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Is Russia weaponizing oil after natural gas misfire?

February 16, 2023

Russia has said it will cut its oil output in response to Western embargoes and price caps. Moscow's move doesn't come as a surprise given the pain inflicted by the sanctions on Russia, but what about its real motive?

A Russian oilfield
Russia's decision to cut oil production in March is an indication of the impact of sanctionsImage: Yegor Aleyev/TASS/dpa/picture alliance

Russia plans to cut its oil production by 500,000 barrels per day starting in March, or about 5% of total current output, in retaliation to Western price caps and embargoes on its exports of crude oil and refined oil products.

While the one-off cut is unlikely to have a big impact on global oil prices in the longer term, further production cuts could drive up prices at a time China's reopening from COVID-19 restrictions is expected to boost oil demand.

That would undermine the price caps backed by Group of Seven (G7) countries that are intended to ensure Russian oil keeps flowing into the global market and prevent any massive spike in prices when their economies are struggling with high inflation.

"Russia might be trying to weaponize oil just like they tried to weaponize natural gas last year," Simone Tagliapietra, an energy policy expert at the Bruegel think tank in Brussels, told DW.

Resilient oil production

Russia's oil production, a major source of revenue for the state, has remained resilient in the face of unprecedented Western sanctions in response toMoscow's invasion of Ukraine. In fact, Russia's average oil output even increased by 1.5% in 2022 to 10.7 million barrels per day from 2021 as Russia successfully rerouted oil shunned by the West to other countries, especially India and China.

However, price caps on Russian oil exports have made it difficult for Moscow to maintain shipments at current levels. Not only are these restrictions forcing Russian producers to sell their oil at massive discounts to the few willing buyers, they are also having to endure high insurance and freight costs amid a tanker shortage.

"By reducing production volume, Russia will turn the market into a seller's market rather than a buyer's market. At least that is one of the things that Russia is hoping for," Bjarne Schieldrop, chief commodities analyst at SEB AB, told DW.

Russian oil firm Lukoil's oil platforms
Russia's oil production, a major source of revenue for the state, has remained resilient despite sanctionsImage: Dmitry Dadonkin/TASS/Sipa USA/IMAGO

Lack of oil storage facilities

Russia has described the output cut as a "voluntary" move, but many experts say Moscow's hand was forced by the sanctions. They had been expecting some output loss, expectations that Russia had managed to defy so far.

At the same time, Russian oil producers are also grappling with a shortage of storage space for their output as tankers are now having to spend more time at sea making deliveries to farther destinations in Asia, as they struggle to find new buyers.

Russia doesn't have enough storage facilities domestically and storing oil abroad in places like Fujairah in the United Arab Emirates, where Russian oil inventories have been rising, is expensive.

"It seems that it has evaluated how much crude and oil products could be sold to those countries [adhering to the price cap] and decided to reduce oil production by the corresponding amount to ensure that Russian oil exports are headed only to India, China, Turkey and other countries that have not joined the cap," said Tatiana Orlova, lead economist at Oxford Economics.

Inflict more pain

The Russian government's budget deficit soared to $25 billion (€23.4 billion) last month, the deepest deficit for January in years, as Western oil sanctions weighed on its finances. Oil and gas revenues nearly halved, dropping 46%, according to data from the Russian Ministry of Finance.

Against this backdrop, experts say Russia has an interest in oil prices going up significantly. That would not only boost Moscow's revenues by making up for reduced exports, it would also inflict further misery on inflation-hit Western economies.

To make matters worse for the West, Russia has the room to cut output further. Russia's early February production stood at 10.9 million barrels a day, but its budget was built around 9.8 million barrels, according to Alexander Isakov of Bloomberg Economics.

"This action [March output cut] might be a first sign of an attempt to exercise pressure on the oil market," Tagliapietra said. "In general, I wouldn't be surprised to see them try and play around with the oil market as they tried to do with gas."

Failed attempt at weaponizing gas

Russia has been called out in the past by the West for weaponizing natural gas. Russian exporter Gazprom cut off most supplies to Europe last year, citing often unconvincing grounds like technical and payment issues.

Western officials saw the cuts as an attempt by Moscow to leverage its position as the biggest supplier of natural gas to the European Union to retaliate against the bloc for supporting Ukraine.

 Russia accounted for around 45% of the EU's gas imports, including liquefied natural gas, in 2021The move heaped misery on the EU as natural gas prices soared to unprecedented levels, driving up inflation and derailing the post-pandemic economic recovery. But the pain has subsided to a great extent.

Europe has managed to replace much of the lost Russian supply from other sources such as the US, Norway and Qatar, easing concerns around blackouts and energy rationing. Gas prices have fallen dramatically, helped by mild weather and lower consumption, even though they remain well above early 2021 price levels.

"The key takeaway from the natural gas event was that weaponizing natural gas was a success, but only for a very short period," Schieldrop said. "So, basically the historical knowledge about weaponizing energy supply is that it doesn't work. Russia is very afraid of weaponizing oil because the effect can be very temporary."

Weaponizing oil is a complex affair

Russia could find it even more difficult to reap rewards from weaponizing oil since it is more fungible and available globally, making it easier for countries to source alternative supplies, as has been the case over the past year.

Then there is the OPEC+ alliance of oil producers, which includes Russia and Saudi Arabia. The alliance has so far decided not to replace the lost barrels resulting from Russia's unilateral decision that sent benchmark Brent crude prices above $85 per barrel.

But their stance could change if Russia introduces further unilateral cuts, driving up oil prices to levels where they start threatening demand. 

"Then you will see potentially a response from OPEC to compensate and then it's just going to result in a loss for Russia," Schieldrop said.

Edited by: Tim Rooks

Ashutosh Pandey
Ashutosh Pandey Business editor with a focus on international trade, financial markets and the energy sector.@ashutoshpande85