Kremlin looks to squeeze cash from oil companies

The Russian authorities continue their efforts to balance the books: after demanding funds from big business, they are now looking at oil companies. In particular, the Finance Ministry is changing the way it calculates taxes for oil companies. Instead of relying on prices from energy agency Argus, which currently shows a $40 discount on Russia’s Urals blend compared to benchmark Brent, the ministry will soon use its own formula.

The new formula

The Finance Ministry has introduced legislation that will change the rules for calculating taxes on oil companies. At present, the ministry bases Mineral Extraction Tax (MET) and other oil taxes on the market price for Urals crude in the European ports of Rotterdam and Augusta, as reported by Argus. These are the same prices that the ministry publishes every two weeks as its “average price for Urals oil.” The discount on Urals compared to Brent is derived from these figures. Since the European oil embargo came into force late last year, the price for Urals has dropped, and the discount to Brent increased to up to $40 per barrel.

From April 1, the Finance Ministry will abandon Argus’ prices altogether. The Urals prices will still be pegged to Brent, but the discount will now be set by the Russian authorities.

Initially, the discount will be dropped to $34 per barrel and it will continue to fall step by step until it reaches no more than $25 per barrel in July. This will increase the tax burden on oil companies and help ease Russia’s budget deficit. That deficit is increasing in part due to a fall in oil and gas revenues — last month they were down 46% year on year.

Under the new arrangements, Russia is expected to gain up to 700 billion rubles ($9.4 billion) in additional revenue. The Finance Ministry’s proposed legislation is a compromise between the government and the oil industry. Initially, the proposals were much tougher: the ministry wanted to cut the discount to $20 and impose the changes as quickly as possible.

Combined with an announced reduction in oil production, the new formula will help the Finance Ministry raise the 8 trillion rubles ($115 billion) in oil-and-gas revenues envisioned in the 2023 budget. Economist Alexander Isakov of Bloomberg Economics Russia calculated that, if expenditure and non-oil and gas revenues remain as planned, the overall budget deficit will be just 4.3 trillion rubles. That’s not far off the planned 2.9 trillion ruble deficit.

Can the oil companies pay?

With Western sanctions and an enforced pivot towards Asian markets, Russian oil companies may not seem like an obvious cash cow. However, some believe they are not suffering nearly as much as advertised.

Since the European Union imposed its oil embargo, the Russian oil market has been extremely opaque — and analysts suspect that companies are, in fact, selling at a discount far less than the publicized $35-40.

Sergei Vakulenko, a non-resident fellow at the Carnegie Endowment for Peace, has explored this theory in at least two articles, arguing that the Argus prices for Urals lost any meaning after the start of the war. Up until Dec. 5, when Russian oil was still exported to Europe, it was profitable for Russian oil companies to sell at a low price: they could offload cheap crude to their own refineries and then sell the resulting oil products at full market price in Europe. As a result, he suggested, oil companies avoided taxation, circumvented sanctions and made money trading with Europe.

Once the European embargo came into force, Vakulenko believes a similar story began to unfold in Asia. Based on analysis of public data and conversations with traders, he suggested that Indian buyers were getting Russian oil at a maximum discount of $10 per barrel, rather than the headline $30 to $40 figure. An analyst at a leading investment bank who spoke with The Bell and said he believed Vakulenko. Much of the difference has been pocketed by trading and shipping companies connected to Russian oil majors.

To some extent, Western sanctions have succeeded in making Russian exports less transparent not only for the West but also for the Russian government, Vakulenko told The Bell. “Circumstances have created an enormous rent-capturing opportunity at the expense of Russian state coffers and the European consumer,” said Vakulenko. “The Russian state was deprived of a substantial share of oil revenue.”

The new formula put forward by the Finance Ministry should reduce incentives for oil companies to manipulate prices and oblige them to pay more tax.

Why the world should care

High spending and a fall in revenue is one of the biggest financial challenges facing the Russian government this year. There will be no repeat of the oil-and-gas bonanza of spring 2022, which largely canceled out the early impact of sanctions. Russia’s technocrat officials will have to show ever greater ingenuity and persistence to fill the state’s coffers without stifling the economy. Of course, there is little they can do to change the primary cause of economic uncertainty and rising expenditure — the war in Ukraine.