(Originally posted to FB 5 May 2010)
In recent months, the regime has prepared the launch of 8-10 billion euros of energy bonds. Last week, the first phase of the issuance (valued at 250 million euros) was the first step to test the reaction of international capital markets, minus the U.S. and the U.K., to the government-backed 8% rate of return over 3 years, which, on the surface, appears a promising investment.
In this short note, a number of observations are made pertaining to the risks involved in participating in the scheme to both foreign and domestic buyers of the bonds. Given the absence of reliable data on the cost of the bond-generated revenue, a degree of speculation in the assessment is unavoidable.
Even taking into account the relative ease at which the market accepted government bonds a few years ago, the new bonds are quite different on many levels.
The last (and only time) that the government issued bonds the value was 1 billion dollars (less than 700 million euros). At that time the global economic environment was quite positive compared to the present day liquid-short banking sector. The emerging economic slowdown in the euro zone triggered by the Greek debt and similar situations in Portugal, Poland, Ireland and Spain have elevated the cost of borrowing and exacerbated the liquidity shortage barring the Chinese and Malaysian financial systems, which lessens the appeal of these bonds to Western institutional investors beyond what the sanctions have done already.
In Iran, since 2001, the energy sector has been showing serious signs of diminishing productivity and falling returns to new investment for the following reasons, which have made it the second least productive industry in the leagues of top 10 oil-rich economy (Nigeria is the least productive).
Since 1999, the level of investment in the oil industry has been about one-third of what it should have been to maintain the productivity of the oil fields/wells compared with the average investment-output ratio for the region. The Majlis’ (Iranian Parliament’s) own calculations, as well as the Minister of Oil’s statement in February 2010, reported a 70 billion dollar shortfall in investment over the last 9 years. The issuance of 8-10 billion euros, about 14 billion dollars, will not be remotely enough to address the collapsing infrastructures in Gachsaran, Khoramshahr, Ilam, Nazar Tapeh and Pars oil fields. The money will only be a temporary means of risk-sharing to involve foreign capital, and at a time when sanctions will make investment even less profitable if they involve the energy industry as a means to pass some of the risk to foreign buyers.
The energy sector will almost certainly be affected by sanctions since all Sepah (Iranian Revolutionary Guard Corps) business interests are to be targeted, and in recent years, through creeping takeovers, Sepah-owned companies are now the largest entities in the Iranian oil industry. After the dispute with Total of France and an Italian company which refused to re-structure payments based on kickbacks, and the shock Total managers in France received when the kickbacks to officials during the second administration of President Khatemi were leaked by the “reformists” in Tehran, Western interest in future deals declined further, especially when the direct involvement of Mehr Investment in the Pars fields Phases 11-16 resulted in explicit demands for a 12 percent off-the-books contract payment in cash.
Three months after President Ahmadi Nejad was elected in his first term, the government agreed with China National Petroleum Corporation. (CNPC) on a 20 year deal which effectively transferred pricing option to CNPC and agreed to a barter-based payment which allowed China to pay 50-65% of the value of oil purchased in Chinese goods. A year and half after the exit of Total and other European firms, CNPC replaced all the companies with a nominal undertaking of 5 billion dollars investment over 11 years. Three years after the agreement, China has invested less than one billion dollars of which 700 million dollars have been in distribution and delivery facility to Chinese vessels and almost nothing in the production infrastructure.
In 2009, pursuant to a split between the Sepah commanders in Mehr Investment and Khatemolanbia, which had received a sum of 8.9 billion dollars from the special oil account despite objections from the Parliament’s less influential members, informed the leadership that unless a further 22 billion dollars of credit was not provided, they will not be able to deliver targets for which the 8.9 billion dollars had been transferred to them. Given the massive leakage of oil and gas money to the Far East, government, Mr Hosseini first, mentioned the issue of energy bonds as a means to make the Iranian oil and gas industry the pioneer in the application of sequential-pressurization, a technique that Sepah has opted for because of its low level technical requirement but one that enables, at best, a 10-15 percent reclaiming ratio of available oil instead of 40-60 percent as experienced using more advanced methods used in Sakhalin, North Sea, and Mexico.
It is almost certain that a substantial amount of the revenue raised through the bonds will go to the Sepa, where accountability and performance assessments are most difficult to implement.
The highest risk associated with the new bonds (“energy investment shares” as the government calls it now) is that in the case of a partial sale when some of the bonds are not taken up by buyers, the value of those purchased will see a high discount as an investment that was not assessed as worth investing, and this will see a loss of value. The guaranteed return on the bonds will not guarantee an automatic pay off if the investment does not generate improved productivity that can finance the buyback. In the event of shortage of hard currency, buyers will be left with promissory notes which will have a declining valuation as the delay increases.
The most likely winners of the scheme seem to be U.A.E. banks which have shown interest in the bonds and two Chinese banks which have indicated a take up of 3-7 percent of total bonds each. In all cases, such a concentrated purchase by institutions which have close links to their national governments has the potential for acquisition of strategic control or at least interests in the Iranian energy sector which is and will be for some time to come, the lifeline of the economy.