Part I, below, includes details of the recent Bangestan award and an explanation of why Iran is so tense about PSAs. In Part 2, which will appear in Iran Energy Focus next month (June 2005), Mr. Hosseini tells us what direction we can expect Iran to take in its buy-back deals. He also discusses expected changes in Iran's oil policy after the Khatami administration and examines the effects of US sanctions and pressure.
Mr. Hosseini is one of the key decision makers in the Iranian petroleum sector and was responsible for drawing up the initial buy-back agreements. Prior to becoming NIOC deputy managing director, he served in several high-profile positions, including deputy petroleum minister for international affairs and deputy petroleum minister for petrochemical affairs. He has also been widely recognised for his achievements in the Iranian steel industry.
Iran Energy Focus: To begin, we'd like to discuss the awarding of the Bangestan oil field's development to Petro Iran. This came as a surprise to many, particularly since Total, BP, Shell, and Statoil were also in the bidding for the "crown jewel" of Iranian buy-backs. Which issues conditioned the final decision?
Hosseini: We discussed Bangestan with various companies over a long period. In the beginning, many aspects of the project were still unclear to us and we explored different technical viewpoints. These gradually changed, sometimes by large margins, and this was an issue for us. I remember Total once announced that it could produce 600,000 bpd from the Mansouri oil field. The fact that production of a field could increase to 600,000 bpd from 50,000 bpd or 100,000 bpd was of course attractive to us. But when we studied the details we realised that Total's estimates were unrealistic. It would have in the best case been a temporary rise as the result of big investments and lots of injections, but there would eventually have been a sudden drop.
While the tender was ongoing, the field was producing oil and we were also drilling new wells to maintain production. This resulted in new data about the technical features of the field that opened new horizons before us. For example, we had previously thought a comprehensive gas injection into the Ahvaz field could help us realise our production goal of above 300,000 bpd. When we presented companies with our new findings, however, we realised that this could not be reached.
EOR/IOR technology is much more complicated than simply developing an oil field. Several major companies had submitted bids for these projects, including BP, Total, Shell, Agip, and Statoil. Tenders are an efficient way to decide the details of projects but they are a limitation as well. In EOR/IOR projects, you are chiefly prioritising technology and if you award a project to the company that has submitted the lowest bid, there is no guarantee that it will be able to best serve the interests of the country. Even though our laws oblige us to accept the lowest bids, I do not think that this should be the top priority in EOR/IOR tenders. It would be much better to make decisions through careful technical studies and debate. We cannot hold a tender and only later begin to think what to do with the various options we have. We should know what we are looking for and aim to obtain it.
Some companies are not big but have high-level expertise in IOR operations. Many little known companies are very efficient in handling IOR operations and have successfully carried out very specific projects. Certain Chinese companies, for example, have adequate expertise in special cases of reservoir operations in very harsh regions.
Companies like Shell and BP have focused a lot of attention on EOR/IOR projects but you can't say that only a particular type of company is right for these kinds of projects. I think we should look for the companies that have developed the required EOR/IOR experience either at the experimental scale or the pilot scale. We should identify them, enter talks with them, and give them the chance to persuade us that they can handle the projects. These are the theoretical things we had in mind, the limitations we faced, and the problems involved. But as for awarding Bangestan to Petro Iran, I should say that the proposals we received were all optimistic, but not as optimistic as we thought once we examined the technical details. We finally came to the conclusion that we could not make a huge investment simply on the basis of optimism. This is why the negotiations were prolonged and the scope of the tender changed twice. This made some bidders leave and others replace them.
IEF: How did the bidding processes develop and how capable do you think Petro Iran is in handling the project?
Hosseini: Three bidders ultimately remained in the tender: BP, Total, and Shell. When we evaluated their financial proposals, we realised that Shell's bid was against the framework of our tender regulations and had certain deficiencies. It claimed the proposal was correct from a technical point of view, but we could not accept offers that went against our established criteria. This brought the number of bidders to two - Total and BP.
We had certain concerns with BP. It offered a long-term approach on a trial and error basis. Although the complexities of IOR allow for a certain degree of trial and error, we were short of time and could not make long-term investments in an oil field without knowing whether it would be profitable. Another problem was that we realised that although BP was often active in our tenders, it showed no real seriousness in the talks. A good indicator was that it had not taken up a single project in Iran for the past decade despite maintaining an office in Tehran. We have by now realised that BP just wants to be in Iran to see which project it can obtain. Later, when BP CEO Lord Browne said his company's investments in Iran jeopardised its US interests, it was proven to us that we had been correct in our understanding of the company. Still, we always want to have reasonable relations with international companies. To do this, we need to do our job correctly and not break ties with anyone, so we talked with BP in a friendly environment and clarified outstanding issues on both sides.
Subsequently, the only bidder remaining was Total. Total, however, had arrived at completely new estimates over Bangestan, totally different from the scope of the tender. It had carried out its own survey based on data obtained from the new drilling operations that the NIOC carried out. The new data were completely different from what we had originally obtained. Total told us that it could proceed with the project under our conditions so that we would be satisfied but warned us that as a professional company it thought we could not obtain the expected results and did not recommend that we handle Bangestan on the scale we had devised. It suggested that we start the development at a low scale, but this was not useful. One way was to implement the project as a pilot test.
The tender was no longer ongoing, however, and we had to announce a winner unless we wanted to start all over again. It is usual that after a company wins a tender, we have to conduct time consuming talks before singing the contract in order to match expectations and determine procedures. Another problem we had was that our licence for developing Bangestan would expire on 20 March 2005. The talks had already taken too long and we were doubtful whether the Majlis would extend the licence. We did not think it would be possible to conclude the contract before 20 March if we negotiated with Total over Bangestan outside the tender procedures.
Therefore, we decided to award the project to a relatively qualified Iranian company and avoid lengthy contract procedures. We considered Petro Iran qualified and knew that we could arrive at an agreement with it over Bangestan in a shorter time. It has completed several other projects such as Forouzan and is seriously working on projects such as Salman.
Petro Iran is a successful Iranian company and one of our main options in the Bangestan tender though this does not necessarily mean that it has the IOR technology we require. We anticipated that Petro Iran would bring in a foreign company, such as Total, to assist it. The framework of the agreement has been drawn up in a way to satisfy the expectations of foreign companies. This will also help Petro Iran find first rate foreign partners for this project easily.
IEF: Could you please elaborate? It seems that you are talking about a new framework for contracts and this is of particular importance when considering that Petro Iran had problems with BHP over the development of Forouzan/Esfandiar.
Hosseini: This is not a new framework per se. We are by now completely familiar with the expectations of foreign companies. They change from time to time as the result of new experience, management requirements, and shareholder demands but we nevertheless know to what degree we must change a contract to make it more attractive. We tried to design the contract with Petro Iran so that foreign companies would not have problems with its conditions. Petro Iran is a subsidiary of the Ministry of Petroleum and we do not expect it to make a big profit out of the Bangestan project. We have considered a margin for change in the deal's rate of return. For example, suppose we consider a rate of return of 14 per cent for a project. If a foreign company asks for a rate of return of 15 per cent, Petro Iran will then have the flexibility to consider a rate of 13 per cent for itself while allocating a rate of 15 per cent for that foreign company.
In general, we have arranged things in a way that such facilities can be considered for foreign companies bidding for Iranian projects. We are not sure the method that Total proposed on pilot-testing Bangestan was the best. Yet we have enabled Petro Iran to decide for itself the procedures for project even though we will ultimately need to approve.
IEF: Some say buy-back deals are inefficient and need to be revised. What do you think?
Hosseini: The issue of buy-backs is very important and I would like to go into detail about it. When the buy-backs were being drawn up, the NIOC applied the experience it had obtained over the years. The buy-backs are, in fact, the fruits of a series of both sweet and bitter experiences, mostly bitter. I do not want to say that I have any personal position about other kinds of contracts such as concessions, PSAs, or special service contracts. I do not want to say that I have closed my eyes to these formats of contract and that I want to sign only buy-backs.
Let me tell you about a case in which several US corporations that operated in Iran before the 1979 Revolution filed a complaint against Iran at The Hague. You may in fact be the first people I've talked to about this. The US companies were suing for losses they had suffered after Iran had suspended their PSA agreements. I was involved because I was responsible for the out-of-court negotiations. We obtained some very good experience from this case.
These US companies had made investments in Iran's oil sector as PSA or joint ventures before the 1979 Revolution. During the course of later upheavals in Iran, including the takeover of the US Embassy and Iraq's invasion of Iran in 1980, these companies left Iran and never came back to continue the projects. Iran could not stop its oil exports simply because US companies were no longer there to operate the projects. At the same time, we had developed the expertise to manage them. Therefore, we took control ourselves without actually violating the rights of others. The US companies contacted us and we told them we had no problem continuing to co-operate with them. They even continued purchasing Iranian crude before the US Embassy takeover and the ensuing hostage crisis. Nonetheless, the companies, which were members of consortia or JVs operating in the Persian Gulf region, first refused to come back to Iran. Later issues, including disputes in Iran-US relations and the case at The Hague, just made everything more difficult for their return to Iran's oil sector. Therefore, it was quite natural that we took control of our own oil sector affairs.
Throughout the court proceedings, Iran always stressed that it would pay the companies all their due rights within the framework of the existing agreements. The US companies, however, preferred to take the case to court and get a verdict against Iran. What happened in court could in fact serve as the basis of a very interesting report. One of the useful experiences of the case at The Hague was about PSA and JV projects. The PSAs and JV contracts clearly stressed sharing the production of the projects and not sharing the underground reservoirs. Therefore, those companies had right to the oil produced at the fields and their investment was naturally the offshore and onshore facilities they had constructed. All the investment was known and no complexities needed to be clarified. We were ready to pay them whatever investments of this kind they had made or allow them to control the facilities they had constructed themselves.
IEF: How did the case develop in the courts?
Hosseini: When it was determined that Iran must pay their losses, the issue of literal compensation was raised. We learned many things during the debates over literal compensation. The first was that the companies believed they had contractual rights to the oil under ground and although the court was about to vote for this, we fortunately prevented it because it would have set a precedent. In our legal contracts, they had rights over the oil above ground only, i.e., the produced oil. Some international companies claim that they want nothing to do with our underground reservoirs, but our earlier experience proves otherwise.
We asked the court for advice and the court said the US companies also had a share in the underground oil. We said we should determine how much oil there is under the ground, but the figures the experts reached were inaccurate. US experts set the reserves at a billion barrels while our experts said the reserves were 50 or at most 100 million barrels.
We had to make a decision about what to do when the companies raised the estimates from, for example, 100 million barrels to 150 million barrels. We needed to decide how we were supposed to pay them. There are so many risks associated with every barrel of oil under the ground: whether there is any oil in a reservoir, and whether it can be brought to the surface. There are risks associated with the technical features of the oil produced at the field: its marketability, who will buy it, and for how much. The US companies divided whatever oil there was under the ground and determined our share of the reservoirs. We formed an assumption that that the oil under consideration as our share was already pumped up to ground without factoring in the associated risks.
We accepted this and asked the court what we should do. We thought the share of a certain company might become, for example, 20 million barrels. I remember in one of the court sessions, the lawyer for Lavan Petroleum Company (Lapco) said the price of each barrel of oil must be determined. The price at that time was about $10 a barrel. At this price, 20 million barrels would amount to $200 million. We told Lapco that it would be paid its interest separately and would receive a total amount of $200 million for the oil. It rejected this and said that the price should be calculated based on what it was in 1979, which had risen to some $40 per barrel following the Revolution. When asked whether it wanted to receive $40 per barrel it responded that it needed to check the forecasts and compare future price projections with the current figures before making a decision.
All the forecasts at that time were in its favour. The company brought us documents showing what the EIA, OPEC, or IEA said. The final figures it presented were $100, $98, or $95 for a barrel of oil. Then it said we needed to pay in cash. Although this was not common practice in any business in any economy anywhere in the world, the court nonetheless voted for it.
IEF: What would you say were the most important lessons from this case?
Hosseini: It chiefly made us realise that these contracts would be favourable to us only as long as we were on friendly terms with the companies and would not guarantee our rights when we encountered problems. Certain things are defined according to international law but not necessarily included in the contracts specifically. This is because most disputes are taken to court and the courts are not experts on oil issues. The experts who commented on the case in court naturally considered the interests of those who had employed them.
We also came to the conclusion that the risk the companies accept in PSAs is that of exploration, whereas most of our projects are for development and the exploration costs are not very high compared to development expenses and the revenues gained. This is particularly true in countries with a very high potential for oil discoveries, such as Iran. Therefore, the rewards can be huge and disproportionate to the risks. A company will, for example, accept a small risk of $20 to $40 million for exploration operations and eventually discover a major reservoir of crude resulting in large profits.
Lapco, which I mentioned earlier, discovered 2 billion barrels of crude after drilling the very first well. Its total investment through a PSA was perhaps $10 million, of which we had paid $5 million. It spent $5 million for a 50 per cent share in an oil field that held 2 billion barrels of oil. These comprehensive rights were within the framework of the contract but did not match the exploration risks that major oil-producing companies accepted.
IEF: Under what circumstances do you think PSAs are a good contract format to adopt?
Hosseini: I believe that from the viewpoint of an oil-producing country, contracts such as PSAs or concessions may be best when the potential for discovering oil is low. In these cases, the government has no motivation to make investment itself and it is much easier to engage a company that is ready to accept the risks to handle the operations.
Take Brazil as an example. The Brazilian government employs a contactor and asks it to make the explorations at a certain project. They will spend $40 to $50 million on the project without really knowing whether oil will be found. If it is, the contractor is entitled to a reasonable reward. The percentage that belongs to the contractor is higher because it has accepted the risks. In Iran, companies do not take enough risks to be entitled to the huge rewards they were receiving before the 1979 Revolution.
We gained other experience as well. For example, we have a concession project that dates from before the Revolution and continues now because we are partners with another country. The Mobarak field is shared with the Emirate of Sharjah. We implemented no changes in the Mobarak contract following the Revolution and have learned that when we have no authority over a project, very heavy costs are imposed. In the case of Mobarak, all costs fall on Iran and Sharjah, not the company working there. The operator has incentives to extract all the oil until the last drop, at any cost. Therefore, it does not care for our interests because it would have us and our partner pay all the costs.
I remember that in one instance the operator wanted to drill a well and quoted us a price. The cost of drilling operations is normally very high and one should be careful making decisions about such operations. We took the proposal of the operator and had our engineers assess it, deciding that the well would have most probably turned up dry. Therefore, we told the operator not to carry out that particular drilling. The company responded that it is in charge of the operations and it was up to them to decide where to drill. It ignored our warning, and although our expectation came true after a period, we were nonetheless forced to pay the charges for what we had already rejected as inexpert.
I have realised over the years that we receive only royalties from the revenues at Mobarak. The project was too costly for us and the contractor billed us huge sums over its operations. We have received only enough to pay the royalty dues, something like $1 for each barrel. The contractor was only concerned about exploiting the Mobarak reserves until the very last drop and was not at all concerned about the costs at the project. This cannot really be called fair.
IEF: Were these the main issues that made you opt for the buyback contracts?
Hosseini: The sum of these experiences made us realise that we needed to devise a new framework for our contracts. We anticipated that foreign companies would come back to Iran, but we needed to prepare that framework to facilitate better cooperation with them. Iran needs the companies because they have modern technology and access to world markets. It is to our benefit that they come here, make investments in our projects, and transfer technology in the buy-backs.
We have tried hard to draw our expectations and those of the IOCs closer to each other without giving up our own expectations or imposing anything on the companies. Some might say that Iran had to adopt buy-back agreements instead of PSAs due to constitutional restrictions, but I believe that although this affected our decisions we chose buy-backs as the ideal form of oil contract because of the experiences I just outlined. I reject the idea that Iran had to look for other formats of contracts because of constitutional restrictions. This is because I myself had a central role in devising buy-backs. We also knew that we must be aware of IOC expectations because we are dealing with global rivalry. If Iran refuses to make its contracts competitive, companies will go after projects in other countries with much better conditions.
We consulted several foreign oil companies when studying oil contracts. We talked with experts at Total and also with Japanese experts for quite a while. We also negotiated with Conoco for about three years. The result of all these talks was that we were able to prepare Iran's first buy-back, which was a service contract.
IEF: What are the benefits of buyback contracts for Iran?
Hosseini: Buy-back contracts have in my view been very efficient so far. Iran has been able to attract above $30 billion in investment over eight years through such agreements. Apart from the Sirri buy-back, Iran started significant efforts in attracting foreign investment through oil deals after 1998. Most have already come on stream. NIOC reports indicate that its oil revenues from buy-back projects stood at about $9 billion by the end of 2004, of which $2.5 billion was used to pay contract debts.
This is a great achievement for Iran. We made a decision seven years ago, began work, and were able to make $9 billion in the early years of production. This was done without putting any negative pressure on the country's other revenues or the state budget. It also created a successful business for the country. With respect to gas development projects, Iran attaches a great significance to the development of South Pars. It is particularly important when considering that Iran shares the South Pars field with Qatar. The fact that it holds huge reserves of gas has already increased its significance. Besides, Iran is trying to replace gas with oil products in its domestic energy consumption. This will have major economic benefits for Iran because oil products can be used to produce other products with added value and there is a growing market for oil products compared to gas. We will need to make giant efforts in our oil and gas sector and we have been able to do this thanks to the buy-backs.
IEF: Thank you for your time.
Note: The second part of this important exclusive interview will run in the June issue of Iran Energy Focus. An advance copy of the interview will be made available to subscribers only. Contact firstname.lastname@example.org about subscriptions to Iran Energy Focus
© Menas Associates 2005
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