Russia’s oil export revenues are at far greater risk from a global economic downturn than the price cap forecast by the United States and the European Union.
Recession is a surefire way to reduce Russia’s revenue from the export of crude, diesel and other refined products.
In the event of a global economic slowdown in 2023, Russia’s export earnings could drop by a third to a half, based on the experience of the past two decades.
US and European policymakers will not deliberately plunge their economies into a recession just to intensify economic pressure on Russia; deprivation is not an attractive option in electoral politics.
But if their economies slip into recession anyway, which currently seems likely, Russia’s export earnings will fall sharply.
The price caps planned by the G7 and the European Union on Russian exports of crude from December 5 and products from February 5 represent an attempt to achieve the same reduction in income without tipping economies into the recession.
RUSSIA’S OIL REVENUES
Russia’s crude export volumes have remained broadly stable between 220 and 260 million tonnes per year between 2004 and 2021, according to trade statistics compiled by the United Nations.
Commodity exports more than doubled from 81 million tonnes in 2004 to 186 million tonnes in 2016, but have since fallen back to around 145 million tonnes per year since 2018.
Revenues were much more variable and closely correlated to the price of Brent. Russia’s annual revenues peaked at between $263 billion and $283 billion a year during the period of very high prices between 2011 and 2013.
They fell to $140 billion during the 2009 recession; $130-165 billion during the volume wars and mid-cycle slowdown of 2015-2017; and $118 billion during the first wave of the coronavirus pandemic in 2020.
Like other major oil exporters, Russia’s earnings are strongly pro-cyclical, enjoying a double-hit in booms due to rising volumes and prices, and a double-hit in booms. decreases due to lower prices and deliveries.
Chartbook: Russia’s Oil Exports
If the proposed crude price cap were set at around $70-75 a barrel, with appropriate mark-ups for refined products, this would result in revenues close to the decade average between 2012 and 2021.
For US and European policymakers, this is clearly a superior option, but there are questions about whether the cap is feasible.
The cap depends on the segmentation of the global market into separate markets for sanctioned and non-sanctioned oil, with different prices prevailing in each for what is essentially the same product.
Firms routinely segment markets to charge different prices to customers based on characteristics such as customer type, age, gender, ability to pay, stickiness, order size, and ability to access to alternatives.
In this case, US and EU sanctions, including on the provision of shipping, payment and insurance services, aim to ensure that the segments remain separate.
Sanctioned oil could only be traded freely below the price cap, while unsanctioned oil could be traded at any price, including prices well above the cap.
Sanctions regulations will be designed to ensure that sanctioned oil cannot be transferred across the barrier to become non-sanctioned oil.
However, like any company that tries to maintain segmented markets, the barrier will be more stressed as the price difference between the two markets is greater.
If the crude cap is set at $60-65 a barrel, while rogue crude is trading at $120, the incentives for circumvention will be enormous.
If the cap is set at $75-80, while unauthorized barrels are trading at $85-90, the segmentation will be easier to maintain.
CAPACITY LEVEL DEFINITION
The effectiveness of market segmentation will therefore depend on (a) the level at which caps are set; (b) current prices for crude and unauthorized products; and (c) the intensity of enforcement of sanctions.
A low crude price cap of $60 a barrel would aggressively reduce Russian revenue, but could be difficult to sustain if rogue oil prices rise above $100 and hinge on heavy enforcement.
A high price cap of $80 would have much less impact on Russian revenues, but would be easier to maintain if prices stayed around $90-100, and could be largely self-enforcing.
Current prices for crude and refined products are constantly changing, so caps should be adjusted regularly to maintain the same level of segmentation with the same level of enforcement.
Policy makers would also have the ability to modulate the intensity of enforcement to make the barrier between the two market segments more or less porous.
For example, with crude prices currently at $90-100 a barrel, policymakers could opt for a low cap of $60 but a relatively relaxed approach to enforcement, or $80 with a tighter enforcement.
The options look very different, but the practical outcome could be the same: a lower cap makes decision makers appear tougher while a softer application lowers the practical barrier.
Recession and price caps are proving to be complementary rather than substitute approaches to reducing Russia’s oil revenues.
The recession would lower prices for unauthorized oil, making it easier to enforce a lower cap. If recession is averted and prices rise, it will become much more difficult to maintain a low cap without more enforcement.
RUSSIA AS A MARGINAL PRODUCER
Sanctions against oil producers are easier to introduce and enforce when the market is characterized by excess production and excess production capacity.
Over the past three decades, sanctions against Iraq, Libya, Venezuela and Iran have all been introduced when there was a market surplus and/or alternative supplies were available.
But the market is currently in deficit and alternative suppliers such as US shale companies and Saudi Arabia have been unwilling or unable to increase production.
Russia accounted for 13% of global production in 2021, and an even higher share of crude traded by tanker, far higher than Iraq, Libya, Venezuela or Iran at the time they were sanctioned.
At present, the world market’s marginal barrel comes from Russia, and the terms on which it is made available will determine prices for all other producers and consumers.
If Russia refused to sell all or part of its exports at the capped price, it would worsen the global shortage and drive up prices for unauthorized oil.
Even a reduction in Russian crude exports of 1-2 million barrels per day would likely push prices back above $100 and potentially much higher.
Shortages of diesel and other middle distillates are even worse than for crude, and consumers rely heavily on Russia for them.
RECESSION AND ALTERNATIVES
In the event of a recession, crude and diesel consumption would be affected, reducing the appeal to crude exporters and Russian refineries.
Ultimately, if oil consumption fell by an (unlikely) 8 million barrels per day, equivalent to a deep depression or the first round of coronavirus lockdowns, consuming countries would have no need for oil at all. Russian.
Even a more plausible drop of 2 million barrels per day, equivalent to a deep recession, would significantly erode Russia’s market power.
Recession remains an extremely unattractive option for US and European policymakers. The alternative to reducing dependence on Russian exports is to encourage other sources of supply.
The need to make the sanctions policy feasible at an acceptable cost explains why US and European policymakers have shown interest in easing sanctions against Venezuela and have kept alive the prospect of a nuclear deal with Iran.
It also explains why the Biden administration has lobbied vehemently, if not ineffectively, to increase domestic crude production and diesel production from U.S. refineries.
Source: Reuters (Writing by John Kemp; Editing by Susan Fenton)