Discounted Russian oil prices have started recovering, maintaining Moscow's revenues

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The author thanks Steven Fries and David Wilcox for their advice and comments.

Description

At the beginning of the Russia-Ukraine conflict, the price of Russian crude oil dropped relative to international benchmarks. By the beginning of April, Urals crude, Russia's flagship export blend, was $35 per barrel cheaper than the Brent benchmark oil price, or 34 percent in relative terms. But this discount has since shrunk as Russia has found alternate buyers and Europe prepares for tighter sanctions.

Many European buyers refused Russian oil for reputational reasons. Others incurred difficulties in settlements, shipping insurance, and increased freight rates (essentially a tax on Russian crude) caused by international sanctions against Russia. The heavily discounted Urals price was necessary to compensate buyers for increased costs and risks.

This chart shows, however, that at the beginning of August the discount on Russian oil began to shrink. In fact, it has narrowed by $10.6 per barrel, or from 39 percent on August 1 to 24 percent on August 25.12 One factor driving the recent decline in the Urals discount may be increased European purchases ahead of the European Union's embargo on seaborne imports of Russian crude to be imposed at the end of the year.

Russia's oil output and exports have also returned to pre-conflict levels. According to a recent report by the International Energy Agency (IEA), Russia rerouted two-thirds of its petroleum exports from the European Union, the United States, Japan, and South Korea to India, China, Turkey, and other countries, including new markets. This diversion led the Organization of the Petroleum Exporting Countries (OPEC) to revise its August forecast for Russian oil and gas condensate production in 2022 up to an average of 10.88 million barrels per day (bpd), up from 10.63 million bpd forecast in its July report. Russia averaged 10.80 million bpd in 2021.

With Moscow quickly restoring its export flows and now regaining pricing power, its weekly export duty receipts have been hovering around $160 billion to $180 billion, exceeding some $140 billion in January, according to Bloomberg estimates. If the goal of Western countries in refusing Russian oil was to squeeze the Russian government's revenues, then those actions have so far proved less than successful.

It is uncertain whether and for how long Russia will be able to sustain production at this level—its production is still below its OPEC+ quota—and whether the Urals discount will keep shrinking once the EU embargo on Russian crude comes into effect. The IEA predicts that some 1.3 million bpd of Russian crude will have to find new destinations once the embargo is fully implemented. However, OPEC evidently believes Russia will succeed, for the most part, in finding willing buyers; they predict Russia's oil production in 2023 will decline only 0.4 million bpd relative to 2022.

Notes

1. The actual rebound may have happened earlier but was not registered due to Urals price discovery problems. Thus Argus, a major price agency, mentioned deteriorated visibility (declined transparency) of the Urals market in Europe, because of which the quotes were not updated for a few months.

2. Russia's ESPO blend exported to Asia saw an even earlier and stronger rebound. It is now traded at par with the Dubai benchmark.

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