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Global Risk Insights

Global Risk Insights

GlobalRiskInsights.com provides the web’s best political risk analysis for businesses and investors. Our contributors are some of the brightest minds in economics, politics, finance, and…

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New Oil Tax Laws In Russia Could Backfire

Russian Oil Tax Law

Eurasian integration in the new Eurasian Economic Union forces Russia to introduce a so called “tax maneuver” in its oil industry with negative consequences.

Eurasian economic and political integration acquired special importance for Russia in the wake of the Ukrainian conflict, which was ignited by Ukraine’s desire to join the European trade bloc rather than the Eurasian one.

Russia is now trying to strengthen ties with its neighbors via the Eurasian Economic Union (EEU). The Union will be launched in January 2015 by five countries: Russia, Belarus, Kazakhstan, Armenia and Kyrgyzstan.

The establishment of a single economic space requires common regulations for a wide range of issues. Adjustment of tax rates, in particular export duties, is of primary importance. For example, crude oil export duties in Kazakhstan ($80 per ton) are considerably lower than in Russia ($350-370 per ton).

Related: Russian Credit Rating Slashed, Economic Future Remains Dim

Unless aligned, the difference is highly likely to incentivize Russian oil companies to export crude oil through Kazakhstan and Belarus. This in turn would seriously damage oil-dependent Russian budget (estimated losses of $40-50 billion annually).

In this vein, Moscow introduced a so-called “big tax maneuver” in the oil industry, a gradual reduction of export duties on oil and light oil products over the course of three years (1.7 times for oil and 1.7–5 times for petroleum products) with a simultaneous increase in mining extraction tax (1.8 times for oil and 6.5 times for gas condensate) and export duties for fuel oil.

The “maneuver” should in theory balance budget losses from export duties with new gains from the mining extraction tax (MET). However, according to Russian finance minister Anton Siluanov, tax changes will negatively affect the budget anyway, since an increase in MET leads to a reduction in corporate profits inflicting lower tax collections (losses of about $5 billion in 2015).

Another aim of the tax reform is the modernization of the oil refining industry. Currently, the sector has low refining depth at about 72% against 85% in Europe. Despite a decrease in export duties for fuels, oil refineries are expected to face serious drop in profit margins due to higher domestic prices for crude oil and growing cost of production. Government officials estimate that 100-150 small and medium private refineries will close due to inefficient economics. Accordingly, hi-tech refining engineering and equipment will be on the rise.

Russia's oil refinery industry

Russia’s oil refinery industry in 2013 (production in million tons). Data: EY

The “maneuver” has also been repeatedly criticized by political heavyweight Igor Sechin, CEO of the Russian state oil giant “Rosneft” and close ally of Vladimir Putin. According to him, the tax changes will undermine the economy of the new oil refinery projects, namely Rosneft’s huge Far East Petrochemical Company, which will cost RUB 1.3 trillion ($32 billion).

Related: Ukraine-Russia Gas Deal Still Possible Despite Setback

Even such powerful lobbying did not stop the bill. Now Rosneft seeks compensation by applying to receive up to RUB 2 trillion ($48 billion) from the Russia’s national sovereign funds.

A clear beneficiary of the “maneuver” is Belarus. Once again Belarusian President Aleksander Lukashenko managed to maximize gains for his regime. After a set of talks, with increasing stakes at each round, Russia agreed to a deal whereby Belarus will keep proceeds from oil product exports, which will effectively add $1.5 billion to the Belarusian budget.

The “maneuver” is a classic example of political risk. Russia is strongly interested in tighter political and economic integration in the region, even though it inflicts budgetary losses amid a deteriorating economic situation. The political intentions forced the Russian government once again to change oil tax rules, which have already been altered more than a dozen times over the last five years. The unpredictable investment environment undermines the oil sector’s competitiveness and requires thorough reassessment of investment projects with possible suspensions.

By Alexey Kobylyanskiy

Source - www.globalriskinsights.com 

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