Russian oil and gas firms have historically focused on production of natural gas rather than crude oil because of the differential taxes applicable on the two products. As a result, gas production has made up a larger chunk of the Russian oil and gas firm’s revenues as they concentrate on more lucrative gas production.

Russia

Tax on mineral resource extraction

At the federal level, a tax on mineral resource extraction (MRET) is applied on all oil and gas companies. However, the tax for oil is set based on the world market prices and a depletion factor specific to each oil field. On the other hand, the tax on natural gas is set at a fixed rate per unit volume. This means that while the tax on oil production is based on revenue numbers in currency terms, the tax on gas production is based on physical volume produced. In a world where oil prices are highly uncertain and have jumped exponentially in the past, the MRET has presented a disadvantage for oil production in favor of gas production.

Gazprom OAO (MCX:GAZP) (OTCMKTS:OGZPY) (FRA:GAZ), the leading Russian oil and gas firm had only 9.99 percent of its production in 2012 in crude oil while the remaining came from gas. By March 2013, this portion had reduced even further to 6.73 percent.

Figure 1: Gas production as a percentage of total production 

Source: Company filings
Source: Company filings

Russia’s gas production

‘With Gazprom OAO (MCX:GAZP) (OTCMKTS:OGZPY) (FRA:GAZ) leading Russian gas production, the country’s other integrated companies focus their extraction activities on oil. They use the gas they produce alongside the oil for their own energy needs. Other European companies prefer to minimize risk, maintaining a balanced oil-gas production profile,’ analyzes Philipp Chladek.

Rosneft has recently increased its focus on gas even further via the acquisition of TN-K Energy Group Inc (OTCMKTS:TNKY) from BP plc (ADR) (NYSE:BP) (LON:BP). Through this acquisition and by capitalizing its assets, Rosneft plans to increase its annual production of natural gas, bringing it up to 100 billion cubic meters by 2020.

Figure 2: Russian gas production and percentage of gas production in Russia for major producers

Source: Bloomberg
Source: Bloomberg

Advantage of a longer oil reserve life

A gas-oriented production system also means that companies like Gazprom OAO (MCX:GAZP) (OTCMKTS:OGZPY) (FRA:GAZ) have the advantage of a longer oil reserve life. As they continue to extract the gas reserves from newly discovered fields and leave the crude oil in these wells untouched, their asset values increase. Gazprom has an oil reserve life of over 45 years, which is extremely beneficial for the firm.

The worth of these oil reserves is often kept in store for decades. The firms can then reap their oil reserves once they run low on natural gas. Furthermore, the presence of these reserves on the company balance sheets means strong risk ratings for the company and better negotiating power for reserve swap deals.

Monopoly in Russia’s oil and gas market

Competitors of Gazprom OAO (MCX:GAZP) (OTCMKTS:OGZPY) (FRA:GAZ) recognize the monopoly that the firm has established in the Russian market. They continue to request an equal taxation regime for oil and gas products to be able to better compete with the gas giant.

A tax break has been offered recently in the form of a decrease in export duties on crude oil, but increases in MRET sets it off. Russia might be funding its federal budget via the oil revenues, but it needs to create a better competitive atmosphere to retain the European integrated oil companies’ investment. Drastic changes to the oil regime are needed to increase the crude oil production of the country and to reap the values of accumulated oil reserves.