It is now more than 30 years since Ayatollah Khomeini inspired Iran’s Islamic Revolution. Rarely has one nation consumed the thoughts of policymakers, particularly in Washington, for so long and the next decade will be no different.

The removal of subsidies on fuel … is set to be the dominant domestic issue over the next few years

But Iran is now at a crossroads and the choices before it will have a significant impact, not only on its population of more than 66 million, but on the Gulf and the wider Middle East region. Fariborz Ghadar, director of the US-based Centre for Global Business Studies lays out two possible scenarios for the country.

The first sees negotiations over Iran’s nuclear ambitions fail, the Iranian economy in bad shape and the government resorting more to coercion and intimidation to maintain power. Tehran’s reliance on the Iranian Revolutionary Guard Corps (IRGC) would increase, pushing the Islamic Republic further towards a military dictatorship and even undermining the control of the clerical establishment.

Uncertain future for Iran

This would be the worst option, says Ghadar, eventually leading to a swift military takeover. In the backlash, all political opponents would be pushed into the background, acquiescing to whatever the government ordained.

The second scenario also foresees a deteriorating economic situation, but with very different results. Iran’s powerful theologians and technocrats may well decide that change is needed, bringing about a deal with Europe and the US.

The energy sector in particular is suffering through a lack of access to financing and technology

So far, the clerical strongholds of Najaf and Qom have been remarkably consistent in their strategy, weighing the current economic costs against the domestic political value of the Islamic Republic’s ideological stance in resisting foreign, and more specifically, US pressure. But they are not above compromise.

“The Ayatollahs have been very good at reading the tea leaves,” says one source in Iran.

Many in Iran believe that Tehran’s stubborn stance over its nuclear programme has not been worth the price the country has paid, but the opposition has so far remained silent on the issue. Indeed, it is viewed as a separate issue from their desire for greater democracy.

If Tehran were to re-enter the international fold, a renewed confidence would lead to accelerating economic growth, allowing Iran to realise some of its enormous potential. Looking back, the early part of this century would be seen as a lost decade.

Under the second scenario, Dubai, with its long tradition of trade with Iran and a thriving expatriate community, would benefit as a trans-shipment hub for the Gulf’s most populous country.

Iran’s political direction

The removal of subsidies on fuel and other goods and services is set to be the dominant domestic issue over the next few years and how this is handled could play a major role in determining the political direction of the country. In January, the Iranian parliament approved a subsidy reform plan aimed at saving an estimated $20bn a year.

Despite the obvious financial benefits, Tehran was slow to start the reforms. It was only in December that the first phase of cuts were implemented, raising prices for petrol and industrial fuels. Many in government are concerned that a reduction in subsidies will, in the short-term, lead to high inflation and political unrest. With unemployment standing at 11.8 per cent in 2009, the loss of subsidies coupled with rising inflation could create a social tinderbox in an already tense nation.

The country’s unique demographics increase the likelihood of unrest. According to the Washington-based International Monetary Fund (IMF), the average age of Iran’s 66.4 million people is 27 years. Young and increasingly urbanised, this segment of society has become disaffected by the current establishment.

“This is the crossroad. Iran cannot stay like this for another five years,” says Ghadar. “At some point in the next year or so, they will have to remove the subsidies. They just don’t have the money. The removal of subsidies may force them to come up with a compromise. External pressure is important, but internal pressure also may bring about possible change.”

Washington has imposed sanctions on Tehran in one form or another for more than 30 years. Initially narrow in scope and poorly enforced, they were hardly an effective tool in shaping Iranian attitudes. But the latest round of sanctions has proved much more successful. In less than six months, the toughened US and UN sanctions are already starting to bite.

The energy sector in particular is suffering through a lack of access to financing and technology. Iran’s oil minister Masoud Mirkazemi warned in May that the country needs to invest $25bn a year to maintain production levels. Without this, he added, the country could see rapidly falling oil output. 

Oil production forecasts for Iran

Iranian ministers are rarely so forthcoming. That a minister in the fourth largest oil producer in the world should issue such a stark warning highlights the serious problems facing the country. Analysts estimate the natural decline rate of Iran’s crude oil production at 8-11 per cent a year. By 2015, output could be down to 3.8 million barrels a day (b/d) from 4.2 million b/d in 2008, or, in the worst case scenario, production could drop as low as 3.3 million b/d.

The Islamic Republic’s energy projects, which aim to increase production, are grinding to a halt due to a combination of protracted negotiations and fleeing investors. Iran’s ambition to become a liquefied natural gas (LNG) exporter will depend heavily on the political climate over the next few years. Without Western liquefaction expertise, it may never happen.

Furthermore, its gas might need to be diverted for reinjection into mature oil fields or to meet rising domestic fuel use. By 2020, Iran will require at least 10 billion cubic feet a day (cf/d) for reinjection to maintain its crude oil production levels. This is roughly equivalent to Qatar’s total current LNG exports. Some estimates put the figure at closer to 20 billion cf/d in the next decade.

European and US policymakers tend to look at the Supreme Leader Ayatollah Ali Khamenei – the highest clerical authority in the country – and his president, Mahmoud Ahmedinejad for signs of what is to come. But there are several other personalities of influence, including the leaders of the opposition Green Movement and former presidents of the Islamic Republic.

Khamenei and Ahmedinejad have pegged their political futures to each other in a symbiotic relationship, which relies on the strength of the IRGC. The IRGC has steadily been increasing its power – taking over the protection of the Gulf from the Iranian Navy in early 2009 and winning a number of large non-military contracts. Their intervention in quashing the Green Movement, along with the Bassiji paramilitary group, while the military retreated, held the government together in 2009 and saved Khamenei and Ahmedinejad’s careers.

Peaceful resolution for Iran

But how much longer Khamenei can keep the IRGC under control? Approaching 75 years of age and with reported health problems, it is not a long-term solution. There have been suggestions that Washington may be willing to confer international legitimacy on Tehran’s hardline regime in return for a compromise on its nuclear ambitions – much to the dismay of the opposition. 

Ahmedinejad may be loathed in Riyadh and Abu Dhabi, as recently leaked US embassy cables demonstrate, but a progressive, economically vibrant and democratic Iran could actually pose a greater challenge to their regional hegemony.

The prospects for either a peaceful resolution to the nuclear standoff or a peaceful evolution towards a more democratic Iran are poor. But engagement with Tehran is needed. Without Iran’s cooperation it will be difficult to bring long-term stability to Iraq and Afghanistan. It could also become a stabilising force in Lebanon and the long-running Israel-Palestine conflict.

But as 30 years of sanctions have shown, it will be no easy task. Efforts to bring Tehran back to the fold will remain a priority for Western powers in the decade ahead.