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Commentary on Proposals of Economic Development Ministry of Russian Federation on Reduction of Transneft’s Profitability Level

Date of publication: 20 July 2020

The Ministry of Economic Development of the Russian Federation (Mineconomrazvitiya of Russia) is the federal executive body responsible for the development of state policies and legal regulation in the field of analysis and forecasting of socioeconomic development. However, the approaches to the tariff regulation of Transneft proposed by the Ministry, such as reduction of Transneft’s profitability level in terms of net profit (according to the consolidated statements), indicate that the ministry has not gained a sufficient understanding of issues related to state regulation of the activities of natural monopolies.

In accordance with Federal Law No.147-FZ On Natural Monopolies dated 17 August 1995, the activities of natural monopoly entities are subject to state regulation, including oil and petroleum products transportation through trunk pipelines.

According to the Register of Natural Monopoly Entities in the Fuel and Energy Sector under Section III, the Transportation of Oil and (or) Petroleum Products via Oil Trunk Pipelines, which was formed by the FAS of Russia, an authorised federal executive body responsible for the adoption of regulatory acts and control over compliance with antimonopoly legislation and legislation in the field of natural monopoly entities’ activities, Transneft and its subsidiaries, as well as dependent companies that transport oil and petroleum products through trunk pipelines, are subject to state regulation.

To determine the profitability, the Ministry of Economic Development of Russia used indicators of the consolidated financial statements of Transneft for 2019. These statements were prepared based on the financial statements of 85 organisations. However, only 18 of them carried out regulated activities in 2019 – “transportation of oil and petroleum products via trunk pipelines” – on the territory of the Russian Federation.

In accordance with Article 2 of the Federal Law On Natural Monopolies, the activities of natural monopoly entities that belong to spheres not related to natural monopolies cannot be regulated this way.

Thus, the approach proposed by the Minister of Economic Development in relation to Transneft contradicts the current legislation.

In addition, it should be taken into account that the FAS of Russia sets long-term/agreed tariffs at the initiative of oil companies on the basis of relevant agreements concluded between Transneft and the said oil companies for the purpose of making capital investments. Essentially, the indicated tariffs are surcharges added to the current tariffs. Their establishment makes it possible for Transneft to finance the creation of technical capabilities needed to satisfy the oil company's need to increase the volume of transportation via the routes in which it is interested, without making other consumers responsible for financing the construction of the corresponding infrastructure. That is, the net profit obtained from the surcharges is targeted in nature, and its use is approved by the regulatory authority.

In this regard, when analysing Transneft’s profitability, one should include performance indicators only for the regulated types without considering income (net profit) received from long-term/agreed tariffs.

Analysis of changes in the profitability (net profit) of Transneft's oil transportation since 2013 (in 2014, a decision was made to freeze tariffs, and from 2015 to 2020, in accordance with Order of the Government of the Russian Federation No. 377-r dated 14 March 2014, tariffs are being restrained according to the Inflation Minus rule) showed that if in 2013 (the base for comparison) it actually amounted to 23.9%, and in 2019 it was only 10%.

Thus, Transneft’s profitability, which is under state regulation in accordance with the Federal Law On Natural Monopolies, in terms of regulated activities is comparable to the profitability of oil companies operating in the market: Gazprom Neft – 15.7%; Lukoil Oil Company – 8.2%, Rosneft Oil Company – 7.5%. Moreover, for the specified period, the net profit margin of such an efficient Russian oil company as Tatneft was 20.6%; for Surgutneftegas, the figure reached 25.7%.

Also, when comparing Transneft’s performance indicators with foreign pipeline companies taken from open sources, one can see that the Company's profitability is lower than the median of the sample.

In this regard, unfounded arguments about the “overestimated” profitability of Transneft and about the “excessive tariff burden on service consumers” have no objective grounds.

It is necessary to pay attention to the fact that, under the existing tariff system, sufficient updating of fixed assets intended for oil transportation is impossible. Reduced tariffs will lead to reduced capital investment financing sources and, accordingly, to accelerated ageing of fixed assets.

Considering the facts listed above, we assess the approach proposed by the Ministry of Economic Development of Russia as contradicting the interests of the state, which is the main shareholder of Transneft, and the statutory goals of the joint-stock company (making profit), as well as fraught with a critical reduction in tariff sources for maintaining the Russian system of oil trunk pipelines in a technically and environmentally safe and reliable condition.

Oil companies, in addition to oil transportation services, use services and purchase products from other industrial sectors, such as construction, manufacture of equipment, machinery, food, electricity, consumer goods, etc. However, the Ministry of Economic Development of Russia considers the "high" profitability of Transneft only, that is, it proposes to increase the economic efficiency of oil companies exclusively by reducing the profitability of the state company.

It should also be remembered that the owners of the Russian oil industry companies are non-residents and individuals, and it is them who will receive the additional profits from the reduced oil transportation tariffs.

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