These Russian oil pumps may have less work in the coming months.
Photo: Andrey Rudakov/Bloomberg via Getty Images

Russia’s invasion of Ukraine represents the most serious challenge to peace in Europe since World War II and, according to some, the start of a new era in world history.

The response from the West has been almost as monumental. While renouncing a military confrontation with Russia, NATO and its allies have waged something akin to a financial war against Vladimir Putin’s regime. In addition to sanctioning Russian oligarchs and seizing their Western assets, the US and EU have effectively ousted the entire Russian banking system from the global financial order. Russian banks can no longer use international payments known as SWIFT to conduct transactions, forcing companies to do business at a snail’s pace, one phone call at a time. Not that Russian banks have so much business to do, given that engaging in virtually any form of trade with Russia will now expose foreign companies to secondary sanctions.

More important than these measures, however, was the freeze that central banks across the West imposed on Russia’s sovereign assets. Since his 2014 invasion of Crimea, Putin has carefully built up one of the largest foreign exchange reserves in the world. This $640 billion stockpile was intended to give the Russian leader greater geopolitical leeway by insulating his economy against the threat of crippling sanctions. One of the worst consequences of the sanctions for the penalized nation is that they depreciate its national currency: while most of the world boycotts Russian exports, the demand for rubles dries up. This increases the Kremlin’s borrowing costs and the prices Russian consumers have to pay for imported goods. With its huge stock of foreign currency, however, Russia’s central bank could create demand for rubles by buying them back with its own dollars and euros.

But there was a flaw in that plan. Although Russia has hundreds of billions of foreign currencies, these funds are legally stored in central and commercial banks in New York, Paris, Berlin and other cities around the world. The West has exploited this fact to cut off Russia’s access to its own sovereign wealth.

Never in modern history has an economy of Russia’s scale been subjected to such extraordinary ostracism. The value of the ruble fell rapidly. According to analysts at JPMorgan Chase, the Russian economy is now on course to contract by 7% this year. Other forecasters paint an even bleaker picture, with the Institute of International Finance projecting a 15% contraction in Russia’s GDP. Putin’s regime owes much of its popular legitimacy to its success in returning Russia to economic stability and modest growth after the 1998 debt crisis. contracted by 5.3%.

And economists can actually be underestimate the economic difficulties that lie ahead – both for Russia and for its adversaries.

For all their technocratic brutality, the West’s sanctions had a loophole big enough to get the tankers through: deals involving Russian energy exports, which make up about a quarter of its economy, were exempted from sanctions, to avoid Western consumers to pay for Putin’s sins.

On paper, this provided the Kremlin with a valuable lifeline. As long as Russia could continue to sell oil and gas to the United States and Europe, it would continue to accumulate dollars and euros, which it could then use to support the value of the ruble. And that has indeed helped to cushion the fall of the Russian currency over the past week.

If Western governments have thrown Putin a lifeline, however, his private sector is steadily cutting it off.

Over the past few days, Western traders and refiners have reduced their purchases of Russian oil, with some ceasing to deal with Russians altogether. Meanwhile, oil giants Shell and BP have both announced that they are abandoning their partnerships with Russian state oil companies and halting extraction projects in the country.

“The enablers of oil exports – banks, insurance companies, tankers and even multinational oil companies – have enacted what amounts to a de facto ban,” said Tom Kloza, global head of oil. energy analysis at the Oil Price Information Service. new York Times Last week.

The motivations behind this emerging boycott vary from company to company. For one thing, while Western sanctions include exemptions for energy trading, executing such transactions without breaching another restriction in the process is a tricky and time-consuming business. Many buyers would simply prefer to do business with less vexatious suppliers. At the same time, some shipping companies do not want to expose their ships to the risk of attack; shortly after Putin’s invasion began, a missile hit a Moldovan tanker.

There is also a widespread belief among traders that as Russia steps up its attacks on Ukrainian civilians, Western governments will eventually feel compelled to use their remaining economic weapon. Buyers are therefore seeking to anticipate this development by finding new suppliers now. Finally, many actors in the energy trade simply do not want to fund war crimes (or at least be seen do it). This moral objection to facilitating Russian energy trade is not limited to executive suites. In Britain on Friday, dockworkers refused to unload a tanker full of Russian gas, forcing the ship to be diverted.

As a result, Russia is struggling to find buyers for its key exports, even though it offers the country’s highest quality oil at $20 a barrel.

If this de facto embargo were to continue, the consequences would be devastating for the Russian economy and heavy for virtually all others.

“We’re in uncharted territory if you take 13% to 15% of the world’s oil out of the pool,” Brenda Shaffer, senior energy adviser at the Foundation for Defense of Democracies, told CNBC on Thursday. “Sanctions on Iran and Venezuela, that’s not even comparable to what it could do to the world oil market if you actually pulled most Russian production.” Shaffer went on to note that while many are applauding Shell and BP’s exit from Russia as a “feel good moment”, these moves “are going to be a huge, huge shock to the state of these companies and to the stock market. “. in general.”

By late Friday morning, a barrel of Brent crude oil was trading at $114.50, its highest level in nearly a decade. Meanwhile, the Dow Jones Industrial Average was down 500 points on the day.

Given Putin’s broad war goals — which include dissolving the Ukrainian government and establishing a Kremlin-aligned puppet regime in Kyiv — the sanctions are unlikely to be lifted anytime soon. And if they were to stay in place for much longer, they have the potential to reshape the global economy in a lasting way.

Already, European leaders are discussing efforts to permanently reduce their dependence on Russian energy through both an acceleration of decarbonization efforts and, in the immediate term, aggressively seeking reserve liquefied natural gas from other suppliers. For its part, Russia is likely to steer its own export strategy away from Europe towards China.

If Putin’s rogue geopolitical strategy is to be sustainable from a distance, he will need the partnership of Xi Jinping’s regime. It is no coincidence that, shortly before Putin’s invasion, Russia and China announced a “limitless” partnership intended to counteract the coercive influence of Western powers. But here, too, Putin’s fortifications against economic bombardment have crumbled. Chinese political leaders have found Putin’s offenses against the international order easier to defend in theory than in practice. After Russia’s first days of messy and bloody fighting, Beijing distanced itself from Moscow, refused to back the ruble against Western attacks and called for the protection of civilians in Ukraine.

And China’s political leaders are more sympathetic to Russia than to its big business. Chinese banks have mostly avoided Russia since the start of the war, fearing to jeopardize their access to more profitable Western markets. If China finally agrees to serve as Russia’s financial saviour, Xi will have the clout to extract lopsided terms of trade from Moscow.

Even if Putin withdraws from Ukraine in a few weeks and Western nations lift current sanctions, American and European businesses and investors are likely to remain wary of Russia, given the risks inherent in doing business with a rogue state.

Thus, Putin’s War of Conquest is about to usher in not only a new geopolitical era – one in which the European Union spends far more on defense and NATO enjoys a new sense of purpose – but also a new economic era, in which world trade is increasingly divided between antagonistic blocs. These two developments could interact in dangerous ways. As Russia and the West become less interconnected economically, relations between the world’s two largest nuclear powers could become even more strained and tenuous than they were before the current crisis.

In the immediate term, the costs of adapting to a less globalized economy could be high. Already hit by high inflation before Putin’s invasion, the West will now see its energy costs skyrocket. In Russia, the scale of the devastation and disruption that awaits us is difficult to grasp. For some of the world’s poorest people, a sudden drop in wheat exports from Russia and Ukraine could very well mean starvation.

By drafting its sanctions, the West set out to destroy the Russian economy. For now, he seems to be succeeding beyond his wildest hopes (and/or fears).

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