RUSSIA: Government reconsiders oil taxes

Analysis

Three developments have come together to put oil taxation high on the Russian government's agenda:

• The government was already committed to considering a differentiation of natural resource extraction tax (NDPI) rates by type of oilfield, with the possibility of this change being introduced in 2007.
• The rate of growth of Russian crude oil output, having been around 10% per annum in recent years, has slowed to a crawl: 2.2% year-on-year in the first eight months of 2005 (see RUSSIA: Investment is needed if oil output is to rise - July 7, 2005).
• Complaints about rising petrol prices have become louder in Russia lately, just as they have in many other countries.

'Real effect'.It has become possible to argue in Russia recently that the overall burden of taxation on oil companies is too high, and is discouraging investment in the industry. The rates of export duty on crude oil were made more steeply progressive at higher oil prices from last August, and NDPI rates were raised from the start of this year. Therefore, a link between tax rates and the industry's slowdown is plausible. In a recent report on the Russian economy, the IMF attributed the recent slowdown in Russian GDP growth to political uncertainty, the Yukos affair and excessively high taxation of the oil industry.

The impact of higher taxes has been hard, if not impossible, to estimate because of the difficulties in separating that impact from the side effects of the state's attack on Yukos. However, the representatives of the oil industry have been quick to blame the slowdown on the rise in tax rates. The Yukos affair is now over and its real effects will not be clear for some time; tax rates are something that might be changed in favour of the producers (see RUSSIA: Destruction of Yukos will change oil outlook - August 10, 2004).

Variants of reform. The structure of the NDPI has been an issue under discussion in the background, with its own momentum. The Ministry of Economic Development and Trade (MERT) has favoured a tax that would be levied at lower rates on 'high-risk oil' -- fields that are heavily depleted, reserves that are for other reasons particularly difficult to extract or especially costly to export, and newly developed fields where infrastructure has to be put in place. The Ministry of Finance has preferred a uniform NDPI tax structure for all fields, on the grounds that introducing tax breaks would mean introducing new opportunities for tax evasion and corruption.

The rise of retail petrol prices has added a popular demand for lower taxation of oil products in the domestic market. The NDPI rates are linked to export prices -- one proposal has been to break the tie. Another possibility is to weaken the linkage without entirely removing it.

Tax burden. Russian oil industry is subject to the following taxes:

• NDPI on all crude production;
• export duty on all crude exported (around half of all production);
• excise taxes and VAT on domestic sales of oil products;
• export duties on exports of oil products; and
• profits tax.

At a Urals export price of 60.00 dollars per barrel, the NDPI is 11.23 dollars and export duty is 26.76 dollars. At that price level, the NDPI alone takes 22% of every extra dollar on the price, and the overall marginal tax rate -- often quoted as 90% -- is, according to calculations by the United Financial Group think tank (for all oil, whether exported or not, refined or not), about 84%.

Possible tax changes. Recent reports suggest that differentiation of the NDPI is likely to be introduced. Exactly what the tax breaks will amount to is not yet known, but an oilfield estimated to be 80-90% depleted would, in one proposal, get a 50% reduction in NDPI, and there might be substantial tax breaks to encourage development in new areas. It is also likely that the link between the NDPI and export prices will be weakened or removed in order to soften the impact of rises in world prices on domestic petrol prices and slightly tilt the tax advantage to favour supplying the domestic market. One proposal would, at present prices and exchange rates, reduce the NDPI from about 9 dollars to approximately 4 dollars per barrel.

Changes of this sort in the structure of taxation of the oil industry are probable, and could be announced before the end of 2005. There is more uncertainty about the overall burden of taxation on the industry. Reportedly, MERT would like to increase the marginal rates of export duty, while differentiating the NDPI and weakening its link to export prices. The underlying idea is to favour supplies to the domestic market without reducing the state's overall tax take from oil.