The unprecedented and extensive sanctions to limit Russia’s oil export income, including the EU embargo and an oil price cap imposed by the Group of Seven (G7) countries in December 2022, have successfully reduced Russia’s export earnings and budget revenues. In the wake of the sanctions, Russia’s current account surplus fell from $124 billion in January–May 2022 to $23 billion in the same time frame in 2023. The Russian Ministry of Finance also reported about a 50 percent year-on-year drop in government oil revenues in January–May 2023 and a widening budget deficit. Less clear is the impact of each different measure initiated by the West to punish Russia for its invasion of Ukraine in early 2022. Evidence indicates, however, that the embargo has had more of an effect than the price cap, in part because the cap’s level is too high and enforcement is lacking.
Because of the EU embargo, European buyers of Russian oil have essentially disappeared, and Russia is accepting price discounts to maintain export volumes from ports (on the Baltic and Black Seas) that have traditionally supplied Europe. As prices in this market were used to calculate taxes from oil, revenues fell . In an attempt to prop up oil prices, on April 2 Russia announced an oil production cut of 500,000 barrels per day. The Ministry of Finance also changed the benchmark tax oil price to take into account shifts away from exports to Europe.
While the EU embargo has been effective, the success of the price cap appears to have been limited at best. The price cap was intended as an innovative step to reduce Russia’s revenues while keeping its oil flowing to the global market. It allows G7/EU providers of shipping services, including ship owners and insurance companies, to remain involved in the trade with Russian oil as long as the oil is sold below a certain price. This threshold was set at $60/barrel for crude oil. Many energy experts were skeptical about the price cap regime’s effectiveness when it was announced, citing the potential for circumvention. But the problems appear to be more fundamental.
For an important segment of the Russian export market—shipments of Urals grade crude from Baltic and Black Sea ports—the EU embargo has driven down prices so much as to make the cap’s level of $60/barrel irrelevant. As for exports from Pacific Ocean ports, which never supplied Europe and where, therefore, the EU embargo could not have an impact, prices stayed above the $60/barrel threshold. But G7/EU companies remain involved to a significant degree, indicating that the cap is not enforced properly. The introduction of the price cap did, however, ensure that Russian oil remained on the market, and global prices did not rise because of lower supply. This objective had been a key concern of the sanctions coalition.
Because of these defects, financial sector sanctions should be adopted to strengthen oil price cap implementation and curb Russia’s ability to accumulate assets abroad.
Price Cap Violations Are Occurring
Evidence of potentially widespread violations of the price cap has emerged at Russia’s Pacific Ocean port of Kozmino. Data on shipments show that half of the oil was exported on vessels that were either owned or insured by entities in G7/EU countries in the first four months of 2023 (figure 1, top bar). At the same time, 96 percent of exports for which price information is available were priced above the cap’s $60/barrel threshold, with an average price of more than $70/barrel (figure 1, bottom bar). This means that at least 24 million barrels with prices above $60/barrel appear to have been transported on vessels that fall under the cap’s regulations. These violations are likely the result of straightforward falsification of the records oil buyers are required to provide to G7/EU shipping and insurance companies with regard to price cap compliance.
To address these problems, financial institutions should be required to inform implementing agencies (such as the US Office of Foreign Assets Control [OFAC], the UK Office of Financial Sanctions Implementation [OFSI], and EU member states’ institutions) of any transactions under the cap that they facilitate and notify them of suspicious activities. Regulators should also mandate that G7/EU insurance and shipping companies retain full documentation of trades, contracts, and transaction prices. Sanctions should be enforced on a “strict liability” basis, meaning commercial participants would be liable for sanctions violations, and additional financial institutions in Russia and third countries should be subject to sanctions.
“Shadow Reserves” Available to Russia Are a Problem
According to our calculations based on proprietary data, Russia’s export earnings from oil remain substantial, at about $50 billion in January–April 2023. As the Bank of Russia has not been able to conduct reserve operations in US dollars or euros because of sanctions imposed in early 2022, Russian banks and corporates acquired $147 billion in new assets abroad last year (figure 2)—and little is known about their physical locations or currencies of transaction. These funds may not formally belong to the Russian government, but they could be used to increase monetary and fiscal policy space.
Western sanctions on the Bank of Russia and the National Wealth Fund immobilized assets and banned transactions; they did not affect flowsinto reserve funds held by Russian entities that may not formally belong to the government but could be used to buttress its finances and enable the government to circumvent energy sanctions and capture oil market arbitrage. The ownership structures of these entities are opaque. Russian energy companies may employ third-country shipping companies, oil traders, and refineries to generate revenues in excess of the price cap.
Western central banks and bank supervisors should identify the exact nature and physical location of these “shadow reserve” funds and remove them from the reach of the Russian regime, perhaps by imposing sanctions on third-country financial institutions.
Since February 2022, sanctions appear to have restricted access to a substantial amount of Russia’s reserves, but information on these assets is limited. Roughly $312 billion is estimated to have been immobilized (figure 3), but this number is based on the Bank of Russia’s data. Coalition authorities should improve the transparency and credibility of sanctions enforcement by identifying these assets, publicly disclosing the information, and ensuring that they these funds are effectively kept out of reach. The European Union has taken an important step by expanding reporting obligations for frozen assets in its 10th sanctions package. Based on these new requirements, it found that it had immobilized more than $215 billion in Bank of Russia assets.
Shifts in the currency composition of Russian exports and imports have materialized since February 2022: Between the start of the full-scale invasion and the end of 2022, the share of US dollar and euro transactions in Russian goods trade fell from around 80 percent to slightly less than 50 percent, and the shares of ruble- and yuan-denominated transactions rose, according to the Bank of Russia. Additional sanctions may compel Russia and China to cooperate further while paradoxically strengthening the negotiating power of China (and other emerging economies) with Russia. New financial sanctions should increase pressure on Russia’s financial resources.
Benjamin Hilgenstock is a senior economist at KSE Institute (Kyiv School of Economics). Guntram Wolff has been the CEO of the German Council on Foreign Relations (DGAP) since August 2022. He was director of Bruegel from 2013 to 2022.
1. Shipments for which price information is not available are those that appear in trade data under transaction terms other than FOB (free on board), on which the price cap is applied.
Data in figure 1 are proprietary and have been excluded. The rest of the data underlying this analysis can be downloaded here [zip].