Crack in Western shield: How Russia circumvents sanctions and what could stop it

Contents

• Oil under ban: Secret fleet of Russia
• Swaying rails of Russia's military-industrial complex
• Military economy collapse

Russia has been living under unprecedented restrictions imposed by the West for over two years. When Russian troops invaded Ukrainian territory, sanctions from Kyiv's allies were anticipated as a "devastating blow" that would irreparably damage Russia's military-industrial complex and force Moscow to stop.

However, this scenario did not materialize. Russia has adapted to the restrictions and consistently finds loopholes within them – smuggling necessary imported rocket components, utilizing an entire fleet of tankers to sell oil, and finding allies willing to help Moscow circumvent the Western shield.

After two years of war, foreign components are still found in Russian rockets, and proceeds from oil sales continue to fill the Kremlin's coffers while Russia's military-industrial complex remains productive. Skeptics, citing these examples, argue that sanctions meant to "crush" the Russian economy within months have not worked. However, the situation is not as stagnant as it may seem at first glance, and Moscow's desperate attempts to bypass international bans are clear evidence of this.

Oil under ban: Secret fleet of Russia

When Ukrainian military attacks on Russian refineries intensified, the effects were not far behind. To date, Russian diesel fuel exports have dropped by 25%. Russians themselves need petroleum products primarily to meet front-line needs. But exports mean money, and Moscow is losing it.

As attacks on Russian refineries became more widespread, the US declared that it did not support this practice. Initially, the Financial Times reported this. Later, US State Department spokesperson Matthew Miller confirmed it. Americans' primary concern is the potential rise in oil prices on the world market.

Many have questioned how, if the West has been battling Russia for two years, imposing sanctions on oil and petroleum products, the world market can still be critically dependent on Russian products. This is especially true given that the share of Russian oil products on the world market is far from the largest, says Vladyslav Vlasiuk, Advisor to the Head of the Office of the President of Ukraine and Secretary of the Yermak-McFaul International Working Group on Sanctions against Russia.

"I don't understand some of our partners' statements because the share of Russian oil products on the global market is somewhere around a few percent statistical error. These are their diesel, gasoline, etc. They have not been exporting much lately because they have an army and need it themselves," Vlasiuk told RBC-Ukraine.

Sanctions that somehow restrict Russia in its oil and petroleum operations were implemented almost immediately after Russia invaded Ukraine and have since been supplemented. For example, in the eighth round of sanctions that took place just over a year ago, price restrictions related to maritime transportation of oil and petroleum products to third countries were established, followed by further restrictions on naval transportation. As a result, the ceiling price was set at $60 per barrel.

A tanker carrying Russian oil in China (photo: Getty Images)

To circumvent sanctions, Russia has established an entire shadow tanker fleet. This involves Russians purchasing many tankers from carriers, often old, and using them to transport oil and petroleum products. Crucially for the Kremlin, these shadow tankers are not subject to the same obligations regarding price limits as tankers from companies registered in coalition countries imposing price restrictions. Moreover, Olena Bilousova, Senior Research Lead, Military and Dual-Use Goods at KSE Institute, noted that these tankers are uninsured.

"The aggressor uses a shadow fleet, transporting oil under the flags of other countries, primarily Panama, Gabon, Liberia, and Vietnam. These are old tankers, most of which are over 15 years old, and they lack proper insurance in case of accidents. This poses a significant environmental threat; if oil spills into the sea, Russia will not be held accountable, and without insurance, no one will compensate for damages," explained Bilousova to RBC-Ukraine.

Thanks to the shadow fleet, Russia "patches" the price difference – instead of receiving $60, they get $70. The price difference is justified by services they allegedly provide, such as ship insurance or broker rentals. However, it is clear that if these services are provided to the tanker, they are nominal. As a result of these maneuvers, by the end of 2023, the shadow fleet accounted for 50 to 60% of the volume of oil exported by Russia. Notably, the shadow tanker does not take shadow routes in this story.

"A tanker fleet, whose documents indicate that it violates rules or lacks insurance, sails through the same Danish Strait, or from Novorossiysk, or the Pacific coast. And they sail; for them, the main thing is for the recipient country to accept them," Vlasiuk noted.

It turns out that the country whose territorial waters a tanker carrying Russian oil passes through ostensibly cannot stop the vessel due to the principle of freedom of navigation. In this case, the tanker may have a conditional document stating that it is prepared to be accepted in the port of the recipient country. However, in the case of sanctions, the principle of freedom of navigation can be violated, but the hitch is that not every country will agree to this.

"We have been discussing what to do with some countries for several months. Some countries will not refuse (to accept tankers), while others might refuse. Here, we use the argument of environmental risks because the ship is old and often uninsured. And if the tanker comes from the Pacific coast, it will head directly to China, Burma, Sri Lanka, and India," added Vlasiuk.

Tanker Maximus (Photo: Getty Images)

When Ukrainian analysts and participants in the Yermak-McFaul group observe an increase in oil exports, they draw the attention of Western partners to this. The first signs of this trend were noticed in mid-summer 2023, and by September, it became clear that the Kremlin had its shadow fleet. In response, Western countries began applying secondary sanctions to carriers, and by February, this had already "knocked out" companies and individual vessels from the sea.

This move did not stop the shadow fleet but significantly restricted its capabilities. Now, a sanctioned vessel cannot receive services in most ports. Services such as servicing, repairs, chartering, insurance, banking operations, and fuel procurement are limited for shadow tankers. Thus, vessels of the Russian shadow fleet are being driven not just into the gray but into the black zone, where a tanker becomes a "boat" shuttling between Russia and its few partners.

According to the KSE Institute, completely stopping Russian oil exports is likely impossible, but reducing them to a minimum is entirely feasible. For example, EU coastal countries through which tankers pass can use geographically "narrow places," restricting their maneuverability and imposing stricter insurance requirements when passing through their waters.

"In this way, Russia will be forced to rely on Western insurance services, improving the enforcement of sanctions. Punishments for violations should also be strengthened, including significant fines and expanded sanctions, especially regarding entities outside the G7/EU that assist Russia," Bilousova adds.

The scheme of restrictions and sanctions on carriers is working slower than desired. Russia can earn around $300 million from crude oil exports in a typical week, equivalent to what Ukraine expects from the Netherlands as assistance. While Russia's position in the petroleum product sphere is not critically important, the share of Russian crude oil in the global market is approximately 30%, meaning its departure from the market would significantly disrupt it.

Swaying rails of Russia's military-industrial complex

Numerous materials have recently been in the public domain suggesting that Western sanctions have not had a significant impact on the Russian military-industrial complex. These claims seem particularly convincing against the backdrop of news that components of American origin from 2023 were found in the 3M22 Zircon missile that the Russians launched toward Kyiv at the end of March.

Such stories abound. Foreign components appear in Russian munitions. Particularly prevalent are components of American origin in Russian army missiles. The National Anti-Corruption Bureau of Ukraine has documented nearly 2,800 foreign components in Russian military equipment.

Research conducted by the Kyiv Institute of Economics and the Yermak-McFaul group arrived at a disheartening conclusion – practically 95% of components are produced by companies headquartered in countries of the sanctions coalition. Moreover, 70% of components come from the USA.

Nizhny Novgorod Machine-building Plant (photo: Getty Images)

Undoubtedly, America wouldn't directly sell its technologies to Russia, and the US government isn't interested in shadow paths either. However, within the same sanctions imposed on Russia's military-industrial complex, as with oil, there are numerous loopholes. Two of them are re-export and smuggling.

Analysts from the Yermak-McFaul group highlight re-export as the primary method of obtaining Western microelectronics. It is crucial in this scheme to legally purchase a particular part from the manufacturer. Then, it "drifts" through other countries and eventually ends up in a Russian "Zircon" missile.

"It could be a Brazilian company or Dubai. Then, the component travels, for example, closer to Russia and Kazakhstan. There's another chain, a third chain, and from Kazakhstan, it goes either legally as a re-export or as contraband across the border closer to Russian plants," says Vlasiuk.

The volume of re-exports undoubtedly does not compare to what Russia received before the full-scale invasion, but they exist. Similarly, smuggling exists. If you imagine that there are approximately 100 foreign components in a cruise missile, smuggling 10,000 such parts into Russia is not a problem. And 10,000 parts mean 100 missiles.

Ukraine's allies, upon learning that their components are found in Russian missiles striking cities, are dismayed. Some countries engage in dialogues with their manufacturers, urging them to strengthen control over sales, conduct firm inspections, etc. Others are taking more decisive actions. For example, the Netherlands banned the sale of its machines for chip production to China last year because Russia purchased them from China. This concerns microelectronics from the renowned company NXP. According to Vlasiuk, China is the leader in the "re-export" chain to Russia.

In the analysts' opinion, Russia's ability to procure components depends on the country's ability to control its manufacturing. If Moscow loses the ability to obtain certain Western technologies, then, according to Vlasiuk, it won't be able to produce weapons within a week. But this isn't happening.

Military economy collapse

It would be a mistake to think that sanctions have no impact. Economists believe it's essential to consider the overall situation rather than each aspect. For example, in 2023, due to restrictions on energy resources in Russia, exports fell by 28%, the trade balance decreased by 62%, and the current account surplus by 79%. As a result, the ruble sharply collapsed, and efforts to combat inflation intensified.

This story has led to another consequence—Russia depleted its reserves and constrained its maneuverability to finance the budget in 2022-23. By February 2022, Russia had used up half of the liquid assets of the National Welfare Fund, including hard currency. The Central Bank of Russia was deprived of access to reserves worth $300 billion.

The Kremlin proudly claims that GDP grew by 3.6% in 2023, which is true. However, this growth was achieved because Russia shifted to a wartime economy, resulting in increased production of weapons and related industries. If this artificial stimulation of the economy ends, it will likely stagnate, and even the efforts of Central Bank Chair Elvira Nabiullina may not be able to help.

Sanctions have a cumulative effect, and Russia is far from a poor country. Time is needed to slow down these processes. However, sanctions alone cannot win the war, and time is running short for Ukraine.