Pondering further Russian sanctions

With US lawmakers prepared to hit Russia with more sanctions*, the domestic oil and gas industry is bracing for what potential impacts may come. Karen Boman lays out concerns voiced at a July Atlantic Council Event.

[*Update] The US Senate passed its Russian sanctions bill in a vote of 98-2 on Thursday, 27 July, after being nearly-unanimously approved by the US House of Representatives, 419-3. The bill has been sent to President Donald Trump for him to sign or veto. 

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Shah Deniz. Image from BP.

For companies with interests in exploration and production projects that have ties to Russia (deepwater and Arctic), new sanctions aimed at the country could cause unintended consequences, such as forcing them to divest interest to avoid sanctions – and being replaced by other foreign investors, according to foreign policy experts at an Atlantic Council event on 19 July.

In June, the US Senate passed with a 98-2 vote on the Russian Sanctions Review Act of 2017, which would expand Directive 4 sanctions currently forbidding US individuals and companies from providing goods and services to “exotic,” or future oil projects in Russia, to include projects outside of Russia that involve Russian companies.

The expanded sanctions have raised questions among members of the oil and gas industry – who have been lobbying Congress to voice their concerns – about what could constitute a sanction violation and how that would hit US oil companies.

The sanctions go beyond whether the current US state department lawyer thinks a project meets current statute criteria, and could potentially be a deterrent to future activity, said David Mortlock, senior fellow, Global Energy Center, Atlantic Council. He is concerned that the potential consequences of Russian sanctions have not been studied at the same depth that Iran sanctions have, given that Russia’s economy is larger than Iran’s, and that US companies have invested in Russia, and not Iran.

Even the threat of sanctions could seriously undermine the project and impact its financing, said Richard Morningstar former US ambassador and founding director and chairman, Global Energy Center, Atlantic Council. The odds of sanctions being imposed under the bill are less than people may anticipate, but that’s not good enough, Morningstar said, adding that, “uncertainty is the worst thing for people in business.”

Energy projects as a category should not be immune to sanctions, Morningstar added. But, he is concerned that broad sanctions will impact every project involving a Russian company. Instead, he said, appropriate targeting to avoid counterproductive results, rather than unilateral sanctioning, is needed.

The Shah Deniz project in the Caspian Sea is a perfect example of a project that could be impacted in unforeseen ways. Bringing Caspian gas to Europe and oil to the rest of world through the Southern Corridor has had US bipartisan support for years, Morningstar said, as Caspian gas will help diversify European gas supply away from one source in part of Europe. Lukoil, a private Russian company, holds 10% interest in the project, and has two American directors and one British director; these factors could bring the project under sanctions and negatively impact project financing. For these reasons, a carve out similar to that provided under Iranian sanctions for a subsidiary of the National Iranian Oil Co. that holds a 10% interest in Shah Deniz is needed.

“What a gift,” Morningstar said. “Can you imagine a better gift to give to the Russians than to eliminate a source of competitive gas?”

The success of Iranian sanctions is due to the US and Europe sticking together. The US learned the difficulty of enforcing unilateral sanctions, Morningstar said. Unilateral sanctions such as those on Libya and Helms-Burton, generally don’t work, and could create problems for US companies. To avoid major fights with European allies over Iranian sanctions, the US had to make deals with Europeans and European companies.

Putin. Image from Kremlin.

But former US Ambassador Daniel Fried, distinguished fellow, Future Europe Initiative and Dinu Patriciu Eurasia Center, Atlantic Council, argued that the real source of uncertainty for business is not sanctions, but the lack of rule of law in Russia and uncertainty over Russian President Vladimir Putin’s intentions. Fried believes that Putin is betting he can lean on Ukraine longer than the US can resist; he will hold out if he thinks [the ties between] Ukraine and US will collapse.

“We got into this because he made war on his neighbors,” said Fried. “I think the authors of this bill are doing the right thing.”

Still, Fried sees room for improvement in the bill’s energy provisions. He believes US Congress should amend Section 223 of Directive 4 to deny Russia the ability to inject poison pills [in which Russian companies increase interest in projects so US companies might be forced to withdraw] into legitimate energy exploration projects. Limiting the poison pill to companies with 50% interest or greater means that US investment in projects with smaller Russian interests wouldn’t be impacted. He also thinks Section 225 – which addresses situations when US companies must back out of projects due to sanctions, allowing companies from other countries to come in – also might be too harsh and should be revisited.

Fried also thinks that the limit placed on the US Office of Foreign Assets Control’s (OFAC) authority to grant licenses without permission from Congress should be removed. Fried believes the bill authors thought a limit would prevent Trump from creating loopholes. But Fried believes keeping OFAC’s regulatory licensing authority intact is critical for fixing unintended consequences.

“It’s a system that has worked for decades,” Mortlock said. The one time that OFAC’s authority has been limited – in the mid-1990s for Cuba – has hindered US ability to supply humanitarian aid and pro-democracy programs.

In February, OFAC issued a limited, sensible license that allowed US companies to pay for licensing fees to Russia’s Federal Security Board for the import of technology. December cyber sanctions on Russia had prevented US companies from paying those fees; OFAC addressed the outcry with the license.

When drafting the sanctions, Congress agreed to go after oil from future “exotic” projects like deepwater, not conventional oil production. Natural gas projects also were taken off the table for sanctioning, Fried said. He attributed these decisions to not “wanting Putin to get a windfall from a spike in oil prices.”

“The US wanted to send a message to Russia that, if it goes down an aggressive path, it faces a dark future in keeping its production levels high in years out,” Fried said.

The Trump administration has continued the Obama administration’s sanctions, which were negotiated with the EU. The EU, for its part, has extended another six months on existing sectoral sanctions until January 2018.

The draft of new Russian sanctions was motivated by concerns that Trump would immediately, or as soon as possible, unilaterally lift sanctions and break solidarity with the EU, and that the Obama administration didn’t adequately respond to Russia’s cyber hack of the presidential election.

Jeffrey Turner, managing partner, Public Policy Practice with law firm Squire Patton Boggs LLP, said some amendments to the bill may be possible due to a drafting error the Senate made before completing action on the bill. The US House of Representatives has the prerogative to ensure it is the entity responsible for drafting revenue bills.

In the end, the panel members agreed that sanctions were justified, but the question remains: what should those sanctions look like?