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. Last Updated: 07/27/2016

Oil Tax Burden Weighs Down Sector

MTA LUKoil technician on a rig in the Baltic Sea. A new mineral resources tax has made developing new fields costlier.
Tax risks and fear of political uncertainty are acting as a drag on the country's oil- and gas-dominated stock market, which was a star performer in 2006 but has underachieved this year.

Although the RTS index has rallied to all-time highs, its 12 percent gain in the year to date falls short of other emerging markets and pales by comparison with last year's 70 percent rise.

"Russian oil companies are not benefiting from high oil prices. [They] do not do as well as international oil companies due to this heavy tax burden," said analyst Igor Kurinny at ING in London.

The country's mineral extraction tax, which came into force in 2007 and takes into account factors such as oil-field depletion and water content in reservoirs, is weighing heavily on Russian oil's profitability.

It has also made developing new fields expensive.

"Our costs are constantly increasing," Leonid Fedun, LUKoil vice president, told a newspaper recently. "Now we have to develop new regions from zero and the costs today are not even comparable with before."

This tax, combined with a hefty export duty -- which rose again this month by over $3, to $34.29 per barrel -- means the state's marginal tax take is almost 90 cents on the dollar.

Oil industry bosses have lobbied for a lighter burden, so far in vain. The Industry and Energy Ministry declined to comment on oil taxation for this article.

Oil and gas stocks, as measured by the RTS sector index, are down by 5 percent this year, even after a 17 percent run-up since mid-August.

While energy companies comprise only 10 of the 50 companies in the RTS benchmark, they have a combined weighting of over 50 percent. Russian stocks have an estimated 2007 price-to-earnings ratio of around 10.

"Given the big share oil and gas companies take of the index ... they are an anchor which limits the performance and growth of the RTS," said Konstantin Reznikov at Dresdner Kleinwort.

Only one oil stock, Tatneft, the largest producer in oil-rich Tatarstan, is up this year, with a 15 percent gain.

State-controlled Gazprom and LUKoil -- both with a maximum 15 percent RTS index weighting -- are down 3 percent and 4 percent, respectively, in the year to date.

But if sky-high world oil prices take a fall, the country's high taxes would soften the impact on stocks.

"If international oil prices decline, the international companies will be hit hardest as Russians will be protected by the buffer the taxes represent," Reznikov said.

Analysts believe state-controlled companies such as Rosneft could receive tax cuts in early 2008, while private companies such as LUKoil may miss out, except perhaps on new offshore projects.

The country's gas sector has escaped high taxation so far, instead charged with a small flat rate. Proposals to raise this fivefold and mimic oil's mineral extraction tax have failed to gain traction over recent months.

Further state consolidation in the energy sector also remains a large question.

Shares of closely held oil firm Surgutneftegaz have been volatile on market speculation that the Kremlin -- which controls over one-third of the oil industry -- is considering creating a new state oil major by wrapping assets of Rosneft with Surgut and other firms.