War in Iraq: What's at Stake for Russia?
Nov 22, 2002 stratfor.biz

Summary

Russia might be too internally fragile to survive a U.S.-led war against Iraq without sliding into a deep crisis. At best, Moscow will be weakened economically, politically and internationally; at worst, the nation could suffer economic collapse and internal instability that severs its status as a U.S. ally.

Analysis

This piece, the first in Stratfor's "Iraq War Stakes" series, examines what is at stake for Russia in a U.S.-led war against Iraq. Such a war probably would affect Russia more than any other world power, with implications that could have a profound impact on the post-bellum world order.

Prospects for Economic Collapse

Russia has much to lose and little to gain in the event of a U.S.-led war against Iraq. For Moscow, virtually everything is at stake: the nation's economic health, internal stability and international standing and influence.

Oil is the blood of world economy, and this blood likely would turn bad for Russia in the event of war. During the course of military action, global oil prices would jump sharply and then enter a deep and prolonged spiral, should the United States win the war and establish control over the Iraqi oil industry -- which likely would mean soaring production levels. On the surface, it would appear that Russia, a major oil exporter, would benefit during the war and suffer afterward, but in reality the nation likely would suffer both during and after the conflict.

Russian oil production is already at maximum levels, meaning that domestic energy companies would not be able to boost production significantly enough to take advantage of higher prices. In order to benefit from a temporary wartime price hike, they would have to increase exports by diminishing sales to Russian customers. Moreover, the prices of Russian gasoline and other refined products would skyrocket with the increased global price.

Therefore, the country could face both an internal supply shortage and cosmic energy prices that would shut many Russian citizens and businesses out of the market. We should not forget that the Russian economy is correctly dubbed a "wild market" in which everything is for sale for a profit. Moscow's attempts to intervene in the market probably would fail: The country does not have strategic petroleum reserves, an idea which is only in the early stages of discussion.

Needless to say, an energy supply shortage or prohibitive prices, or both, would severely hurt industry and citizens alike. Vast, distant regions such as Siberia and the Russian Far East, which already have experienced energy shortages for several consecutive years, would be hardest-hit, possibly leading to the collapse of regional economies and businesses. However, the national economy as a whole would continue to limp along. Should a war in Iraq continue for several months, however, the concomitant supply shortages and high domestic gasoline prices could knock the crutches out from under even the national economy.

Even the more probable scenario of a fairly rapid U.S. victory will not allow Moscow to breathe easily. U.S. control over the Iraqi oil industry would be a likely, if unintended, consequence of military victory and would lead to much higher production levels from Iraq. This is integral to Washington's strategic interest: decreasing global oil prices to levels that would allow a sustained U.S. economic recovery.

During his Nov. 22 visit to Russia, U.S. President George W. Bush said Washington would protect Russia's economic interests in Iraq, although Foreign Ministry sources say he did not elaborate or give any guarantees. To protect Russian oil interests, Washington would have to agree that Iraq's richest fields would remain under Moscow's control following the overthrow of Hussein, and it would have to block the expansion of U.S. energy majors into the country.

It is important to note, however, that there is more at stake in Iraq than Russia's oil concessions -- its oil-dependent economy also would suffer, and Washington cannot protect Moscow from the consequences of a price decline.

According to the Hong Kong-based Asia Times, some U.S. State Department officials say Washington is seeking a crude price of $13 per barrel. Mikhail Khodorkovsky, the head of Russian energy giant Yukos, predicts that oil prices following an Iraq war would be $14-$16 in the best-case scenario for Russia, $12-$14 in the worst.

Washington's oil price strategy is distinctly at odds with that of Moscow, whose federal budget for 2003 is predicated on prices of roughly $24 to $25 per barrel.

Speaking in Houston recently, Russian Energy Minister Igor Yusupov said the nation's economy still would be healthy if oil prices dropped to $20 to $25 per barrel, and the budget even could be maintained at current levels if prices fell to $20 to $21, since Russia could make up the difference with higher oil revenues stemming from the current "war premium." However, the Kremlin would have to slash spending plans if prices fell below $20 next spring or summer, Yusupov said.

Some Russian Finance Ministry officials privately admitted to Stratfor that nothing -- even writing off some Soviet-era debt, which has been discussed with U.S. officials -- would save Moscow's 2003 budget if prices fall below $20. Although national economies can survive even if state budgets are ruined, provided they have some fiscal reserves, this is hardly the case for Russia, where the economy is already in crisis. Russian weekly Argumenty i Facty, citing government experts, writes that the lowest crude price Russia can sustain is $18 per barrel.

Assuming that Hussein does not torch Iraq's existing oil wells, the country could double current production levels to 2 million barrels per day in a matter of weeks or months -- depending upon certain political scenarios -- and likely could reach 5 million bpd within three to four years, Stratfor believes. If U.S. actions in post-war Iraq take global oil prices down to $13, then the Russian economy could slide into a much deeper and prolonged crisis. Not only would there be no clear prospects for recovery, but complete economic collapse could not be excluded either.

Impact on Energy Companies

An Iraq war would have several negative ramifications for the Russian energy sector, particularly for oil companies.

First, the war would significantly reduce the value of their assets, in some cases causing companies to operate at a loss. Their share prices would drop accordingly. Second, the prospects for selling Russian oil directly to the United States would be diminished: Not only does the country currently supply very little of U.S. energy needs, but its oil is also more expensive to extract and to ship than that from the Middle East, and again, the post-war market eventually could be flush with Iraqi production. Third, any chances that Russian energy majors could maintain influence in the Iraqi oil sector would be destroyed.

All Russian oil majors recognize a very real threat of losing their market value should the United States and its energy majors capitalize on victory in Iraq. Their response is to try to sell large portions of stock before the war starts, seeking to accumulate a nest egg to tide them through the rough aftermath of war. Russian major TNK is trying desperately to sell a large portion of its stock to BP, Shell and probably ExxonMobil and TotalFinaElf, RusEnergy reports. BP executives recently held talks with Yukos about acquiring a large amount of that company's stock as well, according to the Wall Street Journal. Sibneft also is considering such a move, Fortune has reported.

However, Western companies are in no hurry to acquire stock in Russian energy firms, knowing full well that time is on their side: After the Iraq war, it should be possible to buy shares of Russian oil majors at a fraction of their current prices.

Moreover, Russian Energy Ministry sources say they fear that once Russian energy companies lose value, U.S. energy giants will acquire them outright -- snapping up key companies and leaving others to go bankrupt. Acquisition by U.S. energy firms might be a good thing for globalization and for Russian oil workers who are picked up by the mergers -- but Russians are afraid that if this happens, their country will lose not only energy security but also sovereignty to the United States.

The future of Russian oil companies' concerns in Iraq also are at stake in the potential war. Russian majors have lucrative contracts in Iraq, all stemming from the special relationship Moscow has maintained with the regime of Saddam Hussein. The biggest of these is a $20 billion LUKoil contract to develop a giant West Qurna oil field, where the Russian company has a 52.5 percent stake in a joint venture. Though LUKoil and other Russian majors currently have profited little or moderately from deals with Iraq, due to international sanctions, they have hoped to seize huge revenues once the sanctions are lifted.

Russian oil majors -- including LUKoil, Tatneft, Zarubezhneft and others involved in Iraq -- fear that if the Hussein regime is toppled, U.S. companies will replace Russian firms as dominant players in the Iraqi oil market. Though the Bush administration denies seeking to dominate the post-war oil market in Iraq, Russians and others have several reasons to doubt these claims.

First, it would be politically natural for U.S. companies to take precedence in the oil market of a country led by a pro-U.S. or even U.S.-appointed government. If the Japanese army were to take over Baghdad, then Japanese oil companies would do the same.

Second, the statements of the pro-U.S. Iraqi opposition further prove to Russians and others that the future of Iraqi oil belongs to the United States. For instance, the Iraqi National Congress (INC), Iraq's main opposition group favored by Washington, recently stated -- not for the first time -- that a post-Hussein government would review existing oilfield development deals with French and Russian companies and could favor U.S. firms instead, Reuters reported in October.

Third, there is some evidence that the Bush administration already is working with the Iraqi opposition to shape the future of the nation's oil industry following the ouster of Hussein. The U.S. State Department has scheduled an early December meeting with Iraqi opposition members, who likely would oversee the industry following the war, to discuss plans for the oil and gas sector. State Department officials want to create an Iraqi oil and natural gas working group of between 12 and 20 members, including both Iraqi opposition and U.S. officials, according to the Financial Times.

U.S. energy majors reportedly have been working with the Iraqi opposition; some U.S. oil companies have had contact with INC leader Ahmad Chalabi, according to the Financial Times.

In addition, Russian oil companies probably could not compete successfully for whatever bids a post-Hussein government in Baghdad makes available, due to their own financial and technological limitations. Moscow and other governments also fear that a pro-U.S. government in Iraq would favor U.S. companies over those of other countries.

Geopolitical Positions Worldwide Threatened

Russia's international influence likely would be strongly diminished as well following a war in Iraq. Most important, the security situation could deteriorate along southern Russia's vast borders with Muslim-majority regions. In the likely event of a U.S. victory, Russia would be bombarded with accusations from the Islamic world that it enabled such a victory -- first, by betraying Moscow's traditional partnership with Iraq and not standing firmly enough to block the attack, and second, by depriving Iraq of modern weapons capable of repulsing the U.S. offensive.

It is one thing for Russia to support the U.S. war against al Qaeda -- something many Islamic governments also do -- but quite another to support, however halfheartedly, a U.S. military effort against Iraq. The Islamic world's perception of Moscow's stance would alienate not only radicals, but mainstream Muslims as well. Moreover, it would be easier for Muslims to blame and retaliate against a weakened Russia than the much stronger United States. Iraq's Hussein already appears to have issued a veiled threat to Moscow, telling the Kremlin it faces consequences unless it "takes the Chechens' cause into account."

Russia long has been battling Islamist militants, both Russian- and foreign-born, with Chechnya serving as the main battlefield. Moscow's quiet acquiescence to U.S. war plans potentially could draw mainstream Muslims and some of their governments into the radicals' long-term offensive against the country. That means that financial, logistical and recruiting support for Islamist militant groups could grow significantly. It also is possible that new northern Caucasus fronts in the battle against Russia -- in places other than Chechnya -- might be opened, and attacks on strategic and civilian targets in Russia proper could increase. The Kremlin's so-called "betrayal" of Iraq would not be the only factor at play in such a trend, but it certainly would feed into that trend.

On a larger scale, Russia stands to lose whatever international prominence it still has following a U.S.-led war against Iraq.

The nation never managed to regain the international standing the Soviet Union shared with the United States during the Cold War; nevertheless, Russia still enjoys significant influence in the Middle East. Washington has used Moscow as a diplomatic proxy in moderating the policies of several nation-states that oppose the United States -- such as Syria, Iran, Libya, Lebanon and Yemen -- until recently. And Arab regimes have used it in a similar capacity concerning U.S. policies in the Middle East. In addition, military-technical assistance given to many Middle Eastern countries has brought cold, hard cash to the Kremlin. And both the United States and Arab states have been content for Russia to play the role of intermediary in the Israeli-Arab conflict -- something that Washington's close alliance with Israel renders it unable to do.

A U.S. victory in Iraq might change all of these things overnight, possibly to the point that Russia is expelled from the Middle East political scene altogether. Not only would the Muslim world see Russia as a tool of the United States and traitor to the current Iraqi regime -- thus destroying Moscow's political clout -- but Washington's burgeoning influence in the region also would leave Russia without a role to play in U.S.-Arab relations.

The looming war against Iraq would not be the first conflict in that country to hurt Russia. The 1991 Persian Gulf War, in which Soviet leader Mikhail Gorbachev sided with the United States, signaled the end of the Soviet Union as a superpower. This time, major powers again have looked to Moscow to lead resistance to the U.S. war effort, since Russian interests will be the most hurt among the global powers -- but the Kremlin has offered only passive resistance to Washington. Avoiding a confrontation with the United States might be a wise choice for Moscow, but other world powers see this behavior as a sign that Russia is ceasing to matter in its own right. Following a war in Iraq, the world's important players are unlikely to take Russia's position into account on any major international issue.

The European Union already has been frustrated by Russian President Vladimir Putin, since he unexpectedly dropped his opposition to Washington's scrapping of the Anti-Ballistic Missile Treaty -- a measure Europeans viewed as essential for checking Washington's global ambitions. The EU had hoped, since the breakup of the Soviet Union, that Russia would take its cues from Brussels rather than from Washington, but that has not happened so far. The likely U.S. victory in Iraq and Russia's inability to stop the war or extract any meaningful concessions from Washington will further diminish Russia's weight in European eyes. Brussels likely would cease to consider Russia an equal or reliable partner that could support Europe's international agenda.

China also could take a similar attitude. Beijing has set an example of how to stand firm in defense of one's national interests vis-à-vis the United States without sliding into a direct confrontation with the world's only superpower. Russia seems to have leapt from one extreme -- confrontation with the United States during the Soviet era -- to the opposite, an inability to make any use of its junior ally status. Like Europe and others, China might view Russia following the Iraq war as a country that lacks an independent foreign policy, and treat it accordingly.

Internal Stability at Risk

All of these factors -- economic deterioration, security threats and loss of international standing -- could have a severe impact on Russia's internal stability. In the event of a post-bellum oil price-slump, Russian citizens might see their last means of survival slipping away -- and begin demanding the resignation of their government and the president they see as unable to improve the situation he was responsible for creating.

To ensure their own dominance, parts of the Russian political and business elite then could seek alternatives to Putin and, possibly, to his openly pro-U.S. course. It is difficult to say which political forces might capitalize on the negative consequences of an Iraq war, but such attempts could be expected from every spectrum of the political opposition -- from liberals who are more pro-Western than Putin, to communists, or even to parts of the Putin administration who want to abandon his ship before it sinks.

At that point, the military's role in politics would become vital. Putin's popularity is already much lower with the army than with the general public because some generals and likely a majority of officers and soldiers perceive him as surrendering the nation's dignity and unable to defeat Chechen militants. Retired or active-duty officers might answer the calls from the populace and some political forces to take up arms and help change the regime.

New Islamist attacks throughout Russia -- encouraged by Russia's role in the U.S. war effort against Iraq and subsequent "bad" reputation in the Muslim world -- also could complicate matters for Moscow in the aftermath of war. If Putin's government is unable to resolve the economic and social crises and possible political crisis following the Iraq war, then a change in his government and possible change of regime could not be excluded from the worst-case scenario.

Conclusion

Stratfor does not at this point predict unmitigated disaster for Russia in the event of a U.S.-Iraqi war, but we do believe that, internally, Russia is probably the weakest of the current U.S. allies, and that it might be the first to collapse in the worst-case post-war scenario. Russia risks falling into systemic crisis, while Washington risks seeing a valuable ally become a potential enemy. Putin is desperate to remain in power and is begging for Washington's understanding, but it remains to be seen what, if anything, Washington would be willing or able to do to shore up his regime.

For Putin, the ideal reward for his pro-Western course and alliance on the Iraq issue would be for his country to become a junior but respected U.S. ally, much like France or Germany -- or, even better, a special ally such as Israel. Such treatment for Russia probably would help to avert the negative consequences of a war in Iraq. But Washington appears unwilling -- and cannot afford -- to supply Russia with the same kind of aid it gives to Israel, amounting to $3 billion in military aid alone. Nor would an economically and socially weakened Russia command the respect that Washington shows to western European powers, despite their many quarrels.