Insights

ashurst iran desk insight 01 Dec 2016 Building a New Silk Road

How Iranian transport changes and carries on

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Iran has always been a hub. Historically it has connected the Middle East and Central Asia and, on a global scale, Europe and the Far East. With the recent lifting of major international sanctions, Iran’s transport connections with the world are being reinvigorated. The political environment in Iran is now conducive to inwards investment and commercial involvement.

Despite three decades of relative isolation Iran is not an undeveloped market. It does, however, have significant capacity for further growth. Its underlying development, when compared to other emerging markets, is a major drawcard for international companies looking at the latest – and perhaps last – major frontier market to emerge onto the global economy.

The Iranian transport sector is fed by an established pipeline of transport projects including new construction, ongoing operations and the maintenance of existing infrastructure. International firms entering Iran can draw on broad-based domestic experience and a relevantly skilled but underutilised workforce possessing substantial capabilities in engineering, urban planning and other transport-related fields. While the project pipeline and tendering process function well, the market struggles with effective and integrated implementation. Iran’s transport sector is not state-of-the-art, but its indigenous capability will be a boon to companies entering the market. Iran is seeking to modernise this sector through best-practice management, integrated planning and new technology, with the help of world leaders in transport.

Iran’s Minister of Roads and Urban Development, Abbas Akhoundi, envisages some US$55bn of investment in the coming years in transport infrastructure alone and US$80bn in the transport sector overall. Of the US$55bn expected for infrastructure, US$25bn is slated for railway infrastructure and the remaining US$30bn for roads and motorways. The government currently spends over US$35bn annually on the sector, but this level of investment has not been sufficient to meet demand and, as a result, yearly passenger and freight targets are consistently exceeded. Iran’s transport sector is booming and is under mounting pressure, as a result of increasing usage by an 80 million strong population, increasing tourism and a greater focus on regional connectivity.

With the notable exception of Tehran and, to a lesser extent, other urban centres, the country’s transport infrastructure lags. Iranian transport is two-tiered: big ticket projects in and between major centres are significantly more developed than the deteriorating infrastructure in rural and suburban areas. Plugging this infrastructure gap will be a significant opportunity for international companies and investors. Iran has long-established international partnerships in transport and infrastructure, particularly with China and, to a lesser extent, Europe, but it remains far behind its near- and long-term potential.

With major economic reforms, the opening of the market, and the removal of the majority of international sanctions earlier this year, opportunities for international companies and investors to engage Iran is unprecedented. However, significant challenges remain in navigating the Iranian market.

Structure of the Iranian transport sector

While Iran’s regulatory system can appear complex it is navigable and is becoming more so, as a result of the major economic reforms being introduced by the government. Although deep-seated issues with large monopolies in parts of the economy remain, including in the transport infrastructure sector, increasing transparency and consistency are already resulting in significant and sustainable improvements in the ease of doing business, particularly in the areas where the greatest value-add opportunities for international firms lie.

Transport infrastructure in Iran is overwhelmingly government-built and is administered by the Ministry of Roads and Urban Development (MRUD). After construction, responsibility is transferred to organisations which are agencies and affiliates of MRUD for maintenance and further development, in partnership with regional and provincial organisations. These agencies operate under Ministers’ Deputies while teams in MRUD govern new projects, providing oversight and managing international firms’ interactions with Iranian companies.

The most important of these agencies, in terms of interaction with foreign investors and firms, are:

  • Company for Construction and Expansion of Transport Infrastructure
  • Road Maintenance and Transportation Organisation
  • Railways Company of the Islamic Republic of Iran
  • Ports and Maritime Organisation
  • Civil Aviation Organisation

This structure involves juggling a partnership with a number of different organisations (MRUD, its agencies and private sector partners) as well as numerous onwards referrals. However, it also means a predictable group of institutional and regulatory parties, where both institutional and personal relationships can be established and built on over the long term. When embarking on new investments and partnerships, international firms need to understand these inter-relationships and ensure an appropriate and careful risk allocation.

One of the hallmarks of Iranian business practice in recent decades has been the shifting of risk to external partners, where the downside of the market can be particularly significant. Iranian preferences for certain partnering arrangements and models involving a limited number of major institutional stakeholders need to be approached prudently and used by international companies only after extensive due diligence and clear-cut risk allocation.

Funding models, project financing and partnering

The ease of doing business with Iran promises to improve in light of the economic restructuring and regulatory reform being introduced by the Rouhani government. Nonetheless it presents significant challenges in the near- to medium-term. By virtue of a relatively sophisticated tender framework administered by the MRUD, international companies can bid for public tenders or, after a round of pre-qualification, register with MRUD and be directly invited to bid for specific tenders on the basis of credentialed capabilities.

Iranian industry, as guided by the government, has certain preferences in how it structures transactions with international partners and investors. The most common models of engagement fit firmly within the Iranian government’s requirement for maintaining ultimate control – a legacy of Iran’s political and commercial history. The most favoured international contracting models are Joint Ventures, Buy-backs, and Build, Operate, Transfer (BOT) models. International firms and investors looking at Iran should expect to operate under such an arrangement. Business can be conducted through government-vetted commercial agents, joint ventures or – unusually for the Middle East – an Iranian-registered and regulated business with up to 100 per cent foreign ownership.

The MRUD-administered project pipeline contains details of projects which had, up until recently, been suspended, and is therefore a useful source of opportunities for international companies keen to develop business leads. The introduction of new projects into this pipeline is expected to pick up pace in the new economic environment once the considerable backlog of projects suspended under sanctions has been cleared.

Engagement with Iran's transport sector

A number of European companies have been “early movers” in re-establishing themselves in the Iranian transport sector. Peugeot Citroën, Renault SA, and Airbus have capitalised on their long-term reputation and their relationship-building strategies in Iran to secure major joint partnerships and sales early in the new post-sanctions environment. In addition, in the immediate aftermath of the lifting of the UN sanctions, Alston, SNCF and Italy’s Ferrovie dello Stato have all sealed significant deals in the rail sector – which is perhaps set to become the most fertile industry sector for foreign investment. An extensive series of deals between Iran and Germany’s Siemens includes the flagship project for a modern, high speed train on the Tehran-Qom-Esfahan line and major plans to more than double Iran’s railway network, which is already ranked 21st in the world by the International Union of Railways with 11,106 km of railroad.

The German and French deals are indicative not only of the extent of Iran’s transport ambitions, but also provide a guide to how international firms should conduct business in Iran. Siemens, Peugeot, and Renault all have highly developed reputations and long-standing connections in the Iranian market, despite lows in recent years when trade halved. Siemens and Peugeot in particular have effectively pursued steady network-building as part of a long-term strategy.
 
For Iran, more than other markets in the region, the business culture is cautiously conservative. While commercial reputation-building and institutional connections are important, they are not the full story. For international firms, it is essential to have a senior partner or prominent manager conducting the firm’s business in Iran through personal relationships which have been solidly embedded within the business structure, and to avoid a quick handover or high turnover in relationships. To be most effective, this relational and reputational foundation should be laid steadily, and ideally, long before the conclusion of a transaction. This is required both to solidify and improve the deal itself, as well as to guard against any backsliding – a practice still far too common in Iranian business practice.

These European early movers’ use of trade missions and other opportunities to enter the Iranian market has also been exemplary. They have been prominent in trade missions and have followed up with their own initiatives to maintain and build institutional and personal connections, leveraging cross-cultural business insight. Compared to the Western “transaction-focused” style of business, Iran’s commercial culture is strongly personal, if less intensely and showily so than in the Arab countries. More than other Middle Eastern markets, Iranian partners value personal seniority embedded in reputable institutional structures.

Transport projects signed off since Implementation Day

project country company
Electrification of the Tehran-Mashhad railroad including the provision of the signalling equipment, the electric locomotives, passenger train coaches and the maintenance services for the railroad 
Germany 
Siemens
Construction of the Tehran-Isfahan high-speed railway plus a third of the provision of 500-passenger coach trains 
Germany 
Siemens
Participation in the construction of the Tehran-Hamadam and Qom Arak high-speed rail lines. The deal is worth an estimated €3bn 
Italy 
Ferrovie dello 
Stato Italiane
Construction of power stations and overhead power lines along the Garmsar-Sari- Gorgan-Inche Burun route in Iran which will electrify 495 kilometres of railway and building 32 stations and 95 tunnels 
Russia  Russian Railways
 Development of three airports in Iran  France  Bouygues Group and VINCI Airport

Sector analysis

Iran is highly ambitious for all aspects of its transport sector, both as a focus of economic development and a foundation for continued market advancement. While top priorities are the modernisation of the rail and air sectors, port and road transport come a close second. With the development of this transport infrastructure, the hope is that Iran’s transport network will re-energise its regional and global connective role for its large and mobile population, such as through the Iranian North-South Transport Corridor (INSTC) project – a key aspect in Iranian geo-political strategy to develop and modernise a new silk road by land, sea and air.

Rail

After the UN sanctions were lifted earlier this year, President Rouhani announced plans to extend the Islamic republic’s rail network to 25,000km by 2025, with calls for US$28bn to be spent modernising the nation’s rail network.

Ports, Airports and Special Economic Zones (SEZs)

In addition to the rail sector, each of the ports, airports and SEZs all offer opportunities for international investors. Imam Khomeini International Airport (IKIA) and other Iranian airports are the focus of major and rapid change. Speculation about the potential for Tehran to regain its status as a Middle Eastern hub is widespread and of some substance where one takes a longer term view. Work is ongoing on a major expansion of IKIA, partly in an attempt to relieve pressure on the outdated Mehrabad airport in central Tehran but also to build capacity for further growth in terms of international connectivity. Airports and ports around Iran generally operate under current capacity, but this is expected to change rapidly. While Iran already has 16 Special Economic Zones it is pursuing major plans to develop these, as well as their transport hub hinterlands, into major regional players in the medium term, building on prioritised development of immediate transport needs.

The size of post-sanctions opportunity in Iran

Iran’s windfall from the removal of sanctions is expected to be up to US$100bn; in other words, equivalent to the authorised capital of the Asian Infrastructure Investment Bank but concentrated to one market without pre-conditions. Much of this “thawed” capital has been earmarked for infrastructure investment, particularly in projects which have been delayed over the past 2-3 years, on account of the uncertainty caused by sanctions. While it will plough this capital into transport, Iran is banking on significant foreign project financing to reach the US$30bn of additional transport investment required over the next six years, and to meet the rapidly growing sector’s needs in future.

The benefit of doing business in Iran, particularly compared to other Asian markets, is that it has a pipeline of bankable and relatively well-structured projects which are coordinated by a single ministry and its agencies for which infrastructural fundamentals are firmly in place. This will ensure a strong project flow both now and in the future: one that requires international expertise, technology and financing to complement indigenous capabilities. This synergy is likely to be reinforced in a virtuous cycle: Iran will rebuild experience through dealing with foreign firms and institutional investors even as it draws on significant capability in managing a broad pipeline of projects to significantly grow its transport sector. While the spectre of ‘snap-back’ provisions in the Joint Comprehensive Plan of Action (JCPOA) in relation to Iran’s nuclear programme loom large, the prospect for snap-back appears significantly diminished following the Iranian elections in early 2016 and ongoing political dynamics both domestically and internationally.

Conclusion

The hallmark of a successful approach to the Iranian transport sector is not to focus on the much- hyped gold rush of interest in Iran. Instead, firms should focus on the prospect of a golden age to come in Iran as a major world market. Iran’s business culture requires this as does the long-term nature of developing and maintaining transport infrastructure.

Iran’s promise as a market is not only in its potential to be a world-leading economy propelled by future growth through an expanded transport network for its 80-million inhabitants, but also as an important hub and connector between the Middle East, Central Asia, and further afield. Transport infrastructure underpins this growth and connection. It will, in turn, be bolstered by broad-based and reliable demand growth. Investment in Iran, provided it takes into account Iran’s particularities, can bring great rewards. The potential in the Iranian transport sector is now starting to be realised, and will offer exceptional business opportunities well into the future.

ashurst's iran desk
Ashurst is ideally placed to advise clients entering the transport market in Iran. The Ashurst Iran desk consists of Persian speaking partners and senior lawyers who are familiar with local conditions and institutions and understand how to do business in the country. With established relationships with leading Iranian law firms and across the Iranian business world, we are ideally placed to advise companies seeking to do business in Iran. In addition our market leading transport team operates at the heart of the industry across the globe. With a dedicated team of specialist worldwide, we can assemble teams to provide high quality advice, tailored to our clients’ needs. We have a pragmatic approach, with innovative legal expertise and detailed industry knowledge of how to realise exciting and ambitious projects.

 

 

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This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.

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