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Energy 30 April, 2020 10:00 am   

How much does Russian oil really cost? (ANALYSIS)

The oil price crisis is affecting every oil producer in the world. At a time like this oil companies are trying to outdo their competition in assurances on how long they are able to last. In case of Russia’s ability to withstand the crisis contradictory information cropped up. What is the real price of extracting Russian oil? – asks Mariusz Marszałkowski, editor at BiznesAlert.pl.

Russia’s diversified oil industry

Russian oil is not extracted in one specific area. The drilling takes place on the Arctic shelf in the northern part of the country and in the south, in the Caspian Sea. Oil platforms are being constructed on Sakhalin’s shelf on the Pacific Ocean, and also on the Baltic Sea a dozen kilometers north of Kaliningrad. Additionally, Russian oil has more than one brand.

The most well known brand of Russian oil is Urals (REBCO mixture), which mostly comes from Western Siberia and the Volga region. The other kind is ESPO extracted in Eastern Siberia and sold to China. The Falcon is a light brand of oil produced on the Sakhalin shelf and exported to Asia via the Kozmino oil terminal.

Such a variety of brands and locations makes it extremely hard and complex to ascertain the average cost of oil extraction in Russia. On top of the differences between deposits, various extraction techniques and logistical difficulties, there is also the issue of quite a complicated tax system imposed on the production of oil in Russia.

There exist two official stories on how profitable it is to extract oil in Russia. The first one is positive and it assumes that it costs USD 4 for extracting a barrel of Russian oil. The other one is negative and predicts Russia’s oil sector’s demise every time the market oil price plummets. Neither of these is 100% correct.

Oil extraction cost in Russia is high

A report drafted by IHS Markit and released last October is one of the most high-profile attempts at calculating the extraction costs of Russia’s oil. The document was ordered by Saudi Aramco and released before an upcoming stage of privatization of the company. It said that extraction cost in Russia was a lot higher than in Saudi Arabia. According to IHS Markit the oil extracted onshore was USD 42 per barrel, whereas offshore extraction was USD 44 per barrel. The producers that top this cost are the US with USD 49 per barrel, Kazakhstan with USD 46 and Venezuela’s offshore extraction with USD 63 per barrel. The cost per barrel in Saudi Arabia is estimated at USD 17.

Oil extraction cost in Russia is not high

When commenting on the IHS Markit report, Russia’s energy vice-minister Pavel Sorokin stated that the report’s calculations had been overestimated and that the real cost of production per barrel had been lower than the one the authors of the report had arrived at.

The second story in the discussion on extraction costs, told mostly by Russia’s oil producers is a lot more favorable. At the beginning of March this year Nail Maganov CEO of Tatneft said in an interview with TASS that USD 8 per barrel was not a critical figure for his company. Vagit Alekperov, owner of Lukoil, expressed a similar view when he said that his company would find no difficulty operating even if oil prices were at USD 9-11 per barrel. Whereas, Alexander Dyukov, CEO of Gazprom Neft, said his company extracted oil in developed fields at USD 3-5 per barrel. Rosneft’s cost per barrel extraction was USD 3.8 according to the company’s 2019 yearly financial statement.

The above figures are a lot lower than what IHS Markit claimed in their report. Where do these differences come from?

Extraction and then some

The extraction cost provided by heads of oil companies and the figures in financial statements do not reflect the real costs that Russian oil companies have to bear. We should bear in mind those are joint-stock companies that want to attract potential investors and investors are motivated by a quick and plentiful buck. This is why the figures provided by the CEOs and chairmen do not tell the whole story. Their goal is to placate the current and encourage potential investors interested in purchasing shares and engaging in other forms of bankrolling the companies. Another issue with these figures is the internal conflict between the chairmen for a position in this hermetic company, especially among companies where the state has shares.

Three types of producers’ costs

More often than not the extraction cost presented in the media includes only current expenses that the Russian oil companies need to bear on a given oil field (i.e. energy and maintenance costs, etc.). Staff costs, rotational staff transportation, food, administrative and marketing costs, etc., should be added to this. However, these are not all of the components that are included in the extraction cost for Russian oil.

There are three categories of oil extraction costs:

Operating expense (OPEX) – direct costs of extracting the raw material from the ground. These figures are used most often by representatives of Russian companies when commenting on their costs.

Capital expenditure (CAPEX) – the costs of exploration for new oil fields, geological research and exploration and extraction licenses. It includes all the expenses a company needs to bear to sustain a stable production and ensure the right replacement ratio between the old and new deposits.

Taxes – costs imposed by the state on the extraction of minerals (NDIP), export tariffs, excise duty and property taxes. These costs do not include the corporate income taxes.

Additionally, oil companies need to pay for, e.g. transporting the oil to oil trunk lines or oil terminals, administrative costs, financial operators (paying for trading offices, etc.). According to minister Sorokin OPEX costs for the majority of oil fields are between USD 3-8 per barrel. CAPEX is between USD 4-9 per barrel. Therefore, the average OPEX plus CAPEX of Russian oil companies is between USD 9 and 20 per barrel.

It is worth noticing that the lower threshold pertains to old deposits that have been exploited for years and where production started back in the Soviet era. In case of new projects, investment and operational costs are a lot higher. However, these are exempt from the third category of oil extraction expenses, i.e. the taxes on mineral extraction.

According to Bloomberg, CAPEX and OPEX for Rosneft, Lukoil and Gazprom Neft is not more than USD 12 per barrel. In case of Rosneft that’s USD 11.3 and in case of Lukoil USD 10.2 and for Gazprom Neft USD 9.8.
It is worth noticing that the above figures do not include the transportation and storage expenses. The state-owned Transneft is responsible for these services. The company manages over 70 thousand kilometers of oil pipelines across the entire country. Additionally, it is also responsible for securing storage capacities for oil and oil products. Transneft’s storage capacity is estimated at about 21 m tons.

According to Raiffeisen Bank, in 2019 Rosneft paid Transneft USD 4.2 per barrel for oil transportation. So if we add the transport expenses to OPEX and CAPEX, it will turn out that the cost of one barrel for Rosneft is over USD 15.

Taxes

Operational, investment and transport costs are not the only elements that need to be included in the costs of oil extraction. The taxes that have to be paid are a lot more complicated.
Below I will focus on detailing the two main taxes that Russian companies are paying to the state coffers, i.e. the mineral extraction tax (NDIP) and export tariffs.

The NDIP tax is the main fiscal tool that affects Russia’s extraction industry. The tax is imposed on every ton of the extracted raw material. The money goes directly into the state budget.
The formula for calculating the extraction tax is:

NDIP = index of the raw material price * fixed rate on extracting minerals – indexes of the extraction specification

The index of the raw material price is calculated every year by the Federal Tax Authority on the basis of the price of the Urals oil and Dollar’s exchange rate. In March 2020 the index was 3,9187.

The fixed rate on extracting minerals is RUB 919 per one ton of the raw material. This is the part of the extraction tax that has changed in the past few years due to the tax maneuver mechanism.

The index of the extraction specification is the most complicated element of the NDIP formula. It depends on many factors, including the raw material’s market price, depletion level of the deposit, the amount of material still in the deposit, index of the brand and quality of oil, etc. This means NDIP is different for every company, so calculating an average does not say much. Still, the tax is a significant burden on oil companies.

In 2018 NDIP constituted about 27% of Rosneft’s income. The tax’s participation in Tatneft’s income in 2018 was even higher – at 31%. Some freshly exploited oil fields (especially in the Arctic and Caspian Sea regions) are exempt from the mineral extraction tax. The second burden for Russian oil companies is the export tariff imposed on oil. This tax is determined every month on the basis of the average price per barrel of the Urals oil.

This mechanism is progressive and depending on the raw material prices across the world either helps or harms oil companies. When the oil price is above USD 70 per barrel, it is estimated that the tariff eats up over 50% of sales profit. However, when the price drops below USD 20 the burden goes down almost to zero. The tax rate is updated on the 15th of every month.

At the end of March, when the price of Urals dropped in the harbors in Rotterdam and Augusta (reference ports for Russian oil) to USD 10-12 per barrel; due to the high tariff between the 15th of February and 15th of March, Russian producers sold their oil below costs, i.e. netback (cost of extraction plus transport minus tariff).

In April the tariff plummeted spectacularly to levels last seen in the late 1990s. In March the tariff was at USD 52 per ton, in April it dropped to USD 6.8. The tariff for oil fields in Eastern Siberia, on the Caspian Sea and the Prirazlomnoye field is now at zero.

As recently as in 2014 the export tariff was at 60%. After the introduction of the so-called tax maneuver, i.e. a gradual lowering of the export tariffs and a simultaneous increase of the NDIP rate, in 2020 the tariff dropped to 30%. The goal is to use the corrective indexes to lower the tariff to 0% by 1 January 2024. However, the mineral extraction tax will go up. The increase will be proportional because the NDIP corrective index in 2019 was at 0.167, whereas in 2024 it is to be 1. In case of tariffs, the index in 2019 was at 0.833 and in 2024 it will drop to 0.

Conclusions

It is not easy to ascertain the final cost of Russian oil production as it depends on many factors. The operating costs provided by the companies cannot be considered a full answer as they are only one component of the final figure. It is also incorrect to calculate the extraction costs when oil prices in world markets are high, because taxes and tariffs distort the real cost that the companies need to bear.

The final price of Russian oil for consumers is also impacted by external factors such as the limit for sulphur in fuel oil in maritime transport imposed by the International Maritime Organization in 2019, or the discounts granted by the Saudis to their European clients that were part of their strategy during the price war with Russia.

In order to find buyers, Russian companies have to be a lot more flexible than they were just a few years ago. This situation will only get worse, since as of 1 May the unprecedented oil cuts introduced as part of the OPEC+ deal will go into effect. These will force Russian and international companies to redefine their investment plans for the coming year. The continuation of the tax reform as part of the tax maneuver is now also in question. It was supposed to bring a RUB 10 billion revenue to the federal budget.

In times of cheap oil the state will have to choose between maintaining the necessary level of budget revenue and supporting the key branch of its economy. Therefore, it is up to the state whether Russia’s oil sector will handle the current crisis.



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