Tortoise's path: How sanctions on Russia's oil and gas revenues work

The first sanctions against Russia were imposed back in 2014. For the EU, this marked the beginning of a review of its foreign policy, as the 2008 Russian-Georgian war, which was condemned in resolutions and statements, did not lead to the imposition of restrictions.

From 2022, the restrictions significantly expanded, becoming more severe and aimed at causing harm to the aggressor. The EU has adopted 13 sanctions packages since February 2022 and extended their validity for another six months in January of this year.

Sanctions and export controls have been introduced by a coalition of more than 30 countries, accounting for 50% of the world's economy. Several states have not supported unilateral restrictions on Russia, including China, India, Iran, the UAE, Israel, and Saudi Arabia. Turkey, a NATO member, and Serbia, a candidate for EU membership, have also not joined.

The imposition of sanctions in 2022 can be divided into several stages. The first stage of restraint (November 2021 – February 20, 2022) saw diplomatic negotiations taking place.

The second stage began with Moscow's recognition of the independence of the self-proclaimed 'People's Republics' of Donetsk and Luhansk on February 21. The United States and the EU imposed several trade, financial, and individual restrictions on the same day. Sanctions were also announced by the United Kingdom (February 22), Australia (February 23), and Japan (February 24). Germany suspended the certification of Nord Stream 2 on February 22.

The third stage began on February 24.

Sanctions against Russia are aimed at achieving three goals:

• reducing revenue from the export of raw materials;
• undermining Russia's military potential and its ability to continue the war;
• causing significant damage to the Russian economy.

In the economic sphere, sanctions are aimed at Russia's payment channels (banks and the financial system), Russian reserves, and oil revenues.

Oil price cap

Sanctions on fossil fuels consist of two elements: an import ban and a price cap on sales.

A number of countries have imposed an embargo on the maritime import of Russian oil and certain petroleum products, with some exceptions. The EU adopted the first ban in June 2022.

A price cap of $60 per barrel of oil (about 159 liters) was set in December 2022 to reduce Moscow's revenues. This was supplemented by restrictions on petroleum products: $45 per barrel for discounted petroleum products and $100 per barrel for premium petroleum products. The Price Cap Coalition includes the G7 countries, Australia, the EU, with Norway and Switzerland also introducing restrictions.

The restriction works by allowing companies from coalition member countries to provide maritime services related to Russian oil (transport, insurance, financial) only if the sale price is equal to or less than $60. If the purchase price exceeds the limit, sanctions are applied.

The price cap essentially acts as a discount on Russian oil, allowing buyers from third countries to negotiate better sales terms. Additionally, about 90% of the marine insurance market is occupied by companies from coalition countries.

Crude oil accounts for 56% of Russia's revenues from the export of all fossil fuels. Losses over the year since the introduction of restrictions are estimated at 34 billion euros or 14% of the decline in oil export revenues. In the first quarter of 2023, losses reached a peak of 180 million euros daily, falling to 50 million euros in the second quarter and 90 million euros in the third quarter.

The loss of revenue depends on world oil prices and the coalition's ability to find and punish violators. Oil prices over the past two years have been volatile, reaching $120 per barrel in June 2022 and currently hovering around $80.

High prices in 2022 were because sanctions were announced with a deferred date, leading to a situational increase in demand as consumers stockpiled additional volumes in preparation for a possible supply shortage, which ultimately did not materialize.

How to bypass sanctions?

The effectiveness of sanctions has recently weakened. The price in the second half of 2023 exceeded the $60 per barrel cap, and the size of the "discount" decreased. The difference in price between Brent and Urals oil was $40 per barrel in January 2023 and $15 in the second half of 2023.

This leads to a gradual strengthening of export control rules. The question arises regarding the establishment of monitoring for oil supplies and the expansion of restrictions.

The chart shows a comparison of Brent crude oil prices and Russian export prices. The introduction of sanctions in December 2022 led to a drop in prices. However, from the second half of 2023, the value has exceeded $60 per barrel. Note that the export price is calculated based on the value of Urals and ESPO pipeline oil.

Russia is using a "shadow fleet" to export oil, consisting of tankers from countries that have not joined the sanctions. This allows for an increase in the sale price. In October 2023, 62% of Russian oil was transported by the "shadow fleet." Over the year of sanctions, such tankers have been responsible for 38% of Russia's total oil exports: 47% of crude oil and 27% of petroleum products.

From the second half of 2023, there has been stabilization in the transport of oil by the "shadow fleet" at the level of 65-70% of Russian oil.

A related problem is the use of vessels from the EU and G7 countries or insured ones in these countries. Russia is still relying on this method of export. In October-November 2023, one-third of Russian oil was exported with the involvement of providers from EU or G7 countries.

The import of petroleum products made from Russian oil is one way to weaken the impact of sanctions. The raw material is processed in a third country and then sent to its destination. For example, Britain imported about 3% of petroleum products (worth 660 million euros) made from Russian oil. Processed oil from Russia may also have reached the United States.

Where did the oil and gas go?

Third countries that buy oil at a discount are benefiting from the oil restrictions. Russia is forced to look for new buyers for whom the discount is a significant condition.

The volume of exports of crude oil and petroleum products remains at the level of the beginning of 2022. However, the destination countries have changed. Exports of raw materials have been reoriented from Europe to the East.

The chart shows the volumes of Russian oil exports by destination countries. The share of the EU has been declining since the start of the war, while India has become one of the main trading partners.

"Energy products" make up 2/3 of Russian exports to China. India has become one of the main trading partners, with a 134% increase in oil imports from Russia, totaling 32 billion euros per year. In total, 46% of maritime oil supplies go to the country. New markets have also emerged, with Myanmar being the largest at 758 million euros.

It should be noted that the reorientation of Russian exports to the East entails higher logistical costs, especially compared to the export of pipeline oil to the EU.

Europe's energy security

When discussing restrictions on Russian energy resources, Europe should be primarily considered, as it was one of Russia's main clients in the past. The EU is working to change the situation. For example, the REPowerEU plan aims to eliminate dependence on Russian gas by 2030.

The embargo covers about 90% of oil imports from Russia. However, Europe continues to buy Russian oil and gas.

The EU accounts for 8% of oil exports, making it the third-largest buyer after China (52%) and India (33%). Oil reaches Bulgaria by sea, which is one of the exceptions to the sanctions, and through pipelines to the Czech Republic, Slovakia, and Hungary. One of these pipelines passes through Ukrainian territory.

The chart shows the largest buyers of Russian oil and gas among the EU countries. The gas reaches France and Spain through LNG terminals, while Hungary, Slovakia, and the Czech Republic receive energy resources through a pipeline. These three countries will be the first to suffer in case of a transit stop through Ukraine.

The EU is the largest buyer of Russian gas via LNG (50% of the total volume) and pipeline (39%).

Although the EU has not introduced sanctions against Russian gas, a price cap of 180 euros/MWh was agreed upon in December 2022. The restriction has not yet been used, with March supplies costing 30 euros/MWh. This is a reflection of the 2022 energy crisis.

The United States banned the import of Russian oil and gas in March 2022. This was relatively easy to do, as the country is self-sufficient in energy resources.

Instead, sanctions are imposed on companies and energy projects. For example, the Arctic LNG 2 project has been subject to restrictions by the United States.

What about Russia?

The strengthening of sanctions depends on the state of the Russian economy, as the goal is to undermine its ability to wage war.

In 2023, the Russian economy showed growth of 3.6%, higher than forecasts. The drivers of growth are the military and related industries, as well as construction. Domestic demand is driven by fiscal stimulus, which accounts for 10% of GDP in 2022-2023.

After a sharp drop in February 2022, the ruble exchange rate stabilized and is gradually depreciating. Compared to October 2022, the ruble has lost about 40% of its value against the dollar. However, this leads to an interesting effect: devaluation allows budget revenues to be maintained in conditions of falling dollar export revenues from oil exports.

In addition to changing the countries for exporting raw materials, there has also been a change in the origin of goods for import, with China and India becoming the main sources.

The chart shows a significant increase in imports from China and India to Russia, while imports from the EU, US, Britain, and Japan have decreased. Source: The New York Times.

What's next?

The effectiveness of the oil price cap depends on the efforts of coalition members to comply with sanctions.

Improving monitoring and enforcing price cap restrictions should be one of the top priorities. There are still "loopholes" that allow sanctions to be circumvented, such as the export of petroleum products made from Russian oil and processed in other countries, the "shadow" fleet, and the question of limiting banking operations in case of price exceedances.

The price of Russian oil changes along with world prices. And the question arises: what will be the discount if, for example, Brent rises above $100 per barrel? OPEC is trying to raise prices through a reduction in supply. In case of a drop in the value of oil below $60, the effect of the restrictions will disappear.

Proposals are being heard to limit the maximum price to $30 per barrel. This is expected to reduce Russian revenues by another 49%. However, the problem remains the same – monitoring and enforcing sanctions.