Emptying the Kremlin’s Energy Piggy Bank

Photo: Russian oil tankers parked at a rail station. Credit: sergejf via Flikr.
Photo: Russian oil tankers parked at a rail station. Credit: sergejf via Flikr.

To elevate pressure on the Putin regime, a coordinated approach is needed to fast-track sectoral sanctions on the Russian oil and gas sector.

As the Kremlin’s unprovoked and malevolently prosecuted war of aggression against Ukrainian independence drags on, calls for the international community to increase pressure on Putin via sectoral energy sanctions grow louder. There is a good reason for this. Reuters reported that in 2021, hydrocarbon exports represented 36% of the Russian state budget, with exports by sector including $110.2bn in crude oil, $54.2bn in pipeline natural gas, and $7.6bn in liquified natural gas (LNG).

Given the significant role that hydrocarbon revenues play in funding Putin’s war machine, it is vital that the international community immediately take steps to staunch the flow of money. However, even when the sanctions lever is pulled, it will take time for implementation to take effect and the impact to be felt in the Kremlin, while risking both supply and price shocks if not calibrated properly. That should not deter the international community from recognizing that a wartime level of effort is needed to work as quickly as possible toward reducing and ending Putin’s ability to cash in from hydrocarbon sales.

Sanctions on worldwide Russian oil and gas exports require a coordinated, phased approach to heap additional pressure on the Putin regime right now, while avoiding the creation of regional energy security-of-supply crises around the world. Given the usual presence of wind-down periods and general licenses in both sanctions legislation and Executive Orders that can delay impacts, these steps should be taken in rapid succession to maintain immediate and sustained pressure on the Putin regime, while also ensuring regional energy security.

To achieve this, a three-phase, escalatory energy policy, and sanctions ladder should take the following form:

1. Continued private sector avoidance and energy security planning.

Global energy majors, including Exxon, BP, Shell, Equinor, and others have begun to withdraw from existing oil assets in the Russian Federation, while canceling planned future investments. Furthermore, as I wrote for CEPA last week, the combined risks of sanctions, physical security (especially in the Black Sea given the proximity of the Russian Novorossiysk oil export terminal near the Kerch Strait), and reputational damage, have thus far largely deterred global energy traders from importing Russian Urals crude oil, even in the absence of government sanctions.

This has led the Urals benchmark price to drop to an unprecedented differential below the global Brent crude oil benchmark price. As of March 7, the five-day rolling average differential was $22.97 per barrel for Russian Urals compared to Brent. The continued separation of Urals from Brent can potentially reduce the economic shock of future oil sanctions, as the Brent price is further baked into economic expectations. Moreover, the market is already working to identify new supply sources, while global production is urgently ramped up. The longer this continues, the greater the likelihood that Rosneft and other Russian oil producers will have little option other than ramping down their own production, given the glut of Urals oil filling Russian ports and export storage facilities.  Recall that this is what happened to some US oil producers when the oil price trade turned negative shortly after the outbreak of COVID-19 in early 2020 given the unprecedented drop in demand coupled with storage limitations.

On the European natural gas front, the European Union (EU) should focus on evicting Kremlin-controlled Gazprom from ownership stakes in critical gas storage facilities across Western Europe. If left unaddressed, there is a high potential for issues ranging from conflict-of-interest to strategic security concerns, as the warmer months arrive, and Europe’s gas storage facilities need to be filled before next winter.

All of these private sector actions should be encouraged by policymakers to the greatest extent possible, as they can put immediate significant pressure on the Putin regime in an even faster manner than policy mandates like sanctions can deliver. Sadly, however, it’s likely impossible to keep this self-regulated private sector action going indefinitely absent government intervention.

Case in point? On March 4, reports emerged of Royal Dutch Shell purchasing a cargo of Russian Urals at its historic discount. This generated widespread outrage, including an impassioned statement by Ukrainian Foreign Minister Dmytro Kuleba, rhetorically asking Shell, “doesn’t Russian oil smell like Ukrainian blood to you?” Shell later issued an apology, vowing to donate any profits from that purchase to Ukrainian humanitarian relief.

 2. Targeted, technology-calibrated export vessel sanctions

While active diplomacy works toward coordination of emergency energy security measures to help mitigate potential security-of-supply shocks from sanctions, targeted, technology-calibrated shipping sanctions can begin to be rolled out in the coming days.

These can either be individual vessel sanctions or designations of Russian corporate shipping lines. The latter approach would undoubtedly be easier for governments to coordinate in the short term, simply targeting Russian hydrocarbon shipping lines themselves (e.g. OOO Gazpromflot, JSC Rosnefteflot, and PAO Sovcomflot). In either case, these interim sanctions could be made on a targeted and technology-calibrated basis similar to sanctions on the Russian Nord Stream 2 construction fleet over the years, but in this case based on metrics like vessel capabilities, capacity, and usual markets served.

3. Coordinated blocking sanctions on Russian oil and gas exports.

Finally, punitive sanctions on the Russian oil and gas sectors can be announced following active coordination with partners and allies. In particular, this is needed to ensure that global energy traders ultimately continue to avoid Urals oil so that its price doesn't inch back toward the global Brent benchmark, a differential that is currently depriving the Kremlin of cashing in on surging energy prices.

At the same time these sanctions are applied (likely with sanctions on oil preceding gas, given greater fungibility in the oil market), there should be a rapid push for additional energy diversification infrastructure deployments in Europe to ensure gas supply security during the next heating season, combined with a rapid push to secure additional LNG cargoes to help fill European storages. German Chancellor Olaf Scholz, for example, has called for the rapid construction of two liquefied natural gas, or LNG, terminals in his country and others should follow to ensure sufficient LNG capacity.

The type of infrastructure deployed matters too. Infrastructure options such as LNG floating storage and regasification units (FSRUs) at strategic locations (such as in Brunsbuttel, Germany, and Gdansk, Poland) around the European coastline, should be prioritized over larger-scale permanent infrastructure that would take longer to develop. Furthermore, a wartime level of effort and funding should be allocated to construct the needed onshore infrastructure associated with each FSRU that would normally take years of project development.

In other words, we need to have parallel tracks:

  • punitive three-phase energy sanctions to degrade the Kremlin’s war-making funds (private sector action, vessel designations, sectoral sanctions)
  • unprecedented efforts to reconfigure global oil supply chains, and
  • ensuring that Europe completes much-needed gas import and diversification infrastructure.

This may all sound like a tall task, and indeed it is. But the core of this effort is simply the continuation of policies that have been developed over time, just with an unprecedented level of urgency.

After all, the EU has been working on reducing Russian gas dependence via the European Energy Union framework since 2015, and Central and Eastern European countries have further pushed this objective via the Three Seas Initiative (3SI) in recent years. And the US and international oil importers have taken policy decisions to get through geopolitical shocks in the past.

For the sake of Ukraine’s struggle, we must rise to the occasion. For the sakes of those millions of people now exposed to the Kremlin’s malice, failure is not an option.

Dr. Benjamin L. Schmitt is a Postdoctoral Research Fellow at Harvard University, a Senior Fellow for Democratic Resilience at CEPA, and a “Rethinking Diplomacy” Fellow at the Duke University Center for International and Global Studies. (Twitter: @BLSchmitt)

March 7, 2022