The Directions of Taxation System Improvement of the Oil Sector Possible directions to improve the taxation system of the oil sector are the changes in the criteria of severance vacations provision, application of regional step down coefficient to the severance rate for the whole period of the develop ment, transfer to ad valorem severance rate, implementation of some kind of net income taxation.
1. Severance Tax Vacations An important element of the adopted amendments is the establishment of two criteria for privileged severance rate provision for new oil fields in the East Siberian RUSSIAN ECONOMY IN trends and outlooks oil and gas province: the volume of oil production of 25 mln. tons and the period of 10 15 years depending on the kind of license for the subsoil area exploitation.
If just a volume of production (25 mln. tons) is established as a criteria for tax rates allowances, then the privilege can prolong for quite a long time up to the whole period of exploitation for small scale oil fields. At the same time this could stimulate the development of small scale oil fields, whose development, as a rule, is connected with higher capital and exploitation costs as calculated per ton of oil produced (higher costs in this case will be compensated by a longer period of privi lege implementation).
If the period of zero rate application (10 15 years) is the only established cri teria, this will create strong stimuli for oil production acceleration in the first years of development which will lead to the decrease in the level of final oil extraction.
The establishment of the upper limit for accumulated oil production (25 mln. tons), at which the implementation of tax privilege expires, does not create incentives for acceleration of oil production at quite big oil fields.
At the same time the presence of such criteria at small scale oil fields, oil pro duction at which at normal development rates will be considerably lower than mln. tons, creates strong stimuli for their development with the aim to exempt from taxes the biggest possible amount of the oil produced.
The results of estimations for investment profitability in oil production in East Siberia with the different length of the tax vacations, which were carried out in IET with the application of imitation financial model for a typical oil field developing, are summarized in Table 27. These calculations take into account the stage of the oil field development, i.e. the oil fields that are ready for development are singled out (lines 2 and 3), which can use severance privilege straight from 1 January 2007, and oil fields, which are not ready for the development, which require some time for additional exploration and making first investments to get a state license for subsoil area exploitation (lines 4 and 5). The time for additional exploration and first in vestments implementation is assumed to be 2 years from the moment of license registering. Thus, for an oil field, which is not ready for the development, tax vaca tions of 10 years from the moment of license registering correspond to 8 years from the moment of oil production, 7 year long vacations correspond for the pe riod of 5 years from the moment of oil production beginning.
Calculations that were carried out testify quite low profitability of the invest ment in East Siberia oil fields in the environment of the state of the art taxation system (line 1 Table 27). At the same time the established criteria for severance al lowances provision in the world oil prices range9 are regarded as excessive (the re sults of the corresponding calculations are given in lines 2 and 4 of Table 27). Ac Most of the recent forecasts of the leading foreign organizations on world oil prices for middle term and long term prospects are in the range of USD 40 57.5 per barrel. Thus, in accordance with the basic version of the last long term forecast by the USA Ministry of Energy, the average figure for the world price for oil in real terms is USD 57.5 per barrel in 2010, USD 52 per barrel in 2020. Long term forecast for the world oil prices by the International Energy Agency of Organization for Economic Cooperation and Development is equal to USD 55 per barrel (in prices of 2005).
Section The Real Sector cepTable investment profitability (the price of oil being USD 40 per barrel and higher the internal profitability norm exceeds 20%) is secured by considerably shorter period of tax vacations: 5 years for oil fields, which are ready for the devel opment, and 7 years for the oil fields, not prepared for the development (lines and 5 of Table 27). Quite high profitability is secured also by the extension of sev erance privilege for the first 15 mln. tons of oil produced (line 6).
Table Profitability of Investments in a Typical Oil Field in East Siberia Profitability under Different Period of Tax Vacations, as percentage Oil grade Urals price, as USD per barrel 30 35 40 45 50 55 1.Severance: existing 7.2 10.1 12.7 15.2 17.5 19.9 22.taxation system 2. Severance: 10 year tax vacations for an oil field 16.4 21.3 26.0 30.6 35.1 39.6 44.ready for the develop ment 3. Severance: 5 year tax vacations for an oil field 12.1 16.5 20.8 25.1 29.5 33.9 38.ready for the develop ment 4. Severance: 10 year tax vacations for an oil field 15.2 20.0 24.7 29.3 34.0 38.5 43.which is not ready for the development 5. Severance: 7 year tax vacations for an oil field 12.1 16.5 20.8 25.1 29.5 33.9 38.not ready for the devel opment 6. Severance: tax vaca tions up to production of 13.3 17.9 22.4 27.0 31.5 36.1 40.15 mln. barrels Source: IET estimations The analysis of adopted amendments to Chapter 26 of the Tax Code of the Russian Federation, which deals with severance zero rate application at new oil fields of East Siberia oil and gas province, allows drawing the following conclu sions:
1. The length of tax vacations should be differentiated not only by kind of the license for subsoil area exploitation, but also by the extent of oil field development:
for the oil fields, which are ready for the development or are at an early stage of ex ploitation, tax vacations should be of shorter length than for the oil fields, which are not ready for the development, as in the former case no time is needed to conduct additional exploration work (or such exploration can be carried out at the same time as oil production) or for the implementation of primary investments.
2. The established length of the tax vacations for the level of the world prices that is forecasted is excessive and can be reduced. According to out estimations, tax vacations for the oil fields of the East Siberia oil and gas province, which are not ready for the development the tax vacations can be reduced from 10 to 7 years, and for oil fields, which are ready for the development or are at the initial exploita tion stage – from 10 to 5 years.
RUSSIAN ECONOMY IN trends and outlooks 3. It would be preferable to establish the application of the scheme with one criterion for severance privilege provision – the amount of the oil produced. And the volume of 25 mln. tons is considered excessive at that. With such a limit the invest ment profitability seems excessively high, and at the oil fields of middle scale 50% of the oil produced is actually exempt from the severance. As the calculations demonstrate, necessary investment profitability is secured by the limit of 15 mln.
The approach that is suggested has the following advantages:
first, such a criterion (the volume of accumulated production) does not give incentives for oil production acceleration, as severance privilege provision is not limited by a certain period;
second, such a criterion can be uniform, as it can be applied to all kinds of the licenses (both for the licenses for exploration and production and the licenses for geological exploration (search and exploration) and production), for privilege re ceipt in this case does not depend on the time of the start of production;
third, such a criteria can be applied to the oil fields at different stages of the development (both for the oil fields that are ready for the development or are at the initial stage of exploitation and for oil fields that are not ready for the development).
It should be, however, taken into account that if the only criterion used is the index of accumulated oil production all the oil produced at the small scale oil fields can be subjected to severance privilege. However, the development of such oil fields, which otherwise can remain undeveloped, is meanwhile stimulated.
2. The Application of the Territorial Step down Coefficient to Severance Rate for the Whole Period of the Development The introduction of a step down coefficient to severance rate, which is ap plied at the development of new oil fields in some regions (for instance, East Sibe ria), for the whole period of the development can be an alternative for severance tax vacations.
The value of such a coefficient can be defined by calculation from the re quirement of the necessary investment profitability during the development of the oil fields in the corresponding territory. For instance, the value of such a coefficient for East Siberia can comprise 0.5. Such a value of the coefficient secures accepT able profitability of the investments in oil production (Table 28).
Table Investment in a Typical Oil Field in East Siberia Profitability under the Application of a Step down Coefficient to Severance Rate, as percentage Oil grade Urals price, as USD per barrel 30 35 40 45 50 55 1. Severance: existing taxa 7.2 10.1 12.7 15.2 17.5 19.9 22.tion system 2. Severance: step down 13.0 16.6 20.1 23.6 26.9 30.3 33.coefficient of 0.Source: IET calculations Section The Real Sector From our point of view such an approach has several important advantages over the tax vacations scheme:
first, according to this approach, severance is paid from the very start of the production;
second, this approach does not provide incentives for oil production acceleration in the first years of the development. Thus, it does not have distortion effect on the subsoil area managers and production profile;
third, this approach takes into account higher costs for production and sale over the whole period of the development (for instance, in regard to east Siberia higher oil transportation costs take place over the whole period of oil fields exploitation);
fourth, such a coefficient can be uniform, as it is applicable to all kinds of the licenses (both for the licenses for exploration and production and the licenses for geological exploration (search and exploration) and production), and for the oil fields at the different stage of development (both for the oil fields that are ready for the development or are at the initial stage of exploitation and for oil fields that are not ready for the development);
fifth, such an approach provides investor with a lower profit the price for oil growing as compared with the scheme of tax vacations (Tables 27, 28).
3. Transfer for Ad Valorem Severance Rate Ad valorem severance rate is a more flexible tax tool as compared with the specific tax rate. The tax basis for ad valorem severance rate application is oil price at the production point, which allows to take in account the difference in oil sales price, which is accounted for by its quality and supplies direction as well as the dif ferences in transportation costs of the oil producers due to their geographic loca tion.
Application of ad valorem fixed rate will lead to the results different from the results obtained with the application of the existing formula for specific severance rate calculation. To preserve the mechanism of tax load progressive dependence on the oil price it is necessary to establish progressive dependence of ad valorem severance rate tax on the Urals price. In this case, on the one hand, tax load in rela tive terms will grow along with oil price, and, on the other hand, the advantages of ad valorem rate will be in effect. For instance, the tax sum will take into account the real price of sales, differences in costs for transportation and in oil quality.
Different approaches can be used to secure progressive ad valorem rate.
First, the progressive dependence of the tax rate on the level of world prices for oil can be determined in the form of a Table, similarly to the existing routine of oil ex port duty determination. Second, in order to do this a certain formula can be used, which determines the progressive dependence of the tax rate from the oil price.
Not only does this approach allows securing the progressive dependence of the severance rate on the oil price, but also to use the advantages of ad valorem rate.
The application of severance ad valorem rate assumes the use of market prices for oil to calculate taxes, the application of ad valorem rate being otherwise RUSSIAN ECONOMY IN trends and outlooks inefficient, as this creates opportunities for tax payers to underdeclare their tax li abilities by selling the oil produced at too low prices. The determination of market prices for oil is, however, connected with a number of serious problems, which are accounted for by the special features of the Russian gas and oil sector and the ab sence of developed market infrastructure. Russian market for crude oil is charac terized by high concentration of oil production and processing within the frame work of vertically integrated oil companies (VIOC), whose share in oil production and processing is more than 90% in the country, by absence of transparence and limited number of participators, most of whom belong to or are connected with VIOC. Transportation limitations make oil market even more incompetitive. As a re sult, transfer (intracorporative) prices, established by VIOC management, prevail at the internal Russian oil market.
At the same time, before the formation of the developed crude oil market, in our opinion, directive prices (prices established by the government), calculated market prices for oil, determined by a special method on the basis of world oil prices and calculated domestic oil prices, can be used in order to calculate taxes.
Calculated domestic oil price for taxation aims is reasonable to determine on the basis of retail trade prices for oil products sales at the domestic market. In contrast to the crude oil market the domestic oil products market is well developed, charac terized by a big number of participants and the number of deals, higher transpar ence, and competitiveness.
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