Buy Backs

In almost every  oil producing territory, hydrocarbon taxation takes the form of either a concession or production sharing contract.
There is, however, one major exception; Iran.
Due to constitutional restrictions and Iran’’s suspicions of foreign investors in the oil and gas sector, the concept of ‘‘buy backs’’ or service contracts was introduced as a controlled and workable vehicle for foreign investment. Buy backs are essentially service contracts in which the Iranian National Oil Company, NIOC, subcontracts certain aspects of its responsibilities to a foreign party. No other form of direct investment in the oil gas industry is allowed by foreign persons or companies under current regulations.
The commercial rewards in buy back contracts have changed gradually since the first contract was signed with TOTAL in 1995. The level of return afforded to contractors has reduced from an average of 21% to around 15%. Such tightening of returns to the foreign parties reflect the level of competition for quality assets in the sector and the level of return which participants have been prepared to accept in the contracts signed to date.



Under a buy back contract the foreign investor will not own any part of the Iranian oil or gas field. The contractor is the designated operator for design, construction, commissioning and start up of all facilities and this responsibility passes to NIOC immediately after start up. The foreign partner provides all the capital for the project and is compensated for its costs and awarded an agreed level of profit. The details of the development programme are contained in the field Master Development Plan, which clearly states the work to be performed and the agreed capital cost for such work.

Cost Recovery

Illustrated by the schematic above, under the contract the contractor is compensated for all capital and operating costs and bank charges incurred in fulfilling the specifications of the Master Development Plan. Costs due for recovery are amortised over an agreed number of years (generally five to ten years) from the date of first production. Any costs, which cannot be recovered in any given period, are carried forward and recovered with interest in subsequent periods. If the actual field costs are greater than anticipated then the extra cost is borne solely by the contractor and the additional costs are not eligible for cost recovery.

The result is a contract in which the contractor essentially takes significant risk for the return of what has over time become an ever more modest level of reward. Upside is often negligible with several companies in recent years suffering significant write-downs as a consequence of industry inflation increasing costs to the point of non-recovery (Statoil in particular comes to mind). Looking forward, with considerable uncertainty now presiding around future investment in Iran and many of the contracts currently in place coming towards an end, we think Iranian buy backs are likely to become an even less significant feature of company portfolios for some years to come.

Source: Deutsche Bank " Oil and Gas for beginners"