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. Last Updated: 07/27/2016

INDUSTRIES IN TURMOIL: Oil Profits on Devaluation, For Now




This is the first in a series examining how industries are affected by the financial crisis. Today, oil. Tomorrow, retail.


Oil company profits will temporarily soar from the ruble devaluation, but the fallout of Russia's financial crisis will eventually catch up to the nation's biggest industry.


For now, the ruble's 60 percent dive since Aug. 17 means energy companies have seen a sharp slide in their ruble production costs while their hard-currency export earnings remain stable. About 90 percent of Russian oil companies' costs are in rubles, while half of revenues are in dollars.


The drop in ruble expenses will temporarily restore profitability to oil companies, which have suffered losses this year in the face of heavy taxation and depressed oil prices. Radically reduced expenses could postpone severe cost-cutting measures such as layoffs and production cutbacks that were beginning before the ruble devaluation.


Tyumen Oil Co., Russia's seventh-biggest oil producer, said cost-cutting measures had already helped it lower production expenses from 530 rubles per metric ton in February ($12 per barrel) to 385 rubles per metric ton in August ($8.50 per barrel before the devaluation).


At Wednesday's exchange rate of about 16 rubles to the dollar, Tyumen's costs have plummeted to only $3.30 per barrel. Even with world oil prices depressed at $12 per barrel, Tyumen stands to make a huge margin on crude sales.


Any advantage will likely end in three to six months, however, as labor and equipment costs catch up with inflation.


Oil companies are already facing problems brought on by the frozen banking system, nervous foreign lenders and a domestic market rapidly going to pot. The Central Bank's decision last week to impose new controls on foreign-currency earnings could also cut into oil company profitability.


"The benefits of the devaluation will be very short-lived, I think," said Jim Henderson, an oil analyst with MFK Renaissance. "The question is, how long will expenses stay less, and how much cash is available? Clearly, money deposited in Russian banks is not as secure as it once was."


Oil analysts speculate that major Russian oil companies have lost millions, and possibly billions, of dollars in rickety banks. Even if that money is not lost forever, it is currently unaccessible, leaving some oil majors without the funds to pay export fees.


A spokeswoman for Surgutneftegaz said it is too early to determine whether the company has suffered losses from the restructuring of the short-term debt market, in which Surgut was a big investor, or from the breakdown of the banking sector. But she acknowledged that conducting daily business has become difficult.


"Interbank transactions have halted, and it's very hard to figure out" how to transfer money, said spokeswoman Raisa Khodchenko.


Export shipments at the main Black Sea ports of Novorossissk and Tuapse were halted last week because oil companies couldn't find the funds to pay customs duties.


Getting exports to market is vital for most oil majors, who have pledged their oil as payment for loans from foreign banks. The export-backed loans are exempted from Russia's 90-day moratorium on repayment of foreign debt, and most oil companies have vowed to make the payments.


Still, concerns that Russia has become too risky an investment are giving m any foreign banks reason to scrutinize oil loans as they come up for renewal, analysts say. Under many export credits, companies are required to make regular interest payments but are allowed to roll over the principal payment when the loan comes due.


"Companies are going to find it difficult to roll over debt or will find it more expensive," Henderson said.


On the brighter side, if acting Prime Minister Viktor Chernomyrdin is confirmed, oil companies could be in for tax breaks and softer tax collection. Despite his tough talk on founding an "economic dictatorship" in which taxes will be meticulously collected, many doubt Chernomyrdin will keep up the tax fight started by Prime Minister Sergei Kiriyenko.


No matter who is in the Kremlin, oil companies are going to have an even tougher time collecting payment on the domestic market. Many oil companies in recent months have angled to increase domestic cash sales as export earnings have dropped by opening new gasoline stations and offering discounts on refined oil products.


Continuing devaluation and inflation, which has further evaporated liquidity in the Russian economy, will put a crimp in those plans.


Increasing signs of state controls on foreign exchange and profit repatriation are also bad news for oil majors. Measures quietly passed by the Central Bank last week could make it harder for energy companies to squirrel profits away to tax havens.


In a bid to keep hard currency within Russia's borders and to keep track of profits for tax purposes, the bank last week ruled that all exporters are required to collect cash payment or a letter of credit through an authorized Russian bank in advance of delivery.


Oil companies are widely believed to funnel some export profits to offshore tax havens. Analysts say they do so by selling their crude oil at a slight discount to the market price to affiliated offshore trading companies, which then sell the oil on to a second buyer for a markup. The first sale is transacted through Russian banks but the second is not, allowing oil companies to keep a sliver of their profits clear of the taxman.


The new regulation could complicate this scheme unless the offshore trading companies are able to provide up-front cash payment.