Iran should join the Energy Charter to boost oil flows and reassure the world that it intends to comply with the nuclear deal

Iran should join the Energy Charter Treaty (ECT). Joining the ECT, the world’s multilateral energy investment treaty, would encourage greater energy investment flows into Iran leading to a more rapid increase in oil and gas production. Full membership of the ECT will also reassure the world that Iran intends to comply with the nuclear agreement it reached with world powers in July.

Following years of sanctions, Iran requires huge investment flows to rebuild its oil and gas industry. Given low oil prices and alternative supply sources elsewhere in the world, and the fear that sanctions could be snapped back, ensuring large investment flows into Iran will not be easy. Full Iranian membership of the ECT, with its investor protection and dispute settlement regime, would provide substantial reassurance to investors and the wider world that Tehran is committed to the nuclear deal and to opening its markets.

After years of sanctions, the Iranian energy sector is in a poor state. Oil exports are down to just over one million barrels a day (mbd) compared to approximately 5.5 mbd before the 1979 revolution. Even though Iranian officials have made claims that they can rapidly boost existing production, it is an open question how much additional production could be rapidly brought online. Perhaps as much as 500,000 to 800,000 barrels per day (bpd) in eighteen months, perhaps as little as 300,000 bpd. Even the supposed wall of Iranian oil sitting in tankers amounting to approximately forty million barrels is not what it seems. At least half, and perhaps as much as two-thirds, is low grade oil that will be difficult to sell to refiners.

For significant and sustained increases in oil production Iran needs substantial capital investment in modern pipeline networks, drilling technology, and terminal facilities. Its traditional supergiant fields such as Gachsaran and Marun need modern knowhow and technology to reduce depletion. This is in addition to obtaining the capital to open up new fields. Iranian estimates place the capital requirement at between $50-$100 billion.

Natural gas production is in a worse state. Despite being the second-largest reserve holder in the world—with thirty-four trillion cubic meters of reserves—Iran produces approximately 170 billion cubic meters per year. Overwhelmingly, gas production is consumed domestically with only a relatively small amount exported (up to 10 bcm) to Turkey. To substantially develop the Iranian natural gas resource base to reflect its massive reserve holdings will require capital investment of approximately $100 billion.

It can be argued that given that Iran is the world’s fourth-largest reserve holder of oil and second-largest reserve holder of gas generating capital flows into Iran will not be that difficult. One of the major attractions of the Iranian energy market is the low cost of onshore production. Most of the fields have been thoroughly mapped and analyzed. Unlike in Iraq, there are minimal security threats to production.

Whilst the positive case for capital flows is accurate so far as it goes, it overlooks the significant barriers to capital arriving at scale in Iran. First, low oil prices and the prospect of continuing low oil prices due to falling Chinese demand and more sources of supply reduce investors’ willingness to risk capital. Second, even when sanctions were lighter and some European companies like Total moved into Iranian oil fields red tape and onerous contract terms ensured that they soon exited the country.  Iranian officials are promising a more liberal regime for investors with better terms and less red tape, but history is likely to make investors cautious. Third, the nuclear deal’s provision to “snapback” sanctions will cause major Western energy firms and their investors to worry that at any moment the energy market will be shut should the deal unravel.

By becoming a full member of the ECT Iran would be providing a significant degree of reassurance to Western energy companies and Western governments that it is committed to opening its energy markets and will not renege on the nuclear deal. The ECT stems from the collapse of the Soviet Union. The ECT, which was drafted in the early 1990s and came into force in 1998, was aimed at encouraging investment in the energy sector of ex-Soviet states. The underlying deal with the ECT was to encourage energy investment flows into the ex-Soviet states in return for protection for energy investors against expropriation.

Since 1998, more than seventy cases have been settled or are currently in arbitration. The most significant of those cases, at least because of the size of the award, is the Yukos case (where the award was $50 billion).  The increasing effectiveness of arbitration regimes such as the ECT stems from the underlying reality that as emerging economies engage with globalization they find that they develop an external capital base and greater internal demands for external capital investment. Almost all states engaged in the dispute settlement process ultimately comply with awards handed down by arbitrators. When they don’t, as the Russian Federation is finding out in the Yukos case, access to capital becomes much more limited, and the award can be enforced against state-owned assets not subject to sovereign immunity (a limited class of assets).

It can be argued that the ECT will only make a marginal difference, but Iran can enter into a host of upgraded bilateral investment treaties with investor states that would have more or less the same effect. However, upgrading and then negotiating a dozen more investment treaties would take a lot of time and delay investment into the sector. It can also be argued that Iran has now very few overseas investments that could be seized if it did not comply with the ECT’s investor protection provisions that ensure the effectiveness of the ECT’s arbitration regime. That argument, however, overlooks the experience of emerging economies entering into more globalized markets. As Iran becomes more enmeshed in the global economy it will develop a significant external asset base. There are overwhelming incentives to do so: from transferring technology to capturing value further down the supply chain. Equally, as the Iranian economy opens up it will develop a much more sophisticated financial infrastructure that will require foreign capital to develop and sustain it.

Becoming a full member of the ECT will not ensure capital flows into Iran. It would, however, send a clear signal of intent to the world that Iran intends to honor the nuclear deal and that it is now fully open for business.

Alan Riley is a Non-Resident Senior Fellow in the Atlantic Council’s Global Energy Center.