Why the latest Russia oil sanctions could hurt its war economy

Russian President Vladimir Putin. Reuters

When it comes to sanctions on Russia, the Trump administration has a reputation for chickening out and the EU for pulling its punches. But the latest measures against Russian oil and gas sales look tougher. For three reasons, they might put real pressure on President Vladimir Putin’s war economy.

Three main sets of new oil sanctions were announced last week. First, the two largest Russian oil companies, Lukoil and state-owned Rosneft, and any entities owned half or more by them, are blacklisted by the US and EU. They supplied a quarter of Russian oil exports to China last year. Lukoil’s trading arm, Litasco Middle East DMCC, is mentioned. In addition, secondary sanctions mean that third-party companies dealing with Lukoil or Rosneft could also face exclusion from the American financial system.

Two of the other big exporters, Gazprom Neft and Surgutneftegaz, had already been sanctioned by the US and UK in January, the EU hitting Gazprom Neft in May. Separately, the UK and EU also designated Shandong Yulong Petrochemical, a major Chinese buyer of Russian crude, for sanctions. The EU sanctioned the Liaoyang refinery, in north-east China, which is the only Chinese refinery running exclusively on Russian oil, delivered through the East Siberia pipeline.

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Second, London and Brussels targeted more vessels in the “shadow fleet” transporting sanctioned oil. The US has not added more ships to its blacklist since January, a weakness in the measures, since American sanctions are generally more effective. About 500 to 550 vessels are on the British and EU lists, and only 216 on the American. But the US has sanctioned Chinese ports such as Dongjiakou and Rizhao, known for handling Russian and Iranian petroleum.

Third, resale to Europe of products refined from Russian crude is banned, which will halt a lucrative trade from India.

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Why are these measures likely to hit harder?

First, they target both the main Russian sellers, and their key customers. This is in contrast to earlier bans, which diverted oil from Europe to India and China, allowing them to extract discounts, but without hurting Moscow’s overall sales very much. Attempts at imposing a price cap on Russian oil transported with European ships proved largely ineffective because of evasion, lack of enforcement, and the expansion of the shadow fleet.

China, at about two million barrels a day, and India, with around 1.75 million bpd, are the key buyers of Russia’s crude. The main Chinese state companies, PetroChina, Sinopec, CNOOC and Zhenhua, will stop handling their usual 250,000 to 500,000 bpd of seaborne Russian oil, at least temporarily. India’s Reliance may have to halt the 500,000 bpd it buys from Rosneft.

Second, market conditions are propitious. Oil prices have slipped pretty consistently this year, apart from a couple of war-related spikes, from a high of $82 a barrel for Brent in January, to $61 just before these latest sanctions. Their announcement caused a jump on Thursday to a cent short of $66, still well below the start of the year.

Kuwait’s Oil Minister, Tariq Al Roumi, said that Opec would be ready to raise production in case of shortfalls caused by the sanctions. The expanded oil exporters’ alliance Opec+ gathers next on November 2, too early to assess the impact. It may choose for now another moderate increase of 137,000 bpd, as it did last month.

The keenness of Opec+ to regain market share is a vital positive for the effectiveness of sanctions. If Saudi Arabia, the UAE, Iraq and others fill in for losses from Russia, this will avoid a spike in petrol prices. Any hint of higher pump prices would spook US President Donald Trump, already under pressure over inflation and the economic impact of tariffs.

Third, the sanctions serve a double purpose for Mr Trump. He has appeared curiously reluctant to take tough action against Moscow. Beijing is a different matter. The latest shot in the trade war, China’s new restrictions on rare earth exports, are a threat to military and high-tech industries, both in the US and worldwide. Restricting access to discounted Russian crude may be more about winning the trans-Pacific confrontation than the war raging in eastern Ukraine.

Will these sanctions do serious damage to the Russian economy, or even hobble its military effort? Oil and gas earnings make up a quarter of Russia’s overall budget. They are already 21 per cent lower this year in Russian currency terms, mostly because of weaker prices combined with a stronger rouble.

The pressure on Russia’s petroleum industry is supported by Ukraine’s continuing drone assault on refineries. Russian exports of refined products were down 9 per cent in September on a month earlier. Oil products are easier to disguise and ship in smaller packages than crude oil, for which Moscow which has only three notable buyers, China, India and Turkey.

But there are still three crucial caveats. The effectiveness of the sanctions depends on the cat-and-mouse game of enforcement versus evasion. Russian traders have proved adept at using fronts and the shadow fleet to keep oil moving. China, not willing to submit to Washington’s diktats, may reconfigure ports, refineries and banks to keep buying Russian oil outside the ambit of the sanctions.

Mr Trump may again shift course, convinced by a conversation with Mr Putin, or a rise in oil prices, or an easing of Chinese trade tensions. The White House may be talking tough and yet not be either capable or willing of properly policing its measures. Brussels remains allergic to higher energy prices, and its Russophilic members Hungary and Slovakia continue to hamper action.

Finally, with the frontline in Ukraine essentially deadlocked, the Kremlin is not winning, but it is not obviously losing either. The Russian economy is weakening, but this is not 1917, with breadlines in the streets of St Petersburg. These new sanctions are a blow, but not a crippling one, and not enough on their own to force Mr Putin into serious peace talks.