High-Profile Arrest Is Latest Sign of Dysfunction in Russian Refinery Sector

Russia’s largest independent oil refiner, New Stream, recently emerged from financial devastation to resume operations. But multi-million-dollar fraud charges against its former board chair underscore the problems in an industry reeling from decrepit facilities and a new, profit-gutting tax code. At the same time, the arrest of New Stream’s Dmitry Mazurov, on July 13, cast renewed spotlight on corruption and malfeasance in Russia’s energy sector that have led to charges against a number of other prominent industry executives this year (RBK, July 15).

New Stream suspended operations at its Antipinsk refinery, which processes nine million tons of oil a year, in April. That month, a court in London granted a trading house’s request to seize New Stream assets in order to cover outstanding bills the company owed. The ruling against New Stream prompted the company to file for bankruptcy protection in May. Work resumed on July 20, under an operating partnership between New Stream’s main lender, Russia’s state-owned financial giant Sberbank, and SOCAR, Azerbaijan’s national oil and natural gas company. In the meantime, however, Sberbank claims New Stream still owes millions of dollars on its loans (Vedomosti, June 5).

The financial debacle prompted Russian prosecutors to prepare a $29 million fraud case against Mazurov. New Stream is only the latest in a string of Russian energy company to have one or more of its key executives face trial since the start of 2019.

In January, prosecutors charged Rauf Arashukov, advisor to the CEO of Gazprom Mezhregiongaz, a subsidiary of the Russian gas giant, with stealing $453 million worth of gas over several years. His son, Raul, who at 31 became the youngest senator in Russia’s upper house of parliament, was arrested on separate charges the same day (Interfax, January 31). The authorities in March accused Mikhail Abyzov, the former federal minister for open government, of embezzling $62 million from two energy companies in Siberia (RIA Novosti, June 5). And in June, several executives of Transneft, Magistral, Nefteperevalka and Petroneft were arrested in connection with the contamination of the Druzhba pipeline, which delivers Russian oil to Western Europe through Belarus and Ukraine (Interfax, June 11). The contamination, the result of chemically tainted oil being sent through the pipeline, forced Russia to suspend Druzhba’soperations, costing the energy industry billions in lost sales and clean-up expenses (see EDM, April 26; see Commentaries, June 21).

Mazurov’s case highlighted the Russian refining industry’s need for modernization. Although vertically integrated companies such as Rosneft and Lukoil own most of the country’s 6.5 million barrels a day of capacity, even these giants’ refineries desperately need upgrading (Rossyiskaya Gazeta, June 17, 2018).

Russia ranks third in global refining capacity, behind the United States and China. But that capacity is much lower than it should to be, particularly since Russian production is about the same as the world leaders, the United States and Saudi Arabia. Although the government created an ambitious incentive package a decade ago try to spur refinery modernization, its refineries continue to lag behind other energy powers in a key output measure known as refining yield. This is essentially the percentage of finished products a refinery produces from its raw materials.The US yield is highly efficient at 98 percent. In the European Union, it is 90 percent (YandexZen, March 15, 2019). While in Russia, it is only 81 percent (Vestifinance.ru, December 27, 2018).

Already smarting from low oil prices and Western sanctions (over Russia’s seizure of Crimea, support for eastern Ukrainian “separatists,” and meddling in the 2016 US presidential election and Brexit vote), the Russian refining sector suffered a further heavy blow on January 1 of this year. On that date, Russia’s parliament adopted a law to shift oil taxes from exporters to producers—the so-called “tax maneuver”—over the next six years (TASS, July 24, 2018).

Domestic producers have sought to pass the tax on to refineries by charging them more for crude. So far, government measures to help those refineries maintain their profit levels have failed. Worsening the situation has been the state-mandated increase in excise taxes for gasoline and diesel that led to record prices of those products last year (Realnoe Vremya, June 6, 2018; Petroleum Economist, July 19, 2019).

The situation for Russian refineries is now so bad that some industry experts contend it is impossible for them to make a profit. These plants face a classic Catch 22 situation: They need to modernize to increase their profits, but competition from more efficient refiners in other countries and the Russian tax-code change mean a profit crunch that will make it even harder to free up capital for modernization. If this hard-luck situation continues, further consolidation of the Russian refining sector in the hands of giants like Lukoil, Rosneft and Gazpromneft is inevitable.