Oil Laws and Changing Petroleum Legal Regimes

Iran has adopted three Petroleum Acts; in 1957, 1974 and 1987. Until 1951, when the Iranian parliament nationalised the oil industry, no legislative framework existed to regulate the negotiating process between international oil companies (IOCs) and the Iran's government. Contracts were individually validated in the Iranian Parliament once an agreement had been reached; but due to the absence of any binding legal framework, Iran's rulers faced no restrictions on the types of contracts or the terms and conditions they could grant to foreign individuals or companies. Until 1957, when Iran implemented its first Petroleum Act, IOCs were able to take advantage of the relative lawlessness of Iran's petroleum sector, reaping substantial profits from Iran's petroleum reserves and contributing to a massive loss in potential revenue for the government.

=Petroleum Acts=

Petroleum Act of 1957
A major objective of the 1957 Petroleum Act was the rapid exploration and extraction of petroleum throughout the country and continental shelf, and the expansion of downstream activities such as refining, transportation, and sale of petroleum products. The Act vested in the National Iranian Oil Company (NIOC) definite functions and responsibilities as the owner and authority for all national oil resources. To this end, the NIOC was permitted to enter into contractual relationships with entities, Iranian or foreign, possessing the requisite technical and financial competence. The resulting joint companies, which ran all the activities to explore, exploit, produce and operate in a specific area, were so-called 25-75 contracts, based on the simultaneous negotiation of a contract between the NIOC and Italian oil firm Eni, in which the foreign partner received 25 percent of final revenues. Iran's 1957 petroleum law forbade any kind of partnership consisting only of foreigners that led to ownership of petroleum resources.

The 1957 law also charged the NIOC with dividing the country into petroleum districts, and to conserve at all times at least one third of the total exploitable areas, including the continental shelf, as national reserves.

Petroleum Act of 1974
Sharing agreements, permitted under the 1957 law, were forbidden under the Petroleum Law of 1974, which when passed rendered the 1957 law void. The 1974 law was in direct response to the oil shock of 1973, the rapid price increase (from about $3 per barrel to $12 in just a few months) that resulted from the Arab oil embargo on the US in late 1973. The 1973 oil shock improved the Iranian government's bargaining position, and it used the 1974 law to establish a contractual regime characterised by higher government share of revenues and maximum control. The 1974 law established state ownership of oil and again declared Iran's oil industry national, this time in a true sense, with production sharing agreements no longer possible. The NIOC was permitted to attract investment only through service contracts, by which foreign companies are merely contractors which receive remuneration for any services they provide, without gaining ownership of any oil. This contrasts mechanisms previously used in Iran, such as concessions and production sharing agreements. For the first time in Iran, a systematic and competitive bidding system was devised, including specific provisions as to remunerations.

Petroleum Act of 1987
The Petroleum Act of 1987, ratified on 1 October of that year, cancelled all foreign investments in Iran's petroleum industry. Notably, wording in the 1987 law replaced the NIOC, which in all previous laws had been held as the sole authority over all petroleum industry activities, with the Ministry of Petroleum, which had been established after the 1979 revolution. However, the NIOC and all its subsidiaries continued to deal with all petroleum-related activities of Iran, under the nominal auspices of the Ministry of Petroleum.

The significance of the 1987 law was that it outlawed foreign investment completely, rendering Iran's petroleum industry independent from any foreign assistance or participation. This move can be traced, according to some observers such as Nima Shahri of The China and Eurasia Forum Quarterly, to intensely nationalist feelings during the Iran-Iraq war of 1980-1988, in the midst of which the 1987 law was written. Pursuant to the law, the only investment in the petroleum industry could be made by the state, coming from its annual budget. Since this was very difficult to achieve, the state entered into pure service contracts with international entities, through which the foreign companies provided services without investment, in return for a fixed remuneration generated by the sale of extracted oil. In a pure service contract, all risk is borne by the state, and is characteristic of a situation in which the state has substantial capital but seeks outside expertise and/or technology.

=Easing of foreign investment ban since 1994= The pessimistic attitude towards foreign investment reflected in the 1987 law did not promote the further development of Iran's oil industry, and the Budget Act of 1994 provided a measure of easing on the strict ban on foreign investment prescribed in the 1987 law. The 1994 act introduced the buy-back contract as a legitimate means of attracting investment. Buy-back agreements are risk service contracts, in which an international contractor searches for oil at its own risk and expense. Note 29 of the 1994 Budget Act allowed a maximum of $3.5 billion of foreign investment, provided that it did not create any commitment for the government or state banks. Budget Acts validating the buy-back mechanism continued until 1999, when separate legislation validated Buy-back agreements as the main upstream oil and gas contractual mechanism of the country.

In many ways, however, the buy-back mechanism has not been a success. Buy-back contracts are not particularly investor-friendly, as they do not provide as much certainty as the alternatives, e.g. Production Sharing Contracts (PSAs). Buy-back contracts' failure to meet the country’s critical investment needs, compounded with other issues such as US sanctions and increasing domestic consumption, mean a change to make the current contractual mechanisms more favorable to foreign investment is increasingly necessary and likely.

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