The hole in the middle of sanctions
The gaping hole in Western sanctions on Russia
US and EU sanctions have cynically left Russian energy exports untouched over fears of economic disruption at home
By ANDREW SALMON
As fighting rages across Ukraine, the energy sector is emerging as a target – just not by Western sanctions.
The world has been shaken by news of a fire at a Ukrainian nuclear plant, while the Ukrainian defenders and inhabitants of Mariapul are struggling in the dark after power supplies to the besieged city were cut.
But while Russia targets output as it begins siege warfare, and Ukrainian citizens suffer increasing levels of violence and hardship, Western moves to help the embattled nation resist its invaders have a massive blind spot: Russian energy products that make up a whopping 60% of national exports.
Moreover, the two key Russian banks that handle the bulk of these exports have escaped the sanctions regimen that has ejected other Russian financial institutions from the global SWIFT transactions system.
These studious moves by Western nations not to use the most effective tool at their disposal are grounded in hard economic realities.
While the EU’s leading economies are heavily dependent on Russian gas, the US fears pushing up pump prices and does not want to put its European allies under undue pressure.
And both Brussels and Washington likely fear the impact on a shaky global economy of blocking the world’s third-largest supplier from energy markets.
This all means that despite the unprecedented breadth of Western sanctions on Russia, Moscow’s key financial pressure point remains untouched.
To be sure, the sanctions regimen being implemented on Russia – from industry to media, from finance to sports – is sweeping and impactful. Global ratings agencies have just downgraded Russia’s sovereign debt to junk status, raising the possibility of a debt default.
But Moscow’s biggest insulation against that scenario are sustained energy exports, including to Western markets including the US.
“Russia was the world’s third-largest producer of petroleum and other liquids (after the United States and Saudi Arabia) in 2020 … Russia was the second-largest producer of dry natural gas in 2020 (second to the United States),” notes the US Energy Information Administration, or EIA.
Russian President Vladimir Putin has leveraged the country’s energy resources to strategic effect. Image: Twitter
The world’s largest physical country is home to some 6% of global oil reserves and 20% of natural gas. National energy giant Gazprom, the world’s leading natural gas supplier, employs about 400,000 people.
Russia’s exports in 2021 totaled $493.3 billion. Of these, 59.3% were energy, according to the website Trading Economics.
Dependence on this vast resource has deeply compromised some of the West’s leading economies as they confront Russia.
“Europe is Russia’s main market for its oil and natural gas exports, and by extension, Europe is its main source for revenues,” writes the EIA. “Russia is a major source of oil and natural gas for Europe.”
Germany is the leading customer for Russian gas, followed by Italy and France.
Notably, the key Russian banks handling energy payments are Gazprom Bank and Russian Sherbank. Despite widespread hoopla that surrounded the removal of other Russian financial firms from the global SWIFT transaction system, the two key banks retain their SWIFT access.
This does not sit well with Kiev.
Ukraine’s Foreign Minister Dmytro Kuleba has called on overseas governments to impose a “full embargo” on Russian oil and gas. But despite the earlier shutdown of Russia’s Nord Stream 2 Baltic pipeline, that has not happened.
Josep Borrell, the High Representative of the European Union for Foreign Affairs and Security Policy, was asked directly by TV reporters on Friday if the West would sanction Russia’s energy exports.
Borrell, entering a foreign ministers’ meeting in Brussels, would say only that “everything is on the table.”
The West’s dependency is known to the Kremlin, said a Ukrainian expert.
“In my experience dealing with [Putin’s] team and him personally, one of the cornerstones … is that the energy supply is so important to the West … that no matter what [Russians] do, they’ll always be forgiven, that Western countries will crawl back on their knees asking for their oil and gas,” Andriy Kobolyev, the former head of Ukraine’s state-owned natural gas company Naftogaz told media outlet Politico this week.
Kobylyev has been in the United States lobbying for sanctions on Russian energy exports.
Pump jacks are seen at the Lukoil-owned Imilorskoye oil field, outside the west Siberian city of Kogalym, Russia. Photo: Reuters / Sergei Karpukhin
Pump jacks are seen at the Lukoil-owned Imilorskoye oil field, outside the west Siberian city of Kogalym, Russia. Photo: Agencies
Politico noted that the US continues to import about 540,000 barrels of Russian oil daily, on the logic that if the US halted imports, Russia could simply sell the oil elsewhere. It added that US President Joe Biden was reluctant to apply pressure on Russia-dependent European allies, which are now joining the US in other sanctions.
But it is not only European vulnerability. In America, a key political issue is US consumers’ sensitivity to high oil prices.
“We don’t have a strategic interest in reducing the global supply of energy,” a White House PR official admitted on Thursday. Russian energy sanctions, “would raise prices at the gas pump for Americans,” he said.
Still, criticism is growing.
Republicans are lambasting the Biden administration for axing the 800,000 barrels per day Keystone XL Pipeline on climate change grounds while continuing to buy Russian oil. And a bipartisan bill promoted by 18 senators was filed on Thursday, demanding that the US halt Russian oil imports.
Western reluctance to hit Russia’s key exports may be due not only to over-reliance but to wider macro-economic conditions.
The Ukraine war coincides with a jittery global economy seeking to exit two years of the Covid-19 pandemic. In this fragile environment, energy is the key commodity that pushes up inflation.
Brenda Shaffer, senior advisor for energy at the Foundation for Defense of Democracies think tank, told US media outlet CNBC that the removal of the world’s third-largest supplier from markets would deal “a tremendous jolt” to global oil prices and the world economy.
Such a massive step has no precedent.
“We’re in unknown territory if you pull 13% to 15% of global oil out of the pool,” Shaffer told CNBC. “Sanctions on Iran and Venezuela … are not even comparable to what that could do to the global oil market if you actually pulled away most of the Russian production.”
These harsh – indeed, embarrassing – realities contrast with widespread bullishness about sanctions from Western leaders and approving coverage of sanctions by Western media.
On the macro level, there is still no signal that energy exports will be curtailed. On the micro level, a certain level of sanctions resistance is built into the Russian economy.
For example, the elevated interest rates established by Russia’s central bank as a crisis-control measure might actually be welcomed by the average Russian.
In 2018, Russia boasted homeownership rates of 89%, largely as a result of passing home deeds over to inhabitants after the fall of the USSR, meaning mortgage percentages are low.
Moreover, Russian household debt as a percentage of GDP was only 22% in 2021, compared with 79% in the US and 87% in the UK.
Elsewhere on the global chessboard, Western efforts to forge a unified front are complicated by the primacy of Moscow’s other major industry: arms.
Two crucial states that the West seeks to enlist in its confrontation with China – India and Vietnam – are heavily reliant on Russian weaponry.
Russia’s armaments industry offers weapons that are lower priced, but with similar levels of sophistication to those sold by Western arms exporters. Moreover, a 2021 US Congressional Research Service Report noted high levels of path dependency – the ongoing purchase of updated versions of legacy systems.
Russian troops have crossed the border with Ukraine despite Moscow’s earlier assurances it did not plan an invasion. Photo: AFP / Anadolu Agency
As carnage continues to surge across Ukraine, the West’s half-hearted sanctions response is not mirrored by the grim determination apparent in the Kremlin.
Russian President Putin has insisted to his people in a Russian TV broadcast that his offensive is going according to plan. Given multiple logistical and tactical blunders, losses of men and kit, and ongoing damage to civilian areas, that looks like sugar coating.
But as long as Putin and his forces have oil and gas revenues flowing unhindered into national coffers, Russia’s war effort has a better chance to succeed.