MAPLECROFT: Russian Finance Minister Anton Siluanov manoeuvres into position with oil tax reform

MAPLECROFT: Russian Finance Minister Anton Siluanov manoeuvres into position with oil tax reform
Russian minister of finance Anton Siluanov tax manoeuvres will cut oil exports to zero and move the burden upstream / wikicommons
By Daragh McDowell of Verisk Maplecroft June 18, 2018

In an early policy win for Finance Minister Anton Siluanov, Russia is preparing a major change in how it taxes oil. The second phase of the so-called “tax manoeuvre” will shift the tax burden entirely upstream by increasing the Mineral Extraction Tax (MET) while zeroing out export duties from 2019-2024. This completes a shift to putting the tax burden squarely on upstream that started in the first phase of the manoeuvre, from 2014-17, which saw export duties halved and MET almost double.

The tax manoeuvre is closely associated with Siluanov. Alongside his promotion to First Deputy Prime Minister in the post-election reshuffle, the policy’s well-publicised approval is a sign that his star is in the ascendant.

For purchasers of Russian oil exports the manoeuvre should be cost-neutral, at least at first. The impact will be largely felt by refineries, in the form of higher gate prices, which the government expects will encourage investments to improve efficiency and value-add. Over time, the quality of Russian refined oil products entering the European market should improve.

Lower tax with broader base

The below graph illustrates how the tax split on each barrel of oil will change as the manoeuvre is completed, both in terms of the marginal and effective rates of MET and export duties. The model assumes an average Urals crude price of $60 per barrel, and a $/RUB exchange rate of 62.

A key benefit of shifting the tax burden entirely to the point of production is that it ensures a greater number of barrels overall are taxed. In total, the Finance Ministry expects that over the six-year implementation of the manoeuvre the exchequer will gain an additional RUB1-1.6 trillion ($16.15bn-$25.85bn), depending on price fluctuations.

Crucially, this is cash the government will be able to spend. Under the current fiscal rule, when the oil price is above $40 the additional revenues generated must be used either to cover the deficit or be deposited in the National Welfare Fund. By expanding the number of barrels being taxed, the manoeuvre increases the revenues available for spending while maintaining the $40 fiscal rule.

Sweetening the deal

The tax manoeuvre’s main purpose is to encourage further modernisation of Russia’s refineries and increase the production and export of lighter fuel products. The assumption is that increases in MET will be borne primarily by refiners in the form of higher gate costs. The removal of export duty also eliminates tax incentives for exporting refined products over crude, placing pressure on domestic refining.

The risk is that this will make refineries servicing the domestic market unprofitable, forcing the Kremlin to subsidise them or face the prospect of gasoline imports. The government has proposed the imposition of a negative excise duty – essentially a cash subsidy – but proposals reported thus far have been highly complex and of questionable practicality.

Fuelling discontent

Even prior to the implementation of the manoeuvre, rising petrol prices have already become a political headache to the Kremlin. So far in 2018 the pump price for petrol has risen by around 6% year on year, and diesel has risen by 9%, and the topic was discussed at length during Putin’s annual “Direct Line” press conference. Increased prices at the pump are a highly visible sign of an increased cost of living, which combined with a decline in living standards since the 2014 crisis will fuel political discontent.  

Russia’s recent improvement on Verisk Maplecroft’s Civil Unrest index, from a high-risk score of 4.80/10.00 in the forth quarter of 2017 to a medium risk score of 6.13/10.00 in the second quarter of 2018, is driven in part by a sustained fall in inflation. The index assumes that increases in the cost of living make people more likely to engage in protests and other acts of civil disobedience.

The upward pressure on prices will cause the score to deteriorate, significantly if accompanied by an increase in the frequency of protests. As regional protests have become increasingly economically motivated, this is a likely outcome if the Kremlin can’t keep petrol prices under control.

The higher you climb the harder the fall

That being said, the economic and industrial impacts of the manoeuvre may not be as important as the political impacts. Siluanov is the figure most associated with the reform, and Putin’s approval is a clear signal of his rising place in Russia’s political hierarchy. As Siluanov’s profile grows, he will increasingly become a target for those disadvantaged by, or ideologically opposed to, his economic liberalism.

The political transition underway in Putin’s fourth term is also perceived by most of the elite as a zero-sum game, with any rise in status for one player meaning a setback for others. Siluanov’s ascendance will be seen as a “win” for the faction of liberal economists, such as Alexei Kudrin and Elvira Nabiullina, and a ‘loss’ for conservatives and statists.

Siluanov’s rising favour is therefore something of a mixed blessing. It will give him the authority to push through greater economic liberalisation, while also making him a target for intrigue. Equally, the blame for any political fallout from the policy, such as greater civil unrest, will be laid as his door. As former economic development minister Alexei Ulyukayev – currently serving an eight-year prison sentence – can attest, the stakes in Russian inter-elite fights can be exceedingly high.

The views and opinions expressed in this article are those of Verisk Maplecroft and do not necessarily reflect those of the wider group of Verisk companies.

 

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