How petrochemical industry support project can lead to bankruptcy of leading manufacturing companies

Reverse excise tax will provoke unequal conditions

The goal the president of Russia announced in 2018 in his Address to the Federal Assembly is to increase the share of investments to 25% of GDP by 2024. Since petrochemistry plays a significant role in the global economy, exerting a significant influence on key industries, construction and agriculture, the goal is to increase the share of petrochemicals in Russia's gross product by 2030 with a decrease in its import component. It is proposed to stimulate the achievement of the set goals through forming a reverse excise tax on ethane and LPG. The task has turned out to be not easy.

The analysis of the industry as of 2013 showed a significant gap between Russia and the leading countries in terms of production of chemical products, the depth of processing of raw materials, and a significant dependence of the domestic market on imports.

As a result of the need to take corrective measures and determine further measures to overcome this situation, in April 2014, the ministry of industry and trade and the ministry of energy in Russia developed and approved the strategy for the development of the chemical and petrochemical complex of the Russian Federation for the period up to 2030. The strategy was based on targeted installations to increase the depth of hydrocarbon processing in Russia. The goal was set to increase the volumes of petrochemical production in Russia by 2,6 times to the level of 2014, double the share of the chemical complex in the country's GDP and reduce the import component in the Russian petrochemical market by 2030.

However, in 2018, summing up the interim results, the government recognized that the desired indicators and goals had not been achieved in 5 years. It was necessary to re-examine options for correcting the situation and review approaches to increase the volume of processing of ethane and LPG in Russia.

One of the quick and effective measures could be to review the customs policy in terms of increasing export duties on LPG. This would help ensure that more raw materials would remain in Russia for domestic processing into products with higher added value, which would already be exported. In the end, this would benefit the country, the producers of raw materials, and those who process them. Petrochemical enterprises have repeatedly initiated concrete proposals on this issue.

Against the backdrop of a weakening ruble and rising prices for raw materials, the introduction of the reverse excise tax on ethane and LPG for some companies and its absence for others, the processing of LPG becomes unprofitable for independent processors who purchase raw materials on the free market. This may eventually lead to a serious reduction in the production of chemical products and the export of even more raw materials. What does this mean for the regions? A decrease in production and profit of enterprises will result in a significant reduction in tax revenues and the suspension of investment projects. Revenues to regional and municipal budgets will significantly decrease, and social programmes will not be implemented. In the worst case scenario, the situation will lead to the closure of existing production facilities and the loss of jobs.

While industrialists are sounding the alarm, a final decision at the government level has not yet been made. Now the situation looks like this: Russian producers of raw materials have the opportunity to sell LPG for export, which is certainly profitable against the backdrop of a growing dollar; they are implementing their own projects to create new production facilities for processing ethane and LPG; claiming to receive the reverse excise tax on ethane and LPG and setting high prices, they are selling the extracted raw materials to Russian processors who are their competitors in this segment.

This is confirmed by a major project of SIBUR — the construction of the Amur gas chemical facility (Amur GCF). The company's task is to process ethane extracted from gas exported to China. Taking into account plans to introduce the reverse excise tax for ethane processors, SIBUR declared its readiness to even increase the capacity of future production by another 50%. Taking into account the possibility of receiving a reverse excise tax for LPG, SIBUR also considered expanding its recently launched ZapSibNeftekhim megaproject. “The ministry of finance likes the reverse excise tax — let it be the reverse excise tax. I think it is right that both ethane and LPG, which are being processed, should have preferences," said Leonid Mikhelson, SIBUR's largest shareholder, on the sidelines of the World Economic Forum in Davos this January.

The processors that do not have their own raw materials but have been investing in existing production for many years, paying taxes, and are budget-forming in their regions, are waiting for the final decision of the government. As Realnoe Vremya found out, these companies do not ask for benefits and preferences, they advocate the equality of conditions in the market. Companies are waiting for compliance with the current law 'On protection of competition' that guarantees all producers to establish equal internal market conditions.

The conditions set out in the bill may stop production

When at the end of spring 2019, the bill was submitted to the regions and major participants of the Russian chemical market, it immediately became a cause for confusion: the document assumes receiving the reverse excise tax only for those who, starting from 2022, introduce new capacities for processing LPG and ethane. In fact, according to the version of the bill that appeared in the spring of 2019, only new monomer manufacturers could count on state support. Established processors found themselves not only in disadvantageous position against entrants but with almost no chance of survival, and among them, there are largest petrochemical enterprises — Kazanorgsintez and Nizhnekamskneftekhim, part of TAIF Group, Gazprom Neftekhim Salavat, Salavatnefteorgsintez, Stavrolen, which have already invested hundreds of billions of rubles in the production and ready to continue to invest in lengthening the chain of subsequent process stage — the processing of monomers to polymers, and further.

By purchasing LPG and ethane on the free market, the existing petrochemical companies that have not received support in the form of the reverse excise tax will have to respond by lowering prices to maintain their competitiveness in the increased polymer market, which, of course, will immediately affect both the volume of utilization of existing production capacities of plastics, rubbers, etc., and the financial results of companies. It is the existing production facilities that will be put at risk of survival, despite that the bulk of polymer production is concentrated in these companies. In this situation, the plans to double the production of large-capacity polymers by 2025 and to increase exports by seven times are still an open question. Many of the existing ones, including large processors, will be on the verge of bankruptcy.

“On the falling petrochemical market with a small profit margin, the advantage such as reverse excise tax for some and absence for others may cause the situation when existing plants, deprived of support, will be forced to stop," Deputy Director General of Kazanorgsintez PJSC for Economy and Finance Fanis Kalimullin described the most pessimistic forecast. “Under the current configuration of the bill, we, as well as a number of other participants in the Russian petrochemical market, may find ourselves in a disastrous situation, and this may, on the contrary, not stimulate but slow down the development of the industry," he added.

“We've already gone further and are working on the construction of production facilities for processing monomers that create added value, improving and bringing production to the final product: we make plastics from propylene, pipes from plastics. And we were not going to return to increasing the production of monomers without further processing. This should be taken into account when forming the draft law," said Alla Evstafyeva, the deputy director general for economics and finance at Nizhnekamskneftekhim PJSC.

“The estimated amount of losses of TAIF Group in the forecast parameters of the ministry of economic development of Russia will amount to more than 130 billion rubles in just 5 years, and in the future, this amount will only increase, while tax revenues to the republic's budget will be reduced to a minimum. Then the question about the future fate of the petrochemical companies of the republic will arise," Albert Shigabutdinov, the chief development adviser to the director general of TAIF PSC (at that time — director general of TAIF PSC — editor's note), outlined a possible pessimistic scenario at the annual general meeting of shareholders of the parent company TAIF Group in June 2019.

According to TAIF Group's forecasts, in line with the adopted enterprise development strategy, tax payments and social expenditures not related to production activities were expected to grow significantly by 2030. But this is only possible if all the group's investment projects are launched. Whether these plans will remain relevant in the new economic realities is difficult to predict, since much will depend on the final version of the bill.

Some investment projects are becoming impractical when creating unequal market conditions. Even global projects necessary for the country's economy, such as the implementation of the memorandum of strategic cooperation between TAIF Group and German holding Linde AG for the period up to 2025 with a total investment of up to 12 billion euros, can be affected. The document was signed in June 2017 at the St. Petersburg International Economic Forum. The project is so large-scale and important that it had been discussed and approved before signing at the bilateral meeting of the presidents of Russia — Vladimir Putin and of Germany — Walter Steinmeier. Tatarstan President Rustam Minnikhanov and Prime Minister of Bavaria (Germany) Horst Seehofer were present at the signing.

In other words, the very configuration of the draft bill puts a number of already established participants in the petrochemical market, including Kazanorgsintez PJSC and Nizhnekamskneftekhim PJSC, in a deliberately disadvantegous position, which can not push for further development but discourage the activities of the enterprise and its development programmes. This may be beneficial to individual market participants, but definitely not for Tatarstan or the country as a whole. Non-market competition related to support of certain petrochemical industries, potential additional expenses and attempts to cover losses resulting from the debt burden associated with that existing refiners are already implementing new investment projects — this is what enterprises that have already invested money, effort and time in creating capacities that are already operating today will get. It turns out that with fundamentally identical technologies, new companies that invest in the creation of monomer production receive benefits, jeopardizing the effectiveness of projects that have already shown their efficiency and are developing further their capacity for subsequent technological conversions. A reasonable question arises whether the emergence of new projects will cover tax losses and economic risks from the disappearance of existing enterprises.

Preferences for capacities

At first glance, the idea of giving the reverse excise tax to petrochemical companies that process LPG and ethane, subject to the construction of new facilities, fits harmoniously into the complex of solving the tasks set by the president of Russia to accelerate the growth rate of investment in fixed assets and increase their share to 25% of GDP. According to the lawmakers, this mechanism should stimulate businesses to invest more actively in the creation and modernization of gas chemical production facilities. According to the government's forecasts, the successful implementation of the roadmap should lead to an increase in the production of large-capacity polymers to 11,1 million tonnes by 2025, against 5,3 million tonnes in 2019. It is assumed that it will be possible to increase the volume of exports to 4,4 million tonnes by 2025.

In 2019, the ministry of finance and the ministry of energy of the Russian Federation decided on the size of the reverse excise tax on ethane. “For ethane, the principal decision was made — 9,000 rubles per tonne of reverse excise duty. This amount is sufficient to provide a normal economy for the construction of new projects — this adds 3-4 per cent of IRR (internal rate of return) to large standard project. In our opinion, this is made economically attractive and in order for such projects to appear," Pavel Sorokin, the deputy head of the ministry of energy of the Russian Federation, explained in an interview. So far, up to 10-11 million tonnes of ethane, which is contained in gas, is burned annually and in Russia alone.

“The question remains whether we will support existing projects in terms of processing gas raw materials or only new projects. If we support new projects, the existing ones will eventually find themselves in unequal competitive conditions," Aleksey Sazanov (the director of the department of tax and customs policy until 2020, and currently state secretary-deputy minister of finance of the Russian Federation — editor's note) admitted in October 2019. But at the same time, he noted that “support for all projects will lead to tens of billions of lost budget revenues”.

However, if we look at it from the other side, the budget will compensate for the invested funds from additional tax deductions by launching new processing capacities for ethane and LPG and improving the efficiency of existing production facilities.

“The decision to introduce reverse excise tax on ethane and LPG was made in order to stimulate the processing of this raw material in the country and create more attractive conditions for launching new projects. The relevant draft bill is currently being developed, it is premature to talk about its specific parameters," Sazanov explained in response to the request from Realnoe Vremya. At the same time, he expressed confidence that “the adoption of the bill will increase the competitiveness of oil and gas chemistry. With a large raw material potential that Russia has, the share of ethane and LPG that is processed now is insignificant, due to the lack of processing facilities. The proposed state support measures will provide an impetus for the construction of new facilities for processing this raw material in Russia.”

To make the draft law really useful for the development of the petrochemical industry, the government, having heard the current participants of the petrochemical market, revised the text of the bill so that not only newly built production facilities but also existing enterprises could receive the reverse excise tax.

However, an additional condition was introduced — they need to invest at least 65 billion rubles in new production capacities for processing ethane by the end of 2026 and another 65 billion rubles by the end of 2027 in new capacities for processing LPG. Only by fulfilling the condition for investments totalling 130 billion rubles, despite the previously made investments in the development of petrochemicals, the enterprises will be able to claim the right to receive the reverse excise tax on LPG and ethane, in the part that existing production facilities process at already existing facilities.

Solution found?

The discussion of the draft law on reverse excise continued all last year. Some of the proposals formulated by the current gas processors to adjust the bill were recognized as justified. However, the search for a way out of the situation was delayed.

It was planned to return to the detailed elaboration of nuances after the New year holidays, but the previous government resigned before making a final decision on the issues discussed and laying them down in the bill. The petrochemical industry is once again waiting to see whether their proposals will be remembered, whether there will be any new solutions, or whether the bill will remain in the same version, and existing independent petrochemical companies will again find themselves at a severe disadvantage.

Just recently, the ministry of finance has come up with a new proposal. On March 23, 2020, the agency announced a new option for providing the reverse excise tax on liquefied petroleum gases (LPG) — without introducing MET for associated petroleum gas (APG), which was supposed to partially compensate for falling budget revenues. The ministry of finance announced a decision to establish a permanent rate of reverse excise tax on LPG in the amount of 4,500 rubles a tonne. While previously it was assumed to gradually increase the amount of negative excise tax: from 2023 in the amount of 4,500 rubles, from 2024 — 5,500, from 2025 — 6,500, from 2026 — 7,500 rubles.

In anticipation of the decision on the final configuration of the bill, it remains only to hope that the government will support Russian producers using the same approach to application of reverse excise duty on the processed ethane and LPG, contributing to the objectives of development of the petrochemical complex in Russia as a whole, not individual businesses, avoiding a one-sided decisions that destabilize the situation in the industry and leading to irreparable losses.