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Smart Oil Sanctions Against Russia

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June 14, 2022

By: Edward C. Chow, CESP Visiting Senior Fellow

This article was originally published by CSIS and is reprinted here with permission of the author.

From the start of Russia’s unprovoked, unjustified, and brutal war against Ukraine, which Vladimir Putin reignited on February 24 after invading Ukraine in 2014, the United States and its allies decided against direct military intervention. A no-fly zone enforced by the United States or NATO and efforts by Western navies to free Ukrainian ports from Russia’s blockade to bring critical matériel in and essential Ukrainian food exports out might have ended the war in weeks.

There are arguable reasons for the West not to intervene directly, including the risk of enlarging the war. This meant that economic sanctions became the default second-best policy option. However, what might have taken weeks to achieve militarily will now take many months, if not years. The West should also understand the economic and political consequences both to Ukraine and to itself.

When it comes to economic sanctions against Russia, energy is the obvious place to look, since the sector generates half of Russian central government revenue and most of the country’s export earnings. Unfortunately, it is not possible to restrict exports from the world’s largest exporter of oil and gas combined without serious impact on the global market, since there is simply no equivalent spare capacity elsewhere or strategic stock drawdown available.

Crude oil prices are now about $30 per barrel higher than before February 24. International natural gas prices have gone through the roof. Even U.S. natural gas prices are about three times higher than last summer. All this is happening before there is any real reduction in Russian oil and gas exports. The jump in oil prices means Russian oil revenue has not suffered, even though it has to offer discounts to nontraditional buyers to move barrels.

If the West actually achieves the stated goal of banning Russian oil and gas, crude oil prices may increase to a record level above $150 per barrel from around $120 today, and the United States will be looking at $6 per gallon gasoline, not the $5 per gallon price this summer. In reality, Western policymakers are conflicted between wanting to do something to stop Russia but without accepting the economic consequences of our actions.

All along, the wrong target was set for energy sanctions. The objective should be to significantly reduce Russian oil revenue, not volume. It seems that the U.S. Treasury Department understood this but could not dissuade its EU counterparts from announcing an oil ban at the beginning of May, which caused the global oil price to rise by $10 per barrel. The treasury’s alternative suggestion of a Russian oil price cap would be cumbersome and impossible to enforce.

History shows that oil sanctions are notoriously leaky, whether they are against Saddam Hussein’s Iraq or apartheid South Africa. Oil always moves at the right price, whether it is with a price discount when an oil exporter is sanctioned or with a price premium when an oil importer is targeted. Oil sanctions are no substitute for the use of military power, as was learned in Iraq and Libya.

The answer is for the West to impose a hefty oil import tariff on Russian oil, say $50 per barrel at current prices, and dedicate the collected funds to Ukrainian humanitarian relief and future reconstruction. In this scenario, Western refiners can still buy Russian oil, but a large portion of the price will be collected by their governments in the form of the tariff. This would relieve the logistical problems of inland refineries in Europe currently dependent on crude oil transported by pipeline from Russia, which has complicated enactment of the European Union’s Russian oil ban.

Countries such as India, China, and Turkey that have no interest in restricting Russian oil exports would pay a price no higher than slightly above market price, minus the tariff set by sanctions participating countries. There would be no commercial reason for non-sanction participating countries to pay more. In this example, Russia would be forced to sell its oil at around $70 per barrel, with significantly higher discounts than what it offers currently. The level of import tariff can be recalibrated as conditions change.

The damage would be to Russian central government revenue through its collection of export tax, and not to Russian oil producers who will continue to produce so long as the price they get is above their production cost. The Russian government would have to choose between retaliating by cutting oil exports or losing revenue because Russia has limited ability to redirect oil flows. No secondary sanctions will be needed since the objective is not to stop all Russian oil exports, which is against Western interests, as it would severely damage the global economy and strain alliance unity in supporting Ukraine. Instead, the Russian government would be deprived of economic rent from oil exports and Ukraine would gain funds for urgently needed humanitarian relief and reconstruction.

Preparation for the G7 and NATO summits at the end of this month in Europe provides the opportunity to design more effective Western oil sanctions against Russia, rather than risking the sanctions regime unraveling due to political pressure, when even higher prices and energy shortages would hit Western consumers and industry. This requires a realistic understanding of what energy sanctions can and cannot do in the short to medium term and what other measures, including hard military power, should be taken if the objective is to stop Putin’s war as soon as possible.

Image: ALEXEI DRUZHININ/Sputnik/AFP/Getty Images