Sanctions, Oil Prices and Making Russia Pay

By W. David Montgomery

Although economic warfare has little prospect of saving Ukraine from Putin, it could be an important part of a longer-term strategic response. Unlike China with a diversified economy linked throughout the global economy, Russia has been described as “Upper Volta with a gas station (and nukes).” Energy is the source of 50% of Russia’s export revenues and the source of almost all of Russia’s dollar and Euro earnings. Reducing Russia’s oil and gas exports, or in the alternative driving down the price Russia receives for oil, would deprive Russia of these earnings and limit Putin’s ability to conduct wars of aggression. But nothing is that easy.

The West faces several dilemmas in dealing with Russian energy exports:

  1. It is impossible to reduce Russian oil exports significantly without an export embargo that would closely resemble a blockade of shipping out of Russia, risking further escalation. A full embargo could raise oil prices above the peak they reached in early March, and those price spikes have already produced political backlash.
  2. Europe has let itself become dependent on Russian natural gas, and it will take at least several years before Europe can find alternative sources. Reducing Russian natural gas exports will therefore come with considerable pain for our European allies.
  3. The painless way to inflict pain on Russia is to increase U.S. oil production and if possible that of other countries. This approach would not even count as economic warfare, because it is not directly an attack on Russian assets. The obstacles are the Biden Administration’s stubborn denial that its policies have reduced U.S. oil production and its higher priority on sending signals on climate policy than on dealing effectively with Russia. The dilemma is whether reducing Russia’s economic power is so important that eliminating sanctions on Venezuela and Iran could be contemplated.

If all of Russia’s oil and gas exports could be interdicted, I estimate that Russia’s GDP would fall by about 30%. Doing this would require both the EU and the U.S. to suffer some economic pain. If U.S. were to get back to the trend in producing oil and gas that it was on before the last election, it might be possible to keep gasoline prices here from rising above levels already seen this year, and to soften the impact on Europe of cutting energy ties with Russia.

Limiting Russian exports

The dilemma on reducing Russian exports is that making sanctions work requires almost as much backbone as sending fighter planes and other direct military support to Ukraine. We learned in the Arab oil embargo of 1974 that oil is a fungible commodity that is easy to redirect from one destination to another.

Some history about sanctions and embargoes reveals why it is so hard to prevent Russia from exporting oil without use of military force. The Arab oil embargo of 1974 had zero effect except to cause policy makers in Washington to panic and impose price controls and rationing scheme that played havoc with the economy. Saudi Arabia and other Islamic countries announced they would no longer sell oil to the United States. Oil traders immediately started making calls and bought cargoes on other tankers at sea to replace the supplies that the Arabs had diverted from the US. Not a barrel of oil went missing. That is a generic problem with sanctions in the fungible oil market. Crude oil is constantly in movement around the world, and traders buy and sell it on the ocean frequently. Sanctions on oil exports only work if everyone joins in, and China is one of Russia’s biggest customers and unlikely to help.

Some data on world oil supply and demand show the problem. World oil production is conveniently close to 100 million barrels per day, making it easy to calculate percentages. Russia exports a little over 7 million barrels per day of crude oil. The OECD accounts for roughly 50% of oil imports worldwide, and I would guess it takes about the same percentage of Russia exports, 3.5 million barrels per day. That leaves plenty of room for other countries to buy whatever the OECD does not take from Russia, while the OECD would be replacing oil not purchased from Russia with oil that would have gone to those other countries.

The only ways completely shut off Russian oil exports are a naval blockade or financial sanctions that make it impossible for Russia to be paid.

Under President Trump, the U.S. unilaterally imposed sanctions on Iran for violating terms of its nuclear deal that worked. According to BBC’s summary account,

The reinstatement of US sanctions in 2018 – particularly those imposed on the energy, shipping and financial sectors that November – caused foreign investment to dry up and hit oil exports. The sanctions bar US companies from trading with Iran, but also with foreign firms or countries that are dealing with Iran.

In May 2019, Mr Trump ended exemptions from US secondary sanctions – such as exclusion from US markets – for major importers of Iranian oil and tightened restrictions on the Iranian banking sector. He said the decision was “intended to bring Iran’s oil exports to zero, denying the regime its principal source of revenue”.

As a result of the sanctions, Iran’s gross domestic product (GDP) contracted an estimated 4.8% in the 2018 and is forecast to shrink another 9.5% in 2019, according to the International Monetary Fund. The unemployment rate meanwhile rose from 14.5% in 2018 to 16.8% in 2019.

We did not just stop buying oil from Iran. President Trump enforced sanctions not just on Iran but on anyone buying oil from Iran. That broad action was what shrank Iran’s oil exports and hurt its economy.

Those are the steps that neither Biden nor other OECD countries have been willing to take. To stop Russian oil exports, the US and the EU must make it impossible for importers to pay for Russian oil and punish those who try. The sanctions that ban financial transactions with Russia have large loopholes, and explicitly exempt payments for oil and gas. Announcing that we will no longer purchase oil from Russia is by itself nothing but empty virtue-signaling, no more effective than my refusal to deal with Starbucks. To stop exports of oil from Russia, it would be necessary to make it impossible for any country to purchase that oil. Financial sanctions on Russia would have to extent to all transfers of dollars or Euros to Russia, and probably to go further to impose secondary sanctions on all importers of Russian oil. Even then, eventually China could get oil by pipeline and conduct settlements in rubles and renminbi. Eliminating sea-borne exports could well require searching and seizing ships coming out of Russian ports, a blockade at least as risky as MPD’s proposals for aid to Ukraine.

Replacing Russian natural gas

Russia also earns Euros for its natural gas exports, on which Europe depends. The near-term consequences for Europe of foregoing Russian esports this winter would be very hard, and the willingness of German, Netherlands and other recipients of oil and gas exports to stand with Ukraine in the face of Russian threats to cut them off has been admirable.

Over the course of several years, it would be possible to for Europe to replace those supplies. Not, as some Greens proposed, by adding more wind and solar power, but keeping nuclear powerplants would help. The most important source would be natural gas. There are no doubts regrets throughout Europe that the pipeline from Turkey to Europe was not completed, but a North Sea pipeline from Norway is due to come on-line in about a year.

Another source of replacement supplies would be natural gas, shipped to Europe in the liquid state (LNG). I know from the time when I was working on LNG exports from the United States that Hungary, the Baltic States, and other former Iron Curtain countries were anxious to obtain those supplies from the United States. Regasification terminals in countries importing LNG are quick to build, but the export terminals where natural gas must be compressed and liquefied are massive structures that cost billions. They also require permits that have taken multiple years to process, and additional natural gas supplies that the Biden Administration and state bans on fracking are keeping in the ground.

Impacts on oil prices

No matter how it might be accomplished, cutting off Russian oil exports without providing replacement supplies would be costly for American consumers. I thought I would perform some back of the envelope calculations that I have found illuminating over the years.

At the beginning of February, before Russia’s invasion started, crude oil had already reached $90 per barrel and gasoline prices averaged $3.45 per barrel. Like inflation for the economy as a whole, gasoline prices rose to that level because rising demand due to the end of Covid lockdowns outstripped supply held down by the policies of the Biden administration. Then in the first week of March, fears of supply interruptions caused crude oil prices to peak at close to $130 per barrel, and gasoline prices tracked that increase penny for penny. Now that panic buying seems to have receded, as the realization sank in that there have not been and will not be any noticeable reduction in Russia’s exports or world oil supply.

The rapid drop in crude oil prices since the announcement of U.S. and UK decisions to stop purchasing Russian oil is a market confirmation that the announcement means nothing. Only sanctions that stop Russia from being paid for oil exports or a blockade that prevents it from shipping oil will make a difference.

By my calculations, real sanctions that cut off half of Russia’s exports would have driven crude oil prices up to a bit less than the $130 level they reached in early March. Now that markets realize that no effective action is being taken, world oil prices have dropped precipitously from their peak on March 8 and prices at the pump should follow. It is infuriating, but pump prices have always risen penny for penny for crude oil prices, but they only float down slowly when crude oil prices fall. Nevertheless, they do come down. If we did nothing more to limit Russian exports than make pointless announcements that we are no longer buying from them, gasoline prices should by summer be back down to the $3.50 range.

If we did impose sanctions that cut Russian oil exports in half, a likely number if only financial measures were used to enforce them, world oil prices would be likely to return to peaks they reached in early March. Gasoline prices would rapidly follow, to last weeks reported average of $4.25. The good news, such as it is, is that by my calculations we have already experienced these impacts.

If we cut off all of Russia’s exports, we could expect to see another 75 cent per gallon increase in retail gasoline prices, or $5.00 per gallon on average. Even that would moderate as consumers found more ways to reduce oil consumption — which includes home heating oil, diesel fuel and feedstocks for petrochemicals. If the Administration came to its senses about releasing US oil and gas production from restrictions demanded by climate alarmists, the pain would be even more short-lived.

A better way

We could deprive Russia of oil revenues while making ourselves better off by restoring the U.S. oil production sacrificed by this Administration on the altar of climate change. If we were to replace Russian oil with our own production, even a full embargo might not raise U.S. gasoline prices much above current levels, once the panic-buying caused by fears of sanctions on Russian exports ceased. That might still be too much for the American public to stand, but it would make Russia pay a heavy price.

Based on the same calculations I made for reduced supply, every 1 million barrels of additional production from the US could reduce world oil prices by $12.50 per barrel and reduce gasoline prices by 30 cents per gallon. We could get another 2 million barrels per day by removing the constraints on oil production placed by the Biden Administration.

Since it peaked in December 2019, U.S. oil production has dropped by 400,000 barrels per day. Before Biden (BB), U.S. oil production was predicted to rise 1.5 million barrels per day between 2020 and 2022. That means we should credit Biden with cutting off almost 2 million barrels per day of U.S. oil production. Federal regulators have been slow-walking permits for drilling on Federal lands, taking a year or more to approve permits for drilling on lands already leased. Woke investors and banks have been refusing to finance oil and gas drilling. The Keystone pipeline that in a huge demonstration of climate virtue Biden cancelled on his first day in office, would have opened even more Canadian oil resources.

Even without Keystone, getting U.S. production back up to its BB trend would take $25 per barrel off world oil prices and 60 cents per gallon off gasoline prices. That would be just about enough to keep gasoline prices at early March levels, a painful choice, while enforcing sanctions that would take away all of Russia’s oil export revenues.

Ending regulatory programs designed to make it harder to produce natural gas, such as new methane emission regulations, and pre-empting state bans on fracking to produce natural gas in New York, Maryland and other states would allow additional natural gas to be produced to ease Europe’s move away from Russian gas. Completion of pipelines to move natural gas to export locations is also needed. That would be a good deal for the U.S. and Europe.

Instead, the Biden Administration is already reported to be thinking about removing sanctions on Iran and Venezuela to increase oil supply, without increasing our own. That would have similar consequences for Russia and U.S. consumers but at the cost of allowing Iran to resume its course toward nuclear weapons and cement the hostile Maduro regime’s hold on Venezuela. Another dilemma, trading national security interests in one area for those in another.

Effects on Russia

Russia’s export earnings for 2021 were recently reported by Reuters. Russia’s revenues from crude oil exports were $110 billion in 2021 and oil products were almost $70 billion. If half of Russia’s oil exports could be stopped, that would have been a loss of $90 billion last year. Since last year’s prices received by Russia averaged about 30% less than the prices it is receiving now, the loss would now be about $120 billion. A full blockade, naval or financial, would cost Russia over about $240 million or 16% of its 2020 GDP of just $1.5 trillion.

If the EU ceased purchases of Russian natural gas, Russia might lose another $60 billion in export revenues for a total of $300 billion or 20% of GDP.

The cost to the U.S. and the EU of imposing these costs on Russia would be substantially reduced if the U.S. were to remove constraints on oil and gas production and replace Russian exports of natural gas to Europe with American LNG. That might be the only way to make the cost politically tolerable, though the chances that this Administration would do so are not promising.


Since this has been a long journey through numbers, let me summarize the story about the cost and effectiveness of cutting off Russia’s oil exports.

“Just don’t tell her please that tough sanctions would be too expensive … “
Source: Donald Tusk Twitter account
  1. It is not easy to target one country’s oil exports. It takes sanctions that prevent the oil exporter from being paid for oil, or a blockade to stop tankers from leaving Russian ports.
  2. If we could reduce Russian oil exports by half, that raise gasoline prices back to $4.25 per gallon and cost Russia 8% of its 2020 GDP.
  3. A full embargo on Russian oil exports would raise gasoline prices to $5.00 per barrel and cost Russia 16% of its GDP.
  4. We could reduce gasoline price impacts in each case by about 60 cents per gallon if we got U.S. oil production up to its trend forecasted before the Biden election.
  5. If Europe gets off Russian gas, Russia would suffer an additional loss of 4% of its GDP, and we could provide substantial replacement supplies to Europe if we freed up natural gas production and sped up construction of LNG export terminals in the U.S.

Thus a feasible series of actions could put a hurt of 20% of GDP on Russia and reduce its long term economic growth prospects accordingly. Whether American and European consumers could stomach the energy price implications is less clear.

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