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Jan 01, 2016

Iran Nuclear Deal: The Road Ahead Under JCPOA

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On July 14, 2015, the P5+1 (the US, the UK, France, China and Russia, plus Germany), along with the European Union (EU) and Iran, reached an historic agreement curbing Iran’s nuclear program in exchange for sanctions relief. The Joint Comprehensive Plan of Action (JCPOA) lays out a framework for lifting certain nuclear-related United Nations, EU and US sanctions against Iran. In exchange, Iran has agreed to considerably scale back its nuclear program and never to “seek, develop or acquire any nuclear weapons,” a promise that will be verified by detailed inspections and monitoring by the International Atomic Energy Agency (IAEA). On October 18, 2015, the JCPOA was formally adopted, setting in motion a 10-year timeline under which sanctions relief will be phased in as Iran takes verified steps to fulfill its obligations.

On the horizon for the JCPOA is Implementation Day, expected in early to mid-2016, which will mark the beginning of the phased lifting of sanctions against Iran. For companies around the world looking to capitalize on business opportunities, it will be necessary to carefully assess the evolving sanctions environment and understand the risks inherent in venturing into the Iranian market. The first round of sanctions relief under the JCPOA will commence on Implementation Day, and updated guidance is expected to be issued by the EU and the US Department of Treasury’s Office of Foreign Asset Control (OFAC).

JCPOA Timeline

Key dates under the JCPOA timeline:

Adoption Day - October 18, 2015 JCPOA formally comes into effect EU: Begins to adopt regulations lifting many of its nuclear-related sanctions targeting Iran, to be effective on Implementation Day US: President has issued sanction waivers in relation to so-called secondary sanctions, to be effective on Implementation Day
Implementation Day (Expected early 2016) UN, EU: Most nuclear-related sanctions lifted; human rights-related sanctions remain in place, as do certain asset freezes US: Most secondary sanctions lifted; primary sanctions remain in force subject to limited licenses granted by OFAC to non-US entities that are owned or controlled by a US person to engage in activities with Iran that are consistent with the JCPOA
Transition Day (No later than October 18, 2023) UN, EU: Lift remaining nuclear-related sanctions US: Formally terminates secondary sanctions which, since Implementation Day, ceased to be applied
Termination Day (No later than October 18, 2030) UN, EU: Termination of all remaining EU sanctions; passing of UN Security Council resolution terminating Resolution 2231 (ending the UN involvement) US: No additional commitments

 

Prior to sanctions relief from Implementation Day, Iran must take a number of steps relating to its nuclear program, including reducing its enriched uranium stockpile, dismantling large parts of its nuclear infrastructure and completing the IAEA’s roadmap for clarifying past and present outstanding issues regarding Iran’s nuclear program. The roadmap report was issued by the Director General of the IAEA on December 2, 2015, and on December 15 the IAEA Board of Governors in a special session voted to adopt a new resolution closing the roadmap process and focusing the attention of the IAEA on implementing the JCPOA.

UN/EU and US Sanctions Relief Under JCPOA

UN/EU Sanctions Relief

On Implementation Day, the UN and EU will lift a range of sanctions:

  • The UN Security Council (UN SC) will terminate all past resolutions relating to Iran’s nuclear program and simultaneously suspend sanctions as long as the conditions of the JCPOA are met (Resolution 2231). These new restrictions generally entail UN SC oversight of UN members’ planned trade with Iran in military or nuclear-related technology through a procurement working group.
  • The EU will no longer prohibit EU persons from participating in Iran-related transactions, such as the transfer of funds between EU persons and entities and Iranian persons and entities; import and export of Iranian oil; and investment in the oil, gas and petrochemical sectors.

Both the UN and EU regimes will grant EU companies, banks and investors substantially greater access to the Iranian market than US companies and their foreign subsidiaries. However, companies subject to both EU and US rules may face difficult compliance issues.

US Sanctions Relief

The US currently imposes both primary and secondary nuclear-related sanctions against Iran:

  • Primary sanctions are those applying to US persons, as well as non-US entities that are owned or controlled by a US person, non-US persons who cause US persons to violate sanctions maintained by OFAC and persons involved in transferring US-regulated goods or technology to Iran.
  • Secondary sanctions generally apply to non-US persons and are intended to work by threatening non-US companies with the possibility of, among other things, being designated themselves as sanctions targets under US rules if they engage in transactions prohibited under the US secondary sanctions regime, even if those transactions take place entirely outside of US jurisdiction.

Under JCPOA, US primary sanctions remain largely unchanged. The US will not allow US persons, such as parent companies, to facilitate activity that US persons could not do themselves. The US financial system will remain off limits for transactions involving Iran. OFAC will also be able to license certain exports of commercial aircraft and related parts, and the import of certain foodstuffs and carpets.

In contrast, most US secondary sanctions will be waived on Implementation Day. Secondary sanctions that are to be lifted include, in relation to energy and petrochemicals, sanctions that to date have targeted persons engaged with Iran in transactions involving petroleum, petroleum products, refined petroleum products, petrochemical products or natural gas and liquefied natural gas, as well as the provision of goods and services related to supporting or facilitating those transactions.

In addition to limited primary and general secondary sanctions relief, the US will also begin to delist certain individuals from the Specially Designated Nations List, among others. This will allow non-US individuals to conduct transactions with these individuals. However, companies should be aware that certain individuals delisted from nuclear-related sanctions will remain subject to other US sanctions, such as those relating to terrorism and human rights violations.

Opportunities

Overview of Oil and Gas Opportunities in the Post-Sanction Environment

According to a 2015 British Petroleum Report, Iran has 18.2% of the world’s proven gas reserves and 9.3% of the world’s proven oil reserves. When sanctions against Iran are lifted, increased production and sales of gas and crude oil will present a source of significant revenue for Iran. Serious natural gas development is expected in the region as well. For example, Qatar’s successes in the region have been based on reserves in the North Field (known as South Pars in Iran) which is shared with Iran.

Upstream opportunities are critical to the long-term viability of Iran’s plan to play an important role in the global energy market. The National Iranian Oil Company (NIOC) in October announced its plan to introduce over 50 new oil projects immediately after the lifting of sanctions, increase oil production by 500,000 barrels per day within months, and return to its pre-sanction capacity of four million barrels per day. To achieve this goal, Iran will likely lean heavily on foreign investments.

Downstream projects announced by the Ministry of Petroleum include re-launching the development LNG liquefaction projects; terminal and oil tanks at Jask, Lavan and Siri; a pipeline from Goreh in Bushehr to Jask; and the Bahregan Oil Terminal.

The NOIC and Its Related and Subsidiary Companies

The petrochemical industry in Iran is controlled by the Ministry of Petroleum (MOP). The MOP controls the exploration, extraction, exploitation, distribution and exportation of crude oil and oil products, as well as the licensing for importing the same. Under the MOP are four major subsidiaries: the NIOC, the National Iranian Gas Company (NIGC), the National Petrochemical Company (NPC) and the National Iranian Oil Refining and Distribution Company (NIORDC). Each subsidiary is charged with a different mandate, and each has a further set of subsidiaries enabling it to carry out its obligations.

Under this system, the NIOC is responsible for all oil and gas exploration, production, refining and transportation. The Pars Oil and Gas Company (POGC) is a subsidiary of the NIOC, which is mandated to develop the South Pars gas field and North Pars gas field. Under this mandate, the POGC is responsible for awarding the contracts for different phases of development. The Petroleum Engineering and Development Company (PEDEC), also a subsidiary of the NIOC, is responsible for the buy-back projects under operation.

The NIGC is responsible for the treatment, transmission and delivery of natural gas to the domestic, industrial and commercial sectors and power plants. Transferred to NIGC’s control in 2010 is the National Iranian Gas Export Company (NIGEC), which supervises all gas pipeline and LNG projects. Also under the NIGC are several development, storage and transmission subsidiaries.

The NPC is responsible for all petrochemical production, distribution and exportation. Output capacity of the NPC is expected to double from 2010 levels after sanctions relief. Finally, the NIORC handles oil refining and transportation, with some overlap of NIOC.

The Iranian Petroleum Regime

The Iranian constitution prohibits foreign persons from owning oil and gas reserves, as all rights in oil and gas are vested exclusively in the NIOC. Only the NIOC can explore, extract, transport and export crude oil, natural gas and LNG.

To exploit its resources, the NIOC has traditionally entered into long-term contracts on a “buy-back” basis. Buy-back contracts are arranged such that the contractor funds all of the investment and then receives remuneration from the NIOC in the form of an allocated production share. After a set number of years, the contract is considered complete and the NIOC owns the facility outright. In 2007, the scheme was altered to allow contracts to extend for as long as 20 years. This system was the primary means by which Iran attracted foreign investment.

However, the model was widely criticized by international oil companies (IOCs) for low rates of return, inflexible terms and short-term involvement of contractors in projects. In an effort to attract necessary capital and technology, NIOC undertook wide-ranging review, headed by a restructuring committee, which engaged in consultation with IOCs to develop a more investor-friendly regime. According to NIOC, however, “The key issue is that the reserves in the ground remain with the state, which is exactly in line with the term’s production sharing agreements ─ and crucially in line with the Iranian constitution.”

After much anticipation, a recent two-day conference in Tehran introduced the new Iran Petroleum Contract (IPC). Although full and final details are still to be released, the conference did introduce 52 projects, including 14 exploration and development blocks, along with major onshore and offshore fields such as South Azadegan and the North Pars gas field. The exact date of the tenders’ release will reportedly depend on feedback from IOCs at the Tehran summit, but there are hopes to finalize the contracts by the end of next year.

The IPC sets the basic structure for all future petroleum contracts with the State of Iran. It was passed under the Petroleum Act as a Cabinet Resolution. However, as the Iranian constitution requires the Iranian parliament to approve international agreements, political sensitivities will still need to be considered. It has been described as a “risk service contract,” which is designed to spread investment risk on a sliding scale for a foreign investor and offer more flexibility in terms of collaboration, competitive terms, pricing and booking of reserves to the foreign investor. IOCs in the Iranian upstream energy sector will be expected to sign an IPC. To sign an IPC, IOCs will have to form a consortium (operator) with at least one Iranian domiciled oil company (LOC). The consortium can be incorporated or unincorporated, and there will be no fixed minimum equity participation requirement for the LOC.

Iran has said that a key difference between the new and old contracts will also be that companies will be able to maintain involvement in a project from the exploration phase through development and on to production, including any agreed improved/enhanced oil recovery (IOR/EOR). Another benefit is said to be that cost recovery will begin on the first day of production from a project. From first production, the operator is paid fees on a per-barrel recovered basis, and fees will be calculated by reference to an “R” factor tied to a crude oil price index and will include a premium for smaller and riskier projects. Further, costs will be recovered from the production and sale of oil. However, the “cost” of oil will be capped at 50%, and all financial risk will remain with the contractor or foreign oil company. Foreign contractors must commit to improving Iranian know-how and technology, and employ Iranian nationals as much as possible.

Interested parties must wait until February 2016, however, for further details about the IPC. Until a copy of the IPC is available, many questions will remain, including the required form of the investment vehicle, the form of obligations arising from joint operating agreements, resolving disputes within the managing working group, governing law and dispute resolution arrangements. The risks associated with “snapback” (as discussed below) are not within the NIOC’s control and will need to be considered very carefully.

Considerations When Dealing in or with Iran

Violation of US Sanctions

OFAC advises that the US government will continue to vigorously enforce both primary and secondary sanctions targeting Iran until Implementation Day. To that end, OFAC recommends that businesses be “exceedingly cautious” in exploring talks with Iranians before the lifting of sanctions, as arranging for contracts or services to begin after Implementation Day is a violation of current sanctions.

Post-Implementation Day, businesses will need to be acutely aware of the narrow nature of the relief granted as it pertains to US persons. While EU and other non-US persons will have substantial freedom to deal with Iran, US persons are limited to only those exceptions provided by OFAC licensing. Outside of these exceptions, US persons will generally remain prohibited from engaging in economic activity involving Iran, its persons and its entities.

There appears to be a significant advantage for non-US financial institutions under the JCPOA to be able to conduct business with Iran. In reality, however, the position is likely to be more nuanced, with non-US financial institutions remaining cautious about doing business with Iran for fear of incorrectly navigating the complex US primary sanctions regime. In short, those non-US financial institutions which treat themselves as US persons for the purpose of sanctions compliance in many respects (generally to avoid inadvertently coming into the fold of and breaching US rules) may continue to follow US rules. US subsidiaries of foreign companies and foreign companies with certain other ties to the US will remain prohibited from engaging in economic activity involving Iran. Transactions in US dollars and through US banks will also remain prohibited.

The Risk of “Snapback”

A risk for those looking to deal in and with Iran is the possibility that sanctions will “snap back”—the undoing of all granted sanctions relief under the JCPOA. Of greatest concern may be the ease with which snapback can occur. The JCPOA allows
participant states to dispute Iran’s fulfillment of its commitments before the UN SC and requires Iran to resolve the matter. If unsatisfied with Iran’s response, the JCPOA requires the UN SC to vote on a resolution to continue the phased lifting of sanctions. If the resolution fails to pass, all currently lifted sanctions will “snap back” into place.

Moreover, the JCPOA does not provide any assurances to protect commercial contracts permissively formed prior to any snapback. The recital states that “[i]n case of reintroduction of Union sanctions, adequate protection for the execution of contracts concluded in accordance with the JCPOA while sanctions relief was in force will be provided consistent with previous provisions when sanctions were originally imposed.” According to the White House, “there is no grandfathering clause…if snapback does occur, there are no exemptions from our sanctions for long-term contracts.”

The US Office of Foreign Assets Control has advised US businesses that contracts with Iranians must include provisions to enable termination of the contract if sanctions are snapped back. Presumably, the consequences of termination in such circumstances will be a matter for commercial negotiation between parties. European businesses may be similarly advised. Companies will also want to consider appropriate contractual provisions governing demobilization and exit strategies.

Iranian Business Landscape

A final concern about conducting business in Iran is the relatively unchartered business environment. The World Bank ranks Iran as 130 in its Ease of Doing Business report, 172 in the area of construction permits, and 161 for property registration. The World Bank also cites poor trade, tax and investor protection regimes as business concerns. The UK Department for Business, Innovation and Skills has stated in a recent notice to business that “[e]ven as sanctions are lifted Iran will remain a challenging place to do business, and banks and other financial institutions may remain reluctant to handle
Iran-related transactions while full US sanctions remain in place.”

Iran has passed laws to attract foreign direct investment, namely the 2002 Foreign Investment Promotion and Protection Act. Although the Act does allow for 100% foreign ownership, as sanctions are eased and foreign ownership swells, the relatively untested law may come under scrutiny.

Iran’s banking and financial sector, which may benefit significantly from regulatory and structural reform, is reportedly likely to be constrained in spite of internal moves to reform. Financial institutions wishing to establish operations in Iran would need to obtain a regulatory license from the Iranian government.

Of course, companies should always be sensitive to the wide-ranging extraterritorial scope of some anti-corruption laws, such as the US Foreign Corrupt Practices Act and the UK Bribery Act.

Final Thoughts

As companies seek to capture significant opportunities arising out of the JCPOA and related sanctions relief, the risk of non-compliance with US sanctions, risk of sanctions snapback, high political risk and other legal and regulatory risks will need to be carefully assessed, managed and mitigated. Primary sanctions will continue to apply in and be enforced by the US. The complicated process of lifting UN, EU and US secondary sanctions will continue to evolve in the lead up to Implementation Day, but until then, enforcement agencies have reminded us that all sanctions remain in force.