Incentives designed to facilitate the development of new oilfields in Russia may be a reason for World Trade Organization (WTO) complaints, but the likelihood of such a scenario is small. The E.U. has not yet filed any complaints with the WTO relative to Russia’s oil preferences for domestic producers. The representatives of the relevant ministries and industry experts agree that the questions raised by the European Union so far are of a technical nature and will be addressed in the course of the upcoming negotiations.

The real picture

The purpose behind the Russian authorities’ extending tax benefits to oil-producing companies is to stimulate the development of new territories in view of the depletion of Western Siberian fields, which was a multi-year resource cushion for the domestic oil industry. Russia, in particular, has a favorable tax regime for fields with heavy oil.

President Vladimir Putin instructed to step up efforts to create conditions for the development of new oilfields, noting that the attractive tax regime for hard-to-access oilfields will result in increased production volumes of 40 to 100 million tons of oil per annum by the year 2020. While the need to stimulate oil production at new fields is very much felt on the ground in Russia, for the E.U., the existence of incentive mechanisms may be seen as incompatible with existing WTO rules. The task of the negotiators from the Russian side is to prove that the government benefits support oil production as a whole, and not certain companies in particular. The Ministry of Energy expects to settle with the E.U. authorities all dispute regarding the application of preferential export duties on oil, said Deputy Minister Pavel Fedorov. “We looked at the substantive part of the dialogue between the E.U. and the Ministry of Economic Development that is in charge of the work with the WTO. Here we see that there are no problems, the questions are easy to resolve. I think that there will not be any problems,” he said. According to the Energy Ministry, there is no reason to say that Russia’s preferential rates subsidize some countries, while discriminating against others.

No conspiracy

Most industry experts point to the technical nature of the E.U.’s claims about the preferences for the oil industry. “This is not about the fact that our companies will get some competitive advantage. The Russian government is hardly going to agree with that premise. These issues will not be able to influence the process of Russia’s WTO integration, and will be resolved in the course of negotiations,” said Nomos Bank analyst Denis Borisov. According to BCS analyst Vladislav Metnev, the Ministry has adequate arguments to explain that this mechanism is not for the support of individual companies, and, as such, merely constitutes a feature of the Russian tax system. “I do not believe in conspiracy theories. The Russian position is clear, so it will not result in the escalation of the conflict, because there is no reason to argue, and all parties are reasonable and will avoid an argument,” commented UBS analyst Konstantin Cherepanov. A source in the Ministry of Economic Development said that the issue has been raised so far only within the circle of experts. At the same time, the story surrounding Russia’s tax benefits spans four years already, and the introduction of incentives for the development of remote fields began in 2008. At the time, Russia’s partner-countries did not object to the measures taken. “Here, there are no preferences for export duties. It is not as the though the export duty for the E.U. is different than the export duty for the United States. In this situation there is no such principle. It has nothing to do with foreign trade,” the Ministry source summed up, adding that from this point of view it is quite difficult to understand the position of the E.U.

Tax on extraction

Unlike most of the WTO members, Russia subjects the oil sector to tax on the basis of revenue, as opposed to the companies’ financial results. “In fact, what we are talking about here is a system that will tie taxation to the bottom line results, as opposed to total revenue because the benefits are provided based on the economics of the project,” said Borisov. On December 4, 2012, the Russian President signed into law a measure extending benefits for the Russian oilfields with hard-to-reach resources that takes effect from January 1, 2013. The measure, prepared by the Ministry of Energy, provides for assessing a duty equal to 10 percent of the normal export duty on oil for hard-to-reach oil exports. The government is also bound to take measures before March 1, 2013 to implement regulations for setting export duties on oil and certain types of oil-produced goods.

The differences in the application of export duties suggest that there is simply no single tax space in Russia, according to Cherepanov. “Indeed, it appears that some oil producers are in more favorable tax conditions. At the same time, WTO rules by implication provide that such barriers should be minimized, and that there should be one universal flexibility, accessibility, and openness. This is the logic with which the E.U. is questioning Russia,” he said. According to Metnev, this situation presents a common problem with the taxation of the oil and gas industry in Russia. The tax in Russia applies to the physical volume of the oil extracted, and not the profit generated from it. The situation with the E.U.’s concern for tax incentives is one of the reasons for the authorities to consider switching to profit-based taxation, the expert concluded.