Why Sanctions on Russia Aren’t Targeting Oil and Gas

There’s an elephant in the room. Since Thursday, when Russian troops stormed into Ukraine, the U.S., the E.U., and their allies have announced a raft of sanctions designed to hurt Russia’s economy and financial system, and make President Vladimir Putin reconsider his invasion. But measures targeting exports of oil and gas, which provided 36% of Russia’s national budget last year, are conspicuously absent from the public discussion.

Some Ukrainians are not happy. “We need real sanctions, not just some problems for Putin’s friends,” Ukrainian lawmaker Oleksiy Goncharenco said in a video posted to Twitter Thursday. “We need an embargo on Russian gas and oil because every barrel of Russian oil and every cubic meter of Russian gas is now full of the blood of Ukrainians.“

E.U. Commission president Ursula Von Der Leyen says the bloc will target Russia’s energy sector through an export ban preventing European companies sending technology to Russia that it needs to upgrade its refineries. And the U.S. Department of the Treasury says it will heavily restrict the ability of Gazprom, Russia’s state-owned energy conglomerate, to raise money for projects from the U.S. market. But so far, the call for restrictions or an embargo on Russian oil and gas, echoed Friday by Ukrainian president Volodymyr Zelensky, feels far outside the realm of possibility.

It’s not hard to understand why. Western energy embargoes would be painful for Putin, but he wouldn’t feel their full effects for several years. In the short term—which is what counts during an invasion—Europe and the rest of the world have more to lose.

On average, the E.U. relies on Russia for 35% of its natural gas—though some countries are more dependent than others. Tensions over Ukraine have already worsened a European fuel-price crisis that began last year due to shortages as the world emerged from the pandemic. Right now in Europe, a megawatt hour of natural gas costs nearly ten times what it did a year ago.

Sanctions on Russian energy would push prices higher globally, and fears that they might be introduced have already had an impact: on Thursday natural gas prices spiked 51% in Europe, and crude oil—of which Russia is the world’s second largest exporter—hit a seven-year high of $105 a barrel. When those sanctions didn’t materialize later in the day, prices fell a little, and Russian gas flows through Ukraine to Europe actually increased.

But experts are not ruling out a more aggressive strategy on Russian energy from the E.U. and U.S. as the war in Ukraine unfolds. “In a sense, no one has quite accepted the gravity of the situation, and many are still conducting politics as usual. That will likely change in the days and weeks ahead,” says Michael E. O’Hanlon, director of foreign policy research at the Brookings Institution think tank.

In the medium term at least, the Ukraine invasion is a turning point for Russia’s oil and gas exports. E.U. officials say they will unveil a strategy to reduce dependence on Russian energy as quickly as possible on March 2, including a target to reduce fossil fuel use by 40% by 2030. “The politics and the national security implications of this make it very hard to see how we keep doing business as usual,” O’Hanlon says, “with a guy slicing up large chunks of eastern Europe.”

Here’s what to know about how Russia’s oil and gas factors into the West’s response to the Ukraine invasion.

Would an energy embargo force Russia to back down on Ukraine?

Probably not, because of the time it would take for the Russian economy to feel the effects.

Europe does hold sway in Russia’s energy sector. It buys more than 70% of the country’s natural gas and an embargo by the bloc would have a “very serious” systemic impact on Russia’s state energy companies within several years, says Maria Pastukhova, a Berlin-based expert on the geopolitics of energy at climate research group E3G.

But cutting Russia off from selling its oil and gas to Europe would not “immediately translate into tangible damage to the Kremlin,” she says. That’s because Russia has built up all-time high foreign exchange reserves of $630 billion, thanks in part to high commodity prices over the last year as the world has emerged from COVID-19 lockdowns. The reserves, combined with Russia’s ultra low sovereign debt, will insulate the state from much of the economic pain the west tries to inflict in the next few months.

Could Europe get by without Russian natural gas?

For a little while, yes. Since tensions began building with Russia late last year, European leaders have worked to coordinate increased imports of liquid natural gas (LNG), a liquified form of the fuel that can be shipped from far away, from countries like the U.S. and Qatar. Luckily, warmer weather in Asia—which is the normal buyer of these same resources—has reduced demand for gas for heating there, freeing up LNG supplies for Europe. With spring now only a few weeks away, the region could make it through to autumn without shortages even if Russian supplies were cut off, according to Massimo Diodoardo, vice president of global gas research at energy consultancy Wood Mackenzie.

A temporary interruption to the gas trade between Europe and Russia—triggered by either side—would, however, turn into a tense tussle between the two countries. “Russia would be losing billions of dollars of gas revenues every month,” Diodoardo says. “But for Europe the [price increases triggered by an embargo] would be prohibitive. The longer they go without Russian gas, the more they run the risk that by next winter there won’t be enough gas in storage, then they have to start cutting demand.” That would mean rationing gas use in some countries.

Europe’s options to reduce its need for Russian gas are very limited in the short term. While LNG shipments might be helping right now, Europe may struggle to keep these imports at current high levels once cold weather and demand return to Asia. And the renewable energy projects that Europe wants to roll out to replace natural gas (and reduce greenhouse gas emissions) will not be ready overnight.

All of this could start to change in the next three to five years, analysts say. The Ukraine crisis has forced a reckoning in Europe over its future energy links to Russia. On Tuesday, after Moscow formally recognized the independence of two breakaway Ukrainian regions, German Chancellor Olaf Scholz froze the approval process for Nord Stream 2—a recently-completed $11 billion pipeline that was set to double the amount of natural gas sent directly from Russia to Germany. Though the pipeline may eventually go ahead, Scholz’s decision was an about-face for a country that has long sought to frame its energy needs as separate from its political interests.

In their forthcoming strategy to wean Europe of Russian gas, E.U. leaders are expected to create new rules obliging utilities to fill storage facilities over the summer to avoid shortages in winter, and to set more ambitious targets for reducing fossil fuel use in the next few years. That will require member states to step up spending on renewables and on improving insulation in buildings and other efficiency retrofits.

What will the Ukraine invasion and western response mean for global energy prices?

The invasion will increase energy prices around the world for months as markets are rattled by uncertainty over oil and gas supplies. There are fears that conflict in Ukraine could destroy or disrupt the country’s natural gas infrastructure, which normally carries roughly a third of Russian exports to Europe, or that Russia could curtail oil and gas supplies to the west in response to sanctions—though analysts say that is unlikely given the international reputational damage it would do to Russia’s state energy sector.

But even without direct measures targeting energy, current financial sanctions on Russia—including plans by the E.U. and U.S. to restrict Russian banks’ access to their countries’ markets—could have knock-on effects that mean utilities around the world have to pay more to buy fuel from Russia. Oil prices may climb as high as $130 a barrel, analysts say.

If there aren’t energy sanctions or disruptions to oil and gas flows, prices may in the next few weeks fall a little from their current near-record highs, says Di Odoardo. “But they will remain extremely high as long as there’s not any sort of rapprochement or truce between Ukraine and Russia.”