Change in oil and metals extraction taxes: What it means for the Russian equity market

The Russian government has approved an increase in the mineral extraction tax (MET) and changes to excess profit tax (EPT) for oil, proposed by the Ministry of Finance (MoF).

The main amendments include:

  • Elimination of oil tax breaks for high-viscosity crude oil and depleted fields starting from 2021. This system will be replaced by EPT
  • The list of the regions falling under EPT taxation will be expanded to include the North Caucasus, Sakhalin, Orenburg and Samara regions
  • For a number of oil fields in the Tatarstan and Yamalo-Nenets region, a tax deduction was introduced should the Urals oil price for the tax period exceed the base oil price (in 2021 – USD 43.4 per barrel). If the oil price is lower than the base level, the tax deduction will not be applied
  • The MET on certain base metals and ores, such as iron ore, nickel and copper will be increased by 3.5-fold starting from 2021. PGM (Platinum Group Metals) are not part of the deal. New mining projects, protected by special investment agreements with the government, are also excluded from the tax hike.

These changes have cost the Russian market around 5% of its fair price due to the reduction in upside potential of the companies in the energy and materials sectors.

Among the oil producers, the hardest hit was Gazprom Neft and Tatneft. Gazprom Neft shares suffered because company’s Novoportovskoye field in the Arctic will lose its current tax breaks. Tatneft, one of the largest users of privilege of export duty exemption, will see that advantage removed by the new bill. High-viscosity crude oil accounts for some 10%-13% of Tatneft’s production – the largest proportion among Russian oil producers. Both Tatneft and Gazprom Neft still may gain some benefit starting from 2021 as they operate in regions eligible for tax deduction. But there is a deduction limit of RUB 36 billion in total (~USD 0.5 billion) for each company. Tatneft could get a monthly tax deduction of RUB 1 billion (USD 13 million) for ultra-high-viscosity crude oil development in Tatarstan if the Urals price is above the base level in the budget. Gazprom Neft could also get a RUB 1 billion (USD 13 million) monthly tax deduction in 2021-2023 for its Novoportovskoye field in Yamalo-Nenets region. This could partially absorb the impact of the tax changes.

Though the tax amendments affected the fair price valuation of these companies, the current upside potential is 51% for Gazprom Neft and 26% for Tatneft.

As for the materials sector, the tax changes will be less aggressive and should have a smaller effect on the price of the companies in the sector. Metal companies do not have high debt and tend to offer an attractively high dividend yield. At the same time, the rouble’s devaluation has helped metal companies to stay afloat. We do not expect significant damage in the financial position of companies in the materials sector. The fall in their net profit margin is not expected to exceed 2%. Most of the companies in the industry have a net profit margin of 20%-50%, so the impact of the tax increase will likely not be dramatic.

Although these tax amendments will not affect PGM this time, one lesson learned from the changes is that the MET can be raised if a commodity performs well over a period of time. Gold producers enjoyed a rally earlier this year as a result of the pandemic panic. If gold prices remain high and even achieve new record levels, gold producers would significantly increase their earnings, in which case the MET on them could be increased.

While the government faces industry criticism for these tax measures, in our view it is a necessary step for the economy at the moment. The coronavirus pandemic has created a large hole in the budget, with oil revenues cut by half. And the aftermath of Covid is expected to last for quite a long time. The Ministry of Finance foresees three years of budget deficit equating to 2.4% of GDP in 2021 and around 1% of GDP in 2022 and 2023. So, the newly approved tax revenues will come in handy to help to plug the budget holes. The Ministry expects to generate around RUB 230 billion (USD 3 billion) in additional revenues from the tax amendments on minerals. Oil tax revenues from oil are expected to be RUB 37.4 billion (USD 0.5 billion) in 2021, RUB 24.6 billion (USD 0.3 billion) in 2022 and RUB 11.5 billion (USD 0.2 billion) in 2023. The Ministry has calculated that had these measures been in place last year, revenues from oil would have been some RUB 200 billion higher (USD 2.6 billion).

(Please see the full version of the article with graphs in the attached pdf file.)

Authors: Egor Kiselev PhD, Head of International Business & Investment Marketing; Gennady Sukhanov, Deputy Head of Equities & Head of Research; Aleksandra Kuznetsova, Junior Investment Specialist; Marina Tsutskiridze, Junior Investment Specialist

Changes in oil and metal extraction taxes
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