THE TAX SITUATION IN RUSSIA’S OIL INDUSTRY AGAINST THE BACKGROUND OF THE ECONOMIC CRISIS

By Sergei Kolchin

After Gazprom, Russia’s oil companies are the main tax contributors to budgets at various levels. They also head the list of budget debtors. According to State Tax Service statistics, as of July 1, 1998, the oil companies’ debt to the federal budget was 2.7 billion rubles–4.7 billion, if deferred payments are included.

Almost half the total Russian oil company debt goes back a long way, sometimes as far as the early period of market reforms (1992-94). Yuganskneftegaz debts to the budget, for example, originate from unpaid deliveries of fuel to agricultural enterprises in 1992-94, while Nizhnevartovskneftegaz debts originate from the “oil for tinned meat” barter deal with Kazakhstan (Russia refused to accept tax payments in tinned meat). Naturally, all these stories–which are circulated by the oil companies themselves–are only partly true. Even the government, however, admits that the oil companies have amassed hopeless debts, and that such debts are due in large part to the accumulation of penalty charges on payments not made because of the general chaos in the country’s accounting system. The government’s attempts to resolve the mounting debt problem did not make a dramatic difference. In fact, the president used edicts and decrees more as a means of extracting taxes from the oil companies than as a resolution of the problem. Both sides, moreover, were well aware of the rules of the game–“if you help to plug the hole in the budget, we will leave you alone.” It was Alexander Livshits who provided the most pithy explanation of these rules: “You have to share.”

But the situation changed noticeably when oil prices fell on the international market. In the first half of 1998, the average price for a ton of Russian oil for export was US$83 dollars, compared with $118 during the same period in 1997. With these prices, Russian oil companies were left, after tax, with a mere US$3 for each ton of oil produced (for comparison the corresponding figures for Norwegian, American and British oil companies were US$10, $14.5 and $21 respectively). It was clearly more difficult for them to “share” their income. The oil companies complained, with some justification, about the unreasonable tax pressure on this branch of industry. Whereas, in the country as a whole, tax payments make up 35 percent of turnover, the figure for the oil industry is nearer 60 percent–more than twice that for Western oil companies.

The whole principle of taxation in this branch of industry is astonishing: Taxes are levied on turnover, rather than on profit, as they are in the rest of the world. The government might have responded sympathetically to the oil companies’ complaints, had the economic situation in the country not started to deteriorate sharply in 1998. Empty government coffers and growing social tensions did not permit the introduction of measures essential for a country whose economy is based, as Russia’s is, on the export of raw materials. Small tax concessions–for example, in contributions towards the revival of the mineral and raw material base or in duties on pumping oil through pipelines–did not have any noticeable effect. The oil companies estimate that these compensated a mere 5-10 percent of what they lost due to the fall in world oil prices. The devaluation of the ruble last August had a far more palpable effect: It at least gave the oil companies the chance to show positive profitability figures. Vagit Alekperov, president of Lukoil, even described devaluation as the salvation of the country’s financial system. It is doubtful whether other representatives of this system–bankers, for example–would agree with him, but for raw materials exporters it was undoubtedly a deliverance.

However, their gain may well be short-lived, as it may be offset by a growth in prices for related industry products. While the change in the exchange rate is to the advantage of the raw materials exporters, they did not react with a great deal of enthusiasm to the freeze on foreign credit payments. The danger of losing the trust of creditors is too great. Alekperov said that Lukoil would meet all its financial obligations despite the moratorium. Semyon Kukes, president of the Tyumen Oil Company, spoke in a similar vein. According to its press release, Tyumen believes that “a unilateral refusal to meet commitments. It and also has a negative effect on these companies’ reputation in foreign markets.”

After a period of quiet in August and September, due to the crisis of government and economy, the oil tax battle was revived with renewed vigor. As early as October the heads of the thirteen largest oil companies made public their appeal to Prime Minister Yevgeny Primakov’s new government, in which they expressed their common concern over its economic and fiscal plans. The main criticism, it is true, related to the actions of previous cabinets. The appeal stated: “The policies of a high exchange rate for the ruble and monetarist regulation have weakened the economy of the country, contributing to the squeeze on exporters and to the growth in profits for importers.”

But the oil companies were even more concerned by their future prospects as defined by the plans set out by Primakov’s government. Additional taxes have been proposed by the Ministry of Finance, which the oil companies estimate at US$15-20 per ton of oil produced. These are made up of export duties (10 ECU per ton), an increase in the hard currency element of the export tariff for transportation, and indexing excise duties. The Ministry of Finance estimates that while the dollar rate was rising the oil companies received US$500 million in extra income. The oil companies’ displeasure at these plans was first indicated by Mikhail Khodorkovsky, the head of Yukos, who said that “we simply cannot and will not pay” the increased taxes. Vagit Alekperov of Lukoil echoed this sentiment, pointing out that the oil companies had already paid a substantial “tribute” in advance while the ruble rate was high and oil prices were falling, when the companies were forced to borrow in the West to settle with the budget. Apart from this, he pointed out that the figures in the 1999 budget are clearly unrealistic: world prices of $14 per barrel and an annual production rate of 300 million tons. According to Alekperov, figures of US$10-11 per barrel and production of no more than 285 million tons are more realistic.

Against this background, the industry headquarters–the Ministry of Fuel and Energy–quickly produced its tax proposals for oil companies. The Ministry of Fuel and Energy did agree that a return to export duties was necessary (as the Ministry of Finance was insisting), but proposed scrapping the hard currency element in the tariffs for the transportation and trans-shipment of oil. In addition, the oil companies proposed introducing a sliding scale for export duty–US$1.4 per ton at world prices of $73 per ton, rising by $1 for every 10 percent rise in price from the base level. However, with hopes for an IMF credit slim and the government having announced emergency measures for the economy, there is every reason to believe that the final export duty on oil will be considerably higher, though not as much as the 10 ECU originally proposed by the Ministry of Finance. The government has proposed setting the duty at 4 ECU. As regards excise duty, the Duma budget committee proposed in November 1998 that it be replaced with a tax on additional income from hydrocarbon extraction. Here payments to the budget will depend directly on the profitability of the fields. It is estimated that the treasury will lose about 5 billion rubles per year with this scenario, but these are probably only nominal losses, given that taxes are certainly not being paid in full. The government is also ready to agree to the introduction of a tax on additional income, stressing, however, that the new tax should only be levied on wells already in service to avoid encouraging unprofitable production in old oil fields. The final tax regime for the oil industry in 1999 will probably still be very harsh for the oil companies, bearing in mind that sources of funds to replenish the budget are very limited.

At the same time, the tax regime has to take into consideration the objective situation with regard to world oil prices, which makes extraction at the majority of Russian oil fields unprofitable, and that there are no funds left to develop new ones. The consequences of harsh measures may be the loss of significantly larger sums than if there were a more lenient tax system. Therefore we can expect to see compromise decisions which strike a balance between the two margins of economic reality: the lack of sources of tax contributions and the threat of the complete degradation of the oil industry.

Dr. Sergei Kolchin heads the sector of economic statistics and comparative international analysis of the Russian Academy of Sciences’ Institute of International Economic and Political Studies in Moscow.