July 31, 2017

Iran’s Energy Resurgence at Risk as U.S. Grows More Confrontational

Iranian Oil Minister Bijan Namdar Zanganeh, left, welcomes Chairman and CEO of France's Total Patrick Pouyanne, for their meeting prior to attend a ceremony to sign a deal to develop an Iranian gas field, Tehran, Iran, July 3. (AP Photo/Vahid Salemi)

Heightened tensions between Washington and Tehran look certain to stall already challenging efforts by Iran to attract billions of dollars in foreign investment for its oil and gas industry. Iran finally signed its first major energy investment contract in early July with French energy giant Total but expectations that the deal will be the first of many have been upended by the worsening political climate triggered by new sanctions imposed on Iran by the United States. New legislation, which imposes further sanctions on Iranian groups and individuals aiding the Islamic Revolutionary Guard Corps and Iran’s ballistic missile program, has ignited a firestorm in Tehran, where officials say it undermines the landmark 2015 nuclear accord. The bill, “Countering America’s Adversaries Through Sanctions Act,” imposes additional sanctions on Russia, Iran, and North Korea. Passed by the Senate on July 27, the bill has been sent to President Donald J. Trump for final approval, which he is expected to give.

Though the bill does not directly specify measures against Iran’s energy sector, the deteriorating relations between Washington and Tehran will almost certainly further deter potential foreign oil and gas investors. They already are treading cautiously in Iran for fear of running afoul of existing U.S. non-nuclear sanctions that affect the financial and banking sectors and impose complex regulations on companies seeking to do business in Iran. Iran’s Deputy Foreign Minister Abbas Araghchi argued the new bill could “affect successful implementation” and reduce the economic benefits of the Joint Comprehensive Plan of Action (JCPOA), or nuclear deal, which took effect in January 2016. President Hassan Rouhani has also made unspecified threats that Iran will respond with retaliatory measures if the bill targeting the country’s ballistic missile program becomes law.

Iranian Crude Oil Production ReboundsThe Total-led project to help develop a portion of the massive South Pars gas field Iran shares with Qatar is worth almost $5 billion. Even this represents only a small fraction of the $200 billion of investment Iranian officials say the country needs to rehabilitate and expand its aging energy sector over the next five years. Iran’s crude oil production has increased by around 900,000 barrels per day (kb/d) since international sanctions were eased on January 16, 2016. However, production capacity has plateaued at around 3.8 million barrels per day (mb/d) and foreign investment and advanced technology is needed for further growth. Iranian Oil Minister Bijan Namdar Zanganeh recently announced a higher crude oil production target of 4.7 mb/d by 2021, which looks extremely ambitious even under the best of circumstances.

Trump Plays His Hand on Iran

The newest congressional action came one day after the Trump administration reluctantly recertified that Iran is in compliance with the JCPOA, which is required every 90 days by Congress. Trump only signed the certification at the eleventh hour and numerous reports suggest he is not prepared to recertify Iran’s compliance in October, when the next review comes due. The U.N.-brokered nuclear accord was negotiated with Iran by the five permanent members of the Security Council (China, France, Russia, the United Kingdom, and the United States) plus Germany and the European Union, and eased international sanctions in exchange for Tehran limiting development of its nuclear program and agreeing to strict international monitoring of its nuclear-related activities. Trump, however, argued during the presidential election campaign the JCPOA was “the worst deal ever” and said he planned to scupper it once elected.

Trump clashed with the Defense and State departments over certifying Iran’s compliance as the midnight deadline on July 17 approached, with officials from both agencies arguing that the agreement achieves the overriding objective of halting Iran’s nuclear development plans. Even as he signed the recertification, he created a team of like-minded loyalists within the White House to explore options to retreat from the deal.

Trump could revoke the JCPOA at any time since final authority rests with the executive powers of the president, a mechanism adopted by the administration of former President Barack Obama to bypass congressional objections to the accord. If it were to do so, however, the White House would open a Pandora’s box of problems that would severely worsen already poor relations with European allies, set up a confrontation with Iran, and necessitate the development of a new policy approach toward the regime in Tehran. For international oil companies, entering into new business contracts in Iran may be untenable if the Trump administration upends the JCPOA or threatens to do so every 90 days.

Iran Crude Oil Production

Unintended Consequences

The controversial “Countering America’s Adversaries” sanctions bill and the Trump administration’s threats to withdraw from the Iran nuclear deal have strained already fraught U.S. relations with European allies. The United States and Europe have worked hand-in-glove in coordinating a united policy with regard to Russia since the end of the Cold War, but the Trump era has ushered in policy changes that have rankled EU officials, who promptly urged Washington to maintain coordination on Russian sanctions with its allies and G7 partners. The EU raised strong objections to the legislation since it includes new secondary sanctions on Russia’s energy industry and cautioned that “the US Bill could have unintended unilateral effects that impact the EU’s energy security interests.”

The EU is already at odds with Trump’s very public condemnation of the Iran nuclear deal and threats to abandon the hard-won international accord. Stepped-up efforts by the United States to withdraw from the accord could potentially see European energy companies sidelined from working in Iran but, at the same time, they may also make firms more defiant if there is an international consensus condemning a unilateral move by Washington. Equally, the new congressional legislation targeting Moscow will in all likelihood lead to even stronger energy ties between Russia and Iran at the expense of European firms. Soon after the bill was passed in the House of Representatives Russia announced it had signed a memorandum of understanding to develop more Iranian oil fields.

Collateral Damage for Iran’s Energy Projects

Expectations were high that foreign oil and gas companies would flock to Iran after France’s Total signed the first major energy investment deal with the country’s oil ministry in more than a decade. Iranian officials hailed the contract with Total as opening a new chapter in the country’s energy history but other companies still remain wary, and even more so following the escalating confrontation between Washington and Tehran. Iran has been struggling for two years to attract international oil and gas companies to invest in its energy sector, an effort complicated by a combination of poor contract terms, stiff opposition to foreign investors from political hard-liners, a history of difficult business relationships, and a reputation for widespread corruption. U.S. non-nuclear sanctions on Iran have also created a web of financial regulations that need to be navigated, and that leave companies vulnerable to hefty penalties if they inadvertently violate sanctions. Prior to the JCPOA, the U.S. Department of Justice fined European banks a staggering $15 billion for violating sanctions, and fears are the Trump administration could be even more aggressive in imposing penalties.

The much-debated Iran Petroleum Contract that will govern joint ventures with international oil companies has been subject to protracted review and criticism by Iranian officials. However, the re-election of Rouhani has eased the passage process. The contract was still being reviewed in April by the Supreme National Security Council but after more than 150 changes, it is now basically a framework agreement with specific details of the contract negotiated privately with individual companies rather than a rigid, fixed contract for all projects as originally drafted. Zanganeh was called to defend the contract with Total before Parliament and was given the seal of approval despite criticism from hard-liners. In fact, only bare-bone details of the agreement have emerged and there has been speculation that a number of concessions were made by Iran to get the contract done, including a favorable exit strategy for Total if the deal goes south. Total is the operator at 50.1 percent of a consortium including the China National Petroleum Corp with 30 percent and the National Iranian Oil Co (NIOC) subsidiary Petropars. The contract for South Pars Phase 11, worth an estimated $4.8 billion, is for 20 years and expected to have a capacity of 2 billion cubic feet per day or 400 kb/d of oil equivalent, including condensate, with gas production online in 2021 and sold into the domestic market.

Iran’s Major Oil and Gas Fields

Iran Major Oil and Gas Fields

Source: International Energy Agency

Iran estimates that it needs $140 billion in foreign investment to increase oil production to 4.8 mb/d and natural gas output to 45 billion cubic feet per day by 2022, but these targets have appeared overly ambitious and now even more so given the deteriorating relationship between Tehran and Washington. NIOC is hoping to finalize 10 contracts by the end of the current Iranian calendar year, March 20, 2018, and no doubt the bulk of the deals will be with Russian companies. It has signed 33 oil memorandums of understanding with 28 domestic and foreign firms since sanctions were lifted, with Russia inking the largest share. NIOC reported Russia set a record for foreign contracts on July 18 following the signing of a memorandum of understanding to develop the Shadegan and Rag Sefid fields in the southwestern Iran. The Oil Ministry has qualified almost 30 companies to bid on projects but officials have a history of overstating progress on contracts and no significant contracts with other major European energy companies appear to be in the works. Royal Dutch Shell signed a preliminary memorandum of understanding in 2016 to explore the Yadavaran field but has yet to make a serious commitment given the many uncertainties in the current political climate.

The inevitable collateral damage from Washington’s new non-nuclear sanctions and the Trump administration’s more confrontational approach toward Iran have raised the geopolitical risk premium for companies looking to invest in Iran’s oil and gas sector. Trump could use his executive powers to overturn the agreement but it is unlikely European partners would endorse such a move, so a decision of this magnitude would come with an enormous reputational cost to the United States. Nonetheless, while international energy firms have long experience operating in highly volatile political environments, the escalating risks in the coming months and years from a capricious U.S. president and an aggressive Congress may be too high for even the boldest companies. For Iran, reaching the psychologically significant pre-sanctions production level of 4 mb/d may be the best that it can hope for now.

Diane Munro is a non-resident fellow at the Arab Gulf States Institute in Washington.