Vagit Alekperov, Kirill Pokrovsky, Alan Sarkisjan.
Russia: New Sources of Growth.We have it, we don't have to "go to war "for it, and we are Europe(at least till the Ural mountains:)
Russia’s economic and political development, as well as its foreign relations, are a topic for incessant
discussions in the mass media worldwide. Most contribution to these discussions comes from politicians
and public figures while the business world viewpoint receives insufficient coverage.
It is worth noting that the current economic growth is provided
by launching new production facilities, rather than more intensive
operation of the existing ones. In the past years, capital investments
have shown a record-breaking rate of over 20%.
One of the main questions today is whether these trends are stable
enough. Will Russia be able to maintain a high growth rate for its
economy under a changing global environment of declining economic
growth rates and falling oil prices?
Answers to these questions are of paramount importance for Russia’s
relations with the USA and the European Union. Any attempt to
transform the discussions about the future of these relations into
a purely political or ideological issue is a trick aiming to evade the
discussion of real problems.
In the past years, Russia’s government has done a lot to secure a
long-term development of the country. Russia has settled its external
sovereign debt before maturity. The national gold and currency reserves
have come close to 500 bln US dollars, giving Russia a strong place
among the world’s top three countries in this ranking. Such measures as
separation of the budget into the general and the oil-and-gas segments,
establishment of the reserve fund and the national welfare fund have
paved the way for an effective financial policy for decades to come.
These measures enable Russia’s new government to focus on creating
incentives for further economic development, including tax burden
reduction, improving investment climate and fighting corruption.
Russia has already made its first steps towards these goals. A few days
ago Aleksei Kudrin, Russia’s Minister of Finance, disclosed The Main
Trends in Tax Policy until 2011 which envisage a reduced value added
tax and mineral resources tax, tax preferences for companies incurring
significant social expenditures, changes in the depreciation policy to
incentivize rejuvenation of the fixed assets, improved efficiency of
The proposed changes will have a positive impact on the development
of Russia’s oil and gas industry. It is common knowledge that the
industry has been stagnant in the recent years due to the poor condition
of the raw material base in the traditional areas of production. Over the
last three decades, the greater part of Russia’s oil and gas was produced
in Western Siberia. Today, we face the necessity to look elsewhere to
replace this major but depleted raw material base of Russia.
This has happened before its time – a consequence of unreasonably
fast development of Western Siberian fields in the Soviet era. There
have been a number of cases when accelerated production policies were
used even after the privatization of the oil industry. Naturally, this has
brought a slump in oil production growth rates in Russia from 9 – 11%
at the beginning of the current decade to 2% in 2006-2007.
Positive changes will become even more evident as the tax load on
the oil and gas industry decreases. Everyone, including government
officials, understands nowadays that it is essential to create conditions
to attract investments for development of new production areas.
According to the Ministry of Natural Resources, the amount of
investments in exploration required to ensure long-term additions of
hydrocarbon reserves is at least 55 bln US dollars, out of which 52 bln
is to come from the corporate sector.
Whether our country likes it or not, it will have to start competing
for investments in the coming few years. Otherwise it won’t be able to
retain its leading energy superpower status.
The actions of the Russian government indicate that the creation of
a favorable investment climate in the oil and gas industry is one of its
On January 1, 2007, amendments to the Tax Code of the Russian
Federation came into effect establishing a reduced rate of the Mineral
Extraction Tax (MET) for fields with a depletion degree of 80 percent
or more. Additionally, to incentivize the production of ultra-heavy and
Eastern Siberia’s oil, the tax authorities have introduced the zero MET
rate for such fields.
1. Promotion of International Activities. The majority of Russian
companies have only begun their acquisitions overseas. This process
is hindered by several factors, the main ones being shortage of
profitable assets and state protectionism, which not infrequently has
I am convinced that this process can be accelerated if cooperation in
the corporate sector is based on international covenants. It does not
necessarily have to be formal agreements. The essential idea is that
partners should be able to trust one another and be sure that their
national interests will not be infringed upon.
In light of this, an extremely positive signal for the Russian business
was the statement made by the then presidential candidate and now
President-elect of the Russian Federation Dmitry Medvedev, who spoke
about the necessity to offer state support for international activities
of Russian companies, above all in highly competitive global markets,
such as the energy sector and high-tech engineering.
2. Tight Control over Production Costs. Due to a number of objective
reasons the costs incurred by Russian companies in oil production are
about 50% lower than the respective costs incurred by the international
majors. This is, above all, connected with the specificities of the raw
material base, the bulk of which is comprised by onshore fields situated
in the regions with developed transportation infrastructure.
Depreciation of the US dollar exchange against the Russian ruble,
which in the last 5 years exceeded 100%, has become the basic factor
contributing to the escalation of costs.
In order to retain their competitive advantage in terms of costs Russian
companies should select exploration and production projects with the
The majority of the Russian companies, does
not develop remote reserves. The Company has only recently started
participating in deep sea projects in West Africa, as well as in a project
for bituminous oil production in Venezuela.
The fact that all the fields which are to be commissioned by the
Company in the near future are located either onshore or in shallow
waters has a positive influence on the upstream costs.
3. Gas Business Development. At present, the greatest part of Russian
oil and gas companies’ earnings (with the exception of Gazprom) come
from the oil business segment. Firstly, it is accounted for by the high
level of concentration of assets in the gas sector and, secondly, by the
state regulation of the gas market.
Nevertheless, now is a favorable moment to invest in gas projects.
According to the latest data, the Mineral Extraction Tax will remain
unaltered for gas at least until the year 2011, i.e. the moment when the
domestic gas prices are completely liberalized. It means that gas projects
are going to enter a phase of steady growth in profitability in the next
Here, Russia will retain its advantage over the competitors as holder
of considerable gas reserves both in Russia and abroad. Uzbekistan is a
key region for the Company in terms of gas production. The maximum
production level for the projects to be implemented in this country will
come to an annual 15 bcm. At that, gas will be sold at market prices.
The contribution of the Uzbek projects in Russians’s overall operating
results can hardly be overestimated: these projects will raise the
Company’s gas production in 2008 by 17%, while the net profit for gas
activities will be doubled.
4. Investments in Oil Refining. In the conditions of increasing
global oil prices the export duty system currently effective in Russia
contributes to a higher profitability of refining. At present, Russian
companies’ profits from refining one ton of oil exceed the oil export
profits by one hundred US dollars.
All these factors contribute to an increase in refining volumes in Russia.
In the past five years, this figure (applicable both to LUKOIL and
Russia in general) has grown by 24%. Within the same period the
share of the refining sector in Russian’s net profit has increased from
10 to 25%.
At present the Russian Government is elaborating amendments to
the tax legislation aimed to promote production of high quality
The Technical Regulations, requiring Russia’s transition to the
European fuel standards between 2009 and 2013 have come into effect.
It is planned to differentiate the motor fuel excise rates based on quality
and environmental safety.
Russian has a vast experience in manufacturing and marketing of
petroleum products compliant with the European quality standards.
The Company operates in 12 EU-countries, where two of the
Company’s seven refineries and over 1,200 filling stations are located.
Within the next 10 years,
5. Business Diversification. For Russian oil and gas companies,
investments in energy assets will become the main source of business
diversification in the coming years. The favorable conditions have
been created – the spin-off of the heat generating companies formerly
incorporated in the RAO UES of Russia has been completed, their
shares are traded on the Russian stock market.
LUKOIL took an active part in the privatization of energy generating
facilities. The Company purchased a controlling interest in the Eighth
Territorial Generating Company (TGK-8), a major electric power
generating company in South Russia. The acquisition price was about
30% lower than the market price.
Annual gas consumption of TGK-8 comes to about 7 bcm and will
grow along with the implementation of new investment projects.
According to the Company estimates, the synergy effect from gas
supply from North Caspian fields to TGK-8 power stations will reach 2
bln US dollars.
The South Russian energy assets will become the core of LUKOIL’s
new business sector, which will also comprise the power stations located
in the Company’s fields and oil refineries. Development of the new
business line – the electric power segment – will enable the Russia
to simultaneously attain several objectives including enhanced
efficiency of raw materials utilization, providing electric power to own
facilities and business diversification.
It is evident that the above-mentioned list of challenges confronted
by Russian oil and gas companies is not exhaustive. However, it helps
assess development prospects for the coming decade.
It is of utmost importance that these plans meet support of the
Russian Government, whose priorities for the near future comprise
enhancement of Russian economy’s global competitiveness and Russia’s
integration in the international labor division system.
Today, business and the state speak one language in Russia, and
the basic concepts are law abidance, economic feasibility and social
responsibility. And this is the best basis for sustainable economic
and social development irrespective of any changes in external
business environment.Vagit Alekperov, Kirill Pokrovsky, Alan Sarkisjan.