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Iran: Rouhani re-election crucial, but no silver bullet, for oil and gas companies

Iran: Rouhani re-election crucial, but no silver bullet, for oil and gas companies

May 19 marks another crucial date in the calendar of international oil companies entering Iran’s oil and gas sector.

Before committing to any investments, most companies will want to see Rouhani affirmed as president for a second term. This caution is understandable. The 2015 nuclear agreement has so far survived the election of Donald Trump as US president, but could in all likelihood not survive the removal of one of its key architects and proponents.

All of the indicators point toward a Rouhani victory. Counting in his favour are: the historic record of incumbent presidents; a strong anti-hardline current in last year’s parliamentary election; and what appears to be a successful defence of the broad support base that secured him the presidency in 2013.

A second Rouhani term would almost certainly pave the way for further foreign investment in Iran’s oil and gas sector. The main challenges facing foreign companies will, however, remain the same: the threat posed by US sanctions and uncertainty over the resilience of the nuclear agreement.

Foreign companies can do little about these obstacles. Their exposure to the risks posed by them, however, will depend on one key investment decision in particular: choosing which of the pre-qualified local companies to work with.

Peeling back the layers of sanctions risk.

Foreign companies are required to work with at least one local company on upstream projects in Iran. But before considering which company they will have to navigate several layers of sanctions risk.

At the highest level, companies face well-known barriers such as the reluctance among foreign banks to do business with Iran. While sanctions on Iran’s banking sector have been lifted, years of isolation during the height of the sanctions regime have left the sector lagging behind in key areas such as compliance, accounting and transparency. Coupled with uncertainty over how US courts will interpret and enforce sanctions, this has led most banks to conclude that the risk of carrying out transactions with Iran is still too high.

Number of US blacklisted Iranian entities by sector/category

Source: US Treasury Department; Verisk Maplecroft.

Despite these challenges, foreign oil and gas companies are confident that the difficulties posed by Iran’s banking system can be overcome. More than a dozen foreign companies have signed agreements for Iranian upstream projects, and so far 29 foreign companies have prequalified to participate in Iran’s upstream sector.

For these companies, understanding the relative risk of running foul of US sanctions when operating in Iran’s oil and gas sector will be crucial. The stakes are high, as even inadvertently doing business with one of the Iranian entities placed on the US Treasury Department’s Specially Designated Nationals list could result in exclusion from the US financial system or billion-dollar fines.

As illustrated by the chart above, the number of blacklisted entities in the oil and gas sector is higher than in other sectors that attract interest from foreign investors, such as mining, consumer goods and auto-manufacturing, but much lower than in construction and engineering.

Avoiding agreements with high-risk local companies will be crucial

At the more granular level, choosing a local partner will not just be a case of going through the list of local companies pre-qualified by the Iranian National Oil Company (NIOC) and picking one that is not blacklisted by the US.

While most foreign companies will stay clear of the Revolutionary Guard-owned Khatam ol-Anbiya, the picture is less clear-cut for the other 10 pre-qualified companies. So far, 11 local companies have been approved by NIOC, with at least another two likely to be announced soon.

The pre-qualified local companies are a mix of private, semi-private and state-owned companies. Analysis carried out by Verisk Maplecroft shows that there is significant variation between these in terms of their upstream credentials, financial capacity, risk management proficiency, and exposure to sanctions risks.

Most importantly, the extent to which the companies are linked to the IRGC and Iran’s Supreme Leader, Ayatollah Ali Khamenei, varies dramatically. Understanding the nature of these links will be an essential part of assessing the vulnerability of potential local partners to being targeted by the US in the likely event of a further expansion of the list of blacklisted entities.

Washington has already illustrated its willingness to expand the blacklist, with 25 new entities added in February in response to Iranian missile tests. Verisk Maplecroft has classified half of the pre-qualified local companies as highly exposed to sanctions risks. Selecting a local partner that has both a strong upstream track record and low exposure to sanctions risks will be extremely important.

Crucial investment decisions await after election

There is no doubt which of the presidential candidates foreign oil companies favour. Although unlikely, defeat for Rouhani would at the very least act as a brake on foreign investment and could ultimately spell the end of the nuclear agreement.

The complexity of remaining US sanctions and the volatility of US-Iran relations also mean that the decision whether to enter Iran at all will still not be an easy one even if Rouhani is re-elected. Given Iran’s potential, many will. Although high levels of uncertainty come with the territory, the onus will be on the foreign companies themselves to take active steps to minimise their exposure to sanctions.

It will not be an easy decision, but following the election on May 19, one of the first items on the agenda will be to find the right local company to work with.

By: Torbjorn Soltvedt, Principal Analyst, MENA

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