Sanctions on Russia are counterproductive

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Sanctions on Russia are counterproductive

Wednesday, 08 November 2023 | Uttam Gupta

Sanctions on Russia are counterproductive

In a globally interdependent world, actions that severely restrict the flow of goods and services across national boundaries are bound to be counter-productive

In a bid to punish Russia for its military action against Ukraine, in June 2022, leaders of G7 viz., the United States, Germany, France, Britain, Italy, Canada and Japan had vowed to explore the feasibility of measures to bar imports of Russian oil at price above a certain level. In September 2022, their finance ministers (FMs) said:

“We confirm our joint political intention to finalise and implement a comprehensive prohibition of services, which enable maritime transportation of Russian-origin crude oil and petroleum products globally. Providing those services would only be allowed if the oil and petroleum products are purchased at or below a price (the price cap) determined by the broad coalition of countries adhering to and implementing the price cap.”

On December 5, 2022, they set the price ceiling at US$60 per barrel. It was meant to weaken Russia financially by undermining its ability to generate revenue from the export of petroleum products while ensuring that supplies to them (read: G7/EU) are not impacted. Unfortunately, things haven’t panned out as intended. 

Russia is a dominant player in the global energy landscape.

It is the third-largest producer of crude oil with over 12 per cent share in global crude production and the second-largest exporter. In the case of natural gas (NG), it is the world’s second-largest producer with a share of 10 per cent. In world export, its contribution is even higher at 25 per cent. When it comes to EU countries, their dependence on Russia is even higher, drawing 40 per cent of their NG supplies and 25 per cent of crude from it. Some countries in the bloc viz. Germany, the Netherlands and Poland, source a much higher percentage of their requirements from Russia.

In this backdrop, huge disruption in supplies from Russia caused by a deadly cocktail of economic and financial sanctions imposed by the EU countries (besides the USA); physical incapacitation in the supply chain and clogging of sea transportation routes – in the wake of military action by the former against Ukraine in February - led to steep increase in the price of both crude oil and NG. As a result, the EU countries bought all their requirements at elevated prices as during that period, the price cap wasn’t in force. This led to a huge increase in their import bill.

According to the Centre for Research on Energy and Clean Air, Russia received about 158 billion euros in revenue for the sale of oil, NG and coal from February to August 2022, more than half of which - some 85 billion euros worth - was from the EU. Russia’s revenue increased even as overall export volumes dropped by 18 per cent compared with the corresponding period before the invasion of Ukraine.

Even after the cap came into force on December 5, 2022, the G7 bloc has achieved little in restricting Russia’s earnings. As it is, fixing the ceiling price at US$60 per barrel is laughable considering that the cost of producing oil is substantially lower, in fact, a fraction of this number. Even if exports were made at this price (between December 2022 and June 2023, most of Russia’s crude was selling at less than this price implying no violation), it would still be generating a lot of surpluses to keep its war machinery well-oiled.

Since, July 2023, the price has been above the cap, courtesy of reduced availability of oil worldwide as a result of Saudi Arabia and Russia cutting production by one million barrels per day (mbd) and 0.3 mbpd respectively over and above the cut agreed to in the meeting of OPEC + in April 2023. Russia has been able to benefit from this as well. For instance, according to S&P Global Platts, its key export grade crude sold at around US$75 per barrel enabling it to garner oil income of US$211 million a day during September 2023.

What has come in the way of G7 enforcing the cap?

The G7 wanted to enforce it by requiring the participating countries to deny Western-dominated services, including insurance, finance, brokering and navigation to oil cargoes priced above the cap. To secure those services, buyers would make “attestations” to service providers, saying they bought Russian petroleum at or below the cap. However, service providers won’t be held liable for false pricing information provided by buyers and sellers of Russian petroleum.

Put simply, the buyer (say, a trader in Germany) needs to give a piece of paper to the service provider saying ‘it has bought Russian crude at or below the cap’. If the latter doesn’t have this document, the G7 country will impose sanctions on that service provider. They feel confident, it will work because many vessel owners, traders and most insurers are based in the EU/USA; hence amenable to sanction.   

What if the buyer refuses to provide requested price information or gives a fudged document mentioning a price less than the cap even though the purchase is at a higher price or hides the true origin of Russian oil, etc? In any of these scenarios, the G7 country won’t be able to take any action as per their agreement ‘Services providers can’t be held liable for false pricing information provided by buyers and sellers’.

  The sellers and buyers of Russian oil can use a host of other methods to circumvent the cap. For instance, the price can be set as oil leaves a Russian port, not what’s paid by a refinery in, say, India. While the former can stay well within the US$ 60 per barrel level, transportation costs and margins of trading companies (albeit Russian-affiliated) in countries not participating in sanctions are inflated to yield the desired net back in Russian hands.

Given the above, it is no surprise that despite numerous instances of ‘loading Russian oil at all ports within Russia’ by vessels owned or insured by Western nations - in the wake of a surge in crude price, there has been little sign of enforcement action initiated by the G7 authorities. Reports of the U.S. Treasury Department sanctioning two ship owners (in October 2023) accused of carrying Russian oil priced at US$75 and $80 per barrel while relying on US-connected service providers is the tip of the iceberg.

This apart, there are umpteen parallel fleets and insurance companies – under non-Western ownership - which can be used for handling, shipping and insuring Russian oil. To conclude, ever since the start of the Ukraine war, the USA and EU countries have been on a dangerous course of imposing economic sanctions on Russia. Far from hurting, their acts have ended up bolstering its coffers. It happened on a mammoth scale through most of 2022 when there was no cap and continued to swell during the first half of CY 2023 when the cap was symbolic.  

Since July 2023, the swelling of coffers has accelerated. Meanwhile, the actions of G7 continue to bring more misery to the people in these countries due to soaring energy bills, high inflation and economic slowdown.

The G7/EU should shun the chosen path. They need to recognise that in a globally interdependent world, actions that severely restrict the flow of goods and services across national boundaries are bound to be counter-productive. The damage will be much greater when a crucial commodity such as oil is the target and the quantum involved is huge.

(The writer is a policy analyst, views are personal)

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