Constrained by the OPEC+ production cuts and the necessity to balance its 2020 federal budget, Russia has started to play with one of the most dangerous policy instruments it has at hand – upstream taxation. For decades, Russian oil companies have been complaining that the constant tinkering with upstream terms is complicating their long-term strategic deliberations and unnerving potential foreign investors. This September, without the usual state media fanfare, the Russian parliament has approved the first reading of a Finance Ministry-masterminded bill that would seek to abolish tax breaks that Moscow deems superfluous, along with paving the way for the oft-promoted profit-based taxation system. The underlying rationale for this rather bold move (on the back of many years’ foot-dragging) lies in the Kremlin’s fear that the coronavirus-triggered economic slump will have a larger than expected impact on the nation, hence the need to create additional sources of income for the budget deficit not to surpass 4% of GDP this year. While sticking to its routine of preferential treatment for Rosneft, the Russian government has at the same time tried to move in the direction of a more equitable playing field.
High-viscosity tax cuts
The Finance Ministry, led by one of the remaining liberal-leaning top officials Anton Siluanov, has long voiced its discontent over the preferential treatment high viscosity fields get despite their relative paucity. According to Siluanov, with the removal of high-viscosity tax breaks Russia’s budget would receive an additional $1 billion in 2021-2023. Since almost all high-viscosity fields are located in the Volga-Urals region, such a move would hit oil companies in an uneven manner – Tatneft and LUKOIL will be the main sufferers, as could be attested by the downward movement of their shares. In August-September 2020 alone, Tatneft’s shares have dropped almost 16 percent whilst LUKOIL’s have decreased some 12 percent (although truth be told, the Navalny poisoning and Russia relapsing into a 2nd wave depression also played a significant role).
Up until now, the position of the Finance Ministry was to provide tax breaks based on criteria like a well’s operational performance upon which the finance team had zero supervision and thus found quite difficult to assess in an objective manner. The Finance Ministry has been incapable of overpowering the Tatarstan regional authorities which have intensely lobbied for an easing of new terms. The end result is that Tatneft might apply for a tax deduction of up to 36 billion rubles (almost $0.5 billion, roughly corresponding to the aggregate tax breaks it enjoyed in 2019), a quite tangible deal sweetener that comes with one caveat – for the regional oil company to avail itself of the deduction, the annual average Urals quotes for the given year should exceed the fiscal breakeven level, in the case of 2021 amounting to $43.4 per barrel.
Additional tax breaks for Rosneft
It is becoming a tradition that the Russian government pushes through some additional concessions for the leading national oil company Rosneft, in this instance the Federal Assembly has granted this privilege within the same legislation that saw LUKOIL and Tatneft’s high-viscosity tax breaks eliminated. As usual with Rosneft-lobbied initiatives, the case for granting the declining Priobskoye field additional exemptions is a nuanced one. The Finance Ministry has long withstood administrative pressure to provide tax breaks to the field saying that the economic case remained unconvincing, however, this year the Ministry itself has drafted and put forward legislation that stipulates a 10-year period of MET concessions to the amount of $0.5 billion a year.
Although the tax breaks come with the same proviso that they would be applicable only if the average annual price is above the fiscal breakeven, such generosity amidst the COVID-19 pandemic (in Russia the first wave was just about to subside when it organically reshaped itself as the second wave) should really be noteworthy. The Priobskoye field started producing in 1988 and peaked in 2009 at 680kbpd, dropping to some 460-470kbpd today – Rosneft claims that with the aid of the new tax breaks it could develop an additional 70 million tons of crude from the field’s reserves. Not only is the majority of Priobskoye located in the flood plains of the Ob River, but its complex geology also combines low permeability, stacked reservoir accumulation, and low productivity with massive aggregate recoverable reserves of some 2.4 billion tons.
Profit-based taxation
The key element in Russia’s upstream taxation review, namely the finetuning of a comprehensive excess profit tax (EPT) scheme, stems from the Finance Ministry’s insistence on leveling the playing field for oil companies as 60% of Russian oil production relies on some sort of tax exemption. Profit-based taxation is not a novelty in Russia, several dozen oilfields are already functioning under an EPT pilot launched in 2019. The scope has been limited so far – the main EPT pilot participants were freshly-launched Eastern Siberia fields with export duty exemptions and mature Western Siberia oilfields with involvement being fully voluntary. The EPT rate is now fixed at 50% – this is levied from the aggregate revenue once all the expenses, a reduced mineral extraction tax (MET) rate, and a specific amount of unreimbursed expenses from previous years are deducted.
As much as moving to EPT seems a timely decision for the Russian authorities, the Finance Ministry’s current proposal will create a lot of bad blood with oil majors. It is fields with export duty exemptions that largely embraced the new taxation scheme, but under profit-based taxation they still paid the MET, albeit at a reduced rate, meaning that oil companies could save billions of rubles in tax payments. Moscow estimates that government revenues lost in 2019 due to this amounted to 213 billion rubles ($0.22 billion). Cognizant of this loophole (which some FinMin officials have labeled as the largest gaffe of this century), the Finance Ministry now wants to close it down by means of a mark-up factor.
By Viktor Katona for Oilprice.com