Iran may soon reopen to business and foreign investment following years of economic sanctions. Diplomatic talks between Iran and the P5+1 group of countries (China, France, Germany, Russia, the UK and the US) over its long-debated uranium enrichment programme finally led to a first agreement in principle in March. Iran accepted key restrictions on its nuclear development and wide supervision as the US and the EU committed to lifting the sanctions that have weighed on the Iranian economy ever since the Islamic revolution in 1979.
There is still a long way to go, however, with the two parties divided over timing and other implementation details. As the June 30 deadline for a definitive agreement approaches, foreign investors are gearing up to eventually step in and fill the investment gap originating in decades of sanctions.
“The Iranian economy has the highest potential among the emerging economies; that’s the way I see it in the future,” said Iranian president Hassan Rouhani at the 2014 World Economic Forum in Davos. Mr Rouhani, considered a moderate cleric, often takes much of the credit for resuming diplomatic talks with Western countries after the tense years of his predecessor, Mahmoud Ahmadinejad.
The 'potential' Mr Rouhani refers to lies in the fundamentals of Iran’s economy. With a young, tech-savvy population of more than 77 million people, Iran boasts the largest human capital and consumer market base in the whole of the Middle East and central Asia. Combined with its vast endowment of natural resources – the country holds the world's fourth-largest proven crude oil reserves and the world's second largest natural gas reserves, according to the US Energy Information Administration (EIA) – Iran should be enjoying the fruits of its economic success.
That has not been the case though. Iran first struggled to turn billions of petrodollars into inclusive social and economic development during the years of Mohammad Reza Pahlavi, shah of Iran from 1941 to 1979. Then it found itself isolated and stifled by economic and financial sanctions as the leaders of the Islamic revolution gradually fell from grace with their counterparts in the Western world.
Today, Iran’s economy is far from being an emerging market hotspot. Its annual output shrank by 6.6% and 1.9% in 2012 and 2013, respectively, as international sanctions became tighter than ever, before recovering and growing by 3% in 2014, according to figures from the International Monetary Fund. Total FDI amounted to $3bn in 2013, not even 1% of GDP, which puts Iran among the world’s worst performers in terms of FDI-to-GDP ratios, according to World Bank figures.
Yet investors have not forgotten about Iran. As soon as the March agreement in principle was struck, international oil companies did not waste any time in voicing their interest in resuming activities in Iran.
“In Iran we are waiting for developments,” said Claudio Descalzi, chief executive of Italian oil company Eni, at a conference in April. At the same conference, Vagit Alekperov, president of Russia’s Lukoil, said: “We hope that sanctions will be lifted.” Officials of other oil companies including Shell, Total and China National Petroleum Corporation have also publicly stated their interest in Iran.
US sanctions first targeted Iran’s hydrocarbons sector after the approval of the Iran and Libya Sanctions Act in 1996. All major Western oil companies active in Iran were gradually forced out of the country. Today, the good times of the Iranian hydrocarbons industry appear long gone. Production averaged 3.2 million barrels per day in 2013, basically half that of pre-Islamic revolution levels, and exports alone fell to about 1 million barrels per day, according to EIA figures.
“The oil and gas sector in Iran is in critical need of technology, capital and markets if it is to attempt to recover from its current condition,” Paul Stevens, energy expert at the London-based think tank Chatham House, wrote in a research paper in March 2015. Iranian authorities estimate they need $130bn to $145bn in new investment by 2020 to keep oil production capacity from falling.
“Realistically, the only way the sector’s needs can be met is to bring the international oil companies into the upstream on a major scale. The two obstacles to this hitherto have been the economic sanctions and the unattractive terms of the existing buyback agreements,” said Mr Stevens.
The Iranian government is in the process of introducing new oil and gas contracts to replace the old, unappealing buyback schemes, which basically required oil companies to take care of the initial development phase, then wait to be refunded. The new Iranian petroleum contract will allow an oil company to engage with the different phases of field development – exploration, development, production – and share the revenues generated by the sale of oil, according to the contract's first draft, which typically recalls a standard production sharing agreement.
Yet sanctions targeting the local hydrocarbons sector, which forbid any investment in upstream and downstream projects above a $20m threshold and heavily limit Iran’s oil and gas export capacity, may not be lifted overnight.
“Iran’s priority is to lift sanctions on subjects able to generate the [highest] cash flow, such as petroleum and natural gas, as quickly as possible,” says Rakesh Bhala, an international trade law professor at the University of Kansas. “On the other hand, the US would likely prefer to hold that as a bargaining chip until much later and first liberalise sanctions on different topics. Yet it doesn’t have to be all or nothing; a compromise can be struck.”
Opportunities for market-oriented foreign investors do not lie in the hydrocarbons sector alone. Iran’s manufacturing base is struggling to keep up with the needs of its wide consumer base. The local automobile market is almost exclusively in the hands of two local producers, Khodro and Saipa. Smartphones are a rarity and they are mostly imported illegally. The country produces 90% of its medicines, but local producers focus on generic medicines, lacking the know-how to address the need for specialised drugs. As a final deal with the P5+1 gets closer, a range of foreign companies, including pharmaceuticals company Bayer, oil and gas group Total, telecommunications firm Orange and car-maker Renault, have sent senior representatives to Iran to develop relationships.
Financial investors are keeping a close eye on the ongoing diplomatic talks too. With a market capitalisation of IR2,957,000bn ($103bn), the Tehran Stock Exchange is already one of the largest markets in the region – although most of the listed companies are directly or indirectly controlled by state firms, and the real free-floating value represents about one-fifth of the market. The market index gained more than 15% as concrete chances of a first framework agreement emerged at the end of March, and despite losing some of the ground gained in the following weeks, the interest of foreign investors is reportedly growing ahead of a possible definitive agreement.
A deal with the West may also give Iran the chance to join that international business community from which it has essentially been banned for decades.
“Currently, Iran is the only mid-sized to big economy that is not part of World Trade Organisation [WTO],” says Farshad Ghodoosi, an Iranian doctoral candidate at Yale Law School in the US. “Its potential membership of the WTO would act as another signalling factor to potential investors that it is a safe zone for them to invest. Another important step that Iran might take is to sign and ratify the Convention on the Settlement of Investment Disputes Between States and Nationals of Other States. This opens the door for investment disputes arising out of FDI in Iran to be adjudicated at the International Centre for Settlement of Investment Disputes in Washington, DC. “
The eyes of the business community have now turned to Vienna, where a final round of talks between Iran and the P5+1 group is taking place. Should a final deal be struck, business consultants are ready to replace diplomats as the agenda-setters for the development of relations between Iran and the West in the years to come.