Is Russia arming oil after a natural gas misfire?

Russia plans to cut its oil production by 500,000 barrels a day from March, or about 5% of total current production, in retaliation for Western price limits and embargoes on its exports of crude oil and refined oil products.

While the one-off cut is unlikely to have a major impact on global oil prices in the longer term, further production cuts could lift prices at a time when China’s reopening of COVID-19 restrictions is expected to boost oil demand.

That would undermine price caps backed by Group of Seven (G7) countries, which aim to ensure that Russian oil keeps flowing to the global market and prevent any massive rise in prices when their economies are struggling with high inflation.

“Russia may be trying to arm oil, just as it tried to arm natural gas last year,” Simone Tagliapietra, an energy policy expert at the Bruegel research institute in Brussels, told DW.

Resilient oil production

Russia’s oil production, a major source of revenue for the state, has remained resilient in the face of unprecedented Western sanctions in response to Moscow’s invasion of Ukraine. In fact, Russia’s average oil production increased by 1.5% in 2022 to 10.7 million barrels per day from 2021 as Russia successfully redirected oil rejected by the West to other countries, especially India and China. .

However, price caps on Russian oil exports have made it difficult for Moscow to keep shipments at current levels. These restrictions are not only forcing Russian producers to sell their oil at steep discounts to the few willing buyers, they are also having to bear high insurance and freight costs amid a shortage of tankers.

“By reducing production volume, Russia will turn the market into a sellers’ market rather than a buyers’ market. At least that’s one of the things Russia hopes for,” said Bjarne Schieldrop, chief commodities analyst at SEB AB, to DW.

Lack of oil storage facilities

Russia described the production cut as a “voluntary” move, but many experts say Moscow’s hand was forced by sanctions. They expected some production loss, expectations that Russia has managed to defy so far.

At the same time, Russian oil producers are also grappling with a lack of storage space for their production, as tankers now have to spend more time at sea making deliveries to farther destinations in Asia as they struggle to find new buyers. .

Russia does not have enough storage facilities at home, and storing oil abroad in places like Fujairah in the United Arab Emirates, where Russian oil stocks have been rising, is expensive.

“It seems that there has been an assessment of how much oil and oil products could be sold to these countries [adhering to the price cap] and has decided to reduce oil production by the corresponding amount to ensure that Russian oil exports are only directed to India, China, Turkey and other countries that have not adhered to the cap,” said Tatiana Orlova, chief economist at Oxford Economics.

inflict more pain

The Russian government’s budget deficit soared to $25 billion (€23.4 billion) last month, the biggest January deficit in years, as Western oil sanctions weighed on its finances. Oil and gas revenues nearly halved, down 46%, according to data from the Russian Ministry of Finance.

In this scenario, experts say Russia has an interest in oil prices rising significantly. Not only would this increase Moscow’s revenues by offsetting reduced exports, it would also inflict more misery on inflation-hit western economies.

To make matters worse for the West, Russia has room to further reduce production. Russia’s production in early February stood at 10.9 million barrels a day, but its budget has been built around 9.8 million barrels, according to Alexander Isakov of Bloomberg Economics.

“This action [March output cut] it could be a first sign of an attempt to put pressure on the oil market,” said Tagliapietra. “In general, I wouldn’t be surprised to see them try to play with the oil market like they tried to do with gas.”

Failed attempt at gas weaponry

Russia has been criticized in the past by the West for arming natural gas. Russian exporter Gazprom cut most supplies to Europe last year, citing often unconvincing reasons such as technical and payment problems.

Western officials saw the cuts as an attempt by Moscow to leverage its position as the biggest supplier of natural gas to the European Union to retaliate against the bloc for supporting Ukraine.

Russia accounted for around 45% of EU gas imports, including liquefied natural gas, in 2021. But the pain has largely eased.

Europe has managed to replace much of Russia’s supply lost from other sources such as the United States, Norway and Qatar, easing concerns about blackouts and energy rationing. Gas prices have fallen sharply, helped by mild weather and lower consumption, although they remain well above early 2021 price levels.

“The main takeaway from the natural gas event was that natural gas weaponry was a success, but only for a very short period,” Schieldrop said. “So basically the historical wisdom about arming energy supplies is that it doesn’t work. Russia is very afraid of arming oil because the effect can be very temporary.”

Oil as a weapon is a complex subject

Russia may find it even more difficult to reap rewards from weapons oil, as it is more fungible and globally available, making it easier for countries to obtain alternative supplies, as was the case last year.

Then there is the OPEC+ alliance of oil producers, which includes Russia and Saudi Arabia. So far, the alliance has decided not to replace lost barrels resulting from Russia’s unilateral decision that raised benchmark Brent oil prices above $85 a barrel.

But his stance could change if Russia introduces further unilateral cuts, pushing oil prices to levels that start to threaten demand.

“Then you will potentially see an OPEC response to compensate and that will result in a loss for Russia,” Schieldrop said.

Edited by: Tim Rooks