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Wednesday, March 08, 2006

OPR UPDATE: DEATH AND TAXES IN RUSSIA, OR, 'ARE YOU CERAIOUS?'

Cambridge Energy Research Associates (CERA) is well known for its optimistic production and reserve assessments. So what do they make of the decline in Russian production growth from the 8.5 percent mark achieved from 2000 to 2004 to last year’s 2.5 percent growth? They attribute the slowdown to the demise of Yukos, the “forced sale” of Sibneft to Gazprom, and high taxes on Russian production.

Konstantin Kovalenko, a research associate in CERA’s Moscow office told Petroleum Economist this week that between 1998 and 2004 Yukos and Sibneft output increased by 92 percent and 96.5 percent respectively. Following the forced transfer of Yukos main production asset Yuganskneftegaz to state owned-Rosneft and the purchase of Sibneft by state owned Gazprom, production the two companies’ output declines contributed 55 percent to the overall drop in Russian production growth. In Sibneft’s case, once the state’s purchase plan became clear, Sibneft cut back on investment in new fields and withdrew large amounts of money in dividends.

The other primary cause for Russian production growth declines is the steep tax scheme levied on Russian production. The Russian state takes a cut of about 50 percent in production and export taxes on revenues above $25 per barrel. However, the rate rises to two-thirds when the price hits $50 per barrel. According to Kovalenko, “90 percent of everything above $25 per barrel goes to the government.”

While the investment climate and taxes can no doubt did have a significant effect on production, the CERA analysis (at least as described in the Petroleum Economist article) doesn’t quite tell a complete story. Left unclear is whether or not Yuganskneftegaz’s production actually fell, or was simply transferred to Rosneft’s ledger. To the extent that the latter is the case, the dissolution of Yukos would not explain Russian decline.

As far as taxes go, the explanation makes sense only if the tax rate was revised upward to the current high levels in 2004; otherwise the taxes themselves wouldn’t explain the decline. Some other variable must be at work to explain the change.

All this is not to say, however, that Russia wouldn’t do itself a huge favor by ceasing its predatory accumulation Russian oil assets and revising taxes to make production more lucrative. Death and taxes may be certain, but they are no friend to production growth.

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