In Translation: Officials Drill Ahead on Oil Tax Reform

Article by Margarita Papchenkova and Elizaveta Bazanova. Translation by Nick Trickett.

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Photo: E. Razumniy, Vedomosti

On April 20th, a long-awaited reform for oil sector taxation was approved during a meeting with Russia’s Deputy Prime Minister, Arkady Dvorkovich. According to two federal officials, the transition from the severance tax (MET) to a tax on added income (NDD) will take place from next year. Dvorkovich’s representative refused to comment on the matter.

Unlike the MET, which depends on the quantity of extracted oil, the NDD is taken from the revenue of oil sales against the deduction of expenses for extraction and transportation. The rate will be 50%, with an export duty preserved in  a reduced form, as well as a small MET. The new tax is intended for the pilot fields in Western Siberia that are 20-80% depleted (as of 1 January, 2016) with production up to 10 million tons a year, as well as for new fields with depletion rates at 5%. In order to insure against budget losses, there will be limited expenses accounted for before the tax is calculated: the initial bar was 9,510 rubles per ton, but the Ministry of Finance then lowered it to 7,140 rubles.

The Ministry of Finance and the Ministry of Energy had been unable to reach an agreement on the reform for two years, and when they finally reached a compromise, Rosneft upset their plans at the finish line. Last year, the company requested an exemption from the MET for its gigantic Samotlor field due to its high water cut. Prime Minister Dmitry Medvedev was tasked with working through the request, but the Ministry of Finance laid down an ultimatum: take the NDD or the exemption. “You can’t carry out tax reform with one hand and continue giving out exemptions to the MET with the other. It’s not a systematic approach,” Alexei Sazanov, director of the Ministry of Finance’s tax department explained. The Ministry of Finance proposed Samotlor be included on the list of projects covered by the NDD.

You can’t carry out tax reform with one hand and continue giving out exemptions to the MET with the other. It’s not a systematic approach.

Dvorkovich approved the NDD without a binding decision for Samotlor. According to a participant at the meeting, the Deputy Minister pledged to evaluate the effect of an exemption for Samotlor without offering a concrete timeframe. According to an official from the Ministry of Energy, it’s not necessary to bind the NDD to the Samotlor exemption – it’s guaranteed that the exemption will increase production at the field, and the NDD is still an experiment. He added that the whole sector would benefit from the NDD, and that Rosneft would be the only exemption.

According to two officials, the fate of the Samotlor exemption will likely be decided by the president. One high-placed official is certain that if the question isn’t raised again, it’s possible the “topic will go away.” Officials told Vedomosti that Andrei Belousov, aid to president, supported an earlier exemption to the MET for waterlogged fields.

Falling budget revenues from the Samotlor exemption may reach 80 billion rubles, by the Ministry of Finance’s calculations. The NDD reform will also bring losses – around 25-30 billion rubles proceeding from the latest parameters of the bill. The Ministry of Finance points out that it will create a hole in the budget together with possible losses from small returns from state companies’ dividends (less than 50% of net income under the IFRS). The Ministry of Energy objects, says one official: there are additional oil and gas revenues, primarily from the freeze on oil extraction, which can plug the hole.

It’s surprising that a reasonable decision was reached in the end, remarks Grigoriy Vygon, Managing Director of Vygon Consulting. He says that the bill on the NDD was ready long ago and needs to get going. Direct accounting of costs in the taxable base helps make the tax system more complete and develop new reserves that are unprofitable in the current conditions, says Denis Borisov, the director of Ernst and Young Moscow Oil and Gas Center. “The quicker the experiment with the NDD starts, the better.” Vygon is patient, saying that for two to three years, they’ll administer the reform and then talk about scaling the experiment can start. “In the coming years, the current regime will remain the basis of the tax system – no fewer than three years are needed for the pilot tests of the NDD and the assessment of results,” says Borisov. Borisov believes that point-based tuning should continue on the basis of “win-win” (more extraction, more budget and company revenues, more revenues from related sectors), including the creation of stimulus for fields with a high water cut. “It’s a question of a compromise between budget interests, companies, and the country’s economy,” he says. “It’s necessary to evaluate the need for exemptions, not only for privileged waterlogged fields, but for the industry as a whole.” Vygon is categorical in saying that this calls for thinking about modifications to the NDD’s  parameters, not a new exemption per the MET: “in this way, the decision will be systemic rather than targeted as it has been thus far”.

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