by Zachary Waller
No matter where in the world you are, taxes are a complicated thing if you’re a large business. Russia is no exception to this rule. With the fall in oil and natural gas prices (and subsequent decline in state tax revenue from the sector), the Russian Federation (specifically the Russian Ministry of Finance) has begun exploring potential changes to its tax regime for oil and gas production and export, changes that could have large implications for oil and gas companies working in Russia.
In order to understand what these changes could mean for oil and gas companies in Russia, let’s first take a look at what taxes look like for companies right now.
Currently, oil and gas companies working in Russia are subject to a corporate income tax, a value added tax (VAT, with certain exceptions for the gas sector), a mineral resource extraction tax (MET), a subsurface use tax, and an export duty. While the corporate income tax (20%) and value added tax (18% on goods, works, and services) are relatively straightforward in how they are calculated, things get interesting when calculating MET and export duty (we will not look at the subsurface extraction tax as it can vary and is specified in each different license issued to oil and gas companies by the government).
According to the report by Vygon Consulting, MET for oil is currently calculated by taking a figure of 766 rubles per ton of oil and multiplying it by a coefficient K, where K = (PUrals – 15) * (PUSD / 261), PUrals is the price of Urals oil and PUSD is the USD/RUB exchange rate. For gas, the calculation is even more complicated, as the tax is calculated by the formula S = (Si * Erf * Kc) + Ctr, where Si is an initial fixed rate of 35 rubles per thousand cubic meters, Erf is the value of a reference fuel, Kc is a coefficient expressing the complexity of the gas, and Ctr is the cost of transportation. Further complicating the MET on gas is the fact these variables can change depending on a multitude of factors, such as the oil price, USD/RUB exchange rate, domestic gas prices, and foreign gas prices (just to name a few).
Along with MET, export duty is the other interesting part of the Russian tax regime on oil and gas. When oil is priced below $15 per barrel, the oil export duty is 0. When oil is between $15 and $20, the duty per barrel is calculated as S = 0.35 * (PUrals – $15). For oil between $20 and $25, the formula is S = $1.75 + 0.45 * (PUrals – $20), and for oil above $25, the duty can be calculated as S = $4 + 0.42 * (PUrals – $25). For natural gas the calculation is much simpler: the export duty is 30% of the export price (with LNG as well as gas going to Belarus and Kazakhstan not being subject to export duty).
What these various formulas do is create a situation where the Russian state stands to profit most from high oil prices, as companies see their shares of the pie go up only slightly when prices increase, while seeing them decline only slightly when prices fall.
Oil and gas play a huge role in the budget of the Russian government. For example, in 2014, revenues from MET and export tax on oil alone constituted 46% of the Russian government’s revenue. With today’s low oil prices, the Russian government has been losing more and more of its budget that used to come from oil and gas and has begun rethinking the specifics of its tax regime on oil and gas in order to take more rubles from the oil and gas trade and inject them into state coffers.
As part of the current tax regime, there are a number of fields receiving tax breaks, something the Ministry of Finance would like to end. Under the proposed changes, these tax breaks would be eliminated. However, others would come into play. For example, as a way to encourage development, greenfields would not pay MET until they become profitable.
The biggest change, however, comes to the MET itself. Under the Ministry’s proposal, the MET on oil would be changed from its current formula to a 40% tax on all fields (except not-yet-profitable greenfields). This would not be a huge shock for oil companies, as, at current oil prices, they pay about 42% to MET on fields not receiving tax breaks. Additionally, the Ministry of Finance has proposed a 70% profit-based tax on positive cash flow from oil projects on Russian territory.
This proposal has angered oil companies, which maintain the Russian government should not raise the taxes they pay just because the low price of oil has hurt the state budget. They claim such a tax increase could severely damage investment in the Russian oil and gas sector, with Rosneft boss Igor Sechin even going so far as to say implementing this new tax regime would decrease Russian oil production by over 500,000 barrels per day. The Russian Ministry of Energy has also weighed in, stating the new regime should be introduced in stages and the abolishment of tax breaks should not included in the first stage
It is important to note that these changes to the tax regime are far from certain and nothing will be final until approved by President Putin, who must balance the arguments of the Ministry of Finance and the oil companies.
Ernst & Young Global Oil and Gas Tax Guide 2015
Papchenkova, Margarita and Denis Pinchuk. “Russian finance ministry readies for fight with big oil over tax”. 29 January 2016. http://www.reuters.com/article/russia-oil-taxes-idUSL8N15C3Z1