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HomeUncategorizedRussian Oil-Price Cap Adds to Fiscal Pressure on Moscow

Russian Oil-Price Cap Adds to Fiscal Pressure on Moscow

Fresh Western curbs on Russian crude sales might not affect Moscow’s public coffers immediately, but they add financial pressure that threatens the country’s sanctions-stricken oil industry and long-term ability to fund the war in Ukraine.

Western countries on Monday imposed a price cap on international sales of Russian crude. The measures, aiming to strike at the Kremlin’s war chest, include a ban on seaborne shipments of Russian crude by the European Union and the U.K. The Group of Seven nations, meanwhile, put a ceiling on other sales by barring Western companies from insuring, financing or shipping Russian crude at above $60 a barrel.

That threshold falls between two key benchmarks for the Russian economy: It is above Russia’s estimated cost of production of around $40 a barrel, according to analysts. That means the country can still turn a profit on most of its oil exports. Russia’s main grade of crude, Urals, is selling currently for less than $50 a barrel, well below international benchmarks.

But $60 is below Russia’s fiscal break-even price of above $70 a barrel, the price that analysts say it needs to balance its budget. So, even if Russian crude prices eventually rise to the level of the cap, its revenue still won’t be enough to cover all of Russia’s costs, widening the country’s budget deficit and potentially prompting big cuts or a dip into Moscow’s rainy-day funds.

“The public finances will remain under pressure, and the budget will stay in deficit, requiring the government to maintain a tight fiscal stance,” said

Liam Peach,

senior emerging-markets economist at Capital Economics.

Russia’s vital energy industry, which is already under severe pressure from Western sanctions that limit funding and imports of key technologies, will take a hit from the new measures. Despite Russia’s efforts to reroute its oil flows to China, India and other countries, analysts and Russian officials expect production to decline as the EU—its biggest market until recently—bans most imports and shippers find it hard to buy insurance.

A tanker moored at Primorsk, a Russian town on the Baltic Sea.



Photo:

Alexander Ryumin/Zuma Press

“I expect there to be even more de-risking going forward, making Russian crude even more toxic,” said

George Voloshin,

an expert on Russian energy. “Given how much Russia needs to export to keep its finances in order, all these issues will inevitably result in production declines.”

The uncertainty around the price cap and its impact on Russia has already pushed the price of Russian crude lower in recent months. Argus Media, an energy-data provider, said the price of benchmark Urals crude exported from Primorsk on the Baltic Sea fell to about $47.90 a barrel on Monday, down around 30% from the start of November. That is a hefty discount to Brent, the global yardstick, which traded above $78 a barrel Wednesday.

Shrinking energy revenues represent another pressure point for the Kremlin, which had been using a windfall of oil-and-gas sales earlier this year to stimulate the economy and fund its military operation in Ukraine. It comes amid a string of battlefield losses for the Russian army in recent months and as the military is rapidly burning through its reserves of missiles and ammunition.

U.S. gas prices have been up and down throughout the year and now more uncertainty is on the horizon as a European Union embargo on Russian oil imports kicks in along with a price cap on crude out of Russia. WSJ explains how these moves could impact prices at the pump for Americans. Illustration: WSJ

The Kremlin on Monday said it was working on a response to the measures.

Dmitry Peskov,

President

Vladimir Putin’s

spokesman, claimed that the cap wouldn’t affect Russia’s ability to sustain its military operation in Ukraine.

Russia might cut some small volumes of oil production and adjust its supply chains amid the EU embargo following the sanctions, Deputy Prime Minister

Alexander Novak

said Tuesday. Moscow plans to launch a mechanism banning Russian companies from selling oil to countries that abide by the price cap by the end of 2022, he said.

“Nevertheless, we do not see this as a tragedy, companies will find interaction mechanisms among themselves to sell relevant products,” Mr. Novak said, as cited by state news agency TASS.

The new curbs come as state coffers have already taken a hit in recent months.

Even before the West agreed on the cap, the Russian government had planned for budget deficits for the next three years and said it would tap into its sovereign-wealth fund to plug the gap. In October, revenues from a one-off energy tax on gas exporter Gazprom PJSC helped prevent the budget from veering into a deficit for the year.

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Russia has boosted spending this year to support the war effort and stimulate its economy. Budget expenditures have risen 17% to around 29 trillion rubles, equivalent to $460 billion, compared with last year.

The oil-price cap could increase the budget deficit to 3.1% of gross domestic product next year from the planned 2%, according to

Elina Ribakova,

deputy chief economist at the Institute of International Finance.

A big question is how effective the price cap will be in practice. It is an untested market tool designed to limit Russian revenue while keeping enough of the country’s oil flowing to stem any big price rises.

There are ways for Russia to reroute its exports and circumvent the cap. Shipping companies in Dubai and elsewhere have amassed a fleet of what is called shadow tankers, which traders say Russian producers could use to move their oil. It has also tried to establish domestic insurance and reinsurance companies.

Still, the International Energy Agency expects that Russia’s total oil output will fall by 1.4 million barrels a day next year as more buyers shun its supplies. This year, Russia has produced around 11 million barrels a day on average, according to the IEA.

This compounds the long-term problems that have plagued the Russian energy industry due to sanctions and an exodus of Western energy companies this year.

Deputy Prime Minister Alexander Novak said Russia might cut some small volumes of oil production and adjust its supply chains.



Photo:

Yelena Afonina/Zuma Press

“If Russia cannot sell all its output, this reduces the incentive for the oil sector to invest in new production and open new fields,” said

Jason Bush,

a senior analyst at consulting firm Eurasia Group. “Without new fields opening up, Russia’s oil output would be in constant decline as production from mature fields declines.”

Last week, analysts at Rystad Energy estimated that investments in exploration and drilling in Russia would fall to $35 billion in 2022, down from expectations of $50 billion before the war and $45 billion last year. This year’s level would be below the Covid-19-induced lows of $40 billion in 2020, it said.

The decline in investments will lead to a drop in final investment decisions and force operators to make hard decisions on spending, Rystad said.

“The war in Ukraine has cost the Russian oil and gas sector dearly, with project investments taking a significant hit,” said

Swapnil Babele,

senior analyst at Rystad. “This year looks set to be the start of a multiyear slump that will make the Covid years pale in comparison.”

Write to Georgi Kantchev at georgi.kantchev@wsj.com

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