Russia announced that it will cut oil production by 500,000 barrels per day, around 5 percent of output, in March, after the West imposed price caps on Russian oil and oil products—the latest of which went into effect on February 5, 2023. Russia is the world’s second-largest oil exporter after Saudi Arabia, making Brent oil prices rise from the announcement by more than 2.5 percent to $86.6 per barrel. West Texas Intermediate also increased, briefly rising above $80 a barrel. Despite the sanctions, Russia had been selling the entire volume of the oil it produces to countries that are not following the ‘price cap’ that Western countries set on Russian oil. In fact, Goldman Sachs estimated that the actual price Russia is receiving for its oil is significantly higher than the cap.
The G7 countries, the European Union and Australia agreed to ban the use of Western-supplied maritime insurance, finance and brokering for seaborne Russian oil priced above $60 per barrel beginning on December 5 as part of Western sanctions on Russia over its invasion of Ukraine. The EU also imposed a ban and set price caps on purchases of Russian refined oil products, such as gasoline and diesel, beginning February 5. In turn, Russia banned deals involving any application of the price caps. Russia’s announcement of the self-imposed oil production cut, however, may indicate that the price caps have had or will have some impact.
For the past five years, Russia, along with Saudi Arabia, has been a co-leader of OPEC Plus–a group of oil producers that banded together to control the global oil market by setting production ceilings on its members. Russia’s production cut could miss its OPEC Plus oil production ceiling by about a million barrels a day. In terms of the overall global market, a reduction of 500,000 barrels a day would represent about 0.5 percent of oil output. According to OPEC Plus, it plans to stick with cuts of about two million barrels a day for the rest of the year.
Production cuts usually result in an increase in prices, which may be exactly what Russia wants. Russia, the world’s third-largest producer of oil after the United States and Saudi Arabia, has been forced to sell its oil at a significant discount, estimated to be as much as 50 percent, to attract new buyers in Asia to make up for embargoes imposed in the European Union and elsewhere. Russian companies found markets in China, India, Turkey and elsewhere to compensate for the loss of their key customers in Europe. Late last year, however, the Kremlin conceded that oil revenues, a critical part of the country’s budget, would become “less predictable.” With an abundance of Russian oil, buyers could extract leverage for discounts of as much as $40 a barrel on Russia’s most important crude oil grade, Urals. Markets are not trading with their normal transparency since Russia’s invasion of Ukraine and the ensuing Western sanctions.
Many analysts, however, were surprised at how well Russia’s oil output held up last year. In 2022, Russia’s oil production increased by 2 percent to 10.7 million barrels per day due mainly to sales to Asia, especially, to India and China. For example, around 70 percent of January-loading cargo of Russian Urals oil was intended for India. Russia was able to redirect its oil exports to Asia, marshal a fleet of tankers unencumbered by Western penalties and adapt evasion schemes perfected by its allies Iran and Venezuela.
In 2022, Russia increased its oil export earnings 20 percent to $218 billion, according to estimates from the Russian government and the International Energy Agency. However, following new sanctions from the West, Russia is facing more challenges in selling oil, a major source of revenue for the state budget, which posted a $25 billion deficit in January. Lower export volumes reduced Russia’s current account surplus by 58.2 percent to $8 billion in January. By cutting back production, Russia may be trying to raise the price it receives. If less Russian oil is available, buyers may be forced to settle for a smaller discount. This comes at a time when the U.S. Strategic Petroleum is at its lowest level in four decades, and upon the announcement by the Biden Administration of another sale of 26 million barrels of oil supplies.
Conclusion
Russia blunted the impact of Western sanctions by redirecting oil exports to China, India and Turkey, exploiting its access to oil ports on three different seas, extensive pipelines, a large fleet of tankers and a sizable domestic capital market that is shielded from Western sanctions. As such, Russia was able to re-engineer, in months, decade-long global oil trade patterns. For example, Russia’s oil exports to India have grown sixteenfold since the start of the war in Ukraine, averaging 1.6 million barrels per day in December. But, tougher times are expected with the EU ban on Russia’s refined oil products and associated price caps, which will reduce revenues in its state budget that has already begun. Expecting problems, Russia announced a self-imposed oil production cut.
Any reduction in oil supplies risks raising prices in the global market. That market could also become stressed from rapidly increasing demand from China, the world’s largest oil importer, which has lifted Covid-19 restrictions. Americans need to understand that the oil market could become very tight again with Russian supplies decreasing and China demand increasing, which would make oil prices escalate and increase gasoline and diesel prices. President Biden has already used the nation’s emergency oil supplies to lower gas prices before the mid-term election. If he continues down that path to control prices, there may no longer be an emergency reserve with the type of oil that American refineries need.
