How Russia evaded oil price cap sanctions

Amid the future of the sanctioning package imposed on Russian oil transactions, including the infamous price cap measure, being currently reviewed by Western leaders, the Foreign Policy Journal has looked back at the efficiency of the sanctions and the consequences they had for Russia's energy industry, if any. Caliber.Az reprints this article.  

"Discussions around the future of the price cap placed on Russian oil exports by the G-7 and European Union were high on the agenda of the US-EU summit in Washington last week. The debate is raging around what to do with the policy, which imposes a maximum price of $60 per barrel for Russian oil exported with the assistance of Western shipping or insurance firms. Proponents of the cap argue that it represents a critical tool to curb the Kremlin’s ability to finance the war in Ukraine. Critics believe that Russia easily dodges the cap, rendering it ineffective.

The reality is more nuanced: Both sides are right. Over the past year, the oil price cap has largely succeeded in lowering Russia’s hydrocarbon revenues. Yet looking at the precedent set by other sanctions regimes, it was always clear that Moscow would gradually manage to evade the measure and make it ineffective in the long term.

Debates on the effectiveness of sanctions typically tend to eclipse a crucial question: What were the original objectives? The United States, the EU, and their allies had three goals in mind when they imposed a price ceiling on Russian oil.

First, like-minded countries wanted to send a diplomatic signal of unity to the Kremlin. Second, Western countries wanted to curb Russian oil revenues in a bid to degrade Moscow’s financial ability to wage war against Ukraine. Third, G-7 and EU states wanted to avoid supply reductions that would drive up oil prices and have a detrimental impact on the global economy. As the price cap was being negotiated, some analysts were warning that taking Russian oil off the market could send crude prices to $200 a barrel.

Looking at these three goals, the oil price cap has been a success. On the diplomatic front, Western unity around the measure has been perfect, sending a loud message of resolve to the Kremlin. On the economic front, the data speaks for itself: According to the Kyiv School of Economics, in the first eight months of 2023, Russia’s earnings from oil exports were 30 percent lower than over the same period in 2022.

Of course, part of this is due to lower global oil prices and the EU’s embargo on Russian oil, which meant Russia had to divert those supplies to customers paying less than the Europeans would have. Yet even critics of the price cap acknowledge that the measure played a big role. And on the third objective, like-minded allies can claim mission accomplished: On average, and despite output cuts by OPEC, oil prices have remained below 2022 levels throughout most of 2023.

Overall, the price cap has done precisely what Western policymakers intended it to do. The measure has decoupled the Russian oil market from the global one, creating a wedge between global prices and what Russia can get for its crude. Instead of selling its oil at the spot price, Russia has to negotiate the value of each shipment with potential buyers, giving consumers of Russian oil the bargaining power to drive prices down.

Moscow also faces inflated costs to ship its oil, which further weighs on its revenues. Insurance firms now charge a premium to underwrite Russian oil shipments, and Russian oil tankers now have to travel, on average, more than three times the distance they used to in order to reach their customers.

The price cap has proved effective over the past year or so, but a look at other sanctions regimes makes it clear that the measure would not succeed in the long run. The first cautionary tale has to do with US sanctions on Nord Stream 2, the Baltic Sea pipeline that was meant to bring Russian natural gas to Germany. In 2019, Washington imposed stringent sanctions on the project, forcing Western companies to exit the deal. Moscow had a ready-made solution: It assembled an armada of Russian ships that completed the construction of the pipeline with no Western involvement.

Moscow has put this strategy to good use to dodge the oil price cap. Over the past year, it has bought the equivalent of more than 110 Aframax oil tankers to build a sanctions-proof oil fleet. As a result, G-7 and EU firms now ship less than 30 percent of Russian oil, putting the majority of Russian crude out of reach of the price cap.

The second sanctions insight that Russia has put to good use comes from North Korea, a master of sanctions-dodging. Despite comprehensive United Nations sanctions, the regime of Kim Jong Un still manages to import oil and export coal by relying on vessels doing so-called dark voyages. During such journeys, ships hide their location by illegally turning their transponders off and perform covert ship-to-ship transfers of their cargo in the middle of the South China Sea, which has the effect of hiding the full route.

To dodge the price cap, Russia has adopted North Korean tricks with gusto: Many ships in Russia’s newly assembled oil fleet reportedly send fake signals to obscure their location, making it difficult for Western governments to track their whereabouts and detect sanctions circumvention.

The third lesson comes from Iran. Over the past two decades, Iran has been reorienting trade away from Western economies and toward nonsanctioning countries. This is not sanctions evasion, since Tehran is simply doing business with countries that never signed on to sanctions. Russia has been doing exactly the same with its oil: China, India, and Turkey—none of which supported the price cap—now absorb 80 percent of Russian crude exports.

Taking a step back and putting the lessons from Iran, North Korea, and Nord Stream 2 together, it is clear that sanctions targets always adapt. From this perspective, the oil price cap could only be a medium-term tool; there is no such a thing as a sanction that works forever.

What’s next for the price cap? Besides lowering its level below $60, proponents of the measure have three suggestions to resurrect it.

The first revolves around stepping up enforcement—a popular buzzword, as if Western officials dealing with sanctions were sitting idle. This sounds great in theory, but it is hard to understand what it would entail in practice. One option would be to increase scrutiny of the documents that G-7 and EU firms provide to self-certify that they are not dealing with Russian oil sold above the price cap. Another proposal is to develop a white list of G-7 and EU commodity trading groups that shipping companies would be required to use to transport Russian oil. [Currently, it is up to ship owners to check that they are not transporting oil for traders evading the price cap; good luck with that.]

However, these measures would fail to address two structural issues. Stepping up enforcement requires time, money, and trained government officials, all of which are in short supply. More importantly, these measures would do nothing to curb the development of Russia’s own tanker fleet.

The second suggestion, therefore, is to tackle the dealings of Moscow’s oil tankers. This plan would force ships transiting via Western maritime chokepoints, such as the Danish straits or the Gulf of Finland, to have proper spill liability insurance. There are precedents: Turkey requires tankers transiting through the Bosporus strait to prove they have such insurance from a well-capitalized firm. Compliance is easy to check—insurance certificates can be verified online in a few seconds for the majority of the global fleet of oil tankers. Assuming that no reputable firm would accept insuring Russian ships, this option would deal a short-term blow to Moscow—and that is better than nothing. Yet this plan, too, is no silver bullet. Non-Western maritime chokepoints, such as the Suez or Panama canals, would never implement such a measure. As a result, Russia would gradually adapt and ship more oil from its Pacific and Arctic ports, thereby skirting G-7 and EU-controlled waters.

The third proposal is the most powerful: It entails imposing sanctions on Russian oil firms and international businesses helping Russia to dodge the price cap, such as bad-faith commodity traders or companies selling old oil tankers to mysterious Russian clients.

On paper, this looks like a straightforward way to give more bite to the price cap. However, it is not an easy one to implement. For example, when Washington sanctioned Russian aluminum producer Rusal in 2018, the measure included the usual secondary sanctions, so that all firms doing business with Rusal also faced the risk of falling under US sanctions. To avoid this risk, the vast majority of commodity traders refused to touch Rusal’s supplies, provoking a 30 percent jump in aluminum prices. The ripple effects of the Rusal sanctions on global manufacturing supply chains were so serious that Washington had little choice but to backtrack and lift the measures.

Sanctioning Russian oil firms would have similar effects. Russia accounts for about 12 percent of global oil supplies, roughly double Rusal’s share of global aluminum production. Besides the damage to the global economy, a spike in oil prices would give Moscow’s propaganda machine the ammunition to claim that the West is fueling global poverty. It would also revive transatlantic tensions. US-EU unity on Russia sanctions has been watertight since the start of the war precisely because the United States has not resorted to secondary sanctions, which the EU has long disliked.

Sanctions on firms helping Russia dodge the cap would not have such massive consequences and are thus more appealing. But their effectiveness would be limited. As soon as one such company would fall under sanctions, another would take its place in an endless game of sanctions whack-a-mole for Western governments.
Policymakers never like to admit it, but there is no such a thing as a perfect sanction. The oil price cap has done its job over the past year, but it was never meant to be a long-term fix. Sanctions targets always adapt, and Russia will be no exception to the rule.

What’s the best long-term option for sanctions on Moscow, then? Slow-acting measures that deprive Russian oil and gas firms from Western technology are the surest way to provoke a slow asphyxiation of the Russian energy sector. Russian hydrocarbon fields are depleting, and developing new fields will require Western know-how that will not be forthcoming.

Such sanctions have been in place since 2014, and they still represent the most effective long-term measure against the Kremlin. However, they will take time to work. Sanctions are a marathon, not a sprint".