The future of Russian oil production

The Russian government has already introduced tax breaks for oil fields located in new regions of oil extraction; in fact, it has lowered taxes on oil extraction from both developed oil fields and small new ones. Source: AP

The Russian government has already introduced tax breaks for oil fields located in new regions of oil extraction; in fact, it has lowered taxes on oil extraction from both developed oil fields and small new ones. Source: AP

There country’s main mission should be to either conserve natural resources or to invest profits from them in new assets.

According to experts, Russia will continue to actively export oil until 2020, even after which significant decreases are not expected. Russia is rightfully considered a reliable exporter of raw materials for its partners abroad. However, this wealth of raw materials cannot last forever if only because raw materials are exhaustible. Experts see bright prospects for the Russian economy if it diversifies along the lines of the Chilean scenario. 

The Russian economy is highly dependent on its raw materials. This is no secret to anyone with the least bit of knowledge of the country. According to the Federal Tax Service, taxes on oil and gas production in Russia account for nearly half of the federal budget. If we add metal and timber exports to those of oil and gas, then we will have 85 percent of all Russian exports. Such a heavy dependence on its natural resources, also known as its “raw materials habit”, makes Russia a stable oil and gas exporter on which one can rely in the long term, but it also creates a certain number of economic problems.   

“Production indices for the oil industry in recent years have remained at a high level,” Energy Minister Alexander Novak said in an interview with RIR. “The falling trend in production that manifested itself at the start of the world financial crisis in 2008 has been overcome. Thanks to timely stimulus measures applied by the government, we produced more oil in 2011 than in any year in the post-Soviet period: 511.4 million tonnes. According to our general plan for the development of oil production, the level of production will remain stable until 2020 when it should reach around 530 million tonnes.” 

The Energy Ministry’s forecast of 530 million tonnes by 2020 is entirely realistic. After all, in the east and north of Russia there are actually no less than 20 open oil fields that have yet to be developed. For example, the Vankorskoye and Verkhnechonskoye oil fields in eastern Siberia, from where oil is transported to China, could, according to Novak, supply Chinese demand for a minimum of five years, after which this demand will be satisfied by neighbouring oil fields in eastern Siberia and Yakutia.

However, we see two clear threats which could upset the Energy Ministry’s plans to reach a production level of 530 million tonnes of oil by the year 2020. One threat is the current tax on the extraction of minerals and the other threat is the oil industry’s weak ties to other sectors of the Russian economy.

The key problem with the tax system as it now stands is that it is not a company’s profit that is subject to taxes and duties, but the absolute indices of its earnings. Despite the fact that this approach did at one time make it possible to simplify the administration and collection of taxes, it does not take into account the economics of the oil industry and virtually blocks the inflow of investments into it. To put the problem more simply, the higher the price of oil, the greater the volume of its production, and the higher the taxes on that output. As a result, no matter how much a company increases its production of oil from developed oil fields, the potential increase in revenue will be wiped out by taxes. Existing tax regulations make the extraction of significant volumes of oil both at new and at already developed fields unprofitable.

Of course, the Russian Government has already introduced tax breaks for oil fields located in new regions of oil extraction. It has lowered taxes on oil extraction from both developed oil fields and new small ones. On September 24, Energy Minister Alexander Novak announced that the government had decided to significantly lower customs duties for oil extracted from fields in eastern Siberia. Duties, he said, would be cut almost in half. Moreover, the cabinet of ministers intends to extend the zero percent tax rate already in effect for eastern oil fields. The tax break was supposed to end on January 1, 2017, but has now been extended to January 1, 2022.

These advantages will affect oil fields in Krasnodar Territory, the Irkustk Region, Yakutia and the Yamalo-Nenetsky autonomous area. In developing these fields oil companies have had to deal with two basic difficulties: an undeveloped infrastructure and a harsh natural environment. The lack of infrastructure hampers the delivery of oil to its end user and makes the process of transportation very expensive. The harsh environment raises the cost of extraction and decreases its profitability. But a zero percent tax rate for oil fields with an undeveloped infrastructure makes no sense. Transportation of oil from remote areas remains difficult. If the cost of transporting the oil cancels out the advantage of not having to pay taxes on it, the oil companies involved have no extra incentive.

As it is, Russian oil companies barely manage to develop difficult-to-access oil fields because of the increased costs, bad weather conditions, the lack of necessary technology and infrastructure and the long distances to the market. We are now faced, for example, with the task of extracting oil from the Arctic shelf. But we cannot do this without foreign partners since we don’t know how to extract the oil and whom to sell it to. The existing markets for our oil in Europe, for example, are only shrinking.

Hoping for emergency government stimulus and help from foreign partners are such major companies as TNK-BP, currently engaged in developing oil fields in Yamal  (extraction is scheduled to begin there in 2016-2019), and Surgutneftegaz, which plans to increase extraction by developing three oil fields in Yakutia. As for the shelf projects, Rosneft is already conducting geological reconnaissance missions on the shelf of the Karskoye and Pechorskoye seas, where extraction is set to begin by 2020. But if the government does not make the necessary corrections to the tax legislation, such projects will remain in development in perpetuity.

The problems with delays in development of other sectors of the economy, was recently outlined for RIRby Valery Mironov, deputy director of the Development Center at Moscow’s Higher School of Economics: “Oil is a public resource. We should, if we are even extracting these resources, not spend them on current consumption, but convert them into new assets so as to give them in some shape or form to the next generation; our children and grandchildren. Therefore our main mission should be to either conserve these resources or to invest profits from them in new assets. Whether those new assets would be infrastructure, or human capital, or new factories is a matter of budget policy. But in principle it should be forbidden to spend profits from raw oil on current consumption.”

According to Mironov, there are three possible solutions to this problem. The first is to invest raw-material profits for the diversification of the economy. Develop non-raw material sectors of the economy. The second solution is to invest raw material profits in real assets abroad. The third is to invest money in controlling the world market for energy resources.

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