Energy Sector: End of the oil and gas rent era

Summary

In 2016, the situation in the Belarusian oil-processing sector proved to be more difficult than in 2015, mostly due to the conflict over the price of Russian natural gas, which caused Russia to reduce its crude oil supplies to Belarus. In value terms, too, the year was one of the hardest ever for the Belarusian oil sector. On top of that, the drop in natural gas prices for Europe affected the amount of the gas subsidy enjoyed by Belarus, and at the end of the year, Russia increased its natural gas fees for Belarus.

The oil and gas conflict was not resolved in the first quarter of 2017. The very fact that the conflict has remained for so long is a factor that impacts the prospects of cooperation between Belarus and Russia in the oil and gas sector.

Trends:

• Significant deterioration of the terms of oil processing resulting from a drop in global prices of oil products and reduction in the volume of crude oil supplies from Russia;
• Reduced comparative advantages of Belarusian companies based upon energy costs;
• Increase in natural gas prices;
• Inconsistent energy tariff policy;
• Liquidation of cross subsidies by the original deadline of 2020 is even less likely.1

Oil and gas

Gas and oil talks with Russia were traditionally conducted separately. Furthermore, in the Russian administration, supplies of crude oil and gas are in fact supervised by various “Kremlin towers”: energy supplies are run by various groups and economic entities. However, the year 2016 put Belarus in a unique situation, when oil and gas delivery terms appeared to be interconnected. In 2016, Belarus imported 18.1 million tons of crude oil, down by 20.8% from 2015, when 22.8 million tons were imported. The average import price of crude oil amounted to USD 218.7 per ton, down by 13% from 2015 (USD 247.3 per ton). Natural gas import edged down by 0.8% to 18.6 billion cubic meters from 18.95 billion cubic meters. The average natural gas price went down by 5.4% year-on-year to USD 137 per 1,000 cubic meters from USD 145 in 2015.

The significant reduction in Russian crude deliveries was due to the new energy conflict between Russia and Belarus. The reason behind the conflict was the decline in global oil prices and resulting decrease in natural gas rates for European consumers of Russian gas, which is pegged to the oil price. For Belarus, the Russian natural gas price is calculated based upon a separate formula: the fee for the Yamalo-Nenets Autonomous District of Russia plus transportation costs. As a result, the gas price for Belarus did not decrease. At the same time, the natural gas price for European consumers markedly dropped, almost to the level of fees paid by Belarus. The Belarusian economy thus de facto lost the “gas subsidy”, which had been formed for years by the considerable difference between the prices paid by European buyers and Belarusian consumers (although Belarus still enjoys prices that are lower than the average for the CIS and the Baltic States).

The difference in gas fees is crucial for Belarus to preserve the competitive advantages of its economy, whereas any reduction in the price was considered by the Belarusian authorities as a painless means to do away with cross subsidies, the instrument that would make it possible to cut cross subsidies while keeping energy rates for the population low. Furthermore, in the long term, further reduction in natural gas fees was required by Belarus in the context of the looming common energy market of the Eurasian Economic Union (EEU), which would allow importing electricity from Belarus at attractive rates.

In early 2016, the attempts to agree lower Russian gas prices for Belarus, including at the level of vice-premiers of both countries, were unsuccessful. The Belarusian side insisted on reducing the natural gas price to at least USD 117 per 1,000 cubic meters. Since the start of 2016, Belarus had paid USD 73 per 1,000 cubic meters, citing the equal-profit prices pattern. As a result, the country began to accumulate significant debts, which by October 2016 had exceeded USD 300 million (and amounted to USD 500 million at the end of the year). In response Russia cut crude oil deliveries to Belarus in the third and fourth quarters of the year by a total of 5 million tons.

In October 2016, the Belarusian authorities announced an unscheduled increase in rates (by 50%) on oil transit by the oil mains OAO Gomeltransneft Druzhba and Polotsktransneft Druzhba from Russia to other European countries. The increase was a unilateral move that was made without any consultations and in violation of existing intergovernmental agreements. Later, the decision to raise tariffs was canceled, and instead the Russian side undertook to restore the volume of crude oil supplies to Belarus on condition the country repaid its natural gas debt. The debt was not repaid, though, and crude deliveries were reduced in the third and fourth quarters of the year. As a result of negotiations, the price of natural gas supplies to Belarus in 2017 increased by a bit more than 1% to USD 141.1 per 1,000 cubic meters.

The reduction in Russian crude oil supplies affected the Belarusian export of refined oil, which went down by 22.7% to 13 million tons, at an average price of USD 311 per ton. Therefore, 2016 became the least profitable year in the history of Belarus’s oil processing (Table 1). The main contributors to the situation were the decline in the volume of processing and drop in global oil prices, as well as decreasing world oil prices and cheapening oil products in international markets.

Export of oil products to countries beyond the CIS suffered the most: the decline was reported at 33.5%, whereas export to the CIS increased by 8.4% year-on-year. At the same time, supplies to the CIS turned out to be more profitable on a per ton basis: USD 402 vs. 260.

According to Prime Minister of Belarus Andrej Kabiakoŭ, in 2016, the country’s direct and indirect losses caused by the drop in crude supplies amounted to 0.3% of GDP.

Therefore, by the end of 2016, Belarus had found itself in a tough situation in the wake of the reduced Russian oil and gas subsidy. Amid the continuing crisis and deteriorating terms of trade with foreign partners, Belarus needed the subsidy to expand, in order to be able to enjoy the same amount of budget revenues as it had in previous years. Furthermore, the country requires the oil and gas subsidy to grow in the medium term to have a competitive edge in the prospective single energy market of the EEU, as well as to keep low electricity rates for households.

However, Russia is unable to keep the same amount of subsidy, mostly because of the ongoing crisis in its own economy. The typical “bargaining” methods to have Russia keep its subsidy for Belarus, such as new trade and economic barriers and use of foreign policy mechanisms appear to be fruitless, the more so because the oil and gas conflict of 2016 has already caused serious losses for the country’s economy.

In this situation, benefits will be limited for Belarus, if there are any benefits in store for Minsk at all. There will only be positive results for Belarus if both countries seriously reformat their relationship within the EEU, or, possibly, if Belarus becomes more dependent on Russia, both politically and economically.

Electricity and tariff policy

Although Belarus had planned to cut electricity import by 10.7% in 2016, its purchases of electricity (traditionally from Russia) increased by 13%, to 3.2 billion kWh from the expected 2.5 billion kWh. State policy on energy rates remains highly uncertain, and there is no clear and understandable vision of further activities.

To comply with the IMF requirements, the authorities markedly increased utility fees in 2016. Starting 1 January 2016, many rates were increased by 20%, according to a resolution by the Council of Ministers, including electricity and natural gas rates. The sharp increase in tariffs, as well as difficulties in calculating the amounts of payments dissatisfied the population, which caused the president to sign decree No. 107 “Concerning payments for utility services provided to households, ” which reduced certain tariffs.

Nevertheless, electricity fees for households increased by 20% due to the inclusion of VAT in electricity costs (previously the VAT component was subsidized from the state budget). The base rate increased to BYR 1,188 from BYR 990.

According to officials, even though the rates were increased, Belarusians were paying only about 70% of electricity costs. Therefore, the elimination of cross subsidies, which had been scheduled to take place in 2017, did not become a reality. In March 2016, it was de jure postponed until 2020 by resolution No. 169 of the Council of Ministers. Previously, the period of 2017–2018 was repeatedly mentioned as the deadline for doing away with cross subsidies; however, this time, according to the state plan for the development of the electrical energy complex (which forms the basis of resolution No. 169), cross subsidies will be eliminated as soon as Belarus launches its nuclear power plant.

There are doubts that Belarus will be able to deal with cross subsidies by 2020, because the development plan for the sector mentions the “supposed increase in personal incomes” as a reason to remove cross subsidies. However, according to preliminary data by BelStat,3 in 2016, personal incomes went down by 7.3% in real terms year-on-year. Overall, real incomes have been falling since 2014; however, in order to do away with cross subsidies, the state will have to almost double electricity fees.

Compare, for example: in the first half of 2016, private households in Lithuania paid EUR 0.094 per kWh (industrial consumers paid EUR 0.123); Estonian households and industrial companies paid EUR 0.088 and EUR 0.123, respectively; Latvian consumers paid EUR 0.117 and EUR 0.163, respectively; and Polish buyers paid EUR 0.081 and EUR 0.133.4 For its part, the basic rate for Belarus was at EUR 0.0507 per kWh, and industrial consumers paid EUR 0.123. The gap between the rates applicable to private and industrial consumers in Belarus is more significant than that in Europe.

Given the ongoing decline in personal incomes, the Belarusian authorities see the room for maneuver in reforming their energy policy, especially on energy tariffs, narrow. Households will obviously oppose the liquidation of cross subsidies, which is needed to bring down the financial burden of the state. Nevertheless, in years to come, even more resolute and better weighted decisions will be required to put in place reforms in energy tariffs.

Conclusion

The year 2016 saw profits of the Belarusian oil-processing sector plummet. However, whereas previously profits were only affected by global oil prices, last year, Minsk was involved in a new energy conflict with Russia, which resulted in a decrease in the volume of oil deliveries to Belarus. The conflict became the most protracted one in the history of the bilateral relationship and continued in 2017.

A peculiarity of the current situation is the fact that the terms of trade that Belarus insists on are required to not only receive profits “here and now,” but also have preventive measures in place to change rules of the game in the common market for electricity of the Eurasian Economic Union. Furthermore, changes in the terms of supply of energy from Russia are extremely important for preserving “social” electricity rates for households amid the crisis, and – potentially – maintaining the internal sociopolitical stability.

Another major issue is that Russia, affected by its own economic crisis, has developed resistibility to the “typical” leverage normally employed by Belarus in trade wars, and is not ready to make concessions. In 2017, Belarus found itself in a highly uncertain situation concerning the work of the energy sector. One way or another, for Belarus, the era of the oil and gas rent seems to be coming to an end, which opens the “escape exit” for the Belarusian authorities, envisaging reforms in the energy sector.