CGES: Russia grappling with faulty oil export tax system

Russian producers and the government have been hit hard by a crude export tax system that has proven incapable of coping with the rapid drop in oil prices that started in early July.

Since October, the government has been forced to make unscheduled reductions in the export tax rate, twice cutting tax rates for November and December. “Had they not done so, oil producers in the country during October would have received just $1.43/bbl on average to cover production and transportation costs and pay mineral extraction taxes,” said analysts at the Centre for Global Energy Studies in London.

“In November the situation would have been even worse, with the formula derived export tax exceeding the average price of Urals by more than $15/bbl during the first half of the month,” CGES said.

Lowered export tax rates have improved the situation “somewhat,” the analyst said. But the high cost of transporting oil from West Siberian fields to export terminals on the Baltic and Black seas has many producers still operating at a loss, even after the export tax has been reduced. Reductions have at least kept the tax “only just below” the monthly average Urals prices. “The margin in October was $17/bbl and fell to less than $12/bbl during the first half of November,” CGES said.

Faulty formula

“The problem for Russian oil producers lies in the formula adopted by the government for calculating oil export taxes,” CGES analysts reported. Under the current system, taxes are changed every 2 months based on the average price of Urals crude over a 2-month period prior to the effective date of the new tax rate. Thus, the tax rate for October and November was based on the average level of Urals oil prices during July and August.

“This meant that, according to the formula, producers would have been required to pay $485.80/tonne ($66.60/bbl) in October and November 2008, but this rate was initially cut for both months to $372.20/tonne ($51/bbl), with the November rate subsequently cut again to $287.30/tonne ($39.40/bbl). Crude oil export tax for December and January was originally set at $306.50/tonne ($42/bbl), was first cut for December to $287/tonne ($39.30/bbl), and then again to $192.10/tonne ($26.30/bbl),” analysis reported.

Under pressure from Prime Minister Vladimir Putin, the Russian government is revising the methodology for calculating the oil export tax. As proposed, the new export duty will be based on the average Urals price over a 30-day period ending in the middle of the month prior to implementation. Thus, the January export duty would be based on the average Urals price over the period from Nov. 16 to Dec. 15, said CGES.

“Putin wants the new export duty rules approved and in place by the beginning of December, allowing them to take effect in time for the beginning of 2009, although by then it is hoped that oil prices will have stopped falling quite as fast as they have been in recent months,” the analysts reported.

Changes to the export duty may provide short-term relief for Russia’s oil producers but “will do little to boost investment in the new exploration and production that is needed to reverse this year’s decline in the country’s oil output, which now looks likely to be around 0.5% down on last year,” CGES analysts said.

“Although new fields have been brought into production in East Siberia and Timan Pechora, they have yet to have much impact on overall production levels. Rising production from Surgutneftegaz’s Talakan field and the TNK-BP-operated Verkhnechonsk, both in East Siberia, and the Lukoil-Conoco Yuzhno-Khlyuchu (YK) field in Timan-Pechora, together with the expected startup of Rosneft’s Vankor field and TNK-BP’s Uvat development and the beginning of year-round production from the Gazprom-led Sakhalin-2 project should all help to stabilize Russian production next year and return the country to year-on-year output growth,” the analysts said. However, they added, “The next stage of the country’s oil development requires massive investment in East Siberia and much greater changes to the oil taxation regime.”

ESPO pipeline link

In an Oct. 29 report, CGES noted that most of the new fields that Russia hopes to bring on stream are in East Siberia and will be linked to the new East Siberia-Pacific Ocean (ESPO) pipeline that will transport oil to Skovorodino for delivery by rail to an export terminal on Russia’s Pacific coast near Nakhodka.

In that report, CGES said oil production data from the central dispatching unit of Russia’s Ministry of Industry and Energy showed a year-on-year drop of 370,000 tonnes (90,000 b/d), a fall of 1%, in August. Aggregate Russian oil production over the first 8 months of 2008 was reported a little above 325 million tonnes, equivalent to 9.73 million b/d, using a conversion factor of 7.3 bbl/tonne for Russian oil. Production during January-August was 1.4 million tonnes lower this year than last, a dip of 0.42%. Allowing for an extra day as a result of 2008 being a leap year, daily production was down by 80,000 bpd, a fall of 0.8% compared with the same period in 2007.

Protracted slowdown

Russia’s oil production growth has shown previous signs of faltering, most notably in early 2005 when production rates fell from peak levels reached in the third quarter of 2004. However, CGES analysts said the recent slowdown has been more protracted, extending from a month-on-month decline in production to the first year-on-year drop since the revival of the Russian oil industry in the late 1990s.

The Russian government expects its total 2008 oil production to be up 1% (4.9 million tonnes) above last year’s 491 million tonnes total. “It will be helped, of course, by the extra day this year, which is worth an additional 1.34 million tonnes of oil at the current average rate of production. Were this rate to be maintained for the rest of the year, aggregate oil production for 2008 would be just short of 489 million tonnes, 2.2 million tonnes down on last year’s level,” said CGES analysts. However, they said prospects for a surge in Russian output in the last quarter of this year are mixed.