The signing of the JCPOA regarding Iran nuclear sanctions may usher in a new era of major international investment in the Iranian oil and gas industry.

After months of intense negotiations, on July 14, 2015, the United States, European Union, United Kingdom, France, China, Russia, and Germany agreed to a Joint Comprehensive Plan of Action (JCPOA) with Iran regarding Iran's nuclear program that has the potential to open the Iranian oil and gas industry to billions of dollars of international investment.

The JCPOA may be the first step in a process of sanctions relief that could have a transformative impact on Iran and the international oil and gas industry. Amir-Hossein Zamimana, formerly part of the nuclear negotiating team and the Deputy Minister of Petroleum, has been managing discussions with selected major international oil companies (IOCs) and has announced that the energy sector will require at least $185 billion of investment over the next six years. With the world’s fourth-largest proved crude oil reserves and the second-largest natural gas reserves, Iran may well become a highly attractive potential venue for IOCs seeking reserve replacement.

Even before the most recent round of sanctions was enacted against Iran in 2012, the terms and conditions offered by Iran to IOCs under the approved "buy-back" contract structure proved so onerous that many decided to exit the country based on the substantial economic losses they incurred. Recognizing the need to entice IOCs to reconsider investing in the country in connection with sanctions relief under negotiation, in late 2013 Iran formed the Oil Contracts Revision Committee (headed by Mehdi Hosseini) to prepare new, more favorable terms for foreign investors. While the government has not publicly released the full terms of the new Iranian Petroleum Contract (IPC), there has been substantial public discussion regarding the high-level terms that are expected to be included in the IPC, and selected terms have been provided to the IOCs.

Below, we discuss (1) certain terms of, and the challenges associated with, the current buy-back contract structure, (2) key IPC terms that have been discussed publicly, and (3) the timing and the potential roll-out of the IPC and sanctions relief.

The Current Buy-Back Contracting Structure

Foreign or private ownership of natural resources in the reservoir is forbidden under Iran’s constitution. Instead, IOCs have been investing primarily through buy-back contracts that are disadvantageous compared to contracts offered by most other host governments, and that have ultimately proved to be unprofitable for many IOCs.

The buy-back contracts are essentially a constricted form of risk services contract. They allow the IOC to act as the operator of the field during the exploration and development phase, but provide that the National Iranian Oil Company (NIOC) takes over operatorship during the production phase. The NIOC uses proceeds from production to pay the IOC a set sum from production volumes, and the IOC is not compensated for boosting production. The terms of the contracts have been short, with a payback period for exploration and development expenses incurred by the IOC of five to seven years, giving the IOC only a short time to recoup its investment. The buy-back contracts cap the profit the investor can make per barrel of oil, irrespective of increases in the commodity price. In addition, the IOC must pay for any cost overruns beyond initial projections without reimbursement—which presents a challenge for large, complex projects where budgets often increase dramatically. Under this structure, the IOCs have been unable to book the applicable reserves, which is problematic for those IOCs for which reserve replacement is a significant concern.

The New Iranian Petroleum Contract (IPC) Structure

The proposed IPC framework is designed to address some of the perceived limitations of the buy-back contracting structure and result in economics that will incentivize IOCs to invest in some of the country's more challenging projects. The IPC structure is expected to be offered for investment in somewhere between 34 and 74 oil fields. The IPC terms have not been publicly disclosed and remain subject to change. That said, the following potential key features of the IPC framework have been reported in publicly-available sources:

• Joint Venture Structure; Booking of Reserves: While still described as a services contract by Iranian commentators, the new IPC structure also has been described as a joint venture or partnership structure where NIOC or a subsidiary of NIOC would partner with the IOC. It has been reported that, under the IPC structure, foreign investors are expected to be able to book reserves on their balance sheets under some circumstances, even though title to the hydrocarbons produced will not be transferred as they would be under a typical concession contract or production sharing agreement (PSA) structure.

• Participation in Production and Enhanced Oil Recovery Phases: The IPCs will offer much longer terms than were available to foreign investors under the buy-back contracts, lasting through the production phase and potentially through the enhanced oil recovery phase. This more than doubles the time periods offered under the buy-back contracts and provides the IOCs a much greater opportunity for cost recovery than the current buy-back contract structure.

• Compensation: IOCs will be compensated per barrel produced, and the price per barrel and aggregate amount payable will not be fixed. The profit paid per barrel will vary depending on the risks involved and fluctuations in oil prices. The compensation may include an additional risk-reward element in which companies working in very high-risk fields will be paid more per barrel than companies working in low-risk fields.

• Work Program and Budget: The IPC structure is expected to require submission of a work program and budget that will be approved by a joint venture development committee made up of officials from the partner companies and will allow for recovery of related costs. Cost estimates may be changed each year, but changes would be subject to NIOC's approval. If approvals are regularly obtained, this would eliminate one of the key risks with the buy-back contracts, which provided that cost overruns were not recoverable from future production proceeds.

• Local Content; Technology Sharing: Under the IPC, the local content requirement may be 51%. High local content requirements have been challenging for IOCs in other countries with rapidly expanding oil and gas exploration and production industries. In addition, foreign investors will be expected to share technology and management expertise with their Iranian partners.

Timing of Roll-Out of the IPC and Sanctions Relief

While the final proposed terms of the IPC may be approved in Iran in relatively short order, it is expected that investment by IOCs in Iran's upstream oil and gas sector will not begin until well into calendar year 2016 due to the likely timing of sanctions relief under the JCPOA. Until sanctions relief under the JCPOA, IOCs, particularly "US persons" (as defined below), should continue to exercise caution in discussions and negotiations regarding investments in Iran.

Once the Oil Contracts Revision Committee led by Mr. Hosseini has finalized the proposed terms of the IPC, it will be submitted for approval by President Hassan Rouhani's cabinet. Shortly before the JCPOA was signed, Iran announced that it planned to release details about the terms of the IPC and the oil and gas projects available to be contracted at an investment conference in London in late 2015. Iran has delayed the conference, which was scheduled to occur in September 2015, once before, expressing a desire that it occur after the initial sanctions relief becomes effective so that the IOCs can more actively engage in discussions. Iran expects detailed negotiations with IOCs regarding specific fields (once permitted to commence) to take as long as six months.

The JCPOA is only the first step in unwinding the complex global sanctions regimes that restrict investment in the Iranian oil and gas industry. We provide a description of the terms of the JCPOA and the steps required for its implementation here. Assuming the requisite approvals are obtained, sanctions relief will be initiated after the International Atomic Energy Agency (IAEA) verifies that Iran has implemented key nuclear-related measures (Implementation Day). Implementation Day is not a fixed date known today, but may occur in December 2015 or later. Until Implementation Day, the current sanctions regimes remain in effect.

Notwithstanding the deal regarding the JCPOA, “US Persons” are still currently prohibited from entering into executory contracts for Iran-related transactions until US sanctions are lifted after Implementation Day. "US persons" means US nationals, US permanent resident aliens ("Green Card holders"), entities incorporated in the United States, individuals or entities in the United States, or entities established or maintained outside the United States that are owned or controlled by a "US person.” For a "US person" to sign such an executory contract before Implementation Day would be dealing in property or an interest in property involving Iran or a Specially Designated National, which is prohibited by current US regulations as applicable to "US persons.” The current Iran sanctions regulations expressly state that such executory contracts are property or an interest in property because they involve "contracts of any nature whatsoever, and any other property, real, personal, or mixed, tangible or intangible, or interest or interests therein, present, future, or contingent."

It appears that non-"US persons" (as defined above) having no US nexus (e.g., not incorporated in the United States or owned or controlled by a “US person”), not acting in or through the United States or a "US person" and otherwise not generally subject to US jurisdiction may enter into executory contracts with Iran without risk of exposure of an OFAC enforcement case for so doing. Even in these cases, potential non-“US person” investors in Iran are well advised to seek clearance from the relevant regulators that these contracts do not violate United Nations, European Union, or other non-US sanctions.

Summary

The signing of the JCPOA may usher in a new era of major international investment in the Iranian oil and gas industry by IOCs. While the terms of the IPC are not yet completed and remain subject to further approval, initial reports indicate that the IPC is likely to be substantially more beneficial to IOCs than the current buy-back contracting structure and has the potential to allow them to book the applicable reserves, which may generate increased interest in investment in the country. Assuming that the JCPOA is approved and the IAEA verifies that Iran has implemented key nuclear-related measures, investment could commence as early as calendar year 2016.