Urals premium hurts Russian integrateds
Russia’s Opec+ compliance has pushed its benchmark grade to a premium over Brent. But this is not good news for the country’s large integrated oil firms
Urals crude typically trades at a discount to Brent and many other international benchmarks because of its high sulphur content, which adds costs at refineries. And this discount widened in March and April as lockdowns resulted in scaled back operations at refiners in Europe—the main destination for Urals.
However, under the new Opec+ deal Russia has pledged to curb supply, excluding condensate, by c.2.5mn bl/d, to 8.5mn bl/d in May, June and July. Urals is thus scarcer, driving up the price as some refineries cannot easily switch to other grades.
Urals had a $1.90/bl premium to Brent on Tuesday, which narrowed to $0.85/bl on Wednesday, Moscow-based bank VTB Capital estimates. The premium was c.$2/bl in May and June, according to rating agency Fitch, but the average has narrowed to c.$0.50/bl over the last week.
“Many European refineries have historically been using Urals over other oil slates, so readjustment to other crudes is taking time,” says Dmitry Loukashov, VTB’s head of oil and gas research. “Also, the gasoil and gasoline cracks are at their historical minimums and this puts pressure on light oils.”
But Russia’s leading integrated producers are hurting, rather than benefitting, from the premium. “It might seem counterintuitive, but Russian oil majors are in a detrimental position, losing money due to the Urals premium,” says Loukashov.
While there is an obvious benefit to higher prices for their crude, firms are hit by higher transfer prices for refinery feedstock, while product export prices are predominantly Brent-based.
“The rouble is sensitive to Urals, which leads to higher transport and other costs if denominated in dollars, and an increase in the damping tax,” Loukashov adds.
Russia added the so-called ‘damping’ mechanism to its tax code last year to prevent politically uncomfortable spikes in domestic fuel prices. It entails fuel suppliers paying extra into the budget when domestic product prices are higher than export netbacks—receiving a subsidy when the opposite is true.
“The rouble is sensitive to Urals, which leads to higher transport and other costs if denominated in dollars, and an increase in the damping tax,” Loukashov, VTB
The 2mn bl/d reduction in Opec+ cuts combined with refiners making further progress on their ability to switch away from Urals should put further downward pressure on the premium. Integrated firms will certainly hope so.
Russian oil majors would suffer a $1.6bn, or 5.4pc drop, in core earnings (Ebitda), if Urals maintains a $2/bl premium over Brent compared with a $1.5/bl discount, VTB projects. And damping tax payments could reach up to $6.7bn in 2020 versus a $4.1bn subsidy in 2019, the bank estimates.
Gazprom Neft will be worst off among the majors, as it refines a larger share of its own crude. The firm will take a 9pc hit to Ebitda at a $2/bl premium, according to VTB. In contrast, Tatneft, which produces only Urals and sells most of it, could gain a 1pc boost to earnings.
Core earnings for the second quarter will already be weaker, reflecting three months of low oil prices. But the effect of non-cash impairments—on the back of revised market assumptions—which pushed many Russian producers to net losses in the first quarter will be significantly reduced.
The so-called ‘Kudrin’s Scissors’ effect, should also have a more positive Q2 impact. Named after former Russian finance minister Alexei Kudrin, the effect references Russian producers continuing to pay high rates of tax even after sharp declines in oil prices due to a lag in how oil export duties are calculated. It badly hurt producers in the first quarter, but they stand to gain in the second quarter now prices are recovering.
Consultancy Rystad Energy estimates Russia’s upstream sector had a tax burden of no more than 30pc in May and June, versus more than 60pc in March and April, on the back of an eightfold fall in export duty.