At the end of the 19th century, Lord Curzon, then the British Viceroy of India, described Iran and its neighboring Arab countries as “pieces on a chessboard upon which is being played out a game for the domination of the world.” Fast-forward to the 21st century and not much has changed, as the ongoing nuclear negotiations between Iran and the West have started to show implications well beyond the Middle East peacemaking process, even spilling over into the European Union’s strategic decisions on how to consciously uncouple from Russia’s gas supply monopoly. So far, while Iran reached an interim one year deal with the West in early 2013 to freeze all nuclear activities on the condition of being provided with a temporary easing of some sanctions, the pace of progress remains slow. For now, the West is failing to propose an attractive policy that would alter the intransigent stand of the Iranians. Meanwhile, European-Russian relations have taken a turn for the worse with the illegal annexation of Crimea, the deliberate destabilization of Ukraine by Russia, and the imposition of restrictive EU measures against the Russian Federation. While the political stance has many economic implications for Europe, the most stinging aspect is Russia’s tightening monopoly over the European Union’s energy supply. Moreover, with Germany’s decision to stop all domestic nuclear energy production after the environmental backlash experienced after the Fukushima incident, the European Union is likely to substitute even more of its energy demand with natural gas from Russia rather than polluting coal from Eastern Europe. If the European Union intends to speak with one voice vis-à-vis Russia and not remain politically influenced by a Russian monopoly on its gas supply, it will have to start diversifying its energy supply.

Realistically, Europe must pursue a win-win strategy with Iran where an easing of sanctions would entail a reciprocated of game-changing magnitude, able to address its main energy supply dilemma. The long-term substitution of Russian gas with supply from Iran is one potential solution. For Iran, replacing Russia as the EU’s long-term gas supplier is a highly lucrative avenue worth exploring, particularly as the recent drops in oil prices have started to impact the government’s federal budget. As a result, the implications for the relationship between Iran and Russia will have to be carefully addressed; where, in recent years they have developed closer economic ties but historically have maintained more of a tense relationship. While there is no complete pipeline network in place that fully connects Iran’s gas grid to Europe, the country is already connected to Turkey via the Tabriz-Ankara pipeline—a prospective solution. The success and political repercussions of such a proposed deal can, however, only be approximated. Still it remains crucial to do so as only then will policy makers be able to negotiate concessions directly addressing deeply intertwined global systemic developments.

Tara Shirvani Graph (Economist)

Europe’s Energy Security: Gasping for Russian Gas

The annexation of Crimea and the consequent threats of gas supply shutouts by Russia have been a crude awakening for Europe and its energy dependency. The Ukrainian crisis has led to the reiteration of an inconvenient truth: when it comes to political negotiation power, Europe will always remain strongly influenced by its single dependency on Russian gas supply. According to studies by the European Parliament, in 2013 Russia provided 43.2 percent of the European Union’s gas imports, 31.38 percent of its oil imports, and 26.7 percent of its coal imports. As oil and gas exports to Europe account for almost 52 percent of Russia’s federal budget income (US$515 billion), the Euroepan Union acts not only as crucial trade partner for Russia but also as vital economic crutch to its rather fragile real economy. The magnitude of the EU-Russia energy dependency becomes ever more apparent when analyzed on a per country basis (see figure above).

Several eastern and northern EU member states, including Lithuania, Estonia, Bulgaria, and Slovakia, rely on a single Russian supplier and single pipeline route for up to 80-100 percent of their annual gas supply. Other EU members have managed to hold a relatively diversified energy portfolio where Russian imports, nevertheless, hold a dominant share; Germany, for instance, sources up to 40 percent of natural gas from Russia. With Gazprom owning most of the pipeline network into the European Union, it is able to charge member countries different gas prices and leverage its dominant position in the market. As 50 percent of Russian gas imports transit through Ukraine to provide these countries with about 16 percent of gas consumption, a Ukrainian transit halt scenario would mean an imminent EU security threat. The European Parliament has stated that in this scenario, up to 86 billion cubic meters (bcm) of gas per year would have to be reallocated. As a result, Italy, Turkey, Germany, Czech Republic, and Hungary would feel the economic pinch most severely. According to research by the University of Cologne analyzing the available gas reserves of EU member states, the consequences of a complete Russian gas embargo would be first felt by Finland after one month, Bulgaria and Poland after three months, and by Greece, Estonia, Hungary, Cyprus, Slovenia, and Austria after six. Germany, Italy and France would fall within a nine-month grace period before gas storages are fully depleted.

At first glance, the last rounds of sanctions by the European Union imposed onto Moscow seem considerable enough to alter Russia’s political stance and force the European Union to rethink its energy policy. However, with the latest sanction package only intending to target the Russian oil industry and its access to credit, the decision to exclude the gas trade will in many ways be less economically stinging for the Union. Crude oil, a commodity which is regularly traded on the international markets, is simple to store and transport, and can easily be sourced and sold by both partners elsewhere. On the contrary, natural gas is mostly sold as part of long-term contracts to o set the cost of a pre-existing and highly expensive pipeline network system. Still, prices will always be influenced by political instability in transit countries like Ukraine or Belarus.

With the widening rift between the European Union and Russia over the political situation in Ukraine and Syria, Vladimir Putin began to give Europe the cold shoulder and rebalance gas supplies eastward. Consequently, Moscow recently signed the single largest deal in the history of the former USSR: a US$400 billion gas contract with Beijing, providing China with 30 years of energy supply. Likewise, Putin’s abrupt abandonment of the South Stream pipeline project, intended to ship Russian gas via the Black Sea to Bulgaria by circumventing Ukraine, proves that Russia is not willing to cave anytime soon unless the Union drops its opposition to Russian meddling in Ukraine. As a result, European energy companies have a strong vested interest in developing alternative pipeline routes and finding new gas suppliers, and as such, have started to lobby for alternatives. The shift of natural gas supply from Russia to supply from Qatar, Algeria, or Norway is an avenue worth exploring, if the EU is willing to accept a substantially higher energy bill. Still, one should note that due to the current fragile economy of several EU member states, a higher national energy bill, not phased in over the long-term, can lead to higher levels of inflation and possibly a prolonged period of recession.

Gas Supply from Iran: Europe’s Long-Term Saving Grace

While the European Union is not importing any oil and gas from Iran to date, the long-term potential of opening and stabilizing trade patterns with the energy-rich country should be carefully considered. This is especially important given that alternative energy suppliers en par with Russian gas exports are few and an EU increase in energy efficiency measures and renewable energy sources remains incomparable in scale and impact. With falling oil prices currently falling below the benchmark price required for the Iranian government to balance their federal budget, a window of opportunity has opened up for the two counterparties to find a way out of their impasse.

From a supply perspective, Iran’s gas production volumes are more than promising. According to recent BP statistical reports, Iran holds the second-largest natural gas reserves after Russia—equivalent to 15.8% of global total gas reserves. It shares the world’s largest offshore gas field, the South Pars/North Dome field, situated in the Persian Gulf with Qatar which holds an estimated 1,800 trillion cubic feet of natural gas. After the Islamic Revolution of 1979 and the Iran-Iraq war, the country suffered from a notorious lack of sufficient refinery capacity which diminished its total production volume for natural gas to 166.6bcm, of which it currently only exports 9.4bcm. The European Parliament has highlighted Iran’s total export capacity to be more than 150bcm/year, which in the future, could easily rival current Gazprom’s export volumes of 140bcm to the European Union.

While there is no pipeline network that currently fully connects the Iranian gas grid to Europe, the country is already connected to Turkey via the Tabriz-Ankara pipeline. This section transports gas from the South Pars gas field to the city of Bazargan at the border of Turkey. Iran is strongly bidding for the continuation of the pipeline network with the construction of the ‘Persian Pipeline’: A 3,300km network system which crosses Turkey before reaching Italy. Here it splits into a northern and southern section, transporting gas to Germany, Austria, Switzerland, France and Spain. The capacity of the Persian Pipeline is estimated at ~37-40 bcm per year and would require foreign investments of around USD 7billion. This route would bypass Russian territory and allow the EU to import 25-30bcm per year—equal to the total Russian gas export to Italy and Germany in 2013. Another long-term energy delivery option for Iran to Europe would be via Liquefied Natural Gas (LNG) at an estimated export capacity of up to 10bcm/yr by the year 2017. The gas supply would be transported via a pipeline system to the Omani LNG hub and then shipped via cargos to the Mediterranean seaports.

With the trade-offs in the previous rounds of nuclear negotiations not having been attractive enough for the decision makers to sway their positions, there is now a possibility to expand the pie. Europe’s desire to decouple its gas dependency from Russia provides an opportunity for Iran to negotiate better terms with the Union, now potentially more willing to compromise as part of the nuclear talks. Finding a comprehensive solution as part of such a long-term quid-pro-quo strategy could develop a trickle-down effect that can greatly affect the peacemaking process both in Ukraine and Syria. This linkage strategy between Iran and Europe will require long-term concessions from both parties. Herein the European Union vouches to reach a more substantial long-term deal on gas shipments from Iran, which includes investments in upgrading Iran’s refining capacity and the completion of the Persian Pipeline project. In return, the EU would require Tehran to be more compromising as part of the nuclear negotiations and ask Iran to show a sign of goodwill now to get the deal done in time. If for nothing else, the Iranians have an incentive to provide oil and gas to an energy-starved European market to gain a larger leverage as part of its nuclear talks.

With Iran’s consent of this request from the European Union, Moscow will realize that its leverage over EU member countries would wane down in the medium to long-term future. Once Iran has ‘opened up’ and its relationship with the West has normalized, it is likely for the country to be competing with Russia for a larger share of the EU gas market. With a new gas rival on the block, Russia may try to save as much of its grip over Europe as possible. An option would be to strike a deal over Ukraine in an attempt to save one of its main gas transfer countries to the EU—its largest gas market for the foreseeable future.

Despite this potential competition, the relationship between Iran and Russia—developed since the Islamic Revolution in 1979—could seem like a cozy one. Especially since, in recent years, Moscow and China have been avid supporters of Iran in situations of striking nuclear deals, even now with Moscow and Tehran recently negotiating a deal for Russia to construct eight new nuclear reactors—an addition to the existing Russian-built plant in Bushehr. However, it is important to note that nations are mainly driven by self-interest and coalitions are formed as part of aligned interests which are subject to modifications at any point in time. The Russo-Iranian rapprochement is a direct consequence of the current global balance of power. While they have currently developed closer economic and political ties, their relations have historically been far from ideal and warm.

Ever since the Treaty of Gulistan in 1813 and the Treaty of Turkmenchay in 1828, the relationship between Russia and Iran has been tense. Following the military victory of Russia over Iran, Crown Prince Abbas Mirza surrendered control of several considerable territories in the Southern Caucasus, which include present-day Armenia, Azerbaijan, and Georgia. Iranians today still refer to the Russian annexation of land owned by the Persian Empire as the historical origin of their uneasy relationship. The Russo-Persian liaison has deteriorated even further after being unable to agree on the status and ownership of the Caspian Sea together with Azerbaijan, Turkmenistan, and Kazakhstan. Russia, Azerbaijan, and Kazakhstan all advance the division of the seabed and its underground resources along the median line. Such a proposed deal would allow the three states 64% ownership of the underwater area of the Caspian Sea and its resources. Iran does not acknowledge such bilateral agreements as this would leave the country with only 11-14% ownership of the Caspian Sea.

Instead, Iran advocates the transformation of the Caspian Seabed into a joint-ownership model, which would divide the seabed into five equal national shares of 20% each. The final ownership model is of paramount importance for the construction of the Trans-Caspian gas pipeline from Turkmenistan to Azerbaijan along the bottom of the sea. Russia and Iran fail to see eye-to-eye on the final framework and the pipeline deal would require the agreement of all five Caspian countries to go ahead.

As such, Tehran is not cultivating closer ties with Moscow because it believes it to be a viable and trustworthy partner; rather, it found itself with limited options, as its interests today, as in the past, are overlapping more with the West. After all, a surge in Iranian oil exports to Europe after the lifting of sanctions could lower oil prices even further and negatively influence Russia’s growing budgetary pressures. This in fact may encourage Russia to negatively influence Iran from entering the market in the long-term.

Regardless of Iran’s potential for considerable gas exports in the future, the current spare capacity of Russia’s pipeline network system will shape the nation as the dominant energy supplier of the European Union for the foreseeable future. Iran is well-advised to continue reforming its domestic energy sector, fortify its efforts of normalizing relationships with the West, and shape up to be the credible energy provider of choice for the European Union in the midterm future.

One should note the possibility that an imminent EU-Russia-Iran rapprochement, based on the above outlined long-term strategy, also has the potential to be transposed onto the peacemaking process in Syria. A more compromising Iran, Russia, and European Union will send a strong signal to the conflicting parties: that the international community is addressing this conflict from a single voice—ultimately reducing the possibility for forum shopping. Yet, it is important that the European Union, Russia, and Iran realize that newly negotiated order is in their best interests. Ultimately, Iranian gas supply to the EU can be the crucial building block in that direction.

The views expressed in this article are solely those of the author and do not express the views of the World Bank, its Board of Executive Directors or the Governments they represent.