The news immediately following the removal of some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network has been a moment of victory for the international community in condemning Russia’s invasion of Ukraine. Soon after the sanctions took effect, the ruble sunk 21 percent compared to the U.S. Dollar (USD). Russia’s central bank is in damage control mode, raising interest rates to 20 percent. At a glance it might seem like these punishing sanctions could force Russia to change course, but any optimistic takes should be tempered by a review of the effect of sanctions after Russia’s annexation of Crimea in 2014.

The exchange rate of the ruble at time of writing is $0.01—one ruble equaling 1.1 cents. Before the sanctions, the exchange rate was about $0.014. But when sanctions were imposed after the annexation of Crimea, the ruble went from about $0.029 to $0.016. It is still early in the sanctions response to know just how badly the Russian economy will suffer under sanctions, but it is important to understand that so far, the declines are roughly consistent with the effect in 2014, and those sanctions clearly did not induce any relinquishment of Ukrainian territory, nor did they deter the Russian aggression on display today.

The reason Russia has been able to weather the previous round of sanctions, and likely will weather this storm as well, is due to the interactive effect between economic sanctions and the value of Russian exports. Russia is the world’s third largest producer of oil and liquid fuels at 10.5 million barrels per day (roughly 11 percent of global supply), and is also the world’s second largest natural gas producer, at 25 quadrillion British thermal units. Oil is a global commodity traded in USD, and natural gas contracts often have prices indexed to oil prices. What this means is that as the value of the ruble relative to the USD falls, the price that Russia’s major exports command increases in the local currency.

Unlike the United States and other western nations where oil and gas production are controlled by private companies, Russia’s oil and gas production is managed by state-owned enterprises. Oil and gas production in Russia directly finances Russia’s budget, including its military budget, and in 2019 oil and gas exports accounted for 39 percent of Russia’s federal budget revenue. Part of the reason oil and gas is such a lifeline to the Russian budget can be attributed to the effect of the sanctions. In January of 2014, the ruble was $0.03 USD, and by December 2014 it fell to $0.019 USD. In that same year, Russia was the largest producer of crude oil and exported 4.7 million barrels per day. The price of oil in January 2014 was $108/barrel, and by December had fallen to $62/barrel—thanks to high U.S. production. The value of Russian oil exports went from 16.9 billion rubles per day in January to 15.4 billion rubles per day in December, as the sharp decline of oil prices was counteracted by the rising ruble value of oil from the sanctions. If oil prices had remained constant, then the effect of the sanctions would have been to increase Russian export value in the local currency to 26.7 billion rubles per day. In plain English, the harder the sanctions hit, the more valuable Russian energy exports become and the better they are able to sustain the Russian budget.

In 2022, oil and gas prices are rising instead of falling like they were in 2014. In late 2021, spiking energy prices—especially in Europe—were called an “energy crisis.” Concerns about energy constraints in response to the Russia-Ukraine war are further causing energy prices to jump. Not surprisingly, fear of even higher energy prices—which put pressure on the economy as well as inflation—have caused energy to be exempt from sanctions on Russia. All this is to say that unlike in 2014, when USD flows to Russia were falling, now they will be rising.

Europe is a major consumer of Russian energy, getting 41 percent of its natural gas and 27 percent of its oil from Russia. In 2019, the European Union imported 88 billion euros worth of energy from Russia, and it is set to exceed that amount for 2021. For reference, the Russian annual military budget is approximately $60 billion USD. It is not a stretch to say that the European Union’s imports of Russian energy are sustaining Russia’s war effort against Ukraine.

It is also important for policymakers to understand more fundamentally what causes exchange rates to fluctuate. Just like a commodity, a currency value is a product of supply and demand. Sanctions on Russia reduce their supply of foreign currency, as well as the demand for rubles, which causes the exchange rate to swing in favor of the foreign currency. For energy commodities that will be traded in foreign currencies, this also creates a steady supply of foreign currency to Russia that dampens the effect of the sanctions.

The upshot of all this is that without sanctions on energy, Russia’s economy retains an incredibly strong lifeline, and in particular the Russian government will retain the ability to cover key expenditures—like war expenses. Sanctions on Russian energy are unlikely because they would be economically crippling to Europe, which is already suffering economically due to high energy prices. Western nations are re-learning a key lesson from the energy crises of the 1970s, which is that it is a strategic mistake to rely on adversarial regimes for energy.

After Russia’s 2014 invasion of Ukraine, the European Union should have started transitioning away from Russian energy, but instead it increased its Russian energy imports. Germany, a key EU and North Atlantic Treaty Organization member, gets 66 percent of its natural gas from Russia. To truly contain Russia’s expansionist ambitions, the European Union needs to rely on alternative energy suppliers—such as the United States. Until that happens, the West’s sanction response to Russia will always have only a fraction of the impact it should.

Image credit: Andrii Yalanskyi