Tax hikes risk for Russian companies: Impact on the Russian equity market

Earlier this year the Russian government approved an increase in the mineral extraction tax (MET) and changes to the excess profit tax (EPT) relating to oil. 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.

Gas, gold, PGM (platinum group minerals) and diamond production fell outside the tax reforms this time.  But if the Russian government were to decide to increase tax on these sectors too? How would it impact the Russian equity market?

We believe the main companies potentially at risk from future tax hikes are gold producers and nickel and PGM producer.

We have already seen that the government can increase the tax rate if a commodity performs well over a period of time. 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. Currently, gold producers are taxed at 6% on their revenues. We do not expect the MET for gold producers to be increased 3.5-fold as it was for other base metals and ores this year. But if we assume that the MET on gold producers could rise from the current 6% to 12%, then the fair price for companies represented in the Russian index could fall by 8% for each. Taking into account their total weight in the Russian index of 9%, the upside of the index would fall by 0.7%.

The main nickel and PGM producer represented in the Russian index mines one polymetallic ore and pays the MET for this mined ore. Even though the company has already undergone the MET increase, it still pays less tax compared to other metal producers. Before tax amendments the company had a special MET regime for metals, which was calculated at RUB 730 (~USD 10) per tonne of ore mined, so the tax was not tied to the price of metals. Basically, it paid around 1.5% of its revenues in tax. From 2021, the MET on the company will increase 3.5-fold, which will amount to around 4.5% of revenue. For other miners, the MET has risen to account for 8% of their revenues. That means that the MET for nickel and PGM producer is still lower than for other non-ferrous metal producers. If metal prices remain at their current level, then the MET for the nickel and PGM producer could also increase to 8%. Should this happen, the company would lose 5% of its fair price. Taking into account its weight in the Russian index of 4.5%, the upside of the index will decrease by 0.3%.

In total, the potential tax amendments for nickel and PGM producer and gold producers could cost the Russian market around 1% of its fair price.

Russia’s gas and diamond producers performed quite weakly over this year and do not have any excess profit that can be taxed. This makes us believe these sectors are on a long tax hike hold.

In November, we have seen oil prices rise by 28%. Does this mean further tax amendments in the oil sector are possible? We believe a tax hike could occur should the oil producers achieve excess revenue, which could happen if oil prices reach USD 65 per barrel and the rouble weakens over the next year. For instance, in 2019, the average oil price was around USD 64/bbl and the rouble weakened by about 11%, which resulted in the oil companies making strong profits. This led to tax amendments for the sector in 2020. However, we expect the rouble to strengthen by about 5%-6% and the consensus view is that oil prices will remain around USD 47 – USD 53 per barrel[1] over the next two years. For this reason, we believe a tax hike on oil companies to be unlikely.

[1] EIA and Fitch Solutions oil price forecast for 2021-2022

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

 

Authors: Gennady Sukhanov, Deputy Head of Equities & Head of Research; Marina Tsutskiridze, Junior Investment Specialist

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