«We expect Russian oil & gas (O&G) companies to continue generating strong profit and cash flow in 2019-2021», Fitch Ratings says in a new report. The Russian government’s tax overhaul is likely to have only a minor negative impact on the upstream sector, but a mixed impact on the downstream sector.
We expect Russian O&G companies to report impressive rouble EBITDA growth of around 50% yoy on average in 2018, fuelled by a rise in oil prices and rouble depreciation. Average oil prices reached an all-time high in rouble terms in 2018, and we expect them to change little in 2019. Our expectations of strong medium-term profits have been incorporated into our rating case for Russian O&G producers, and we forecast them sustaining a modest median leverage of around 1x in 2019-2021.
The Russian O&G sector is undergoing tax reforms, the so-called «tax manoeuvre», whereby export duty (ED, introduced in 1992) paid on oil and oil products exported from Russia will be gradually reduced in 2019-2023 until it is cancelled in 2024. A higher mineral extraction tax (MET) will fully offset the ED reduction, making the ED decline EBITDA-neutral.
However, upstream companies will pay $0.4-0.5 per barrel of oil produced if export netbacks for gasoline and diesel exceed domestic prices by a certain amount. This will marginally increase the Russian upstream sector’s total tax burden. We estimate that a 3% decline in EBITDA compared to 2018 is likely if the Brent oil price exceeds $65/bbl in 2019 due the changes in tax structure.
This will marginally reduce the profits of oil producers, while integrated oil companies will compensate for this new tax with higher EBITDA in their downstream segment.
Starting in 2019, the government introduced an experimental tax on additional income (TAI) that is levied on a limited number of oil and gas fields along with ED (if applicable) and reduced MET. TAI is profit-based and designed to encourage the development of greenfield and increase output of brownfield sites.
This should benefit both producers and the state budget as oil production levels could decline in the course of the next decade in the absence of profit-based taxation. The scope of TAI could be extended to a larger number of fields, depending on the initial result of the trial.
The impact of the «tax manoeuvre» on the downstream sector will vary according to several factors. Russian refineries currently enjoy a significant benefit of lower average ED on oil products relative to ED on crude oil: a refinery may, for instance, pay 50% lower duty on a refined and exported barrel of oil compared to an exported barrel of unrefined crude. Buyers of refined products in Russia also benefit from the presence of ED as it reduces domestic prices.
The effect of the tax reforms on refineries will depend on their complexity and robustness of regional demand to rising domestic fuel prices. The ‘manoeuvre’ will cut tax benefits for the least sophisticated refineries, increase prices on oil products, but limit the impact on certain groups of consumers, eliminate tax benefits for countries that purchase Russian oil and refined products at domestic prices, and support remote refineries.