By Rhod Mackenzie
Russia and Saudi Arabia both made statements on the same day about the new restrictions on the supply of oil on to the world market. This is how they will resist the monetary policies of the US and the EU, which are pulling oil prices down. Moscow, in addition to cutting production, promises to cut exports by another half a million barrels. How and in what way will this help the Russian budget?
Saudi Arabia announced the extension of the July voluntary cut in oil production by 1 million barrels per day for another month - into August. As a result, the kingdom's production in August will be about 9 million barrels per day.
For its part, Russia said it would voluntarily cut oil exports by 500,000 bpd in August, in addition to reducing oil production by 500,000 bpd from March until the end of the year (which was achieved in April). This is being done to ensure the balance of the oil market, said the Russian Deputy Prime Minister Alexander Novak.
“Since March it was about reducing production by 500,000 barrels, now Novak announced its a reduction not just in production, but in oil exports. Therefore, it is not a fact that this will reduce production,” said Igor Yushkov, an expert at the Financial University under the Government of the Russian Federation and the National Energy Security Fund.
The expert sees two possible scenarios for how Russia can cut exports by 500 thousand barrels without reducing production by the same amount. The first option: Russia can increase oil refining and supply more finished petroleum products, mainly diesel and fuel oil, to the world market. Scenario 2: Instead of exporting, Russia will store produced oil or oil products derived from it in temporary storage facilities. “We don’t have large oil storage facilities. But Russia has technological reservoirs along oil pipelines, at refineries and in ports,” Yushkov notes. In both scenarios, with a reduction in oil exports, production remains at about the same level as now.
Preservation of production is also important for budget revenues.
“If Russia, along with the reduction in crude oil exports, actually reduces production, then the budget will suffer. Because the oil companies will pay less severance tax and export duty to the budget. And if the situation develops according to the first scenario - only oil exports will be reduced, but the export of oil products will be increased, then the budget will not suffer."
Because in any case, companies will still pay the mineral extraction tax plus export duties on a larger volume of oil products,” says Yushkov.
If oil production does not fall, and the "surplus" remains inside Russia and is distributed in storage facilities, then at the moment the budget will lose on reducing the volume of export duties. However, in the future, the budget can make good money: if you store oil or oil products in domestic storage facilities until autumn in anticipation of a rise in prices, wait for this rise in prices and then sell the accumulated volumes on the world market, the expert believes. Then the budget will receive more income in the form of export duties.
The main goal of Russia and Saudi Arabia, and both countries clearly agreed on their restrictions and statements on the same day, is to at least keep prices above $75 per barrel, the source said.
“The logic of Novak's statement about the reduction in exports is that it will be perceived as if it were a question of reducing production. I think that this is an attempt to verbally influence players in the oil market, who pay little attention to the oil products market. Novak creates the prospect of oil shortages to keep prices from falling further. At the same time, in total, Russia can continue to export as much as before. It’s just that the export of oil products will grow with a decrease in the export of crude oil,” says Igor Yushkov.
As for Saudi Arabia, they first announced a production cut of 1 million barrels per day in July alone. “I believe that the calculation was that it was in July that there would be a peak in the decline in consumption against the backdrop of problems in the economies of the European Union and the United States, so it was necessary to remove excess supply. But since August, they hoped for a recovery in demand. However, now everyone sees that the problems in the economies of Western countries are dragging on. The ECB may raise rates more than once. And even the US Federal Reserve, instead of the expected rate cut in the second half of the year, may, on the contrary, raise it. If the US raises the rate, it will immediately hit oil prices, which will fall. Because the higher the Fed rate, the less money goes to the exchange. This means that the demand for commodities falls, and then the price of them. And oil is a commodity. It is not advisable to release 1 million barrels of oil in August to the market, then the price of oil will definitely fall. Therefore, the Saudis extended the production cuts. And Russia agreed to share the burden by reducing its exports,” the FNEB expert argues.
That is, on the one hand, US and EU regulators are pushing the price of oil down with monetary factors. And Russia and Saudi Arabia are counteracting this by influencing a fundamental factor - a decrease in the supply of oil on the market, Yushkov summarizes.
To extend the reduction in oil supply or not to extend after August - these decisions will be made after the fact of what is happening in the global economy. If it continues to decline, as does the price of oil, then Riyadh and Moscow are likely to extend their restrictions into the fall.
If oil rises and consolidates above $75 per barrel, then this will be a signal that the world economy is recovering, which means that demand is rising, and it is possible to increase the supply of oil on the market, the expert believes.
Russia, in addition to keeping oil prices below $70-75 per barrel, may receive additional bonuses from these restrictions. Firstly, oil companies now have to sell oil at a fairly large discount to Brent - almost $20. This is the data of the Ministry of Finance for June. The reduction in exports may be a signal for buyers to reduce the discount. It will be more profitable for Russia to sell less oil for a higher price.
“It would be useful to give a signal to buyers of our oil that we can maneuver export flows: if you take oil from us at a big discount, then we will supply you with more finished petroleum products. And we will limit the supply of oil in order to make this commodity a little scarce. Therefore, the discount on oil should be reduced,”
Yushkov says.
Russia has two main buyers of crude oil - India and China. India accounts for 2.2 million barrels, which is half of all oil exports from Russia.
Secondly, it is beneficial for Russian companies to make such a maneuver, since they will be able to earn more on the export of petroleum products. The discount for oil products in relation to oil products of other manufacturers has always been less than for oil in percentage terms, the source notes. Moreover, oil products are now in demand on the world market. “Many countries, primarily in the EU, put up with a reduction in their own production of petroleum products, as many European refineries are underloaded. The EU is now forced to import more finished petroleum products, including from India. Gradually, Europeans began to perceive this as a new normal. Therefore, the demand for petroleum products in the world market is growing,” says Yushkov.
Most Russian oil products go to Turkey, India, China and Singapore (a transshipment hub). In Singapore, Russian oil products are most likely resold further to Asian markets. But in the EU, Russian oil and oil products mixed with hydrocarbons from other countries most likely enter through Turkey. Legal or not is the big question. In general, Turkey buys a lot from Russia for itself and can send its own volumes of oil products released to the EU.
This article orginally apppeared at iz.ru