Russia's oil refineries likely to maintain rates despite subsidy cut

Russian oil refineries are not expected to lower their crude processing rates despite the imminent slash of compensation under the damping mechanism from September.

The recently approved amendment to the Tax Code, which will see the halving of compensation from Sept. 1 until the end of 2026, however will put pressure on business profitability, according to Russia-based sources.

"A slump in damping payments will have a negative impact on the Russian oil refineries' marginality," Tamara Kandelaki, Chairman of the Committee on Economics at the Oil Refiners and Petrochemical Association, told S&P Global Commodity Insights.

But Russian crude processing rates are not directly correlated with marginality, Kandelaki noted, adding that refining capacities will be used according to supply and demand balance.

"No country can fully replace Russian oil and oil products on the world market. It is possible to change the geography of deliveries, but only to a certain extent," Kandelaki said.

Under the damping mechanism, originally introduced in Russia in 2019, the budget partly offsets the difference between higher export prices and indicative domestic prices for gasoline and diesel in order to secure stable supply of the domestic market.

In 2022, the federal budget spent Rb2.17 trillion ($31 billion) on payments, raising the average profitability of crude oil refining by $15/b, according to finance ministry data.

Move postponed to autumn

The Russian finance ministry has estimated that slashing the payments could save Rb30 billion per month for the federal budget. When the idea was flagged earlier this summer, some officials with Russian oil companies indicated that refineries could reduce their processing rates. In June, Gazprom Neft CEO Alexander Dyukov was quoted by local media as saying that the planned amendments would hit refining margins and result in reduced processing and will also refineries' potential to invest in upgrades.

"Undoubtedly, the slump in payments under the damping mechanism is painful, but oil refineries will think twice before deciding to upset authorities by lowering the processing rates," Stanislav Mitrakhovich, a senior analyst at Russia's National Energy Security Fund and a researcher at the Russian government's Financial University told S&P Global.

Russian refineries, the majority of which belong to state-owned companies, are also expected to accommodate the crude that is falling out of exports as part of Russia's pledge under OPEC+.

Meanwhile, in order to mitigate the negative impact of the lower subsidy, the Russian government has abandoned the idea of bringing back the obligatory sale by exporting companies of their foreign currency revenues, Mitrakhovich said.

Furthermore refineries will continue to benefit from the excise refund for each metric ton of processed crude and of firm domestic spot prices of oil products, according to Russia-based market sources.

Domestic shortages

However, by cutting the compensation, which was making domestic sales more attractive than exports, the government could have played a role in the shortages that plagued the domestic market this summer.

The earlier plan to enforce the damping mechanism changes from July was postponed in order to safeguard products' availability during the high-demand summer season. Nonetheless the ensuing price rises and shortages inside Russia were partly attributed to the planned lower compensation.

In addition, market sources have seen them as a factor in diverting Belarus diesel from the Russian market.

A lack of Belarus diesel since early August helped push up diesel prices on the St. Petersburg exchange, according to market sources.

However Mitrakhovich dismissed the impact of the damping mechanism on Belarus volumes, noting that landlocked Belarus has limited export outlets, especially in the context of infrastructure constraints.

Weaker ruble

Meanwhile, the weaker ruble has benefited refiners as it has increased the value of their exports.

"We are accustomed to ruble fluctuations -- for export, it is profitable, for domestic, it is not very good, but 'plus by minus' gives a plus," Kandelaki said.

The Russian currency has weakened by 26% this year as a result of a collapse in export revenues and growing budget spending.

The weaker ruble in the short run benefits oil products exports, Mitrakhovich added. However in the long run the weaker ruble can be a disadvantage for refiners as they still depend to an extent on Western technology.

Author Elza Turner, Vladislav Vorotnikov

By Spglobal.com, 09/07/2023