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Specific taxes applied to natural gas

Renaissance Capital

20 June 2019

Russian oil & gas

A very different regime

There are differences between the specific taxation of the oil sector and the charges levied on the gas industry, the most important of which are in respect of excise, MET, and export duty.

In contrast to the fixed rate per tonne that used to apply to oil extraction, excise levied on gas was ad-valorem-based until the end of 2003. Specifically, a 15% tax was levied on domestic shipments (except to households, which were exempt) and exports to CIS markets. Exports to non-CIS markets incurred a 30% excise rate. As part of the introduction of the MET in 2001, a 16.5% rate (of wellhead prices, which were low) was applied to gas output from the outset, on 1 January 2002. In the gas segment, however, excise had been the key tax.

However, this changed markedly in 2004, following a broad range of tax changes approved in 2003 to accommodate the lower VAT rate introduced from 2004. After much wrangling, the 16.5% of wellhead value MET was replaced by a fixed sum per thousand cubic metres (mcm) extracted, set at RUB107/mcm initially. This figure was materially lower than the government had initially proposed, thanks to lobbying by Gazprom and the independent gas producers, we think.

Later, however, the government more than made up for its abolition of the excise tax in 20043 with a sixfold increase in the export duty, to 30%. Initially, a fourfold rise had seemed likely. The imposition of a high export duty seemed an attempt to claw back tax revenue lost through the lower-than-expected MET and Gazprom’s significant (profit tax) savings from accelerated depreciation of its pipelines, which was allowed under the amended Profit Tax Chapter of the Russian Tax Code.

Moreover, the base rate for MET was increased to RUB135/mcm from 1 January 2005 to compensate for the abolition of VAT levied on gas exports to non-Customs Union CIS countries, and to RUB147/mcm from 1 January 2006 – the latter merely the result of indexing the per-unit rate. It was left unchanged in 2007, we believe in recognition of the need to augment supply.

Following the approval of much higher regulated gas tariffs in November 2006, the Ministry of Finance set about capturing what it considered windfall gains for Gazprom. The Ministry of Finance – supported by the Ministry of Economic Development – called for the MET rate to grow towards RUB735/mcm by 2010. Gazprom and other gas producers, on the other hand, strongly opposed the measure, saying that higher profits were required to augment supply, the principal objective of ongoing gas reform.

Discussion continued until a decision was made at a March 2008 government meeting to leave the MET rate unchanged until at least 2011. The proposal contained in the Ministry of

Finance’s financial plan through 2023 assumed the MET rate for gas producers would be indexed to CPI from 2011 onwards. In line with this logic, the government had approved a 61% increase in gas MET from 2011, to RUB237/mcm, and proposed to link MET to the inflation rate in the future. However, matters changed again in 2011 when the government approved the Ministry of Finance’s proposal to continue hiking gas MET for Gazprom at rates substantially above inflation, while keeping them lower for all other producers. Gazprom MET therefore went up by 115% to RUB509/mcm in 2012, with approved further increases of 14% to RUB582/mcm in 2013 and 6% to RUB622/mcm in 2014. For non-

Gas industry taxed very differently

There is a relatively low MET, with taxes loaded on the export channel via a 30% export duty

MET rates for Gazprom and nonGazprom producers are differentiated from 2012

3 Gazprom’s gas exports to Turkey via Blue Stream pipeline are subject to the excise tax, reintroduced from 2015. The excise tax – but not export duty – is allowed under the intergovernmental gas supply agreement between Russia and Turkey.

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Renaissance Capital

20 June 2019

Russian oil & gas

Gazprom producers, the government decided to keep MET at previously approved rates of

RUB251/mcm in 2012, RUB265/mcm in 2013, and RUB278/mcm in 2014.

We believe the differentiation of gas MET by producer unnecessarily complicated the tax regime and created an uneven and unfair set of investment incentives. We were therefore not surprised to see the government change its mind during 2012 to propose much higher rates for non-Gazprom producers, while also increasing the rates for Gazprom again.

Specifically, the government’s budget committee in May 2012 approved a 33% hike to

Gazprom’s MET by YE13 to RUB679/mcm, with further increases of 36% and 35% to RUB859/mcm and RUB1,062/mcm envisaged by YE14 and YE15, respectively. For nonGazprom producers, the committee approved much higher growth rates of 77%, 104% and 77% to RUB445/mcm, RUB726/mcm and RUB1,049/mcm by YE13, YE14 and YE15, respectively. According to this plan, non-Gazprom producers were to pay just 1.2% lower MET, compared with Gazprom, by 2015. This was a substantially lower discount than the 55% envisaged under the 2011 decision. This decision by the government’s budget committee caused significant debate among industry participants, particularly nonGazprom producers, who had hoped that their discounted rates would continue for longer. In the end, they succeeded in keeping the previous decisions unchanged, while the government re-focused on the new formula-based approach for gas MET, which was introduced from 1 July 2014, and enshrined into a law the tax preferences afforded to non-Gazprom producers.

A formula-based approach to gas & gas condensate MET

After nearly one year of consultations, on 21 May 2013 the Russian government approved a gas MET formula, which was introduced from 1 July 2014. The formula-based approach represented a transition to a more predictable tax environment for domestic gas producers. It takes into account tax differentiation based on the share of gas exports, share of gas condensate output, complexity of gas reservoirs (which takes into consideration depletion rates, depth of the producing horizons, and geographical location of producing fields) and future growth in gas transportation tariffs.

The new formula to calculate MET for natural gas (from 1 July 2014), measured, and collected, in rouble per mcm produced is:

MET = RUB35 x 0.15 x (weighted average price) x complexity coefficient + gas transport coefficient

For Gazprom only, the result is further multiplied by an adjustment coefficient which was set at 1.37 for 2016, 1.7969 for 2017 (2.2738 for 4Q17), 1.4022 for 2018 (2.055 for SepDec 2018) and 1.4441 for 2019-2021. This reflects a similar approach to that of the oil MET, which saw a “temporary” increase in MET rates for crude oil for the period 20172019 to cover budget shortfalls, but the duration has been extended to 2021, as is the case with Gazprom. According to the current version of the Tax Code, this coefficient will disappear from 2022, but this deadline is subject to further adjustments, we understand.

The complexity coefficient is defined as the minimum of three other coefficients that measure the field’s depletion rate, its geographical location and the depth of the producing horizon:

▪If the depletion rate is less than 0.7, the complexity coefficient is set as 1. If the depletion rate is greater than 0.9, the complexity coefficient is set as 0.5. In between, the complexity coefficient is calculated as (2.75 – 2.5 x depletion rate).

New gas MET formula in place from 1 July 2014

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▪New gas fields located in the Yamal and Gydan peninsulas may benefit from a complexity coefficient of as low as 0.21 in year 1, rising by 0.066 pa as the field is developed – although the duration of the benefit cannot exceed 12 years. All gas fields located in the Astrakhan region are assumed to have a complexity coefficient of 0.65. All gas fields located in the Irkutsk region, the Russian Far East and the Sea of Okhotsk are assumed to have a complexity coefficient of 0.1 (until 31 December 2033) and 1 (from 1 January 2034). Furthermore, the complexity coefficient is set at zero for gas produced in all those regions that are not connected to the UGSS.

▪Gas and condensate fields located in all other geographical areas, and in which ABC1+2 reserves do not exceed 1tcm, can further benefit from a reduced complexity coefficient, which measures the depth of the producing horizon. It is set at 1 if the field’s producing horizon is located above 1,700 metres; 0.5 if it is located below 3,300 metres; and 0.64 if its depth is in a range of 1,700-3,300 metres.

The gas transport coefficient (GTC) is defined as follows:

▪For Gazprom:

GTC = 0.5 x (absolute increase in the average gas tariff increase in excess of inflation) x (average transportation distance by independent gas producers / 100) x (1 / share of

Gazprom gas production in Russia’s total gas output)

▪For non-Gazprom:

GTC = –0.5 x (absolute increase in the average gas tariff increase in excess of inflation) x (average transportation distance by independent gas producers / 100)

▪The GTC was set at zero for 2014.

▪The GTC is set at zero for gas produced in all those regions that are not connected to the UGSS.

Given that the formula-based approach results in potentially different MET rates applied to different fields (not just to different producers, as was the case previously) and requires specific knowledge of at least five field-specific characteristics, many of which are not publicly available, analysts and investors may find it difficult to accurately predict MET rates for each Russian gas producer. Moreover, the regular financial reports of Gazprom and NOVATEK do not disclose their respective MET rates, although Gazprom periodically provides its estimates in investor presentations. Rosneft and LUKOIL report their gas MET rates regularly. We summarise publicly available gas MET rates in Figure 136, complementing them, where necessary, with our own estimates.

Figure 136: Gas MET rates for Gazprom and non-Gazprom, RUB/mcm

	2010	2011	2012	2013		2014		2015	2016	2017	2018	2019E
					1H		2H
Gazprom	147	237	517	610	700		754*	681	752	1,110	1,356*	1,216*
Non-Gazprom	147	237	251	326	471
NOVATEK						463*		479*	485*	526*	583*	577*
Rosneft							496	520	535	547	558	561*
LUKOIL**						132		162	208	253	305	353*

Note: New formula-based MET rates were introduced from 1 July 2014. *Renaissance Capital estimates.

** LUKOIL reports the gas MET rate for its largest gas field – Nakhodkinskoye in West Siberia – which is subject to a special regional reducing coefficient.

Source: Tax Code, Company data, Renaissance Capital estimates

Renaissance Capital

20 June 2019

Russian oil & gas

MET has become more difficult to estimate

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Renaissance Capital

20 June 2019

Russian oil & gas

The new formula to calculate MET for gas condensate (from 1 July 2014), measured, and collected, in roubles per tonne produced is:

MET = RUB42 x 0.15 x (weighted average price) x complexity coefficient x correcting coefficient + rebalancing of the export duty (from 1 January 2019)

In this formula, the weighted average price (WAP) is defined as follows:

WAP = [ (average gas price) x (share of gas output) + (average condensate price) x (share of gas condensate output) ] / (1 – share of gas output) x 42 + (share of gas output) x 35

Average gas price = (average domestic price) x (share of domestic sales) + (average export price) x (share of gas exports)

Average condensate price = (Urals x 8 – crude export duty4) x exchange rate

Share of gas output = 35 x gas output ÷ (35 x gas output + 42 x gas condensate output)

Share of condensate output = 1 – share of gas output

A correcting coefficient in the gas condensate formula was introduced from 1 January 2015 to coincide with the increased crude oil MET rates under the initial 2014-2017 tax manoeuvre, discussed previously. The coefficient was set at 4.4 for 2015, 5.5 for 2016 and 6.5 thereafter. From 1 January 2019, the gas condensate formula is further adjusted to reflect the final phase of the tax manoeuvre and the rebalancing the tax burden between export duty and MET.

Additional gas tax exemptions

In July 2011, the State Duma adopted MET exemptions for natural gas and gas condensate with effect from 1 January 2012. Zero rates now apply to natural gas produced in the Yamal Peninsula and used for LNG production for 12 years (or 250bcm for gas, and 20mnt for gas condensate), with similar terms being extended to the Gydan Peninsula from 1 January 2015. In addition, all LNG produced in Russia is subject to zero export duty from 2015 (this decision simply formalised the existing status quo, as in 20052010 LNG was not on the list of goods subject to an export duty; pre-2005 the export duty was set at EUR40/t).

4 Calculated using 2014 coefficients, i.e. pre – tax manoeuvre.

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