Fortune Favors The Bold, Especially In Iran

Introduction

The tentative framework deal reached between Iran and the P5+1 nations over its nuclear program has raised the prospects of a broader thaw in relations. If Iran can be accepted back into the international community, the harsh sanctions on Iran's economy could be lifted. That could lead to an opening up of Iran's oil sector.

While that won't mean a return to the pre-revolution days before 1979, it could result in extraordinary opportunities for the few international oil companies willing to brave the political risk.

Massive Oil and Gas Reserves

And the bounty could be big. Iran is sitting on the world's fourth largest oil reserves and the second largest reserves of natural gas.

Western sanctions have cut into Iran's oil exports. Iran exported 1 million barrels per day less in 2012 - when the real biting sanctions took hold - compared to the previous year. Its export revenues fell by more than half between 2011 and 2013 as a result. Iran therefore has a strong incentive to finish off a deal with the West.

Foreign oil companies are not allowed to take ownership of any oil fields. The state-owned National Iranian Oil Company (NIOC) owns and operates all oil and gas operations. Instead, international companies would need to partner up with NIOC and earn through buyback contracts, in which companies receive a portion of production in exchange for their investment.

There is a lot to like in Iran. Iran's oil generally comes in the form of medium, with an API gravity between 22 and 36. The bulk of its production occurs in the western province of Khuzestan, which borders Iraq to its west and the Persian Gulf to its south. Several of Iran's most productive fields are located there, including the Ahwaz-Asmari, Marun, and Gachsaran.

Investment Needed to Revive Iran

But Iran, due to increased isolation from international markets, has suffered from a lack of investment. As such, many of its fields are old and mature, and are showing their age. The biggest fields are in decline. Production could be reversed, but it would require private investment. Consider this: Iran has not brought a new oil field online in over 8 years. It is merely surviving off of oil fields that were developed decades ago.

That means that there is quite a prize to be had for companies that do enter into Iran. In the recent past, activity has been largely made up of Russian and Chinese companies. Gazprom (MCX: GAZP), Russia's state-owned firm, had helped develop the massive South Pars natural gas field. South Pars is Iran's largest natural gas field, holding around 40% of the country's total natural gas reserves. Iran has outlined 24 phases to develop South Pars, the first 10 of which are completed.

Gazprom tried to expand its footprint in Iran after its initial work on South Pars, but the Iranian government grew impatient after Gazprom slowed investment due to fears over international sanctions. Gazprom's contract was cancelled. China National Petroleum Corporation (CNPC), China's government-owned oil company, was also involved in South Pars, but its contract was cancelled as well after it delayed development - again, due to international pressure. Similarly, CNPC lost the contract for the South Azadegan field. The combined North and South Azadegan field was Iran's largest oil discovery in 30 years when it was discovered in 1999, holding an estimated 6 to 7 billion barrels of recoverable oil. China is still operating the North Azadegan field, and expects to begin producing 150,000 barrels per day sometime this year or next.

One of CNPC's compatriots, Sinopec, is developing the Yadavaran field, which holds an estimated 3.2 billion barrels of recoverable oil and 2.7 trillion cubic feet of natural gas. Sinopec brought 25,000 barrels per day online in 2013, but hopes to ramp up to 85,000 barrels per day this year. By 2018, it hopes to add another 50,000 barrels per day.

Offshore is a bit less developed, owing to some of the same problems mentioned above. Project delays resulting from international pressure, unattractive contract terms offered by the Iranian government, as well as managerial problems at the NIOC, have stalled progress in Iran's oil sector.

Nevertheless, if some of these problems can be sorted out, the Persian Gulf could be an exciting place for international companies for both oil and gas. The South Pars field still has a long way to go. And there could also be more oil fields like the Abuzar - Iran's largest offshore field - which produces 175,000 barrels per day.

There is a huge upside for liquefied natural gas (LNG) exports, although that is probably a bit farther off into the future. Iran consumes a lot of its natural gas domestically, leaving less for export. But Qatar, just across the maritime border in the Persian Gulf, has turned itself into the world's largest LNG exporter. With Qatar drilling from basically the same natural gas deposits as Iran, it goes to show how significant political problems can be. Qatar is essentially sucking up and exporting the same natural gas that Iran could be.

Politics - the Big Unknown

But that is the problem with companies moving into Iran. The Iranian government has cycled through numerous international partners to develop its fields, at times having cancelled contracts for multiple companies. In fact, politics have been the single biggest obstacle to Iran meeting its full potential. Oil nationalization in 1951, the revolution in 1979, the war with Iraq in the 1980's, and the international sanctions since 2012, have all significantly impacted Iran's overall oil output. Reuters analyst John Kemp recently put together a chart plotting Iran's historic oil production, and the ghosts of Iran's political past are clearly visible.

Iranian President Hassan Rouhani hopes to remedy that record. He has actively courted international oil companies. In 2013 Iran's oil minister stated that he wanted international companies to come to Iran. He specifically mentioned Total (NYSE: TOT), Royal Dutch Shell (NYSE: RDS.A), Eni (NYSE: ENI), Statoil (NYSE: STO), BP (NYSE: BP), ConocoPhillips (NYSE: COP), and Chevron (NYSE: CVX).

Unattractive contract terms had been a point of contention for private companies even before sanctions were slapped on. Without ownership over reserves, the amount that can be recouped is critical. Several European companies balked at the stingy terms Iran offered in the pre-sanctions era. This time around, to sweeten the pot, Iran has revised its terms for investment over the last year, increasing fees it will pay to companies. Riskier projects will earn companies higher fees.

Iran is also seeking to model their new contracts to more resemble production-sharing agreements common in places like Iraq, a much more familiar and attractive agreement to private companies. But the devil will be in the details.

Conclusion

It is not even clear if a comprehensive nuclear deal can be reached. Without that, Iran's oil sector will stagnate and remain in limbo. But if a deal is secured, sanctions will lift and the rush will be on.

Iran will still need to compete for international investment in a low-oil price environment. But it has the reserves, both onshore and offshore; both in oil and in gas. With the massive reserves in place, one way or another, some company will be brave enough to take the plunge.