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Russian tax changes to keep refining margins, investment low: analysts

Moscow — Investment in Russian refining remains risky and refining margins strained if not negative with the latest tax changes in the refining and motor fuel retail segments unlikely to remove the sector's volatility, independent Vygon Consulting said Wednesday.

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"Today, investment in refining is at high risk," said Grigory Vygon, the consultancy's founder and head. "There is no guidance, no long-term tax policy, any return requires five-six years. There may be higher-priority projects with decent returns where one could invest money. That is why no investment decisions in this regard are being made. It would be highly risky in these conditions."

Related story: Putin signs law to phase out Russia crude export duty by2024

Gasoline-oriented plants are at the highest risk at the moment, and will remain there in the next five-six years, he said, as regulations change often as the state attempts to hold back retail gasoline prices, by putting pressure on refineries or filling stations.

After Russian gasoline prices rose by 5% in one month in May, as companies preferred more profitable exports to domestic supplies offering lower netbacks, with wholesale prices exceeding retail prices at one point, the government decided on several measures to stabilize prices, including an immediate excise duty cut on gasoline and diesel as of June.

While gasoline prices stabilized following relevant state instructions to companies, the move did little to change the refineries' economics with refineries and filling stations still vulnerable, the Moscow-based consultancy said in a research report.

"The situation is abnormal, and needs to be discussed," Vygon said. "The key issue is refineries' permanent negative [margins]. We expect nothing good of such refining," Vygon told reporters.

The consultancy estimated current average refining margin in Russia at $2-$3/b, its chief analyst Sergey Yezhov said. The plants mainly focused on domestic gasoline supply, however, have negative refining margins, he added.

TAX CHANGES

The comments followed Russia passing last week the laws on phasing out crude oil export duty and introducing an excise duty refund on processed crude starting next year to mitigate the impact on the industry from the rise in crude prices and the disappearance of the indirect subsidy of the spread between crude and product export duties.

The so-called negative excise will be based on the amount of crude plants process, the light products they deliver to the domestic market, and their distance from the markets they supply.

The changes are part of the so-called tax maneuver completion. The tax maneuver was first introduced in 2015 and aimed at encouraging refineries' modernization and higher light oil product yield through gradual cuts in export duty on crude and light oil products, and export duty hikes on heavy oil products.

The new crude export duty amendment law envisages cutting crude export duty yearly by 5 percentage points over six years starting 2019 and completely abolishing it in 2024.

The developed mechanisms for completing the tax maneuver are expected to add Rb1-3 trillion ($16-$47 billion), consumers being the main source of that, Vygon said, adding the decisions are imperfect and give no guarantees of future financial stability of refineries and filling stations.

"These are inconsistent decisions that change in emergencies, there is no long-term industry guidance. This is simply not serious. People will stop investing and we will never achieve any goals this way - in modernization, or in enhancing our companies' competitiveness," he said.

MOTOR FUELS

With domestic gasoline supplies inefficient today, the state would need to spend Rb400 billion to compensate the difference between the domestic price and the export netback, Vygon said.

Instead, the state is creating a negative stimulus, which may result in companies exporting more naphtha, said Yezhov.

"This goes against the initial targets of subsidizing refining. Everything is manually controlled now, this doesn't allow changing gasoline volumes, and it doesn't allow exports. This cannot last forever," he said.

Further developments will partly depend on to coordination with other members of the Eurasian Economic Union, including Belarus, which relies almost entirely on Russian duty-free crude to load its two 22-million mt/year refineries. The EAEU also includes Armenia, Kazakhstan and Kyrgyzstan.

Earlier this week, two Duma deputies proposed a bill to regulate prices on gasoline and diesel, but that would go against Russia's agreements with the EAEU members, which foresees "conducting coordinated energy policy, based on market-based price-setting," deputy head of Federal Anti-Monopoly Service, Anatoly Golomolzin, said earlier in the day as quoted by RIA Novosti agency.

Yet, with more gasoline-producing units planned for launch in the coming years under the modernization program, and stalling gasoline demand on strained economic situation, Russia may see 10 million mt/year gasoline surplus by 2025, Yezhov said.

By that time, Russian refinery throughput is expected to rise by up to 14% from 2017 levels to 320 million mt/year, he said.

The consultancy forecasts Russia's gasoline output at 45 million mt/year by then, and diesel production is expected at 110-115 million mt/year, up 15% and nearly 50% accordingly.

--Nastassia Astrasheuskaya, nastia.astrasheuska@spglobal.com

--Edited by Maurice Geller, maurice.geller@spglobal.com