How to Make Energy Sanctions against Russia More Effective

While Western sanctions have clearly failed to deter Russia from invading its sovereign neighbour, their task now is to constrain. Sanctions and export controls aim to constrain Russia’s economic and military options in order to coerce a behav­ioural change in the Kremlin. This is inevitably much harder to do than to deter, as it requires water­tight enforcement in sanctioning countries and multi­lateral cooper­ation to prevent the target from mitigating the impact with the help of third countries. Does it mean that sanctions are futile as a policy of denial? No, but it requires smart design, robust enforcement and enhanced cooper­ation with the private sector.

There is one area where constraining Russia’s options is key – the energy sector. The energy sector has tradi­tionally been a cash-cow for the Russian budget. Histor­i­cally, about 40 per cent of federal revenue came from the sale of hydro­carbons. As the Russian economy grows on the back of military spending, any export revenue in the energy sector is directed towards the country’s military-indus­trial complex. To target Russia’s lucrative extractive economy, the G7 imple­mented an oil price cap, a two-pronged policy which aimed to encourage Russia to supply oil to the markets while slashing its budget revenue at the same time. By design, the policy was inten­tionally slow-paced – to avoid roiling the already tight oil markets, avoid spiralling inflation and avoid overcom­pliance from commodity traders. Initially, the price cap worked as intended: it slashed Russia’s budget revenue by 40 per cent in January 2023 while increasing the discount for Urals to 40 dollars per barrel. However, as enforcement lagged, the effec­tiveness of the price cap waned. Moscow has been effective in diverting its crude to China, India and Turkey, using a vast shadow fleet and dodgy insurance. In the second half of 2023, the discounts narrowed to 14 dollars per barrel while the budget revenue grew from 13 billion to almost 18 billion dollars per month.

Ramp up enforcement of the oil price cap

What measures in the energy sphere are necessary to increase pressure? First, ramped up enforcement of the oil price cap is essential. Tight­ening require­ments around the attes­tation process is key. As soon as the G7 countries stepped up enforcement in early 2024, compliance with the price cap grew, leading to a larger discount of 18 dollars per barrel. While it is futile to expect the Global South to join the price cap, its robust enforcement would incen­tivise them to demand deeper discounts, an outcome in line with Western sanctions policy.

The Biden administration’s executive order imposing secondary sanctions on foreign financial insti­tu­tions for any involvement in Russia’s defence sector has added another strain on the country’s energy exports. Banks in China, Turkey and the United Arab Emirates started severing corre­spondent accounts with Russian credit insti­tu­tions, thus making it hard to conduct inter­na­tional payments. India became reticent to accept the shipments of Russian oil exports – all due to the risk of secondary sanctions. Although the executive order does not target the energy sector, the chilling effect is there and it is reflected in months-long payment delays, making Russia’s circum­vention efforts more cumbersome.

Target the Shadow Fleet

Second, targeting the shadow fleet would deprive Russia of the alter­native that exists outside the G7’s reach. When the Biden admin­is­tration started sanctioning shipping companies and vessels, the impact was immedi­ately evident. The majority of vessels targeted could not dock in ports or find new buyers. The capacity of the shadow fleet is not limitless, so launching inves­ti­ga­tions and imposing heavy penalties would alter the risk calculus even for rogue actors in the industry. As a result, it would increase the sanctions premium, leading to higher shipping costs and lower revenue for Russia.

Enforce insurance and sanction flags of convenience

Third, the West can leverage the remaining choke­points up its sleeve – Russia’s reliance on European ports for its crude exports and US nexus in the industry of fleet regis­tration. As the majority of Russian crude passes through European waters, it is up to EU countries to step up require­ments for adequate and well-capitalized insurance. This would not only force the Kremlin to rely on G7 insurance again, but would also reduce the risk of environ­mental disasters.

There is also asymmet­rical US leverage over vessel regis­tration. While Russia is actively using flags of conve­nience from countries like Liberia, Panama and the Marshall Islands, their management is often headquar­tered in the US, thus giving US author­ities the possi­bility to impose sanctions on them. This repre­sents a vulner­a­bility for Russia’s oil fleet.

Lower the oil price cap

Finally, the West should consider lowering the price cap and expand measures to complete the ban on Russian hydro­carbons. With oil prices rising, there is an urgent need to recon­sider the cut-off point for the price cap. By lowering the cap to 30 dollars per barrel, Russia’s budget revenue would be slashed by 49 per cent. Maintaining the status quo will not constrain the Kremlin’s coffers fast and suffi­ciently enough. Russia’s macro­eco­nomic challenges would only start appearing at oil prices below 40 dollars per barrel.

Comple­menting the oil price cap, an EU/G7’s ban on Russian pipeline gas, nuclear energy and Liquified Natural Gas (LNG) would deprive the country of future export earnings. Moreover, such a policy would be strongly aligned with the EU’s commitment to decouple from Russia’s fossil fuels by 2027.