Western Energy Companies to Re-enter Iran’s Oil and Gas Sector

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Iran is planning to increase its oil production by an additional 1 million barrels per day (mb/d) in 2014, provided that negotiations result in the easing of oil export sanctions imposed in 2012 by the West. This could have significant economic consequences for global oil markets, and political ramifications for the Middle East.

During the years of economic isolation, Iran lost most of its international oil markets, as other OPEC producers took its market share. The sanctions have hurt Iran's oil and gas field facilities, which became technologically outdated and in desperate need of modernization.

At the World Economic Forum in Davos, Iranian president Hassan Rouhani's call for the European and U.S. companies to start investing in Iran's economy is seen as another attempt to woo foreign—primarily Western—investors to enter Iran's oil and gas sector.

Iran's efforts to lure foreign investments are nothing new. Previous Iranian presidents Khatami and Rafsanjani were keen supporters of foreign investment. Their presidential tenures in the 1990s and early 2000s are generally seen as the golden age of foreign oil investments in Iran, which rapidly ended following Mahmoud Ahmadinejad's presidency, which began in 2005.

It seems that the start of Geneva negotiations last November might finally break the vicious circle of Iran's misunderstandings with the international community that have affected the country's economy so severely.

The key to Iran's deal with the Western oil giants lies in the success of political negotiations, but equally in the attractiveness of the terms that Iran will be willing to offer international investors. The current buyback formula, developed by the Iranian government in the mid-1990s to circumvent strict constitutional limitations over foreign investments in the country's oil and gas sector, did not bode well with investors. It is generally seen as unfavorable by the oil companies, due to the high level of risk and lower potential return on investment.

According to a state-owned National Iranian Oil Company (NIOC) official, buyback agreements have attracted only $50 billion in the past 15 years. Considering that Iran has the fourth largest oil reserves and second largest reserves of natural gas in the world, the amount is relatively modest, especially when compared to other Gulf countries such as Qatar, which managed to attract $200 billion over the same period.

Iran's top oil official, oil minister Namdar Zanganeh, has admitted that Iran is currently negotiating with several U.S. and European oil companies, which he would like to see invest in Iran. This is particularly important for the U.S. oil giants Chevron, Exxon, and Conoco that the U.S. government effectively banned from investing in Iran after the Iranian revolution in 1979.

Iran is in desperate need of foreign investment and technical know-how, following decades of relative decline of its oil and gas resources. Iran's current oil production of about 2.7 mb/d is a far cry from the pre-revolutionary days, when the country was producing over 6 mb/d. Similarly, Iran wants to reestablish its position within OPEC, lost to other producers during the years of international sanctions, and to maximize its production share from the oil and gas fields shared with neighboring countries.

Both Rouhani and Zanganeh have already announced major changes and a move from the buyback model toward a formula more favorable to Western companies. The final contract model will be announced at the September conference in London.

But the issue is primarily political. Iran has a cumbersome past when it comes to its natural resources, going back as far as 1950s. The real question is whether the country is able and ready to make a significant shift in this direction.

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