As Ukrainians suffer through another day of indiscriminate shelling by Russian forces, Western leaders are meeting in Washington, London and Brussels to discuss new sanctions aimed at deterring and punishing the Kremlin’s aggression.
The sanctions introduced since the Russian invasion on 24 February are already far-reaching. Western countries have imposed a slew of financial restrictions, including freezing the assets of Russia’s central bank, limiting its ability to access its dollar reserves. The US, EU and UK have also banned people and businesses from dealing with Russia’s central bank, finance ministry and wealth fund.
Russian banks Bank Otkritie, Bank Rossiya, Novikombank, Promsvyazbank, Sovcombank, VEB and VTB will be removed from the Swift messaging system, which enables the transfer of money across borders. However, the ban stopped short of including those banks handling energy payments.
Russian President Vladimir Putin, Foreign Minister Sergey Lavrov and Kremlin-favoured oligarchs – including Igor Shuvalov and Alisher Usmanov – have also been sanctioned. Their assets in the US, EU, UK and Canada will be frozen and many have also been hit with a travel ban. The EU, UK, US and Canada have launched a transatlantic taskforce to find and freeze the assets of sanctioned individuals and companies.
There are also new restrictions on products that can be sent to Russia, including dual-use goods – those that can have both a civilian and military use – such as chemicals and lasers. Germany has put on hold permission for the €10bn Nord Stream 2 gas pipeline to open between itself and Russia. The US, EU, UK and Canada have banned Russian flights from their airspace, and the EU has banned the sale of aircraft and equipment to Russian airlines.
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On 8 March, the US and the UK also announced new energy sanctions against the Kremlin: the US said it would be banning all imports of Russian oil and gas, and the UK announced it would phase out Russian oil imports by the end of 2022.
The sanctions impact on the Ukraine conflict
The sanctions already put on the table are unprecedented in Russia’s post-Soviet history, closer to the restrictions imposed on Iran in recent decades – and they are already starting to take effect. The Russian stock exchange has effectively been frozen since the start of the war, and the ruble is down 30% against the dollar. Inflation is rampant, at around 9%, and cannot be effectively eased by the central bank, which needs to be very sparing with its reserves because of the sanctions imposed on it.
“Of all the sanctions, the ones that address the central bank’s strategic reserves are the most important,” says Maria Pastukhova, senior policy advisor for energy diplomacy at the environmental think tank E3G. “Of course, some parts are in other foreign currencies, some in gold, but the powers of the central bank to bolster the economy have still been severely curtailed.”
Although the sanctions specifically circumvent the Russian energy sector, it is already experiencing some painful side effects. The oil majors are pulling out, with BP, Shell, Equinor and Exxon Mobil having all announced plans to withdraw from shareholdings or joint projects in the country, and outside of the energy sector, a range of international investors have reached the same conclusions. The payments giants Visa and Mastercard have both announced they will withdraw their services from Russia, joining the likes of Apple, Airbnb, Boeing, Google, Microsoft, Netflix, PayPal, PwC, Spotify and TikTok in restricting their services in the country. “These will have long-term consequences for the Russian economy,” says Pastukhova.
Nonetheless, none of this will likely have much of an effect on the Kremlin’s immediate behaviour in Ukraine. Sanctions are designed to undermine the global competitiveness of an economy and its ability to grow further resources for aggression, and as such they can only be expected to work over time.
“Sanctions can only really have an impact long term, by destabilising internal politics, but will they act as a deterrent for Putin in Ukraine? No," says Pepi Bedi, a leading trade finance expert who has financed Russian energy supplies into Europe for over 27 years. "As we saw in 2008 and 2014, he doesn’t care about the effects on the Russian people, and he has already factored in the economic costs.”
Russia has never been better prepared for sanctions as it is now. It has one of the world’s lowest debt-to-GDP ratios at 18% and has built up its strategic foreign currency reserves over the years to hit a record $630bn latest year. At the start of the Ukraine invasion, Russia was more robust than it was after it invaded Crimea in 2014.
“There is the ban on Swift, but if we are not targeting the energy sector because we are worried about the effects on Germany, Poland, Italy and so on, then what is that we are targeting with the Swift payments?" says Bedi. "In recent years, Russia has accelerated the use of its own payment cards, like MIR, and its own version of Swift, SPFS, so it is pretty immune by now."
In the 2014 Crimea crisis, sanctions meant Western banks were restricted from funding large pre-export financings for Russian commodity players such as Rosneft and Gazprom Neft. However, those banks found a way around that by providing large ‘prepayment’ deals to commodity traders like Glencore and Vitol, who then on-lent the money into the Russian commodity sector. “People will always find ways around these sanctions,” says Bedi.
Bedi thinks that since 2014, Russia has learnt to live without Western finance. Before Crimea, the Russian economy was a large player globally, buying assets in the likes of South Africa, the US and Asia, but has since turned inward. The Russian government and companies have increasingly maintained their revenues within Russia, allowing them to be “prepared for losing access to the US dollar”, says Bedi. “Unless the European countries put in sanctions involving the euro, which is extremely unlikely given their dependence on Russian gas, the Kremlin won’t see a huge effect.”
The EU’s painful choices
However, in the wake of events, there has been a real turning point in the EU’s perception of its dependency on fossil fuel imports. Russia is now a symptom of a much bigger challenge of an overall dependency on oil and gas imports that are now increasingly seen not as a source of soft power, or as a bridge for cooperation, but as a major liability and a significant risk to the resilience of European energy systems.
That is now spurring action on multiple fronts in discussions over how to accelerate Europe’s energy transition. The EU is looking at what new technologies can help speed up the transition, as well as how to address the energy demand. “We have started to not just talk about supply, which is now entrenched in geopolitics and can’t be changed from today to tomorrow, but about how to address the issue by changing energy consumption,” says Pastukhova. “European countries are finally turning to the potential energy efficiency measures and new technologies in gas-dependent sectors, such as heat pumps for heating.”
However, there is also an opposing dynamic going on, where the pull away from Russian fossil fuel supplies is pushing demand for alternative supplies of fossil fuels from elsewhere. Plus, there is, of course, scepticism about the environmental sustainability of boosting LNG and coal imports to increase strategic energy reserves, particularly in the immediate aftermath of the COP26 climate conference in November. “So, we are at a crossroads,” says Pastukhova.
Nevertheless, the willingness of the EU to risk inflaming Europe’s current energy crisis by sanctioning Russian energy is undeniably growing as Russian forces employ increasingly barbaric tactics in Ukraine. The European Commission announced on 8 March that it aims to reduce EU demand for Russian gas by two-thirds by end of 2022, with the aim of achieving energy independence from Moscow "well before 2030" – but would banning Russia energy imports have any effect on Putin’s Ukraine offensive? Almost certainly not, agree Bedi and Pastukhova. Gas exports only contribute around 13% of Russia’s budget revenue, “meaning the sanctions on the foreign currency reserves of the central bank are a much more drastic measure than cutting off oil and gas supplies”, says Pastukhova.
EU countries are reliant on Russia for 40% of their gas supplies and cannot reduce that reliance quickly without resorting to measures such as demand destruction, including shutting down non-critical industry segments, or rationing heating and other gas-dependent activities.
Europe imports around 400 billion cubic metres (bcm) of gas each year, with Russia supplying around 175–200bcm. Can Europe find another 175–200 bcm in alternative gas supplies and/or reduced gas use? “Very tough,” says Nikos Tsafos, the James R Schlesinger Chair in Energy and Geopolitics at the Center for Strategic and International Studies. He explained in a recent editorial that the shortfall would be almost impossible to make up either through increased LNG imports or by reducing internal demand.
The International Energy Agency’s recently published a 10-Point Plan to Reduce the EU’s Reliance on Russian Gas, claiming the bloc could cut Russian imports by more than a third within a year. “[But] remember that revenues from gas are a small part of the Russian foreign balance,” warns Tsafos. “Even if you hit all energy exports, Russia has enough non-energy exports to cover most of their import needs – before dipping into reserves. [So] you are not inflicting that much pain.”
Cutting off Russian oil supplies would be a more effective measure. The country is more sensitive to oil disruptions given that oil contributes around a quarter of the state’s revenue. So, the share of oil revenues in the Kremlin’s Ukraine war chest is significant. The EU could more easily find alternative supplies on the global oil market than alternative supplies of gas, given the market is much more liquid and is not tied by physical infrastructure such as gas pipelines.
However, cutting Russian oil supplies that cannot then be quickly rerouted to other markets would result in Russia essentially dropping out of the global oil market, which could have drastic repercussions. Russia produces and exports about 10% of global oil and a disruption of that scale in the global market would result not just in an exorbitant oil price – which already hit a 14-year high of $139 a barrel on Monday – but also have knock-on effects on vulnerable oil-dependent economies such as India.
“That might cause a level of geopolitical and economic turmoil that we have never experienced before,” warns Pastukhova. “The closest situation would be the oil crisis of 1973, but we really don’t have any proper comparisons. Targeting oil would be both effective and extremely painful [for the EU], so I don’t see that happening anytime soon. The only way the EU would be able to cut Russian oil supplies would be to try and reduce its oil consumption, which would take some time.”
All eyes are now on Brussels, as the world waits to see just how much pain the EU is willing to inflict on itself to punish Putin for his bloody campaign. The low-hanging fruit has already been picked – only difficult trade-offs remain.
Understand the impact of the Ukraine conflict from a cross-sector perspective with the Global Data Executive Briefing: Ukraine Conflict