Russia’s Latest Output Cut Shows Its Oil Weapon Is Weakening
On February 10, Russian Deputy Prime Minister Alexander Novak announced that Russia plans to cut its crude oil production by 500,000 barrels per day in March—that is, by approximately 5 percent of its total output at the time of writing. The Kremlin has described the move as retaliation for the Western sanction’s regime and price caps (Interfax.ru, February 10). However, market observers reject this explanation, instead stipulating that Moscow has been forced to adjust its oil production due to the impact of sanctions coupled with various market-related factors. Most importantly, in either case, the Kremlin seems to have limited capacity in weaponizing its crude exports to the extent it tried with its natural gas supplies back in 2022.
Now, the most consequential Western restrictions imposed directly on Russian oil exports include:
• The European Union’s ban on Russian crude oil imports (with notable exceptions, especially regarding pipeline imports) effective since December 2022 (Europa.eu, June 3, 2022);
• The G7 price cap on Russian crude oil imports effective since December 2022, which was initially set at $60 per barrel level and will be adjusted and reviewed every two months (Europa.eu, December 3, 2022);
• The EU ban on the import of Russian oil products (with minor exceptions) effective since February 2023 (Europa.eu, June 3, 2022);
• The G7 price cap on the import of Russian oil products effective since February 2023, which was set at $100 per barrel for premium-to-crude products and $45 per barrel for discount-to-crude products (Europa.eu, February 4).
Until now, these Western restrictions had a limited transformative effect on Russia’s overall crude output, as the country’s total production level has remained consistent through the past few months at around 9.8 million or 9.9 million barrels per day (Interfax.com, February 8). And this is only slightly less than the production rate of 10.2 million barrels per day back in February 2022 (Interfax.com, June 17, 2022). However, this does not mean that the Western sanctions and price caps have had no impact at all.
In truth, Western restrictions have already forced a notable change in the direction of exports for Russia’s energy companies, with much of Russian crude being rerouted from Europe to Asia (see EDM, February 23) and diesel cargoes being offered to customers in Africa, the Middle East, Asia and even South America (Infobrics.org, February 27). Moreover, the sanctions—together with the unwillingness of Western companies to import Russian oil—have drastically affected the price of Russia’s crude. The main Russian crude grade, Urals, has been officially traded in January 2023 with as much as $40 per barrel discount as compared to the Brent grade (The Bell, February 18). To put this in context, before Russia’s full-scale invasion of Ukraine, this price difference had not exceeded $3 or $4 per barrel (Neste.com, accessed February 28).
Now, it remains uncertain whether Moscow’s announced cut in output will translate into reductions in the export of crude and other oil products or some limitations on refinery production. On the one hand, media reports have revealed that Russia plans to significantly lower crude transshipments through its Western ports, including Primorsk, Ust-Luga and Novorossiysk (Bruegel.org, February 23). Such a move would support the notion of the Urals-to-Brent discount. On the other hand, one should understand that marketing those oil products under Western sanctions is much more difficult for Russia than raw crude oil due to various reasons that include lower storage capacities within Russia and the requirement of closer geographical proximity for deliveries of such products to potential buyers. Therefore, Russian companies may be forced to reduce refinery production, thus lowering diesel volumes available for export.
Of course, it cannot be completely ruled out that Moscow will not try to weaponize its oil exports in the same way it did with natural gas exports in 2022, unilaterally halting the supplies to several European countries. For example, on February 23, major Polish oil and gas company PKN Orlen publicly stated that Russia had halted its crude supplies to Poland (Radio Free Europe/Radio Liberty, February 25). In truth, several Central and East European countries still rely on Russian crude and have been unable to replace it quickly or fully with alternative grades. As a result, this leaves the region susceptible to future Russian weaponization of its crude supplies and will likely lead to price hikes.
Even so, it seems that possible disruptions in Russia’s crude exports would not be massive in character, as the overall Russian state budget simply relies too much on revenue from oil exports to afford the loss of all remaining European buyers. In January 2023, the Russian budget registered a record-high deficit, and analysts are constantly debating whether the Russian economy could handle significant losses in oil and gas revenues (Brusselstimes.com, January 11; Carnegie Politika, February 10). Moreover, if the Kremlin would indeed like to limit oil exports, then it should have cut down supplies back in 2022 when such a move could have had a lasting impact on world markets—at least one that would have been much stronger than the potential impact of taking similar measures now.
SOURCE – OILPRICE.COM