Parallel markets: LNG sanctions evasion ecosystem yet to fully develop

This is the third of a three-part series on LNG sanctions evasion and the shadow fleet, focusing on the ecosystem of services needed and the emergence of global hubs that form parallel marketplaces.

The full ecosystem needed to circumvent sanctions on Russian LNG has yet to fully develop beyond the shadow fleet and will need commercial services hubs, trading and brokerage of discounted cargoes, non-dollar payment mechanisms, and end-users insulated from sanctions violations, mirroring a market like oil.

Until these get developed, it could still remain difficult for Russian LNG volumes to find a market, according to executives at the recent Asia Gas Markets Conference held by S&P Global Commodity Insights in Singapore.

Commercial channels to move Russian, Iranian and Venezuelan crude to India and China have included blending petroleum products in anchorages at offshore ports in Iran, Indonesia and Malaysia, along with the emergence of Mumbai, Dubai and Hong Kong as hubs for shell companies and to facilitate transactions.

During the recent APPEC 2024 oil conference in September, Dubai-based executives said Western countries lacked jurisdiction over companies in the UAE, despite recent attempts by the US, UK and the EU to pressure the country from becoming a hub for sanctions evasion.

Small commodities trading hubs like Yiwu in eastern China's Zhejiang Province are also used by Iranian or Russian companies to open escrow accounts and receive payments for petroleum products delivered to independent refineries. These funds are used to order manufactured goods as a barter trade.

“In essence, sanctions avoidance is the latest offshoot of the much broader and older practice of smuggling. Which, in turn, is impossible to fully eradicate, but also one with clear limitations on its scope -- it simply cannot grow beyond a certain level, unless a particular jurisdiction deliberately enables it,” said Alexey Eremenko, associate director, Global Risk Analysis, Control Risks.

“The focus of the Western sanctions effort has in fact been, over the past year at least, on enforcement, or preventing the “parallel economy” from growing too much. This is likely to continue,” he said, but added that capacity remains a limitation as organizations like the US Office of Foreign Assets Control only have about 200 employees, and there is only so much they can enforce, even with help from other agencies like the US Department of Justice.

“On the other hand, the December sanctions -- which shifted much of the burden of enforcement on banks servicing transactions possibly involving sanctioned goods -- were an ingenious solution that has significantly increased efficiency of enforcement.”

Parallel market

Government controls on commodity markets have historically resulted in price distortions and exacerbated supply issues. Price caps create black markets, enrich speculators and opportunistic businesses, and amplify market imbalances, such as the US oil market controls in the 1970s in response to Middle East oil embargoes.

Traders already see US sanctions creating a parallel market for discounted petroleum products. Sanctions evasion is no longer the remit of only Russia or Iran-backed entities and now involves normal businesses from Dubai to Delhi to Dalian looking to profit from the parallel market.

These hubs are becoming harder to regulate as sanctioning an entire country is politically sensitive.

Eremenko said the US approach has been balanced and avoids overt pressure on the smaller countries because of the risk of pushing such countries away and closer to geopolitical opponents like China, Russia and BRICS+ more broadly.

“Therefore, we believe the US is likely to contain its pressure over sanctions avoidance below the threshold of a serious diplomatic or economic escalation. This would make US sectoral sanctions against, e.g., Malaysia or the UAE unlikely,” he said.

But measures one level below, such as sanctions against particular companies in such jurisdictions are fair game and the US has already designated hundreds of entities and individuals for circumvention of Russia sanctions, including in Switzerland, Germany, India and dozens of other counties, Eremenko added.

“Actual companies significant for local economies have so far been spared -- but this may change. Broader sanctions against entire smaller jurisdictions also remain possible, but less likely as the next step, since this would still constitute a stronger escalation,” he said.

Eremenko said more clarity on US sanctions policy can only be expected after the Nov. 5 elections and implementing a major upgrade, such as a full ban on Russian oil and gas, would require either considerable political will or an external shock.

“Realistically, we expect a next step on the US sanctions escalation ladder to likely be sanctions against some significant bank, possibly in China.”

Money train

In September 2023, the European Bank for Reconstruction and Development published a paper documenting an increase in the use of local currencies like the yuan due to trade sanctions on Russia, illustrating the growth in parallel markets.

Between Russian, Iranian and Venezuelan crude oil exports, the three countries account for around 14% of global physically-traded crude oil that is no longer paid for in dollars. Russia is the world's fourth-biggest LNG producer and accounts for roughly 8%-9% of global physical LNG trade of over 400 million mt/year that could follow the same route.

An S&P Global Ratings’ report in August noted that Beijing’s efforts to boost yuan-denominated commodity transactions face hurdles, but could instead rely on non-economic factors or strategic considerations, including escalating geopolitical events and shifting national interests.