The Decline of the Petro-Czar

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

© 2009