On Mar. 6, at a meeting in Vienna of the “OPEC +” oil-producing countries, Russia took the world by surprise by refusing to continue to limit its oil production in the interest of supporting prices. In return, Saudi Arabia responded that it would increase production to record levels to seize market share as well.
This dispute sparked a crisis in the industry, driving the price of oil down to its biggest one-day decline in a generation and roiling financial markets. These developments come at a time of declining demand, as the world begins to grapple with the economic slowdown brought by the COVID-19 pandemic.
However, rather than attributing this oil shock to the coronavirus entirely, it is worth examining whether the seeds for Russia’s sudden move were planted by the Trump administration’s expansive use of economic sanctions.
U.S. Economic Sanctions
U.S. economic sanctions are a powerful instrument of U.S. national security policy, prohibiting doing business with certain individuals, companies and organizations, and at times extending to whole industry sectors or even entire countries. The Trump administration has raised the use of sanctions to a new level, designating as Specially Designated Nationals and Blocked Persons (“SDNs”) on average more than 1,000 parties a year since taking office, including the entire of government of Venezuela led by Nicolás Maduro.
Though technically U.S. sanctions restrictions generally apply to persons subject to U.S. jurisdiction, given the status of the U.S. dollar as the world’s reserve currency, they impact non-U.S. persons as well. For example, when the U.S. withdrew from the Iran nuclear deal known as the Joint Comprehensive Plan of Action and reimposed sanctions, European companies and financial institutions also retreated from doing business with Iran out of concern such activity could jeopardize their access to U.S. dollars.
The Trump administration considers vigorous deployment of U.S. sanctions to be a means of applying “maximum pressure.” The ability to freeze others out of the U.S.-led global financial system is what gives credence to that view.
Impact of Sanctions on Russia and the Response
The U.S. recently imposed sanctions aimed directly at Russia’s energy sector.
Nord Stream 2
On Dec. 20, 2019, the President signed into law the National Defense Authorization Act, which within its provisions provides for “secondary sanctions” against non-U.S. persons; for example, persons who participate in laying the gas pipeline running from Russia to Europe known as Nord Stream 2, including cutting them off from the U.S. financial system. As a result, a Swiss-Dutch company contracted by Russia’s gas company, Gazprom, immediately stopped work. The U.S. has expressed concerns that Russia is using energy as a tool of foreign policy to try to cultivate relations with members of NATO, such as Germany. Though Nord Stream 2 is almost complete, the sanctions paused the project, stifling Russia’s ability to timely finish construction.
Rosneft Trading
On Feb. 18, the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) sanctioned Rosneft Trading S.A., a Swiss-incorporated trading arm of Russia’s energy giant, Rosneft, “for operating in the oil sector of the Venezuelan economy.” U.S. sanctions on Venezuela authorize them to be imposed on any person who “materially assisted” the Maduro regime, and OFAC determined that Rosneft Trading facilitated oil shipments on behalf of Venezuela’s national oil company, Petroleos de Venezuela. The Trump administration has been frustrated in its efforts to catalyze a democratic transition away from the Maduro regime, as Russia has assisted Venezuela in circumventing U.S. prohibitions on trading in Venezuelan oil. Sanctioning an entity controlled by Russia represents a meaningful escalation.
In April 2014, OFAC designated the CEO of Rosneft, Igor Sechin, an SDN after Russia’s annexation of Crimea, in large part due to his loyalty to Vladimir Putin. Mr. Sechin has argued that, in imposing sanctions on oil-producing countries like Iran, Russia and Venezuela, the U.S. has been able to use energy as a “weapon,” as U.S. shale oil production could cushion the market from collateral impacts like oil price and supply shocks that would typically result.
On the heels of these recent rounds of sanctions by the U.S. targeting Russia, at the OPEC+ meeting it appears Russia now decided to drive down prices to try to undermine this U.S. source of energy leverage.
Why Saudi Arabia Decided to Act
Saudi Arabia’s reasons for dramatically ramping up production could include retaliating against Russia by challenging it to sustain operations at an even lower price per barrel, or perhaps joining Russia in seeking to drive higher-cost U.S. shale oil producers out of the market.
However, U.S. sanctions may also provide a clue. The impact of the U.S.’s isolation of Iran from the global financial system has already propelled the oil revenue the country depends on into a downward spiral, so much so that recently it was reported that at least 25% of Iran’s oil rigs have been sidelined as a result. With Iran believed to be afflicted with mass casualties due to COVID-19, forcing Iran to conduct any remaining oil transactions at a fraction of former prices could exacerbate the damage to the country’s economy and destabilize the Iranian regime.
In September 2019, when drones sent by forces generally believed to be associated with Iran attacked Saudi oil fields and facilities, Saudi Arabia did not strike back. Perhaps now it has.
Key Takeaways
- The U.S. has made effective use of economic sanctions in the global energy space, perhaps in particular because U.S. shale oil production has provided a hedge against blowback effects.
- By conditioning access to the U.S. financial system on compliance with sanctions, the U.S. has also gotten non-U.S. persons to comply in order to preserve their access to U.S. dollars.
- Russia now may have retaliated against the extraterritorial reach of U.S. sanctions, targeting U.S. shale oil producers at a time the industry is already vulnerable due to COVID-19.
- Major powers use energy as an instrument of influence, and within this sphere sanctions and the impacts they can trigger have become an essential part of the toolkit as well.
Mario Mancuso is a partner at Kirkland & Ellis and leads the firm’s international trade and national security practice. A former member of the president’s national security team, he specializes in counselling clients on international trade and national security matters, guiding clients through the CFIUS process, and resolving crises involving economic sanctions and export control-related investigations by the U.S. government.
Sanjay Mullick, a partner in Kirkland’s Washington, D.C., office, regularly represents clients on investigative, regulatory and transactional matters related to economic sanctions, export and import controls, anti-money laundering and anticorruption.
Doug Bacon, a corporate energy partner in Kirkland’s Houston office, focuses on merger and acquisition transactions including extensive experience advising public companies and private equity investors.
Anais Bourbon, a law clerk at Kirkland, also contributed to this article.