Energy Markets and the Design of Sanctions on Russia

Russia is the world’s largest commodity and energy exporter. It is difficult to design effective sanctions against a huge player like Russia, especially when many of the sanctioning countries themselves are dependent on energy and commodity imports.

Perhaps for this reason, the initial sanctions, after Russia invaded Ukraine, did not even target energy. But harsh financial sector sanctions affected energy trading nevertheless, with the demand for Russian oil falling and the demand for oil from the rest of the world rising. ?

The timidity toward energy sanctions is changing. Since the US has announced an embargo of all coal, gas and oil imports from Russia (March 8), more and more countries have been implementing import moratoria. Their discussion has moved to “sanction picking,” with individual countries imposing import restrictions they feel they can afford and, different from previous sanction regimes, no one getting punished by secondary sanctions for still consuming Russian coal, gas, or oil.

Two things we have learned in those few weeks:

• Energy sanctions have a dual price impact. In oil, for example, the demand for Russian oil declines; and it trades at a large discount to global oil prices. Because overall now less oil is available, however, the demand for oil from places other than Russia increases: global oil prices rose after the invasion. The art of targeting sanctions effectively is to minimize the effect on the general price level of oil, while maximizing the discount (and minimizing volumes) of the oil produced under sanctions.
• Second, to manage this price differential has been quite successful so far. Part of this success is due to the voluntary and gradual nature of individual country moratoria. It pays to be flexible to see how the price differential develops. This flexibility will also help to deploy the sizeable available safety valves (e.g. the Strategic Petroleum Reserve, the spare capacity in OPEC countries, an acceleration of US fossil energy production), once its time comes, in the most effective manner.

An article of mine which has just been published concludes that ‘sanction picking’ looks like the right strategy; and that the scope for more sanctions is far from being exhausted. If there is political will, this road can be travelled further. The paper is short, sweet and available here.?