Russia's energy sector suffers as the Kremlin is compelled to raise taxes

Putin hikes charges on oil and gas companies in response to the G7's price cap on Russian petroleum.

According to officials from the western coalition, the G7-led price ceiling on Russian oil exports has prompted the Kremlin to hike the tax burden on producers, inflicting a further blow to an energy industry already reeling with western sanctions.

A member of the G7-led coalition's examination of the tax shift, determined that the measure was likely to backfire by sacrificing the industry's ability to invest for the long term in order to cover a deficit in government budgets.

“Russia’s changes will . . . undercut the future production capacity of the Russian oil and gas industry by taking away revenues that could otherwise be used to invest in equipment, exploration and existing fields.”

In April, Russian President Vladimir Putin modified the country's way of taxing oil businesses by basing levies on the Brent crude worldwide benchmark price minus a predetermined discount, rather than the price of Urals, the country's principal export crude, which has been trading at a lower price in recent months.

Moscow expected to grab up to Rbs600 billion ($8 billion) in additional money and patch the hole in oil export revenue produced by western sanctions aimed at limiting finance for the Ukraine war.

Russian oil and gas tax revenue declined by 45 percent in the first quarter of 2023 compared to the same period last year, with refined oil products falling by 85 percent year on year. According to the official, such funds account for 45 percent of Russia's budget.

“The tax change they are making is prima facie evidence that their revenues are suffering significantly,” the official said.

The G7 price cap for crude oil, set at $60 per barrel, was implemented in December following months of negotiations in an effort to keep Russian oil flowing to the global economy and avoid market disruption while reducing Moscow's revenue. Western officials claim they are reaching both objectives as part of their strategy to compel the Kremlin to make "hard choices" economically if it wants to continue supporting the war. According to a G7 price-cap alliance official, Russia was robbing from its "future" in order to pay for the "present" conflict with the tax adjustment.

According to OilX, a part of consultancy Energy Aspects, Russian oil production dipped last month to 10.4 million barrels per day, presumably reflecting the Kremlin's vow to restrict output in response to the price cap. According to OilX, exports were 4.7 million barrels per day, which was lower than the five-year average. Despite G7 countries' belief that their price cap is operating as intended, customs records show that Russian oil producers got better pricing for at least some exports. Last month, the International Energy Agency assessed that the weighted average price for Russian oil exports had increased over the $60 per barrel price cap threshold in April, with one crude stream in the far east selling for as much as $74/b in recent weeks.

Brent crude was pricing at $71.40 a barrel this week, down over 30% from a year ago.

G7 finance ministers and central bank governors will meet in Japan this week ahead of a leaders conference later this month, with Russian sanctions anticipated to be at the forefront of discussions. "There will be a focus on the price cap and how it succeeded," said a coalition official.

Members of the G7-led price cap coalition would also "intensify efforts to combat evasion, including the use of deceptive practises to access coalition services for oil traded above the cap" in the coming time, according to the official.

According to the source, the G7 price cap alliance will strive to assist oil service providers in complying by highlighting "red flags" such as "manipulation of ships' location tracking or failure to itemise shipping, goods, customs and insurance costs separately from the oil itself."

By taxing oil sales at a discount to Brent prices rather than the Urals price, Moscow acknowledges that Russian oil will sell at a discount to foreign markets for the foreseeable future. The official from the price cap coalition described it as a "sea change" for the Kremlin: even if it was designed to earn more revenue from Russian oil sales in the short term, it was a tax structure that would have been widely viewed as extremely unfriendly to the government prior to the dispute.

According to the coalition member's research, if Russian oil had been taxed based on Brent prices minus a fixed discount rather than Urals before the Ukraine war, the Kremlin's monthly oil profits would have been between $5 billion and $6 billion lower.

By fLEXI tEAM