US Sanctions, Russian Supply Levers in Ukraine Crisis

Fears are mounting that Russia's oil and gas exports to Europe could get caught in the crossfire amid mounting US-Russia tensions over Ukraine. Amid already tight energy markets, the cost of sanctions directly targeting exports could simply be too high, particularly as a first step. Moscow, which denies any invasion plans, is meanwhile very unlikely to cut off energy supplies to Europe — for budget and reputational reasons — while its de-dollarization efforts leave it better able to withstand possible new sanctions. The two sides are still talking, with top diplomats set to meet in Geneva on Friday.

● US sanctions threats are aimed at deterring Russian military action in Ukraine.

US officials have been threatening hefty new sanctions on Russia’s economy, already under economic restrictions for several years. On Wednesday, US President Joe Biden provided more detail, saying Washington would block Russian banks from the US financial system in the event of an invasion, with US officials increasingly viewing Russian action as likely. That would complicate payments for dollar-denominated oil sales. Other measures could include restrictions on exports containing US-sourced material “that go at certain fundamental strategic industries” in Russia, National Security Adviser Jake Sullivan said last week. On Thursday, the US sanctioned four individuals it says are linked to the Russian security service.

Cutting Russian financial institutions from the global messaging system Swift could make sense in the event Russian banks were blocked from the US system, but not before that. Any such move could exacerbate Europe's gas crisis by initially muddying the payment process and longer term could put more wind in the sails of the Russian (and Chinese) alternatives.

US lawmakers have meanwhile been outcompeting each other on sanctions legislation. A Republican-backed bill, voted down, would have essentially compelled Biden to target Nord Stream 2, a move that could have undercut the administration’s tactic of using the threat of sanctions on the pipeline as a deterrent to Russian military action in Ukraine.

Democrats, however, have their own legislative package aimed at deterrence. If passed, it requires the president to periodically make a determination of whether Moscow “is engaged in or knowingly supporting a significant escalation” in Ukraine. If so, the bill requires sanctions against Russian President Vladimir Putin and his cabinet and at least three Russian banks; a ban on the US purchase of Russian sovereign debt; and sanctions on extractive industries, including the oil and gas sector. But the proposed law also allows the president to waive sanctions if it is in the US' "national security interests" — the same exception that saw the Biden administration forgo Nord Stream 2 sanctions earlier this year.

● Wholesale oil and gas cutoffs — via Western sanctions or Russian action — are unlikely.

There are no details about new punitive measures against Russian oil and gas envisaged by proposed new US legislation. However, bans on purchases of Russian oil and gas are seen by experts as unlikely in a first batch of measures, given Europe's high dependence on them — particularly with gas prices soaring in the current tight market. Russian gas accounts for about 40% of Europe's gas imports, and Russian oil about 30% of its oil imports.

Russia has its own reasons for not halting supplies, not least to support the state budget. At an envisaged 9.542 trillion rubles ($125 billion), oil and gas revenues make up some 38% of the 25 trillion ruble federal budget for 2022. Energy Intelligence understands that Gazprom last year generated at least $55 billion in export revenue in Europe, up from some $23 billion in 2020, and despite keeping export volumes mostly flat. Pipeline gas exports are a particularly important source of Russia’s budget revenue: Unlike LNG exports, they are subject to a 30% export duty, which in absolute terms has been boosted by the gas price rally in Europe.

Further, Russian gas transit to Europe has remained mostly uninterrupted for years despite varying degrees of conflict between Moscow and Kiev. Flows to and via Ukraine were disrupted during a 2008-09 contract dispute. But during the most recent military escalation in 2014, transit flows remained stable despite cutoffs of direct sales to Ukraine. Also, the role of the Ukrainian transit has significantly reduced over the past decade, and Europe now has more alternative routes to receive Russian gas.

● Russia is now better prepared to withstand deeper sanctions.

Russia has been growing its gold and hard currency reserves, which reached $630.6 billion at the beginning of this year. The share of US dollars in those reserves went down to just about 16% in the middle of last year, the latest available data from the Russian Central Bank, thanks to Russia's de-dollarization efforts. This compares to past levels of nearly 50%.

Foreigners now hold only 20% of Russia's sovereign debt following the earlier US ban on buying newly issued bonds. And in preparation for a possible disconnection from Swift, Moscow also announced plans last year to stop using the US dollar as a reserve currency in its rainy day National Welfare Fund (NWF) — worth $185.2 billon in early December and largely funded by income from higher oil prices. The level of dollars in NWF stood at 35% in the middle of 2021.

Aa part of Russia's de-dollarization steps, the country's biggest oil producer, state-controlled Rosneft, has switched to euros for payments for its export volumes, while the role of local currencies in Russia's trading with international partners has grown.

Still, despite the low probability of disconnection from Swift, other proposed financial restrictions would be painful and lead to capital outflow, credit finance shrinking and slow-down of the economy, analysts note. The Russian stock market has already lost more than 20% of its value, the biggest collapse since the beginning of the Covid-19 pandemic, on Western reports about a looming military conflict in Ukraine and subsequent sanctions.

● Russia still possesses gas leverage.

In response to the US and Germany using sanctions and regulatory delays against Nord Stream 2 as leverage against Russia, Gazprom appears to be using its tight-supply tactic to apply counterpressure. Growing political tensions, aggravated by the looming antitrust investigation by the European Commission, do not seem to be giving it much motivation to send extra gas, with spot sales virtually unseen in 2021.

But Gazprom has not reduced gas flows below contractual levels, unwilling to risk its reputation as a reliable supplier. All bets could be off in the event of a full-scale (but unlikely) war over Ukraine. But volumes via Ukraine and through the Yamal-Europe pipeline via Belarus and Poland are low anyway, while direct flows to Europe via Nord Stream and Turk Stream are far less likely to face disruption. Nor can Russia simply redirect piped volumes to China.

Russian Gas Pipelines to Europe