Heading into 2018, a consensus prevails across the industry that Russia's refining sector is in need of further reform, with the vast modernization program being implemented over recent years now widely seen as outdated as a result of shifts in the global macroeconomic and oil demand outlooks.
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Changes to the program -- launched in 2011 -- as well as further changes to the country's tax regime for oil products, will be the subject of discussion at government level early next year that are likely to shape the future of Russia's refining sector.
Despite the specter of major changes ahead, crude processing by Russia's refinery fleet is likely to remain roughly flat year on year at 280 million mt in 2018, according to energy ministry forecasts, although that could tip one way or the other depending on crude export levels.
The country's crude production is expected to remain flat as long as thn-OPEC production cut deal remains intact, it is currently expected to run through to the end of the year -- with Russia continuing to show strong conformity.
On the back of the modernization program, the yield of light products is set to grow to 64% in 2018 from 62% in 2017, according to the energy ministry data, with a further reduction in fuel oil production likely. Russia, a major exporter of fuel oil to Europe, has already significantly cut fuel oil production as a result of its modernization program, with output dropping 20% year on year to 57.1 million mt in 2016.
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Russia's Vygon Consulting expects the country's fuel oil production to have slipped more than 10% by 2020 from current levels, as efforts to get more value from the bottom of the barrel outpace the impact of higher refining activity.
A potential revival of processing at complex refineries as oil prices recover and the launch of new primary refining units, means Russian fuel oil yields could increase by 5 million mt by 2020, according to Vygon Consulting analyst Yana Feshina.
"On the other hand, there is a plan to launch new deeper refining processes using gasoil and fuel oil as feedstock to make motor gasoline and diesel... as a result, the new processes will use 10.5 million mt of fuel oil," Feshina said, adding that Vygon Consulting expects fuel oil output to be 42.7 million mt in 2020.
Refining margins have also recovered this year from the critical levels seen in early and mid-2016, when they were widely negative at Russian plants, but the situation in the industry remains difficult.
"Russia's average 2017 refining margin stands around $3/b, enough for plants to survive and supply oil products to the domestic market, but creating no stimuli for any sort of modernization," Alexei Sazanov, head of the tax and customs department at the finance ministry, said in October.
While the progress of modernization has slowed down significantly in recent years as refining margins narrowed due to major tax changes over 2015-17 as well as the drop in oil prices, warnings have become increasingly urgent about the need to reconsider the program's priorities.
Many observers point to an emerging problem marketing the surplus of diesel coming out of Russia's refineries, with output now nearly double domestic demand.
The modernization program envisages a further nearly 20% increase in diesel output by 2020 but most research points to a slowdown in diesel demand in Europe, the key outlet for Russia.
The construction of a large number of hydrocracking units for diesel and jet fuel production needs "reconsideration" given the change of emphasis in both Europe and the Middle East, and future technical rules on liquid fuel and bunker fuel, said Denis Borisov, head of Moscow oil and gas center at Ernst & Young.
CALLS FOR SUPPORT
With the economics of many refineries -- especially those located further away from key domestic or international markets and therefore with greater transportation costs -- remaining a concern, companies continue to push for tax breaks to help their operations.
Russia's top crude producer and biggest refiner by volume, state-controlled Rosneft -- which has canceled three new planned units and delayed the launch of several more -- recently called for additional tax breaks as part of "systemic fiscal solutions" for its refineries, including lower pipeline and railway transportation tariffs and a rebate on excise tax.
Other refiners would also like to see state support of the sector, which has labored under an increased tax burden in recent years.
"If we do not develop this [support] mechanism, the industry will freeze where it is. It wouldn't be right or smart to be upgrading so well in the past several years and to stop half-way," said Dmitry Mazurov, the head of the independent Antipinsky refinery, located in the Tyumen region.
The energy ministry too seems ready to back changes next year.
"There should be a new agreement, either a new four-party agreement or a new agreement on completing the modernization," deputy energy minister Kirill Molodtsov said in December, referring to the 2011 agreement between the oil companies, federal environmental, industrial and nuclear supervisor Rostekhnadzor, the Federal Anti-Monopoly Service, and Rosstandard, the federal agency on technical regulating and metrology.
"A lot will depend on the state of the third [lowest-margin] group of plants -- those that have not started modernization or have not made it to deep processing," Molodtsov added.
Those plants include several independent refineries, such as Antipinsky, Novoshakhtinsky, Yaysky, and Rosneft's Samara and Saratov groups of plants, according to market experts.
The energy and finance ministries are to present the government with proposals on stimulating further refinery modernization by January 15.
The current proposals from the ministries include a rebate on oil excise duty.
While the parameters are yet to be agreed, a negative excise tax of Rb1,000/mt ($17/mt) should be enough given the current crack spreads, according to the finance ministry's Sazanov.
At the same time, the finance ministry has not abandoned the idea of canceling export duty on crude altogether.
Effectively a subsidy, refineries get additional revenue from the difference between export duties on crude and oil products.
But the idea has so far failed to win the support of the energy ministry, which fears the move would make most plants unprofitable.
The ministry is concerned that the move could create risks to domestic motor fuel supply by adding pressure on refineries that will not have completed their modernization in time.
Molodtsov earlier suggested the export duty should not be removed before 2020-22.
Sazanov said he expects a decision on this by the end of 2018, which suggests there will be vigorous tax discussions continuing throughout the year.
So far, while maintaining the export duty parameters in place next year, official plans envisage two excise tax hikes on motor fuel, one at the start of the year and one in the middle, that are expected to add Rb40 billion (nearly $700 million) to the state budget, according to the finance ministry.
The move will cost producers 1.7% of their EBITDA next year, according to VTB Capital analysts' estimates.