Time to Make a Move

The recent drop in oil prices has impacted Russian GDP negatively, as predicted, but the economy may end up benefitting from the situation – and could even become healthier as a result.

The Russian tax system makes it difficult for many sectors of the economy to function efficiently. Export duties on oil and petroleum products make the domestic price of oil much lower than the international market price. To be more precise, domestic prices are equal to the international market price minus the export duty (and with the price of oil at $100 per barrel, the Russian price is approximately half the international price). Domestic gasoline prices are also considerably lower than in Europe, where producers buy raw materials at international market prices. This lowers the incentive for Russian oil companies to make significant long-term investments in increasing production efficiency. Currently, the crude oil processing yield in Russia stands at 71%, while in Europe and the United States this figure ranges from 90% to 95%. Given market prices, the Russian oil industry has had negative economic added value for more than 20 years.

The cancellation of export duties would make domestic market oil about twice as expensive as its current price of $100 per barrel. The tax-free price of fuel could therefore increase by up to 70% (not accounting for potential competition from foreign companies). Obviously, such a move would be unpopular from a political standpoint. But given today’s low oil price, the gap between the global and the domestic prices is now much narrower, and the jump in the price of petroleum products would not be as drastic. At the very least, there are precious few opportunities for this to happen. Therefore, the cancellation of export duties would be less politically risky.

Given the price of $100 per barrel, the cancellation of export duties would make domestic market oil about twice as expensive. The tax-free price of fuel could therefore increase by up to 70%, not accounting for potential competition from foreign companies

If duties were canceled, the budget would see a revenue shortfall. This could reasonably be compensated for by increasing the Mineral Extraction Tax (MET). Oil companies have expressed anxiety about the shrinking of what they say are already marginal profits. However, even putting aside how vertically integrated most of them are, and given a higher domestic price due to canceled export duties, a tax shift from refining to production could be made relatively painlessly, both for the industry and for GDP in general. Naturally, it would take some time to accurately adjust taxes (which, in turn, depend on the price of oil), but at $60 dollars per barrel, this adjustment would not be so costly. This means that the current oil prices are conducive to a ‘tax maneuver,’ which is what the government calls the transfer of budget revenues from export duties to the MET.

Above all, reform opponents fear a negative impact on GDP, which may occur due to rising production costs. Nevertheless, when carrying out such a move, a reasonable hike in petroleum product prices is achievable. A significant rise in inner prices would attract European players to the Russian market, which would put pressure on domestic producers. First, it would force them to increase oil-refining efficiency through long-term investments. Second, it would also put pressure on monopolist producers, which would increase competition and lower profit margins. These profit margins are at 30% in Russia, whereas the same figure in Europe is around 15%. According to calculations by the Gaidar Institute and the Russian Presidential Academy of National Economy and Public Administration, increased petroleum product efficiency and increased competition could improve the health of the economy and even have positive effects on output. This scenario, while contingent on a 15% increase in gasoline prices, is quite realistic – though it would require several years and fair competition among Russian and foreign producers.

High oil revenues are certainly no guarantee of real economic growth in the future. But a drive to achieve greater efficiency and improve competition in manufacturing sectors, along with an honest effort to end the over-dependence on raw materials, are key to diversifying the economy and accelerating convergence with leading world economies. A refusal to subsidize inefficiency is the first step towards achieving these goals.

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