The Russian-Iranian Energy Relationship

Petroleumworld`s

The Russian-Iranian Energy Relationship
By Florence C Fee

Are Russia and Iran, with 20% and nearly 50% of the globe’s provenoil
and gas reserves, likely to develop a policy of coordination of
production and exports, potentially influencing global prices and/or
supply, to the detriment of energy consumers? In a world where energy
importing countries are newly concerned about security of global
supply, this has become a legitimate question.

This author would argue that if one examines past history, current
Russian and Iranian national interests, and the complexities
surrounding their modern bilateral relations, it is difficult to
envision Russia and Iran being inclined, or even able, to create an
alliance to coordinate their oil and gas output and exports.

It is fundamental to remember that Russia and Iran have long been
historical rivals. For both the Soviet Union and successor state
Russia, Persian-Muslim Iran was neither a client state nor a close
ally. The consequences of this competitive historical relationship can
still be felt today. And while both countries have, since 1991, forged
solid, growing, state-to-state relations, and in some cases relations
of mutual dependency, their overall energy relationship is marked by
competition, friction, and ambiguity. Further, relations are mainly
regionally focused, centered on the Caucasus/Caspian Sea and Middle
East areas and include some very divergent market positions. A main
feature of Moscow’s interactions with Iran have been to further
advance Russian interests in these two geographic areas which Iran
straddles, the Caspian Sea and Middle East.

Reserves

The possibility of a coordinated energy policy by both states has been
occasioned by growing international awareness of the enormous
hydrocarbon reserves of both states, the fact those reserves are
firmly under state control, and the willingness of both states to
affect energy policy for wider geopolitical purposes.

Russia and Iran control about 20% and 47% of the world’s oil and gas
reserves. Conservative estimates are that Russia today holds 48
trillion cubic meters (tcm) of natural gas reserves, or nearly 30% of
the world’s total. This excludes the huge upside gas
exploration/development potential of Russia’s Northern and Arctic Seas
and continental shelf. As regards oil, Russia holds 75bn barrels or
approximately 8% of world oil reserves. Again, exclusive of
yet-to-be-discovered oil reserves in the vast prospective onshore East
Siberia region nor offshore in the north and Far East. Iran holds 27
tcm of gas reserves, or about 17% of the world aggregate and possesses
138bn barrels of oil or 12% of world’s total. Given this undeniable
reserves base, one may ask what does each state hope to achieve in
their energy policies?

Russian State Interests

As the international affairs maxim goes, nations do not have `friends,’
they have `interests.’ Russia’s national interestsin the energy
sphere, as they relate to Iran, are to:
Secure export outlets for expanding Russian oil and gas volumes,
including developing a predominant globally-competitive LNG industry;
Monitor OPEC, of which Iran is a member, to prevent adverse impacts of
its decisions on Russian exports and maintain price stability;
Secure the Turkish and southeast Europe gas market, from Iran among
others; Persuade Iran to join the Russian position on Caspian Sea
demarcation and common access to its surface waters;
Protect a lucrative export arms and nuclear technology market,
including to Iran;
Ensure Russian firms participate more broadly in Iranian upstream
oil/gas plays and other energy ventures;
Cooperate with Shi?a Iran to halt the flow of Sunni Wahhabi Islamic
fundamentalism into Russia;
Partner with Iran to promote a longer-term Asia-to-Europe trade and
transportation corridor to rival the Suez Canal.

Iranian State Interests

Iran’s State interests, as they relate to Russia and energy, are to:
Expand its oil and gas production capacity and develop its offshore
gasfields, including monetizing the huge South Pars field in the Gulf,
so as to not lose market share to Russia and other non-OPEC producers;
Access foreign capital and advanced (ie US/European, not Russian)
upstream oil and gas technology;
Develop export gas markets regionally and internationally, including
developing a new LNG industry;
Promote new gas pipeline markets such as Turkey, the Balkans and
central-east Europe;
Satisfy domestic energy demand for its mostly young 67mn population
living predominantly in northern Iran;
Secure a larger share of the Caspian Sea oil and gas reserves and
counter Russian hegemony of the Caspian surface waters;
Become a major oil and gas transit route between the Caspian countries
of Kazakhstan, Azerbaijan, Turkmenistan and Asia-Pacific consuming
nations.

Indeed, the Russian-Iranian energy relationship is evolving into more
and more points of competition, overlap and intersection. This trend
has been encouraged under the Russian strategically-focused,
geopolitically assertive presidency of Vladimir Putin. But it remains
ad hoc and self-interested on Moscow’ s part. Ironically the growing
interaction in some areas has also been furthered by the indirect
influence of the U.S. sanctions policy towards Iran.

Closely analyzing these State interests reveals the complexity of the
bilateral relationship.

Export Outlets

Russia is the world’s largest gas producer and exporter and second
largest oil producer. It relies on energy exports for two-thirds of
its export revenues. With oil prices up by $40/B from four years ago,
sustained by strong global and Asian energy demand, energy resource
holders naturally aim to produce and export to the maximum to win
market share and take advantage of high prices. For Russia this is a
special priority and challenge given: (a) itsmassive size within two
continents Europe, and Asia, plus the Arctic, (b) the fact that its
energy export transportation systems are transitioning from the
Soviet/Comecon era to present Russia and newly independent neighbors,
(c) recent problems with Russian export transit states, and (d) the
fact that its national economy is hugely dependent on export oil and
gas revenues making energy outlets all the more important. The Russian
goal has become building and increasing the capacity of as many export
outlets, on its territory, as possible.

Such export `outlets’ can encompass export infrastructure such as
pipelines, crude and product terminals, LNG liquefaction and
regasification plants and LNG tankers, river barges, ice-breaking
tankers, etc, as well as swaps since, in the absence of pipelines,
swaps can result in increased exports to world markets. For Russia it
is vital to have as many export outlets under its control and
operating at maximum capacity in order to defend important existing
markets such as Europe and create new exports markets in Asia and the
US.

It is now a cornerstone of Kremlin energy policy that Russian energy
resources must be exported across Russian territory, via Russian ports
and terminals, using Russian State-controlled infrastructure such as
pipelines, railways, distribution grids, etc. Russia was leaning in
this direction but recent pricing and security disputes with transit
states Ukraine and Belarus have cemented the policy. Significantly for
Caspian producers, Russia does not view Iran as a transit country for
the export of Russian oil or gas to the Gulf.

Though for many Western oil firms, this export option would make
eminent technical and commercial sense.

Rather, Moscow has given the highest priority to boosting its own
export capacity, first doubling, now further expanding, the Baltic
Pipeline System throughput, completing the Blue Stream export gas
pipeline to Turkey, expanding the Russian Atyrau-Samara pipeline
carrying Kazakh crude into and through Russia, promoting the Nord
Stream gas pipeline under the Baltic Sea from Russia direct to
Germany, and fast-tracking the Eastern Siberian-Pacific Ocean export
oil and gas lines to China and Asia markets.

Despite this priority, in the past year Russia has failed to realize
new export outlets in its territory leading to a slowdown in its crude
production and export growth. The output slowdown may have been due
not only to limitations on export capacities, but also depletion of
fields currently in production.

Nonetheless, this has occurred while neighboring producers Azerbaijan
and Kazakhstan, with the Baku-Tbilisi-Ceyhan (BTC), Shah-Deniz, and
Atasu-Alashankou export pipelines, have opened new Caspian export
outlets to Europe and Asia.

While Russia will undoubtedly participate in exporting Russian
volumes through Atasu-Alashankou, the BTC and Shah-Deniz outlets,
bypassing Russiaand Iran, represent geopolitical and commercial
setbacks for both states.

As regards Russian-Iranian cooperation over Caspian-Gulf oil swaps,
this trade, originally pursued by Russian firm Lukoil, which never
reached a substantial volume, has now been largely supplanted by
Kazakh/Turkmen-Iranian swaps.

Seeking to become an important transit route between the Caspian and
Asia Pacific, Iran has recently expanded its oil facilities at its
Caspian portof Neka and by October 2006, Kazakh and Turkmen crude
shipments through Neka averaged 136,000. The Neka volumes move via
pipeline to the Tehran and Tabriz oil refineries in northern Iran,
with the Kazakh and Turkmen producers receiving equivalent volumes of
Iranian light crude at Kharg Island in the Gulf for onward delivery to
Asia-Pacific and Europe.

OPEC

Both Russia and Iran are major global oil producers and exporters but
as regards OPEC, they hold divergent positions. Russian oil production
in early 2007 stood at 9.5mn b/d of which about 4mn b/d are
exported. Iran hopes tobring its 4mn b/d oil production to a
production capacity (if not outright production) of 5mn b/d by 2008.

While Russia and Iran compete in crude exports as discussed above,
both agree on the need for stable world oil prices. Iran is a member
of OPEC, and Russia is not, nor does it intend to join any time
soon. As a non-member observer, Russia has the best of both worlds:
unconstrained by oil export quotas, and is the beneficiary of the
price stability OPEC quotas provide. At the same time, Russia seeks to
maintain good relations with OPEC as the ultimate guarantor of oil
price stability. This is as true for gas as it is for oilas gas prices
generally lag behind oil prices by about 6 months. And with Russia
being the world’s largest exporter of natural gas gives it
anotherincentive to support, if not join, OPEC.

As an OPEC member, Iran is bound with adherence to its output quotas,
while also facing the imperative need to increase its own production
rates not only for urgent economic reasons, but also for technical
reasons. Iran is concerned to speed the development of its so-called
`shared’ reservoirs or fields, ie oil and gas bearing structures
in borderland areas. These include three major fields: South
Pars/Northern (Iran/Qatar), Azadegan/Majnoon (Iran/Iraq) and Anaran
(Iran/Iraq). Near-term production by contiguous states could harm
Iran’s eventual output levels from those fields. Further
hamperingdevelopment has been the fact that some fields, ie Azadegan,
are strewn with landmines from the 1980-88 Iran-Iraq war.

For Iran and other OPEC producers, Russia is not yet a threat to their
strategy. However should Russian crude export volumes substantially
increase, this will bring Russia and Iran more and more into
competition as the latter struggles to meet domestic demand and pushes
back against the loss of export markets to non-OPEC producers like
Russia.

As regards the potential for a gas `opec,’ whatever Iran’s stated
position, it is highly unlikely that Russia, the dominant producer of
the two, would agree to such a cartel. For Moscow, state control over
export policy is primary; agreeing to cede some of its control, by
coordinating output or export policy with another state or states,
would appear antithetical to current policy.

Turkish And Balkan Markets

This is a market where Russia and Iran are in current competition,
with Russia defending its position and Iran seeking new
markets. Russian gas exports to Turkey are via three pipeline systems:
Transbalkan I, Transbalkan II, and Blue Stream. Turkey is demanding
price concessions for Russian gas having overestimated its domestic
gas demand. Further, the now operational Shah-Deniz gas pipeline from
Azerbaijan, traversing Azerbaijan, Georgia and Turkey, is delivering
Azeri gas into Turkey. Iran would like to compete with Russia ongas
exports not only to Turkey, but also to Bulgaria, Romania and Greece
and further west in Europe (see Nabucco below). This is not a market
Russia will easily cede to Iran.

The proposed Nabucco gas pipeline project, for which Iran would be a
major gas supplier, has the potential to threaten Russia’s hold over
export routes from the Caspian and deliveries to southeast Europe. It
is being supportedby the EU as one means to reduce that bloc’s
dependence on Russian energy supplies, a most sensitive issue
following Russia’s January 2006 disruption of European gas deliveries
over a dispute with Ukraine and a December 2006 crude supply
disruption due to Belarus pricing issues. The 3,300km Nabucco pipeline
would bring 25-30 bcm/yr of gas from Azerbaijan and Iran to central
Europe, bypassing Russia. The line would run from Iran and the Caspian
through Turkey to Bulgaria, Romania, Hungary and Austria. Construction
is expected to begin in 2008.

Russia will vigorously oppose this challenge to its control of Caspian
export outlets, as well as its dominance of the Turkish, Balkan and
east-central Europe gas markets. Russia has signed an agreement with
Nabucco-participant Hungary to explore constructing regional transit
routes in Hungary for supply to east-central Europe and to consider
extending the Bluestream pipeline from Russia to Turkey then to
Hungary and onward to Austria and Italy in an effort to provide an
alternative to the Nabucco pipeline. The progress in advancing
construction of the Burgas-Alexandropolis export oil pipeline from
Bulgaria to Greece, with partners Russia (51%), Bulgaria and Greece,
is yet another manifestation of Moscow’s focus on the Balkan market
and control ofexport outlets.

Caspian Ownership/Security

Russia and Iran continue to dispute legal ownership of the Caspian Sea
including subsea mineral rights. While Russia has been successful in
bringing two other Caspian littorals, Kazakhstan and Azerbaijan,
around to its preferred median-line solution, it is finding it
difficult to win round Iran and Turkmenistan Russia has formally ruled
the Caspian since 1828 when it gained full control of the inland sea
under the Treaty of Turkmenchaisk. After the demise of imperial Russia
in 1917, the Soviet Union granted Iran limited control overa small
part of the sea (13%) in the Soviet-Iranian Treaties of 1921 and
1940. But with the break-up of the FSU, and the creation of three
newly independent Caspian littoral states (Kazakhstan, Azerbaijan,
Turkmenistan), Russia has promoted a median-line solution equidistant
from each state’s coastline, with disputed fields to be developed
jointly. As this solution gives Kazakhstan, Azerbaijan and Russia the
greatest share of the Caspian, unsurprisingly, they are supporters of
this approach.

Iran and Turkmenistan do not accept the median-line solution. Tehran
has consistently held out for an equal share Caspian solution giving
every littoral state a 20% sector, regardless of length of
coastline. This approach gives Iran a 7% share increase (versus
13%). As Caspian development projects have proceeded, it is clear the
northern Caspian basin is more prolific than the southern basin. Thus
Iran’s only hope of gaining a larger share ofCaspian wealth is by
extending its sector size. Also developing southern basin reserves
offshore Iran will be more costly being located in 600-800ms of water
versus 10-50ms in the north Caspian. Tehran continues to insist that
all five littoral states must agree demarcation before joint
exploration-development projects can proceed.

Paradoxically, while Russia and Iran diverge on how the Caspian Sea
should be split, they are united in their opposition to Kazakhstan’s
plansto build a subsea trans-Caspian pipeline to ship Kazakh, and
potentially Turkmen and Uzbek, gas exports, to Europe. Both oppose
construction of pipelines across the Caspian seabed until demarcation
of the sea has been agreed among the littorals. They are agreed that
in having lost market share due to BTC and Shah-Deniz transport
systems, they are not eager to see additional bypass outlets take
shape in the Caspian.

Security represents another contentious issue between Russia and Iran
in the Caspian Sea, particularly over control of surface waters. This
became an especially topical issue in 2006 when the Tengizchevroil
joint venture, the Eni-led consortium developing the Kashagan field,
and the Kazakh state oil firm, Kazmunaigaz, agreed to a create an
export system (KCTS – KazakhstanCaspian Transport System) to deliver
Kazakh crude from Tengiz and Kashagan to the BTC pipeline in
Baku. This system would utilize an oil tanker fleet plying the Caspian
waters rather than a trans-Caspian pipeline and would bypass both
Russia and Iran (as do BTC and Shah-Deniz).

Arms And Nuclear Technology

In nuclear and military assistance, Iran has been a very profitable
market for Russia. For Iran, its dependence on Russian arms is
growing; it is now Russia’s third largest arms buyer. In early 2007,
Iran took delivery of sophisticated Russian Tor-M1 anti-aircraft
missiles, a sale worth a reported $1bn-plus, for defense against air
attacks, including on Iranian nuclear facilities.

Since 1991 Russia has also sold Iran tanks and armored battle vehicles
both critical components for the Iranian army.

Russia plans to undertake a $5bn project to build five nuclear
reactors in Iran. The US opposes those plans claiming the technology
involved is dual-purpose, useable for both civilian and military
applications. Iran defends its right to acquire `advanced nuclear
technology’ for producing nuclear energy and has pledged to cooperate
with the IAEA. The Kremlin insists it has been assured by Tehran that
it has no plans to develop nuclear weapons and has agreed to sign the
IAEA Additional Protocol expanding international inspections of its
nuclear program. From Russia’s perspective, the IAEA position and
Iran’s interest in greater transparency in its nuclear program open
the way for greater Russian-Iranian nuclear technology cooperation. In
the Kremlin’s view however, such an important revenue stream with
Iran is not going to be sacrificed to US wishes.

Iranian Upstream

Russia is not content with the level of Russian firms’ involvement in
the Iranian oil and gas upstream. Delays in rooting Russian companies
in Iran reflect not only Iranian problems implementing the opening of
its energy sector to foreign investors, but also the fact that, for
Tehran, Russian firms are not the preferred operators. Iranians want
to attract the most modern, sophisticated oil and gas field technology
available and in many cases that comes from international energy
firms.

Russian upstream participation has so far included the Russian gas
monopoly Gazprom’s participation in the early phases of the huge South
Pars gasfield;
Lukoil’s interest, with Norsk Hydro, in the 2bn barrels Anaran block
in western Iran next to the Iraq border; and Rosneft and Zarubezhneft
role in the massive Azadegan oil field near the Iraqi border. In the
past, the Russian pipeline construction company, the Gazprom-related
Stroitransgaz, had builta major portion of one of Iran’s main gas
trunk lines between Asaluyeh on the Gulf coast to the Vali Asr gas
processing plant in the interior. Gazprom would also like to build
Iran’s subsea export gas pipeline to India. New Delhi has stated it
will not consider an onshore Iran-India gas pipeline that transits
Pakistan, for security reasons.

But for the Russians, the South Pars field, with its estimated
aggregate cumulative production range of 13 tcm, a stunning one-half
of all Iran’s recoverable gas reserves, and 17bn barrels of
condensate, is the prize. Revenues are estimated to be $11bn/yr,
yielding total revenues of $700bn over the life of the field. Gazprom
has offered to build a pipeline from the project’s landfall to an
onshore oil field (Agha Jari) for gas reinjection. Later development
phases of South Pars are intended as feedstock for producing and
exporting LNG for European and Asian markets. Expanding its holdings
in the Iranian upstream remains a major priority for Kremlin energy
strategists, as well as helping `shape’ the nascent Iranian LNG
industry to ensureit does not become a threat to encroach on future
Russian LNG markets in Europe and Asia.

Muslim Ties

An area where Russia and Iran appear to be in close alignment is the
matter of Muslim ties, specifically the question of the export of
Islamic fundamentalism from Iran into Russia. Radical Shi’a Islam is
not an issue that divides Russia and Iran. Moreover, by strengthening
its cooperation with Islamic Iran, Moscow is able to gain protective
cover with its own 20mn Russian Sunni Muslims. Russia has a legitimate
concern regarding radical Islam fomenting unrest or rebellion in its
Volga and Caucasus Muslim regions. However, it does not see Iran as
representing such a threat. Iran is Shi’a, and Russia sees the
Sunni/Wahhabi form of Islam as more dangerous and
threatening. Sunni/Wahhabism emanates from states such as Pakistan and
Saudi Arabia, not Iran. There are very few Shi’a Muslims in Russia as
the main Shi’a group in the FSU are Azeri Muslims who are of Turkic
origin and largely secular.

In this regard at least, Iran’s foreign policy has evolved from
ideological goals to geopolitical interests best shown by Tehran’s
policy towards the Chechen conflict. After the October 2002 Moscow
theater hostage crisis, the Iranian government’s reaction was
generally muted and supportive of Russia. This position reflected not
only relations with Moscow on Islam as described above, but also
Iranian realpolitik, as well as its dependence Russian military and
nuclear development assistance. But perhaps paramount was Iran’s
concern about the potentially destabilizing effect of ethnic
sentiments among its own minority populations.

Iran’s respect for Russia’s territorial integrity reflects its own
problems with its ethnically diverse population. Iranian minorities –
Azerisin the northwest, Kurds in the west, Arabs in the south,
Baluchis in the southeast, and Turkmen in the northeast – have at
different times expressed separatist or autonomous sentiments. The
theocrats in Tehran fear that someday Iran, like Russia, may confront
a separatist rebellion in one of its provinces. That point of
commonality between Moscow and Tehran and its influence on their
relations cannot be overestimated.

Conclusions

Russian and Iranian energy resources, given their size, both
separately and together, are important to future global energy
supply. In examining the potential for both coordinating their oil and
gas production and export policies, it is clear the likelihood of that
occurring is low, due to the nature of their bilateral relationship,
their multiple competing national interests, particularly over new
export oil/gas markets, and the ongoing impact of their historic
rivalry.

While Iran and Russia do have strong, state-to-state ties across a
wide range of important energy-related issues, it is a complicated
relationship. Both consider themselves partners and allies in some
areas and are clear competitors in others. They appear willing to
resolve outstanding issues (Caspian demarcation); exhibit sensitivity
towards each other’s problems (restive or separatist minorities,
territorial integrity); have many points of mutual dependence (stable
oil/gas prices and markets, arms and nuclear technologytrade, opening
new international trade routes); as well as having points of
competition (oil and gas exports, sharing Caspian resources, securing
regional gas markets; building new LNG industries). Both do not now
coordinate their export gas policies because inter alia they are
competing for similar markets and are both on the cusp of developing
their own LNG industries well beyond their borders and even regions.

One element influencing Russian-Iranian bilateral relations, if
inadvertently, is the US sanctions policy towards Iran which appears
to behaving the consequence of moving Russia and Iran into closer
cooperation. Russia and Iran both seek to assert their independent
foreign policy as a counter to US policy. At the same time, US
dependence on imported gas is growing significantly and is the world’s
fastest-growing market for LNG. Given Moscow’s and Tehran’s
massive aggregate holdings in oil and gas reserves, and recognizing
the complexity and multi-dimensional nature of their bilateral
relations, as well as the low likelihood of their aligning export
production policies, it would seem prudent for energy importing
nations to view them, amongst other issues, in a strategic, long-term,
energy supply perspective.

Florence C Fee is a former executive with Chevron and Mobil, heads
international energy consultancy F C Fee International, Inc,
specializing in risk management in international upstream energy
projects.Petroleumworld not necessarily share these views.

Editor’s Note: This article was was written exclusively for Middle
East Economic Survey ( MEES), is a further development of an earlier
one by the author on "Russian and Iranian Gas and Future US Energy
Security" (MEES, 15 September 2003) – and was originally publish in
MEES, VOL.VOL. XLIX, No 11, 12-Mar-2007. Petroleumworld reprint this
article in the interest of our readers.

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