This paper analyses the status of the Russian economy after two years of war in Ukraine, focusing on the critical role of oil. It delves into new developments in the Russian oil sector, and proposes approaches to cut the flow of Russia’s oil revenue, which accounted for 24% of the Russian federal budget revenue in 2023. 

Executive Summary: 

As part of the first phase of Western sanctions against Russian oil, the countries of the Price Cap Coalition (including the EU, G7 and Australia) refused to import seaborne crude oil and oil products from Russia and introduced a price cap policy on Russian oil and petroleum products. Initially, in early 2023, the Russian oil sector faced significant problems, but over time companies learned a number of ways to circumvent Western sanctions. In response, in October 2023, the coalition began the second phase of the price cap, which focuses on improving the enforcement of sanctions and imposing secondary sanctions. 

The short-term outlook for the Russian economy is surprisingly positive (in 2023, the nominal GDP grew by 3.6% and the growth is expected to continue in the coming few years) but, in the longer term, uncertainty remains high: labour productivity is declining in tandem with rising wages, there are labour shortages, military spending is skyrocketing (in 2024, an increase of 62% is planned, compared to 2023) and high dependence on the oil sector continues (oil accounted for 24% of the federal budget revenue in 2023). If there are no unexpected shocks, the economy may remain stable, however, when the new basis for the economic development of Russia is war – a long-term economic destroyer –short-lived economic bubbles are to be expected. 

In the longer term, Russia’s war economy will consume more than it generates in terms of new added value. Based on these economic assumptions, Western countries may not plan further significant sanctions against Russia. After all, their strategy is to keep Russian fossil fuels flowing to global markets while reducing the Kremlin’s earnings that can be spent on warfare in Ukraine. However, Russia continues to sell its oil at prices several times higher than average production costs, allowing the country to increase its military spending. Moreover, if the war drags on for several more years, Ukraine will face severe economic and military pressure, and hostilities could spread to other regions. 

Therefore, it is critical to tighten oil sanctions by: 

  1. Closing the loopholes within sanctions that have already been adopted. Not all violations can be punished, but a number of high-profile examples will discourage others from breaching sanctions.   
  1. Ratcheting down the crude oil price ceiling. There are proposals to lower crude oil prices to $30 per barrel, however, this price would allow Russia to continue making a profit because average oil production costs remain below this level. If a radical reduction of the cap is considered too risky for the stability of the global oil market, the Price Cap Coalition can resort to a gradual decrease through several, smaller cuts. The same policies should be applied to Russian oil products. 
  1. Squeezing Russian oil into peripheral countries, such as those in Africa, Latin America, and Asia, to cut profits of the Russian oil business. These countries are geographically distant and are not ready to pay high prices for fossil fuels. Forcing Russia to shift its oil sales to these geographies will keep some volumes of Russian oil in the global market while at the same time decreasing the Kremlin’s income. 

Photo by zhao chen on Unsplash