Russia's Financial Turmoil Forces New Oil Tax Changes

Implications: Russia's primary revenue sources are taxes on oil and gas. Russia's oil taxes have been falling as oil prices fall and Russian oil production stagnates. Additional oil tax changes wil occur to spur new oil productiion and increase revenues.

Analysis: Russia relies on oil and gas taxation for about half of its budget revenues.  Significant reductions in these taxes will harm Russia's budgets and future budget planning.  A major cause of the recent revenue declines, in addition to falling oil prices, is Russia's stagnating oil production.

Russia's oil production is stagnating as its 2008 nine month production declined by one percent, the first decrease since 2000.  A significant contributor to the production decline are high taxes on the oil sector.  For crude oil that is exported, the government takes 90 percent of the revenue of the marginal barrel, leaving little for re-investment in the industry.  With extremely high costs for new production in regions with little or no infrastructure, investors have been reluctant to explore and develop new oil production to offset the declines in more tradtional  regions of the Volga-Urals and West Siberia.

Oil prices in general have declined sharply from the earlier highs this of about $147, with oil now trading at a little over $100 per barrel.  Urals blend, the Russian benchmark, trades at even lower prices. 

Russian oil taxes are made of three components: the Mineral Extraction Tax (MET), the Export Duty (ED) and the profit tax.  The MET is a constant percentage of 22% for all crude oil above $9 per barrel.  The ED changes every two months and is based on the average cost of the Urals blend.  In a declining oil price market and with a lag of two months in ED tax changes, the ED can have a major impact on what companies get for their exported crude oil and on their earnings.  This is today's situation.

For the first time in memory, Russian oil producers are actually losing money on all their exported oil production.  The combination of the MET, high Export Duties based on prices this past summer and operating and transportation costs mean that Russian producers are losing $13 or more per barrel.  The Export Duty for August/September was set at $495.90 per ton or $67.67 per barrel.  For October/November the Export Duty was set to decrease to $485.80 per ton or $66.30 per barrel.  Last week at Primorsk, a major oil terminal in the Bay of Finland,  crude oil exporters were receiving about $85.70 for their crude oil.  Oil taxes--MET and Export Duty--equaled $85.10.  Add in transportation and operating costs and the result was a loss of $13 or more barrel. 

The Russian government, in addition to injecting massive amounts of cash into the Russian financial system, took additional action and lowered the Export Duty as of October by 20 percent to $372 per ton or $50.75 per barrel.  With oil prices up several dollars in recent days and lower Export Duties, Russian companies should be in the black on their export sales from October 1 onward.  This will provide some relief to Russian oil producers.

In addition to the oil tax changes that will occur on January 1, 2009, the government is considering additional tax changes to take effect on January 1, 2010.  These changes will focus on the MET, the Export Duty and possibly more favorable depreciation to write off 30 percent of new equipment costs.  The latter will have an impact on the profit tax component of oil taxes, since the profit tax applies to revenues after deducting costs.  It will have no impact on the MET and Export Duty since these taxes are applied to revenues without any consideration of costs.

The Russian government was forced to act quickly to stem the hemorraging in its financial system and it was forced to act decisively to help the oil sector's stock value and liquidity.  Time will tell whether the tax changes that will take place on January 1, 2009 and the additional oil tax changes contemplated for 2010 will stem the fall in oil production.