Russia’s Shrinking Budget Surplus Limits Putin’s War Options - Global recession a bigger risk to Russia’s oil revenue than price cap
WSJ: Russia’s Shrinking Budget Surplus Limits Putin’s War Options
As its budget surplus melts away, so does the Kremlin’s ability to support the embattled economy and fund its offensive in Ukraine
Russia’s war in Ukraine and the sanctions it triggered are depleting Moscow’s coffers, hurting President Vladimir Putin ‘s ability to support the economy and fund the military.
Data released by the Russian Ministry of Finance on Friday showed that in the year to October, the government budget surplus stood at 128 billion rubles, or around $2.1 billion, down from a surplus of 2.3 trillion rubles in the same period last year. In October, revenues from a one-off energy tax helped prevent the budget from veering into a deficit for the year, which economists expect to happen by the end of the year.
The government’s shrinking fiscal runway adds pressure on the Kremlin, which had been using ample energy revenues earlier this year to stimulate industry, placate the domestic population and finance the war. It comes amid mounting setbacks on the Ukrainian battlefields for the Russian army, which was forced to withdraw from the key southern city of Kherson.
Softening energy prices in recent months and Moscow’s move to throttle its gas exports to Europe have taken a toll on public finances because oil and gas sales make up the bulk of Russian state revenues. Mr. Putin’s decision in September to mobilize around 300,000 men has further strained the budget, analysts say.
“The Russian economy is under pressure from multiple fronts at the same time,” said Janis Kluge, an expert on the Russian economy at the German Institute for International and Security Affairs. “The economic crisis and the lower exports of oil and gas means that Russia will have a hard time making ends meet next year.”
Analysts at Capital Economics forecast that the budget will register a deficit of 1.8% of gross domestic product for 2022 as a whole. The budget deficit is expected to grow to 2.5% of GDP next year and to 4% in 2024, according to the forecast. The Russian government itself expects to run a deficit at least until 2025.
While Western countries routinely run large budget deficits they can finance on global markets, sanctions have mostly cut off Russia’s access to external funding.
The darkening prospects come after the Russian economy showed signs of stabilizing over the summer. GDP is expected to shrink between 3% and 3.5% this year, according to recent forecasts by the country’s central bank, a shallower decline compared to forecasts earlier in the year after sanctions dealt a body blow to the economy.
Quarterly data, however, depicts a worsening trend. While the economy contracted by around 4.1% and 4% in the second and third quarters respectively, it’s expected to shrink by 7.1% in the fourth quarter, according to a report by the central bank published this week. For the year as a whole, Russia is expected to record the deepest recession for any large economy.
While softening energy prices are threatening revenues, expenditures have been growing rapidly. The Ministry of Finance hasn’t published a detailed breakdown of spending since February, but Olga Bychkova, an economist at Moody’s Analytics, estimated that expenses on national defense, social transfers to offset high inflation, and other steps supporting the economy make up the biggest share.
The fiscal outlook is further weighed by the looming European embargo on Russian oil and the Group of Seven’s planned oil price cap intended to limit Moscow’s energy revenues. The budget is also feeling the pinch from the ruble’s strength, which lowers the local currency value of tax revenues.
Mr: Putin’s decision to draft hundreds of thousands of men for his war, meanwhile, has disrupted businesses, diminished labor supply and added new costs for equipment for the extra recruits.
Russia’s central bank said last month that the mobilization “will serve as a deterrent to consumer demand and inflation over the horizon of coming months.” The Russian Union of Industrialists and Entrepreneurs reported last week that a survey taken in October of more than 100 companies—most of them large firms—showed a decline in their workforces due to the troop mobilization.
“Mobilization is taking its toll, undermining business and consumer confidence and exacerbating labor shortages,” Mr. Kluge said.
Economists at the Vienna Institute for International Economic Studies forecast that the mobilization would deepen the recession in the fourth quarter and shave off 0.5 percentage points of GDP growth for the full year.
The government has been supporting the purchasing power of average Russians through hikes in social entitlements, such as pensions and support for families with small children. As a result, the share of households directly dependent on payments from the state—pensioners, public sector employees, welfare recipients—has continued to increase, analysts said.
At the same time, public sector spending on infrastructure will be cut in order to keep the budget deficit in check, according to a recent report by the Bank of Finland Institute for Emerging Economies.
“The overall result is that the government’s financing needs are likely to increase much more into next year, which will put pressure on the government,” said Liam Peach, an economist at Capital Economics.
To plug the budget gap, the finance ministry has said it would tap into the National Welfare Fund, Russia’s main sovereign wealth fund, to the tune of 1 trillion rubles to finance government spending. The government could also ask state-owned banks to hold more government bonds and raise taxes on the energy sector, Mr. Peach said.
The real extent of the hole in Russia’s budget will become clear in December, analysts said. Russia’s expenditures at the end of the year are usually much higher than in earlier months, Mr. Kluge said.
“The outlook for next year is much worse because one-time effects of windfall revenues in the early months of the war will be exhausted,” Mr. Kluge said.
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Reuters. Column: Global recession a bigger risk to Russia’s oil revenue than price cap
By John Kemp
LONDON, Nov 11 (Reuters) - Russia's oil export revenues are at much greater risk from a global economic recession than the price cap being planned by the United States and the European Union.
Recession is a sure-fire way to reduce Russia’s earnings from the export of crude, diesel and other refined products.
If there is a global economic slowdown in 2023, Russia’s export revenues could fall by between a third and a half, based on experience over the last two decades.
U.S. and EU policymakers will not deliberately plunge their economies into a recession simply to intensify the economic pressure on Russia; privation is not an attractive option in electoral politics.
But if their economies go into recession anyway, which currently appears probable, Russia’s export revenues will fall sharply.
The G7 and European Union's planned price cap on Russia’s exports of crude from Dec. 5 and products from Feb. 5 represents an attempt to achieve the same reduction in revenues without tipping economies into recession.
RUSSIA’S OIL REVENUES
Russia’s crude export volumes were broadly steady at between 220 million and 260 million tonnes per year between 2004 and 2021, according to trade statistics compiled by the United Nations.
Product exports more than doubled from 81 million tonnes in 2004 to 186 million tonnes in 2016 but have since settled back to around 145 million tonnes per year since 2018.
Revenues were much more variable and correlated closely with the price of Brent. Russia’s annual earnings peaked between $263 billion and $283 billion per year in the period of very high prices between 2011 and 2013.
They dropped to $140 billion in the recession of 2009; $130-$165 billion during the volume war and mid-cycle slowdown of 2015-2017; and $118 billion during the first wave of the coronavirus pandemic in 2020.
Like other major oil exporters, Russia’s revenues are strongly pro-cyclical, getting a double boost in booms from higher volumes and prices, and taking a double hit in slumps from lower prices and shipments.
Chartbook: Russia’s petroleum exports
MARKET SEGMENTATION
If the proposed crude price cap was set at around $70-75 per barrel, with appropriate mark-ups for refined products, it would result in revenues close to the average for the decade between 2012 and 2021.
For U.S. and EU policymakers, it is clearly a superior option, but there are concerns about whether the cap is workable.
The cap depends on segmenting the global market into separate markets for sanctioned and non-sanctioned petroleum, with different prices prevailing in each for what is essentially the same product.
Businesses routinely segment markets to charge different prices to customers based on characteristics such as customer type, age, gender, ability to pay, stickiness, order size and ability to access alternatives.
In this case, U.S. and EU sanctions, including on the provision of maritime, payments and insurance services, are intended to ensure the segments remain separate.
Sanctioned petroleum could only be traded freely below the price cap while unsanctioned petroleum could be traded at any price, including prices well above the cap.
Sanctions regulations will be designed to ensure sanctioned petroleum cannot be transferred across the barrier to become unsanctioned petroleum.
Like any business that tries to maintain segmented markets, however, the barrier will come under greater pressure the wider the price gap between the two markets.
If the crude cap is set at $60-65 per barrel, while unsanctioned crude trades at $120, the incentives for circumvention will be enormous.
If the cap is set at $75-80, while unsanctioned barrels trade at $85-90, the segmentation will be easier to maintain.
SETTING THE CAP LEVEL
The effectiveness of market segmentation will therefore depend on (a) the level at which the caps are set; (b) prevailing prices for unsanctioned crude and products; and (c) the intensity of sanctions enforcement.
A low crude price cap of $60 per barrel would reduce Russia’s revenues aggressively, but could be hard to sustain if prices for unsanctioned oil rise above $100 again, and rely on intensive enforcement.
A high price cap of $80 would have much less impact on Russia’s revenues, but be easier to sustain if prices stay around $90-100, and might be largely self-enforcing.
Prevailing prices for crude and refined products are changing all the time, so caps would need to be adjusted regularly to maintain the same level of segmentation with the same level of enforcement.
Policymakers would also have the option of flexing the intensity of enforcement to make the barrier between the two market segments more or less porous.
For example, with crude prices currently at $90-100 per barrel, policymakers could opt for a low cap of $60 but a relatively relaxed approach to enforcement, or $80 with stricter enforcement.
The options look very different but the practical outcome might be the same: a lower cap enables policymakers to appear tougher while relaxed enforcement eases the practical barrier.
Recession and price capping turn out to be complementary approaches rather than substitutes for reducing Russia’s oil revenues.
Recession would lower prices for unsanctioned petroleum, making it easier to enforce a lower cap. If recession is averted and prices rise, it will become much harder to maintain a low cap without more enforcement.
RUSSIA AS MARGINAL PRODUCER
Sanctions on oil producers are easiest to introduce and enforce when the market is characterised by excess production and excess production capacity.
In the last three decades, sanctions on Iraq, Libya, Venezuela and Iran were all introduced when the market was in surplus and/or alternative supplies were available.
But the market is currently in deficit and alternative suppliers such as U.S. shale firms and Saudi Arabia have been either unwilling or unable to increase production.
Russia accounted for 13% of global production in 2021, and an even higher share of crude traded by tanker, much higher than Iraq, Libya, Venezuela or Iran at the time they were sanctioned.
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At present, the marginal barrel in the global market comes from Russia, and the terms on which it is made available will set prices for all other producers and consumers.
If Russia declined to sell some or all of its exports at the capped price, it would worsen the global shortage, and send prices for unsanctioned oil surging higher.
Even a reduction in Russia’s crude exports of 1-2 million barrels per day would likely send prices surging back above $100 and potentially much higher.
Shortages of diesel and other middle distillates are even more severe than for crude and consumers rely heavily on Russia for them.
RECESSION AND ALTERNATIVES
In the event of a recession, consumption of crude and diesel would be hit, reducing the call on Russia’s crude exporters and refineries.
In the limit, if oil consumption fell by an (improbable) 8 million barrels per day, equivalent to a deep depression or the first round of coronavirus lockdowns, consuming countries would not need Russia’s petroleum at all.
Even a more plausible drop of 2 million barrels per day, equivalent to a deep recession, would significantly erode Russia’s market power.
Recession remains an extremely unattractive option for U.S. and EU policymakers. The alternative to reduce reliance on Russia’s exports is to encourage alternative sources of supply.
The need to make sanctions policy workable at an acceptable cost explains why U.S. and EU policymakers have shown interest in easing sanctions on Venezuela and kept alive the prospect of a nuclear deal with Iran.
It also explains why the Biden administration has pressed stridently if ineffectively for more domestic crude production and diesel output from U.S. refineries.
Related columns:
- Recession would make tough oil sanctions on Russia more likely (Reuters, July 14)
- Oil market confronts U.S. and EU policymakers with unpalatable choices (Reuters, June 29)
John Kemp is a Reuters market analyst. The views expressed are his own
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Kherson reclaimed. What will Ukraine do next, and will Russia lose Crimea?
Kherson reclaimed; what’s next?
On November 11 the Ukrainian army entered Kherson, which had been under Russian occupation since the beginning of March. Thousands of people celebrated this event in the main square, dancing and thanking the military. They tore down billboards with the inscriptions “Russia is here forever”, with the yellow-blue flag all over the city.
With the advance of the Ukrainian army to Kherson the entire Nikolaev region was liberated, except for part of the Kinburn peninsula. The water conduit through which drinking water reaches Nikolaev came under the control of the Ukrainian army, and restoration work will begin after clearing the surrounding area.
The Ukrainian military liberated about 3,000 square kilometers in the south of their country in one day. Ukraine has increased the area of liberated territories tenfold.
What Russia Says
The official representative of the Russian Defense Ministry, Igor Konashenkov, said at a briefing that during the retreat from Kherson to the left bank of the Dnieper more than 30,000 Russian soldiers, about 5,000 pieces of weapons and military equipment, and various properties were withdrawn.
The statement says that not a single piece of equipment or weaponry was left for the enemy. But this is still difficult to confirm.
Also, presumably, several thousand Russian military personnel have changed into civilian clothes and remain on the right bank. “Most likely they are trying to retreat as the Ukrainian military advances, but there is also the possibility that some Russians intend to conduct guerrilla operations in small groups,” writes ISW.
Putin’s spokesman Peskov said that the withdrawal of the Russian army from Kherson does not change anything, the city remains part of Russia, and there is nothing humiliating about the withdrawal of troops. The occupying authorities appointed the city of Genichesk as the new administrative capital of the Kherson region.
As early as November 9, the main pro-government channels in Russia broadcast an official video in which General Sergei Surovikin reported to Russian Defense Minister Sergei Shoigu about the need to “regroup forces and take up defense on the left bank of the Dnieper.” After that, Russian TV channels have simply not touched the topic of retreat from the Kherson region at all.
Blown up bridges
After withdrawing from the right bank the Russian military destroyed the Antonovsky bridge across the Dnieper and blew up the railway bridge. Heating stations, a television center and other important facilities were blown up in the city. There is no electricity in Kherson, and the connection is provided only from the left bank of the Dnieper.
By destroying the bridges the Russian military hopes to block the advance of Ukrainian troops into the central part of the Kherson region. Satellite images also show that Russian troops have prepared the first and second lines of defense south of the Dnieper and are likely to continue efforts to strengthen positions on the left bank in coming days, writes the American Institute for the Study of War (ISW).
Mines
It is reported that everything is mined, from roads to administrative buildings and schools. Therefore the Ukrainian authorities urged the departed residents of Kherson and the region not to rush to return home. Moreover, communications have been destroyed.
The Ukrainian police began “stabilization measures” in Kherson. In fact this is a clearing of the territory, and it will last several weeks.
Representatives of the Geneva International Demining Center believe that one month of intense hostilities means exactly one year of demining activities.
Eight months of active hostilities in the Kherson region is eight years of further demining. Ukraine today is one of the most mined countries in the world.
Outstanding victory
US National Security Adviser Jake Sullivan said: “It looks like the Ukrainians just won an outstanding victory. The only regional center captured by Russia in this war is now again under the Ukrainian flag — and this is quite remarkable.
French President Emmanuel Macron tweeted on the evening of November 11: “Congratulations on the return of Kherson to Ukraine, this is an important step towards the full restoration of its sovereign rights. France will continue to support Ukrainians and Ukrainian women.” This was also tweeted in Ukrainian.
What will the Armed Forces of Ukraine do next and can Russia lose Crimea?
It is logical to assume that the Ukrainians are not going to cross the Dnieper — for then they, and not the Russian army, will be cut off from supplies.
Republic experts believe that “the Ukrainian defense forces are now likely to take an operational pause and bring up air defense, artillery, and armored vehicles. By this time, they will be supplied with ammunition, shells and rockets.”
HIMARS can operate at a distance of up to 80 km, and they will destroy all Russian warehouses and bases in the south of the Kherson region.
But in the short term Kherson will face the fate of Nikolaev, Nikopol, Zaporozhye, Kharkov, Kramatorsk, Slavyansk and Bakhmut — the city will probably be heavily bombed. Russia is at war with civilians by using artillery, multiple rocket launchers and S-300 missiles against them.
There is no electricity in seven regions of Ukraine and there is no clarity on when the electricity supply will be restored. Russia has launched a series of massive strikes on Ukraine’s energy infrastructure over the past month.
Already about fifteen countries are helping Ukraine with the restoration of energy infrastructure.
But it is extremely difficult to weather these bombings. The only option for the Ukrainian army is to expand the buffer zone — that is, to move forward.
An adviser to the Office of the President Arestovich said that there would be no linear counter-offensive from Ukraine; other ways and options would be used to de-occupy the southern regions of the Kherson region.
For example, in the next tranche of military-technical assistance from the United States there will be at least 40 armored boats.
Fierce fighting continues in eastern Ukraine. It is reported that the Russian command is throwing a huge number of mobilized people under Ukrainian tanks and artillery.
On November 11,the President of Ukraine announced a fundraiser for the creation of a flotilla of sea drones to cope with Russian missiles, some of which are launched from ships in the Black Sea. Funds were collected for the first drone on the same day.
On different sections of the Ukrainian-Belarusian border, they have begun to build walls to protect against invasion.
Crimea has thus become the front. There are explosions from time to time in its various regions, primarily where the military activities of the Russian army take place. Russian generals probably understand that after the liberation of Kherson and the south of the Zaporozhye region, the Ukrainian army will bring their counteroffensive further. This has also been stated by Zelensky himself.
The head of the Main Intelligence Directorate of the Ministry of Defense of Ukraine, Kirill Budanov, gave the following forecast in early autumn: liberate Kherson at the end of November, reach the borders on February 23, 2022 by the end of the year, and liberate the entire territory of Ukraine by the end of May 2023.
About the same forecasts were made by the former US Special Representative in Ukraine, Kurt Volker, and the former commander of the US Army in Europe, Ben Hodges. If three officials with name and authority unanimously speak about the same dates, we can assume that this is settled strategy.
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...It's Sunday. Wishing you all the best. UvM
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