New Oil Disorder
Purge in Iran oil sector would rob industry from its experienced decision-makers

August 8, 2005
iranian.com

Iran’s president Mahmoud Ahmadinejad has promised to make sweeping changes in the management of Iran’s state-run oil industry. During his presidential campaign he lambasted the management of this sector and claimed that Iranian oil wealth was controlled by a single powerful family.

" I will cut the hands of the mafias of power and factions who have a grasp on our oil; I stake my life on this... People must see their share of oil money in their daily lives," he said during the election race. Taking him at his word, we should therefore expect major changes in the offing for the management of an industry which makes Iran the fourth leading exporter of oil in the world.

The relationship with international oil companies is also bound to alter. Ahmadinejad has remarked that “The atmosphere ruling over our deals, production and exports is not clear. We should clarify it.” Iranian oil being of such a monumental importance for the country’s economic and political future, the new president’s comments cannot be treated lightly. Moreover, Ahmadinejad would not have made those comments without the backing of the supreme leader, of whom he is a zealous follower, and who has the last word on important issues.

In order to understand the implications of Ahmadinejad’s remarks for the future of the oil industry in Iran, I needed to talk to a person who was thoroughly familiar with the Iranian oil sector. I reckoned that the best person who could enlighten me on this topic was Dr. Parviz Mina, the international petroleum consultant, a former member of the Board of Directors and Managing Director of International Affairs of the National Iranian Oil Company.

I had been introduced to him before and had met him on several occasions at various Iranian events in Paris. He is a straight arrow, well deserving his high reputation for excellence and integrity.

I called him and asked for an interview. He graciously accepted. The following is the result thereof:

The newly elected president in Iran has promised sweeping changes in the Iranian oil sector. He says he will eradicate the mafias of power who have kept the oil industry in their grasp. What do you think is the implication of these statements for the future of the oil industry in Iran?

If Ahmadinejad sincerely believes that the Iranian oil industry is plagued with mafia type corruption, he has no alternative other than to get rid of the entire management. This means that those with years of experience will be replaced by novices who are unable to make expert decisions. After the 1979 Revolution, three echelons of management in the National Iranian Oil Company including directors and heads of divisions and departments were removed.

This move had severe consequences for the country’s oil industry. If Mahmoud Ahmadinejad would embark on another purge and get rid of what he calls ‘mafias of power’ he will deprive the oil sector of people who, irrespective of their ethical standing have gained invaluable experience over the past two decades. This cannot be but disastrous for the Iranian oil industry.

The dilemma he faces is that defenestrating an experienced, albeit corrupt management, who are the people he is going to replace them with? Where is he going to come up with a new team? What kind of capability could such a new management offer to deal with highly complex issues? There can be no getting away from the fact that the oil industry requires expert knowledge in all its various domains.

It would take a long time for the new cadre to learn the skills and gain the requisite knowledge and experience. In the meanwhile, one can only expect that chaos would prevail and the power of effective decision-making be severely curtailed. Corruption has become endemic in the Islamic regime and if it is to be cured, it has to be eradicated from the very top level of the clerical establishment that governs Iran.

The present cadre has seen to it that the agreements with international oil companies lack any semblance of transparency. How is the new team going to deal with these recondite, shady deals? The anarchy that would ensue can only create further uncertainty and frighten away international investors. If such a scenario comes to pass, we can expect a period of very costly stagnation.

The new president Mahmoud Ahmadinejad has made a promise to distribute the oil revenue amongst the population and make people feel its benefits in their daily lives. How in your opinion will he be able to do such a thing? What would the impact be of such a move on the overall national economy?

The fact of the matter is that the oil revenue which has exceeded 500 billion dollars since the revolution has not been properly invested in infrastructure, economic and industrial development, betterment of social welfare and the well-being of the Iranian population. One can expect the new president making a move in the direction of increasing the subsidies particularly on petroleum products. The inevitable effect of introducing such a policy would be the skyrocketing of consumption.

Together with a decrease in international investment that I mentioned earlier and a reduction in production capacity, this increased internal consumption would only erode the volume of export and thus the national oil revenue. According to the statements by the current oil minister, the Iranian production capacity is diminishing by 7 to 8 percent a year while internal consumption is increasing by 6 to 7 percent a year. If the country’s ability to export oil is impaired, that can only translate into a lowering of the standard of living for Iranians.

Belligerence on the issue of enriching uranium can also create difficulties. If Europeans are not able to secure the concessions they seek from the Islamic Republic on the nuclear programme, the dispute would be referred to the United Nations Security Council and the possibility of sanctions would loom larger on the horizon. Sanctions more than in any other sector would hurt the Iranian oil industry which relies heavily on Europe and the United States for its technology.

The purge of the management that we discussed earlier would rob the oil industry from its experienced decision-makers and seasoned negotiators on the one hand, and sanctions would debilitate the industry and contribute to economic decline and great financial loss on the other. In other words, Ahmadinejad’s plan, if implemented can only lead to a more equitable distribution of poverty and economic decline.

Since the 1979 revolution two massive bureaucracies, one in the Ministry of Oil and the other in the National Iranian Oil Company have been growing side by side creating massive duplication and contributing to a lack of transparency and accountability. Do you believe that Ahmadinejad could tackle this problem?

Before the revolution there was no Ministry of Oil. The National Iranian Oil Company as the sole agent of the government ran the entire industry. The Islamic Republic created the Ministry of Oil and put the NIOC under its tutelage. For fifteen years the NIOC was left without even a managing director.

The Minister of Oil appointed seven deputies in charge of supervising the activities of various managers in the National Oil Company. In reality all the major decisions were made by these deputies who, by the way had no expertise. Their only credential was commitment to the Islamic regime and a connection to one of the country’s centers of power. Accordingly, all the prerogative and authority was gradually taken away from the NIOC and given to the Ministry of Oil.

Ahmadinejad has said that he wants to put a stop to duplication and introduce measures that ensure transparency. This would prove as difficult as putting the genie back into the bottle. Bijan Zanganeh, from the time he has been appointed as Islamic Republic’s oil minister has created close to one hundred affiliated and subsidiary companies. All the projects are divided between these companies.

As an example previously all the exploration, drilling and production efforts were concentrated under one director in the NIOC, now there are ten to twelve companies each making decisions and having a finger in the pie. Before the revolution we had in total 54,000 employees working for the Iranian oil industry, 34,000 were rank and file and 20,000 professional staff. Today this number has reached the colossal figure of over 180,000. What is Mahmoud Ahmadinejad planning to do with this monstrosity?

This seems like total anarchy. Were there no regulatory provisions to prevent such an outcome?

This is just it. The haphazard decision-making was due to having neither a statute for NIOC, nor a petroleum law to govern the behaviour of the players and setting clear instructions regarding various interactions. In 1957 after the nationalization of oil, the first Petroleum Act was put together and was passed by the parliament.

In 1974 a new law came into effect and took into consideration the latest developments in the industry and the relationship with international partners. Since the beginning of the revolution, the country’s Petroleum Act as well as NIOC statute has been discarded. The Islamic Republic has also failed to create a statute or Petroleum Act of its own to replace the old one. Decisions are made on the spur of the moment, without any consistency or regard for a long term national interest.

Mr. Kamal Daneshyar the chairman of the parliament's energy commission, anticipating "total change" in the structure of the oil sector and "fundamental" changes in contracts has also criticized the "buy-back" system, under which Iran gives payment in kind to oil companies that develop its oilfields, as "costly and damaging to oil reserves". Could you please elaborate on what the buy-back system first of all is, and then tell us whether it makes economic sense for Iran to engage in this mode of contract?

The buy-back system is an arbitrary scheme which was designed after the revolution to circumvent constitutional constraints on foreign investment as well as parliamentary limitations on external debts. The Islamic regime more preoccupied with empty slogans than genuine national interest put this system into place in order to supposedly disallow any foreign equity and ownership. Well, this was much revolutionary ado about nothing.

In 1974 NIOC drafted a new and innovative petroleum law which was approved by the council of ministers and enacted by the parliament. This new law envisaged that exploration and production agreement with foreign oil companies could only be concluded on the basis of “Risk Service Contract” under which the contractor had no right to the reserves discovered or to the production from the field developed. The model agreement was so structured that it did not contain any of the disadvantages inherent in the buy-back system and thus safeguarded Iran’s long term interests.

Although the foreign company was acting as a contractor working for the NIOC, it was obligated to conduct exploration operation entirely at its own risk. If the exploration was successful and oil was discovered, then the company was obligated to development the oil field on behalf and under the supervision and control of NIOC. Once commercial production was commenced, the contract would have expired and NIOC would have taken over the entire operation.

NIOC was in charge of the production, and for a certain stipulated duration not exceeding fifteen years would sell 50 percent of the production to the aforesaid company with a discount so that the company would be able to recover its original investment and gain a reasonable return on investment. This system provided the most beneficial means for Iranians to harness the capacity of their oil fields.

After the Islamic regime took over, the real objective was the overthrow of the old system in all its aspects. Change was instituted for the sake of change. Based on this vengeful policy the buy-back system came into existence. Under the buy-back agreements despite the fact that the international oil companies are not exposed to any exploration risks and the buy-back contacts are completely risk free involving development work in a relatively simple environment, yet they are guaranteed a predetermined fixed remuneration equivalent to 18 to 20 percent rate of return on their capital investment.

The duration of the buy-back contract is very short thus aligning the interests of the contractor and NIOC is difficult. While the buy-back contract is a fixed rate of return contract, it does not encourage or reward the contractor to improve project return for the benefit of both the contractor and NIOC. After the contractor has recovered all its costs and remuneration, it has no interest in problems that may confront NIOC in the later life of the project. Transfer of technology and management skill is not encouraged under this type of contract.

Furthermore, prior to the Revolution, oil contracts were required to be approved by parliament. The cabinet and parliament were kept abreast of the details of the deals. Any Iranian citizen was legally entitled to have access to the text of these contracts. Today, Iranian members of parliament are complaining bitterly about being kept entirely in the dark about the terms of these contracts.

All these problems are direct results of throwing out the oil law and resorting to arbitrary decision-making. It should be added that the existence of clear rules and regulations not only is to the benefit of the oil producing country, but also is reassuring for the international investor. It puts an end to uncertainty and creates an atmosphere of reliability and trust.

R.B: Dr. Mina thank you very much for this interview.