The Foreign Policy Essay: Could Energy Sanctions on Russia Work?

May 05, 2014

As the crisis in Ukraine drags on, the United States and its European partners are considering using economic sanctions on Russia’s energy exports if war breaks out or Russia takes further aggressive action. To what extent would sanctions be (a) legal, (b) feasible, and (c) desirable?

Sanctions are attractive in principle because they hit Russia where it counts: in the pocketbook. Roughly 70 percent of its exports, and half of Russia’s annual government budget, come from oil and gas income. Of that 50 percent, about 40 percent comes from oil and the other 10 percent from natural gas. Restricting Russia’s energy income is especially attractive because such funds facilitate the kind of cronyism, rentier economics, and foreign policy petro-aggression that is typical of oil-rich states.

Last Monday, the United States and European Union (EU) added new sanctions, including ones that personally target Igor Sechin, the president of Rosneft, the Russian state-owned oil company. Yet these sanctions are generally regarded as relatively weak—the Moscow stock exchange actually rose on the news. For instance, the sanctions forbid BP’s CEO Bob Dudley, an American and a member of the Rosneft board of directors, from dealing directly with Sechin, but not from continuing his business with Rosneft. Senator Bob Corker, the ranking Republican member of the Senate Foreign Relations Committee, called for stiffer sanctions. Could a new round of sanctions work?

Let’s start with the legal question. (Caveat: I am not a trade lawyer. I’d be glad to be corrected on the finer points here.) Russia is not a member of the International Energy Agency or the Energy Charter (and resists such organizations), but it is a member of the World Trade Organization (WTO). The WTO offers it some protection.

Under normal circumstances, any effort by the United States (or any other WTO member) to place a tariff, a quota, or an outright ban on energy exports from a particular country such as Russia would be inconsistent with its WTO obligations. Specifically, the Most Favored Nation (MFN) principle in Article I of the General Agreement on Tariffs and Trade (GATT) and the national treatment principle in Article III specify that all imports, including energy imports, have to be treated in a non-discriminatory way. This means that no measure (e.g., tariff, quota, or ban) could be applied to Russia’s exports that are not also applied to all other states’ products.

So energy sanctions would be illegal under the WTO, right? Not necessarily. GATT Article XXI allows for “Security Exceptions,” stating explicitly that “Nothing in this Agreement shall be construed: … to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests … taken in time of war or other emergency in international relations; or to prevent any contracting party from taking any action in pursuance of its obligations under the United Nations Charter for the maintenance of international peace and security.” Moreover, the WTO member invoking the exception gets to determine what constitutes such “essential security interests.”

This seems like a hole big enough to drive a Russian T-90 battle tank through. If Russia were to invade eastern Ukraine or take some other aggressive action, the United States could probably justify a move to apply energy sanctions by saying it was taking action at a time of an “emergency in international relations” or that it was following its obligations under the United Nations Charter (though this latter claim would be harder to sustain without a UN Security Council resolution on the issue, which is a non-starter given the Russian veto).

Thus, energy sanctions do seem permissible under the WTO in times of significant international conflict.

Are sanctions even feasible, though? The answer to that question depends somewhat on whether sanctions are aimed at natural gas or oil. Sanctions on natural gas almost certainly would not work. The United States does not consume Russian gas in any real quantity, so it has no leverage. The Europeans consume lots of Russian gas, but they do not have an alternative short-term provider, so any action they took would either increase their own energy costs and/or significantly restrict their supply. Naturally, the Europeans are totally uninterested in such sanctions.

If natural gas won’t work, what about sanctions on Russian oil? That option is slightly more promising. The United States imports between roughly 200,000 and 500,000 barrels per day from Russia, depending on the time of year. Europe imports a great deal more.

Notably, the world market for oil is quite fungible, so if the United States and EU were to ban Russian oil imports, they could replace those imports from other suppliers with only modest difficulty. The main problem is that the market’s flexibility cuts both ways: Russia could also find new customers. Indeed, if the United States and EU were suddenly purchasing large amounts of non-Russian oil, and therefore taking it off the market, that would create a huge demand from the rest of the world to replace that oil—which Russia would be delighted to fill. For this reason, oil sanctions that do not involve all the major purchasers are often ineffective in curtailing the target’s oil sales.

Sometimes oil sanctions do seem to work, such as the ones currently on Iran. What makes them different? It is not entirely clear why Iran has not been more successful finding alternative customers for its oil, but many think it is primarily because Iran was simultaneously isolated from financial markets and global shipping insurance providers. It seems unlikely that the United States and its partners would want to (or even could) similarly isolate Russia.

It might be possible to take advantage of the differences in types of crude oil to inflict a moderate amount of economic pain on Russia. Most refineries can handle a range of different types of crude oil (based on the oil’s sulfur content and viscosity), but are optimized to handle a specific type, and it can be costly to switch crude types. Sanctions might be a viable tool if some of Russia’s exports included a type of oil that had the following properties:

1. It could be easily replaced (at low cost) by American or European buyers from alternative suppliers from the Middle East, Africa, or elsewhere.

2. It could not be easily sold (except perhaps at a significant discount) by Russia to alternative buyers.

3. It could not be blended into some other type of Russian oil exports without a significant cost. (For example, blending light/sweet crude into heavy crude is possible, but at the price of losing the price premium that light/sweet crudes typically command.)

In that case, sanctions on Russian oil—or better yet, specific sanctions targeted to that type of oil—could cause Russia some genuine economic discomfort. Still, I suspect that such sanctions would be difficult in practice.

Finally, how desirable would sanctions on Russian oil be? Ultimately, that is a political question, but it should be informed by (a) the amount of economic pain inflicted upon the target and (b) the economic cost to the sanctioners (i.e., the United States and any cooperating partners). The severity of Russia’s economic pain does not have to be greater than the sanctioners’ costs in order for the sanctions to be judged a success—especially if the economic pain Russia feels induces it to change its behavior. And even without the economics, there is something to be said for sanctions on a symbolic level. But generally economic efficiency helps the case for sanctions.

In sum, only a carefully designed sanctions program focused only on oil and not natural gas is likely to be desirable from a U.S. perspective. Such sanctions would probably be consistent with WTO regulations under GATT Article XXI. While effective energy sanctions on Russia are theoretically possible, significant political and technical obstacles exist in practice.

This commentary was originally published by Lawfare.

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