Finance Ministry Reveals Details on Russian Oil Tax Cut Proposals

Tax Cuts for Oil, No Tax Hike for Gas

The Russian Finance Ministry yesterday unveiled its heavily anticipated tax-cut proposals for the Russian oil sector, part of its fiscal policy strategy for 2009-2011. The Ministry, which last week announced that it planned to offer a 100-billion rouble (US$4.2-billion) package of tax breaks and incentives to stimulate stagnating production growth, revealed the first details of the tax cuts yesterday (see Russia: 26 March 2008: Russia's Finance Ministry Proposes Oil Tax Cut, Delay to Gas Tax Increase). Among the key proposals are plans to reduce the mineral extraction tax, change the excise duty on high-quality oil products, and introduce tax holidays for firms carrying out exploration on the continental shelf.

Finance Minister Alexei Kudrin said last week that the tax cut proposals, which will be reviewed by the government on 3 April, envision a reduction on the mineral extraction tax by raising the non-taxable threshold from the current US$9/b to US$15/b. The draft proposals also see a change in the taxation of oil products geared to provide incentives for refiners to produce more high-quality and environmentally cleaner fuels. Currently oil companies pay around US$154/tonne (US$21.01/b) for high-octane gasoline (petrol), US$113/tonne for low-octane gasoline, and just US$46/tonne of diesel. In addition, the draft proposals would provide tax holidays for firms carrying out offshore exploration or granting them mineral extraction tax breaks.

However, the tax proposals may in fact be more notable for what they did not include than for what they did include. As reported last week, the proposals say nothing about an increase on the extraction tax for natural gas, with merely a recommendation that the tax be raised no earlier than 2011. Furthermore, the proposals only briefly touch on the issue of cutting the value-added tax (VAT) for the oil sector, an idea supported both by Russian President Vladimir Putin and President-Elect Dmitry Medvedev. Finally, the proposals do not include any of the proposals from the oil industry itself with regard to scrapping the excise duties on oil products or changing the oil export tariff system. Producers say that this still favours heavy oil products, giving refiners little incentive to upgrade their facilities to produce lighter, more valuable oil products such as gasoline (see Russia: 19 Russia 2008:Rosneft Seeks Reduction in Russian Oil Product Export Tariffs).

Outlook and Implications

The Finance Ministry's tax proposals will be cheered by oil and gas producers alike, but the measures to reduce the crushing tax burden are not likely to go far enough. Gazprom, the Russian gas giant that has lobbied strongly to prevent an increase in the mineral extraction tax on natural gas in the short term, will claim victory in winning a delay in the hike until at least 2011, while Russian oil companies can take comfort in finally convincing the government to ease their tax liabilities. Given the relatively non-controversial aspects of the tax proposals, the government seems likely to approve the changes in more or less their current form.

However, precisely because these proposals are so watered-down, leaving out the more "radical" industry-favoured changes to rebalance the export tariff system, it seems virtually certain that these tax cuts will have only a minimal impact to achieving their aims; namely, to stimulate Russia's stagnating oil production growth. After 53% total growth between 1998 and 2004, annual production growth has slowed to just 2-2.5% since then, and with monthly output registering consecutive declines in January and February this year, there are growing warnings about a potential annual drop in Russia's oil output this year. Although the government appears content to see production grow at a slower but steady clip of perhaps 1%, surpassing 10 million b/d in oil production this year, the government appears less inclined to accept Russia's first annual decline in oil production in over a decade.

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