What's Really Behind Russia's Massive Oil Deal With Iran?

The enemy of my enemy is my friend: At least that's what Russia and Iran are thinking right now.

Aug 22, 2014 at 8:09AM

What's the best way to upset the United States? Russia may have figured it out: Help Iran get around sanctions designed to stop it from developing its nuclear program. Is this political theater, or is there some meat to this off-again, on-again deal?

Yes, no, maybe so
There's no doubt that something is going on between Russia and Iran, but it is less than clear what exactly that something is. Russia, for example, reported the deal, then retracted the announcement. The very next day, it announced the deal again.

Although that makes the agreement look tentative at best, there's good reason for the pair to be hooking up. Both are dealing with economic sanctions. Such punitive actions could make life difficult for Russia, but they are actively making it hard for Iran right now. When you are blocked from dealing with other countries, you naturally gravitate toward countries that are also on the verboten list.

Source: Kremlin.ru, via Wikimedia Commons.

The outline of the deal, which is all that's available, suggests it is a five-year agreement worth up to $20 billion. Russia will provide goods and services to Iran, including food and oil industry expertise. Iran, meanwhile, will get an outlet for its oil. And a big one! Russia appears willing to buy up to half of Iran's oil exports, or roughly a fifth of its total output.

What is Russia really doing?
It's fairly clear that Russia is taking a jab at the United States. After all, the United States is leading the effort to stop Iran's nuclear ambitions. And the United States has been one of the most vocal in the Ukraine row, where Russia is playing the part of the antagonist. One of the biggest efforts has been energy-industry sanctions driven by the United States and EU, though they largely relate to the oil industry and leave deals made prior to August unscathed.  

In a tit-for-tat move, Russia recently unveiled food sanctions that will hit Europe relatively hard. Russia accounts for around a quarter of European fruit and vegetable exports. However, Russia's retaliatory food ban will likely have little if any impact on the United States. That's because the largest U.S. food export to Russia is chicken, but it only amounts to 8% of that U.S. industry's exports. The poultry trade group set the record straight: "we do not expect that a Russian ban on U.S. poultry imports will have a great impact on our industry."

So, while the United States will likely hear about the food ban from its allies, Russia needs to find another way to get under the United States' skin, as it were. And this is a great way. According to Russian Energy Minister Alexander Novak, Russia will help bring Iranian oil to market and aid in the construction of power generation among other things.

Source: ReubenGBrewer, via Wikimedia Commons.

So Russia, which really doesn't need oil because it has plenty of its own, is potentially going to help Iran evade sanctions. Then it's going to help build power generation, which one could interpret as a vague reference to nuclear power, and the nuclear knowledge that goes with that. Which, of course, is a touchstone for the United States. And, if Russia is helping Iran get by without having to engage with the rest of the world, then U.S. sanctions become more bark than bite.

Who needs who more?
In the end, this deal is bigger for Iran than it is for Russia. Iran is looking to boost its oil output to 5.7 million barrels of oil a day from around 3 million barrels. But it really needs help from the outside to achieve that 2018 goal (let alone a market to absorb it). Russia is basically giving Iran the ability to achieve what was once just a toothless challenge to U.S. sanctions.

None other than Russian-controlled energy giant Gazprom (NASDAQOTH:OGZPY) is stepping to the plate on the oil front, saying it's still interested in a soured Iranian deal. Meanwhile, Zarubefneft, another Russian oil company, already has approval to work in the country. Food and other items listed in the agreement will be a big help to Iran, too.

Since history shows that neither Russia nor Iran have proven to be reliable partners, this deal could crumble at any time. And while it is largely political theater from Russia's side, Iran will benefit mightily from the help. That could make U.S. sanction goals much harder achieve in what was once an isolated nation. Like it or not, Russia and Iran just scored points at the expense of the United States.

But scoring points could backfire for Russia and the Western energy companies doing business there despite the sanction games going on. That's because the harder Russia pushes, the more likely it is that the United States and its allies will feel compelled to impose stricter sanctions. The best way to do that is to take a harder line against Russia's energy industry and, indirectly, global energy players working with the country. If you own an oil company doing business with Russia, keep a close eye on this Iranian deal -- it could be more costly than you might imagine.   

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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