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Sanctions start to bite

Restrictions on Russia's financial system are already affecting energy trades. And momentum for longer-term changes is building

1 minute read

The sanctions imposed on Russia over the past three weeks have been among the most stringent on any country in modern times. Kenneth Rogoff of Harvard University, a former chief economist at the International Monetary Fund, described the freeze on the assets of Russia’s central bank, in particular, as “an absolutely radical measure… a break-the-glass moment.” Those sanctions, which were initially intended to exempt Russia’s exports of oil, gas and coal, have been having a growing impact on energy markets. The situation is clearly still very fluid, and the eventual outcomes cannot be predicted with any certainty. But the developments over the past week make it increasingly likely that some of the changes to energy are going to be permanent.

Over the weekend, hopes rose of a possible ceasefire in Ukraine. Wendy Sherman, the US deputy secretary of state, told Fox News Sunday that Russia had shown "some signs of willingness to have real, serious negotiations". Talks between Russian and Ukrainian officials were scheduled to continue on Monday, and there were reports that there could even be a meeting between Russia’s President Vladimir Putin and Ukraine’s President Volodymyr Zelensky. Reuters said upbeat comments from both Russian and Ukrainian officials suggested “there could be positive results within days”.

If there is peace, the deal is likely to include some easing of the sanctions against Russia. International relations scholars have been highlighting the importance of knowing the conditions under which the sanctions can be lifted. As Erik Sand and Suzanne Freeman put it in the War On The Rocks blog, “it is vital that Western leaders combine sanctions with off-ramps for Moscow”.

But until there is a ceasefire, sanctions will have a continuing impact on energy markets, as a result of both government policies and decisions taken by businesses. Last week, the US announced a ban on imports of Russian energy for the first time, with the UK and Australia following its lead. The moves were largely symbolic: the US imported just 672,000 barrels per day of Russian crude and refined products last year, about 8% of its total oil imports.

Most European countries have been clear that they still do not want to cut off their supplies of Russian energy. As Christian Lindner, Germany’s finance minister, put it: “We should not limit our ability to sustain ourselves.” He reiterated that position over the weekend, saying: “Our concern must be to build up maximum pressure on Russia and at the same time to maintain our strategic staying power for possibly a very long time… Therefore, energy supply should not be questioned from our side without necessity.” Even the UK is planning to phase out imports of Russian oil by the end of the year, rather than immediately.

The more significant impact so far has come from “self-sanctioning”: businesses choosing not to buy from Russian suppliers. There is a useful indicator of that effect in the discount of Russian benchmark Urals crude relative to Brent. It has typically traded about $2 a barrel lower, but that has widened to well over $20 a barrel. Reuters data showed an average discount of $23.45 per barrel last week. And even at those prices, spot tenders have reportedly failed to attract interest, with buyers deterred by financing, shipment and reputational risk.

Shell has delivered a lesson in what that risk looks like. Ten days ago, it was reported that Shell had bought a cargo of Urals crude, at a price said to be about $28.50 a barrel below Brent. The story whipped up a storm of protest from politicians and the public, and last week Shell announced that it would immediately stop all spot purchases of Russian crude, as a first step in its planned complete withdrawal from Russian hydrocarbons, including oil, refined products, gas and LNG. Ben van Beurden, Shell’s chief executive, said the company would move as fast as possible to cut Russian oil out of its supply chain, although “the physical location and availability of alternatives mean this could take weeks to complete and will lead to reduced throughput at some of our refineries.”

Uniper, the German power and gas group, was another energy company last week announcing plans to cut itself off from Russian supplies over time. It said that while existing long-term gas contracts with Russia were “part of secure European gas supply”, it would not enter into any new contracts for Russian gas. It is also reviving a plan to site a new LNG terminal in Wilhelmshaven, and seeking ways to diversify its gas supplies. For coal, it expects to end buying from Russia when its current contracts run out at the end of the year.

The medium-term goal for the EU is to put its entire economy on the same footing: able to survive without using any Russian oil, gas or coal, and the European Commission last week published its plan for how to get there “well before 2030”. Its goal is to displace about 155 billion cubic metres per year of gas consumption ⁠— roughly equivalent to the volume imported to the EU from Russia last year ⁠— through a combination of demand reduction and supplies from other sources.

The strategy has two pillars: cutting demand for fossil fuels, through acceleration of renewable energy projects and increased installation of heat pumps; and finding other sources of gas, including LNG, pipelines from Norway and North Africa, biomethane and hydrogen. There is also a proposal to mandate companies to fill gas storage to at least 90% of capacity by October 1 every year.

Many of the goals seem highly ambitious. The target for biomethane production in 2030, for example, is 35 bcm, which is double the amount envisaged last year in the EU’s Fit for 55 plan for emissions reductions. The target for LNG is to have another 50 bcm per year available by the end of 2022. That is a very demanding pace of change, and it will not be a surprise if some of those deadlines are missed.

But the details of the proposals are arguably less significant than the overall objective that has been set. Russia has been a mostly reliable supplier of gas and oil to Europe since the 1960s, through the Cold War, the collapse of the Soviet Union and the rise of Putin. If the EU is no longer prepared to be the reliable customer on the other side of that trade, it will have momentous effects on the energy system , not just in Europe but worldwide.

Delays in progress towards lifting Iran sanctions

While negotiators look for an agreement to bring peace to Ukraine, talks over another international crisis have been facing setbacks. Ten days ago, it looked as though Iran was on the verge of a deal to accept renewed curbs on its nuclear programme in return for an end to the US sanctions that have restricted its oil exports since 2018. Over the weekend, however, there was a warning from European countries that the proposed deal to revive the Joint Comprehensive Plan Of Action (JCPOA) could still collapse.

France, Germany and the UK issued a joint statement that did not mention Russia by name, but warned: “Nobody should seek to exploit JCPOA negotiations to obtain assurances that are separate to the JCPOA. This risks the collapse of the deal, depriving the Iranian people of sanctions lifting”. Russia has reportedly demanded written guarantees that the latest sanctions over Ukraine would not obstruct its trade and military cooperation with Iran. A US state department spokesman said the new sanctions on Russia were “wholly and entirely unrelated to the JCPOA” and added: “We have no intention of offering Russia anything new or specific as it relates to these sanctions.”

Tensions were heightened further on Saturday night, when missiles launched from Iran hit Erbil in the Kurdistan region of northern Iraq. It was believed at first that the US consulate in the city was the target, but it was not damaged and there were no casualties. Iran’s Islamic Revolutionary Guards Corps said it had hit Israeli targets including a “strategic center”, in retaliation for the killing of two of its commanders in Syria last week.

Jake Sullivan, the US national security advisor, condemned the attack as having “targeted a civilian residence in Erbil… without any justification,” and promised that the US would “support the government of Iraq in holding Iran accountable”.

In brief

While the eyes of Europe and the US have been on Ukraine and Russia, Covid-19 has been causing renewed concern in some countries. In China case numbers have been surging, and the city of Shenzhen ordered a partial lockdown starting on Monday. All 17 million residents of the city, which is one of China’s key hubs for the tech industry, will have to get tested three times, and non-essential businesses are being shuttered.

Jilin province also announced a lockdown and increased testing after new cases surged, reaching their highest levels since the first outbreak in 2020. The provincial government blamed the sharp rise in infections on “defective emergency response in some regions”. Shanghai meanwhile has shut its schools.

Quote of the week

“We must become independent from Russian oil, coal and gas. We simply cannot rely on a supplier who explicitly threatens us... The quicker we switch to renewables and hydrogen, combined with more energy efficiency, the quicker we will be truly independent and master our energy system.” — Ursula von der Leyen, president of the European Commission, made the case for why the crisis in Ukraine should accelerate Europe’s transition to low-carbon energy.

Chart of the week

This comes from a new report by Kavita Jadhav, a Wood Mackenzie research director for the Asia-Pacific region, and a team of her colleagues, looking at national oil companies’ (NOCs) engagement with the energy transition. Compared to the western international oil companies, the NOCs are committing a much smaller proportion of their capital spending this year to the energy transition and low carbon technologies: 5% as opposed to 15%. But as this chart shows, high oil and gas prices this year mean that the NOCs are on course to generate enough cash to invest more in oil and gas, cut their debts, pay increased dividends, and at the same time match the IOCs’ spending on the energy transition in absolute terms.