Russia is gradually abolishing oil export levies and hiking its mineral extraction tax, part of the nation's most sweeping oil tax reform project in 20 years.
Some oil-producing companies, including subsidiaries of Rosneft, Gazprom, and LUKoil, will win out as a result of the move, if the government allows them to raise domestic prices for oil and oil products, while refiners will be hit hardest, practitioners told Bloomberg Tax.
The state Duma July 27 adopted, in a final reading, two pieces of draft legislation: Draft Law 493989-7 on finalizing the tax maneuver for the oil sector, and Draft Law 493997-7 on amending the customs duties. The upper House approved them July 28.
Repealing export taxes while simultaneously raising the mineral extraction tax on oil and oil products also introduces an additional income tax on pilot projects in the oil industry, so that the tax burden on companies shifts from production to profits. That draft law was adopted July 5.
1. Fiscal Burden on Extracting Oil Companies
Starting in 2019, oil export duties will gradually decrease each year from the current 30 percent to 0 percent by Jan. 1, 2024. At the same time, the draft law on oil sector taxes suggests amending Article 342 of the Tax Code by gradually increasing the mineral extraction tax rate for oil and gas condensate.
In combination, the provisions shouldn't affect the profits of vertically integrated Russian oil companies, said Sergey Ezhov, chief economist at Vygon Consulting, a Moscow-based firm that provides consulting services for the oil industry. “For the extracting business units, the increase in MET will be exactly the same as the decrease in the export duty, so the financial result of the production won't change,” Ezhov told Bloomberg Tax in an Aug. 2 email.
Gazprom PJSC and Russneft PJSC oil companies didn't respond to Bloomberg Tax requests.
2. Oil Refinery Processes
For oil refining plants, the change will be more painful as it would raise the price of the oil they process. When the laws come into force, taxes for refiners will vary depending on the change in the price of oil, the location of the refinery, the specifics of production, and other factors.
To keep domestic fuel prices from rising, the government offers tax breaks to the refiners that satisfy certain conditions. For instance, refiners that supply at least 10 percent of total output of high-octane gasoline and diesel fuel to the domestic market can apply the negative excise tax—i.e. return the excises from the volumes of oil sent for processing. This tax break also applies to the refining subsidiaries of large oil companies subject to international economic sanctions against Russia.
For remote oil refineries, a new logistic coefficient will be introduced in addition to the excise tax, which will help companies get bigger tax deductions, said Anna Kokoreva, a deputy director at Alpari Group. Among the remote oil refineries are several refining subsidiaries of Rosneft Oil Co. PJSC, Gazprom, and LUKoil PJSC, which means these companies are likely to benefit from applying this measure, Kokoreva told Bloomberg Tax in an Aug. 1 email.
According to Kokoreva, oil refining companies will need to optimize business processes to keep their profits from falling. “It is important to pay attention to the tax benefits, and get all possible preferences if the assets meet the requirements of the law,” she said.
After finalizing the tax maneuver, the government will start lowering subsidies for refiners, so investors should weigh their risks before starting large investment projects in this industry, Ezhov said. “Refineries should create value and be profitable without state subsidies,” he said.
3. Domestic Fuel Prices
Draft law 493989-7 introduces a “dampening” excise tax to prevent a sharp rise in fuel prices in the domestic market. The effects of that mechanism on companies can be both positive and negative depending on the international oil prices. If the price of oil stays at $75 per barrel, companies would receive more than 1.8 trillion rubles ($28.4 billion) over six years in damping payments, Ezhov said. However, if it drops to $40 per barrel, the refineries’ losses would be as much as 2.3 trillion rubles, he said.
4. Domestic Market
As a result of the maneuver, the fiscal burden on oil companies will shift from their activities on the international market to the domestic one. That will stimulate oil exports, increase the oil producers’ export earnings and raise Russia's budget revenues. However, companies will have to restructure their business processes to comply with the new tax legislation, which can “lead to volatility in fuel prices in the domestic market and reduced profitability of oil refining process,” Kokoreva said. “Large companies are unlikely to be greatly affected, but smaller ones may suffer.”
5. Government Pricing
Companies’ overall gains or losses depend on the macroeconomic factors and the government pricing policy, Ezhov said. If the Urals crude price falls, all companies will lose due to the damping mechanism. If oil prices stay at the current level, Rosneft, Gazprom, LUKOIL and the New Stream Group of oil and refining companies—including the Antipinsky Oil Refinery—will benefit, but “only if the state allows them to increase prices for oil products” domestically, he said. In that case, by 2024, consumer prices for residual oil and bitumen in Russia can be expected to grow by 65-75 percent per ton, Ezhov said. But if the Urals price decreases to $60 per barrel, consumers will lose more than 1 trillion rubles in six years, which will make the consumer the “main victim” of the tax maneuver, Ezhov added.
Reporter on this story: Natalia Suvorova