Russia's oil export revenues are at much greater risk from a global economic recession than the price cap being planned by the United States and the European Union.
Recession is a sure-fire way to reduce Russia’s earnings from the export of crude, diesel and other refined products.
If there is a global economic slowdown in 2023, Russia’s export revenues could fall by between a third and a half, based on experience over the last two decades.
U.S. and EU policymakers will not deliberately plunge their economies into a recession simply to intensify the economic pressure on Russia; privation is not an attractive option in electoral politics.
But if their economies go into recession anyway, which currently appears probably, Russia's export revenues will fall sharply.
The G7 and European Union's planned price cap on Russia’s exports of crude from Dec. 5 and products from Feb. 5 represents an attempt to achieve the same reduction in revenues without tipping economies into recession.
Russia's oil revenues
Russia’s crude export volumes were broadly steady at between 220 million and 260 million tonnes per year between 2004 and 2021, according to trade statistics compiled by the United Nations.
Product exports more than doubled from 81 million tonnes in 2004 to 186 million tonnes in 2016 but have since settled back to around 145 million tonnes per year since 2018.
Revenues were much more variable and correlated closely with the price of Brent. Russia’s annual earnings peaked between $263 billion and $283 billion per year in the period of very high prices between 2011 and 2013.
They dropped to $140 billion in the recession of 2009; $130 billion-$165 billion during the volume war 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 revenues are strongly pro-cyclical, getting a double boost in booms from higher volumes and prices, and taking a double hit in slumps from lower prices and shipments.
If the proposed crude price cap was set at around $70/bbl-75/bbl, with appropriate mark-ups for refined products, it would result in revenues close to the average for the decade between 2012 and 2021.
For U.S. and EU policymakers, it is clearly a superior option, but there are concerns about whether the cap is workable.
The cap depends on segmenting the global market into separate markets for sanctioned and non-sanctioned petroleum, with different prices prevailing in each for what is essentially the same product.
Businesses 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 alternatives.
In this case, U.S. and EU sanctions, including on the provision of maritime, payments and insurance services, are intended to ensure the segments remain separate.
Sanctioned petroleum could only be traded freely below the price cap while unsanctioned petroleum could be traded at any price, including prices well above the cap.
Sanctions regulations will be designed to ensure sanctioned petroleum cannot be transferred across the barrier to become unsanctioned petroleum.
Like any business that tries to maintain segmented markets, however, the barrier will come under greater pressure the wider the price gap between the two markets.
If the crude cap is set at $60/bbl-65/bbl, while unsanctioned crude trades at $120, the incentives for circumvention will be enormous.
If the cap is set at $75-80, while unsanctioned barrels trade at $85-90, the segmentation will be easier to maintain.
Setting the cap level
The effectiveness of market segmentation will therefore depend on (a) the level at which the caps are set; (b) prevailing prices for unsanctioned crude and products; and (c) the intensity of sanctions enforcement.
A low crude price cap of $60/bbl would reduce Russia’s revenues aggressively but could be hard to sustain if prices for unsanctioned oil rise above $100 again and rely on intensive enforcement.
A high price cap of $80 would have much less impact on Russia’s revenues but be easier to sustain if prices stay around $90-100 and might be largely self-enforcing.
Prevailing prices for crude and refined products are changing all the time, so caps would need to be adjusted regularly to maintain the same level of segmentation with the same level of enforcement.
Policymakers would also have the option of flexing 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/bbl-100/bbl, policymakers could opt for a low cap of $60 but a relatively relaxed approach to enforcement or $80 with stricter enforcement.
The options look very different but the practical outcome might be the same: a lower cap enables policymakers to appear tougher while relaxed enforcement eases the practical barrier.
Recession and price capping turn out to be complementary approaches rather than substitutes for reducing Russia’s oil revenues.
Recession would lower prices for unsanctioned petroleum, making it easier to enforce a lower cap. If recession is averted and prices rise, it will become much harder to maintain a low cap without more enforcement.
Russia as marginal producer
Sanctions on oil producers are easiest to introduce and enforce when the market is characterized by excess production and excess production capacity.
In the last three decades, sanctions on Iraq, Libya, Venezuela and Iran were all introduced when the market was in surplus and/or alternative supplies were available.
But the market is currently in deficit and alternative suppliers such as U.S. shale firms and Saudi Arabia have been either 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, much higher than Iraq, Libya, Venezuela or Iran at the time they were sanctioned.
At present, the marginal barrel in the global market comes from Russia, and the terms on which it is made available will set prices for all other producers and consumers.
If Russia declined to sell some or all of its exports at the capped price, it would worsen the global shortage and send prices for unsanctioned oil surging higher.
Even a reduction in Russia’s crude exports of 1 MMbbl/d-2 MMbbl/d would likely send prices surging back above $100 and potentially much higher.
Shortages of diesel and other middle distillates are even more severe than for crude and consumers rely heavily on Russia for them.
Recessions and alternatives
In the event of a recession, consumption of crude and diesel would be hit, reducing the call on Russia’s crude exporters and refineries.
In the limit, if oil consumption fell by an (improbable) 8 MMbbl/d, equivalent to a deep depression or the first round of coronavirus lockdowns, consuming countries would not need Russia’s petroleum at all.
Even a more plausible drop of 2 MMbbl/d, equivalent to a deep recession, would significantly erode Russia’s market power.
Recession remains an extremely unattractive option for U.S. and EU policymakers. The alternative to reduce reliance on Russia’s exports is to encourage alternative sources of supply.
The need to make sanctions policy workable at an acceptable cost explains why U.S. and EU policymakers have shown interest in easing sanctions on Venezuela and kept alive the prospect of a nuclear deal with Iran.
It also explains why the Biden administration has pressed stridently if ineffectively for more domestic crude production and diesel output from U.S. refineries.
John Kemp is a Reuters market analyst. The views expressed are his own.
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