The Iran Deal and the Ukraine-Russia-EU Triangle

August 2015
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Signals for the Region

The Iran crisis and its resolution have sent several powerful signals to the EU, Ukraine, and Russia.

The first and perhaps most important signal is that economic sanctions work. The introduction and strengthening of sanctions in 2011 and 2012, respectively, demonstrated their effectiveness on a country quite reminiscent of Russia in its export structure. This also showed that shifting away from EU and U.S. markets is not an absolute panacea. The desire of Iran to escape isolation and its readiness to hold negotiations with the countries of the West ought to be a warning to Russia, which is currently following Iran’s pre-crisis path.

The second important signal is that Gazprom could soon have a major competitor in the EU market. It won’t happen quickly, but Iran would very much like to become a gas supplier to the countries of the EU and it will work actively to achieve this aim. Ukraine, in its move toward the European energy market, is also quite interested in the successful diversification of European energy supplies: the proportion of gas imports to Ukraine from the EU is growing, negotiations to expand access to Ukrainian gas fields to foreign companies are ongoing, and so on. In this way, Iran can fundamentally add another dimension to the European policy of energy choice and diversity.

Third, the P5+1 format showed itself to be effective in the Iran negotiations. Given a situation in which Russian aggression on the territory of Ukraine is in fact a violation of international law and thus an international crime, the “Normandy” format should be expanded to include the United States and Great Britain. Iran had, for a long time, chosen the tactics of refusal and avoidance, but with the implementation of the “P5+1” format the negotiating process found a new channel. Therefore, including additional negotiators in the effort to avoid an escalation of Russian aggression could become a valuable lesson of the Iranian accords.

Fourth, in spite of their friendly political relations, the appearance of Iran on the oil market will have an unambiguous effect on the Russian economy—specifically, it will accelerate its decline. If the Russian side does not attempt to stop Iran’s plans (which will be extremely difficult), the price of oil will continue to drop in 2016, which will affect that part of the Russian budget that depends on oil exports. This in turn will force the country’s leadership to scale back its imperial ambitions for war and aggression in Ukraine.

At the same time, the end of the active phase of the Iranian negotiations and the transition to active monitoring of the agreement’s implementation will increase the chances that events in Ukraine will find their way onto the international agenda. More attention on the world stage will force the international community toward greater involvement in seeking a resolution of the conflict and in halting the aggressor. The resolution of one crisis in effect allows more time and space for the efforts to resolve another.

The Political Dimension: The So-Called Ukraine-for-Iran Bargain?

Russia pursued its own political goals by being an active participant in the negotiations with Iran. While under the sanctions regime, Russia could not openly trade with Iran and contrived circuitous means of trading (see below). After the signing of the agreement, Russia will have the ability to openly offer its goods to Tehran (though it is unclear whether they will be competitive with Western goods).

Additionally, Russia’s participation in the achievement of these peace accords gave it the opportunity to play a role in “great-power politics,” placing it for a moment into the role of an equal partner in the P5+1 format of the leading negotiating countries. There were phone calls from Obama to Putin with expressions of gratitude and John Kerry’s visit to Russia, which allowed the loyal Russian media to contradict the idea of Russia’s isolation from the West. If the country had taken a different position, this would have meant spoiling relations not only with Washington, but with Tehran as well, which obviously eagerly awaited the lifting of sanctions and the unblocking of the country’s economic potential. A démarche would have been yet another signal to the countries of the West about the threat posed by Moscow’s policies. This would have brought Russia several steps closer to international isolation.

Last but not least, Moscow’s constructive role can be explained by the question of nuclear weapons. In spite of its good relations with Iran, Russia did not want to accept an additional member in the existing “nuclear club,” even if it would only have been a potential member. At first glance, this might look like a concern from a bygone era. The frequency with which Russia reminds the West of its own nuclear potential, however, leaves no doubt: for Russia, nuclear weapons are an area of particular “Soviet” pride and its rhetoric and underlying fears have not changed much since then.

Russia’s participation in the negotiations on the same level as Western countries was actively exploited to spread the idea that the world powers had allegedly agreed upon a bargain to trade the Iran agreement for Western non-interference in the Ukrainian-Russian war. This disinformation fits well with the traditional Russian policies aimed at increasing tension and distrust between Ukraine and its Western partners, as well as at forcing a focus on hypothetical threats rather than on solving real problems. From another perspective, the appearance of such theories in the Western media could give new ammunition to pro-Russian politicians who argue that it is necessary to remain neutral on the situation in Eastern Ukraine.

U.S. Secretary of State John Kerry with Russian Foreign Minister Sergey Lavrov in Vienna, Austria, on November 23, 2014, before the two begin a bilateral meeting amid broader negotiations about the future of Iran's nuclear program. Source: U.S. Embassy in Vienna, Austria, https://flic.kr/p/pTDsbx

This idea took on particular resonance after the publication of a document prepared by European Commissioner Federica Mogerini for discussion 1 by the foreign ministers of EU member states. The document highlights potential areas of cooperation with Russia on Syria and Iran, but rules out a return to former relations with Moscow. After John Kerry’s visit to Sochi, American media outlets began discussing the White House’s prioritization of the Iran crisis over the Ukrainian one2. Russian3 and Ukrainian4 media went further and began to loudly discuss the exchange of Russian assistance on an agreement with Iran for U.S. disinterest on events in Ukraine.

American diplomats refuted rumors about a “regional trade-off,” but confirmed the connection between the signing of an agreement on Iran and the West’s position vis-à-vis Ukraine. According to a statement made by Assistant Secretary of State Victoria Nuland, the U.S. does not regard “Russia’s actions as a favor to the U.S. or anyone else.” 5This is once again evident from the recently introduced, increasingly targeted sanctions. In addition, both questions remain on the agenda of the international community and are related to one another. According to Secretary of State Kerry, the rejection of the accords by the U.S. Congress could give the partner countries the ability to step away from the Ukraine issue.6

The Energy Dimension: Fewer Resources for Imperial Ambitions

The signing of an agreement with Iran did not come as a great surprise to oil markets. World prices did not fall significantly, since the market expected a successful conclusion to the negotiations. In addition, discussions are currently ongoing about how quickly Iran will become a full-fledged player in the “black gold” trade and how its growing export potential will make itself felt. For the global market, this will become a significant factor influencing the price of “black gold."

As long as it carries out its obligations according to the agreement, Iran can quickly and actively begin full-fledged oil exports in 2016. According to Iranian officials, the country is ready to increase exports by 1 million barrels of oil per day. American experts are more conservative: their estimates range from 300 to 500 thousand barrels per day.7 According to a World Bank estimate, Iran’s entrance into world oil markets could lower prices by 10% in 20168. Russian experts warn that, as the owner of the largest tanker fleet in the world, Tehran could actively begin trading quickly, which would lower the world price of oil to $40 per barrel.9

"Who has the oil?" A map of the proven oil reserves in the world. Source: Western Oregon University, http://www.wou.edu/las/physci/Energy/oil.html

The removal of sanctions on Iran could create problems for Russia in other areas. In the beginning of 2014, Russia began to negotiate a barter agreement with Tehran (the so-called “oil-for-goods” deal), according to which Iran was to supply Russia with up to 500 thousand barrels per day in exchange for goods worth up to $20 billion. No oil was supplied under this barter agreement because of Russian attempts to insert an intermediary firm into the agreement and the drag this put onto the negotiations10. After the signing of the nuclear agreement with Iran, the rationale for this barter system would disappear, since it will be more convenient for Iran to sell oil on the world market.

In spite of warm Russian-Iranian political relations, economic cooperation will become more complicated for Russian companies than it had been when Iran was isolated. Immediately after the signing of the agreement, Iran informed investors of $167 billion in possible energy projects, and a range of large Western companies have already begun negotiations on participating in them. Against this background, weakened Russian companies will not be able to effectively compete, and thus will lose a great deal of opportunities for bilateral energy cooperation.

All of these factors will weaken the already sluggish Russian economy, impact the value of the ruble, and hasten inflation. Russia is already experiencing unprecedented economic problems. According to Rosstat, in the second quarter of 2015 GDP fell 4.6%, which is equal to the worst quarter of the 2008-2009 crisis. Apart from the sanctions, the falling price of oil has played a large role. 11If the price continues to fall (and the entrance of Iran onto the world market will cause this), Russian economic indicators could fall even lower than the “infamous 1990s.” Although few Russian political experts believe a Russian analogue to the “revolution of dignity” is possible, Russian authorities will nevertheless be compelled to take increased domestic discontent into account and will shift money from large-scale, geopolitical imperial projects over to domestic needs.

This will, in turn, force Russia to decrease its ambitions regarding Ukraine—and not only in terms of waging war, financing terrorists, delivering so-called “humanitarian aid,” or supporting Crimea. This also relates to Russian policies of “decimating” energy markets in Ukraine by buying strategic objects, such as refineries and transportation infrastructure, and freezing them according to Russia’s interests. When forced to count its money more carefully, Russia’s leadership may no longer be able to carry out such a strategy.

The Gas Dimension: Competition for Gazprom in the European Market

The approval of the Joint Comprehensive Plan of Action, confirmed by the UN Security Council, and its subsequent implementation allows Iran to contemplate a return to world energy markets. In view of its price fluctuations, the global media pay a great deal of attention to oil, the export of which Iran can greatly increase over the next two years.

At the same time, the question of Iranian natural gas receives less attention, although the Joint Comprehensive Plan of Action clearly provides for the removal of restrictions on the import and transportation of gas from Iran, as well as on the export of key technologies for gas extraction and investment in the country’s natural gas sector. 12In addition, the document contains language about the removal of Western sanctions on “the purchase, receipt, selling, transportation, or marketing of oil, petrochemical products, and natural gas from Iran,” specifically including liquefied natural gas (LNG).13

The country’s potential is enormous: proven reserves are the second-largest in the world at 1,201 trillion cubic feet (34 trillion cubic meters), which is 17% of world reserves. In 2014, Iran became the third largest gas extractor in the world, after the U.S. and the Russian Federation.14 The corresponding number for marketable gas was 6.5 trillion cubic feet (184 billion cubic meters), and an additional 1.6 trillion cubic feet (45.3 billion cubic meters) were used in stimulating oil wells or burned off as waste.15 According to OPEC figures, Iranian gas production reached 212.8 billion cubic meters.16

Such a situation allows Iran to make its presence felt on the world gas market. The country currently plays only a small role, making up less than 1% of the worldwide gas trade17 and selling gas only via pipelines. According to OPEC, the country exported only 8.36 billion cubic meters of gas in 2014.18 In the words of Ali-Reza Kameli, director of the National Iranian Gas Exports Company, Iran’s export strategy focuses on supplying neighboring countries; the expansion of exports to Europe and LNG production remain long-term goals.19 Iran is already negotiating the purchase of floating LNG terminals, the creation of export corridors to Iraq (on a small scale—5 million cubic meters per day)20 and Pakistan (Chinese investors have expressed interest)21, and on unfreezing the large-scale “Iran-Turkey-Europe” gas corridor, which could reach 35 billion cubic meters annually.22

Iran’s entrance onto the world LNG market will have a delayed effect: besides having access to the Straight of Hormuz, which is a key LNG transport route, the country has to build export capacity from scratch. Apart from this, the country will be subject to regional competition with Qatar, which holds a strong position in the oil market. At the same time, it is possible that increased competition will cause market participants to redirect LNG supplies toward new markets.

In terms of pipelines, according to the National Iranian Gas Company, the country can potentially supply European markets with 25-30 billion cubic meters of gas annually23, although this would require at least $10 billion in investments.24 Iranian gas exports to Europe are possible within the next 5 years. For example, through the National Iranian Oil Company, Iran is already present in the gas space through the Shah Deniz-2 project, which is a key source of gas for the Southern Corridor—the Trans-Anatolian Natural Gas Pipeline and the Trans-Adriatic Pipeline (TANAP-TAP), which would offer the EU new suppliers.

The expansion of the Southern Gas Corridor, which would satisfy EU demand, will be made possible to a great extent through Iranian gas. Tehran can already increase supplies through the Tabriz-Ankara pipeline, which is only currently being used at 70-75% of its capacity, from 10 to 14 billion cubic meters per year.25 Iran can also become a key transit country for gas from Turkmenistan, since it already purchases up to 1 billion cubic meters of Turkmen gas per year to cover seasonal increases in demand26 and increase sectoral investments27. At the same time, much depends on Turkey, which is interested in strengthening its role as a gas hub for Europe. According to a current contract, Iran is to provide Turkey 10 billion cubic meters of gas annually. Other options, however, are being considered, including through Azerbaijan, Georgia, and the Black Sea.28

Thus, over the next 5-7 years, existing gas suppliers to Europe, specifically Russia’s Gazprom, will face increased competition. The more gas Iran supplies to the EU, the more attractive reversed gas supplies to Ukraine will become for European suppliers. Another option made possible by a common European gas market will be swap agreements by which Ukraine receives gas directly on its territory through the exchange of Russian gas for Iranian or Turkmen. At the same time, in order to realize its gas export ambitions, Tehran must await the removal of sanctions and receive multi-billion dollar investments, which will become a guarantee of its resumption of economic relations with the countries of the West.

KRYTYKA expresses deep gratitude to Markian Dobczansky for his volunteer work in translating this article from Ukrainian into English. English text edited by David Kurkovskiy.

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