Russia’s Real Achilles Heel: The Best Way to Cripple the Kremlin

Several members have forwarded on a recent piece entitled “To Deter Putin, How about a Total Ban in Russian Energy?” from Newsweek. It is written by Chris Hartwell and Andreas Umland and had previously appeared on the Atlantic Council website.

The authors initially number off the now familiar litany of Russian offenses to international sensibilities – Ukraine, the shooting down of MH 17 (the Malaysian airline), the Aleppo human tragedy in Syria, and an exit from the Nuclear Security Pact with the U.S. All of these they suggest “is diverging further from the rules-based consensus of the post-Cold War world.”

The Western sanctions introduced in 2014 seem to have little effect, leaving the authors to conclude that the measures should be increased to include an embargo of Russian energy exports to the outside world.

Now I happen to know something about economic sanctions having experience in designing and advising on such measures. There is one overarching reality in estimating their effectiveness. It makes no difference whether we are considering the U.S. policy against Japan prior to World War II (an energy initiative, by the way) or against Cuba, the UN and Western sanctions against Iran, those intent on deterring a North Koran nuclear weapon, or the current U.S./European limitations on Russia.

And one result is very evident…

An Energy Embargo Won’t Solve the Problem

There are always unrealistic expectations about either or both of two assumptions: the effectiveness of the sanctions; and/or how many nations are likely to participate (freely or under diplomatic compulsion).

Unfortunately, Hartwell and Umland fail on both counts. Yes, Moscow certainly and heavily relies on export revenues from oil and natural gas. But recipient countries also need the energy. By simply advocating a blanket embargo of Russian exports, the suggestion harms a far greater part of the world than the intended target.

It also would require a fine line between penalizing and incapacitating a nation. Move too far in the latter direction and Russia starts moving tanks someplace. If you are strangling a lifeline, a government will retaliate.

The principal misunderstanding about sanctions is their function. This is not a surrogate weapon for military invasion. To work, sanctions must have limited and defined diplomatic objectives with clearly proscribed range and application. They also must be used in tandem with other initiatives that also have a foreign policy purpose.

Getting even is neither a sufficient nor an acceptable objective.

Embargos are difficult to implement in practice because they require enforceable agreements among so many affected players. In the case of embargos restricting where a country’s oil exports can go, there would need to be a broad consensus among primary importers, all of whom must meet essential energy needs.

In the case of Russia, an expansive embargo would fail. As Washington learned only too clearly in attempting to enforce sanctions against Iranian sales, one market simply cannot avoid skirting whatever restrictions are applied.

I’m talking about Asia…

As I have discussed before in Oil and Energy Investor, Asian energy requirements are accelerating with the preponderance of global demand shifting there at least through 2035. Economies there survive by playing suppliers against each other, not by eliminating any major source altogether. What cannot be obtained overtly will end up moving in shadow markets anyway.

There will not be anything beyond partial compliance. And then there are the ongoing multi-year contracts already in force, for which legal strictures require compliance. A general energy embargo would not even apply here.

The further complication involves what such an embargo would do inside a country. Effects of a successful economic sanction should not extend to paralyzing a population or making life miserable to average folks. That merely plays into a guaranteed rise in nationalism and further policy intransigence, especially in the case of Russia.

Targeted Sanctions Are the Best Way to Cripple the Kremlin

An across-the-board energy embargo will not work and will be counterproductive.

Yet, energy is still the Russian Achilles heel. The objective in orchestrating an energy sanction against Moscow is to target that which allows outside compliance and still increases the screws. That is found not in oil but in natural gas.

So, if this is to be the route, I would direct your attention to a series of three OEI installments I wrote back in 2014: “The West has Gazprom in Its Crosshairs, (Part I)” June 10, 2014; “The Attack on Gazprom, (Part II)” June 17, 2014; and “It’s Time to Play the ‘Gazprom Card,” August 29, 2014.

Sanctions preventing Gazprom from selling its natural gas abroad will certainly fail. Multi-year (usually twenty-year) contracts are already in force and would be defended legally. Then again, an attempt to close Gazprom exports outright would ratchet up animosity beyond the worst times during the Cold War.

The resolution is to make any new contracts more expensive for the Kremlin to engineer. It just happens that there is a way to do this without impacting existing contracts, where the target is not simply outside Russia but located in nations that already support the current sanctions against Moscow.

To explain, let’s go back to what I wrote in the third of the pieces mentioned above:

Targeting the 800 lb. Gorilla

The plan calls for an initial round of sanctions against Gazprom Marketing & Trading (GM&T), Gazprom’s main avenue for financing exports. These sanctions would limit GM&T’s access to financing only existing contracts, not new ones.

This could be applied immediately against the GM&T office in Houston. The main location is in London (20 Triton Street), a location I’ve been to several times in the past. Others are in Manchester, Paris, Singapore, and Zug (Switzerland).

In this case, both the UK and France would support the move, since it does not impair existing delivery contracts. Those contracts are multi-year, usually spanning two decades, and require the pre-financing of each monthly delivery. Under this plan, those would continue.

But direct pressure could now be directed toward Russia’s Achilles heel – Gazprom – or what I have previously referred to as “the 800 pound gorilla in the room.”

The intent of these sanctions is to hurt Moscow financially, not destroy Gazprom. But the inability of its international trading arm (GM&T) to access working capital puts several major projects in jeopardy – including the building of the ground breaking new Chinese pipeline.

That pipeline project was the “big news” several months ago. But they have yet to finalize how much it will cost (or for that matter what the gas pricing will be or even how that price will be determined).

Here is the most important point to remember in all of this: Moscow must sell additional gas abroad, otherwise its budget will collapse. To do that Gazprom must have the ability to operate freely.

Simply maintaining the current contract volumes is not enough. Sanctioning GM&T hits Russia where it hurts most economically, while it insulates current European import agreements from attack.

Of course, it is true that other GM&T offices internationally could pick up some of the slack, especially via Singapore with Chinese assistance. But this would still make the process considerably more expensive.

The sanctions would still prevent Gazprom from having access to dollar-denominated banking internationally when it comes to financing for new projects.

Remember, the gas trade (like oil) is denominated in dollars globally. It’s possible to bypass that with other currencies, but it costs more. Just ask the Iranians.

One factor is becoming more obvious.

Putting the screws to Gazprom is no longer off the table.

This remains the only energy sanction against the Kremlin I can see that has any change of success. Maybe that’s why I recommended it to policy makers over two years ago.

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