Events and trends in the Russian Federation over the week of December 10-16th
1.On December 5th, the EU embargo on sea deliveries of oil by Russia and the limitation of the price of Russian G7 oil to $60 / per barrel came into force. In addition, by the end of the year, Germany and Poland plan to abandon Russian oil, which received oil through the Druzhba oil pipeline but is already beginning to receive diversified supplies by sea. These sanctions are designed to deter Russia from the war against Ukraine. However, Russia also announced its intention to take retaliatory actions that could affect the market balance and prices.
2.It is quite natural that the Russian Federation’s authorities threatened to retaliate against the countries that will apply the price cap. In the Russian Federation, two options were discussed: establishing a lower limit on the price of exported oil at the legal level or prohibiting the sale of oil to countries that will impose price caps. However, for now, there has yet to be an official decision on the response to the embargo and price restrictions.
China acts in its own interests, and the basis of relations with both Russia and Saudi Arabia is the energy security of the country and the weakening of the influence of the United States. For China, cheap oil from Russia is an opportunistic convenience, while oil from Saudi Arabia is a safer long-term bet.
China perfectly understands the impasse of Russian oil suppliers and has all the leverage; and is starting to diversify its oil supply and wants to reduce Russia’s influence and dependence on it. This will worry Russian manufacturers, who are unlikely to be able to influence the situation in any way due to the impossibility of returning to their European market in the near future. From all this, we can say that Russia will never return to the world’s leading oil trade position.
3. The microelectronics market in the Russian Federation, despite the statements of a number of officials of the Ministry of Economy and increased funding through a specific state program and a state program to support exports, does not show signs of recovery. In particular, according to the consulting agency “Yakov and Partners”, the production of chips in Russia is three times smaller than the needs of the Russian economy, even in the basic segment (technological process 90 nm and above): with a need for 340-360 thousand wafers, approximately only 88-90 pieces are produced (annually).
The Kremlin is trying to find a way out of the situation by directing funds to joint projects on “import substitution” to the Eurasian Economic Union countries and moving the negotiations on the production of chips in the PRC, or on the import of Chinese developments, from a standstill.
Russian microelectronics: China will not help
Scarcity and clan wars
The microelectronics market in the Russian Federation, despite the statements of a number of officials of the Ministry of Economy and increased funding through a specific state program and a state program to support exports, is not recovering. In particular, according to the consulting agency “Yakov and Partners”, the production of chips in Russia is three times smaller than the needs of the Russian economy, even in the basic segment (the technological process of 90 nm and above): with a need for 340-360 thousand wafers, approximately 88-90 pieces are produced (annually).
Existing capacities allow covering more than 80% of demand (current) and produce 26-28 thousand plates per month. However, as we noted in previous reviews on this topic, the problem is complex: the Russian Federation is experiencing a shortage of rare minerals (necessary in the production process), as well as an acute shortage of qualified personnel, which only intensified in light of population’s migration after the announcement of mobilization.
Thus, operating companies are focused on covering critical needs, primarily of the defense complex. They work on an old technological process – the possibilities of manufacturing chips using 65 nm technology and below are critically small (approximately 3% of needs).
Another factor affecting the potential is the shortage and lack of in-house production of lithographic equipment. There is a struggle for the existing technological lines between state corporations, which expect to direct part of the financial flows of state programs to themselves.
In fact, a group of technocrats is trying to enter the scene and, in the future, control investments under the microelectronics development program in Russia. In this case, we are talking about a cash flow of 3-4 trillion Russian rubles over the next five years. However, the success of the Gref-Kirienko group in this direction will not eliminate the systemic problems of the industry:
- lack of technology;
- shortage of equipment;
- shortage of qualified personnel;
- and, as a result, a shortage of microelectronics in Russia.
The way out of the situation is the search for external partners and, in the near future – the production and sale of the range of chips necessary for the Russian Federation. Later on – in the supply of equipment and help in training personnel.
The Kremlin is trying to find a way out of the situation by directing funds to joint projects on “import substitution” to the Eurasian Economic Union countries and to move the standstill negotiations regarding the production of chips in the PRC, or on the import of Chinese developments.
China is in no hurry to help
Earlier in reviews, we touched on the topic of the Chinese direction. The PRC refused to place orders for the production of Russian processors of the KomBat, Baikal, and Elbrus families at its production facilities. More precisely, Chinese manufacturers promised to consider the request in 2023. Similarly, the supply of military and space-class chips to Russia was actually stopped.
Last week, there was information about Xi Jinping’s order to intensify cooperation with the Russian Federation. Part of the Ukrainian mass media managed to declare that the People’s Republic of China is thus moving to a policy of supporting Russia. Indeed, China intends to invest serious money in the Russian economy and increase trade volumes. However, if we analyze the logic of Chinese participation, it is more about linking the Russian economy to the Chinese economy. That is, about the transformation of the Russian Federation into a satellite of the PRC. In particular:
- China intends to invest in Russia’s transport infrastructure, but only along the Belt and Road Initiative.
- China is increasing imports of goods from the Russian Federation. But it is primarily about the supply of raw materials: hydrocarbons, fertilizers, ores, and grain. Moreover, at 20-30% less than world prices.
- China is actively working on developing its exports, seeking to occupy the niches vacated after the departure of European and American companies. In particular, there are 15 brands left in the automobile market of the Russian Federation, of which nine are Chinese. The same happens in the energy, consumer electronics, and light industries.
Thus, it can be argued that the People’s Republic of China pursues a policy of increasing its influence on the Russian economy, turning the Russian Federation into its raw material appendage, but is in no hurry to promote Russia’s technological development.
What about the neighbors of the Eurasian Economic Union?
Another direction is stimulating joint programs with the Eurasian Economic Union partners. One of these is Kazakhstan, which under Tokayev, is trying to form its own electronic industry in cooperation with China. However, the implementation of serious projects in the country rests on the same shortage of qualified personnel, limited technological base, and the position of Chinese partners. Simply put, before the changes in the policy of the People’s Republic of China in the Russian direction, the probability of even organizing flows of “grey imports” of Chinese electronics through Kazakhstan is unlikely. Therefore, the participation of Kazakh companies today is an increase in the supply of GPS trackers to the Russian market.
The situation with Belarus is somewhat different. The country has its own production base of microelectronics. At least five companies manufacture chips using the 90nm process and above. This includes the ability to produce a limited range of military-class elements (the Russian Federation lost this opportunity at the turn of 2010), and most importantly, it has its own production of a complete set of equipment for the production of chips using the 65 nm process and above.
The Russian Federation intensified cooperation with Belarusian enterprises, which are primarily part of the State Military Industry. A significant part of the investment package “for import substitution” for USD 1.5 billion, which was recently announced in Minsk and Moscow, will also go to developing capacities in microelectronics.
A way out for the Russian Federation may be an attempt to “push” Lukashenko on the track of implementing “union programs” regarding integration, especially since one involves cooperation in the field of electronics. If the Russian Federation buys a Belarusian asset (or creates a joint venture), it will be able to obtain technologies and a production base together with personnel. However, since Minsk is in no hurry to agree, this topic will undoubtedly become one of the points of negotiations between Lukashenka and Putin on December 19th.
Expected consequences of the embargo on sea supplies and price restrictions on Russian oil
On December 5th, the EU embargo on sea deliveries of oil by Russia and the limitation of the price of Russian G7 oil to $60 per barrel came into force. In addition, by the end of the year, Germany and Poland plan to abandon Russian oil, which has received it through the Druzhba oil pipeline but is already beginning to receive diversified supplies by sea. These sanctions are designed to deter Russia from the war against Ukraine. However, Russia also announced its intention to take retaliatory actions that could affect the market balance and prices.
These measures will have a moderate impact on oil production and export indicators in the Russian Federation but more significantly on oil revenues. According to our estimates (baseline scenarios of price forecasts and discounts), the total drop in revenues from Russian oil exports may amount to 25-46% compared to 2021 if the Russian Federation does not resort to market manipulation and blackmail in response to the embargo. It is quite natural that the authorities of the Russian Federation threatened to retaliate against the countries that will apply the price cap. Russian leadership discussed two options: establishing a lower limit on the price of exported oil at the legal level or prohibiting the sale of oil to countries that will impose price caps. Nevertheless, for now, there is no official decision on the response to the embargo and price restrictions.
- The impact of the embargo on the world market situation and the position of the Russian Federation until the moment of its retaliatory actions
1.1. Market balance. As a result of the introduced embargo on crude oil supplies, various organizations estimate the drop in Russian oil exports in 2023 to be 1.2-1.5 times the pre-war level. At the same time, the fall in the Russian Federation’s production volume is estimated at a smaller amount of 0.84 – 1.4. However, even if the drop in production is higher than these expected levels and corresponds to the expected drop in exports, it will still not be the minimum recorded volume of oil production in the Russian Federation over the past two years. In particular, even lower production volumes were observed during the pandemic in 2020 and April-May 2022. Crude oil exports to the Russian Federation in 2021 were in the range of 4.3-5.1 mbd.
The specified expected volume of drop in Russian exports – 1.2-1.5 mbd will not cause significant problems in the market. It is expected that Kazakhstan and the US will be able to cover part of this decline by increasing supply in the amount of 1.1 mbd.
1.2. Price situation and Russian oil revenue. The above indicates that the embargo on the supply of crude oil will not have a critical impact on the production indicators of the Russian oil industry. However, the embargo on Russian petroleum products, which will be implemented in February 2023 and will have a significant impact on the volume of oil production, will play a significant role. Thus, the market situation after these measures will have a more significant effect on the income of the Russian Federation: “loyal” buyers of Russian oil, who do not support embargoes and price caps, instead demand significant discounts.
According to Reuters estimates, discounts on Urals oil in Russia’s western ports for sale to India under some deals have risen to $32-$35 per barrel if freight is not included in the price. At the same time, for almost a year of war in Ukraine, freight rates have increased significantly: 11-19 dollars per barrel compared to less than 3 dollars per barrel before February 2022.
The price of Brent hovered below $80 per barrel in early December, while the estimated cost of Russian oil to producers, including production costs, taxes, and transportation to export ports, was around $15-45 per barrel, Deputy Energy Minister Pavel Sorokin said.
Quotations of Russian oil grades relative to Brent before and after the date of the introduction of the oil embargo and price restrictions
The income of the Russian Federation will be determined by oil prices on world markets and the policy of key buyers of Russian oil regarding the demands for discounts, which in turn will be formed based on how strong the “buyer’s market” will be for the Russian Federation and what will be the difference between the price and the established price cap (it is assumed that USD 60 is not the final limit, but it can be revised in the event of a significant change in market conditions). OPEC countries consider a comfortable price of 90-100 dollars. Morgan Stanley, anticipating rising demand and continued tight supply, forecasted a price of $110 per barrel, and Wall Street Bank cut its forecasts for Brent for the first and second quarters of 2023 to $90 and $95 per barrel from $115 and $105 per barrel, respectively.
1.3. Estimating expected losses of the Russian Federation under the scenario of the base range of price assumptions.
According to our estimates, depending on the price dynamics on world markets (without considering the options of crisis price collapses and price shocks) and the policy regarding discounts of key buyers, based on the expected structure of Russian oil exports, the drop in revenue from Russian oil exports in 2023 may amount to 25- 46% relative to 2021. It needs to be reminded that in 2021, oil exports (excluding petroleum products) amounted to USD 110.1 billion, accounting for 22.3% of the total export revenues of the Russian Federation.
- Options for the Russian Federation’s actions in response to the embargo and price restrictions.
The Russian Federation has declared that it reserves the right to respond to the sanctions: refuse to sell the resource to buyers who support the specified restrictions or the establishment of a statutory minimum export price. At the same time, the establishment of a lower price, if it exceeds the limit agreed upon by the member countries of the oil coalition, will actually mean non-sale. At the same time, the Kremlin said they are ready even to reduce the production volume.
Attempts by the Russian Federation to delay exports from Kazakhstan by creating formal obstacles in the Caspian Pipeline Consortium are not excluded. Speculation about the Druzhba oil pipeline supply can also be used to manipulate the price.
Thus, the Russian Federation’s actions may affect the market balance and the price, which is also sensitive to speculation.
Surely, it cannot be ruled out that the Russian Federation will further reduce production and exports (even at the expense of a partial reduction in exports to friendly countries) – such speculative steps may be taken precisely to stimulate price spikes, in which Russia is particularly interested both for the reason of receiving higher prices and due to influencing the stability of countries participating in the coalition. However, it is quite likely that such actions should be expected closer to the introduction of the embargo on the supply of petroleum products in February 2023 because this step will significantly impact oil production in the Russian Federation, which will have to be reduced.
The actions of OPEC if the Russian Federation begins to manipulate the volume of exports remain a certain intrigue. On the one hand, in the public sphere, the leaders of the member countries do not approve of “uneconomic” methods of market regulation. On the other hand, OPEC is also interested in price stability without significant distortions both in the direction of growth and in the direction of decline. However, even individual OPEC countries have enough resources to replace the potential deficit created by Russia.