No. 4, 2009

Oil of Russia magazine talks to Grigory Vygon, Head of the Department for Economics and Finance of the RF Ministry of Natural Resources and Environment

The global financial crisis and the sharp drop in energy prices have changed the environment in which oil and gas companies operate, including in Russia.  This economic situation calls for a modification of the current system of state regulation of the industry. 

Q:  How do you perceive the position of Russian oil and gas producing companies under the global economic crisis?  What, in your opinion, are their growth prospects?

A:  Let us look back at how events developed after the prices began to fall for mineral resources and energy in the middle of last year and the demand dropped for some of these commodities. The degree to which the crisis affected different sectors of the economy varies.  Take, for example, our oil companies. True, the demand for gasoline and diesel fuel has dropped somewhat on the domestic market.  And it will go down further this year, because business activity in the country as a whole is slowing, the volume of freight transfers and the demand for new vehicles are going down, this leading, as a whole, to a cut in the demand for petroleum products.  Considering, however, the significant proportion of exports of crude and petroleum products in the sales mix of Russian oil companies, I believe that there is no reason at the moment for our oil-producing companies to cut production substantially.  The world market may, to a certain extent, be seen as unlimited.  Every additional barrel of Russian oil that appears either as a result of increased production or as a consequence of reduced domestic demand may be put on foreign markets without any material consequences for world energy prices.

Owing to the fall in crude prices, the Central Bank of the Russian Federation has had to pursue a policy of so-called controlled devaluation of the ruble.  The drop in the ruble exchange rate against the U.S. dollar has largely compensated the oil companies for reduced prices of crude, since their revenues are de facto linked to the dollar while their capital and operating costs (with the exception of taxes and levies) are calculated in rubles. 

The situation with respect to small companies is somewhat worse, simply because they rely to a greater extent on borrowed funds and lending.  But this is the problem of so-called cash gaps. The Russian Ministry of Natural Resources and Environment has come up with several initiatives to support small producers.  For instance, we proposed giving them deferment of severance tax payment in 2009.  Regrettably, the Ministry of Finance of Russia did not support our initiative, fearing a state budget deficit.  Every ruble is important to them at the moment.

In addition, the Russian Ministry of Natural Resources and Environment has supported the idea of differentiating severance tax with respect to small fields that was put forward by several companies.  The Ministry has requested information from oil-producing companies confirming that the economic parameters for developing small fields are worse than those for big ones.  So far, however, we are not satisfied with the data provided, as we would like them to be more detailed and accurate.  We will pursue our efforts in this direction.

As far as the overall situation in the industry is concerned, it should be noted that oil production will drop this year.  We are observing a continuation of the negative trends that emerged even before the crisis:  production in the traditional oil- and gas-bearing regions (above all, Western Siberia) is shrinking, while there are not all that many new projects to compensate for this fall. The examples are Vankor and fields in Eastern Siberia and Timan-Pechora oil- and gas-bearing province.  We also laid great hopes previously on Sakhalin projects, but their implementation has now slowed down somewhat. 

Q:  It has become known that the Russian Government is formulating a concept of a model for taxation of new deposits on the basis of the actual results achieved by companies.  Could you tell us more about this initiative? 

A:  At the February meeting this year in Kirishi (the Leningrad Region) under the chairmanship of Russian Prime Minister Vladimir Putin, federal executive authorities (Ministry of Finance, Ministry of Energy, Ministry for Economic Development, and so on) were instructed to consider the issues of taxation in the oil industry.  The Ministry of Natural Resources and Environment is also participating in this process and has put forward its own proposals concerning the concept you mentioned.  It is primarily a question of setting up a system for levying taxes based on profits.  It is not, of course, possible, for obvious reasons, to guarantee companies a return on their investments. But we can develop a flexible taxation scheme that might be adapted depending on a project's profitability. 

Each oil- and gas-bearing region has its own specifics:  some have harsh climates, icing up or storms, while others are located on the deepwater shelf.  Consequently, each of them has its own parameters for implementing oil and gas projects, so a special tax system should be developed for new projects, taking into consideration returns on them but not dependent on the field's geographical conditions.

Q:  What other government measures for state regulation of the oil and gas industries are worth mentioning?

A:  The most difficult situation has taken shape in the coal industry because of the fall in demand for its output both in Russia and on world markets.  For this reason, we are making active efforts to differentiate severance tax in this industry.  The Ministry of Finance, in conjunction with the Ministry of Energy and the Ministry of Natural Resources and Environment of Russia, has drafted a bill to introduce amendments into Chapter 26 of the Tax Code for the purpose of creating a mechanism for deducting coal companies' industrial safety costs and investments from the severance tax.  This will help reduce the risk of accidents and explosions at coal mines. 

Similar tax deduction mechanisms should be introduced in other branches, including the oil industry.  This would encourage geological surveying and channel investments into new production regions.  At the same time, the tax revenues would go down only insignificantly.  I believe that such innovation would be even more important for the oil and gas industry than introduction of a differentiated severance tax.

We are also working actively on a new classification of oil and gas reserves, to bring it as close as possible to reality.  The state needs to have an objective picture of the resource base to make reliable forecasts with respect to production, take pertinent management decisions on construction of the infrastructure, taxation and so on.  We are planning to modify significantly the process of confirming reserves and approving the projects for developing them.  It is clear that, for this purpose, administrative barriers must be lifted, subjective approaches eliminated and decision-makers corruption opportunities reduced.  Unfortunately, the Ministry has had to postpone adoption of this classification until 2012, since it requires greater work input.  Even so, we intend in future to engage actively the Russian oil and gas companies in constructive dialogue in this sphere.