Tax overhaul in Russia aims to keep country at top of oil-producing heap

2011-10-11 10:39:46

Vladimir V. Putin has shown an uncanny mastery of the politics and economics of oil. On his watch as president and prime minister, Russia ascended to the top of the global business, surpassing Saudi Arabia as the world’s largest oil producer.

Yet in a series of meetings over the past two years, more or less, aides have confronted Mr. Putin with evidence that Russia’s pre-eminence in the world of oil will not last if the current imposition of exceptionally high taxes on oil companies is left in place over the next decade.

No matter that high taxes on oil companies are at the heart of Russia’s economic policies. The revenue pads out Russia’s rainy-day funds, which cushion its oil-dependent economy from the pain caused when the prices of commodities sold by Russia fall.

The result of these meetings was a policy swivel by Mr. Putin that should keep Russia on top of the oil-producing heap and prevent the potential loss over a decade of about two million barrels of oil per day to world markets — more than is exported by Libya.

The overhaul will dial back taxes on crude oil exports. The new policy, which took effect Oct. 1, was one condition that helped secure a major investment last month by Exxon Mobil.

The overhaul, known as the 60/66 program for the new tax rates it imposes, is intended to maintain Russia’s current level of oil output — about 10 million barrels per day, about half of the U.S. consumption — despite rising production costs associated with exploitation of fields in the harsh conditions of permafrost in ever more remote parts of Siberia and offshore in the Arctic Ocean.

The tax change and the opening of the Russian Arctic to joint ventures like those under the Exxon agreement suggest Mr. Putin is warming to arguments that the Russian oil industry needs more financial leeway to function and to stay ahead of the sheiks.

“There is definitely a new wind blowing,” Thane Gustafson, a senior researcher at Cambridge Energy Research Associates, said in a telephone interview.

“There is now a very definite consensus, from Putin on down, that unless the oil companies are incentivized in not only raising recovery in the brown fields, but moving more aggressively into onshore frontiers, and offshore, the consequences will be dire,” he said.

Cambridge Energy, a subsidiary of the international business information group IHS, has advised the Russian Ministry of Energy during the drafting of the new tax policy. Also acting in an advisory capacity were the consulting firm McKenzie and the auditors Ernst & Young.

The companies modeled the effects of continued high taxation on Russia’s oil industry. The policy was put in place in 2004 after the arrest of the oil tycoon Mikhail Khodorkovsky, who had opposed the taxes. The models measured rising costs as the output from Siberian fields on land declines.

The offshore and more remote developments that will replace them are even more inhospitable than the Khanty-Mansi region of Siberia, where the primary fields are today.

The study concluded that if nothing were done, total production would drop to eight million barrels of oil per day by 2020.

The tax quandary highlights a key distinction between Russia’s industry and Saudi Arabia’s, which Russia displaced as the world’s largest.

Saudi Arabia, encouraged by the United States, which supports the monarchy militarily, maintains the world’s largest swing production capacity. This is easier in the desert, near ports, where production costs are lower. Still, vast capital outlays are the norm.

Russia, in contrast, is guided by internal considerations in its oil policies. Moscow is trying to maintain an industrial economy alongside its oil businesses, so it taxes oil companies heavily — but the outcome has been taxation so high it has starved the industry of capital, even as production is moving offshore in Siberia.

To check the decline that is projected as a result, the government lowered mineral extraction and crude oil export duties for the first time since 2004 under the overhaul, from 65 percent to 60 percent — the 60 in the 60/66 program.

Petroleum exports account for 40 percent of Russia’s budget revenues. To compensate for this loss to the budget, the overhaul raised the export duty on refined products to 66 percent, from 52 percent, and eliminated an even lower rate for the low-grade fuel known as bunker oil that Russian refineries have been exporting in great abundance.

The program to prolong high levels of oil output in Russia will also, of course, prolong Russia’s dependence on crude oil prices for its economic well-being.

The previous system reflected industrial policy, now partially abandoned. The relatively lower export duty on refined products was a continuation of a Soviet policy of encouraging industrial production over raw materials exports, an idea championed by Mr. Putin. The intention was to encourage a domestic refining industry, with the jobs and additional profits that would, in theory, accrue from exporting gasoline, diesel or aviation fuel, rather than crude.

The problem was, the country’s Soviet-legacy refineries produced far less gasoline and other light distillates per barrel of oil than Western refineries — and far more bunker oil than Russia could consume domestically. In 2004, export tariffs on this fuel were lowered to about 30 percent to help refineries dispose of it. The result was an incentive to invest in new refineries that produced lots of bunker oil, rather than in oil fields. Russian oil companies earn about $10 in profit per barrel of oil pumped from the ground, even at prices higher than $100.

If the company, however, operated a highly inefficient refinery producing copious amounts of bunker oil, it would earn an additional profit of about $23 per barrel because of the lower tax, according to Aleksandr Bulgansky, a senior oil analyst at Otkritie Bank in Moscow.

Companies built intentionally inefficient refineries, nicknamed “samovars,” modeled on early 20th century refineries that simply boiled crude, rather than use catalysts to produce more gasoline. About 250 operate today.

Russia exports about three million barrels per day of refined product, compared with four million barrels of crude.Rather than striving to fix the refining subsidies, this project has largely been abandoned under the new program, in favor of companies that actually explore and drill for oil, critical to Russia’s economy and accounting for 17 percent of gross domestic product.

The policy overhaul that will maintain Russia’s current levels of oil output into the next decade coincided with Mr. Putin’s announcement that he intends to run for president again.

From the earliest days of his presidency, Mr. Putin decided that natural resources exports and energy in particular, could not only finance Russia’s rebirth, but also help restore geopolitical greatness. Oil companies, of course, embrace the lower taxes, too.

“This will allow us to keep production at high levels and increase capital investment at our upstream assets,” Dmitry Sergeev, spokesman for TNK-BP, said of the change.

So important was the Russian tax system to oil investment that Exxon’s agreement with Rosneft included a provision that Exxon and the Russian government would agree to consult on tax matters as a condition of investment.


The New York Times