As Venezuela, so Iran?

Iranian President Mahmoud Ahmadinejad (C) waves alongside Venezuelan Minister of Foreign Affairs Elias Jaua (C-R) outside of the funeral of the late President Hugo Chavez, in Caracas, on March 8, 2013 (STR/AFP/Getty Images) Iranian President Mahmoud Ahmadinejad (C) waves alongside Venezuelan Minister of Foreign Affairs Elias Jaua (C-R) outside of the funeral of the late President Hugo Chavez, in Caracas, on March 8, 2013 (STR/AFP/Getty Images)

Iranian President Mahmoud Ahmadinejad (C) waves alongside Venezuelan Minister of Foreign Affairs Elias Jaua (C-R) outside of the funeral of the late President Hugo Chavez, in Caracas, on March 8, 2013 (STR/AFP/Getty Images)

The recent election upset by Hassan Rouhani, who will shortly become Iran’s president, as well as a period diplomatic repositioning from Tehran and Washington to Moscow and the Middle East, begs the question how the Iranian stalemate with much of the West and Arab world will evolve.

Iran’s citizens have loudly demanded—and Mr. Rouhani has hinted at—a new approach to overcome economic hardship imposed by Western nations suspicious of its defiant nuclear program.

Its oil and condensate exports of around 1 million barrels per day (bpd) continues to plummet, from 2.5 million bpd in 2011 and 1.5 million bpd in 2012. Sanctions have also hit Iran’s currency, inflation, banks and foreign investment, which has complicated other exports and increased poverty. This is slowly and undeniably undermining Iran’s economy. Damage to the economy will continue unless the West eases sanctions.

“It’s not simple to read, but Iranians want an improvement in their lives. They want to get out of the mess they’re in,” said Dr. Leo Drollas, director and chief economist of the London-based Centre for Global Energy Studies and former head of energy studies at BP.

That does not mean Tehran is going to forego enrichment, as the West demands: most Iranians are also proud of their nuclear program, and it is unlikely that the regime will back down now.

The regime’s calculations will inevitably be affected by the unexpected election result, more than by sanctions. There is a pragmatic middle ground that could allow Iran to keep its nuclear program, but only after full disclosure that convinces global powers it is not seeking a weapon. Going forward, negotiation will circle these grey areas.

The parallel story of anti-American ally Venezuela offers a glimpse of what such pragmatism could look like. Venezuela’s economy has passed its inflection point. In the years since, it has been discreetly and slowly improving relations with foreign investors, with mixed results, while publically keeping the confrontational anti-American rhetoric that provides political ammunition at home.

Unsustainable trend

Iran’s oil exports dropped to 700,000 bpd in May, the lowest in decades, but that does not include unaccounted-for sales that sidestep sanctions. Volumes were also much higher at the beginning of the year, and China is increasing its imports.

Meanwhile, production dropped nearly 20 percent in 2012, while domestic demand in the past decade has increased around 30 percent. Put it all together, and the result is Iran’s oil revenue dropped more than USD 25 billion in 2012 from the previous year, and it will drop significantly more this year—especially because US lawmakers are trying to further tighten sanctions.

Beijing remains the most influential player in Iran’s nuclear calculations, considering China is its single largest oil customer. Chinese imports from Iran jumped more than 50 percent in May from April to 550,000 bpd, the same volume as in 2011 and as in May 2012, before the strongest European and US financial and oil import sanctions went into effect.

Expectedly, other heavy oil producers have replaced Iran’s crude supplies. In 2012, Venezuela increased its exports to China 33 percent over the year before, followed by Russia at 31 percent and Angola at 28 percent; the United Arab Emirates also increased its oil exports to China by 30 percent.

Venezuelan lessons for Iran

Venezuela, which has also ramped up supplies to other Asian customers, notably India, offers valuable lessons about the benefits of pragmatism when it comes to defying the West and saving face at home. Venezuela is continuing to expand its markets to decrease exposure to the US, which explains its increased focus on Asia—although its involvement with Beijing is mainly to satisfy Caracas’s own debt obligations. Venezuela borrowed some USD 40 billion from the Chinese government, which is to be paid back in oil. To that end, Venezuela has been shipping between 400,000 and 500,000 bpd to China.

The populist and socialist revolution inherited by Venezuelan president Nicolás Maduro from now-deceased caudillo Hugo Chávez used the state oil company, Petróleos de Venezuela SA (PDVSA), as a piggybank to fund a myriad of social development projects that allowed the revolution to consolidate its hold on power over 13 years. Chavismo pushed its confrontational policies—good for populism but bad for business—as long as it could, and managed to last over a decade. But by 2010, its public budget requirements and debt obligations had started climbing toward unsustainable levels.

First Chávez and then Maduro toned down their rhetoric to attract more investors, offering better terms and more stability in the oil industry, successfully attracting funds that nonetheless were diverted to other sectors, leading to output stagnation. But there are early signs that could change. Over the past several weeks, PDVSA has signed several loan deals worth USD 9 billion, including a USD 2 billion deal with Chevron, a USD 1.5 billion one with Russia's state-owned oil firm Rosneft, and a USD 4 billion agreement with the China National Petroleum Company, along with a separate USD 1.5 billion financing deal with service provider Schlumberger to pay outstanding debts.

Maduro had to bow to investor pressure that demanded that all new funds went to oil joint ventures. He had no choice, because without the additional production the economy, and thus his hold on power, will erode.

Iran’s inflection point

“On the surface, nothing has really changed, apart from the hope from election win,” said Dr. Drollas. “Iran is trying to head toward cat and mouse game, willing to talk, willing to show some things, while at the same time they carry out as secretively as they can their deep nuclear program, not only metaphorically, but under mountains.”

Ayatollah Khamenei, the ultimate decider on nuclear issues and foreign policy, realizes that time is not on his side, especially as West continues to ratchet up pressure and rising domestic economic pain is weakening the regime’s hold on power.

Ultimately the question is when, if at all, Iran's very entrenched hardliners who protect the regime, like the Revolutionary Guards, will budge. It is true that Iran will not be defeated by oil sanctions, but neither will it win. That will especially be the case this decade, when unexpected global oil output will keep prices around USD 100 a barrel.

Economic issues will increasingly weigh on what has so far predominantly been a political and strategic standoff. Iran’s regime, which relies on oil exports for more than half of its revenue, is approaching a tipping point—especially now that its citizens are demanding a reprieve.

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