Sanctions

The Europeans look set to surprise us with significant economic sanctions against Russia (see here and here) that exceed in some respects U.S. measures. The United States likely would expand their sanctions in parallel. I yesterday published an op-ed on what we should make of the moves, and assuming reports of an agreement are true, I think it is worth highlighting four takeaways from that piece and recent developments: 1. These are meaningful measures, with long-term adverse consequences for the Russian economy, but not full sectoral sanctions. Europe, having earlier extended sanctions to 33 individuals and entities, is considering prohibiting European institutions from participating in new debt or equity of majority Russian state banks (similar to U.S. measures earlier this month, but in principle including more and larger banks such as Sberbank); sale of critical energy equipment and technology; and an arms embargo including dual use technology. These restrictions apply to transactions going forward, so existing contracts, such as the French warship sale, would be exempted. (Why can’t Australia, Japan or some other power buy the French ships so they don’t go to Russia?) It is not a comprehensive ban on financial transactions, including the payments system, and so not the “Lehman moment” I have suggested could be the most powerful use of sanctions. But it is sufficiently broad to have systemic effects—thus effectively “level three” sanctions in policy-speak. 2. All of this suggests a substantial, longer-term cost to the Russian economy (and to its trade and financial partners in the west), a threat I don’t think is recognized in recent official or most private forecasts. Wolfgang Munchau has also made this point (and thanks for the shout out). 3. There would appear to be inexorable momentum for further sanctions: (1) Europe now is less of a constraint on further U.S. action; (2) Ukraine is achieving success on the battlefield, and without intensified Russian involvement would likely see further gains. If recent evidence of Russian shelling across the border is any indication, Russia has intensified its support in response to developments on the ground, which is justification for further sanctions; and (3) sanctions are likely to be extended over time in response to evasion. This last point is often unappreciated. As with capital controls, prohibitions on financial transactions create incentives to innovate to evade the control. In some cases, that can be a helpful escape value, but in this case, where the West desires to impose a credible cost on Russia for its continued destabilization of Ukraine, controls need to be extended. If the restrictions on new debt, for example, are evaded in size by using non-sanctioned companies or alternative markets (such as foreign exchange swap markets), I’d expect the types of transactions and/or sanctioned institutions to be extended to close off those flows. This may be only the early innings of the sanctions game. 4. There remains a tension between economic and political timelines. I heard commenters this morning say that it could take a month to see if sanctions would work. I suspect that it could take longer still. The current approach—emphasizing incremental moves and the threat of more to come, works primarily not through an abrupt break in financial market channels but rather through a slow squeeze on trade and finance. Firms hold back on investment, unwind trade and financial relationships, for concern about the future legal and economic risks as much as current bans. As debt comes due, the financial pressure on Russian companies intensifies. Thus the cost of sanctions for the Russian economy is best measured through capital flight, reduced investment, and recession. Yet political pressures point toward the need for more immediate evidence of success. From this perspective, the debate over the pace and intensity of sanctions is far from over.  

The United States has taken what, on first read, looks to be a significant step today, extending sanctions ( see also here) to block new debt and equity issuance by a number of energy, financial and military companies.  It is not quite full "sectoral" sanctions--both because it is limited in what it blocks (new debt and equity of maturity greater than 90 days) and because it excludes Sberbank, which holds the majority of Russian deposits. But I would argue that the reach of this new executive order in terms of institutions covered is sufficiently broad that the effects on the Russian financial system could be systemic. Europe chose not to match these sanctions, so it is critical that large European banks not fill the gap left by the withdrawal of U.S. banks.  Moral suasion from European leaders on their banks (and the desire of those banks not to run afoul of U.S. law in this space post BNP/Citi fines) should be effective, and U.S. officials appear confident that the easy loopholes are closed.  In addition, if any leg of the transactions require U.S. institutions, the deals will fail based on U.S. action alone.  In this sense, the U.S. can go ahead of Europe and pull them along. If Europe, as reported, follows by blocking new loans from the European Investment Bank and European Bank for Reconstruction and Development (something my colleague Heidi Crebo-Rediker has forcefully argued for), we have a comprehensive new set of measures that could have material costs in the long term for a Russian economy that is already in recession. As my colleague Stephen Sestanovich has noted, now also is the time to supplement sanctions with positive measures to ensure Ukraine succeeds. Perhaps the Europeans could expand and accelerate their bilateral aid, so the Ukrainian government can ensure provision of critical public services.  This would also require acknowledging that the current IMF program needs a major rewrite.  But that can come later.

There are reports this morning that the Obama administration is contemplating extending economic sanctions against two large Russian banks-- Gazprombank and  Vnesheconombank (VEB).  This is a step I have called for here and here.  If true, this is a significant event and, given the magnitude of Russia’s links to global financial markets, introduces a new era in the use of economic sanctions.  It also makes sense to do this now, as the current strategy is not working to deter Russian aggression against Ukraine. It is interesting  that the sanctions are aimed at two state-controlled banks most closely associated with the fiscal authorities, and holding back for now on the most active, leveraged banks (e.g., VTB, Sberbank).  So the goal would seem to be to punish the state, not go after corruption or specific activities.  I presume that the sanctions would prohibit U.S. institutions from financing and transacting with the two banks, holding their securities/collateral, or buying and selling their liabilities in U.S. markets.  It is not clear whether the Europeans will match these sanctions, but even if they don’t I believe that the measures could be powerful as long as the major European and Japanese banks do not fill in as U.S. banks depart--and risk of getting entangled in future sanctions.

An end to Syria’s conflict seems unlikely in the near term, as a number of obstacles on and off the battlefield have stymied international diplomatic efforts, explains this Backgrounder.

Ideas matter. Or at least Council on Foreign Relations fellows like to believe that: otherwise, we’d be wasting a lot of our time. With that in mind, I canvassed some of the smartest observers of the energy and climate worlds – scholars, advocates, journalists, businesspeople, and policymakers – for their picks for the most influential studies, reports, in-depth articles, or books of the year in the field. Then I threw my own judgement into the mix. Without further ado, here are my picks for the five most influential energy or climate publications of 2012. This isn’t a list of “the best” analyses of the year – it’s a collection of those that have had the most impact. Read them if you haven’t yet. You’re already feeling their consequences in any case. Ed Morse et al., “Energy 2020: North America, the New Middle East?”. There’s little doubt in my mind that this study, released by Citigroup in March, was the most influential item published on energy or climate this year. Sure, there had been diffuse buzz about “energy independence” earlier, but this report was the first to put hard numbers to the discussion, not just for oil production, but for macroeconomic consequences too, helping vault the discussion onto a new plane. It should go without saying that changes on the ground are the fundamental root of renewed enthusiasm for U.S. oil production. But whether you’re thrilled or appalled by all the energy independence talk, give this paper a lot of credit for bringing it to the fore. Energy Information Administration (EIA), “The Availability and Price of Petroleum and Petroleum Products Produced in Countries Other Than Iran”. Part of me wanted to list this dry report as the most influential energy publication of the year. When Congress passed a tough set of new Iran sanctions in late 2011, it gave the president a way out: the EIA was to issue a report on the price and availability of oil from outside Iran; the president could then decide that the oil market was too tight for sanctions to go ahead. The EIA report, published in late February, could have teed up such a judgment, but instead helped pave the way for Iran sanctions to go ahead. Those sanctions have had more bite than many initially expected. Yes, the report primarily described existing market conditions, but it had considerable leeway in interpreting them. Its real-world impact may have been large. Bill McKibben, “Global Warming’s Terrifying New Math”. How often does an article about climate change get 121,000 likes on Facebook and merit 13,600 tweets? Those are the stats that this Rolling Stone piece, published in July, has racked up. The article, which juxtaposed numbers for fossil fuel reserves (large) with estimates of how much carbon can safely be released into the atmosphere (smaller), has spawned a speaking tour that reportedly has drawn as many as two thousand people to individual events, and a fossil fuel divestment movement on college campuses across the nation that is attracting considerable attention. It has also helped crystallize thinking in some important quarters that U.S. oil and gas gains are incompatible with climate safety. This one is a lot like “Energy 2020” in one important way: love or hate its analysis, it’s getting a lot of traction, in this case particularly among students who will become political leaders some day. This one is a toss up between “Effect of Increased Natural Gas Exports on Domestic Energy Markets” (EIA) and “Macroeconomic Impacts of LNG Exports from the United States” (NERA Economic Consulting for DOE). The first, published in January, forecasted large potential price spikes if natural gas exports went ahead; the second, published this month, concluded that price impacts would be limited and that macroeconomic gains would be had. These are basically the two poles in the ongoing debate over whether to allow liquefied natural gas (LNG) exports. They currently rate a tie. The Obama administration will probably announce its LNG export policy early next year. Then we’ll know which study was really the most influential. Alvarez, Pacala, Winebrake, Chameides, and Hamburg, “Greater focus needed on methane leakage from natural gas infrastructure,” Proceedings of the National Academy of Sciences. Bob Howarth and two of his colleagues threw much of the climate world into intense confusion when they published a paper in early 2011 claiming that natural gas was worse for climate change than coal. The February 2012 paper from Alvarez et al., which looked at how the impact of a shift from coal to gas would affect temperatures over time, seems to have helped people put methane in perspective, and has moved the debate onto considerably firmer ground. There’s still much to contest in the PNAS paper – and much more data to be collected – but it appears to have shifted policy-related discussion from “is gas worse than coal?” to “how do we make gas better for the climate?” That’s a change that can have big real-world consequences. Honorable mentions include Richard Muller’s “BEST” study that confirmed global warming trends, which made a big splash but seems to have since faded; the IHS study that estimated a gain of 600,000 jobs from shale gas (technically ineligible because it was published in December 2011) – its estimates made it into the president’s State of the Union address this year, and seem to have influenced White House thinking on natural gas more broadly; the Breakthrough Institute’s work establishing the federal government’s historical role in promoting shale gas technology, which also made it into the State of the Union, and has helped remind many that federal support remains vital to energy innovation; and the “Darkest Before Dawn” study from three McKinsey consultants that projected widespread grid-parity for solar power within five years, influencing opinion among an important segment of people who think about where clean energy is heading. And finally an invitation to chime in in the comments section: What did this list miss?

The Wall Street Journal delivered some disturbing news yesterday: South Korea “sharply boosted imports of Iranian crude” in April, buying 42 percent more than a year before, and 57 percent more than in March. Analysts have speculated as to whether Seoul was attempting to sneak in extra oil before European sanctions begin to bite. A more careful look at the data, though, suggests that the spike in Korean imports is less peculiar than meets the eye. Oil imports naturally fluctuate from month to month. The big question, then, is how anomalous the jump in Korean imports from Iran is. The figure below shows monthly Korean oil imports from Iran going back five years (all data in this post is from Korean customs). It is clear that month-to-month import levels are volatile. The next figure plots absolute month-to-month changes in Korean oil imports from Iran. One can immediately see that there are several other month-to-month changes that exceed what happened between March and April 2012. We can quantify this: the average month-to-month change is 1.7 million barrels, with a standard deviation of 1.2 million. The upshot is that we should expect to see a month-to-month change of at least 2.7 million barrels – i.e. what we saw from March to April – about twenty percent of the time. If we look only at jumps of 2.7 million barrels or more, we should expect roughly one a year. One can, however, ask the question another way. South Korean imports from Iran have been on a downward trend. April imports, then, should have been lower than March ones. Working from this baseline, the actual April figure looks like a bigger jump. I looked at the absolute difference between monthly oil imports and what one would have expected had the previous six months’ trend held up. Korean imports in April now look a bit more anomalous. Had imports followed their six month trend, we’d have expected them to hit 3.4 million barrels in April; instead, they clocked in at 7.5 million. Our data suggests that this sort of aberration should happen four percent of the time, or once every two years. There’s a risk in doing too many statistical analyses (one of them will invariably deliver a phantom result), but let me give you one more way of looking at the trend. Korean imports from Iran dropped by four million barrels between September 2011 and March 2012, or about 700,000 barrels a month, before rising by 2.7 million barrels between March and April. That jump, then, was four times the monthly trend, in the reverse direction. That looks big, but it turns out to be pretty common: it occurred in 20 of the preceding 53 months. The big test will be what happens in May and June. The Korean government announced earlier today that it expects to report that imports decreased in May. If it does not, and imports stay high, it will be much more difficult to dismiss the April data as an anomaly. After all, very loosely speaking, the odds of something that happens four percent of the time happening twice in a row is about one in five hundred.  If imports do drop, though, the current kerfuffle should go away. But be warned: normal statistical noise means that this sort of scare will be repeated as the sanctions continue. Better and more timely data, along with a clear sense of what constitutes an acceptable import pattern, would go a long way to keeping the sanctions on track.

Talks in Baghdad reflect Iran’s new willingness to discuss its nuclear program, but sanctions may not sting enough to make it change course, says expert Hassan Hakimian.

Upcoming negotiations are shadowed by Iran’s increasing uranium enrichment capabilities. Four nonproliferation experts provide a path for resolving the intensifying nuclear dispute.

As the Iranian oil embargo begins to bite, the widespread assumption is that this should hurt Iran’s oil revenues and government budgets, hopefully inflicting enough economic pain to bring them to the bargaining table. But rather counterintuitively, some basic economics suggest Iran may have cause to thank the United States, European Union, and embargo participants for helping raise their total oil revenue! This can happen because while the embargo against Iran is reducing the overall amount of oil Iran can sell (at least for now), the drop in supply also raises the price for oil and therefore increase the revenue earned on each barrel of oil that Iran can still sell. Which factor wins out? To answer this question, I did a very simple analysis. Let’s say that Iran exports 2.2million barrels of crude oil every day (mb/d), out of global consumption of say 87mb/d. Suppose the international community manages to embargo 100kb/d of exports, so that Iran now can only sell 2.1mb/d of oil. What would that do to Iran’s total oil revenue? Well, the amount of oil that Iran can sell goes down from 2.2mb/d to 2.1mb/d but on the other hand, the price of oil goes up. How much? This depends on the short-term price elasticity of global oil demand. This elasticity determines the relationship, in particular the ratio, of changes in oil prices to oil demand quantities in equilibrium. Good estimates of the price elasticity of global oil demand are hard to get because of data and other statistical issues. But my own estimates put it at 0.02 within one year. Folks at the IMF put it at 0.01 for the non-OECD and 0.04 for the OECD. Assuming that oil prices would be at $100/bbl if there were no embargo, I calculated what would happen to Iran’s total oil revenue in the short-term over different embargo levels and different elasticities. This chart shows my results. It turns out that for low enough elasticities and low enough embargo levels, an embargo can actually raise Iran’s total oil revenue! The price effect overpowers the lower quantity effect. Now a rough guess as to the total amount of oil feasibly embargoed by the United States, European Union, and allies may be 500kb/d. Using my elasticity of 0.02, that puts the hypothetical oil revenue at $80bn annually, a hair lower than the $80.3 it would have been without embargo. So the embargo may be hurting but so little as to be almost useless. Obviously in the real world, there are a lot of other factors that this simple analysis fails to capture. One, there may be more production from elsewhere to offset lost Iranian exports, notably from Saudi Arabia. On the other hand, this rhetoric and fear around an escalation and possible military confrontation in the world’s busiest oil chokepoint has put in more risk premia into oil markets as well. And Tehran has every reason to play up that market fear. Coincidence that the (eventually unfounded) rumor of a fire in a Saudi pipeline that spooked oil markets recently originated from an Iranian media outlet? Proponents of the embargo may have to recognize this dynamic which is undermining its effectiveness, and either increase the quantities embargoed or else try to mitigate the price channel. If not, Tehran may be justified in sending a big schadenfreude-laden Thank You card to Washington and Brussels!

The extraordinary risks posed by a nuclear-armed Iran require Washington and its partners to step up activity on economic sanctions and diplomacy, even while preparing military options, says CFR President Richard N. Haass.

Iran’s threat to close the strategic Strait of Hormuz is intended to signal its deterrent capacity to the United States and bolster leadership at home amid biting economic sanctions, says expert Michael Elleman.

Syria is faced with an increasing number of international sanctions for its bloody crackdown against protesters. CFR’s Mohamad Bazzi says the crises facing the regime are unprecedented, but the regime doesn’t appear to be giving in.