Oil Market Interventions and Consequences

Commentary by Ben CahillandAdi Imsirovic

Published July 16, 2024

A growing share of global oil consists of sanctioned and discounted volumes traded by dodgy intermediaries in an opaque shipping sector. Energy sanctions are a powerful tool to deny revenue to oil-producing states, and sanctions on Iran, Russia, and Venezuela have expanded in the past decade. But the effectiveness of these measures is a matter of debate. Policymakers continue to deploy targeted sanctions, and there is pressure on the Biden administration to ratchet up designations of tanker owners, trading houses, and financial institutions facilitating this trade. However, there are no easy solutions, and sanctions require some retooling.

The surge in U.S. oil and gas production and exports over the past decade has facilitated wider energy sanctions. Following the lifting of the crude oil export ban in 2015, the United States quickly became the world's largest oil producer and a key exporter of crude oil and petroleum products. Last year, the country overtook Qatar and Australia to become the largest exporter of liquefied natural gas (LNG) as well. Following Russia's invasion of Ukraine in February 2022, the United States was a secure and reliable source of energy for the world. U.S. exports enabled Europe to oppose and sanction the Russian invasion without creating a global supply shortage. This was also supported by production growth in Brazil, Canada, and Guyana.

Russia's war on Ukraine and the subsequent EU embargoes and G7 price caps have created important shifts in global oil trade. Oil flows are no longer determined solely by market economics and refinery configurations. Embargoes and sanctions have created new walls and partitions, reshaping export patterns from Russia, Latin America, and the Middle East.

Sanctions on Russian Oil: Not Strong Enough?

Sanctions on oil-producing countries such as Iran and Venezuela are not new, but targeting Russia after its brutal, unprovoked invasion of Ukraine was far more significant. As the world's largest oil exporter, Russia has typically supplied the world with some 5 million barrels per day (b/d) of crude oil and over 2.5 million b/d of finished petroleum products. Losing such a massive volume of hydrocarbons would have been a serious shock to the global economy. The sanctions against Vladimir Putin's regime-including the novel instrument of price caps-were designed to pressure the Russian economy while avoiding supply disruptions and any resulting price shocks.

So far, EU embargoes rather than the price caps have had a larger impact. The embargoes on Russian seaborne crude oil and petroleum products constrained the country's export options. Russia has been forced to export its oil over longer distances to a dwindling number of buyers who have more leverage in price negotiations. India, China, Turkey, and other buyers are now essential outlets for Russian crude oil. Primarily because of higher shipping costs, Urals crude oil-Russia's main export blend-has consistently traded at a discount to Brent crude.

The impact of the price caps is more questionable. Price caps of $60 per barrel for crude oil, $45 per barrel for lower-value petroleum products, including fuel oil, and $100 per barrel for higher-value products such as diesel have been difficult to enforce. Russia has obscured the headline free-on-board price of its oil by loading costs into the shipping and insurance segment in delivered volumes (with cost, insurance, and freight included). More importantly, Russia and its partners have found new ways to evade U.S. and G7 sanctions.

The price caps depend on the dominance of G7-domiciled support services for the global oil trade, including shipping, insurance, reinsurance, and brokerage-but the picture has changed in the past two years. Russia has bought hundreds of tankers to move its oil, including numerous aging tankers that may otherwise have been scrapped. It has sought alternative insurance and reinsurance. Additionally, it has taken advantage of poor regulations and opacity in the shipping industry, which is notorious for flag-hopping and the use of shell companies to obfuscate ownership and transactions. As a result, a large share of Russian oil is trading above the price caps, even for vessels using G7 support services. Most of Russia's crude oil exports to Asia from the port of Kozmino have never traded below the $60 per barrel price cap, given the availability of alternative shipping and insurance in that region.

Notably, sanctions enforcement ratcheted up last fall. Starting in October 2023, the U.S. Treasury Department designated a number of tanker owners, companies, and individuals facilitating Russian oil trade. In February 2024, the Department of Treasury slapped sanctions on Russia's state-owned shipping company Sovcomflot. Other measures have targeted traders and financial institutions involved in Russian oil transactions, discouraging banks from doing business in this area.

But overall, embargoes and price caps have had only a modest impact on Russian state finances. Russia's export volumes have held up thanks to its shadow tanker fleet, and despite crackdowns and pressure on dodgy traders, it has been hard to curtail activity in dark corners of the oil market that enable Russian exports. If anything, there has been evidence that Russian shipping costs have actually been falling. Russia continues to export oil well above its agreed OPEC+ quota. Following a recent drop in refinery subsidies that encouraged refiners to sell petroleum products in the domestic market, Russia's hydrocarbon revenue in June rose by as much as 50 percent relative to last year. It comes as no surprise that the Ukrainian drone attacks have recently targeted Russian oil facilities in an attempt to diminish Russia's key revenue stream, at least temporarily.

Interventions Have Consequences

In the short term, the market has adjusted remarkably well to significant changes in global crude and product flows. Price spikes have been moderate by historical standards, and there have been no interruptions in the global petroleum supply chain. For many policymakers, this may incentivize an even wider application of energy sanctions. But these measures also have some potentially serious, unintended consequences.

The widening of sanctions creates new incentives for cooperation between energy producers and consumers to avoid the reach of U.S. and G7 enforcement agencies. These measures are creating opaque market segments with obscure trading entities, poorly regulated jurisdictions, gray shipping fleets, and substandard insurance. A whole new breed of trading companies has emerged, largely operating from the United Arab Emirates (UAE) and Hong Kong, incentivized by large profits to circumvent sanctions. Much of this trade is underpinned by lending activity from banks with little international supervision.

Dark trade could also have political implications. Tens of billions of dollars in oil revenue have moved off government books. It is possible that illicit oil earnings are being used by Putin's regime to conduct clandestine operations from Central Asia to the Western Balkans and elsewhere to undermine democracy.

Another potentially serious side effect may be environmental. Russia's seaborne exports pass through sensitive choke points in global shipping such as the Danish and Bosporus Straits as well as the Suez Canal. Increasingly, Russian oil is finding its way to market through ship-to-ship transfers from smaller to larger vessels, often in pristine coastal waters around Greece, Turkey, Spain, the UAE, and Oman. These vessels are old and poorly maintained-some are literally pulled from scrapyards-and have little or no indemnity insurance to cover any oil spills.

Time for a Recalibration

The trend of government intervention in oil markets is likely to continue. Due to the size and importance of Russian petroleum exports, sanctions are likely to be selective to avoid disrupting global energy flows. But they will also create new inefficiencies in a delicate system of international energy trade which took decades to evolve. It may turn out that the negative consequences of these policies outweigh the benefits, suggesting it is time to rethink these sanctions and devise new solutions.

Most governments would agree that aging vessels conducting ship-to-ship transfers without adequate indemnity insurance should not be allowed to operate. This is no different from cars requiring insurance coverage before they are allowed on the road. The policing of such insurance could be greatly increased in key shipping chokepoints-in fact, during the very early days of the price cap regime, Turkey blocked vessels from transiting its waters, demanding stronger proof of insurance coverage. Concerns about the oil market impact led to interventions and assurances to the Turkish government that enabled oil transit to continue-but the concerns raised by Ankara are equally if not more valid today. Policymakers should create more exacting standards for acceptable protection and indemnity insurance and proof of such coverage.

There should also be expanded designations of vessels and tanker owners that have broken rules in the past. There is some evidence that such measures are working, sidelining available tankers for Russian exports. Targeting vessels and traders without adequate insurance may be more politically acceptable and easier to gain wide support internationally, especially as it is already based on existing international regulations.

Energy markets are not immune to global fragmentation and polarization. Sanctions are becoming harder to implement in a world of powers such as Russia, China, and India-important energy producers and consumers with different geopolitical concerns than Europe and the United States. Energy sanctions can help achieve economic and geopolitical ends. But targeted secondary sanctions are more effective than complicated schemes encompassing broad groups of actors in a complex, fluid market that rewards risk-takers and rule-breakers.

Ben Cahill is a senior fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Adi Imsirovic is a senior associate (non-resident) with the CSIS Energy Security and Climate Change Program.