20.03.23 Sanctions Review

Will Russia have enough money for the war? Oil prices are falling, but the IEA predicts an increase in demand by the end of the year, rendering sanctions ineffective

In recent weeks, as a result of instability in the US and European banking sectors, oil prices have fallen to around $70 per barrel (or in other words, to their pre-pandemic levels). This rate may pose significant challenges for the Russian government, particularly given the impact of sanctions. However, the International Energy Agency and OPEC+ predict that, by the end of the year, global oil demand could surpass pre-pandemic levels, leading to a potential increase in prices. This is likely to attenuate the effectiveness of sanctions against Russian exports, meaning that the Kremlin will be able to accumulate sufficient funds to offset the economic impact of sanctions while continuing to expand its military production.

Russia’s budget deficit has already amounted to 2.6 trillion rubles in the first two months of 2023, which is just short of the annual target of 2.9 trillion rubles. Despite this, the Kremlin does not intend to curtail its spending on the war. It also needs to find replacement investments for products and components that can no longer be imported due to sanctions. The ability of the Russian government to achieve both of these objectives depends on the price of oil. Over a third of government spending is expected to be covered by oil and gas revenues, primarily from the country’s export of oil and petroleum products. However, oil prices are currently much lower than they were last year. In the first two months of 2023, Russia’s oil and gas revenues amounted to 947 billion rubles, or a 46.4% year-on-year decrease, according to the Ministry of Finance.

Issues in the American and European banking sectors have caused oil prices to plummet in recent weeks, dropping close to 2018-2019’s pre-pandemic levels of just over $70 per barrel. However, given the impact of both sanctions and the spread on ‘toxic’ Russian oil, its price is likely to continue to fall to below $50 per barrel. This could potentially have a significant destabilising effect on the Russian economy.

The International Energy Agency (IEA) and OPEC+ released reports in March predicting a significant increase in global oil demand in the second half of this year. The global market is currently experiencing an excess of supply. IEA analysts note that, ‘The market is caught in the cross-currents of supply outstripping still-lacklustre demand, with stocks building to levels not seen in 18 months.’ InJanuary, industrial stocks of oil and oil products in OECD countries rose to 2.85 billion barrels, and there are preliminary indications that reserves will continue to grow. Despite experiencing general uncertainties when it comes to future supply alongside fears of new shocks to the market, OECD countries are continuing to stock up on oil. 

Before the start of the problems in the banking sector, excess supply kept oil prices in the range of $80-85 per barrel. However, given the discount on Russian oil, even this price does not generate sufficient income for the Russian government. According to the Ministry of Finance, the average price of Brent for the month from February 15 to March 14, 2023 was $83 per barrel, while the price of Urals for the same period was $50.8 per barrel. The MMI channel reports that the spread is slightly smaller than it was the previous month, decreasing from $35 to $32. Despite this decrease, it is still insufficient, as the oil price used for calculating Russian budget revenues stands at $70 per barrel. Additionally, the actual costs are likely to be significantly higher than planned.Global oil supply outstripped demand in the first few months of 2023, partly because of Russia, which was able to effectively redirect its oil to China and India following the introduction of European sanctions. According to experts from the IEA, a year after the full-scale invasion of Ukraine, Russia has continued to supply the market with approximately the same amount of oil as it did prior. Despite sanctions, Russian oil exports fell by only 3.9%, to 4.9 million barrels per day in February.

According to the predictions of both the IEA and OPEC+, the global demand for oil is expected to grow. The IEA forecasts that oil demand will rise from 710,000 barrels per day (bpd) in the first quarter of 2023 to 2.6 million bpd in the fourth quarter, as China and the Asia-Pacific region ramp up their economic activity. However, experts from the IEA are concerned that the anticipated recovery of China’s business activity may end up overshadowing the emerging banking crisis, evidence of which may be found in the recent bankruptcy of the American Silicon Valley Bank and the issues faced by Credit Suisse. If the financial crisis deepens, there will be a decline in energy demand, and prices will drop.

However, the forecast for Russian oil production has been improved under the baseline scenario of demand growth (in the event that a banking crisis is averted). Previously, the IEA anticipated a decline of 1.1 million barrels per day by the end of the year, but this figure has been revised and reduced to 740,000 barrels. If the aforementioned increase in demand occurs, the price situation will also be more favourable for the Russian government.

It is also worth noting that there is a strong possibility that Russia’s real revenues from oil trading may be much higher than previously reported. A team of economists have analysed Russia’s customs statistics and found that the average price per barrel of Russian oil, after the introduction of the price cap, was not $50.4 (as the Russian authorities claimed) but rather $74. However, the effectiveness of this scheme could be jeopardised if Western nations are able to improve their enforcement of sanctions. Moreover, the real impact of Russian oil product export sanctions on the country’s budget remains unknown, as these restrictions were only introduced on February 5. However, in February, the export volume of Russian oil products decreased by 16%, to 2.6 million barrels per day.

Ultimately, the events of the past year indicate that, in times of increased oil demand and higher prices, the impact of sanctions and price caps is limited. The Russian government will still have enough funds at its disposal to wage its war in Ukraine and mitigate the effects of sanctions.