A small and tedious-looking announcement of the ratification of a bylaw relating to the issuance of securities appeared on Iranian government-affiliated websites last week and was unsurprisingly ignored by the world’s international media but not OilPrice.com. To OilPrice.com the blank statement that Iran’s First Vice President, Eshaq Jahangiri, signed off on the issuance of Islamic compliant securities in the calendar year of 1399 (which began on 20 March) means Iran will have access to a massive new stream of capital that it will use to drive forward its long-stalled oil and gas development programme. After that, this funding will be used to build-out the remaining key sectors of its multi-faceted economy in line with Western counterparts in order that it can re-assert its economic power in the Middle East, as it already does politically through the asymmetric use of its military and its neo-military proxies. Specifically, the order signed last week by Jahangiri allows Iran’s state-run companies – which, crucially, includes the biggest players in its oil and gas sectors – to raise up to IRR 65 trillion (US$1.5 billion) through the issuance of Islamic securities (sukuk) internationally. Iranian state companies – and their affiliates – in the oil and gas sector will begin with an issuance level of up to a combined IRR35 trillion to be focused on the development of joint fields and the infrastructure and development projects of any other fields designated as priorities by the Ministry of Industry, Mines and Trade and the Ministry of Energy.
The issuers of these Islamic (shari’ah)-compliant bonds will guarantee the repayment of the main capital and the ‘profits’ from the increased production from the same fields (for projects of the Petroleum Ministry) and project revenues (for the projects of the Ministry of Industry, Mines and Trade And the Ministry of Energy). In effect, investors into these sukuk will have their investments underwritten both by the relevant ministries of Iran and, even more enticingly, by the prospect of increased output from some of the lowest-cost, highest-quality, and most abundant oil and gas resources in the world.
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On a purely technical basis, the offering would appear extremely compelling. Currently, the average rate of recovery across all of Iran’s oil fields, to begin with, is just 5.9 per cent, according to senior oil and gas industry sources in Tehran spoken to by OilPrice.com last week. At some key oil sites, this figure is only around 4 per cent. This compares to an average recovery rate across all of Saudi Arabia’s oil fields of over 50 per cent, and the Saudis have plans – in this instance, realistic ones – to increase this to at least 75 per cent within the next two years.
The fact that the fields of both energy superpowers are in the same bracket from the quality and recoverability perspectives is evidenced in the fact that the lifting costs in both countries are identical, at US$1-2 per barrel – the lowest in the world, in fact. Moreover, in the aftermath of the implementation of the Joint Comprehensive Plan of Action (JCPOA) on 16 January 2016, Iran received several project proposals from top-tier international oil companies illustrating how it would be a straightforward matter to raise the recovery rates on a number of Iran’s key oil fields up to at least 12 per cent within just a year, with much more to come.
Aside from the appeal of the underlying assets that would underpin Iran’s new sukuk – the oil and gas field output themselves – is the unique investment proposition and therefore unique investment community to which sukuk always appeal. Clearly, given that sukuk under Sharia law should avoid investment in activities that are deemed speculative, involve uncertainty, pay interest, are unjust to participants, or are connected to prohibited businesses (such as gambling, alcohol, and the sale of certain foodstuffs), such bonds are always of great appeal to Islamic countries or those with a sizable Islamic community. However, they also increased enormously in appeal to other investor communities as well after the great financial crisis that began in 2007/8, given that all sukuk are underpinned by tangible assets and the notion that both the issuer and investor share both risk and return.
Consequently, over and above the overtly Islamic buyers of sukuk over the years, such as Middle Eastern countries, the Islamic investment community has expanded to include the U.K. (the first Western country to issue a sukuk), through Germany and Turkey (key European hubs for sukuk) to Malaysia (the biggest sukuk centre in the world). Overall, at the beginning of this year, S&P Global stated that it expects the sukuk market’s strong performance in the past few years to continue in 2020, with an estimated total sukuk issuance of around US$170 billion in 2020, including US$40-45 billion of foreign currency issuance, representing 5 per cent growth compared to the US$162 billion issued last year.
Added into this mix, though, are two other factors: private Iranian investment demand and the China backstop bid for all assets Iranian, in line with its view that Iran is an irreplaceable stepping stone in its ‘One Belt, One Road’ initiative. In the case of the former, Iranians have few investment options available to them. Buying US dollars and US dollar-denominated assets, such as gold, is not a realistic proposition for most, and holding savings in Iranian banks is not a recommended one as the vast majority of the private ones are essentially bankrupt.
In this context, even according to a recent figure released by Iran’s own central bank, around 60 per cent of the Iranian banking system’s non-performing loans (NPLs) are ‘category three’ by international debt repayment standards, comprising loans that have yet to be repaid after eight months, meaning that there is little hope of their recovery. Moreover, an internal audit in 2018 by the Finance Ministry showed that at least 70 per cent of the country’s entire NPL burden is related to businesses directly run by – or closely associated with – the Islamic Revolutionary Guards Corps (IRGC), which remains under close U.S. scrutiny, of course.
Consequently, there has been a pent-up demand for investable assets from Iranians still resident in the country and from those wealthy Iranians who have left the country at one point or another since the 1979 Islamic Revolution. Indeed, according to various independent estimates, Dubai alone is home to around half a million Iranians who saw their bank accounts shut down under the sanctions regime and who are looking for better than deposit rate bank account returns, with genuine security of funds attached.
It was always the Iranian government’s intention to harness as much of this dormant non-invested capital as it could in a way that would directly allow the country’s key companies – particularly those in the oil and gas sectors – to utilise it to continue with their capacity build-out and exploration and development projects. Following the classical model for moving capital out of private hands and into the corporate sector (involving firstly increasing the investable base of companies in a benchmark stock exchange and then augmenting this with less tangible bond offerings), Iran has in the last few weeks increased the amounts of some key state companies into which individuals can invest via the Tehran Stock Exchange (TSE), Mehrdad Emadi, head of risk analysis and energy derivatives markets consultancy, Betamatrix, in London, exclusively told OilPrice.com.
“The TSE has nearly doubled in value in just the past month or so after the tacit approval by Supreme Leader [Ali] Khamenei for the incremental divestment by the government of state holdings in a range of major enterprises, including those connected to the oil and gas sector, from a total divestment of between 20 per cent to up to 70 per cent, and the release of these stakes to the [Iranian] public and to private institutions and banks to buy,” he said. Although this spike in TSE values might appear counter-intuitive given Iran’s parlous economic state, it can be seen instead both as a consequence of the extra liquidity being pumped into the system as a product of Iran printing money to deal with the rising budget deficit and of the pervasive view that, as things cannot become much worse, current values represent buying at the bottom of the investment cycle.
It is in this context of wishing to broaden and deepen the pool of investment capital available to key Iranian companies that the new sukuk can be seen (effectively, the second stage of this strategy). It also affords Iran to get more Chinese money in through the back door, without further provoking the ire of the Iranian people who are wary of becoming too indebted to China, both monetarily and politically. “China can be seen as the backstop bid on all Iran’s projects and certainly on any bonds that it may issue, including all of these sukuk offerings,” said Emadi. “Although the current amount is around US$1.5 billion-worth, if they go well – which they almost certainly will – then the intention is to do further offerings in overall increments of US$5 billion or so,” he added.
“Given that the underlying asset will be a share in oil flows from oil and fields this mitigates any concerns over foreign currency credit ratings and there should be enormous interest in buying these sukuk from state-clients of Iran as well as their corporations who will see a political premium in participating in the scheme, most notable amongst them Chinese entities, the Qataris, Malaysia and India, plus natural buyers such as Pakistan, Azerbaijan, Kazakhstan, and Russia,” he said. “Based on the dynamics of previous issuances, the spread needs to be about 10-15 basis points higher than Iraq has aimed for and perhaps even those realised by Kazakhstan,” he concluded.