Everyone got very excited when the budget numbers for December and January came out and showed huge deficits. New oil sanctions came into effect in both those months and were hailed as a big success, reducing the Kremlin’s income and that this was what sanctions were supposed to do to help end the war soonest.
It hasn’t worked. Revenues did fall heavily in January as Western companies cancelled their Russian oil products orders ahead of the February 5 oil product sanctions. But federal budget revenues surged in June to post a surplus of RUB815bn ($8.6bn) that shaves a trillion rubles off the deficit year to date and puts the overall deficit back under the Ministry of Finance (MinFin) target of 2% of GDP. (chart)
As Chris Weafer and Christof Ruehl, two of the very best experts on Russian oil, told bne IntelliNews in an podcast on oil (worth watching again), the January results were a one off and they expected revenues to pick up again in the rest of the year. Russian Finance Minister Anton Siluanov has said the same thing and is sticking to his forecast for a modest 2% of GDP deficit at the end of the year.
The budget debate is all about numbers so let me give you a brief roundup of the main numbers you need to know.
A 2% of GDP deficit is equivalent to RUB2.9 trillion.
The government already blew past that in the middle of March when the federal budget deficit hit its full year target after the first ten days of March.
There was then a big debate at the end of the first quarter on what the end of year number would actually be with analysts predicting everything from RUB3.3 trillion (Alexander Isakov, head of Russia and CIS macroeconomics at Bloomberg) to RUB12 trillion (Kyiv School of Economics).
More recently Siluanov has become a little more pessimistic and said the deficit could be 2.5% of GDP, or RUB3.6 trillion.
Note that as Russia has some RUB6.8 trillion in the liquid part of the National Welfare Fund (NWF) it can afford to cover the deficit for at least two years just from its rainy-day fund, and that is before it taps the RUB17 trillion of liquidity in the banking sector or simply raises taxes. In an extreme it can also tap the international reserves of $580bn or print money, like the National Bank of Ukraine (NBU) has been doing.
These deficit numbers are all cumulative results, adding up each month’s budget receipts to get the total year to date deficit numbers. However, drilling into the month-on-month numbers a different picture begins to emerge.
The chart shows there was a big fall in January but in the subsequent months the monthly deficit rapidly began to contract (although April was an exception). By May the budget was back in profit, albeit with a tiny RUB13bn surplus for that month.
The big change is that in June the revenues jumped to RUB815bn.
Adding all that up, the budget deficit passed its full year target to top RUB3.3 trillion in May, but since then rising revenues have shaved about RUB1 trillion off the cumulative deficit, bring it back down to RUB2.5 trillion – ie it is now less than 2% of GDP.
And the June revenues of RUB815bn are very big. To put that into context, in good years with high oil prices the budget can make as much as RUB1 trillion in a month (and lose that much in bad months in bad years) but in 2021, the last “normal” year, the budget earned an average of RUB250bn a month and in 2022 the average monthly income was around RUB400bn a month.
So why did revenues jump in June? And will that continue?
The core of Weafer and Ruehl’s argument is that the sanctions did not stop Russia selling oil, just forced it to be sold somewhere else.
Pre-war most of Russia’s oil was sold in Europe. It takes about a week to sail a tanker from the Russian oil ports in the Gulf of Finland to Rotterdam in the Netherlands where the oil goes into the EU’s pipeline system. However, as you must know, now all Russia’s oil goes to Asia instead – mostly China and India. That journey takes about two months.
In January Russia’s oil distribution route was abruptly changed. Revenues stopped as there were no sales after tankers switched from Rotterdam to Asia and it took two months for them to get there before they could unload and get paid. Then they have to steam all the way home again – another two months – before they can pick up more oil and start the journey back.
But once this first cycle has been completed the constant conveyor belt of tankers in Russia’s “ghost fleet” making this round trip means that the oil exports will start to flow again like before. Individual tankers might take a lot longer to get to their destinations (and it costs more) but the overall flow of exported oil volumes becomes the same as before, provided there are enough tankers to carry it, which there are.
And that is exactly what the budget results show us. Revenues collapsed in January as all the tankers set off for Asia, but four months later, when the loop was established, suddenly oil revenues jumped up again as the new customers’ money came pouring in. Moreover, note that last week the discount on Urals to Brent shrank to its lowest level since the war started of about $10, still high compared to the $2 norm pre-war. That is because China and India are paying market rates, minus a bit more than usual for transport.
In other words, Russia has successfully switched its oil trade from Europe to Asia and it now has a smoothly functioning market that can’t be sanctioned and will earn very similar revenues to those it was earning before sanctions. And it did this in only four months – just like Siluanov predicted.
The bottom line is that the oil sanctions have not permanently reduced or capped the Kremlin’s income (other than reducing it a bit thanks to higher transport costs). All sanctions have done is introduce a massive distortion into the business.
What will happen to the budget over the rest of the year? Hard to say as a lot goes into this calculation and it depends heavily on what happens to the price of oil, but with the new OPEC voluntary production cuts prices are likely to stay at the current $85 per barrel and could even go higher.
If oil rises to $100, as the Kingdom of Saudi Arabia (KSA) wants, then the sanctions become more problematic for Russia. Another big hole in the regime is the fact that half of the oil export volumes are being carried by Greek tankers, an EU member, that can do this as technically the oil on board costs less than $60 a barrel and so is not sanctioned at all.
But there is a game to be played here as it depends on where you add in the cost of things like transport and services like insurance. Normally these are added at the start of the journey, where the sanctions cap price is assessed, but you can add them at the end too, where they are not part of the sanctions oil price cap price. As Russia now has its own fleet and insurance companies it can, and is, vigorously playing this game.
This is possible as the gap between the cost of a barrel and the cost of a barrel plus services is still narrow. If the price cap were reduced to say $35, as many have called for, that would create a new headache for the Kremlin, but it is clear that the West is extremely reluctant to strictly enforce the oil price cap sanctions as it fears a self-defeating spike in oil prices more than it wants to punish Russia.
Last thing to say is that June’s RUB815bn of revenues is high as it is due to the first revolution of the new oil transport loop. However, if revenues fall back to the 2022 average of RUB400bn per month Russia will have no deficit at all and even the 2021 level of RUB250bn per month means a deficit on the order of 1% of GDP. At this point it’s looking more likely that the Siluanov will manage to hold the deficit to 2% in total than not, and that the Kremlin will have all the money it wants to spend on the war. The oil sanctions have not worked.
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