Aug 4, 2022
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The Russian oil industry surprised not only the West

The EU is clumsily trying to deprive Russia of loopholes for selling oil on the European market. Just a couple of months ago, few people expected that the Russian oil industry would recover so quickly after a failure in the spring. It is not only Western banks that have to rewrite forecasts in the direction of growth, but also the Russian Ministry of Finance. After all, even despite the sanctions discount, the budget receives windfall profits from the sale of oil.

OPEC+ is paltryly increasing oil production – by only 100,000 bpd since September. This is a mockery of the desire of US President Joe Biden to get more supply of oil in the world market and bring down oil prices. But this decision of OPEC + plays into the hands of Russia: the absence of a new supply on the market keeps Russian crude oil indispensable.

At this time, the European Union is trying to put a good face on a bad game: it shows that it is extremely dissatisfied with the duplicity of its importers, who buy “toxic” Russian oil mixed with oil of a different origin. This is a loophole that allows you to bypass the oil embargo. Russian oil (49%) is mixed with 51% of other oil and the so-called Latvian mixture, or Indian or Arabic mixture, is obtained. The bottom line is that Russian oil is not listed in the documents, but the origin of oil appears, whose share is more than half, for example, 51%.

However, the EU indicates in the official journal that Russian oil transported together with oil of other origin in a mixed form is also subject to the embargo, and importers are responsible for complying with it.

The EU believes that European importers should include a clause in the sales contract that the exporter confirms that the oil being sold does not contain Russian oil. However, this requirement is advisory in nature. And, in fact, the prescription of a new clause in the contract is only shifting the responsibility from the Europeans to the exporters.

“Now the share of Russian oil supplies to Europe in mixed form is no more than 10%. Obviously, history is not critical for us. Besides, these are just recommendations. But while there is a consensus in the Western world that the market is not in a very stable situation with the supply of oil, therefore, it is unreasonable to further tighten restrictions before the autumn-winter heating season. On the contrary, we are now seeing a reverse trend. For example, the UK decided to refrain from a ban on insuring ships carrying Russian oil. The talks of the G7 countries about setting a price ceiling for Russian oil also remain at the level of talks,” says Aleksey Gromov, Energy Director at the Institute of Energy and Finance.

When the embargo comes into effect in December, this share of Russian oil supplies as a blend will, of course, grow. Because Russian exporters will undoubtedly become even more active in using this loophole to circumvent sanctions. Will Europe turn a blind eye to this or, instead of recommending not to buy Russian oil as part of the mixture, will it move to total control and punishment?

“Everything will depend on how difficult the situation will be in the global market in terms of supply. So far, we see that despite all the efforts of Biden and other Western leaders, the supply in the market is not increasing much. OPEC’s latest decision (to increase production by just 100,000 barrels per day since September) speaks of very modest opportunities for members to increase production. This decision is based on the banal problem of lack of free mining capacity. To boost oil production, investments and time are needed,” Gromov explains.

Secondly, the expectations of the lifting of sanctions against Iran did not come true, the situation here again reached a dead end. Thirdly, there is no increase in the share of Venezuelan oil in the market. “Finally, and most importantly, American shale producers also cannot, for a combination of reasons, increase oil production, as required by the market,” the source notes.

“Further sanctions against Russia can further rock the global oil market, oil prices and related energy sources, and then everything and everything. Because oil prices underlie the entire world economy, it is its blood,” says Gromov. Therefore, the EU is unlikely to go for tougher sanctions in the next two to three months at least.

Meanwhile, Western experts point out that despite the sanctions, Russia was able to easily redirect its oil from European to Asian markets. Such a conclusion, for example, is made by JPMorgan analysts based on the fact that oil production in Russia has already reached the level before the fall after the start of a special operation in Ukraine. And in the third quarter, Western experts generally expect an increase in oil production in Russia. This is strongly at odds with the expectations of JPMorgan analysts, who were in the spring. Then they were sure that Russia was waiting for a drop in production by 3 million barrels per day. But now they admit they were wrong. Production in Russia remains at the level of 9.5 million barrels per day.

“Production has really recovered in Russia, and in the third quarter there will be its growth relative to the third quarter of 2021. However, one must understand that the real EU embargo on Russian oil supplies will only come into effect on December 5th. Now there is a transitional period, so European traders are calmly buying Russian oil and oil products (diesel), if they cannot replace it with alternative sources. The export of our oil and oil products to Europe has increased compared to March and April,” says Gromov.

“In the spring, none of the experts imagined that the Russian oil industry would be so successful in resisting restrictions just five months after the start of a special military operation in Ukraine,” the expert recalls.

At the end of April, Finance Minister Anton Siluanov spoke about a 17% decrease in oil production in 2022 if the Europeans refuse it. But then the scores began to improve. A month later, Deputy Prime Minister Alexander Novak spoke about the fall in oil production in Russia by 5-8% – from 524 million to 480-500 million tons this year.

Now the scores are much better. Gromov expects that oil production in Russia in 2022 will not fall at all: it will either be at the level of last year, or even grow slightly.

“Given world oil prices, which are significantly higher than last year, Russia’s income, even taking into account the sanctions discount, will be higher. In general, 2022 will be a successful year for the Russian fuel and energy complex,” the source says.

Thus, for seven months of this year, the average price for Urals was $83.27 per barrel against $64.68 per barrel for the same period last year. The growth was 30% – and this is taking into account the discount to the price due to sanctions. According to the statistics of the Ministry of Finance, back in April, the Russian budget doubled revenues from the oil and gas industry compared to April last year, to 1.8 trillion rubles. In the first five months of the year, the budget received 5.7 trillion rubles in oil and gas revenues (preliminary data from the Ministry of Finance).

Each month, the budget also receives additional oil and gas revenues (which used to go into reserves). In June, they amounted to almost 400 billion rubles, which is almost 140 billion rubles more than forecasts. In July, the total amount of funds for additional oil and gas revenues amounted to 285 billion rubles, and in August the Ministry of Finance expects 360 billion rubles of additional income. All this is explained by the rise in oil and gas prices.

When the Ministry of Finance prepared the draft budget, it expected that this year oil and gas revenues would amount to 9.5 trillion rubles, compared to 9 trillion rubles in 2021. However, now the Ministry of Finance plans to put 10.4 trillion rubles into the budget at the end of the year, that is, almost a trillion (900 billion rubles) more than it originally planned, and 1.4 trillion rubles more than it put into the budget last year.

However, long-term forecasts are not so optimistic. Gromov believes that Russia will fully feel the consequences of the EU oil embargo in 2023. Then we will face a real reduction in production and export of Russian oil and oil products. “However, the drop in exports and production will not be as dramatic as it would be if the embargo was in place from the beginning of this summer, and not with a time lag in December 2022. The Europeans provided a transitional period not only for their own companies, but also for Russian ones. We also have six months to reconfigure our supply chains. We are not sitting idly by, and the situation in 2023 will not be a shock for us, the industry is actively preparing for it,” says Gromov.

Russia will be able to redirect the bulk of Russian oil to other markets. Western economists are also convinced of this. Russia has already shown a sharp increase in oil supplies to India, and negotiations are underway to double supplies again. Also discussing an increase in supplies with Chinese companies, although China is already the largest buyer of Russian black gold.

The situation with oil products is a little worse, because such volumes of oil products that Russia supplied to Europe will be difficult to sell to other markets due to the banal lack of market niches, Gromov points out. Therefore, the expert expects a larger drawdown for oil products than for oil. Meanwhile, the Ministry of Finance expects a decrease in oil and gas revenues not only in 2023, but in general in the next three years: in 2023 the budget will receive 9.1 trillion rubles, in 2024 – 8.4 trillion rubles, in 2025 – 7.8 trillion rubles .

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