Russia's brief fiscal reprieve from the Gulf war is already coming to an end. A surge in oil prices in the last months looked like it would bail the Kremlin out which is increasingly struggling to pay for the war in Ukraine. But those hopes look short lived as oil prices are already dropping just as Kremlin military spending surges beyond the budget plan.

Following the memorandum to end the war signed by the US and Iran last week, oil prices have fallen back to pre-conflict levels. Exports through the Strait of Hormuz have resumed, depriving the Kremlin of the temporary revenue boost that had eased mounting pressure on the federal budget deficit. While the spike in crude prices generated several months of windfall income, analysts say the gains barely cover Russia's first-quarter budget shortfall and leave Moscow facing a widening financing gap just as military spending accelerates beyond levels set in this year’s budget.

Brent crude fell back to around $74 a barrel this week for the first time since the US and Israel launched military operations against Iran in late February, roughly 40% below the conflict peak. The decline reflects growing confidence that oil exports from the Gulf are normalising after fears that shipping through the Strait of Hormuz would be disrupted.

Secondary market indicators point to a market returning to surplus after the 20mn b/d of Persian Gulf exports were halted by the war return to the market. The spread between front-month futures contracts has narrowed to around $0.15 and moved into contango, where future prices exceed spot prices, Bloomberg reports, traditionally signalling expectations of oversupply. Premiums previously enjoyed by North Sea and West African crude over Persian Gulf grades have also disappeared.

The physical recovery is already visible. According to the International Energy Agency, the UAE had restored 85% of its pre-war oil exports even before Washington and Tehran reached their latest agreement. Vessel traffic through the Strait of Hormuz has tripled over the past week, tankers have resumed broadcasting their positions via transponders and the International Maritime Organization says Gulf states, including Iran, have provided guarantees of safe passage for shipping.

"For traders, the $75-per-barrel mark for Brent represents a comfortable baseline where the bulls have finally run out of steam," analysts at The Bell wrote.

Windfall barely covers one quarter's deficit

For Russia, the timing is awkward. Higher oil prices during the four months of heightened tensions temporarily lifted export earnings and tax receipts. But analysts estimate the windfall generated only RUB21bn ($280mn) in additional revenues in April, RUB175bn in May and RUB202bn in June, with a smaller contribution expected in July.

Combined, those gains are expected to do little more than offset the RUB570bn budget shortfall accumulated during the first quarter.

Even if Brent remains close to current levels for the rest of the year, additional oil revenues are unlikely to exceed RUB1.8 trillion under optimistic assumptions, with median estimates closer to RUB1tn.

Meanwhile, the federal budget deficit has continued to deteriorate. By the end of May it had reached RUB6 trillion, equivalent to 2.6% of GDP, double the level recorded during the same period last year and already 1.6 times the government's full-year target of RUB3.8 trillion, or 1.6% of GDP. Analysts say the full year deficit is likely to come in closer to 3-4% of GDP – double where it is now.

Current Brent prices translate into roughly $61 per barrel for Russia's Urals crude exported through Baltic ports, only marginally above the $59 assumption enshrined in this year's federal budget.

The fading oil windfall leaves the Ministry of Finance with increasingly limited options. With borrowing costs remaining elevated, additional financing is expected to come primarily through increased domestic debt issuance, a policy that risks putting further upward pressure on inflation.

Fuel shortages add new pressure

Russia's budget problems are being compounded by growing disruption to domestic fuel production caused by Ukraine's escalating drone campaign against the country's refineries.

Reuters estimates Russian crude exports through Baltic ports could reach a record 2.7mn barrels per day in June, up from 2.5mn barrels in May. The increase, however, reflects reduced domestic refining rather than higher production.

Rosstat reported that oil refining fell by 13.5% year on year in May as repeated Ukrainian strikes forced refineries to cut output.

The disruption is increasingly feeding into the domestic economy. Reports indicate fuel rationing has spread to at least two dozen Russian regions, while regional airline Azimuth has warned that shortages and rising kerosene prices are making operations uneconomic.

Reuters also reported that Moscow's Kapotnya refinery, one of the capital's most important suppliers, is unlikely to resume operations before the end of the year following a Ukrainian drone strike on June 18.

The government has sought to reassure consumers. Finance Minister Anton Siluanov has insisted there has been no "sharp spike in gasoline prices", while Rosneft chief executive Igor Sechin has proposed allowing lower-grade Euro-3 gasoline to be traded on Russian exchanges.

Analysts warn, however, that importing fuel while maintaining Russia's domestic price-stabilisation subsidies would place an additional burden on an already stretched budget.

Military spending races ahead of plan

The loss of oil revenues comes just as Russia's military spending balloons well beyond official budget assumptions.

According to analysis by Janis Kluge of the German Institute for International and Security Affairs (SWP), Russia spent RUB5.9 trillion on the military during the first quarter of 2026, a 30% increase from RUB4.5 trillion during the same period last year.

The increase was driven largely by classified expenditure, which rose 43% to RUB4.9tn. Classified spending accounted for a record 38.2% of all federal expenditure during the quarter, with Kluge estimating that around 85% of classified spending ultimately supports military purposes.

Military expenditure represented just under half (46%) of total federal spending during the first quarter, meaning almost every second ruble spent by the federal government went towards the war effort.

The scale of spending has surprised analysts because Russia's 2026 budget was supposed to see a reduction in military expenditure to around 6.2% of GDP from 7.8% in 2025. Instead, Kluge estimates that first-quarter spending alone amounted to around 12% of quarterly GDP and warns that if current trends continue military expenditure could reach 9-10% of GDP this year.

Measured against government income, the imbalance is even starker. Military spending during January-March amounted to roughly two-thirds of all federal tax revenues, which totalled only RUB8.3 trillion as lower oil prices earlier in the year, a strong and slowing economic growth weighed on receipts.

Kluge cautions that part of the first-quarter surge may reflect accounting changes, with some classified expenditure delayed from late 2025 into early 2026 in order to meet last year's deficit targets. If so, spending later this year could be moderate. Even allowing for that possibility, however, he argues that the temporary boost from the Gulf war oil price spike "will most likely be rather limited and only temporary, and nowhere near the additional 3% of GDP that Russia would need if military spending actually reaches 9% of GDP."

The reopening of the Strait of Hormuz therefore marks more than the end of an oil-market rally. It also kills off the boon the Kremlin needs to make this year’s war budget balance at a time when the Kremlin is spending more than ever to deliver an elusive victory on the battlefield.