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A driver fills his car tank at a petrol station in Ploneis, western France, on Jan. 18, 2022, as oil prices are at their highest since 2014.
Fred Tanneau/AFP via Getty Images
About the author: Rachel Ziemba is the founder of Ziemba Insights and an adjunct senior fellow at the Center for a New American Security.
Global equity markets have rallied, and energy prices are off their peaks, shrugging off the risk from the war in Ukraine. In large part this reflects President Biden’s assurance that the latest round of economic sanctions aims to avoid impeding the current energy trade, a view his officials had long signaled. Indeed, the extensive guidance issued by the U.S. Treasury includes an explicit exemption for energy trade and for humanitarian goods, including food products.
However, despite this proactive stance to maintain the commodities that serve as the greatest global links to the conflict, there are warning signs that market actors may be ignoring. Besides the conflict on the ground, which could lead to additional sanctions, important frictions are visible in the physical and financial market as buyers navigate these new sanctions.
The Biden administration’s sanctions policy reflects reluctance to hit global consumers, especially ones in the U.S. and other major democracies that are already suffering from higher energy prices, supply chain issues, and other disruptions relating to the pandemic. It also reflects a reluctance to fill Russian coffers. Thus, the primary targets have been Russian financial institutions, including some of the larger ones, as well as individuals close to the regime, including more recently Vladimir Putin himself. These measures are meaningful, but Russia has had time to prepare. Many targets lack assets in international jurisdictions to freeze. And it remains to be seen if the domestic costs in Russia of weathering the restrictions will lead to policy change.
Thus the measures relating to the energy sector by the U.S.-led coalition either are limited or they are longer-term burns, that is, restrictions on key Russian energy companies accessing finance of longer than 14 day maturity, restrictions on some energy sector equipment from the U.K. and EU, and measures targeting children of oligarchs involved in the energy trade. These energy measures, like those applied when Russia seized Crimea in 2014, aim to restrict Russia’s longer-term energy development, raise the costs of doing business, and constrain activities, but are aimed not to hit current production.
Another reason for the relative calm is the lack of new Russian commodity-supply shocks. Markets bought the rumor of retaliatory shocks and sold when they appeared not to materialize—a rational move. Biden has said he is working with allies on plans to tap strategic petroleum reserves, which may also have helped, though verbal interventions like this often don’t last long. A release is most significant if there is a real supply shock, but Russia has continued to fulfill contracts, albeit just long-term ones and is sticking to its OPEC+ agreements.
Still, Putin has warned that the U.S.-led coalition will face costs for their sanctions and support of Ukraine, but has yet to identify what form retaliation will take. They need not be strictly economic. They may be asymmetric, hybrid measures such as cyber attacks that could impair critical infrastructure. Or Russia may choose to restrict exports to prioritize its own domestic needs as it has done with natural gas (refilling local stockpiles), fertilizer and grain which has suffered from poor harvests. All of these suggest potential risks, even if they are not formally weaponized.
There are also warning signs about commodity trade that markets would be wise not to ignore. Over the last few days, several jurisdictions reported challenges accessing U.S. dollar- and euro-denominated letters of credit for oil and other commodity cargoes from Russia, both before and after the U.S. sanctions were released. In part, these problems may reflect uncertainty and overcompliance as banks do not want to extend credit that may leave them subject to fines, confiscations, or even losses due to conflict. Even some buyers in India and China appear to have had troubles as banks erred on the side of caution while they awaited guidance from sanctioning entities and their regulators. These additional frictions may build as the expectations of further sanctions remain. Escalating sanctions tend to breed overcompliance, at least for a time, even when the counterparties are large enough that the trade seems worthwhile.
These frictions may be reinforced by port and airspace closures that are a result of conflict. Many of the Black Sea ports that handle grain exports and some of the Baltic ports are facing delays. Some of these problems may be temporary, but they are likely to be reinforced by chokepoints for financial plumbing. For example, the previous sanctions on Belarusian potash exports and the addition to the U.S. Treasury’s Specially Designated Nationals list for Belaruskali, one of the world’s largest producers of potash, cut exports. While Russian ports are a possibility as Belarus turns more to the Russian fold, they have capacity constraints. Recent sanctions designations of Belarusian banks may reinforce this. These trends may add to volatility and uncertainty, and reinforce the impact of climatic events for key commodities, including grains, which could add to global price pressures and supply-chain problems.
In the long run, actors are likely to find ways to work around these financial constraints. These may include a greater use of non-dollar and even non-euro financial channels, as India has already experimented with Iran. It may also include the concentration and use of designated banks to take up the role of dedicated channels for key commodities and goods. These workarounds have costs for all involved and may also result in shifts and bifurcations in the global financial system, especially if these dynamics encourage the greater development of digital assets in ways that divide the international system.
The U.S. dollar financial system remains the key game in town for transactions, especially when the European Union and other major advanced economies complement it, but new channels may develop as Russia and others build their resistance economies. Doing so comes at a cost, but as Russia has shown in other cases where it chose to indigenize various products and services, it may be willing to bear it. Unless Russia makes the unlikely choice to back down quickly, further sanctions may be ahead, closing some loopholes. It may not be as easy to insulate the global economy as markets currently think.
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