16.10.23 Review

Military-Oil Solitaire: The crisis in the Middle East could drive up oil prices, providing Russia with additional funds to wage its war in Ukraine

The escalation of the war in the Middle East has the potential to drive oil prices above $100 per barrel of Brent crude. In 2023, production cuts in Saudi Arabia and Russia offset a surge in Iranian exports. However, if Iran becomes involved in the hostilities, its oil supplies will be constrained. There are also risks to the uninterrupted passage of tankers through the Strait of Hormuz, which accounts for 20% of global oil deliveries. In the event of such a negative scenario, the Kremlin would once again reap windfall profits, allowing it to seamlessly increase its spending on the war and mitigate the effects of sanctions. If the war does not alter the course of current events, oil prices may remain at their current levels in the medium term. Nevertheless, this level would still be sufficient for Russia to sustain its war effort and bear the additional costs of sanctions without placing excessive strain on its economy. A more serious slowdown in the global economy than anticipated by experts could cause oil prices to drop further. The threat of tougher export sanctions against Russia also looms. In October, the United States, for the first time, imposed restrictions against those who violate the price cap.

The outbreak of the war in the Middle East has not yet led to a sharp rise in oil prices, but its future trajectory could become a determining factor in their medium-term dynamics, according to experts from the International Energy Agency (IEA) and the Bruegel analytical centre. To curb the increase in global prices resulting from reduced oil production in Saudi Arabia and Russia, the United States has relaxed its enforcement of sanctions against Iran this year. This move has allowed Iran to boost its oil exports to a five-year high. However, if Iran becomes involved in hostilities in the Middle East or its involvement in the Hamas attacks is proven, Iranian oil supplies will be restricted once again. In the case of such events, analysts at Bruegel predict that the price of a barrel of Brent will rise to more than $100. Moreover, the escalation of the war poses risks to the uninterrupted passage of tankers through the Strait of Hormuz, which connects the Persian Gulf in the southwest with the Gulf of Oman in the southeast and, ultimately, with the open ocean. This passage accounts for 20% of global oil deliveries and 25% of global LNG shipments.

If prices soar to $100 or above, Russia will enjoy windfall profits comparable to those seen in 2022 when the average Brent price was $99 per barrel, with total oil exports bringing Moscow a record $590 billion in revenues. This will enable Russia to increase its spending on the war while successfully mitigating the impact of sanctions. The average price of Brent for the first 10 months of this year was $82. However, even at this level, Russia's export revenues are more than sufficient for it to wage war and mitigate the effects of sanctions. If the new war in the Middle East does not disrupt supplies, the IEA predicts that oil prices will remain at their current levels in the medium term. Saudi Arabia and Russia, the two largest oil suppliers, announced in September their decision to continue production cuts until 2024, causing Brent barrel prices to rise to nearly $100, as the market experienced its worst deficit in a decade. However, by early October, the price had dropped back below $85 due to bleak macroeconomic forecasts. As Re:Russia has previously reported, the growth of the global economy in 2024 is expected by most experts to slow down. The markets are under pressure from the tight monetary policy of central banks. Inflation, meanwhile, is decreasing slowly, and China's economic growth has been more subdued than expected. The International Monetary Fund (IMF) and the Peterson Institute for International Economics (PIIE) project global GDP growth next year to be less than 3%.

In September, thanks to the temporary rise in prices and the reduction of the Brent discount to Urals to less than $12, Russia was able to earn a record $18.8 billion in revenues from oil exports, the highest figure since July 2022. In October, revenues will decline but will remain at a comfortable level for Moscow. The budget for 2024, with its record military spending, is based on an average price of $86 for a barrel of Brent and a discount of $15 for Brent to Urals. In this scenario, revenues from the sale of oil above $60 will go to the National Wealth Fund. For these figures not to add up, the global economy would need to slow down more than the IMF and the Peterson Institute predict; such concerns do exist. For instance, Citi analysts project global GDP growth of only 1.7%. As a result, they believe Brent will only cost more than $80 in the first quarter of 2024, and in the fourth quarter, it could drop below $70. Additionally, Russia could face problems created by the tightening of sanctions, which, as Re:Russia has previously reported, have yet to be fully successful. In October, the Price Cap Coalition called on maritime market participants to be more vigilant when it comes to sanctions compliance, and the United States imposed sanctions for price cap violations for the first time against two shipowners from Turkey and the UAE, as well as their tankers.