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Russia looks to streamline oil taxation

The Kremlin has made a surprise move to reform its complex system

Russia is planning a sweeping overhaul of oil taxation as it looks to replenish its coffers and simplify a system that has grown increasingly complex and difficult to navigate over the years. While the net impact to producers from these changes is negative, some will lose out more than others.

The Duma, the lower house of Russia’s parliament, approved at a first reading draft this week oil tax legislation submitted by the finance ministry. It will require two more readings, likely undergoing revision in the process. The proposals are part of a larger tax package prepared by the government.

The plan, as it stands, is to do away with mineral extraction tax breaks for mature oilfields and those that produce highly viscous crude—projects that typically have higher lifting costs. A number of Caspian, Eastern Siberian and Arctic fields will also be stripped of export duty exemptions.

RUB260bn/yr – Extra cash finance ministry hopes to extract

The ministry wants to continue supporting these projects, but under an improved excess profit tax (EPT) regime. This regime was introduced at certain oilfields last year to spur investment in harder-to-recover crude. The long-term goal is to roll it out nationwide, replacing other taxes.

But the ministry is far from happy with the present EPT regime, blaming its introduction for the loss of billions of dollars of receipts last year. It has proposed tweaks, including a limit on the carryover of historic project losses and a revised upper cap on costs that can be deducted from the tax base.

“Nothing is set in stone yet. We still expect heated negotiations to occur as oil industry lobbyists descend upon the Duma,” says Moscow brokerage BCS Global Markets (BCS GM). “But oil tax is almost certainly going up, some on every oil company.” Gas producers are largely unaffected by the changes.

More than just money

The ministry is looking to extract an extra RUB260bn ($3.5bn) in annual revenues from the industry, helping offset the impact of the Covid-19 pandemic and low oil prices. But BCS GM sees its proposals as “going beyond revenue-raising to a major streamlining of the overly complex system”.

Tax breaks at Russian oilfields are typically won through lobbying, and the ministry’s proposals would create a more uniform, and potentially fairer, regime. Increasing the tax burden on the industry may be prudent at a time when the government needs funds to kickstart an economic recovery. However, such sudden and drastic changes highlight the unpredictability of Russia’s tax landscape, which has long made companies wary of investing.

Hardest hit among Russia’s producers will be Gazprom Neft, which could lose up to 21pc of its Ebitda next year if the ministry’s proposals are adopted in full, according to bank VTB Capital (VTBC). This is chiefly because its Novoportovskoye field in the Arctic will lose its current tax breaks. Tatneft, which enjoys support at its highly viscous fields in Tatarstan, could see core earnings drop by 20pc this year, while Lukoil’s could diminish by 8pc.

Sitting prettier is Rosneft, which looks set to fare better from the changes than its peers, according to VTBC. Indeed, the ministry has even proposed providing new major tax breaks at two large Rosneft fields, Priobskoye and Vankor.

Priobskoye is a Soviet-era discovery in Russia’s Khanty-Mansiysk oil heartland that is now struggling with production decline and high levels of water cut. Vankor, located beyond the Arctic Circle, was brought onstream a decade ago but is due to play a key role in Rosneft’s upcoming Vostok Oil megaproject. Tax breaks at Vankor would effectively cross-subsidise Vostok Oil’s undeveloped fields.

“We still expect heated negotiations to occur as oil industry lobbyists descend upon the Duma” BCS Global Markets

Producers worst-affected by the changes are sure to lobby aggressively against them, claiming they are paying more than their fair share. However, over the last eight years the industry’s tax burden has fallen.

“More and more companies are talking about high-margin barrels, and our analysis shows that the share of tax per barrel has decreased, which is good for companies but not the government,” says Mitch Jennings of brokerage Sova Capital. “However, the cost of oil has decreased, and the Russian tax system is skewed in such a way as to benefit companies in a lower price environment.”

Rosneft notably pays the most tax out of Russia’s biggest four producers, at RUB13,585/t of oil, according to Sova Capital, whereas Tatneft pays the least, at RUB10,743/t. This may suggest the rationale for how the extra tax burden has been distributed.

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