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Excess profits tax

Renaissance Capital

20 June 2019

Russian oil & gas

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Oil product taxation

Exports

Renaissance Capital

20 June 2019

Russian oil & gas

Oil product exports are subject to export duties, reintroduced in 1999. These have been changed regularly since. In an attempt to enshrine these rates in law, the State Duma proposed that oil product export duties be varied in line with prevailing crude export duties. Hence, beginning from 1 January 2003, oil product export duty rates began to be denominated in dollars, and were set at the same time as crude oil export duty (every two months) at a level equivalent to 90% of the crude export duty levy. Oil product export duty rates had previously been denominated in euros.

However, in November 2003 the State Duma lifted the 90% cap. After this, officials at the MEDT, which ran the Federal Customs Service until early 2006, indicated that new formulas would be introduced after negotiations with industry. However, the duty levels charged immediately after the amendment continued to be set at 90% of those established for crude exports, at least until mid-2004. On 13 July 2004, however, the government’s Commission on Protective Measures in Foreign Trade decided to increase the duty on refined oil product exports by a smaller amount than the rise due on 1 August 2004 for crude, and also to introduce the increase at a later stage, around 1 September. Therefore, whereas the duty on crude oil exports rose to $69.9/t from August, from $41.6/t, due to the application of the tax bands discussed above, the duty on refined product exports only increased from $35.7/t to $45.4/t.

A member of the Commission told newswires at the time that the new rate entailed pegging the duty rate at some 65% of export duties levied on crude. Encouragingly, the decision was reportedly made on the basis of a broad understanding that a higher duty would have damaged refined product exports without bringing down domestic product prices. Yet this understanding lasted for only a short time. By October 2005, the oil companies came under intense political pressure because of runaway product price rises in the domestic market, although this was merely a result of rampant international prices and the lower export duties imposed.

At first, political coercion led to some price restraint and matters calmed down, but by April 2005 officials took matters into their own hands and introduced a new oil price-linked export duty scale for refined products. The new product export duty calculation scale levied no export duty on products if crude prices (Urals) were below $15/bl. Beyond this level, the duty was calculated based on the crude price minus a base of $15/bl, multiplied by a coefficient of 0.32 (and also multiplied by 7.3bl/t). The resulting figure was then multiplied by 0.7 in order to establish duties for dirty products (fuel oil) and multiplied by 1.3 for clean products (gas oil/diesel mainly, and also for gasoline and jet-kero). This has led to meaningfully higher duties since, yet they remained much lower than those imposed on crude exports.

A further minor change for refined products export duties took place in October 2006. Basically, whereas crude export duties were governed by a strict formula that results in new rates on the first day of every even-numbered month, the formula governing refined products had been applied haphazardly. Tax Code changes approved in 2006 synchronised export-duty changes for crude and refined products.

In October 2008, the Russian government reduced the export duties lag, and oil product export duties have been revised monthly since (vs a two-month revision cycle previously), in line with the revised approach to the calculation of export duties on crude.

In 2003, the oil product export duty was linked and capped at 90% of the crude duty

The cap was removed in late 2003, and more benign taxation adopted from August 2004

New formula introduced in 2005, subsidising refined product exports in general, and fuel oil exports in particular

As part of the final phase of the tax manoeuvre, introduced from 1 January 2019, the structure of product export duties, calculated as a percent of crude oil export duty, has not changed, but their absolute level will gradually decline to zero by 2024 as crude oil export duty gets eliminated.

Domestic sales

In addition, following the abolition of the fuel tax at the end of 2000, another specific charge is levied on oil products sold in the domestic market. Excise is charged on a range of oil products (gasoline, diesel, and lubricants) at the rates shown in Figure 135.

Figure 135: Excise tax applied to domestic oil products, RUB/t

Product export duties will disappear from 2024

Excise is charged on a range of oil products

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Following a quiet period during 2004-2009 when excise taxes were kept flat (taming inflation, in our view), the government started raising the tax in earnest from 2010. From 2011, the government started to differentiate oil product excise taxes to encourage consumers and producers to use higher-quality (and cleaner) products, but this has become a less pressing issue post-2014 as a result of the widespread upgrades of

Russia’s refining capacity and resulting improvements in product quality. This has also corresponded with Russia’s transition to Euro-5 fuel specification standards from July 2016, as discussed on pages 62-63. Following significant growth in domestic gasoline and diesel prices in April-May 2018, the government has temporary reduced excise taxes for both products by RUB 3,000/t between June-Dec 2018, but then reverted to statutory levels from 1 January 2019.

Reverse excise and the damper

The introduction of the final phase of the tax manoeuvre from 1 January 2019 has resulted in reduced export duty benefit (also formerly known as the implied subsidy) to the oil products, compared to the previous tax regime. After consultations with the industry, the government has decided to offset this reversal with the introduction of the oil excise tax, which is a reverse (negative) tax paid to qualified oil refiners in Russia by the government in order to continue stimulating the refining industry as the current export duty subsidy on refined products eventually disappears in 2024.

Qualified oil refiners include those more sophisticated refineries that produce gasoline or naphtha and supply it to the domestic market (or those that have entered into a modernisation agreement with the Russian government), as well as those refineries that are at least 50% owned by Russian oil companies or individuals that are subject to foreign sanctions, an exception tailor-made to include NOVATEK’s Ust Luga refinery, we think.

Starting from 1 January 2019, reverse excise tax is calculated as follows:

Reverse excise = ((Urals – 182.5) * 30% + 29.2) * export duty reduction factor * regional coefficient * (refining throughput – 55% * volume of naphtha –

30% * volume of light products excl. naphtha – 6.5% * volume of petroleum coke – volume of fuel oil) + Damper;

The regional (logistical) coefficient was introduced to differentiate the applicable negative oil excise tax for remote refineries by a factor of between 1.0-1.5x, depending on their geographical location and proximity to export routes. It will be applied to five major refineries, as well as possibly several mini-refineries (assuming they qualify for the negative excise tax in the first place). These are: Achinsk (owned by Rosneft, qualifies for a regional coefficient of 1.5), Khabarovsk (NNK, 1.5), Angarsk (Rosneft, 1.4), Ukhta (LUKOIL, 1.3) and Omsk (Gazprom Neft, 1.05).

Federal Law No. 424-FZ On amending part two of the Tax Code of the Russian Federation and certain fiscal legislative acts, dated 27 November 2018 has also introduced a dampening coefficient (damper) that will be applied to the calculation of the reverse excise tax.

The dampening mechanism was introduced to allow the government to control retail petrol prices in Russia. It will be used to increase or reduce the amount of reverse excise tax to reduce volatility of end-prices, compensating the oil companies with 60% (in 2019) and 50% (thereafter) of the difference between the export netback and the target price within a 10% range of the targeted level (set as RUB56,000/t for gasoline and RUB50,000/t for diesel in nominal 2019 prices). If the actual netback exceeds the target

Renaissance Capital

20 June 2019

Russian oil & gas

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price, the reverse oil excise will increase, reducing the tax burden for the refineries. Conversely, if the actual netback price is below the target price, the size of the reverse oil excise will be reduced, thus increasing the tax take for the government at the expense of the customer. Should the positive difference exceed 10% (i.e., actual wholesale prices are more than 10% above the target prices), the dampening mechanism will not apply and we understand the government can revert to more draconian measures, such as the introduction of the prohibitive 90% export duty rate in accordance with the powers given by Federal Law No. 305-FZ On amending article 3.1 of the Custom Law of the Russian Federation, dated 3 August 2018. Should the negative difference exceed 10% (i.e., actual prices are less than 10% below the target price), the original version of the law assumed no action, while the 27 November 2018 version has no downside limit for the dampening mechanism, effectively meaning that retail petrol prices in Russia will never be reduced: if the oil price goes down, the government’s tax take will increase via a reduction of the reverse oil excise tax.

Starting from 1 January 2019, damper is calculated as follows:

Damper = compensation coefficient * (volume of EURO-5 gasoline sold to domestic market * (gasoline export alternative price – gasoline indicative price + gasoline export surplus) + volume of EURO-5 diesel sold to domestic market * (diesel export alternative price – diesel indicative price + diesel export surplus)), where

▪compensation coefficient is set at 60% in 2019 and 50% after 2019

▪export alternative price = ((Rotterdam price – export duty - transportation expenses to the Northwest Russian port) * exchange rate + excise) * (1 + VAT)

▪gasoline indicative price is RUB56,000 per tonne in 2019, RUB58,800 per tonne in 2020, RUB61,740 per tonne in 2021

▪diesel indicative price is RUB50,000 per tonne in 2019, RUB52,500 per tonne in 2020, RUB55,125 per tonne in 2021

▪gasoline and diesel export surpluses in the amount of RUB5,600 per tonne and RUB5,000 per tonne, respectively, are applicable only when the export alternative is higher than the indicative price; overwise, the export surplus is zero;

Despite its superficial simplicity, the mathematics behind the calculation of the dampening mechanism is quite complex, as the government and the oil companies have each tried to negotiate a favourable outcome for themselves. Therefore, there are several balancing coefficients, kickers and compensatory mechanisms, which, among other things, have resulted in the damper factors being introduced to the calculation of the seemingly unrelated MET. According to the law, this coefficient will kick in if indicative prices are below export netback and thus the export surpluses are non-zero. It will amount to RUB125 per tonne in 2019 and RUB105 per tonne post 2019 for gasoline and RUB110 per tonne in 2019 and RUB92 per tonne for diesel post 2019, which constitutes approximately $0.5/bl or 2% of our estimated average 2019 statutory MET rate, on our estimates. In essence, the rationale behind this approach is to redistribute some of the cost of the damper mechanism from the government to the upstream segment when export prices are too high, relative to the target domestic price level.

The experience of the first few months in 2019 has demonstrated the inefficiencies of the dampening mechanism, for two reasons. First, the presence of gasoline and diesel export surpluses in the above formula can result an unpredictable step-change in the value of damper within a small range of external parameters. Second, the volatility of international

Renaissance Capital

20 June 2019

Russian oil & gas