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11/08/2008 | Renewed Sanctions Call Risks Derailing Iran's Oil and Gas Investment Drive

Global Insight Staff

Nuclear negotiations held yesterday between the European Union representative and Iran—with more expected this week—have been deemed inconclusive by the United States, raising the threat of further United Nations sanctions; meanwhile Iran is preparing new sweetened investment terms to try and attract interest to its hydrocarbon sector.

 

Global Insight Perspective

 

Significance

Initial negotiations yesterday on the Iranian nuclear crisis failed to produce any clear answers to the main questions, while Iran—in an attempt to salvage its oil- and gas-sector development—has announced a willingness to sweeten investment conditions for foreign players.

Implications

Pressure on Iran to come up with a formal answer to an incentives package offered to it in exchange for a settlement of the nuclear row is being ratcheted up under U.S. calls for tightened United Nations (UN) sanctions, which would thwart Iranian attempts to attract new oil and gas investment under improved conditions even before their launch.

Outlook

Iran should give some kind of formal response this week if it is to avoid talks breaking down completely. Given the distance yet to be covered in negotiations, however, these are unlikely to produce an immediate settlement and—depending on Russian and Chinese sentiments—Global Insight continues to expect sanctions to be tightened, perhaps as early as September.

Talks, After All

Iran's main nuclear negotiator, Saed Jalili, yesterday conferred with European Union (EU) foreign policy head Javier Solana over the telephone, stressing the need for "the continuation of talks" and "contacts", according to U.K. daily Financial Times. However, the Iranian representative failed to deliver any kind of answer to the concrete proposal put forward by the so called 5+1 group of states (the United Nations' Security Council's five permanent members—United States, United Kingdom, France, Russia, and China—plus Germany) tasked with resolving the row, prompting Solana's office to characterise the conversation as "inconclusive".

Nevertheless, the timing of the phone call revealed the two sides' conditions for negotiation, as Saturday (2 August) saw a deadline for a definitive Iranian answer—set mainly by the United States—expire with no response. While the United States in particular is demanding Iranian non-conditional submission under international deadline and negotiation frameworks, Iran is asking for negotiations where it is treated as a level player, consequentially refusing to abide by set deadlines, but rather using a greater understanding for its views among the European nations to keep talks going. Indeed, the fact that continued negotiations still seem to be on the cards for both sides demonstrates that—unlike some months ago—there is now a clear will on both sides to find a solution to the standstill. However, this should not be confused with a notion that the sides have moved anywhere closer to each other, as the key players still remain firmly entrenched with their main demands.

Jalili, however, gave Solana a firm expectation of an official letter from Iran answering the 5+1 group's initiative for early confidence-building measures, to be sent sometime this week. A solution to Iran's allegedly illicit nuclear development programme—accused of including nuclear weapons research—would be discussed during a six-week so-called "freeze-for-freeze" period, in which Iran is to desist from employing further uranium enrichment centrifuges, while the 5+1 group stops the process of drafting further UN sanctions. After a framework for understanding and talks has been established, talks are hoped to continue on some kind of mutual understanding of "non-escalation", based on further confidence-building mechanisms. Ultimately, it is hoped that such a process could result in Iran compromising on developing some parts of its nuclear programme domestically in exchange for other technologies, investments, and international safeguards.

Desperate for Investment

Despite official government rhetoric, the Islamic Republic's economy has been hit hard by the UN and unilateral U.S. sanctions, with the prospect of rapid further unilateral EU sanctions (which have already been drafted and broadly agreed upon should the current talks break down) and tightened UN sanctions further threatening growth. Iran's crucial energy industry has suffered in particular, with the National Iranian Oil Company (NIOC)'s fight to halt mature production decline in its oilfields suffering from a lack of enhanced oil recovery (EOR) techniques, while its ambitious gas development scheme labours under a dearth of investment and technological know-how to build LNG export ventures.

In comments today, Seifollah Jahnsaz, NIOC's managing director, said that the company is preparing 15 project packages using a "new method", which he was confident would be successful in attracting foreign and domestic investors. While the new method itself was not specified, it was hinted that the project packages would be offered with better economic terms, and that Iran's buy-back contract model would be modified.

The buyback contract has been created as a peculiarly Iranian way of allowing for private investment and technology inflow, without making IOCs part-owners of Iran's reserves or production. With the nationalisation of the oil and gas sector enshrined in the Islamic Republic's constitution, the buyback contracts have tried to navigate around legal prohibitions about foreign ownership by becoming something akin to technical-service contracts (TSCs), although with the investor managing and operating the development phase of the project, after which the state (through an NOC or its affiliate) takes management charge and uses project revenue to buy it back from the private investor. The addition of certain characteristics taken from production-sharing-agreements (PSAs) has allowed for private investment to be incentivised, although set rates of return and capital expenditure (capex) have made the contracts inflexible and sometimes even damaging for contractors during periods of rising materials and skills costs.

As Global insight wrote some months ago, talks have been held within the Iranian oil industry and at government levels to make the buy-back contracts open-capex, in order for contractors to be able to work in a rising-cost and high-inflation environment. With the Islamic Republic's constitution giving little more room for investor-friendly measures in the energy sector, the "new method" is likely to indicate that Iran is preparing to codify these measures.

Outlook and Implications

While Iran badly needs investment, and should change its inflexible and largely unpopular buy-back contract frameworks in order to successfully attract it from the private sector, no company will commit to such investment under the current geopolitical situation. With further UN—as well as EU and U.S.—sanctions still looking more likely than not, there is no risk/reward calculation currently being made within the energy industry—or in fact most other industries—that comes out in favour of investment deals in Iran.

The damage done to the Iranian economy has been visible not only in the meltdown of its financial sector and the increasing hardships of its import/export businesses, but also in the seasonal gas shortages—despite its vast resources—and its increasing electricity supply problems. As popular frustration is rising the Supreme Leader Ayatollah Ali Khamenei has prompted a line of negotiation to be pursued so that Iran may secure the geopolitical gains it has made across the region and salvage its domestic economy, currently just about kept afloat by high oil export revenues. President Mahmoud Ahmedinejad's government has, however, painted itself into a corner with its unyielding stance on Iran's nuclear programme, under which it has rallied the population in order to deflect interest from its economic policy record.

Given how entrenched Iran's position is on its right to enrich uranium, and how this issue has been used to legitimise all the hardships brought down on the Iranian population, a solution to the nuclear crisis still looks far off and further sanctions look likely. Russia and China—natural moderators of the international pressure against Iran—have lost some of their interest in prolonging the conflict as their energy companies have also realised the impossibility of conducting projects in the current climate. China might also be interested in not upsetting the United States during the imminent Summer Olympic Games in the Chinese capital, Beijing, meaning that further UN sanctions look relatively likely unless Iran agrees to the confidence-building measures. Should it do so, further sanctions will be put off perhaps even until the fourth quarter, even without any results from the negotiations, while a failure to agree to the "freeze-for-freeze" initiative is likely to result in a relatively swift sanctions-tightening process in the UN Security Council.

Global Insight (Reino Unido)

 


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