The Commodity Investor Q&A
With Matt Badiali
April 16, 2008
Q: Why is Russian oil so much cheaper than China's? – R.B.
A: There are two answers to your question...
First, let's compare the big Russian oil companies with the big Chinese oil companies.
|
Company |
Price to Earnings |
Price to Reserves |
Russians |
Lukoil |
7.58 |
$4.62 |
Gazprom |
11.94 |
$1.58 |
Rosneft |
18.70 |
$7.40 |
Chinese |
PetroChina |
10.93 |
$18.44 |
China Petro & Chem |
9.48 |
$28.69 |
CNOOC |
17.26 |
$29.93 |
|
Both sets of companies have roughly similar price-to-earnings ratios. But as you can see, the Russians are cheap by price to reserves, which implies a market discount...
The reason for the discrepancy is taxes. In 2005, the Russian government levied a mineral extraction tax (MET) in addition to export duties on oil and refined products.
Ural Blend is the benchmark for Russian oil... like West Texas Intermediate is for the U.S. The MET is zero when Ural Blend crude is $9 per barrel or less. The tax is 22¢ on every dollar above that. In March, when Ural Blend sold for $100, the tax was $20 per barrel.
The export duty is also based on the price of the Ural Blend, beginning at $15 per barrel and rising from there. Both the MET and the export duty are in addition to a 24% income tax. That leaves Russian oil companies with about a 10% profit from oil production.
Investors hate to see capped profits. And Chinese oil companies don't face taxes anywhere near that high. So that's the first answer to your question. The second answer is much more sinister...
In the 1990s, Yukos emerged from Russia's wave of privatization as a wholly formed oil juggernaut. At one point, the company produced nearly 2% of the world's total oil.
But Yukos CEO Mikhail Khodorkovsky made an enemy of Russia's president, Vladimir Putin. And in 2003, he was arrested for tax evasion. The following year, the government accused Yukos of owing $7 billion in back taxes as well.
So the Russian government gutted the company and sold its main asset, Yuganskneftegaz. The auction was a farce. Only one company bid, and it was a shell for a group of Kremlin insiders.
The group bought Yuganskneftegaz for 83¢ a barrel of proven reserves. The complex produced 1 million barrels of oil per day... With an oil price of $50 per barrel, the owners made back their $9.7 billion investment in just seven months of production.
In other words, Putin systematically dismembered of one of Russian's largest public oil companies... which explains why the current crop of Russian oil companies are selling so cheap. Few investors will chance a repeat performance.
But as I've written before, nationalization is the biggest trend in oil. National oil companies (both public and private) are the gatekeepers to 75% of the world's oil reserves. In that context, investors shouldn't necessarily dismiss Russian and Chinese oil companies...
That said, now's not the time to buy. Chinese oil companies' shares peaked in October 2007 and are beginning to fall rapidly back. But if some proposed tax cuts come through, the Russians' time could be coming.
Good investing,
Matt Badiali
