Putin Pushes Back Against Oil Price Cap
Will It Work?
As I noted last week, the EU/G7 price cap on Russian oil is holding, and is having an impact on Russian oil revenues.
Which may serve to explain why Vladimir Putin at last pushed back against the price cap, enacting a decree that forbids Russian oil firms from selling oil to any country that insists on hewing to the price cap.
Russian President Vladimir Putin signed a decree retaliating against the West's imposition of a price ceiling on Russian oil by banning oil supplies to buyers who joined the cap in February. The document was published on Tuesday.
That it comes just days after Putin somewhat delusionally declared Russia wasn’t losing any oil money because of the cap.
This abrupt reversal only confirms that there is not only a loss of revenue, but a significant and painful loss of revenue.
Putin’s decree banning oil sales to countries that enforce the price cap does not actually come into play until February of next year, so the immediate impact of the decree is functionally nil.
"<...> The supply of Russian oil and oil products to foreign legal entities and individuals is prohibited, provided that the contracts for these supplies directly or indirectly provide for the use of a price fixing mechanism. The established ban applies at all stages of supplies to the final buyer," the decree says .
However, the decree leaves no doubt as to what will happen come next February: any country insisting on honoring the EU/G7 price cap will not be buying Russian oil—period, end of sentence, end of discussion.
In many respects, this is an expected development. As late as two days ago, Kremlin spokesperson Dmitry Peskov went on Russian TV to denounce price caps as something Russia would never tolerate.
He drew attention to the "unacceptability of any ceilings." "Although they are set quite high, but this is a matter of principle. This is interference in the processes of market pricing. And if today we agree to such a generous ceiling, then tomorrow we will have to agree to a ceiling that infringes on interests. Therefore, this can not be discussed. We will never we will agree to such a distortion and destruction of the market pricing process," the Kremlin spokesman emphasized in an interview with journalist Pavel Zarubin.
Not selling to countries that enforce the cap makes sense. If Russia is to maximize its revenue from oil it needs to push the price up, and preferably it needs to eliminate the sizeable discount for Russia’s flagship Urals blend trades against Brent crude.
With a very costly war of attrition in Ukraine, Russia needs all the oil revenue it can generate. Thus the pushback against the cap is only to be expected.
If Putin’s ministers are to be taken at face value, they either don’t believe the cap will hold or don’t understand the impacts of market prices on oil revenues. Finance Minister Anton Siluanov told Russian journalists the Finance Ministry made no alterations to the estimates in the Russian federal budget with regards to the decree banning oil sales to countries enforcing the price cap.
The Ministry of Finance of the Russian Federation did not revise estimates of the federal budget, taking into account the introduction by a number of unfriendly countries of a ceiling on prices for Russian oil. This was announced to journalists on Tuesday by the head of the ministry, Anton Siluanov.
"Honestly, we have not reviewed any estimates (of the federal budget - TASS note). Why? Because we will sell oil anyway," the minister said.
According to him, possible changes in discounts and other consequences of introducing restrictions on oil prices from the Russian Federation will not affect the budget. "In any case, how will the budget change from this? It won't change at all. Since (budgetary) obligations will be fulfilled," Siluanov said.
Such statements are simply absurd from an accounting and finance perspective. Russia’s budget gets about 34% of its revenue from the energy sector. Russia is already running a deeper deficit in 2022 than anticipated because of the war, and decreasing oil revenues are only going to add to that deficit. A drop in oil price hurts government revenues, and a drop in oil production hurts government revenues even more.
There are three ways how a slowdown in the Russian oil industry will affect Russian revenue:
1. A decline of oil prices: oil price drop of 1$ will lead to 0.125 T RUB reduction in Russian revenue.
2. A decline of oil production: Production drop of 1.0 MMBbl/d will lead to $1.36 T RUB reduction in Russian revenue.
3. The indirect impact of a slowdown in the Russian oil industry on revenue
Strangely enough, Siluanov himself acknowledged this separately, as he acknowledged that declining oil prices would result in a larger budget deficit.
"Is a bigger budget deficit possible? It is possible, if revenues are lower than planned. What are the risks next year? Price risks and restrictions," Siluanov said in the latest sign yet that the price cap could be working as intended.
While the actual impacts of the price cap on Russia’s government revenues from oil remain somewhat problematic, a lower price for Russian oil by definition means less money for Russia from oil.
Which raises a question as to whether Putin’s pushback will be effective against the price cap.
When we look at the December prices for Brent crude, West Texas Intermediate, and Urals crude—Russia’s flagship blend—there are clear signs that the price cap has had a depressive effect on the price of Russian oil.
Not only has the price of Urals crude fallen, but it has fallen with respect to global oil benchmark Brent crude. While WTI trades at a discount of ~$5 per barrel consistently, Urals crude has gone from a discount of $18.88 on December 1 to $28.14 on December 23.
To appreciate the magnitude of these price shifts, if we index all three blends to their December 1 price, we can see just how much Urals crude has declined relative to Brent and WTI.
While Brent has lost just under 2% of its December 1 price, and WTI just over 2%, Urals crude has lost over 16%.
If Incorrys' projections are accurate, the drop in Urals’ price of $10.76 per barrel since December 1 would amount to a 1.345 Trillion Ruble decrease in government revenues on an annual basis.
The revenue drop is likely to be even greater, as Russia’s seaborne oil shipments are reported to have collapsed by more than 50% in the first week after the cap was imposed.
But in the first full week after the EU ban on seaborne Russian crude imports came into effect, total volumes shipped from the nation dropped by 1.86 million barrels a day, or 54%, to 1.6 million. A less volatile four-week average also plunged, setting a new low for the year. Baltic Sea volumes should recover with work now ended, but the issues in the East may take longer to solve.
While a drop in shipments is not the same as a drop in production, the reality for the world oil markets is that there was, in the week following the price cap’s introduction, 1.86 million barrels a day less oil than there would have been otherwise, and the price of either Brent or WTI did not move up as a result—quite the contrary, during that same week the price of both Brent and WTI declined.
The upshot of these price dynamics is that Putin does not appear to be dealing from a position of strength regarding the price cap. In the current depressed state of the global economy, the withdrawl of significant volumes of Russian oil from the marketplace does not appear to be likely to trigger a major price spike that would quickly push Brent higher, carrying Urals crude with it.
Absent a spike in the price of Urals crude, should Russia follow through on Putin’s decree and block sales under the price cap, the decline in production brought on by the sales ban would quickly send Russia’s government deficits soaring. Putin needs the Urals crude price to recover quickly once sales start getting banned just to keep oil revenues (and thus Russia’s federal budget) more or less stable—and Urals’ recent price behaviors suggest there may not be much of a price spike to compensate for the production declines—and the price of Urals crude might even continue to decline.
There is also the question of how Putin intends to address the reality that the market price for Urals crude is under the price cap, which means that all oil sold on the open market technically could be viewed as in violation of Putin’s sale ban—including oil sold to Russia’s presumptive BFF China. Gouging one of the only friends Russia has a the moment is not necessarily a wise strategy.
Putin might address this by simply demanding a higher price for Urals crude, above the $60 per barrel price cap. With only three countries—China, India, and Turkey—purchasing much of the oil that would have otherwise gone to Europe, it might be possible for Putin to claw back some of the oil price that Urals has given up this month. It remains to be seen how high Putin can push the price of Urals and ESPO blends, and whether Putin can source and insure enough tankers to transport the oil to its destination.
Putin might not want to sell oil for less than $60 per barrel. Unfortunately for him, at the present time he has little choice in the matter, price cap or no price cap.