Iran Starved of Investor Capital Needed to Fuel Extensive Privatizations

Iran’s long but troubled drive for privatization received a boost earlier this month. Morteza Lotfi, the recently appointed head of Iran’s Social Securities Investment Company (SHASTA), the country’s largest pension provider, announced that SHASTA would list the remaining 25% of its subsidiary companies not currently on the Tehran Stock Exchange. The move was intended to make the companies “more competitive and their financial status more transparent.”

A few weeks later, Lofti made a further announcement that SHASTA plans to sell its stake in 130 companies in a two stage process. An initial tranche of 40 companies has reportedly been prepared for this divestment. Taken together, the two announcements suggest a renewed push for privatization, taking enterprises out of the limbo of SHASTA’s quasi-state ownership in which they have largely languished.

While the market value of the proposed privatization was not given, SHASTA is known to have around 200 subsidiary companies and its holdings are cumulatively valued at USD 9 billion. On this basis, the 130 companies poised for sale could therefore have an estimated value of around USD 5.5 billion, with the caveat that the companies to be offloaded are likely the underperforming firms, with lower valuations than the portfolio average. Nonetheless, in terms of the number of companies and their likely market value, SHASTA’s move would be another historic step in Iran’s economic liberalization.

But there are reasons to doubt that SHASTA’s push for privatization will proceed as planned. SHASTA’s own holdings are a legacy of previous failures in Iran’s faltering drive to reduce state control of the economy. SHASTA’s portfolio of assets expanded most rapidly beginning 10 years ago, when privatization efforts overseen by the Ahmadinejad administration fell short in the face of political pressure, economic unpreparedness, and general mismanagement.

In the course of privatizations in this period, a staggeringly small percentage of the formerly state-owned assets actually passed into the true private sector. As Kevan Harris writes, citing a 2010 parliamentary commission report, “Out of seventy billion USD worth of assets of SOEs divested since 2006 only 13.5 percent of the shares had gone to the private sector.” The vast majority of assets were transferred to the control of "parastatals" and cooperatives such as SHASTA. Critics saw this privatization as merely a “relocation” of state-ownership.

Today, the political barriers to the proposed asset sale remain strong. SHASTA is the investment arm of the Social Securities Organization, which provides healthcare entitlements and pensions benefits for a large proportion of Iran’s middle and working-class members of the labor force. SHASTA’s financial returns are intended to cover the costs of these welfare benefits, and are therefore highly politicized. As Harris explains, “Pensioners  would  hardly  accept  a  selloff  of  SHASTA’s  investment  portfolio  to  the private  sector  without  major  guarantees  of  future  entitlements  by  the  state.” The Rouhani administration has committed to reducing entitlements, but given that SHASTA provides a pension to nearly 40% of the Iranian population, any major change to its portfolio could be a flash-point for opposition.

Aside from the political barriers, SHASTA’s bold plan faces another major obstacle. Iran’s equities markets are insufficiently capitalized to facilitate the sale of the 130 companies at sufficiently high prices.The current market capitalization of the Tehran Stock Exchange is about USD 100 billion. Relative to the overall size of the market, a USD 5 billion divestment by SHASTA, already the market’s single largest shareholder, would be difficult to absorb by other investors, particularly investors outside the circle of bonyads and other quasi-state holding companies.

Some within Iran’s financial sector see Lotfi’s announcements as an empty gesture. As relayed by one financial executive in Tehran, who preferred to remain anonymous, “We are used to these kind of gestures from high new management of SHASTA. They need the money and everyone knows it. But they don’t have the guts to push the button when it’s time.”

The Rouhani administration is well aware of this structural barrier to privatization, and has hoped that in the course of the post-sanctions economic rebound, new injections of capital by foreign investors would boost privatization prospects by alleviating the liquidity problem. Recent developments such as the partnership between Italy’s Azimut and Iran’s Mofid Entekhab bode well for the role of foreign institutional asset managers in the TSE, but there remains a long way to go before Iran can witness the foreign capital fueled privatizations that helped rapidly liberalize the BRIC economies. While the overall number of foreign investors trading on the TSE rose following the lifting of international sanctions and although foreigner trading value has doubled in the last year, this progress is measured from a very low base. 

By comparison, around 60% of shares on the Borsa Istanbul are owned by foreign investors. Acknowledging the important role foreign investors will need to play to see through the off-selling, Lotfi disclosed, “Talks are underway with the Turkish government for dual listing of some of [SHASTA’s] subsidiaries on Borsa Istanbul, which would be a positive step toward attracting foreign investment.”

SHASTA's intended move reflects the precise kind of privatization efforts that Western economic policymakers have long advocated in liberalizing markets. But unlike in other liberalization scenarios, Iran's economic actors find themselves hamstrung by structural challenges that few in the international community seem keen to address. As SHASTA looks to right the wrongs of past privatization efforts, a more concerted effort should be made to support inflows of foreign investment. If success in privatization is to be achieved this time around, Iran's equity market investors will need foreign investors to help carry the burden and unlock the opportunity. 

Emerging Privatization in Iran's Energy Sector Deserves a Second Look

The recent news that Austrian oil firm OMV has signed a preliminary agreement with Dana Energy, Iran’s largest and perhaps most capable private oil exploration and production firm, heralds the future of Iran’s energy sector. The agreement between an international oil company (IOC) and a private Iranian energy company is a significant development, given Iran’s long-held promise to privatize its oil and gas industries. The goal of privatization has been a constant feature of the Iran’s five-year economic plans since the 1990s. As economic sanctions were tightened beginning in 2011, investment dwindled and policymakers focused on promoting self-sufficiency in the oil and gas industries. Without access to new equipment, new technology, or best-in-class expertise, Iran’s production collapsed. This decline threatened government budgets as Iran lost global market share. Very quickly, Iranian authorities realized that achieving self-sufficiency actually required foreign investment-- there were too many technologies and management practices yet to be mastered in Iran’s oil and gas industries.

Iran’s reentry into global energy markets has been one of the most heralded aspects of the sanctions relief afforded as part of the JCPOA nuclear deal. Within the larger scope of economic reform, there was a strong expectation that the Rouhani administration would push for a greater role for the private sector in Iran’s oil and gas industry, finally getting the program of privatization back on track. The commitment is evidenced by the several private companies included in the Ministry of Petroleum’s list of approved local E&P partners for new tenders.

However, the first oil production contract under the new Iran Petroleum Contract (IPC) framework was awarded to Persia Oil & Gas Industry Development, a quasi-state company affiliated with Setad (the entity decreed by Supreme Leader Khomeini that encompasses both publicly and privately held assets, including various industries, companies, and real estate holdings.) The awarding of the contract in October, 2016 raised concerns that Rouhani’s support for private enterprise in the energy sector was being blocked by entrenched interests. A recent report by Reuters examined the range of contracts awarded since Implementation Day. The report concluded that state-owned enterprises were winning the lion-share of the new business, including oil and gas sectors. Of the 110 major contracts examined (collectively valued at USD $80 billion), only 17 contracts, worth USD $14.6 billion, were granted to private sector businesses.

The primacy of state enterprise has raised concerns among policy groups in Europe and Washington that the economic benefits of the Iran nuclear deal are not driving economic liberalization. The concern is particularly acute in the energy sector, given the immense importance of oil and gas revenues to government budgets and the significant involvement of state entities such the IRGC in the extractive industries.

There are, however, several reasons why critics should remain optimistic about the prospects for privatization. The Reuters report overlooks important context for the evaluation of post-sanctions contracts, particularly in the energy sector. First, state enterprise was better positioned than the private sector to win the early post-sanctions contracts. The initial wave of economic interest in post-sanctions Iran was marked by delegations led by economic ministers. Naturally, these government-to-government efforts focused on deals in sectors where government-involvement remains high both in Iran and in Europe. While it is widely known that companies like Iran Air, MAPNA, and Iran Khodro are state owned, it is worth remembering that their potential foreign partners like Airbus, Siemens, and Renault count European governments among their major shareholders. In the short term, while political uncertainty remains high, economic activity will naturally favor state-owned or state-backed enterprises in both Europe and Iran.

Second, concerns about awarding contracts to state entities ignore the matter of the actual contractual obligations of the parties. This is particularly important in the oil and gas industry, where the new IPC contracts enshrine clear provisions that support privatization in the long term. While the former “buyback” contracts treated the IOCs as contractors who handed off exploration and production projects to NIOC for operation, the new IPC contracts call for joint-ventures between IOCs and a local exploration and production (E&P) partner at the contracting stage, with a similar joint-venture managing operations when the project is production-ready. Two such examples are the Shell and NIOC oil exploration agreement and Total’s gas deal with Chinese state oil firm CNPC and NIOC subsidiary Petropars. In both cases, the state ownership interests represented by Iran’s NIOC or China’s CNPC will be diluted in the exploration and operation joint-ventures through the participation of Shell and Total, major private sector shareholders. In effect, the next wave of companies that will own Iran’s production capacity will include foreign, private sector ownership, even if domestic private firms are frozen out. This aspect of the agreements represents a significant shift that is missed when merely identifying the signatories to the contract. The obligation of the signatories to own and operate the assets is paramount.

Another provision in the IPC contracts that supports the agenda of privatization hinges on the question of technical and managerial knowledge transfer. In this sense, privatization can be understood as the propensity to behave in a manner consistent with the norms of private enterprise. While Iranian state-owned enterprises may be winning the majority of oil and gas contracts in the near term, the means by which they are defining their cooperation with foreign energy companies has moved to new ground. The new IPC contracts took long to develop, not simply because of the terms that were being offered to foreign companies in Iran’s energy sector, but also because of the new obligations being placed on Iranian energy firms.

The new joint venture companies established as part of IPC contracts will need to operate to the standards of the major shareholders, namely companies like Shell, Total, and Norway’s DNO. When compared to the companies previously operating Iran’s oil and gas fields, these newly-minted JV firms will need to conduct business more transparently, all the while reacting to market forces and adopting the global best-practices on which foreign partners will insist. Indeed, the IOCs working in Iran are required by the IPC framework to “gradually transfer” managerial positions to Iranian nationals in order to “facilitate the process of know-how and managerial skills transfers to the Iranian party.” While it might be unreasonable to expect oil companies to transfer ideas like corporate social responsibility and environmental protection, more fundamental skills like corporate governance, robust accounting, and compliance and risk management will be critical to the successful operation of the new JVs and will therefore have to be transferred to Iranian managerial teams. The significance of this shift cannot be overstated. It would be meaningless to privatize companies that would continue the bad habits and poor management typical of Iranian state-owned enterprises. Moreover, a well-operated and responsible state-owned oil company is compatible with Western business practice. Italy’s Eni and Norway’s Statoil are good examples.

Overall, the privatization of Iran’s oil and gas industry is proceeding at a greater pace than what a cursory look to the active players would suggest. Given that the redevelopment of Iran’s energy sector is only at the nascent stages of a decades-long process, it is far too early to sound the alarm.  

Photo Credit: OMV