Abstract

We analyze the rate of return (ROR) and risk factors faced by Shell Exploration, an international oil company (IOC), in its Soroosh and Nowrooz buy-back service contract in Iran. In particular, based on our models of cash flow, we analyze the buy-back contract specific risk factors that can contribute to a reduction in the rate of return for the international oil company. Our cash flow models resemble the cash flow of buy-back service contracts before the Iranian government changed the way it determined the capital cost ceiling and pre-defined the oil price in these contracts in 2008–۲۰۰۹٫ Our actual and contractual cash flow models reveal that Shell Exploration’s actual ROR was much lower than the contractual level. Furthermore, we find that among the risk factors that we considered, a capital cost overrun has the greatest negative effect on the IOC’s ROR. Moreover, we show that there is a potential for modifying the contracts in order for the IOC to face an actual ROR closer to the contractual ROR even if the contract faces cost overrun or delay, without exceeding the maximum contractual ROR that the National Iranian Oil Company is willing to give.

Introduction

In recent years, some oil and natural gas producing countries have shown an increasing interest in adopting variations of service-type contracts rather than production sharing contracts or concessions in their oil and natural gas development and exploration projects (Ghandi and Lin, 2014).1 A service contract2 is a long-term contractual framework that governs the relation between a host government and international oil companies (IOCs) in which the IOCs develop or explore oil or natural gas fields on behalf of the host government in return for pre-determined fees and in which in most cases the host government does not hand over the control of the extracted or subsoil or sub-surface resources to the IOCs (Ghandi and Lin, 2014).3 One type of service contract is Iran’s buy-back service contract.