Given that China has put its expansion into Iran on hold for the time being due to the backlash in Iran on the extent of such plans, Tehran is now looking at ways in which it can plug the initial US$280 billion that had been expected from China to develop its oil, gas, and petrochemicals sectors. As U.S. sanctions make direct investment by foreigners extremely difficult and also act as a brake on international investment flowing into the Tehran Stock Exchange, the bond market looks like the only fund-raising game in town for Tehran. The chief executive officer of the National Iranian Oil Company (NIOC), Masoud Karbasian, said last week that Iran is looking at a range of such offerings and, following extensive talks with various senior figures in Iran connected to the Petroleum Ministry, OilPrice.com can now confirm to know what these options are.
Although Iran is in no position to raise capital through a Western-oriented traditional bond denominated in a mainstream currency, its prospects in the global sukuk (Sharia-compliant) market are actually very good. This type of bond has often been used by Middle Eastern countries in the past when they have been uncertain of how a more traditional bond issue would be received by international investors for whatever reason and this is clearly the case with Iran. Targeting such a specialized investor base has the advantage that the pricing for sukuk is generally lower than for a traditional bond issued by the same country. “The appeal of sukuk is determined by its spread - nominal value – not against the usual benchmarks but rather against sukuk alternatives as well as high-yield bonds issued by Iraq, Mongolia, Kazakhstan and even Pakistan,” a London-based risk analyst told OilPrice.com. “However, U.S. sanctions have inserted a significant additional discount in the computation of yield, spread and spot pricing,” he said. Related: The U.S. Smashes Another Oil Export Record
Part of Iran’s appeal to the sukuk investment community – which ranges from the U.K. (the first Western country to issue a sukuk), through Germany and Turkey (key European hubs for sukuk) to Malaysia (the biggest sukuk centre in the world) - is that it is a truly Islamic issuer. The investment universe of sukuk became a lot more skeptical of purported Sharia-compliant offerings during the financial crisis of 2008. The Accounting Auditing Organisation for Islamic Financial Institutions – the Islamic finance standards watchdog – said as long ago as February 2008 that the repurchase undertakings found in around 85% of apparently Sharia-compliant bond- and equity- fund structures that were based on ‘mudaraba’ and ‘musharaka’ principles violated the Islamic duty to share risk.
Iran, though, will issue fully Sharia-compliant bonds, in keeping with its Islamic Republic status. Buyers of the bonds will share in the underlying asset of oil flows from selected oil fields, thus sharing risk and reward, and no interest will be made directly in the form of yield payments. Instead, investors will receive periodic payments of their share of profits on the principal amount invested, as laid down in their certificates of ownership from the issuer and, when the bonds mature, the sukuk holder will also receive back principal amount invested. Given that the underlying asset will be a share in oil flows from some pre-announced oil fields this mitigates any concerns over foreign currency credit ratings as well.
“There should be interest from state-clients of Iran as well as their corporations who will see a premium in participating in the scheme, as they will see both the financial appeal and the political leverage holding of the bond may offer them,” said the London analyst. “Based on the dynamics of previous issuances, the spread needs to be about 10-15 basis points higher than Iraq has aimed for and perhaps even those realised by Kazakhstan,” he added. In addition, there is a lot of investable money both in Iran and with Iranians abroad, with Dubai alone being home to around half a million Iranians who have seen their bank accounts shut down under the sanctions regime, who will not go into the stock market but are looking for better than deposit rate bank account returns. Related: Is Eating Meat Worse Than Burning Oil?
Once the reaction to such Sharia-compliant offerings has been gauged (including the Salaf-structured model that was also used to part-finance the Persian Gulf Star Refinery), Iran is considering another much more inventive bond structure that it thinks will allow for a much more international take-up. This would be an issue denominated in Iranian rials but - crucially for potential foreign buyers – carrying with them the option not only to be redeemed in rials but also in a range of more mainstream currencies at the prevailing spot rate of the day that the buyer decides to redeem the paper. Although the full range of currencies have yet to be finalised, they are certain to include Chinese renminbi and Russian rubles, plus potentially Euros, Japanese yen, and Swiss Francs, according to various Iran sources. “This would also allow China to advance its ‘One Belt, One Road’ plans for Iran at least in terms of economic influence while the backlash against the full range of its intentions for Iran dies down,” said one of the sources, “and the amount of money that would come from China, and Russia, would be hundreds of billions of dollars worth.”
Unsurprisingly, then, one of the lead underwriters and principal distributors of these bonds would be the Peoples Bank of China (PBOC) in Beijing. “One of the structures under consideration is that the Iranian government, or state vehicle such as the NIOC, will issue a bond through the PBOC, which will be backed by the Chinese central bank, either in renminbi or another currency pegged at a specific rate to the renminbi, and the PBOC will then distribute them simultaneously to all of the major Chinese financial institutions, the Hong Kong equivalents, and the Monetary Authority of Macao for further distribution from there,” said the one of the Iran sources. In such a way, the risk for the Chinese in this structure will be minimal, as all of the international sovereign issues will be backed fundamentally by some of the world’s largest hydrocarbons reserves, while, on the other hand, the upside is huge, as it will promote the use of the renminbi as one of the world’s truly international currencies, which China regards as befitting its standing on the world stage.
By Simon Watkins For Oilprice.com
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