Russia adjusts taxes

May 7, 2012
The axiom is repeated often: When a government increases taxation of an activity, less of the activity occurs; when it lowers taxation, activity increases.

The axiom is repeated often: When a government increases taxation of an activity, less of the activity occurs; when it lowers taxation, activity increases. The logic here is clear and compelling. Yet governments occasionally yield to less sound influences and need to be reminded.

Russia has just provided a reminder. To stimulate investment, it recently proposed to lower taxation of offshore oil and gas production. Presto! Big projects are advancing. The country could do more to boost activity. But lower taxation certainly encourages investment.

Sliding scale

The Centre for Global Energy Studies, London, analyzed the Russian initiative in an Apr. 25 report. Under the current tax system, CGES said, the price of Urals crude oil, benchmark for Russian tax formulas, less the sum of mineral extraction tax plus export tax on offshore production would have been $25-35/bbl. Under the proposed system with the Urals crude price at $115/bbl, the margin would be $80/bbl for the least challenging fields and just below $110/bbl for the most challenging fields.

The new system imposes no export tax for offshore production and freezes the profit tax at 20%. The mineral export tax applies on a sliding scale to four categories of offshore fields, varying by degree of operational difficulty. The rates are 30% of sales price for the least challenging offshore fields, and 15%, 10%, and 5% in the other tiers. The tax rates would be guaranteed to remain in place for specific periods, depending on field category, and could be lowered or supplemented by other measures to support investment if oil and gas prices plummeted. The mineral extraction tax now is about 19%.

Further improvement in the Russian investment climate also would come from proposed tax exemptions for imported equipment not produced in Russia. Prime Minister Vladimir Putin mentioned the exemptions during discussion of the tax-reform proposal. He also suggested local-content requirements of 70-75%.

The new offshore oil and gas taxation framework appeared in a regulation signed by Putin on Apr. 12 requiring several ministries to propose, by October, ways of implementing the new regime. The new tax rates would apply to fields starting up after Jan. 1, 2016, and not already receiving tax favors.

Oil companies welcomed the move with more than words. ExxonMobil Chairman and Chief Executive Officer Rex Tillerson and Rosneft Pres. Eduard Khudainatov said in early April that the government's step toward tax reform encouraged them to proceed with a series of agreements under a broad upstream partnership they formed in 2011 that includes exploration of Russia's Kara and Black Seas. Later in the month, a press statement by Rosneft hailed the prospect for lowered tax rates as it and Eni disclosed a strategic cooperation agreement covering exploration in the Barents and Black Seas. The Russian company also mentioned the guarantees "that the favorable tax regime will remain in place for a prolonged period of time."

Already, the promise of tax rates lower and more stable than they have been is encouraging offshore activity. But a large problem remains.

Restricted access

CGES pointed out that access to offshore oil and gas prospects remains "effectively restricted" to Gazprom and Rosneft, which are owned by the government. Lukoil has development projects in the Caspian Sea and limited production in the Baltic Sea, it noted, "but until Russia's private companies are allowed access to other offshore acreage, the development of Russia's shelf will be hampered by the small number of players allowed to bid for licenses."

Governments influence investment in oil and gas activity in many ways. Of those many ways, taxation and access to resources are the most important. Russia, with its world-leading oil production and tantalizing exploratory potential, has moved to improve one of those factors. To just the promise of a tax regime friendlier than before to oil and gas investment, response has been swift. It should make Moscow wonder what might be possible if it broadened access to investment prospects as well.

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