Edward Fishman and Chris Miller
Western sanctions are beginning to hit Russia where it hurts most: its energy exports. Over the last few weeks, the European Union, the biggest buyer of Russian oil, has been working on a plan to ban imports by the end of this year, although objections by Viktor Orban of Hungary have slowed progress.
For energy sanctions to work, however, they must be carefully designed to hurt Russia more than they hurt Western states. Their primary goal should not be to cut the volume of oil and gas leaving Russia, which would further drive up world energy prices and endanger domestic support, but to reduce the dollars and euros flowing into Russia. Moving forward, the EU should therefore focus collective efforts on a more ambitious approach: partnering with the United States and other allies to impose a global regime, backed by the threat of secondary sanctions, to cap the price of Russian oil and slash the Kremlin’s revenue.
Prior rounds of sanctions against Moscow restricted investment and technologies destined for Russia’s energy sector, targeting the country’s refineries and its construction of liquefied natural gas infrastructure. Canada, the United Kingdom, and the United States also banned Russian energy imports, but this had limited impact because all three were small consumers of Russian oil and gas. Until recently, the biggest buyer of Russian energy—the EU—not only declined to sanction energy exports but also designed its financial sanctions to explicitly allow Russian fuel to keep flowing.
But now, the Russian-European energy relationship is unraveling. On top of its discussions about phasing out Russian oil imports, the EU also announced plans to completely end Russian natural gas imports over the coming years. Europe buys slightly over half of all Russian exports of crude oil and refined products such as gasoline, diesel, and jet fuel. Taxing these exports, meanwhile, currently provides around a quarter of Moscow’s budget. The EU effort to halt Russian oil purchases therefore represents a dramatic and welcome shift in the global response to Russia’s invasion.
But Europe’s plans also pose a challenge for Washington. Thus far, the United States has declined to impose the toughest sanctions on Russian energy, including the kinds of secondary sanctions that have been used against Iran to limit oil sales to third countries. This reluctance is explained by the Biden administration’s deference to the EU on matters affecting Europe’s energy security and concerns that reducing global oil supplies would send gasoline prices—and thus inflation—spiraling higher. But now that many Europeans are signaling that they are serious about cutting off Russian energy imports, the United States and its allies need a coordinated strategy. Together, they must figure out how to slash Russian energy revenue without unduly damaging the global economy.
CUTTING RUSSIAN REVENUE
If Washington and its allies are to make good on their intent to sanction Russian energy effectively, they will have to deal with a difficult dilemma. Russian tax revenue from oil is a function not only of the number of barrels sold, but also their price. The United States and Europe have plenty of tools to reduce Russia’s ability to sell oil, but the price is set on global markets. Because of the risk that sanctions pose to potential buyers, Russian firms must now sell their oil at a more than $30 per barrel discount on current world prices. But since the price of oil has increased substantially over the last 12 months, Russia is making roughly the same amount per barrel as it was a year ago.
In other words, sanctions have a complex and contradictory effect on the world’s second-largest oil exporter. The more they succeed at taking Russian supply offline, the higher the world price of oil goes. This is particularly true when there are few immediate alternative sources on the global market to replace the lost Russian supply—precisely the current situation.
The EU’s embargo will exacerbate this dynamic by substantially reducing the amount of Russian oil reaching world markets. Most of Russia’s oil exports are sent abroad via ship, so they can, in theory, be sold anywhere. In practice, however, because around half of Russia’s exports of crude oil and refined products go to Europe, most shipborne exports touch European commodity traders, shippers, and insurers. EU sanctions threaten to prohibit Moscow’s use of some of this infrastructure, limiting Russia’s ability to ship oil to other potential customers.
Although there is some uncertainty about the impact, forecasts suggest that Russian exports would decrease by around 2 million barrels of oil and refined products per day if the EU halts all purchases. Russian government officials have given similar forecasts, foreseeing a 17 percent decline in Russian oil production this year. Given that Russia exported slightly less than eight million barrels of crude and refined products per day before the war, this is a substantial hit, and a meaningful reduction in world oil supply. For the Kremlin, however, such a decline is significant but far from catastrophic, as reduced production will inevitably drive oil prices higher.
For energy sanctions to put real pressure on Russia’s government budget, they need to cut deeper. In April, according to the Russian Ministry of Finance, the government made around half a billion dollars per day taxing oil, roughly a quarter of Russian government revenue. A 17 percent decline in this figure would be painful but manageable. Moreover, because oil is priced in dollars, if the Russian government lets the ruble decrease slightly in value, it can reduce the impact of lower oil taxes on the government budget because each dollar of oil revenue will buy more rubles. In other words, although an EU embargo would be painful for Russia, it would be survivable. This is why Western countries need a new global framework—one that systematically reduces the price of Russian oil while keeping it flowing.
A REVERSE OPEC
Reducing the price of Russian oil while still allowing Moscow to sell significant volumes abroad would curtail the Russian government’s revenues without increasing global oil prices. A price reduction would hit Moscow directly, swiftly reducing the hard currency flowing into the Kremlin’s coffers. And if it were structured in the right way, the price cap would also provide incentives for everyone, including China, India, and even Russia itself, to comply.
To understand how, it is important to consider the tremendous leverage the United States, Europe, and other allies have over Russia’s oil sector. Currently, Europe accounts for roughly half of Russia’s sales of oil and refined petroleum products. Outside of Europe, other large buyers include Japan and South Korea, both of which have signed onto sanctions against Russia and should be amenable to measures that curb the Kremlin’s revenues.
The key to limiting the price of Russian oil is for these allied countries to band together and dictate terms. Think of it like a reverse OPEC: instead of wielding control over supply to set prices, the allies could leverage their control over demand to do the same. OPEC’s power is rooted in the fact that its members produce about 40 percent of the world’s oil. Europe, Japan, South Korea, and other members of the sanctions coalition account for an even greater share of Russia’s oil sales, roughly 60 or 70 percent. Members of the group, moreover, play critical supporting roles in Russia’s shipborne oil exports, from ports to shipping to maritime insurance. These links provide them with additional leverage beyond their purchasing power.
These states could form a buyers’ club that publicly announces a price cap for Russian oil. There’s room for debate about the right price, which would need to be high enough to keep Russia selling. Oil trader Pierre Andurand has proposed $50 per barrel, whereas financier and energy expert Craig Kennedy has suggested as low as $20. So long as the price is slightly above the marginal cost of production, Russia has every reason to keep shipping. In prior periods of low prices, such as 2014 and 2020, Russia continued to export roughly constant volumes of oil. Although Russia could theoretically halt exports, its storage facilities are already mostly full. The Kremlin’s only alternative to selling on the cheap is to shut down production and watch its most critical industry go into a deep freeze while its tax revenue collapses.
Would other buyers agree to a price cap? Beyond the sanctions coalition, the biggest buyer of Russian oil is China, which generally consumes around 15 percent of Russia’s exports, largely via pipeline. Historically, India has not been a major buyer of Russian oil, but it has more than doubled its purchases in recent months to take advantage of discounted prices. Russia also sells oil to many other countries, such as Lebanon and Tunisia, but they are small buyers and can acquire the oil they need from alternative sources.
To bring these other states on board, the United States, Europe, and East Asian allies could enforce compliance by using sanctions to throw sand in the gears of Russian oil shipments that violate the price cap. They could start by imposing full-blocking sanctions on vital nodes in Russia’s oil sales, including Rosneft, the state-owned oil giant; Gazprombank, the main bank serving Russia’s energy sector; and Sovcomflot, Russia’s largest shipping company. At the same time, the United States and others could provide exemptions for oil shipments that comply with the price cap. Such a regime would make it prohibitively risky for global banks and companies to deal with those entities, unless the underlying transaction abides by the price cap. The dire risk of sanctions violations would compel firms involved in such transactions to insist on clear documentation demonstrating that oil cargoes are compliant.
Additionally, allied states could wield the threat of secondary sanctions against non-Russian companies involved in prohibited oil sales. For instance, if a Chinese or an Indian firm were to buy a shipload of Russian oil for a price above the cap, Western states could threaten sanctions against the shipping company that transports the oil, the insurance company that underwrites the cargo, any port operator that provides services to the tanker, and the banks that process associated payments. The same governments could also make it illegal for U.S. and EU firms to provide any of these services, making it very difficult for such a sale to proceed. The risk involved would force Russia to sell at even greater discounts than at present, in effect enforcing the price cap.
The United States used a similar regime to curb Iran’s oil exports, slashing Tehran’s oil sales by more than 60 percent and locking tens of billions of dollars of revenue in escrow accounts. A price cap on Russian oil would be more complex because Russia is a bigger supplier of oil, with more sophisticated international trade and financial linkages. Yet, compliance would not solely rely on the threat of sanctions. Critically, there would also be a positive incentive to comply: buyers of Russian oil would benefit substantially because abiding by the price cap would lower the cost of their own imports. Challenging the cap would be rife with financial risk and carry no economic benefit—it would be charity to the Kremlin. Amid the tightest world energy markets in years, there is little reason to believe Russia’s oil customers would be in a charitable mood.
Currently, only three major importers of Russian oil stand outside the sanctions coalition: China, India, and Turkey. China can continue to import Russian oil via a pipeline that is practically immune to sanctions. This pipeline, however, represents only a small share of Russian oil exports. Because the pipeline operates at capacity, if China wanted to significantly increase its imports of Russian oil, it would need to do so via ship, which already accounts for more than half of Chinese imports of Russian oil. Moreover, as the average price of Russian oil falls, China will likely negotiate a harder bargain for piped oil, further cutting into Moscow’s bottom line. India and Turkey, on the other hand, import much of their oil from Russia via shipping routes that are exposed to Western sanctions. Both are also economically vulnerable to high oil prices and would benefit greatly from lower prices. Although it is unlikely that either would publicly welcome a price cap, both would probably abide by it.
A price cap would be a major innovation in the use of financial sanctions. Given the challenges of sanctioning Russian energy exports, a traditional embargo applied globally would be difficult to implement and, even if it were possible, would send energy prices soaring. The United States and its allies would be better served by focusing on the goal of slashing Russian revenues while keeping enough Russian oil flowing to avoid a massive price spike. Imposing a reverse OPEC price cap on Russia, backed by Western sanctions, would benefit consumers the world over while focusing pressure on the petrodollars flowing into Putin’s coffers.
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