The Iranian president is making his first official visit in 20 years to Europe, yet Russia is not on his itinerary. Can the Kremlin still rely on Iran as a partner?

Iranian President Hassan Rouhani, center, and Iranian Foreign Minister Mohammad Javad Zarif, right, arrive for the signature of bilateral agreements, at the Elysee Palace, in Paris, January 28, 2016. Photo: AP

Throughout the negotiations on Iran’s nuclear program, Russian officials argued that the lifting of sanctions could present unique economic opportunities for Russia in the Iranian market and could significantly boost bilateral trade. Days after sanctions relief for Iran, these statements seem particularly dubious as European nations become the first ones to reap the benefits of the nuclear deal.

Iranian President Hassan Rouhani is making his first official visit in 20 years to Europe, yet Russia is not on his itinerary. Earlier this month Chinese President Xi Jinping visited Iran and sealed multi-billion-dollar deals. It seems that international delegations are flooding Tehran attempting to capitalize on what has been described as the last lucrative market on Earth.

High-profile Russian delegations, however, are notably absent in Tehran. The question arises: How much can Russia benefit from the newly reopened Iranian market and is Tehran at all interested in partnering with Moscow when cash-loaded investors from all over the world are knocking on its door?

Oil and gas

There is no doubt that the oil industry is exactly where Iran’s big return is going to hurt Russia. The sanctions relief did not come as a surprise to oil companies and their clients, since this decision had been anticipated for months.

In fact, it is during these months leading up to Jan. 16 that the fears over Iran re-entering the world economy were affecting the energy market. But it is not the oil price crash that Russia should fear but a more long-term factor, which is securing a share of the market that is currently shrinking.

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Presently out of 4.4 million barrels that Russia exports, 3.5 million barrels (approximately 80 percent) are delivered to Europe and about 988,000 barrels are exported to China. Iran supplies roughly the same volume of oil - 992,000 barrels a day - to China (down from 1.8 million in the pre-embargo period) but none to Europe (as opposed to 758,000 barrels in 2008).

Europe and China, where Iran is planning to restore export volumes, are key markets on which the Russian oil industry relies for its survival. The economies of the EU and China are not in the best shape and are not going to create additional demand for Iran to fill, which is why Russian oil companies will have to compete with Iran. The only factor that may be playing into Russia’s hand is time and the pace at which Tehran may start producing more oil.

According to the Iranian leadership, they can quickly boost exports by 500,000 barrels a day within weeks and by additional 500,000 barrels within months. Some analysts doubt that the country’s oil industry is capable of doing so without considerable investment to revamp the production system. By some accounts in a year Iran’s oil fields will yield additional 800,000 barrels at most, not enough to entirely replace Russian oil in Europe.

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Having lost its European market to international sanctions completely in 2012 Iran will now try to restore its position there. The National Iranian Oil Company has already announced that it will provide a $6.55 discount on heavy crude for European customers. By doing so it will undercut both Saudi oil prices (which will come with a $4.85 discount) and Russian oil prices, winning over some customers. While for Iran the oil price does not matter, at this point it does so badly for Russia.

Even though Iran has the largest gas potential in the world, the prospects for export deals with the EU are still questionable. Presently Iran supplies up to 9 billion cubic meters of gas to Azerbaijan, Armenia as well as Turkey annually and is exploring the possibility of building a pipeline to export its gas to Oman, where it could be liquefied. Yet the country lacks its own liquefied natural gas (LNG) facilities to help it quickly enter the European gas market, unlike its major competitor in the Gulf, Qatar.

There are currently five LNG facilities under construction in Iran, including a liquefaction facility that is between 40 percent and 60 percent complete. One of the options available to Tehran is to build a floating natural gas facility that could liquefy, store and load LNG onto sea carriers. This method seems to be more cost-effective for the country.

The only problem at this point is the oversupply in the global gas market and the fact that gas prices are severely repressed. In Europe, Iran’s LNG will have to compete not only with Russia’s gas but also with LNG supplied from the U.S., which has more maneuvering room for lowering  gas prices. While Tehran hopes to start exporting its LNG to Europe within two years, it is likely to enjoy a marginal role in the European market in the medium term.

Defense and security

The one Russian industry that may almost immediately profit from the recovery of the Iranian economy is defense. Russian-Iranian defense and security cooperation had its ups and downs over the past ten years but the general trend was steady growth in the number of deals.

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A notable crisis erupted when Moscow made a decision to put on hold the delivery of S-300 missile systems to the Islamic Republic following the imposition of UN sanctions. As a response, Tehran filed a $4 billion lawsuit with an international court in Geneva. The S-300 non-delivery remained the only hurdle preventing Russia and Iran from increasing their defense cooperation but in 2015 the two sides settled the dispute and Moscow began supplying these missile systems to Iran.

When Russia joined international sanctions against Iran, the value of its outstanding contracts with the country reached $10 billion, including that for S-300, all of which got frozen. According to Russia’s calculations, it also lost between $1 billion and $3 billion in potential future contracts by joining UN sanctions.

It is expected that by the end of this year Moscow will try to renegotiate these arms deals, just like it did with the S-300 missile systems. However, since 2010 Iran has managed to replace some Russian defense products with domestically produced ones.

Yet Russian-Iranian defense cooperation did not come to a halt as a result of sanctions, it just narrowed significantly. Moscow was still able to supply firearms, radars and some other systems to Tehran, like it did in 2011 when a consignment of “Avtobaza” detectors was sent to Iran.

Russia’s Ministry of Defense lays its greatest hopes for 2016 on Iran. According to the Ministry, this year the Islamic Republic may purchase warplanes, air defense systems, warships and naval equipment from Russia, a total for which could significantly exceed $10 billion.

Months before international sanctions were lifted, Russian media reported a number of deals being discussed between the two countries, including on SU-30 and Yak-130 jets and T-90 main battle tanks.

Russia is in a hurry to sign as many defense deals with Iran as possible. It fears that as soon as Tehran’s relations with the EU and the U.S. improve, it will start exploring the defense market there. To prevent any such competition Moscow’s strategy is to hook Iran onto as many of its arms systems as possible to remain a monopolist in this market for years to come.

Other industries

In other industries prospects for cooperation look slightly less optimistic but are still present. Following the Iran nuclear deal in July 2015, Russia lifted a ban on nuclear cooperation with the country.

Just like in defense, Moscow is Tehran’s partner of choice when it comes to developing the country’s civilian nuclear energy industry. Under the terms of the nuclear deal, Russia’s Rosatom is in charge of shipping Iran’s enriched uranium to Russia. Moscow also agreed to help restructure the Fordow Fuel Enrichment Plant and the Arak reactor to make sure that they aren’t being used to create weapons-grade nuclear material.

More importantly, in March this year the construction of the second nuclear power plant in Iran’s Bushehr will begin with Russia’s participation. The total investment in the project will reach $11 billion. Moscow and Tehran have agreed to build four more reactors at other sites, which makes Iran’s nuclear energy the country’s only industry dominated by just one international company, Russia’s Rosatom.

Russian officials are looking at Iran as a potential source market of agricultural goods, hoping that it can cover shortage in some areas that emerged after sanctions against Turkey were imposed. Russia’s Minister of Agriculture held a meeting with his Iranian counterpart to discuss the prospects of boosting bilateral trade on Jan. 19. They agreed to create a “green corridor” at Russia’s border to simplify the customs procedures for Iranian goods.

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Following the sanctions relief Russia authorized diary imports from four Iranian companies that could amount to $800 million this year. Chechnya is also reportedly negotiating to barter meats produced in the republic in exchange for Iranian fruits and vegetables. But the one problem that is yet to be addressed is that most Iranian products, including processed meat, dairy, vegetables and fruits, do not adhere to the strict health and food regulation that exists in Russia.

Russia’s aviation industry also pins its hopes on demand in Iran. Late last year reports appeared in Russian media claiming that Moscow and Tehran were negotiating local production of the Sukhoi Superjet 100 airliner (SSJ100) in Iran to replace the country’s ailing fleet. The deal would be a boon to Sukhoi’s civilian aircraft production, which is not doing so good due to decreasing domestic demand for its jets.

However, setting up local production of these airliners in Iran would take several years while Iran is in a desperate need of new planes. This is the reason why Tehran is more likely to rely on Airbus jets in the near future, an order that may be signed soon, while local production of the SSJ100 shall remain a long-term project.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.