Oil price drop creates problems for Putin and Rouhani

Both Russia and Iran might react to political and economic isolation by adopting more aggressive foreign policies, says Stephen Blackwell.

Russian president Vladimir Putin. (Vasily Maximov / Reuters)

In view of last week’s decline in oil prices, observers are mulling over the political and strategic consequences. A rapid expansion of oil production in the US has resulted in a global glut of crude. The drop in prices also reflects weak demand and the major exporters’ reluctance to reduce output. Although there have been calls to restrict production, member states of the Organisation of Petroleum Exporting Countries (Opec) are worried that such a move would impact on their market share. For Russia and Iran, two major oil producers at odds with the international community on issues from Syria to Ukraine, reduced revenues threaten serious economic hardship.

Vladimir Putin’s gamble that energy security worries would prevent the West from confronting Russia over Ukraine appears to have been mistaken. Shrinking oil revenues could dramatically compound the impact of sanctions on the Russian economy. Russian banks are already looking to the government for relief from a credit squeeze. Similarly, the finance ministry has cast doubt on a $720 billion plan to modernise the armed forces.

However, Mr Putin will be constrained by diminishing receipts from oil exports. Although Moscow has claimed that a fall in the rouble’s value would partly offset decreased revenues, it will have to intervene at some point to bolster the currency and investor confidence. If this becomes necessary, the only alternative to raising loans on the international markets would be for the Kremlin to draw down on it gold and foreign currency reserves. Mr Putin will resist calls to borrow abroad as he does not want to repeat the experience of 1998 when the Yeltsin government defaulted on its debt. However, there is the risk that sanctions and shrinking revenues could deplete the government’s reserves within two years. Before that point, the fall in revenues could trigger inflation and tip the Russian economy into recession.

The Iranian government is facing similar choices. Since taking office last year, Hassan Rouhani has overseen steady economic growth despite international sanctions. Indeed, the IMF recently forecast that the Iranian economy would grow 1.5 per cent this year and 2.3 per cent in 2015. This growth was kick-started by last November’s initial agreement between the P5+1 powers (the US, UK, France, Russia, China and Germany) and Tehran over Iran’s nuclear programme, which freed up $4 billion in Iranian revenues frozen in overseas accounts. Recent growth has even allowed hardliners to claim that Iran could prosper even if sanctions remain in place.

Despite this optimism, the reduction in oil prices will have an unavoidable impact given that oil exports make up more than half of Iran’s budget. The country’s resources are being stretched by its efforts to prop up the Al Assad regime in Syria.

Although Iran could partially compensate for declining oil revenues by measures such as increasing domestic fuel prices, there is a danger this could provoke serious resentment.

Tehran can only hope to counter falling oil prices by increasing production and exploiting new fields in the Caspian Sea. However, Iran badly needs foreign investment and technological input into its flagging oil sector. Since 2012, the US and the EU have maintained an embargo on Iranian energy imports. Only a deal over the nuclear programme can offer a realistic chance of these restrictions being lifted.

Both Russia and Iran might react to political and economic isolation by adopting more aggressive foreign policies.

Historical mistrust aside, there is also scope for deeper bilateral cooperation. In August, Moscow and Tehran signed an “oil-for-goods” contract exchanging 500,000 barrels of Iranian oil a day in return for Russian goods. Under the terms of the deal, Russia can resell the oil, the most obvious potential customer being China. Also, Iran may be soon offered membership of the Shanghai Cooperation Council, an organisation led by China and Russia that is mooted to evolve into an Asian counterpoint to the Western powers.

Suspicions that the US and Saudi Arabia have orchestrated the flooding of the world oil market will strengthen Russian and Iranian convictions that they face a struggle for survival.

In both cases, it would be unwise to underestimate their determination to prevent international threats from sparking domestic upheavals.

Ideological nationalism, and a growing siege mentality in both Moscow and Tehran, rule out either Russia returning meekly to the negotiating table over Ukraine, or Iran bowing unconditionally to the demands of the P5+1 powers in Vienna.

Though Russia and Iran are feeling the pressure, their responses to the darkening economic skies may be disconcerting.

Stephen Blackwell is an international politics and security analyst