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I don’t think there is a country in the world where fuel prices at gas stations do not stir up emotions. This topic often occupies headlines, is regularly commented on by politicians and ever present in casual conversations. While in importer states the issue is often rightly explained by the fluctuations in oil prices on the international markets or differences in the exchange rate, in case of exporter states it is a lot more complex. What does it look like in Russia? – Mariusz Marszałkowski, editor at BiznesAlert.pl, asks.
Russia is one of the world’s biggest oil exporters. In 2020 512.6 million tons of oil were extracted there, out of which 232.5 m tons were exported. The rest stayed on the internal market.
However, 2020 was a year of many anomalies, including on the hydrocarbon market, because due to low oil prices on the markets, Russia’s oil companies reoriented to delivering fuels to the internal market. This is evidenced by the data on Russia’s oil export. In 2019 the ratio between export and extraction was 47.3 percent, but in 2020 it dropped to 44.2 percent.
Since the very beginning of 2021, Russia’s oil market and politicians have been concerned that the 2018 oil crisis may come back to haunt them. Back then, after a sharp increase in oil prices on international markets, wholesale and retail oil prices on the Russian market soared as well. To make matters worse, the VAT was increased from 18 to 20 percent, which contributed to generating social unrest. This is problematic for the Kremlin, especially at times when local, parliamentary or presidential elections are approaching. In the fall of 2021 Russians will be electing their representatives to the Duma. The support for United Russia, the party in power, is dropping, which means the Kremlin has even more reasons to react to the oil price situation.
The oil prices on the wholesale market have increased by 18.5 percent between January and 17 March, and Russian oil market analysts estimate it’s not over yet. According to the calculations by the Association of Independent Oil and Gas Producers, by the end of this year, the fuel retail prices will significantly exceed the forecast inflation – by 14 percent.
Why are the fuel prices in Russia soaring?
The answer is obviously obvious – because of increasing oil prices across the world. However, in contrast to, e.g. Poland, the hike is not related to the fact that we have to buy this resource at an upped price. In case of Russian companies, the retail fuel market is regulated. This means, the price hikes at gas stations are very limited. In result, in order to increase their revenue, the companies prefer to sell their products (both processed and raw) outside of Russia. Consequently, there is not enough oil to cover the demand on Russia’s very eager domestic market. This in turn drives up the wholesale prices, and then the prices on the retail market (with a delay). After the issues experienced in 2018, the Russian administration decided to introduce a mechanism called the “damper”.
The damper, or “silencer”, has one job – to maintain fuel prices in Russia at a roughly stable level. When oil prices on the global market are high, and the companies want to earn more from exports, the Russian state gives back to the refineries that produce for the domestic market the difference between the indexed price (determined at the beginning of every year) and the export price. The return is in the form of a negative excise tax. When the oil prices are low (which happened in the first half of 2020), and the companies find it more profitable to sell the oil to local refineries, the refineries need to pay an increased excise tax, which fuels the state budget.
Because of this mechanism Russians are not impacted by the drops in oil prices on the world markets, but neither do they, at least in theory, experience radical increases when the prices soar. All this is just “theory”, because the current situation shows that despite the “damper”, the companies still prefer to export their output to foreign refineries.
The mechanism’s issue is that it is indexed each year at the level of five percent. This means, each year until and included 2024 (expiration of the mechanism), the companies will receive a lower “difference”. The indexation does not match the increase in prices on the retail market. According to Gazprom Neft CEO Alexander Dyukov, because of this the retail margin at gas stations is sliding, which impacts the profitability of this business sector.
Rosstat data says that retail prices of gasoline increased in 2020 by 2.5 percent, and in 2019 by 1.9 percent.
What is the government’s plan?
In order to slow down the rising fuel prices, the Russian government will introduce a number of solutions that will stabilize the market.
The first one is to modify the “damper” and the way it is indexed every year. Instead of the regular, 5-percent increase it is to be based on the actual change in the retail prices. Thanks to that the companies will not lose due to the decreasing “compensation”. The second step is to up the amount of fuel that is traded on the exchange. Oil companies are reluctant to sell their products on the exchange, because they can earn a lot more on the regular wholesale market. Increasing the participation of the exchange in oil trade will improve the availability of fuel for other market participants. The third solution pursued by the Ministry of Energy is to up the reserves of fuel by forcing refineries to process more oil. The idea is that this will ensure spare fuel for the annual, spring maintenance works conducted at many Russian refineries.
According to analysts from Vygon Konsalting, this year the government will spend as much as RUB 40 bn (USD 540 million) on the additional compensation, and RUB 135 bn (USD 1.8 bn) in 2022. The Financial Ministry, which is usually opposed to bankrolling the fuel industry, is supportive of the above proposals. This is because the financial pressure on the budget is smaller thanks to the high oil prices on international markets.
Band-aid or a cure?
The steps taken by the government do not address the underlying issues. The market is still very exposed to the fluctuations of oil prices on international markets. Importantly, only large, vertically integrated companies owned by the state benefit from these changes. Smaller, independent refineries and oil companies that barely survived 2020 are losing. For them the only way to stay on the market will be to offer competitive prices, but they won’t be able to cover their losses with profits from export. In result, many of them are already facing a very difficult situation.
Gas station owners are another victims of this system. They need to buy fuels at very high wholesale prices, even though at this point retail prices have stayed the same. This may make the market even more rigid and the state-owned companies may cement it even more.
However, the government isn’t after introducing fundamental changes. The goal is to stop an increase in prices at gas stations until the election to the State Duma in the fall. At the same time the “damper” is also beneficial for the Russian state.
In 2020 due to low oil prices, oil companies contributed to the state budget an additional RUB 400 bn (USD 5.3 bn). It was a huge cash injection applied at a time when the budget was in dire straits.
