With the lifting of sanctions on Iran only a matter of time, Yerevan and Baku are courting Teheran for infrastructure, energy and trade deals. But will destitute Armenia win the contest with its arch-enemy for Iran's favours based on its historically closer ties, or will Azerbaijan beat it to it again, and push Yerevan further into isolation?

When Armenian Prime Minister Hovik Abrahamyan met with his Chinese counterpart Li Kequiang and the management of China Civil Engineering Construction Corporation (CCECC) in Beijing this week, he must have practiced his best poker face to disguise his desperation. On the sidelines of the Euro-Asia Economic Forum, Abrahamyan was looking for money to fund a series of infrastructure projects in Armenia – most importantly the Iran-Armenia railway and the North-South highway – which would improve connectivity and trade with Iran.

The two projects are costly, with estimated price tags of $3.5bn and $1.5bn respectively, but they would create a trade lifeline for the isolated Caucasian country, which is landlocked and has had two of its borders, with Turkey and Azerbaijan, shut for over two decades because of the Nagorno-Karabakh conflict. During this time, Azerbaijan and Turkey's relations have flourished, and they have included Georgia in regional transportation plans, such as the Baku-Tbilisi-Kars railway and the Southern Gas Corridor, but left Armenia in a deep and utter isolation.

Desperate to get out

This isolation has resulted in Armenia turning to Russia, its northern neighbour, for trade, investment, aid and remittances, but this over-reliance has stalled its growth and is starting to backfire. The recession in Russia – which accounts for a quarter of Armenia's foreign trade – has translated into a 4% drop in the latter's trade volume in the first half of 2015. In 2014, oil-rich Azerbaijan ran a $20bn trade surplus, double Armenia's entire GDP. At $41bn in 2014, Baku's foreign trade was larger than Armenia's by a factor of 14. Even resource-poor Georgia's foreign trade is four times bigger than Armenia's.

At the moment, Iran represents Armenia's hope for the better future. As it is quickly emerging out of its nuclear isolation, Teheran could provide energy, financing, and trade access through its Persian Gulf and Caspian Sea ports to Yerevan.

These developments would come as a natural progression of the already good relations between the two countries, which are based on relatively high trade levels (by Armenian standards), interconnected power grids, a gas pipeline, and their animosities with Azerbaijan and Turkey.

But financing the planned road and rail links to Teheran is proving to be a challenge, and Yerevan is running against the clock, as Baku has plans of its own for its southern neighbour.

Russia, Armenia's strategic ally in the region, has financed numerous infrastructure projects, runs and owns most of its large companies, and has provided vital defence support to Yerevan, but it is in no position to foot the bill for the two projects because it is struggling with an economic recession back home. Even if it had the cash, the Kremlin would probably want to keep Armenia under its sphere of influence and far away from Teheran, which it has always perceived as competition. 

The Armenians are running out of options. This railway project has been a fixation for the administration of President Serzh Sargsyan since 2008, when the president first spoke about it in an address to parliament. And they have been unsuccessfully courting financiers ever since they signed a memorandum of understanding with Teheran for the railway last November.

According to Vardan Voskanian, chair of the Yerevan State University's Iranian Studies department, the railway is “strictly important” for Yerevan from a strategic and economic point of view, because it would render “pointless” Turkey and Azerbaijan's economic blockade of Armenia.

In July, Sargsyan went to the BRICS summit in Ufa, Russia with one top priority on the agenda: to finance the railway. But despite making the case for the continental impact of the railway to everyone in attendance, Sargsyan returned home empty-handed.

Meanwhile, the "very good proposals" from an undisclosed Chinese company for the construction of the railway that Transport and Communications Minister Gagik Beglarian revealed to the media in August failed to materialise.

Abrahamyan returned from Beijing with meagre promises of China's "readiness" to support Armenia's industrial and infrastructure development.  The promises are anything but compelling; whereas Abrahamyan emphasised cooperation on "big infrastructure projects", Li seemed keener on promoting tourism, air links, and trade with metals and building materials. Hardly a done deal.

The Azeri way

Li was probably wise to wait this one out. Armenia's railway project might be important to Armenia, but it would be expensive and a nightmare to construct. Iran offered to finance its portion of the railway, which runs 90 kilometres from Julfa to Meghri on the Armenian side of the border. But the 120-kilometre stretch north of the border, which Yerevan has to build and finance, requires digging tunnels through the Caucasus mountains, and is not likely to be completed by 2022 even if financing were readily available.

Meanwhile, Azerbaijan has a better proposal for Teheran. Why not build a 7km railway connecting Astara in Iran with Astara in Azerbaijan, and thus effectively integrating the two countries' railway systems? The project would  cost about $400mn, a tenth of the cost for the Armenia-Iran railway, and comes with the added benefit of offering Iran access to a regional railway network that includes Georgia and Turkey, through the almost-completed Baku-Tbilisi-Kars railway. 

The decision on the Azerbaijan- Iran railway connection was reached in September, according to Mohammadali Najafi, the governor of Gilan Province in Iran. "This railway will facilitate the way from Central Asia and Europe to the Persian Gulf and connect Iran with these regions and the Caucasus", Najafi told trend.az, adding that the office of Iranian President Hassan Rouhani had requested that the project be completed by 2016.

That Iran and Azerbaijan could not see eye to eye for a long time is common knowledge in the Caucasus. The two Shia-majority countries have gotten on each other's nerves for over two decades because of Azerbaijan's secularism, the Azeri minority in Iran, the status of the Caspian Sea, Azerbaijan's cosy relations with Israel, attempted terrorist attacks in Baku allegedly orchestrated by Teheran, and many other issues.

As recently as 2012, when Azerbaijan was still a Western darling and scantily clad pop stars such as Rhianna, J-Lo and Shakira were prancing around its stages, to Teheran's chagrin, spiting Iran was a favourite pastime in Baku. Tensions got so bad that the Islamic Republic withdrew its ambassador from Azerbaijan over a rumoured gay parade that same year. But that is not the case any longer, judging by the flurry of diplomatic exchanges in recent months.

Visits between inter-parliamentary working groups and cabinet members from the two countries have become a weekly occurrence, while the heads of state themselves exchanged four visits over the past year.

In addition to the railway link, recent discussion has revolved around Iran's inclusion in the Southern Gas Corridor (SGC). The latter is, however, a long-term prospect according to Maxim Edelson, Senior Director at rating agency Fitch.

"I understand that the SGC extension will increase its capacity to around 21-24 bcm, and currently does not have room for Iran’s gas. At the current gas prices in Europe – around $220-$230/mcm – I do not expect that there is a lot of appetite from either gas producers or gas off-takers for additional Iranian gas volumes. Thus, the timing of the Iran’s joining the SGC is uncertain to me", he explained in a September 25 interview with bne IntelliNews.

Iran is also exploring two other options to deliver its gas to European markets. One is the existing gas pipeline with Armenia, in which Edelson has little confidence. "First, I am not sure whether the gas pipeline from Russia to Armenia has a reverse flow capability. Second, this gas would have to be exported to Europe via Russia, and I doubt that Russia would want Iranian gas volumes to compete with Gazprom’s at the time of soft European gas demand", he elaborated.

The second option is Turkey, with which Iran has an operational gas pipeline from Tabriz to Ankara, which could be put to use as soon as sanctions are lifted. A second pipeline in on the way, according to Fitch Senior Director Maxim Edelson.

"I would think that Turkey is the most likely option. It is keen to diversify its gas sources to get more price discounts from Gazprom, thus is it more interested in Iranian gas than any of its neighbours. Plus, Turkey has aspirations to become a regional gas hub – hence discussions with Gazprom on 63bcm Turkish Stream. Having 10-20 bcm (over time) of Iranian gas per year would only enhance Turkey’s position as a regional gas hub."

What next?

For all of Yerevan's rush to finance its railway with Iran before Baku, Teheran will most likely pursue stronger ties with both countries, but will do so based on pragmatism, rather than partisanship. The Rouhani administration's rapprochement with the West shows that it can forgive, and, if it was willing to bury the hatchet with the US and the EU, it will continue to do so with a minor transgressor like Azerbaijan.

Officials from Teheran and Baku are already patting each other on the back. "We can have a lot of relations with Azerbaijan. We have established very friendly relations for common good", Rouhani told Iranian media in August, stressing that "neighbours like Azerbaijan are our top priorities to cooperate with" and that "Azerbaijan can act as Iran's gateway to the Caucasus". Meanwhile, the Azerbaijani Minister of Emergency Situations Kemaladdin Heydarov told the Azeri media about how the two "fraternal and neighboring countries will make new contributions to useful mutual cooperation".

At $500mn in 2014, Azerbaijan's trade with Iran already runs higher than Armenia's $291mn, and Teheran is expecting that figure to triple in 2016, according to Iranian Minister of Communications and Information Technology Mahmoud Vaezi.

Armenia has not received such promises as far as trade is concerned, but Teheran intends to triple its electricity exports to Armenia up to 25 billion kilowatt hours per year by 2018, according to Iran's Deputy Energy Minister Houshang Falahatian. Iran will start building a third power transmission line connecting it to Armenia this year, and will complete it by 2018, the official added.  

Observers believe that the planned hydropower plant on the Arax River, at the Iranian- Armenian border, will be one of Iran's first investments in Armenia when sanctions are lifted, not least because the Kremlin has not expressed any objections to it. By joining the EEU earlier this year, Armenia "has lost the right to make independent decisions", believes Ashot Yeghiazarian, a lecturer at the Armenian State University of Economics.

Russia may prove to be a bigger hindrance to Yerevan's plans for Iran than Baku. "Russia likely considers Iran as a potential threat to its interest in the South Caucasus, particularly in the energy sphere", believes Stepan Safarian, head of the Armenian Institute of International and Security Affairs. The fact that Gazprom purchased a 40-kilometre portion of the Iran-Armenia gas pipeline in June is, according to Safarian, a warning for Armenia “not to get too carried away with cooperation prospects with Iran”.

Yerevan's relations with Iran will depend on the Kremlin's decisions from now on, Safarin concluded. Meanwhile, wealthier Azerbaijan has made it clear that its foreign- and internal dealings are no one else's business, which means that it will be free to jump at the opportunity to further ties with Iran faster than its western neighbour.