Wednesday, May 19, 2010

Russian Oil Fortunes Rest on Kremlin's Coffers

Russia runs on oil and gas. Paradoxically, that isn't always a good thing for the country's oil and gas companies.

Rosneft, Russia's state-controlled oil giant, reported first-quarter results this week that were helped by tax and excise benefits on a field in eastern Siberia. Brokerage Uralsib estimates the benefit at $690 million, or about 16% of earnings before interest, tax, depreciation and amortization.

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Pavel Golovkin/Associated Press

Russian army fighter jets left a smoke of colors of the state flag as they flew over Moscow's Kremlin during general rehearsals ahead of the Victory day parade, in Moscow on May 6, 2010.
.Tax breaks to encourage investment in new fields and pipelines are sound policy. And Russia's oil companies suffer high marginal tax rates on much of their production.

The problem for investors, however, is the importance of those benefits. Some 51% of Rosneft's 2010 earnings will come from "regulatory perks" like tax breaks, estimates Alexander Burgansky of Renaissance Capital, a Russian brokerage.

How sustainable are those benefits? Russia estimates it would need an average Urals crude-oil price of $95 a barrel to balance the public budget this year. The average so far is $77.

Russia is far from facing a fiscal crisis, as the successful recent launch of its first Eurobond in over a decade demonstrated. But as Oswald Clint of Sanford C. Bernstein points out, the energy sector provides more than 40% of the federal budget even with the tax breaks. Moscow's "rainy-day" funds have dwindled by almost half since their December 2008 peak.

Risks to budget forecasts abound, not least next door in Europe, where economic turmoil damps demand for Russian energy. That, in turn, could reduce the likelihood of further tax relief for Russian oil producers and raise the risk of existing ones ending. Investors in the sector should keep a close eye on the Kremlin's books.

Write to Liam Denning at

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