It's time to impose Iran-calibre sanctions on Russia

Russia is sometimes described as the world's most sanctioned nation. And while that's true, the long list of sanctions that the G7 coalition has placed on Russia in response to its attack on Ukraine are surprisingly light compared to the fewer but far more-draconian sanctions placed on Iran over the last decade or so.

This ordering of sanctions precedence is a mistake. With its all-out invasion of Ukraine, Russia has moved past Iran into top slot at world's most dangerous nation. Vladimir Putin merits a sanctions program that is at least as onerous as Iran, if not more so, yet for some reason he is getting off lightly. It's time to apply Iran-calibre sanctions to Russia.

What makes a draconian sanctions program draconian?

What makes the Iranian sanctions program so draconian is that many of the sanctions are so-called secondary sanctions, a feature that has been mostly absent in the Russian sanctions program.

When the U.S. or EU levy primary sanctions on an entity, they are saying that American individuals, banks, and businesses (and European ones, too) can't continue to interact with the designated party. This hurts the target, but it leaves foreign individuals, banks, and businesses with free reign to fill the void left by departing American and European actors, thus undoing part of the damage.

Secondary sanctions prevent this vacuum from being occupied. The U.S. government tells individuals or businesses in other nations that they, too, cannot deal with a sanctioned entity, on pain of losing access to U.S. economy. It's either us, or them.

When applied to foreign financial institutions (i.e. banks) secondary sanctions are particularly potent. The U.S. tells foreign banks that if they continue to provide banking services to sanctioned Iranians, the banks' access to the all-important U.S. financial system will end. Since the U.S. financial system is so crucial, foreign banks quickly offboard all sanctioned Iranian individuals and businesses. The sanctioned Iranian entity finds that it has now been completely removed them from the global financial system. This financial shunning effect is much more powerful than the effects created by primary sanctions or secondary sanctions on non-banks.

Notice that I've limited my commentary on secondary sanctions to the U.S. Since it first began to use secondary sanctions in 1996, the U.S. Treasury has become a master of the art, whereas as far as I know they are a tool the EU has long resisted adopting.

The bank-focused secondary sanction placed on Iran over the last decade-and-a-half have been particularly devastating because they target a broad sector of Iranian society, most crucially the Iranian oil sector, the life blood of Iran's economy. Secondary sanctions prevent foreign banks from processing Iranian oil trades on pain of losing access to the U.S., and so most foreign banks have chosen to cease interacting with the Iranian oil companies.

The chart below illustrates the effectiveness of this approach. When President Obama placed the first round of bank-focused secondary sanctions on Iran's oil industry in 2012, the nation's oil exports immediately cratered from around 2 million barrels per day to 1 million barrels. When he removed them in 2016, they quickly rose back up. And when Trump reapplied the same secondary sanctions in 2018, they collapsed once again, almost to zero.

Source: CRS [pdf]

In short, U.S. secondary sanctions imposed huge body blows on the Iranian oil industry. These same forces have not been brought to bear on Russia's oil industry.

A dovish Russian sanctions program

While the Russian sanctions program is often portrayed as being strict, it is far lighter than other sanctions programs, including the one placed on Iran, because it is comprised almost entirely of primary sanctions. (For a good take on this, see Esfandyar Batmanghelidj here). While a small list of secondary sanctions have been placed on Russia, for the most part they have not been of the banking type.*

The second reason why the Russian sanctions program is dovish is that the oil component of the EU and U.S. sanctions campaign has been particularly lenient. Take a look at the above chart of Iran oil exports and you can see very real evidence of damage from sanctions. Scan the chart of Russian oil exports below, however, and it suggests business as usual.

Source: CREA

Sure, the EU and other coalition partners have cut Russian oil imports to almost nil, and that's great. But overall, this effort hasn't done much harm to Putin, since over time the coalition's respective share of Iranian oil exports has simply been taken up by nations like India and China. Both before and after the 2022 invasion of Ukraine, Russia reliably shipped around 1,000 kt/day of crude oil and crude oil products.

Underlying this leniency, G7 businesses are still allowed to engage in the Russian oil trade, as long as this doesn't involve bringing the stuff back to the EU. For instance, foreign buyers of Russian oil (say like Indian refiners) are allowed to hire European insurers and shipping companies to import Russian oil.

There is a limitation on this. European insurers and shippers can only be used by an Indian refiner, or some other foreign buyer, if the purchase price of Russian oil is set at $60 or below. This is what is known as the G7 oil price cap.

Because the insurance and shipping industries of the UK, EU, and U.S. have a large share of the market, Russia has had little choice but to rely on coalition intermediaries for selling at least some of its oil at $60. This has come at a cost to Russia; it must sell at below-market prices. And that certainly makes Russia worse off than a world in which there was no oil price cap.

But the very fact that these purchases are occurring at all, compared to a world in which Iran-calibre sanctions would prevent them from ever taking place, illustrates how weak the oil price cap is. 

Russia's oil export income is the life-blood of Putin's war economy. These funds gets funneled directly to the front-line in the form of weapons and supplies. It's time to get serious about Russian sanctions, remove the dovish oil price cap, and apply to Russia the same calibre of secondary sanctions that so effectively crimped Iranian oil exports.

We may have to deescalate sanctions on Iran in order to escalate them on Russia

What has prevented the U.S. and its allies from applying draconian Iran-style sanctions to Russia? One of their main worries is that taking a major oil exporter out of the market will have major macroeconomic impact. 

Russia currently exports around 4 million barrels of crude oil per day, as well as a large amount of refined products such as gasoline. Assuming that half of this were to be removed by secondary sanctions, world oil prices would probably rise. Voters in the EU and US would get angry. Neutral countries dependent on oil imports – China, India, Brazil – would push back against the colation, because they'd have to scramble to replace a major supplier. Secondary sanctions aren't just a nuisance for these neutral parties. Due to their extraterritorial  nature, secondary sanctions impinge on the sovereignty of neutral nations. This creates hostility, understandably so, the negative blowback eventually flowing back to the U.S.

So if the EU, U.S. and the rest of the coalition are going to get serious about sanctioning the Russia's oil industry, and thus removing a few million barrels of oil per day from the world market, they may need to counterbalance that in order to soften the blow. One way to do so would be to free up more Iranian oil exports, which means softening the sanctions on Iran.

That doesn't mean not applying sanctions to Iran. A version of the $60 price cap on Iranian oil probably makes a lot of sense. However, a fully armed financial battleship – i.e. bank-focused secondary sanctions directed at a major crude oil exporter's oil industry – may be something that has to be reserved for one country only: Russia.

Now, I could be wrong about the world being unable to bear draconian sanctions on two major oil exporters. Maybe I'm creating a false dichotomy, and in actuality the choice is less stark and the coalition can actually apply draconian oil sanctions on both Iran and Russia. If so, I stand corrected.

Either way, Russia's oil industry has skated through the invasion and resulting sanctions remarkably unscathed, as the Iranian counterexample illustrates. It's time to cut off Russia's main source of revenues by putting the same set of secondary sanctions that Iran has faced on Russia's oil patch. 

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* There are a few bank-focused secondary sanctions placed on Russia. Notably, Section 226 of CAATSA (2017) requires foreign financial institutions, or FFIs, to avoid certain sanctioned Russians or sectors on pain of losing access to the U.S. banking system. (See here, for example.) However, the U.S. must not be enforcing Section 226 very tightly because I haven't found a single case of a bank being punished under 226.

This December, another round of secondary sanctions was imposed on FFIs. Any foreign bank that facilitates transactions involving Russia’s military-industrial base may be cut off from the U.S. financial system. Additionally, any bank that conducts transactions for specially designated nationals who operate in Russia's technology, defense and related materiel, construction, aerospace or manufacturing sectors may face punishment. Note that both rounds of secondary sanctions leave the Russian oil industry untouched.