Russian refining: part one

The past year has brought additional political and economic turmoil to Russia. The ongoing Ukrainian crisis motivated a number of countries to apply sanctions against certain businesses and individuals in Russia and the Ukraine, and Russia responded with sanctions of its own. The Russian Ruble slid from exchange rates of approximately US$0.029/RUB in the summer of 2014 to lows in the range of US$0.014 - 0.016/RUB in late 2014 and early 2015, and they are approximately US$0.018/RUB at the time of writing. The Ruble closely tracks international oil prices; therefore, in addition to the international sanctions, confidence in the Russian economy is also being undermined by the weakness of oil prices.

Many economists estimate that, all things considered, oil and gas account for over one half of Russian government income. Although there have been market based reforms and privatisation, the government has stepped back from this course and become more heavily involved in managing the industry. One example is the recent seizure of mid sized oil company Bashneft, which is discussed further in the company section below. Russia's crude export revenues have been reduced by the collapse in international oil prices, and a number of changes are being made in taxation affecting the oil industry, which the government hopes will increase revenues.

The fall in oil prices and the continuing lack of OPEC unity has created an intense focus on events in the Russian oil sector, because it is believed that if Russia increases production and exports, it could flood the market and weaken prices even further. Russia has immense reserves, and production has been held reasonably steady. Across the Atlantic Ocean, oil production in the US has surged, while demand has continued to fall. Oil demand is falling in much of Europe as well. Even though demand continues to grow in Asia, the Middle East, Latin America and Africa, this demand increase has not offset the supply increase. These events have conspired to cut into the call on OPEC oil, a drop of approximately 1.5 million bpd over the past three years. OPEC leaders have been unwilling to rein in production in order to support a price recovery when the end result could merely be to tempt additional production in the US and Russia. A push by Russia to increase oil exports to boost revenue could swiftly shut in additional OPEC oil, given its proximity to the major markets of Europe and its increasingly long reach into Asia. Events in Russia are closely watched by OPEC. Indeed, in September 2014, OPEC held its third high level energy dialogue meeting with Russia, and a fourth such meeting is scheduled for 2015. This article discusses developments in Russia's refining industry and how it is being reshaped by market and regulatory changes, and how tax policies are encouraging exports of both crude and crude products.

Common themes in the structure of Russia's refining companies

Russia's oil companies were wrenched by the dissolution of the Soviet Union. Oil production in the now Former Soviet Union (FSU) region collapsed from approximately 12.6 million bpd in 1987 to less than 7.2 million bpd in 1996, a drop of approximately 5.5 million bpd. During that decade, FSU oil demand fell from approximately 8.46 million bpd in 1987 to 3.84 million bpd in 1997, a drop of 4.6 million bpd. The industry was inefficient, and infrastructure was in sad shape. It took years to institute the reforms needed to make Russian companies competitive in the international market. But Russia did recover and has become a powerhouse in the global oil market once again.

Some common themes emerged as Russian refining companies were reformed. First, most adopted some form of vertical integration. There was a great deal of shuffling and reorganisation as companies strove to improve efficiency all along the supply chain: crude oil exploration and production, crude storage, pipelining and other transport to domestic and foreign markets, refining, product movement, and retail marketing.

Second, majority ownership and control of the oil companies remained with the government, but there was an increased interest in and need for private sector investment and foreign participation. Companies had operated under a centrally planned economy for so long, however, that some of this culture remained, even after privatisation. Most recently, in fact, the central government has seemed more keen to return to direct ownership and management of the oil industry, and it has backed away from privatisation.

Third, the oil industry has been encouraged to expand export activity. Public policy regarding product quality specifications, taxation, and international relations are strongly influencing the volumes and patterns of trade. The recent relaxation of the export duty on refined products offers an example, since it made product exports more economically attractive than crude exports. Russian companies immediately reduced their exports of crude, raised refinery runs, and boosted product exports.

Fourth, and related to the point above, the refining industry has been required to expand and modernise in order to meet tighter petroleum product standards, both for domestic markets and to make Russian exports comply with European specifications. Every major refining company has worked to improve product quality, and many have exceeded expectations and moved to Euro standard fuels well ahead of schedule. The excise tax structure has encouraged this switch. For example, in 2013, the excise tax rates for Euro 5 gasoline were reduced by 8.8%, while the excise tax rates for Euro 4, Euro 3 and lower grades of gasoline were raised by approximately 27% to 28%. In 2014 the excise tax on Euro 4 gasoline was RUB9916/t, while the excise tax on Euro 5 gasoline was RUB6450/t.

As Russia's oil industry has grown and adapted, essentially all of the companies have restructured, entered into joint ventures, acquired new holdings, or merged with other companies. Many have forged stronger international ties as well, with some companies participating in refinery projects abroad. The low oil prices, weaker Ruble, and current sanctions, however, are impeding the ability of Russian oil companies to raise capital, which is making it difficult to pay for the current round of investments, not to mention any future investment phases.

Read part two of this article here.

Written by Nancy Yamaguchi, Contributing Editor. This is an abridged article taken from the August 2015 issue of Hydrocarbon Engineering.

Read the article online at: https://www.hydrocarbonengineering.com/special-reports/31072015/russian-refining-part-one-1209/