Can Energy Exports Save The Russian War Machine Facing Western Sanctions?

By Ariel Cohen, Fletcher Alumnus and Senior Fellow at the Atlantic Council and the Founding Principal of International Market Analysis

Last week President Joe Biden announced a complete ban on Russian oil and gas imports – the latest in a series of debilitating sanctions meant to punish Russian President Vladimir Putin for his crimes against Ukraine.

The declaration followed an already steady stream of US and Western energy companies who were departing the Russian marketplace on their own accord. Shell and BP were the first oil and natural gas companies to break the silence. On February 27, BP announced that it would ‘exit‘ its nearly 20% stake (about $14 billion) from Russia’s state-owned Rosneft. Shell quickly followed suit, announcing that it would be severing all joint ventures (valued at $3 billion) with Russia’s state-owned Gazprom.

Shell and BP were just the first. Soon after, Exxon Mobil announced that it would join the other supermajors by stopping all $4 billion of oil and gas activities, while the French energy giant TotalEnergies has halted any new capital expenditures for new projects in Russia and suspended trade in Russian oil.

This exit has been matched by a UK phase-out of Russian oil imports and an EU plan to lessen its gas imports by two-thirds – both by the year’s end.

Yet the effectiveness of public and private efforts to isolate Moscow remains uncertain. Sanctions have a track record of failure when it comes to forcing major policy readjustment, as demonstrated in the cases of North Korea and Iran’s nuclear programs and ballistic missile development. The only regime change sanctions triggered was apartheid-era South Africa in 1994. Thus far, economic measures have not yet slowed President Vladimir Putin’s war machine.

The US ban on Russian crude, for instance, is primarily symbolic. Russia is the world’s third-largest oil producer and accounted for 11% of the world’s output in 2020 – up to 15% in 2021. Before the departure of western energy companies from Russia, oil made up some 60% of Russia’s exports. But Russian crude represents just 3% of America’s shrinking oil imports – and subsequently a small percentage of Russia’s revenues.

The real game-changer of this initiative would be if Brussels follows suit. Nearly 40% of Europe’s gas and 25% of its crude oil comes from Russia – a $70 billion price tag in 2021. While Europe is actively searching for short, medium, and long-term strategies to reduce their energy dependence on Russia, it is improbable that we will see any sudden and complete bans on imports. Instead, expects to see a gradual ramping down of energy purchases over the next months and years.

Sanctions and the Russian Economy

But while the Russian war machine grinds forward at high costs, the Russian economy – and by default everyday Russian citizens – are reeling from this truly unprecedented level of sanctions.

Close coordination by the West, focusing particularly on the Russian Central Bank asset freezes, has decreased the ruble’s value by nearly 40% since the war began. Ordinary Russians are now unable to withdraw more than $10,000 from their banks in hard currency until September 2022, while Visa and Mastercard bank cards are now unusable. No PayPal, no Western Union allows sending and receiving money to/from Russia. Another less talked about aspect of sanctions is ‘brain drain‘ – high-skilled professionals exiting the country due to punishing sanctions and brutal political repression. People are leaving to unlikely locales like Kyrgyzstan, Uzbekistan, and Armenia. Yet, Putin lashed out recently on “traitors” who are leaving the country, only accelerating the exodus.

Oligarchs have also been feeling the sting of economic sanctions. Some, who amassed their wealth before Putin and oppose the war, got targeted, including Mikhail Fridman and Vladimir Potanin. Roman Abramovich, the owner of Chelsea FC, has had his assets frozen and was disqualified as director of the club.

Putin did not anticipate the severity of Western reaction to his invasion and did not expect the heavy-hitting sanctions. Yet, the Russian leader took several policy steps to “sanction-proof” the country. Learning from American and European reactions to the annexation of Crimea in 2014, Moscow made a number of decisions in the 8-year runup to the re-invasion of Ukraine.

Russia’s main tool for sanction-proofing its economy was building up its international reserves to $632.4 billion before the invasion. However, Western sanctions have effectively frozen half of this amount – much to the surprise of Russia’s central bank. According to Finance Minister Anton Siluanov:

“The total volume of our reserves is about $640 billion, and about 300 billion are in such condition that we can’t use them now.”

Per Bloomberg, $100 billion of Russia’s reserves were held in US dollars as of June 2021 – 16.4% of the total. Holdings in euros topped 32 % and those in yuan at 13.%. While the yuan holdings remain safe for now, Euro and USD denominated reserves cannot be touched. This implies that Moscow may reach a point soon when it cannot pay its foreign debts. The same applies to Russian state-owned companies.

But above all, the most effective sanction-proofing tool in the Kremlin’s toolbox is European energy dependence. Russia provides roughly half of Europe’s primary energy (oil, gas, coal, refined fuels, electricity, etc.) which means that even if the West sanctions Russia’s international reserves and cuts them off from SWIFT, Europe will still have to pay Russia to meet its energy needs.

It is well documented that sanctions themselves are not enough to topple authoritarian regimes – look at North Korea, Syria, Venezuela, and Cuba. Yet sanctions have had tremendous impacts on the citizens of those countries – Venezuela experienced a 30% contraction in its economy in 2020, while the consequences of sanctions against North Korea have left most of the country malnourished.

Still, Putin is aware that Russia does have a healthy history of revolutions and coups following lost wars.

Despite a war fever whipped by Putin’s propaganda machine, sanctions can be a stress multiplier on an already vulnerable political system facing military, economic, and social setbacks. Just recently, Russia’s economy has been so limited that they were contemplating paying off $117 million in interest for two sovereign dollar-denominated bonds in rubles, likely triggering a default. For now, Moscow has dodged the bullet.

But history has shown that Russian revolutions are not just a result of economic despair; they are also deeply intertwined with heavy Russian losses attributed to war. One only needs to look at the Crimean War, the Russo-Japanese War, World War I, and the Soviet War in Afghanistan to see how in Ukraine history may be repeating itself. Sanctions alone may not be enough to stop Putin and his war machine – but a collapsing economy, failing war, and low public support could be the perfect storm that brings long-needed change to Russia. If not, the country would stagnate even worse than the Soviet Union did in its terminal phase.

This piece is republished from Forbes.