The Market Impact of Russia Sanctions

The global Brent oil price will not rise materially, but Urals will fall relative to Brent

The Trump administration this week sanctioned Russia’s two biggest oil companies - Rosneft and Lukoil - and this is a big deal for two reasons: (i) this is the first use of sanctions against Russia since the waning days of the Biden administration and may mark a pivot in the Trump administration towards sanctions; and (ii) these sanctions are a meaningful blow to Russia - they will push down the Urals oil price relative to the global Brent benchmark and thereby depress the flow of hard currency into Russia’s war machine. This is undeniably good news.

The EU yesterday also rolled out its much anticipated 19th sanctions package, which raises the number of Russian-controlled ships it sanctions from 444 to 556 in addition to many other laudable steps. Markets now worry that the combined hit from these measures will take Russian oil off the global market, spiking global oil prices.

In this post, I discuss what impact US sanctions will have on the global oil market, review the reaction of oil prices to past rounds of sanctions and explain how all this will hit Russia. I’ll do a follow-on post tomorrow to discuss what needs to still be done on Western sanctions to really give Russia’s war economy the body blow it deserves.

The chart above shows monthly data for the global Brent oil price (black line), along with oil futures at different points in time. The single biggest sanctions wave to hit Russia was in January of this year, when the Biden administration - in its waning days - sanctioned 183 Russian-controlled ships, including 75 shadow fleet oil tankers. That action was a massive hit to Russia’s oil tanker capacity, especially in the Pacific, and did next to nothing to global oil prices. Indeed, global oil markets were much tighter then than they are now, given multiple rounds of OPEC+ production cuts, which is all the more reason to expect little impact on global oil prices from US sanctions now.

Underneath this lack of any meaningful price effect is a big reshuffling that happens when sanctions hit. In the case of this week’s US sanctions, it’s likely that big refiners in India and China will stop importing Russian crude for fear of secondary sanctions, which could lock them out of US payments networks. Russian oil that would have gone to India and China will now go elsewhere, forcing both countries to buy oil from somewhere else. That’s a big reshuffling in the global oil market, but global supply of oil is unchanged.

However, it will be the case that Russia’s Urals oil price will fall relative to the global Brent benchmark, as it becomes harder to sell this oil on the global market. Fear of US secondary sanctions will raise the “stigma” of Russian oil, raising the Urals discount relative to Brent. We’ve seen this dynamic play out on previous occasions, as the chart above shows. In February 2022, right after the invasion, fear of sanctions kept global buyers away from Russian oil, increasing the discount on Urals crude. The same thing happened in December 2022, when the G7 price cap and EU ban on Russian seaborne oil were introduced. Once the dust settles in global oil markets - it already looks like Brent is starting to fall back - this dynamic will leave Russia worse off.

All of this is good, but it’s not enough to bring Putin to the negotiating table in good faith. For that, the Russian economy needs a body blow, which can only be imparted if the US joins the EU and UK in sanctioning the shadow fleet. There’s a huge number of Russian-controlled vessels that are now sanctioned by the EU and UK that are not yet sanctioned by the US. The US needs to sanction these ships as quickly as possible. I’ll talk about this in tomorrow’s post.