Keeping under the Price Cap: Sanctions against oil have hit the Russian budget but are still allowing for the accumulation of shadow reserves abroad

Russia's revenues from oil exports have plummeted by almost half over the past year, although the volumes have remained relatively stable. Along with the decline in global prices, sanctions have played a significant role in this downturn. However, their effect could have been even more significant as the price cap on Russian oil is yet to be put into effect, according to a group of experts studying shipments from the port of Kozmino in the Russian Far East. Nearly all recent shipments, for which contract prices are known, have exceeded this price cap. A significant portion of these shipments — at least a third — has been carried by vessels owned or insured by EU and G7 companies, but shipping data was falsified or withheld. Although the sanctions have indeed dealt a blow to the Russian economy and reduced budget revenues, the difference between actual and capped prices is deposited in the accounts of foreign subsidiaries of Russian exporters, and the state can tap into this 'shadow reserve,' which is estimated to be roughly equivalent to half of Russia's frozen reserves in the West.

The prosperity of the Russian economy still heavily relies on income from oil exports. In June, Russia exported an average of 7.3 million barrels of oil per day — only 0.1 million barrels less than a year ago, according to the International Energy Agency (IEA) in its latest review of the global market. However, export revenue almost halved over the past year, dropping from $20.4 billion to $11.8 billion. The sharp decline in oil export revenues, in addition to strains on the budget, has led Russia's balance of payments to turn negative, with the ruble weakening against the dollar by 20% since the beginning of the year.

In the second half of this year, the IEA expects global oil consumption to grow by 2.2 million barrels per day (lower than previous estimates), with production expected to increase by 1.6 million barrels per day. To prevent prices from falling, Saudi Arabia is cutting production by 1 million barrels per day, while Russia, which has already reduced its production by 500,000 barrels per day, is promising to cut supplies to foreign markets by the same amount. Along with the decline in world prices, the European oil embargo and the price cap on crude oil and petroleum products set by G7 countries have also contributed to the reduction in Russia's export revenues. However, experts from the Bruegel analytical centre argue that the damage from these measures could have been even greater if the price cap had been implemented more effectively.

The European embargo has forced Russia to sell oil shipped from ports on the Black Sea and Baltic Sea to other buyers at a significant discount. At the same time, the price cap, designed to reduce Russian companies' income from trading with other countries, has not fully achieved its intended effect, according to economists. The data they examined on shipments from the Pacific port of Kozmino indicate that, in January to April 2023, approximately half of the oil — 50.6 million barrels — was exported by ships owned or insured by companies from EU and G7 countries. 24.1 million barrels that exceeded the price cap. In total, 96% of the shipments (76.8 million barrels), for which prices are known in principle, were sold above the price cap — averaging around $70 per barrel. Economists believe that these violations occurred because buyers of Russian oil simply provided fraudulent documents to shipping and insurance companies, which either did not realise this fraud was taking place or turned a blind eye.

The combination of sanctions, price ceilings, and European embargo has significantly impacted Russia's oil export revenues, putting pressure on the country's budget and balance of payments. As the global energy landscape continues to evolve, Russia's reliance on oil exports and its vulnerability to international sanctions remain key challenges for its economic stability.

Experts from Bruegel believe that violations could be reduced if banks start to inform enforcement agencies of the sanctioning coalition countries (such as the US Office of Foreign Assets Control, the UK Office of Financial Sanctions Implementation, and similar bodies in EU countries) about all transactions subject to the price cap. Regulators, in turn, should require insurance and shipping companies from G7 and EU countries to retain all transaction documents. Violations should be appropriately penalised.

At the beginning of this year, independent analyst Sergey Vakulenko warned, in an article for Re: Russia, that a significant portion of oil revenue could be directed to shadow accounts held by exporters outside Russia by circumventing the price cap. The experts from Bruegel have calculated that banks and companies accumulated $147 billion overseas in 2022 (Bloomberg has given a similar estimate).

This amount is comparable to the amount of frozen international reserves held by the Central Bank of Russia, estimatedby the European Commission to be worth over €200 billion. Little is known about where these reserves are held (and in what assets). These funds do not belong to the Russian state but to foreign subsidiaries of Russian exporters or even companies not formally connected to them. However, economists have warned that the authorities could gain access to them. Thus, financial institutions in third countries where these 'shadow funds' are stored should be identified and subjected to sanctions, and the funds themselves should be frozen — just like the international reserves of the Central Bank were frozen.