Legal and regulatory framework applicable to operate an oil business in Iran.
In brief, The Iranian oil and gas legal framework contains a series of critical pieces of legislation, including:
- The Iranian constitution law 1979,
- The Petroleum Act 1987, edited in 2011, addresses the ownership of petroleum resources and the extent of rights and powers entrusted to The Ministry of Oil.
- The Law on the duties and powers of the Ministry of Petroleum 2012,
- the Six Development Plan outlining Iran’s economic policy 2017-2022, and
- The General Terms, Structure, and Model of the Iran Petroleum Contract ( IPC ) or the IPC Resolution 2016, which provides the legal framework for the Iran Petroleum Contract ( IPC )
Iranian Petroleum Contract (IPC) is the latest oil and gas upstream contract framework, which is a combination of Buy-Back (former upstream contract of Iran) and Product Sharing Contract (PSC). The new model, approved by the parliament in 2016, is considered a modern oil and gas regime, and it is similar to Iraq’s Technical Service Contract.
According to the IPC Resolution. (Article 2 a), there are three different categories of IPC contracts:
- Exploration, development, and production contracts ( IPC E& P )
- Contracts for the development of explored green fields ( Discovered fields ) and reservoirs ( IPC D& P ), and
- Agreements for improving recovery rates for existing fields ( IPC IOR/EOR )
Required steps to operate an oil business in Iran by a foreign entity
- Principle of Public Ownership and Risk Service Contracts: Considering the Iranian oil and gas regulatory regime, the main point that an International Oil Company (IOC) should consider is that the state sovereignty considerations prevent foreign entities from owning the oil reserves. The Ministry of Petroleum is tasked with exercising the principle of public ownership and national sovereignty over oil and gas resources in Iran. The Ministry has authorized the National Iranian Oil Company (NIOC) to enter into upstream oil and gas projects on behalf of the Iranian nation.
Because of the above principle, foreign direct investment by foreign entities in oil and gas upstream activities is prohibited. However, foreign entities can invest in such areas with contractual agreements. IOCs can enter the Iranian oil market by signing Risk service contracts with NIOC.
- Winning the IPC Contract: As the NIOC is a wholly government-owned company, all contracts signed by the same is subject to the Tender Act 2005. However, the Tender Act allows certain concerned companies, organizations, and ministers to abandon tender procedures in exceptional cases, providing that they can bring an acceptable justification for that particular case. Prior approval from the relevant authority should be obtained before leaving the tender procedures.
Recently, the Ministry of Petroleum has added an exception provision to the Act of Duties and Authorities of the Petroleum Ministry 2012. The provision provides that, providing that, subject to approval by the Ministry of Petroleum and by complying with the NIOC’s transaction rules, the conclusion of contracts relating to exploration, development, production, repair, and maintenance of the joint oil and gas fields are excluded from the scope of the Tender Act.
The contractor is selected “in the course of a legitimate process, “as defined by the Ministry of Petroleum. The foreign entity does not have to incorporate any company in Iran. If more than one company decides to conclude the IPC in Iran, they can operate in Iran as either a consortium or a joint venture.
- The requirement to establish a Joint venture with an Iranian entity: According to Article 4 ( a ) of the IPC Resolution, the foreign investor ( contractor ) is required to have an Iranian entity which should be an Iranian Exploration and Production Company ( E&P company ), as its partner in signing the IPC. By establishing a joint venture company (incorporative or non-incorporative) between the IOC and a local E&P company, the IOC will give the local company access to the new technology, know-how, and training necessary to manage future petroleum projects. IOCs must choose the Iranian E&P companies only among those whose qualifications are approved by NIOC based on preannounced standards of the Ministry of Petroleum.
Suppose IOC wishes to consider an Iranian E&P company not mentioned in the NIOC list. They can suggest such a company to NIOC to be evaluated and approved based on their preannounced criteria.
- Joint Management Committee (JMC): A management committee is a body established under the IPC contract, composed of the parties’ representatives in the contract. JMC includes equal members of NIOC and contractors (IOC) with equal voting rights. JMC will supervise all the project operations and decide on the technical, financial, and legal matters of IPC within the contract framework. It also makes decisions on the annual work program and budget and the assignment of subcontractors.
According to Article 8 (d) of the IPC Resolution, the IOC is responsible for implementing operations within an approved annual program and budget approved by JMC. The NIOC authority should then confirm such a decision. In most cases, however, the NIOC’s general manager will delegate their authority to their representative(s) in each contract or project to approve the decision of JMC.
- Annual work program and budget plan: After the exploration phase and during the development and production phases, the contractor should prepare an annual work program and budget and propose such a plan to the NIOC for approval within the time frame determined in the contract. Once NIOC approves the program, the contractor should carry out petroleum operations based on such an annual work program and budget. The contractor is only authorized to spend the approved budget plus the permitted uplift and should avoid any deviation from that.
- Obligation to transfer managing positions, technology, and knowledge and training programs: The IOC as the contractor/ operator of the IPC, should share the executive management positions with the Iranian nationals to facilitate the transfer of know-how and managerial skills to the Iranian entity. A contractor will be required to prepare a training program for Iranian partners in the form of an annex to the IPC. In addition, the IOC is obliged to submit plans for the transfer and the development of technology and knowledge as part of its annual operational and financial plan.
- Statutory Local Content Requirement: The IOC is also obliged to maximize the use of local products and services. According to Article 4(b ) of IPC Resolution and the “Law of Maximum help of Iranian Technician, Engineering, Manufacturing, Industrial, and Executive Capability for Implementation of Projects,” at least %51 of the value of the project, excluding immovable properties, must be allocated to services and goods provided from inside Iran.
- Human Resource: Per Article 4(c) of the IPC Resolution, the contractor should employ Iranian nationals to execute the contract and submit comprehensive training plans to improve the quality of national Iranian human resources and invest in training and research programs.
- Minimum Production Level: The contractor must meet a certain minimum production level, which is identified in the field development plan (submitted by the IOC and approved by the NIOC).
- Environmental and safety regulations: The operator must perform environmental evaluation studies and comply with the relevant safety, healthcare, environment, and social rules.
Legal risks that foreign companies should be aware of before considering doing business in Iran
- Legal Complexity: Although the Iranian government has attempted to facilitate foreign business in Iran, mainly by approving Foreign Investment Promotion and Protection Act 2002 (FIPPA), However, some regulations, such as tax and employment regulations, can still be complex and sometimes uncertain, for the foreign entities entering the Iranian market.
- Bureaucracy: There are several stages and bureaucratic hurdles foreign entities might face while setting up a business in Iran. However, using Information and Communication Technology in many government procedures has made it easier for foreign companies to obtain approvals and licenses for conducting business in Iran.
Moreover, corruption and bribery are other issues foreign companies may face in Iran’s administrative procedures.
- Risks and challenges associated with the oil business
- According to the Iranian Petroleum regulations, the foreign entity should have an Iranian entity as its partner in signing an IPC contract with NIOC. Therefore, foreign contractors will need to be careful to make sure that they conduct sufficient and comprehensive due diligence on any potential Iranian partner. An adequate financial, technical, tax, reputation, and legal, due diligence is advised to ensure that the Iranian partner has indeed the capabilities to perform its obligations.
- Another matter discussed earlier is that, according to the IPC resolution, the IOC as the contractor/ operator of the IPC, should transfer the executive management positions to the Iranian nationals to facilitate the transfer of know-how and managerial skills to the Iranian entity. Such obligation can be associated with some production risks in the later stages of the contract. Therefore foreign companies should train the Iranian
partner very well and make sure they have appropriate knowledge at the later stage of the project.
- The contractor /operator must meet the minimum production level addressed in the IPC contract; however, there are no apparent consequences discussed in the Iranian petroleum legal framework in the event of failing this obligation. Therefore, the foreign entity should clarify the penalties under the contract to prevent the risk associated with this matter.
- According to the IPC Resolution, there will be no cost recovery and fee payment until the production phase. In addition, all the risks and costs will be on the contractor if it fails to explore an oil field.
- Please be advised that, per Article 3(b) of the IPC Resolution, the Iranian government, the Central Bank of Iran, and any state bank will not guarantee any commitment of NIOC under IPC contracts.
- Governing Law and dispute resolution: The IPC Resolution introduces Iranian Law as the governing Law for interpreting all terms and definitions, but it does not discuss the dispute resolution mechanism applied to the IPC contracts. However, any option regarding the dispute resolution method negotiated in the contract should comply with Iranian Law.
For instance, it is noteworthy that, per Article 139 of Iran Constitution law, any arbitration clause included in the contracts that concern government or public assets are required to be approved by the Iranian Parliament / The Council of Ministers.