The Russian gas industry asks for a review of the tax system

29.06.2012 — Analysis

In 2012 the Russian government doubled the tax rate on gas production, and this increase will continue through 2013-2014. The decision to boost the tax on mineral deposits has drawn a mixed reaction from experts who predict the collapse of investment projects on the Yamal Peninsula and a drop in the budget revenue for that autonomous district. The region's largest gas operator - Gazprom, OJSC - does not share this pessimism, as it can count on additional income from the domestic sale of hydrocarbons. But as this columnist for RusBusinessNews has determined, some losses are inevitable, given the rise in gas prices and the drop in consumption.

For a long time the Russian gas industry was taxed less heavily than oil. For example, from 2006 to 2011, Gazprom paid a Mineral Extraction Tax of 147 rubles per thousand cubic meters, while oil companies were subject to a rate of 419 rubles per ton of "black gold." But last year the government decided to correct this "injustice" by increasing the tax rate on gas by almost 100%. In 2012 the rate doubled again, and by 2014 the operators of a unified gas-supply system will have to pay 622 rubles per thousand cubic meters.

Industry experts contend that the government's decision is shortsighted. At the Yamal Oil and Gas 2012 international conference, Gennady Shmal, the president of the Russian Union of Oil and Gas Producers, declared that officials are undervaluing the importance of hydrocarbon resources for the country's economy. The oil and gas industry, which accounts for over half of the nation's budget, is being deprived of up to 70% of its revenue. No other industry, either in Russia or abroad, is subject to a rate this high. According to this expert, ExxonMobil pays only 32% in total taxes and the other foreign oil and gas companies - even less.

This excessive taxation means that the Russian oil and gas industry is chronically underfunded. According to Gennady Shmal, ExonMobil and Shell receive investments of $100-140 per ton of extracted hydrocarbon, but Russian petroleum companies get only $35. Mr. Shmal estimated that at least $40 billion a year needs to be invested in every oil company, but in Russia this funding ranges from $25 to $30 billion. An increase in the Mineral Extraction Tax would reduce this investment even further, because financiers will be dismayed by the rising costs.

The expenses of new technology and geological exploration are currently paid for out of net profits, which seriously constrains the growth of oil and gas firms. According to Gennady Schmal, as much as a million meters of exploratory wells were drilled in the Yamalo-Nenets Autonomous District in the 1980s, while only 700,000 meters were drilled in all of Russia in 2011. As such, the hydrocarbons that are being extracted are not being replaced, a fact that is very significant for Yamal, which has over 13,000 inactive and abandoned oil wells.

Large sums are needed, not only for prospecting work, but also to dispose of the casinghead gas. Natalya Kolesnikova, the deputy head of Rosprirodnadzor on Yamal, claimed at the Yamal Oil and Gas 2012 conference that in 2011, Gazprom Dobycha Urengoy, LLC managed to dispose of only 23% of its casinghead gas - the rest was flared. And Yamalneftegaz (a subsidiary of LUKOIL-West Siberia, LLC) used only 8% of its gas. In 2012, these companies were forced to quickly find a way to collect this casinghead gas when the fines for flaring increased substantially. The number of flares in the autonomous district has declined, but Natalya Kolesnikova claims that companies still continue to light up the tundra this way.

A number of projects have been established on Yamal to develop the shelf of the Kara Sea, to construct a pipeline system and a plant to liquefy natural gas, and to build an Arctic port and gas-processing facility. And work continues at the old Urengoy gas field, where they are forced to drill into ever-deeper horizons in order to increase production. New technology, plus difficult natural and geological conditions, requires huge outlays of cash. Experts think it is possible that higher taxes will force some of these projects to be put on hold.

The office of regional policy at Purneftegaz, LLC told RusBusinessNews that they had been instructed by their parent company to estimate the amount of income that would be lost due to the higher Mineral Extraction Tax. Those numbers aren't ready yet, but the employees of Purneftegaz do think a tax increase might slow the work on the Kara Sea shelf, which Rosneft has begun working with Shell to develop.

Gazprom has no current plans to trim its investment program, but Yaroslav Golko, who sits on the board of that gas monopoly, claimed at a press conference that everything depends on the company's revenues. Production fell sharply in May due to the drop in gas consumption in Europe. If this trend continues, Gazprom will produce about 10 billion fewer cubic meters of gas in 2012 than it did in 2011. But nevertheless, the company's senior executives are hoping for an increase in revenue - the monopoly plans to find this additional cash on the domestic market, where consumption of the blue flame grows by 5% a year.

Mikhail Kormchenkin, the director of East European Gas Analysis, feels that Gazprom's forecast is overly optimistic. In view of the looming economic crisis and the 15% increase Russians will soon face in fuel prices, an increase in consumption of even 1% is no sure bet.

If gas companies see a drop in revenue, this will lead to a decrease in investment in the Yamalo-Nenets Autonomous District. Vladimir Vladimirov, the first deputy governor of that district, claimed at a parliamentary hearing in the State Duma that in 2013, investment programs will "shrivel" by 27 billion rubles, by 53 billion rubles in 2014, and 95 billion in 2015. The decline in business activity will have a direct effect on the regional budget, over 50% of which is derived from income taxes. The vast majority of income on Yamal is generated by gas companies.

Even the national coffers will feel the pinch of the shrinking investment programs. The Russian Ministry of Finance recently stated that the government was growing increasingly dependent on petrodollars. For this reason, experts warn that it is not only important to refrain from raising the tax on gas production in the medium term, but if the oil and gas industry is to grow, the system by which it is taxed needs to be completely revised.

Vladimir Terletsky