On April 2, six world powers signed a tentative deal with Iran regarding its nuclear program. Should it be finalized in June, one of the outcomes of the deal will be the lifting of the oil embargo from Iran—a country that has some of the world’s largest oil and gas reserves. IMR analyst and editor-in-chief of imrussia.org, Olga Khvostunova, discusses how the deal could affect the Russian energy sector.

 

According to energy analysts, if Iranian oil is unleashed to the market, it will bring oil prices down. Photo: AFP

 

The nuclear framework agreed on by Iran and members of the United Nations Security Council (the United States, the United Kingdom, France, Russia, and China) plus Germany in Lausanne, Switzerland, has been widely hailed as a significant achievement for Western diplomacy and a breakthrough for U.S. foreign policy in the Middle East. The deal, which is expected to be finalized by June 30, rolls back Iran’s nuclear program so that Tehran will be unable to produce nuclear weapons. In return, the U.S., the European Union, and the UN promise to ease sanctions imposed on Iran in recent years, including lifting the current oil embargo. In terms of the global energy market, the latter is viewed as a potential game changer.

According to the 2014 BP Statistical Review of World Energy, Iran holds 9.3 percent of the world’s crude oil reserves (157 billion barrels, the fourth largest supply in the world). But since sanctions went into effect in 2012, Iran’s export capacity has been severely damaged. The U.S. Energy Information Administration (EIA) reported that crude exports from Iran decreased more than twofold: from 2.5 million barrels a day in 2011 to 1.1 million in 2013.

While Iranian oil has been locked mostly inside the country, the global oil market has undergone some drastic changes. Since last June, oil prices have dropped by about 50 percent and remain low. Today, the market receives a daily excess of nearly 2 million barrels of oil as a result of a number of factors, such as U.S. shale oil production, the Organization of the Petroleum Exporting Countries’ (OPEC) policy to keep output high, and tepid global demand. Simple logic says that once the restrictions are lifted, Iranian oil will pour into the market and slash prices even further. Some analysts estimate that Iran could bring an additional million barrels a day next year, and two million in two years.

Therefore, when news of a preliminary deal with Iran broke, it caused oil prices drop further: an international benchmark, Brent Crude dipped by 3.6 percent to $55 per barrel that day. The shift, however, appears no more than a nervous reaction of the market, as no additional barrels of Iranian oil have been unleashed to the market. Still, a new monthly report released by the EIA on April 7 suggests that lifting sanctions could substantially change the baseline forecast for crude oil prices in 2016—bringing them down to $5–15 per barrel (the EIA currently forecasts that Brent Crude oil prices will average $59 per barrel in 2015 and $75 per barrel in 2016).

Under the current circumstances, a relevant question arises: where would these developments leave Russia, with its economy heavily relying on oil and gas exports and its national currency closely tied to oil prices?

Since the beginning of the Ukraine crisis and the EU’s new resolve to decrease its dependence on Russian gas, Iran has made clear that it could open its vast reserves to Europe and Turkey.

One has to keep in mind that the deal has not yet been finalized, and Iran still has to go certain lengths to comply with multiple restrictions on its nuclear program and have its dedication verified by international inspectors. However, assuming that the deal will stand and market conditions do not change dramatically, it is possible to speculate what the outcome might be for Russia.

First, since Iran won’t be able to immediately ramp up production from its mature oil fields, which have remained virtually flat in in recent years and require enhanced recovery, the initial oil that the country will release to the market is what has been accumulated and preserved in storage. By various estimates, it could amount to 35 million barrels. Still, even if this oil is released at a pace of 500,000 barrels a day (as many analysts predict), it will put a lot of pressure on a market that is already dealing with a 2 million barrel daily surplus. Increased surplus will most likely bring prices down further.

Second, Iran will probably try to reclaim the market share it had before sanctions were imposed, which would clash with the OPEC policy (pursued mostly by its key members—Saudi Arabia, Qatar, Kuwait, and the United Arab Emirates) that aims at maintaining the current level of oil production. To counter OPEC, Iran might start offering its oil at a discount, which could lead to a price war in the region.

Under these conditions, the situation in Russia becomes very vulnerable, especially given the fact that oil and gas shares amounted to 68 percent of the country’s exports in 2013 (EIA’s 2013 data). If oil prices drop further, oil production in the country will decline dramatically in upcoming years—oil companies are already cutting their investment programs. Some analysts estimate that by 2030, Russia’s oil production could decrease by 50 percent.

Third, having the largest proven gas reserves (33.8 trillion cubic meters, according to the 2014 BP Statistical Review of World Energy), Iran potentially poses yet another threat to Russia (which comes in second with its 31.3 trillion cubic meters of gas reserves). Since the beginning of the Ukraine crisis and the EU’s new resolve to decrease its dependence on Russian gas, Iran has made clear that it could open its vast reserves to Europe and Turkey.

Since Iran borders Turkey and Azerbaijan, it can opt to deliver its gas (and oil) through the pipeline system of either country. The EU, which has been looking into every option to overcome Russia’s gas leverage (Europe currently receives about 30 percent of its gas from Russia, with some eastern and southern countries being 100 percent dependent on it), may welcome Iranian gas, thus further diluting Russia’s influence.

Whether the Iran deal will ultimately be a game changer in the global energy market remains to be seen, but it certainly poses a potential threat to Russia. So why would Russia participate in developing the framework for such a deal? Clearly, it isn’t acting out of altruism, nor is the Russian leadership known for being stupid in its foreign policies—if anything, it’s the opposite.

A possible answer is that Russia will try to use the Iran deal (which could go down in history as one of the cornerstones of Barack Obama’s legacy) as a bargaining chip in its negotiation over easing its own sanctions this summer. As sanctions over Ukraine take a toll on the Russian economy, the Kremlin may well be following an old motto: “Kill the demon today, face the devil tomorrow.”

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