Uncertainty Remains In Ukrainian Capital Kiev After Controversial Referendum Gives Russia Control Of Crimea

Following Russian annexation of the Crimean Peninsula, tensions between the West and the Kremlin have been dangerously simmering. Meanwhile, the spotlight has moved to Eastern Ukraine where unmarked soldiers appear to be keen on destabilizing the situation further. Anti-Ukrainian agitators seized government buildings and police stations making a mockery of Kiev’s sovereignty. This sets up an ideal breeding ground for miscalculation on all sides which could potentially be followed by new waves of armed escalation.

The British Foreign Secretary William Hague told the BBC that the UK is willing to make “sacrifices” to impose further economic sanctions on Russia. The US is also prepared to expand its sanctions – which currently include travel bans and asset freezes – against leading Russian figures and strategic economic sectors. According to the New York Times, the White House is said to be targeting Igor Sechin, the president of Rosneft – Russia’s largest state-owned oil company. Rosneft has a major joint venture with ExxonMobil in Russia’s Far East and UK-based oil major BP holds a 20% equity stake in the Russian national oil company. Disrupting Rosneft’s operations could complicate matters in unintentional ways by imposing unnecessary and incalculable future costs on strategic western businesses like Exxon and BP.

In this context, Gerald F. Seib of the Wall Street Journal poses a question that should serve as point of departure for any US sanctions deliberations: “What do you do when the person you seek to punish [Putin’s Russia] is willing to endure more pain than the person doing the punishing [the West]?” It is just like in medicine – find the right pressure point! In the case at hand this would refer to an area in the energy realm that may produce significant pain or other effects when manipulated in a specific manner.

In theory, it would appear that President Obama has at least two alternative pressure points in the energy realm he could harness for his purposes. The US is experiencing in both natural gas and crude oil production an unprecedented growth spurt due to America’s shale-based energy revolution. It is noteworthy that crude oil production is approaching the historical high achieved in 1970 of 9.6 million barrels per day, the EIA notes. The following EIA chart shows the US finally surpassing Russia and Saudi Arabia as world’s top producer of petroleum and natural gas hydrocarbons in 2013.

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Moreover, in the latest “Short-term Energy and Summer Fuels Outlook” the EIA projects world petroleum and other liquids supply to increase by 1.4 million barrels per day in 2014 followed by 1.3 million barrels per day in 2015, interestingly “with most of the growth coming from countries outside of OPEC.” This underscores current and future US energy prowess. The next chart illustrates the widening gap in production growth in the short term between the US and its competitors – especially vis-à-vis its geostrategic foe Russia.

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All in all, US oil production may lend itself to a potentially powerful tool of ‘statecraft’ for the US government in order to influence behavior in the international arena.

Instead, the talk inside the Beltway appears to gravitate towards advocating for expedited US LNG exports to European allies, thereby ideally hoping to force Russia to find new customers for its primarily European-demand-centric natural gas supply model. Many pundits have already exhaustively made clear that this a non-starter in the short term with a bleak outlook for the medium term for a variety of reasons; above all, timing and existing long-term purchase contracts with Asian customers willing to pay higher prices. Consequently, the natural gas angle does not appear to be the most promising pressure point and could backfire on its European allies in the short term given Gazprom’s dominant position in Europe.

The next chart, however, visualizes Russia’s real exploitable pressure point: the Russian economy’s disproportionate dependence on revenues from exporting liquid fuels including petroleum products vis-à-vis natural gas export revenues. This great chart created by Dr. Steffen Bukold of EnergyComment displays Russia’s natural gas (blue columns) net export revenues in comparison to total crude oil (green columns) net export revenues in billion dollars.

Russia’s Net Crude Oil and Natural Gas Export Revenues

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Source: EnergyComment Steffen Bukold

Russia’s net crude oil export revenues amounted to approximately $290 billion in 2012 – according to Dr. Bukold – and therefore were more than four times as high as net natural gas exports in the same year. Meanwhile, EIA data show for 2012 that Russia exported approximately 7.4 million barrels per day of total liquid fuels with the majority (79%) of Russia’s crude oil exports going to European countries (including Eastern Europe).

The main point is that Russia is vulnerable to the global price of oil and its volatility. Note, volatility in the global oil price can, of course, also affect regional natural gas pricing in Europe due to the fact that most European contracts are still indexed to oil.

So Russia’s most tender pressure point is related to oil prices and given the current state of the Russian economy, a decrease in global oil prices could significantly pressure the Kremlin. Rupert Rowling of Bloomberg Businessweek cites Deutsche Bank research estimating Russia’s break-even level required to balance its budget at an average Brent crude price of $101.70 a barrel compared to Saudi Arabia’s break-even level of $93.40 a barrel. DB research also notes that Russia’s fiscal needs would jump to an even higher oil price if the Ukraine crisis leads to a disruption of energy exports.

As such, the oil market represents President Obama’s greatest source of leverage over Russian President Putin. The Obama administration could use the US Strategic Petroleum Reserve (SPR) as instrument, in addition to an executive order lifting the US oil export ban. A report commissioned by US Senator Lisa Murkowski cites various historical cases that could also justify the president’s use of his executive powers in the case at hand. The report concludes: “Even statutes that generally prohibit the export of crude oil contain provisions that permit the president to authorize exports under certain conditions.”

A simple statement by the president that indicates he is contemplating such a step could reassure allies while also sending a signal to the global oil market and Putin. Most importantly, both the infrastructure and oil resources are in place and thus do not require the long lead times associated with US LNG exports. Specially-authorized oil exports could serve as an empirical trial run to assess domestic and global market impacts, the results of which could help inform an eventual permanent lifting of the oil export ban by Congress. Movement in this direction on behalf of the White House could make it more difficult for the Kremlin to cut off European gas supplies by creating a scenario in which the fragile Russian economy would be hit by diminished oil and gas export revenue simultaneously.

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