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Russia sees a major risk to its financial health in lower oil revenues

by SuperiorInvest

Last year, Russia overcame the impact of energy sanctions and restrictions on gas exports to Europe. But 2023 will be much tougher, with lower energy prices and deeper discounts on Russian oil – supported by the G7 price ceiling of $60 a barrel – starting to worry Kremlin economists.

President Vladimir Putin last month called the cap “stupid”, saw no reason to “worry about the budget” and boasted of his “unlimited” ability to finance the invasion of Ukraine. Oil and gas revenues of Rbs 11.6 trillion ($168 billion) last year reached the highest level since 2011, thanks to high prices and the redirection of crude exports to Asia, especially India and China.

But with falling oil prices and the cost of war deepening Russia’s deficit last year to 2.3 percent of gross domestic productPutin and his officials see financial risks ahead. “You need to look at this discount so that it does not cause any budget problems. Discuss it and deliver your proposals,” he told officials last week after Deputy Prime Minister Alexander Novak admitted that “the main risk is gross discounts”.

With oil and gas revenues accounting for 40 percent of the federal budget, the biggest challenge to Russia’s plans is the combination of expanding rebates and falling energy prices. Energy Information Administration, the statistical branch of the US Department of Energy, predictions The average price of Brent oil in 2023 will be $83 per barrel, which is 18 percent less than last year.

“The word ‘discount’ is the key effect of the sanctions. It has become part of the Russian oil reality for a long time,” said Viktor Katona, chief oil analyst at Kpler Commodity Analysis Group.

Buyers of Russian oil are demanding ever wider discounts on Brent crude oil. Last year, the rebates cost Moscow an estimated $50 billion, according to the Kyiv School of Economics, or 12% of its projected revenue. The spread between the price of Brent and Urals, Russia’s leading blend, is now 10 times larger at $30-$35 than it was before the invasion last February.

Urals fell after the $60-a-barrel cap was imposed on Dec. 5 and is currently trading at $44 — about 48 percent below Brent, according to energy data provider Argus. It is also well below the $70 level used as the basis for Russia’s 2023 budget, which forecasts a deficit of 2 percent of GDP.

“This enlargement is the result of the union of the EU [ban on Russian oil shipments], which is a major factor, and the oil cap,” said Ben Cahill, senior fellow at the US-based Center for Strategic and International Studies. “Even if the volume of Russian exports increased, it would not be a big problem [for the west]. They are getting what they wanted: a well-supplied market with Russia, which has lower incomes,” he added.

“The few remaining important importers, such as India and China, have a lot of market power,” added Georg Zachmann, a senior fellow at the Bruegel think tank in Brussels.

How price and production changes would affect Russia's oil revenue in 2023. Heat map comparing Urals oil price to production.  The current price of Urals is $55, which means it needs to produce 10.5 million barrels per day to break even.

This combination makes the Kremlin an estimated 160 million euros a day studies Center for Energy and Clean Air Research (CREA) based in Helsinki.

CREA estimates that Russia’s earnings from fossil fuel exports fell 17 percent month-on-month in December to the lowest level since last February. The finance ministry reports a 7.5 percent rise in oil and gas revenues over the same period, reflecting a 20 percent loss in the ruble’s value last month and a windfall tax on Gazprom.

Russia’s 2023 budget projects a 23 percent drop in all oil and gas revenues compared to 2022, while the Kyiv School of Economics (KSE) predicts the drop could be double that.

Based on Treasury data, if oil output falls 7-8 percent from 2022 levels, which Novak says is possible, and the average price of the Urals is $50 a barrel, Russia will lose 23 percent of its projected oil and gas revenues. for 2023. If Ural averages $35, it will face a 45 percent deficit.

An oil tanker moored in Novorossiysk, southern Russia. Falling oil prices and the cost of the Ukraine war pushed Russia’s deficit to 2.3 percent of gross domestic product last year © AP

Earnings could take another hit when a separate G7 ban on refined petroleum products takes effect next month. China and India prefer to buy cheaper Russian oil to refine at their own plants. Therefore, it will be difficult for Russia to find new markets for kerosene, diesel and other products, even at a lower price, said Katona from Kpler.

Russia also admitted last week that there was a “risk” of lower-than-expected gas exports, although gas provides only a fraction of oil revenues.

Despite the challenging outlook, declining revenues will not necessarily limit Putin’s ability to wage war.

If 2023 is in line with forecasts, Russia can cover losses and finance the conflict at the planned level. It will continue to borrow internally, mainly from state-owned banks, and withdraw money from its $148 billion investment fund, including by selling Chinese renminbi holdings.

Renminbi selling began on January 13 to cover an expected shortfall in oil and gas revenues of Rbs 54.5 billion ($798 million) this month. Moscow has sufficient renminbi reserves for several years of such interventions, Sberbank CIB analysts wrote.

In the likely event that revenues are lower and, as in 2022, spending is higher than planned, Russia will either have to increase borrowing, continue using the fund — something Putin is reluctant to do — or cut spending on economic development and infrastructure, as e.g. previous difficult times, said Alexandra Prokopenko, a former representative of the central bank.

But with the war in Ukraine a major focus of Kremlin policymaking, military spending — which accounts for nearly a third of spending in 2023 — will be the last to suffer any damage, she said.

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