This post marks the second entry in our Year-in-Review series. For prior posts, click here.
Few sectors have been more affected by the sanctions on Russia than the energy industry. As Russia’s largest industry, it has been a focus of sanctions designed to deter the continuation and escalation of the conflict in Ukraine, with policies targeting the trade in oil and gas, new equity and debt, investment in energy projects, and export to Russia of equipment and parts, as well as designations of specific companies and individuals in the sector.
Russia remains one of the world’s largest suppliers of oil and gas, and a key supplier to several economies in Europe. The tension between the multilateral goals of prohibiting Russia from profiting from historically high prices of oil and gas and easing the international energy crisis complicated the implementation of restrictions on Russian oil, gas and petroleum products. In order to balance these interests, the United States, European Union, United Kingdom and other allied countries have implemented various restrictions over the course of the last year, including most recently a coordinated price cap on Russian-origin oil and petroleum products. Russia has responded with increasingly complex measures in an attempt to protect its economy.
The key developments are described below.
Nord Stream 2 Sanctions
Nord Stream 2, a pipeline which runs from Russia through Germany, has been the source of political conflict for almost a decade. Upon Russia’s claims of the Donetsk and Luhansk Republics as independent territories, German Chancellor Olaf Scholz revoked the preconditions necessary to certify the pipeline on February 22, 2022. Soon after, the U.S. sanctioned Nord Stream 2 AG, the company which owns the pipeline, effectively halting the project.
Import Bans
The U.S., UK and EU quickly moved to prohibit the import of Russian energy products. However, due to varying needs among countries, the implementation of the import bans varied. On March 8, 2022, President Biden issued Executive Order 14066, which immediately prohibited import to the US of Russian crude oil; petroleum; petroleum fuels, oils, and products of their distillation; liquefied natural gas; coal; and coal products. The EU followed with prohibitions on the purchase, import, or transfer of coal and coal products originating in, or exported from, Russia in its fifth sanctions package (April 8, 2022) and on oil and oil products in its sixth package (June 3, 2022). Notably, the second import ban was subject to several country-specific derogations to reflect the varying levels of dependency on Russian oil within the EU. The UK followed with a similar measure on July 21, 2022, with the introduction of prohibitions on the import of Russian coal and oil and oil products. The UK prohibitions came into force on August 10 and December 5, 2022, respectively.
Export Controls
Following the impetus of the conflict, the U.S., UK and EU each imposed additional export controls against Russia, including additional controls targeting the energy sector. These followed measures originally introduced in 2014, following Russia’s entry into Crimea.
In 2022, the U.S. Department of Commerce implemented export controls on additional items related to deepwater oil and gas exploration, extraction and oil refining, while the UK and EU imposed increasingly broad restrictions on various products related to the oil industry, including goods or technology used in oil production and refining. The UK also banned energy-related services (including drilling and well testing) for the production and exploration projects related to oil and gas in Russia.
Investment Bans
The U.S. and EU each imposed prohibitions against their citizens investing in the Russian energy sector. Executive Order 14066 prohibited US persons from investing in Russia’s energy sector effective March 8, 2022, and thereafter, on April 6, 2022, EO 14068 prohibited all new investment in categories to be enumerated by the Departments of Treasury and State. These rules further prohibit U.S. persons from approving, financing, facilitating or guaranteeing investments by foreign persons in Russia’s energy sector.
Similarly, as part of its fourth package, issued on March 15, 2022, the EU prohibited EU individuals and entities from acquiring or extending ownership in Russian or third-country entities operating in the “energy sector” in Russia, and granting new loans to, or creating any new joint ventures with such an entity. For these purposes, the “energy sector” covers the exploration, production, or distribution of crude oil, natural gas, or solid fossil fuels, as well as the refining of fuels, the manufacture or distribution of fuel products, and the construction of facilities or installation of equipment for activities related to power generation or electricity production. The UK did not impose an energy-specific investment ban, but rather imposed an outright prohibition on investments in Russian companies and land on July 19, 2022.
Price Caps
In an effort to prohibit Russia from benefiting from historically high energy prices, the U.S., UK and EU, alongside Canada, Japan and Australia (the “Price Cap Coalition”), imposed price caps on Russian-origin oil and petroleum products. The price caps are implemented as a ban on the transportation of Russian seaborne crude oil and petroleum products to third countries and associated services including brokering, financing and insurance, except where the products are purchased at or below the applicable capped price. OFAC issued detailed guidance on the due diligence and record-keeping requirements expected of financial institutions, buyers and sellers, commodities brokers, insurers and other actors in the trading ecosystem. The U.S. guidance also clarified that the caps applied to products in the course of maritime transport, rather than land or pipeline
On December 5, 2022, the Price Cap Coalition announced a $60 per barrel price cap on services related to maritime transfers of Russian-origin crude oil. On February 5, 2023, the first price cap for petroleum products traded at a discount to crude oil was set at $45 per barrel, while the second price cap for petroleum products traded at a premium to crude, for items such as diesel and jet fuel, was set at $100 per barrel.
Products made using Russian-origin crude oil in a third country will not be subject to the cap if the resulting product is substantially transformed or processed in accordance with applicable rules of origin set out in each nations customs law. There are slight variations in the specific rules of origin between the U.S., UK and EU, each of which have published further guidance on origin determinations.
Russian Countermeasures
The Russian response to sanctions on its energy industry has been more aggressive than in other areas due to the importance of oil and gas sales for its economy. The Russian countermeasures have been both targeted to specific projects and applied more broadly to the industry as a whole. When countermeasures have targeted investments from “unfriendly countries” (i.e., countries that have introduced sanctions on Russia and Russian persons), the Russian government generally has done so without definitively expropriating their assets.
One example of a project-targeted measure was the quasi-nationalization of Sakhalin-1 and Sakhalin-2, which are major LNG and hydrocarbon projects. The Russian government pointed to a potential environmental disaster among the grounds for the moves.
The Russian government also has taken measures to slow the exodus of Western companies. In order for companies in the energy and oil production industries to exit a project by selling their shares or interest, they need to first receive special approval from the Russian President. In practice, only a handful of such approvals have been granted in the last six months. This measure complicates the exit of many companies, who have been forced instead to hold their Russian operations for the time being. This restriction operates in addition to another, more general governmental approval required for the sale or purchase of Russian companies by shareholders from “unfriendly countries”.
Finally, Russia also has also taken measures to combat sanctions from other countries. In response to the price caps imposed by the Price Cap Coalition, Russia has prohibited the export of raw oil and raw oil products under contracts with price cap compliance provisions. This rule does not restrict sales to any particular country as long as there is no reference to a price cap mechanism, and even although the price itself may be within the price cap. Russia’s countermeasures continue to evolve and their impact may depend on the market appetite of non-aligned jurisdictions, such as China and India, to engage in trade with Russia as buyers of energy commodities and as alternative suppliers of energy-related technologies.
Other Posts in the Russia Sanctions: A Year-in-Review Series
Russia Sanctions Year in Review: Impact on Financial Services Sector