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Russian Oil Prospects

Recent news about the situation in the Russian oil sector has been largely confined to two or three major oil companies. The Yukos saga has dominated, but there are other trends in the Russian oil sector that influence the country's economy.

It is Russia's most profitable sector and is developing intensively. Oil production is expected to exceed 450 million metric tons this year. Traditionally, Russian businessmen are more optimistic in their forecasts for oil production growth rates than government officials and the scientific community.

More realistic

Andrei Gaidamaka, head of the Investment Analysis and Investor Relations Division at LUKoil, predicts steady growth of four to five per cent a year. The president of the Energy Policy Institute, Vladimir Milov, believes a figure of one to two per cent a year is more realistic.

Any potential growth of Russia's oil production and exports depends on investment, the introduction of new technologies, major systemic solutions concerning the construction of new pipelines and the development of deposits in Eastern Siberia. According to Andrei Klepach, the director of the macro-economic forecasting department at the Russian Ministry of Economic Development and Trade, a maximum of 500 million metric tons of oil will be produced by 2010 if infrastructure and new deposits are not developed. If the government focuses on infrastructure problems by launching the construction of new pipelines, particularly to Nakhodka and Murmansk, and increasing the capacity of the Baltic transportation system, Russia will be able to produce 530-550 million metric tons of oil a year.

Two problems are to blame for these modest forecasts. First, many oil companies are in no hurry to invest in oil production because of low transport capacities. Large volumes of exported oil are transported by rail and ship, which is two or three times more expensive than pumping it through a pipeline. Transportation is the second largest expense item after taxes on the balance of LUKoil. According to Mr Gaidamaka, the Russian pipeline system does not completely meet Russian oil companies' export demand.

Slow rise

Mr Klepach says proposals on pipeline construction are included in a medium-term programme drawn up by the Ministry of Industry and Energy, which has been presented to the Ministry of Economic Development and Trade and will be submitted to the cabinet. At the same time, a corresponding resource base, i.e., the existing cost-effective oil reserves, must cover the creation of new transportation capacities. It is doubtful that this base exists, as production is increasing at a slow rate than exports. In the future, it will become increasingly difficult to guarantee growth in production and exports from reserves in Western Siberia.

The second problem is the instability of the taxation system and differences in the government on how to improve oil sector taxation. Under the current system, if the price of oil is higher than $25 per barrel, oil companies lose up to 90 per cent of additional revenue to pay taxes. Even representatives of the Ministry of Economic Development and Trade doubt that new deposits can be developed and capital-intensive projects implemented in such conditions.

While giving credit to the government for its successes in collecting taxes, businessmen, however, point out that the burden on the oil sector is so great that it affects investment decisions. Over the last three years, LUKoil's tax payments have gone up more than twice against the backdrop of a 100 per cent increase in oil prices. Consequently, Mr Gaidamaka sums up that, with the growth in world oil prices, companies' surplus revenues are transferred to the budget. After new taxation rules are introduced in 2005, oil companies will lose more funds than they may yield from oil trade to pay taxes, says Galina Antonova, the head of the Yukos analytical department.

Representatives of oil companies and government officials are unanimous that the tax burden on the oil sector is approaching a critical point, which means that taxation policy in this sphere needs to be revised. The problem is how to alleviate the burden. At present, the export duty and the tax on natural resources production, which is pegged to the world oil prices, account for the lion's share of tax payments. One of this system's great disadvantages is that a slide in world oil prices may hit domestic production hard.

Tax proposal

Besides, the tax on natural resources production hinders the development of new deposits. According to Arkady Dvorkovich, who heads the Presidential Expert Department, dependence of the tax on natural resources production on world prices makes domestic prices for oil products higher. The majority of experts believe companies' profits and not natural resources production should be taxed.

Whether it is possible to reform the taxes has been widely discussed lately. The Ministry of Economic Development and Trade is in favour of keeping and differentiating the tax on production. For example, one proposal is that the tax should be lower on new deposits and ones close to depletion, but it should be independent from the world prices. However, these measures must be seriously thought through, otherwise the move may favour one party over another. There are also proposals to abolish the export duty and introduce additional profit taxes to make up for falling budget revenues.

Stable legislation is the most important factor. Only in this case will companies be able to make plans for the years to come. Developing the oil sector and making it more attractive for investment are highly important for the state, because revenues from oil sector taxation account for a large part of the federal budget and the country's stabilisation fund.

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