Russia's crude refining sector is expected to see further pressure in the coming year with oil export duty changes coming into force in January in a move likely to extend the recent downward trend in the country's refining throughput and free more barrels for exports.
Russia has been cutting refining throughput since 2015, when it introduced a three-year tax change program, the so-called tax maneuver, designed to stimulate the sector's modernization and undermine the economics of making heavy oil products such as fuel oil.
Coupled with a drastic drop in oil prices, it more than halved refining margins in Russia last year, prompting companies to redirect more crude for exports.
New tax changes, effective as of January 1, 2017, foresee a cut in marginal export duty for crude to 30% from 42% currently and a fuel oil export duty hike to 100% of that for crude from 82% at the moment.
The changes, which also envisage an increase in the mineral extraction tax, will worsen the refining economics further but are not expected to significantly impact crude processing volumes.
The market has mainly adapted to the new fiscal and pricing environment shaped by the tax reform, Russian officials and some experts said.
"In 2017, primary refining will be reducing at a roughly similar pace [as this year]," deputy energy minister Alexei Teksler said.
Processing cuts are to reflect the increasing yield of light products following wide-scale upgrades across the refining sector, which now requires less crude to produce similar volumes of products.
Crude refining is estimated to drop by around 2.5% to 270 million mt, or 5.42 million b/d on average in 2017, following a 2.1% year-on-year contraction to 277 million mt in 2016, according to the ministry's forecast.
Even though the refining margin is set to drop, "nothing radical will happen," said Grigory Vygon, managing director of Vygon Consulting. "Major refineries have mainly updated and optimized their refining flows and an expected insignificant cut in refining margin would not make a huge change to their economics."
Crude exports from Russia are expected to rise year-on-year, supported by refining throughput cuts and overall higher production volumes in the first half of the year in annual terms.
While Russia intends to gradually trim its daily crude output by 300,000 b/d from October levels to 10.9 million b/d, under the six-month agreement with OPEC and other non-OPEC states, the country's production would still grow year-on-year.
Thus, 2017 crude exports are to rise "slightly" from the estimated 253.5 million mt this year, deputy energy minister Kirill Molodtsov said.
It is hard to provide more specific export forecasts currently as many factors remain uncertain, including the pace of oil companies' output cuts.
Supplies to Belarus also remain under question. They could vary from 18 million mt to 24 million mt, depending on talks to settle a gas dispute between Moscow and Minsk, which also impacts crude deliveries.
Processing economics remain an issue of concern as well. The cut in the export-related tax boosts domestic crude oil prices, which are traditionally linked to export net backs, while the increase in heavy products' tax makes the production of fuel oil unprofitable.
Following this year's tax changes, some simple refineries hit "the bottom? in the second quarter, recording the first negative EBITDA in over a decade, analysts at Citi said earlier this year.
The economics improved in the second half of the year, due to a gradual increase in oil prices. Yet, still, average refining margins -- estimated at around Rb800/mt [$1.80/b] -- have remained far below the "comfortable" level, Molodtsov said.
While some analysts believe the 100% fuel oil export duty would ruin the refining economics, sending an average refining margin in Russia into negative throughout 2017, others do not share this view.
The tax change impact would vary depending on refinery complexity and location, with upgraded refineries expected to continue operating in the black. Rising oil prices are also likely to help.
"If oil prices stay above $50/b, complex refining margins will be even higher than in 2016 thanks to 'customs privilege' for light oil products,"Vygon said, adding that major refineries have already optimized their refining flows.
Smaller independent refineries, however, are likely to be particularly hit by the tax change, "with simple plants or those located far away from major markets likely to close or significantly reduce their refining runs," he added.
In general, the 2017 introduction of the 100% export duty for heavy oil products "will reduce the profitability of an average refinery by around Rb400/mt [or $0.85/b]," according to the energy ministry's calculations.
For a refinery with high complexity index and low yield of heavy products, the cut will amount to around Rb200/mt, compared to around Rb700/mt for a simple refinery, the ministry said in a written reply to S&P Global Platts.
In any case, the ministry expects no oil product shortage on domestic market, due to higher light product output, gasoline in particular.
While Russia is a major exporter of diesel, naphtha and fuel oil, its gasoline production was hardly matching domestic needs until recently. The country imported gasoline to cover demand surges during peak seasons.
This year, rising gasoline output allowed Russia to fully meet domestic demand, which has been stagnating in the economic slow down.
Gasoline production is estimated to increase by 1.8% to 39.9 million mt in 2016 and remain roughly flat, at around 39.8 million mt, in 2017. At the same time, fuel oil production is to reduce by 21% to 56 million mt this year and by another 13% to 48.5 million mt next year.
Diesel production is estimated at 75.2 million mt in 2016 and 77.7 million mt in 2017, according to the energy ministry's data.
Overall, tighter economics may prepare the industry for further shake-ups as the government considers cancelling the export duty altogether in the future. This is unlikely to happen before 2021, however, as the consequences for the sector remain unclear, energy minister Alexander Novak said earlier this month, offering some, even if temporary, relief for the sector.