Were sanctions really effective? 

Yes. Russian oil began to quickly go down in price in December. By the end of the month, the average price of Urals had been $50.4 per barrel (the drop in prices continued in January, too). Some of the oil was being sold at $37 per barrel. For the three months before that, a barrel of Urals was being sold for $20-25 more.

Prices of other grades of oil were going down, too: the average price of Brent was $10 lower in December compared to October. But the price of Urals dropped significantly harder: the difference between Urals and Brent surpassed $30, despite the fact that the gap stayed at the $22-24 level from August to November. Before the Russian invasion of Ukraine, Urals was only $1-3 cheaper than Brent.

The price difference between Urals and Brent grew by about $10 immediately after the new sanctions had come into force on 5 December. The main reason for the Urals price drop, aside from the decrease of worldwide prices, is the European embargo, president of the Institute for Energy and Finance Foundation (FIEF) Marcel Salikhov notes in the conversation with Novaya-Europe.

According to the FIEF estimates, the discount offered for Urals compared to Brent has reached $37 per barrel. The increase of the discount on Urals is mostly connected to the increase in costs of freight to the end customer, FIEF analysts think: it takes 31 days to get from the Baltic ports to India, seven days to Rotterdam, and 3-4 days to Poland. Furthermore, it is also a payment for the risk the transporters of Russian oil take upon themselves. The freight cost is put into the discount, Salikhov explains.

Russia exports other grades of oil, not only Urals. In particular, the Eastern Siberia–Pacific Ocean pipeline oil, which is mostly exported to China. This grade is still being sold without any substantial discount in comparison to Brent, the analysts note. But the share of this export is not large; 70-80% of physical oil deliveries come from cheaper Urals, Salikhov notes.

Furthermore, the maritime oil export from Russia has not showcased a stable trend of decreasing as of now. In the past four weeks, maritime supplies of oil have been on the same level as in the second half of 2022, Bloomberg reported on 23 January. Flows of Russian oil have been redirected to Asia — mainly to India and China, Salikhov explains.

“Russian companies have to look for other buyers, those were possibly drawn to the big discount,” he says.

The December drop did not have a big impact on the annual results. In 2022, oil production in Russia grew by 2% and oil export by 7%, Vice Prime Minister Alexander Novak previously said.

So the budget withstood the hit?

By the end of December, the budget saw a record-breaking monthly deficit estimated at 3.8 trillion rubles (€49.4 billion). The problem is not only the embargo: the budget expenditure basically tripled in December. The reason being that many budget-related spendings are postponed to the end of the year.

Furthermore, there was a surplus from the previous months (557 billion rubles, or €7.2 billion). The average price of Urals in January-December 2022 was $76 per barrel — $7 more than in 2021. This is how the Russian federal budget fulfilled its annual revenue plans.

The budget revenue in 2022 amounted to 27.8 trillion rubles (€361.4 billion) — 100 billion rubles above the plan. Oil and gas revenue grew by 27.9% in 2022. All other revenue increased by 0.1%.

It is important to note that the dividends from the record-breaking revenue of Gazprom were also counted in the oil and gas revenue. Furthermore, the government seized Gazprom’s money that the state company had earned before the war. Gazprom paid the government an additional 1.2 trillion rubles (€15.6 billion) in mining taxes — half of its 2021 profit.

Still, the budget expenditure in 2022 ended up being 2.2 trillion rubles (€28.6 billion) higher than planned. Russia’s Finance Ministry revised its assessment of the deficit three times. At the end of September, the expected deficit was estimated at 1.3 trillion rubles (€16.9 billion), which is 0.9% of GDP. On 8 December, the ministry revised its assessment once again, estimating the deficit at 2.9 trillion rubles (€37.7 billion), which is 2% of GDP.

The actual deficit was even higher: in 2022, the federal budget received 3.3 trillion rubles (€42.9 billion) less than needed, or 2.3% of GDP. This may indicate that the sudden drop in oil prices was a surprise for the Ministry of Finance.

What about budget reserves?

To make up for the deficit, Russia’s Finance Ministry issued federal loan bonds and used the funds from the Russian National Wealth Fund. In total, 4 trillion rubles (€52 billion) of the fund’s money were spent in 2022. Over a trillion went to support state corporations by the way of purchasing stocks and bonds. Among the state companies are Russian Railways, Aeroflot, and the Federal Road Agency. During last year, the “liquid” part of the National Wealth Fund (as in, the part not invested into projects) shrunk to 6.1 trillion rubles (€79.3 billion).

The term “liquid” for the uninvested part of the fund is a leftover from the past: after the introduction of sanctions against the Central Bank, dollars, euro, pounds, and yen on its accounts were frozen. To “spend” them, the fund’s money is virtually deducted, and rubles are printed instead. Yen has become the main currency of the National Wealth Fund; it will play a big role in compensating for the shortage of the budget.

This is the only foreign currency used by the National Wealth Fund that had not been sanctioned, leading economist on emerging markets for Oxford Economics Tatiana Orlova explains.

“There are no other ways to conduct currency interventions, there’s not much to be spent. There’s also gold, but the West sanctioned it. It can be sold only to friendly countries. It’s not very liquid, it could bring about secondary sanctions, so China is not very keen on buying our gold for these reasons,” Orlova says.

According to the end-of-the-year data, the National Wealth Fund was storing 309 billion yen — about 3.1 trillion rubles, or €40.3 billion — which is about half of the fund.

In the middle of January, the Central Bank announced that it would start selling the fund’s yen. The money will be used to make up for the under-received oil and gas revenue, the Ministry of Finance explained. The sales will be carried out in accordance with the new budgetary rule. The rule stipulates a target plan on oil and gas revenue that amounts to 8 trillion rubles (€104 billion) per year. The shortage will be made up through the sale of currency belonging to the fund.

“Currency interventions have started happening now because the oil price is lower than the one assumed in the budget, so the revenue has to be compensated with money from the National Wealth Fund. At the same time, it supports the ruble’s standing so it doesn’t continue getting weaker and doesn’t contribute to the growth of inflation,” Orlova notes.

In January, Russia’s Ministry of Finance plans to sell 54.5 billion rubles (€708.5 million) in yen but it admits that the amount of the under-received revenue could end up being a higher number due to the fall of gas export.

For how long will Russia be able to fund the war? 

As of now, it is hard to make confident predictions due to the fact that sanctions on oil products will come into force in February, Salikhov and Orlova say. Their assessment is that the sanctions will hurt export deliveries more than the previous restrictions on crude oil and will lead to reduced oil production.

In 2021, about half of the Russian oil products export went to Europe. For example, almost all of the fuel oil produced in Russia went to Europe, Salikhov notes. In total, Russia exported $70 billion worth of oil products in 2021.

Russia’s oil products are more vulnerable to sanctions because the logistics of their deliveries are more complicated, Salikhov explains.

“An average tanker that transports oil products is about 3-4 times smaller than a tanker that transports crude oil. So, the logistics are more expensive. Russia’s main markets right now are China and India; these countries have their own quite big oil refining [industries]. They’re interested in buying crude oil with a discount and then refining it,” he says.

As a result, Russian companies can partially opt out of oil refining and will sell crude oil.

“It’s quite possible that crude oil export will remain stable but oil extraction will decline due to the decrease in production of oil products,” Salikhov continues.

Using the Finance Ministry table with the analysis of scenarios involving oil and gas revenue (depending on the production rate and the price of Urals), one can estimate the approximate budget deficit. The calculations assume that $1 equals 68.3 rubles.

The United States Department of Energy and the International Energy Agency predict that by the end of 2023, oil production in Russia will have gone down from 10.7 million barrels per day to 9.5 million barrels per day. With a barrel of Urals going for $60, the Russian budget will under-receive 600 billion rubles (€7.8 billion), if it is sold at $50 per barrel the deficit will amount to 1.6 trillion rubles (€20.8 billion), and with the current $45 per barrel it will go up to 2.2 trillion rubles (€28.6 billion).

The deficit could grow even more due to the additional budget expenditure, primarily, on the war. According to Novaya-Europe’s estimates, additional 2-3 trillion rubles (€26-39 billion) could be needed for payments to mobilised servicemen and compensations for injury or death in combat. However, these numbers are very hard to predict.

“We can’t take into account different horrible scenarios, escalation, new mobilisation waves. If the situation continues to worsen, then bigger military expenditure will have to be assumed in the budget,” Orlova says.

For example, if the expenditure turns out to be higher than the planned one by at least one trillion rubles (€13 billion), the Urals price remains at the current level, but oil production decreases to 9.5 million barrels per day, the budget deficit will double — from the currently-planned-for 2.9 trillion rubles (€37.7 billion) to 6 trillion (€78 billion).

This is roughly the same as the amount of yen saved up in the National Wealth Fund and the state’s federal loan bonds in 2022. To make up for this deficit, the government will have to either sell all yen in its reserves (so, almost all of foreign currency) or start borrowing significantly more. Last year, the Finance Ministry already borrowed 3.3 trillion rubles (€42.9 billion) through federal loan bonds — 700 billion rubles (€9.1 billion) more compared to the previous year.

How else can authorities ‘patch holes’?

Urals at $50 is quite a dangerous price for the budget in its current structure, so the government will have to take additional measures, Orlova speculates. She acknowledges that if the Central Bank had not started conducting yen interventions, then possibly it would have had to issue more federal loan bonds.

“The big volume of federal loan bonds has to be paid for with high rates. Which also increases the strain on the budget. It’s an expensive measure. It’s wiser to combine loans and spending from the National Wealth Fund,” Orlova explains.

If the Urals price does not increase, the government will probably have to decrease the budget expenditure in the second half of 2023 or 2024, the expert thinks. According to Bloomberg, as of now the government plans to only cut down 150 billion rubles (€1.95 billion) of expenditure, all of it not related to defence.

Furthermore, the government has other ways of finding additional money. For example, they can repeat the scenario of seizing Gazprom’s earnings.

“There are still enough companies [to take money from]. One can easily imagine the government gathering up the leaders of big companies and saying: ‘So, guys, you earned a lot of money, it’s time to share’,” Orlova says.

Despite the drop in European exports, there is still some money to be seized from Gazprom, too, Salikhov speculates.

“There are still exports to Turkey, China. Two thirds of gas are consumed domestically. There won’t be any additional seizures or big dividends, but Gazprom will still have some profit coming in. Additionally, they can raise prices domestically. For example, the government raised them by 8% on 1 December,” he says.

The government has already approved a change in tax legislation that will allow it to collect several more trillion rubles from oil and gas companies in the next three years. In particular, there are plans to tax Gazprom an additional 600 billion rubles (€7.8 billion) annually. Other changes include raising the mineral extraction tax and the tax rate on profit of LNG producers — from the current 20% to 34%.

The government also plans to “mobilise” funds of coal and fertiliser producers using one-time payments and higher dividends, Bloomberg reported.

“There are other sectors of the economy that could be made to share, for example, imposing a one-off tax. It will be easier to decide at some point ‘by agreement’. If they do it on a one-off basis, it will hurt companies’ willingness to conduct any business in Russia less,” Orlova reflects