Markets ‘Unshaken’ By Russian Output Threat

As Russia’s March 500,000 bpd output cut nears, data from Bloomberg shows that Russia seaborne crude exports have already fallen to a six-week low, but the markets remain relatively unperturbed.

While suffering a 2% drop early on Monday, oil prices have since moderated, with the UAE saying the markets are “unshaken”.

Brent crude was still trading down a slight 0.38% on Monday afternoon EST, at over $86 per barrel, with WTI just under $80. 

If anything, markets responded on Monday more to pending U.S. inflation data than to Russia’s March output cut as a response to Western sanctions. 

Beyond the output cut, Western sanctions are forcing Moscow to perform various oil market acrobatics, from output cuts and the creation of new pricing mechanisms for its flagship Urals crude to selling its crude to China and India at massive discounts. 

On Saturday, Russia’s State Duma introduced a bill that will see the country regulate discounts on its oil exports, Reuters reported. Under the draft proposal, Russia will offer a discount on dated Brent of $34 per barrel in April, which will then decline to $31 in May, $28 in June and $25 in July.

This price cap on the price cap is meant to determine Russia’s industry taxes, from extraction, oil export duties, excise and income. Since the EU implemented its ban on Russian seaborne crude in early December, Moscow has been left without a reliable price-setting mechanism for Urals.  

For now, Russia is using Rotterdam and Augusta ports prices for its flagship Urals. And as of last week, the price of Urals was set to be fixed at $20 below Brent for tax purposes.

So, Is the G7 Oil Price Cap Working?

On Friday, when Russian Deputy Prime Minister Alexander Novak announced the 500,000 bpd output cut starting in March, he noted that this would “contribute to the restoration of market relations”. 

Some interpret this as Russia’s admission that oil demand is not strong enough to support current Russian output, and that the $60 per barrel price cap introduced by G7 could end up working by cutting Russia’s oil revenue and its ability to fund its war on Ukraine.

Related: Saudi Arabia And Russia Face Off Over Chinese Oil Market Share

Last year, against all odds, Russia managed to grow its oil output despite being hit with tough sanctions, a plethora of oilfield service companies exiting the country as well as the refusal by western countries to buy its crude for the most part. Indeed, Energy Intelligence reported that in 2022, Russia’s crude and condensate production increased 2%, with oil production clocking in at 10.73 million b/d, above Russia’s ministry for economic development forecast of 10.33 million b/d. Russia managed to pull off this feat mainly by offering huge discounts on its crude.

But Moscow cannot continue defying the odds indefinitely. BP Plc (NYSE: BP) has predicted that the country’s output is likely to take a big hit over the long-term, with production declining 25%-42% by 2035. BP says that Russia’s oil output could decrease from 12 million barrels per day in 2019 to 7-9 million bpd in 2035 thanks to the curtailment of new promising projects, limited access to foreign technologies as well as a high rate of reduction in existing operating assets. 

In contrast, BP says that OPEC will become even more dominant as the years roll on, with the cartel’s share in global production increasing to 45%-65% by 2050 from just over 30% currently. Bad news for the bulls: BP remains bearish about the long-term prospects for oil, saying demand for oil is likely to plateau over the next 10 years and then decline to 70-80 million bpd by 2050.

The $60 per barrel price cap introduced by the European Union, G7 nations and Australia allows non-EU countries to import seaborne Russian crude oil, but prohibits shipping, insurance and reinsurance companies from handling cargoes of Russian crude unless it is sold for under $60. 

Traders have reported to Reuters that Russia is struggling to fully redirect Urals exports from Europe to other markets such as China and India. India is also having a hard time finding enough suitable vessels. 

Russia’s problems have been compounded by a shortage of non-western tonnage, moderate demand for the grade in Asia, especially in China and a weak export economy. Indeed, Reuters has reported that Russia’s pipeline monopoly Transneft has been unable to fill some of the available loading slots due to a lack of bids from producers while other slots were postponed or canceled. Only China, India, Bulgaria and Turkey are currently willing to buy Urals with the blend now being sold to export markets at below overall production cost including local levies.

Russia might, however, be able to forestall a sharp decline in production for a few years because many of the assets of oil companies that exited the country were abandoned or sold to local management teams who retained critical expertise.

Widening Budget Deficit

Back in December, Russia’s Finance Minister Anton Siluanov said that the country’s budget deficit in 2023 might exceed the expected 2% of GDP as the oil price cap takes a hit on export income. That marked the first time a Russian official has acknowledged that the $60 per barrel price cap imposed on Russia by Europe and G7 nations will negatively impact its economy. Siluanov said that the country will be forced to tap debt markets to bridge the deficit. Russia is projected to have used over 2 trillion roubles ($29 billion) from the National Wealth Fund (NWF) in 2022 as total spending exceeded 30 trillion roubles above the initial budget.

Russia’s economy is expected to contract in the current year, with Central Bank governor Elvira Nabiullina citing “worsening trade conditions” as a key reason. Russia’s cash flows are expected to weaken considerably in 2023 as oil and gas sales to Europe plunge. Ukraine’s Ministry of Economy says it expects that the EU embargo on Russian oil and petroleum products should cut Russia’s profits by at least 50%.

We expect the collapse of profits from oil and gas exports to be at more than 50%, precisely because of the introduction of the EU embargo on oil and petroleum products and the introduction of price restrictions. Oil and gas account for 60% and 40% of federal budget revenues. We expect that Russia’s revenues will fall below the critical level of $40 billion per quarter,” Yuliya Svyrydenko, First Deputy Prime Minister and Minister of Economy of Ukraine has said. 

She has expressed hope that plunging profits will make it more difficult for Russia to continue waging an expansive war.

Meanwhile, the Russian rouble has finally caved in, slumping past 70 per U.S. dollar to a more than seven-month low courtesy of plunging crude prices as well as fears that sanctions on Russian oil could hit the country’s export revenue, Reuters reports. Russian equities have also taken a hit, with the dollar-denominated RTS index finishing in the red last year.