Russia Is Staring at $60/bbl Oil Now and Plenty More Problems Ahead
After Russia started a war in Ukraine, oil prices increased and brought in higher oil export revenues in the short run. Longer term, things are looking rougher.
When oil price controls took effect last weekend, Russia said it would not sell oil to countries insisting on contracts that impose a $60/bbl cap on the oil price.
It is the latest in a series of defiant responses to Western sanctions designed to reduce its oil export revenues.
But in this case, the cap is only a few dollars below the benchmark price used when pricing exports—the Urals blend. That price includes some heavier grades where sellers can only dream of getting a price that high, according to a report on the sanctions from Rystad Energy
Since Russia benefitted from an initial surge in oil prices after it invaded Ukraine this spring, which lasted into early summer, oil prices have declined.
The current value of a barrel of Brent is just below $80, which is pretty good compared to where it has been most of the time since 2014. But selling Russian oil requires discounts exceeding $20/bbl. Before the war, the spread with Brent was only a few dollars, according to Thomson Reuters data.
The fallout from the war has been an extreme stress test for the Russian oil industry. The cap is just its latest test of how quickly it can adapt to sanctions.
When Western countries moved to rapidly eliminate Russian oil purchases, the country successfully turned to Asia, increasing its share of the market by adding sales to major importers such as India and Indonesia, where their leaders had no compunctions about the war and were happy to get the low-cost barrels of oil.
When majors including BP and ExxonMobil pulled out of Russia, Gazprom and Rosneft took over the spending needed to maintain megaprojects to add oil and gas production over the long term.
Adapting to the price cap will require finding tankers to deliver crude to customers willing to flout the price cap rules. The hard part is that the sanctions ban the sale of insurance covering tankers carrying Russian oil if the buyers are not complying with the price cap regulations.
While Rystad said this will lead to a shortage of tankers in Russia’s western ports, which will reduce exports by 500,000 B/D, it predicts that Russia will be able to make up for the lost exports by summer.
But the report qualifies this by saying the pace is hard to predict. For cautious buyers, this level of uncertainty could be used as an argument for continued deep discounts from Russia, whose markets are limited.
Spending cuts this year will force Russian planners to pick winners and losers in the Russian energy sector.
This is the third year of significant underinvestment in the Russian oil industry, and spending “will remain subdued until at least 2025,” Rystad said.
It estimates Russia will spend $35 billion on its oil and gas sector this year, $10 billion less than in 2021 and below the rock-bottom $40 billion spent in 2020 when COVID-19 shutdowns battered the global economy and upstream spending.
“The stagnation in investments will lead to a drop in project final investment decisions and force operators to make hard decisions on spending,” Rystad said.
The spending tilts toward maintaining oil and gas production, while putting off plans to sharply expand liquefied natural gas (LNG) exports.
Oil and gas spending for maintaining current fields is expected to be down 15%, which is modest considering other sectors, as Rosneft and Gazprom commit a large share of their budget to new fields that will be needed to sustain long-term exports.
“Despite not receiving financing from the supermajor, Rosneft is continuing with its important greenfield projects where BP is a partner,” said Swapnil Babele, a senior analyst for Rystad Energy, who led the spending study.
Rosneft this year commissioned the Kharampurskoye gas field. It is also drilling appraisal wells in its Vostok project expecting to add reserves and building facilities at the field that represent more than 25% of the company’s $12.9 billion upstream budget. It spent $13.1 billion last year, Rystad said.
A large share of Gazprom’s $10.4 billion upstream budget will be used to develop gas condensate reserves in the Yamal Peninsula. Before the war, this gas was earmarked for Europe. Now the plan is to move it to Asia, feeding pipelines now under construction, which will delay the start of sales.
The Russian sector most battered by the sanctions fallout is LNG.
Foreign investment and technology played a key role in projects expected to rapidly expand the capacity of facilities to liquefy gas for export.
The departure of Western investment and expertise has hit the LNG sector particularly hard.
Completion of the Baltic LNG project that Gazprom began in May 2021 will require financing, which Rystad said “will be a struggle for Gazprom.” An added difficulty is that the facility was designed to use LNG technology from Linde, which is among the energy service companies that has exited the country.
“We anticipate that Gazprom will have trouble finding funding for the project in the wake of Russia's invasion of Ukraine. Several service providers have already begun to leave Russia,” Babele said. Among them was Linde, whose proprietary technology was going to be used to liquefy the gas.
TotalEnergies has remained in Russia, where it has a stake in a Russian LNG project led by Novatek. But funding remains a serious problem.
The project partners have already halted all financing associated with Novatek's Arctic LNG-2 project, which was depending on support from foreign investors. For now, it looks like Novatek’s expansion program will be pushed back 5 or 6 years.
In the future, the loss of international partners could limit Russia’s ability in areas too young to estimate the loss at this time.
“Russia heavily relies on foreign companies for advanced technology services needed for complicated offshore exploration activities,” said Babele. “Prior to the invasion, Russia had plans to increase its Arctic exploration. These ambitions will now be delayed due to sanctions and the withdrawal of Western companies as they require advanced equipment and expertise.”