Russian oil revenues may weather EU ban, G7 price cap

Two sources close to major Russian producers claim that Russian oil production could drop by between 500,000 and 1 million barrels per day (bpd), as the European Union bans seaborne imports starting Monday.

This estimate falls within the range of market analysts’ projections of the combined effect of the ban on Russian oil and the proposed price cap, but sources indicated that the true level would depend upon several factors still to be determined.

To discuss sensitive market dynamics related to the conflict in Ukraine, Russia called it a “special military operation”, they requested anonymity.

Alexei Kokin, Otkritie brokerage, broadly agreed with their assessment about the likely impact of Western actions on Russian output.

He said that it was roughly equal to the volume of seaborne supply to the EU over the past weeks. “I don’t believe they (Russian producers), will be able to divert it elsewhere.”

To reduce Russia’s ability to finance the conflict, the West is trying to squeeze Russia’s financial resources.

Russia’s largest exports are crude, natural gas, and oil products. They account for the bulk of its revenues. However, high prices on the international market have made it difficult to sell these products and disrupted sales and production.

Russia’s oil and gas revenues grew by more than a third during the first ten months of this year.

Russia exported approximately 8 million barrels per day of oil and products before the conflict in Ukraine began on February 24, 2014.

In response to the conflict, the EU was its largest buyer and cut its purchases. However, Moscow successfully diverted supply towards Asia, so exports fell to 7.6 million bpd.

One of the key variables for 2023 will be the agreement between the EU and G7 countries on a ceiling import limit for Russian oil.

They seek to find a balance between limiting Moscow’s oil income and avoiding shocks to oil prices on international markets, which surged at the time of Russia’s invasion but have since cooled.

The initiative does not include some of the largest importers of Russian oil, such as China and India. Moscow stated that it would not supply oil to those who participated.

It is not clear if shipping companies and insurance companies will have the ability to transport Russian oil around the globe that has been purchased for more than the agreed limit.

Some analysts suggested that navigating this obstacle could be time-consuming and disruptive. However, U.S. bank JPMorgan views the impact of the cap as muted, with Russia able to use its own ships and marshal China or India.

Others perceive a greater impact.

Analyst at the Centre for Energy Development Kirill Melnikov forecasted a decline in Russian production by 1.0-1.5 million bpd in January, compared to November levels.

According to the International Energy Agency, Russian crude oil output will fall by 2,000,000 bpd in the first quarter. However, this assumes that the EU ban on Russian oil products will be in effect from February 5.

CAP AT $60

Prices will likely suffer from the loss of Russian oil to the world markets. This could be a win-win situation for Moscow and other major exporters, as well as a penalty for West consumers who are already facing the highest inflation in decades due to energy costs.

Igor Galaktionov, BCS Mir Investitsiy brokerage, stated that even though the export drop is more than anticipated, the impact on budget revenues is offset by the increase in prices. So budget revenues are unlikely not to suffer greatly.”

On Thursday, the EU governments agreed to a $60 per barrel price cap for Russian crude oil. An adjustment mechanism was also included to maintain the ceiling at 5% below market prices.

The G7 countries had previously proposed a limit of $65-$70 for a barrel, which was based on the current price of Russia’s main export mix Urals. Poland, however, wanted it lower at $30.

Urals, which was mainly sold to European buyers, now has a discount of about $23.50 per barrel versus Brent (the benchmark on the over-the-counter market), which dropped from a $2-3 per barrel discount at beginning of the year.

Brent Brent Dated is priced at $87. This is close to international Brent futures.

Alexei Gromov, of the Moscow-based Institute for Energy and Finance Foundation, stated that he believes the EU’s cap will be similar to the current price at which Russia sells oil.

Russia will continue to export oil at a comfortable rate if the price cap is set at $60/barrel.

Russia will not be affected by international price rises if buyers don’t pay more than the price limit.

Already, Russia’s and other oil producers’ revenues have dropped since June when the United States and other G7 nations proposed a price cap. This has added selling pressure to international oil markets that are already weakening due to the global economic outlook.

Yevgeny Suprov, an economist at Centrocredit Bank, stated that if the price of Russian oil falls to $45-$50/barrel in 2023, Russia’s budget will be in deficit by around 2 trillion rubles ($32 billion).

The central bank anticipates that total oil and gas revenues will reach 8.9 trillion rubles next year.

Revenues are not determined by the crude oil price, but also by the exchange rate at the point of sale.

The rouble can be quite strong as it is right now. This will cause budget revenues in local currency to drop and make it more difficult for the finance ministry to balance the books.

For next year’s budget, the ministry expects Russian oil to average $70.1 a barrel and an average exchange rate of 68.3 Russian roubles for every dollar. This compares to today’s levels at $65 and 61-62 rubles, respectively.

The rouble may have fallen in recent months, but it remains well above the government’s preferred range of 70-80 dollars to the dollar. Russian businesses have asked the central bank for Chinese yuan reserves and to weaken the local currency.

Russia’s oil sector could be affected beyond the European import ban and price cap. China may also be subject to COVID-19 restrictions. China is an important buyer of Russia’s crude.

China has purchased around 2 million barrels per day of Russian oil over the past months, compared to 1.6-1.8 million bpd at the start of the year.

Matt Smith, Kpler’s lead oil analyst, stated that oil markets will continue to be affected by continuing news from China. This is due to the impact that ongoing lockdowns have on oil demand in China.

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