A critical analysis of Iranian buy-back transactions in the context of international petroleum contractual systems

Abstract

This research critically examines the Iranian petroleum contractual system from its birth to the present, and considers its future evolution. Initially, it reviews the development of oil contracts, from the early concessions until the annulment of all obligations as the result of two major events; the Nationalisation Movement and the Islamic Revolution of 1979. The constant policy struggle between the need for foreign funding and technology in the oil industry on one hand and the desire to avoid foreign exploitation on the other is analysed in terms of its impact on the current stance towards foreign investment and the formation of the present contractual model. The embodiment of this complex struggle is the buy-back contractual model that has found widespread use in Iranian petroleum transactions since 1989. This scheme is best described as a short term risk service agreement, whereby the foreign investor provides the funds for petroleum Exploration and Exploitation in exchange for a pre-defined, volume-based quantum of remuneration in case of successful production that serves to both compensate and reward the contractor. The adoption of this system is a compromise solution between the need for foreign capital, expertise and services on one hand and wariness of foreign involvement in natural resources on the other, as evident from the Constitutional limitations discussed later in this study. A crucial element of this arrangement is the transfer of the field's operation back to the National Iranian Oil Company following conclusion of the contract; a legal step which distinguishes buyback contracts from alternative systems that may be contrary to the Constitution. Both the structure and the comparative advantages of the buy-back have been discussed at length, with particular attention to the enabling laws and their flaws. Detailed analysis is devoted to the other major international contractual models, including a comparative evaluation of these alternative systems and their suitability for the Iranian oil industry, given the limitations of the Constitution. The buy-back system is scrutinised from both the foreign and the domestic perspective and the issue of whether revision of its terms or an alternative model would be more appropriate considering the grievances of all the participants. The extent to which the Iranian oil industry was and will be affected by increasing international pressure, particularly as the result of US Sanctions, was considered extensively. It appears that Iran is not yielding to such pressure but rather orienting itself towards alternative allies and continuing to sign contracts based on the buy-back. Particularly stringent examination of specific terms and conditions of buy-back has been conducted through a review of various oil fields so as to determine if the model's perceived flaws manifest themselves in reality. The finding of the analysis described above is that the buy-back contract as implemented in Iran is flawed on basis of the limiting nature of its provisions rather than by virtue of the model itself. A number of provisions, such as maximum contract length and method of remuneration, which are needlessly restrictive, are highlighted and the importance of modernising them in light of the current economic environment is noted. Based on the facts and findings throughout the study, the conclusion arises that evolutionary rather than revolutionary reforms are both required and viable, without undermining the current legal framework. Lastly, the study yields a practical recommendation as to the reforms most crucial to the preservation of Iran's attractiveness to investors, in light of the current economic, political and legal environment.