GEOPOLITICS: The Decline of the Petro-Czar

Plunging oil prices have created an unexpected diplomatic bright spot in the global recession by weakening unfriendly regimes.

What a difference a half a year makes. Last summer, when oil prices hit an all-time high of $147 a barrel, so did the hubris of the petro-czars. Vladimir Putin sent Russian tanks rolling into Georgia, laying bare his ambition to restore Russian dominion over the lands of the old Soviet empire. In Iran, President Mahmoud Ahmadinejad was busy bashing the dollar, which he had declared "worthless," and transferring Iran's reserve wealth into euros. Meanwhile, Venezuelan President Hugo Chávez was in Russia meeting with Putin to negotiate arms deals.

The rise of these leaders was the dark side of an otherwise golden era of growth in the global economy. A prospering world was thirsty for oil, and had little choice but to buy heavily from them. Not now. With the world economy collapsing in recession, and falling demand driving the price of oil down to $37 per barrel, the trio of Putin, Chávez and Ahmadinejad are losing their strength. The empires that they built on oil are proving rickety, vulnerable to inflation and joblessness, and now mounting political unrest is jeopardizing their personal power. "High oil prices and oil wealth reshaped geopolitics in recent years," says energy expert Daniel Yergin. "Now we're seeing the reversal of all that."

The decline of the petro-czars is an unexpected bright spot in a grim global recession. Barack Obama has invited America's enemies to talk, and Putin, Chávez and Ahmadinejad are responding with surprising alacrity, in no small measure because the price of oil no longer supports their geopolitical ambitions. Suddenly, these bold challengers of U.S. "imperialism" want to sit down and have a nice chat with the new administration. Chávez, who frequently referred to George W. Bush as "the Devil," has said that he is willing to talk "on equal and respectful terms" with Obama. Last week, on the 30th anniversary of the Iranian revolution, Ahmadinejad declared his nation "ready for talks." Although Putin is still rattling regional sabers, his aides are starting to make friendly noises: "Relations between Russia and NATO," said Foreign Minister Sergey Lavrov, "should get back on track."

It's been widely noted that Obama comes to power facing an extraordinary array of foreign challenges, from Sudan to North Korea, but what distinguished the petro-czars was the scale and aggression of their ambitions. Putin hoped to create a gas cartel to rival OPEC, and continues to battle the U.S. for political influence and control of gas pipelines across Eastern Europe and Central Asia. Chávez had aspired to finish building the Latin empire that his hero Simon Bolívar once dreamed of, including a regional bank controlled by Chávez himself. Ahmadinejad wanted to restore Iran as a regional powerhouse, backed by nuclear weapons, in a Middle East without Israel. It would be very hard to name three leaders whose declining fortunes better serve U.S. interests.

The decline is dizzying. The petro-states are getting slammed harder than most by the global credit crunch. All three had built their popularity on programs of oil-fueled welfare spending, food and energy subsidies, and other favors to the public. Initial 2009 budgets built around all that spending assumed oil would stay between $86 and $100 a barrel. The result is that falling prices threaten not only the economy, but also the political legitimacy of these regimes.

The impetus to keep spending is driving up deficits and fueling inflation, now in the high double digits, despite falling growth. Morgan Stanley predicts Russia will contract by 3.5 percent this year, and that the Venezuelan economy will contract 1 percent (comparable figures for Iran are not yet available). As foreigners flee Russia faster than from any other emerging market, its stock market has fallen further than any other in the world, down 75 percent since last summer. No wonder Putin, whose men turned a blind eye to Russian partners' expelling executives from big Western oil companies like BP as recently as last May, is now sending welcome signals to foreign investors.

The collapse was far from inevitable. The petro-czars set themselves up to fail, by neglecting to invest enough either in improving their oilfields or developing export-income sources other than oil. Other oil states like Saudi Arabia and the Gulf nations are still comfortably flush, according to Washington-based PFC Energy. Meanwhile, Iran and Venezuela are drawing down their savings just to keep their government budgets running. Russia has spent nearly a third of its $650 billion in foreign assets defending the ruble over the past couple of months. PFC estimates that by year's end, Venezuela will have run through 38 percent of the foreign assets it had at the end of 2008, and Iran will have spent some 25 percent. In short: under the current economic conditions, these petro-nations simply can't stay afloat much longer.

Rising unemployment and deteriorating finances are leading to a political backlash. In Iran, factories are closing en masse, and popular former president and reformer Mohammad Khatami is back to challenge Ahmadinejad in national elections in June. In Venezuela, antigovernment protests are intensifying ahead of this week's referendum, which would allow the president to run for re-election indefinitely. In Russia, numerous street protests have broken out over tax hikes and unpaid wages in the steel and manufacturing industries. In response, the Kremlin has passed a raft of nasty new laws. One makes participating in "mass disorders" a "crime against the state." Plans to fire 280,000 Army officers have been shelved, and the Interior Ministry has set up three "special-purpose centers" in major cities, packed with surveillance equipment designed to combat street unrest.

The petro-czars run among the least efficient oil and gas businesses in the world, in large part because they've made it so difficult for outsiders to do business. In Iran, U.S. and U.N. sanctions mean that most foreign companies won't go near the world's third-richest oil reserves. Russia's recent conflicts with BP, as well as Shell, ended with Russian partners' unilaterally redefining contracts and terms of business in their own favor. When oil prices were way up, Chávez renationalized much of his country's petroleum industry and introduced 16-fold tax hikes for foreign companies; many of them subsequently picked up and left. Now that prices are down, he is quietly trying to coax them back in.

Ties to the West are critical, even though they refused to admit it. In the Russian case, particularly, many of its reserves are tough to reach, buried under layers of Siberian permafrost. Tapping them requires both capital and expertise, which are still found in greatest abundance in American and European companies. Consider that while Qatar can break even when oil costs $10.18 a barrel, Venezuela requires more than nine times that to do the same. The petro-czars might have been able to meet their spending commitments when the average price of oil was a hundred bucks. But this year, without big cuts, all their nations will likely fall into deficit.

The smart thing to do would be to reinvest some of the remaining oil windfall to raise efficiency, in order to compensate for lower prices. That is what some Gulf nations are doing, but the autocrats are taking just the opposite approach. "These countries are trying to maximize revenue, not thinking about the longer-term health of the industry," notes Goldman Sachs's chief energy economist, Jeffrey Currie. "Venezuela in particular isn't doing any proper field maintenance, which ultimately could result in a supply interruption." Whether or not he wins the upcoming referendum, most experts believe that dicey finances and growing tension mean that Chávez's hold on power is the most tenuous of all the petro-rulers.

Ahmadinejad's days in charge may also be numbered. The populist leader campaigned on reforming the oil industry; yet, during his tenure, two central-bank governors have resigned, the last one publicly accusing him of plundering the country's sovereign fund. In January, Iran's Supreme Leader Ali Khamenei ordered 20 percent of future petroleum revenues to be banked in a new fund, which some read to mean that he was putting it out of Ahmadinejad's reach. It's not a bad idea given the president's record of economic mismanagement: his energy subsidies, designed to boost popular support, have grotesquely distorted Iran's internal petroleum markets, helping turn the country into a net gas importer. Inflation is running at 26 percent thanks to the president's ill-conceived interest-rate policies, and tens of billions of dollars of handouts to businesses that were supposed to create new jobs have been largely wasted. Even Ahmadinejad's grandstanding moves to switch oil wealth into euros now seems silly, with the dollar lately rising against the euro. Recent human-rights crackdowns by the president might have been ignored when oil revenues were expected to exceed $100 billion this year. Now that lower prices have put estimates closer to $30 billion, the reform faction, led by Khatami, has a decent shot at winning the election.

Though Russia has been perhaps hardest hit by the downturn, Putin is likely to survive. A good chunk of Russia's oil industry still remains in private hands, so "it's mainly been the oligarchs that have suffered so far in Russia, not Putin," argues Bernstein oil analyst Oswald Clint. And as early as 2004, the Kremlin began placing surplus oil revenue in a rainy-day fund, which is protecting Putin now that the rains have come. While there are growing tensions inside the Kremlin over how to spend the money—Putin wants to bail out favored banks and oligarchs, his finance minister wants to build schools—Moscow is still in stronger shape than Tehran or Caracas. Even after spending billions to prop up the ruble since November, Russia's per capita foreign-currency reserves are still $2,734, much higher than Iran's ($1,421) or Venezuela's ($1,046).

Putin, however, continues to insist that Russia will weather the crisis better than the West. He also continues to promise billions in loans and handouts to neighbors like Belarus, Kazakhstan, Kyrgyzstan and Tajikistan in order to prevent the U.S. or Europe from making diplomatic inroads. Can he afford those promises? That depends on how long the recession lasts: Russia's oil coffers could run dry by the end of 2010 if prices don't recover.

There is, however, one scenario in which the oil czars benefit from their own incompetence and the West loses big. As PFC chairman Robin West points out, their mismanagement will eventually cut global supply. "The danger then is that as the global economy begins to come out of recession in a couple of years, you could see oil prices shoot up, in part because these countries didn't invest as they should have." PFC is predicting $60 oil by 2010; plenty of others think it will go even higher.

In the short term, at least, falling oil prices (some analysts see $25 in view) will ease the pain of recession, and the pain in the neck caused by petro-czars. When U.S. National Intelligence Director Dennis Blair testified that the global recession was now the biggest security threat to the United States, having already produced "low-level instability" in roughly one out of four nations of the world, he did not mention the opportunity at hand. It is the opportunity to exploit the even more glaring weaknesses of one's rivals, to talk to enemies whose problems at home open them to compromise. "It's easy to shrug off the effect of sanctions or corruption or bad financial decisions when oil is in the triple digits," says Vali Nasr, recently tapped to work with Richard Holbrooke, Obama's special envoy to Pakistan and Afghanistan. "That's much harder when the revenue is no longer pouring in." And for now, the oil money is pouring out of these petro-nations.


With Owen Matthews in Moscow, Babak Pirouz in Tehran and Michael Miller in New York

(Source: NEWSWEEK—Published Online: Feb 14, 2009)