to utilize in accordance with the public interest.”

On this basis, the constitution also “absolutely” forbids “the granting of concessions to foreigners for the formation of companies or institutions dealing with commerce, industry, agriculture, services or mineral extraction […].”

The protests are not just a sporadic manifestation of political dissent.  They are a sign of a more structural problem that President Rouhani and his government are struggling to tackle in order to revive the country’s energy sector, and consequently the whole economy.

From 1979 to 1998 Iran did not sign any petroleum agreements with international oil companies. The government only started to pay attention to the development of the country’s oil and gas industry under President Mohammad Khatami, who was in office from 1997 to 2005 .

In order to attract the necessary foreign capital and expertise to develop the petroleum industry, the government introduced a new legal framework, the buy-back service contract (BBSC).

Under this scheme, international oil companies can agree to carry out the necessary exploration activities to develop an oil or gas field, but must hand the field over to the National Iranian Oil Company (NIOC) once production starts.

The scheme overcomes the constitutional constraints on oil production. However, the programme is unattractive for foreign oil companies, which have to make large investments, and then hand the asset back to the Iranian authorities once it becomes profitable. Companies must then wait to be repaid.

This scheme is unattractive in comparison with the legal framework generally used in the oil and gas sector. Production sharing agreements (PSA) commonly used in the international oil industry allow companies to own part of a field’s oil or gas reserves, and also to share the costs and profits of its development.

In this context, the Iranian BBSC system has become a key obstacle to international investment in the Iranian oil and gas sector, on top of international sanctions.

President Rouhani and his government carried out a process of structural reform of the country’s petroleum legal framework in parallel to the international negotiations on the nuclear issue.

This reflects their recognition that the lifting of international sanctions after the nuclear deal would have not been sufficient to stimulate international investment in the country’s energy sector.

The recently proposed Iran Petroleum Contract (IPC) is intended to combine some elements of the BBSC with some elements of the PSA, possibly allowing international companies to gain rights to a certain percentage of Iran’s oil and gas reserves for 20-25 years.

The effective implementation of a new petroleum legal framework is a prerequisite for the country’s comeback into global energy markets.

The Iranian oil ministry had organised a conference in London to present the new legal framework to international investors. But after the January 30 demonstration, the conference was cancelled for the fifth time in two years.

Meanwhile, the Expediency Discernment Council, the powerful Iranian oversight body which reports to the Supreme Leader, has declared that it will review the IPC proposal in detail.

Parliamentary elections will be held in Iran on February 26 to elect both the Islamic Consultative Assembly and the Assembly of Experts, so further delays in the reform of the country’s petroleum legal framework are likely.

However reform is vital and urgent. Delays could compromise Iran’s return to the global oil and gas markets in the short term. This would have unpredictable results not only for the country’s macroeconomic prospects but also for global energy markets.

Simone Tagliapietra

This article was published on the Bruegel Blog