Russian Producers Fall Into Line on Price Cap

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Russian oil companies appear to be united in following the Kremlin line to stop exporting their barrels under any price cap, however high it could be. They are ready to cut production if required and believe they could make more money on lower volumes sold at higher prices.

This means that Moscow's refusal to play by imposed rules that it says violate market principles would in fact prevail over any economic logic that could emerge if the price cap is set at the levels at which Russian crude is sold now or even higher.

Prices for Russia's Urals crude export blend fell below $60 per barrel discount inclusive this week, on the restrictions in China caused by a new wave of the Covid-19 virus. China has been one of the main buyers of Russian oil, replacing Western customers.

Indications that Russian exports could in fact be considered under the $65-$70/bbl price cap that the EU was discussing but failed to agree on, emerged following comments by the Kremlin's spokesman Dmitry Peskov last week. He said there are a lot of nuances that need to be analyzed and Russia is not going to "to shoot itself in the foot." Peskov added that Moscow had "learnt to be sensible and be guided exceptionally by our own interests."

However, Deputy Prime Minister Alexander Novak is unwavering. "I have said it more than once. Irrespective of what the price cap is — even if it is high — it is unacceptable in principle," Novak told reporters at the Russia-China Energy Business Forum in Moscow this week.

Companies Stand by Kremlin

Novak has been in touch with the Russian companies on the issue. He had a meeting with them in the middle of this month and may have another this week.

Russian companies say that they won't agree to any price cap, at least formally, in their contracts with buyers. According to market payers, they will continue selling under a price formula agreed in their commercial contracts. An insider at one Russian company said that some customers in India were pushing to include a price cap clause into new short-term supply contracts that were inked for 2023, but that clause was rejected.

On a practical level, market players believe that sooner or later a way would be found between oil companies and their customers on how to continue supplies under a price close to the cap if it is set in a $60-$70/bbl range. But that would probably be a compromise between the parties, rather than something reflected in contracts, which market players believe Moscow might watch to ensure that political requirements not to sell under a price cap are met.

Experts also note there is a feeling that Russian companies have lost their interest in Western buyers and have fully shifted their focus to Asian customers.

Production Cuts

Novak has said that Russia is ready to cut production rather than sell under the price cap. How big the cut could be depends on the company. For those that don't possess their own refining capacity the cuts could be sizable. Zarubezhneft has said it could reduce its production by 70% following the introduction of the price cap.

Lukoil could be in a better position because it also has refineries overseas including in Bulgaria and Romania that have been exempt from the oil embargo. Italy also wanted to get an exemption for the Lukoil Isab refinery in Sicily, which would otherwise be nationalized.

Meanwhile, Russian crude oil and gas condensate production rose in the first 16 days of November to 10.839 million barrels per day after a small month-on-month decline in October to 10.742 million b/d, according to sources familiar with the official data. This is only 200,000 b/d less than Russia was producing before it started the war in Ukraine.

The draft of the federal budget for 2023-25 envisaged a production decline of some 5% next year. Other scenarios foresee a 7%-8% decline.

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