Growing dependency on oil — The Bell — En

Good morning! This week, our top story is about what was just released financial data reveals Russia’s growing dependence on oil, as well as a collapse in VAT receipts and how China is coming to the rescue of Moscow. We also look at the new owner of McDonald’s in Russia after the American fast food chain decided to leave the country.

Data Reveals Collapsed VAT, Oil Dependence and Rising Military Spending

It is not easy to assess the effect of the “special military operation” in Ukraine on the Russian economy. But one thing is clear: Russia is more dependent than ever on oil export revenues. This was clearly visible in the April budget figures: oil and gas revenues rose, while everything else fell sharply. Judging by the latest data on Chinese purchases of Russian oil, this is a trend that should continue – but there are limits to the rewards of Russia’s much-vaunted “pivot to the East”.

What is happening?

Budget data from the Department of Finance (April statistics have been published May 17) offer a window into how the Russian economy has been affected by the fighting in Ukraine:

  • Revenue from non-oil and gas sources (VAT, personal income tax, etc.) in April fell 18% year-on-year to 1.01 trillion rubles ($17 billion)
  • Oil and gas export earnings, however, continued to rise despite Western sanctions. Amid high oil prices, oil and gas revenues rose to 1.8 trillion rubles in April, from 1.2 trillion the previous month.
  • Russia is increasingly financially dependent on energy export revenues. Compared to April 2021, the share of oil and gas in state revenue has doubled. The share was 63% in April and 48% for the first four months of 2022. Last year, the share was equivalent to 36% of Russian income, and in 2020 it was 28%, according to the Kommersant newspaper.
  • However, even record oil profits could not keep the budget in surplus. The budget saw its first monthly deficit of 2022 in April – 262.3 billion rubles. Finance Minister Anton Siluanov has valued there will be a deficit of 1,600 billion rubles this year.

VAT collapse

One of the most salient details in the finance ministry’s figures (apart from the rise in military spending) is the collapse in VAT receipts. With the tax on mining extraction, it is one of the two major tax contributors to Russia’s coffers, accounting for about a third of total revenue.

In April 2022, domestic VAT raised only 192 billion rubles, less than half of the equivalent figure in April 2021. VAT charges on imported goods in April 2022 fell by around a third.

The payment of domestic VAT was impacted by the contraction in purchasing power that began in March and the massive exodus of foreign companies. “In April, revenues for the overwhelming majority of businesses in Russia took a hit. This has not only affected those who ceased their activities in Russia, but also those who continued to work but lost customers and profits,” said Andrei Grachev, head of tax practice at Birch Legal.

The drop in VAT charges on imported goods is due to a combination of lower imports and the strengthening ruble, a finance ministry representative told The Bell.

Last week The Economist compiled trade statistics for Russia and eight of its main trading partners (largest EU countries, China, Japan, USA and South Korea). These represent almost 60% of Russian imports and more than 40% of its exports. The data showed that the value of Russian imports fell by 44%, while exports increased by 8%.

Rise in military spending

Spending on “national defence” rose nearly 130% last month to $630 billion. This includes the cost of armed forces, mobilization, training, nuclear weapons and more. In April, Russia was spending 21 billion rubles a day on its military needs.

However, Russia’s true military spending is still higher than official figures because it does not include funding for “peaceful items” like vehicles and defense industry subsidies.

China will help – at a price

Russia’s growing reliance on energy export revenues looks even more precarious as the European Union moves toward an embargo on Russian oil. If the EU finally reaches an agreement on an embargo, Russia will become increasingly dependent on Chinese buyers – who fully understand the situation and already dictate the terms.

Since the start of the fighting in Ukraine, major Chinese companies have been careful on the purchase of Russian oil, preferring not to sign new contracts. All the growth in Russian sales to China has come from small Chinese oil refineries, not large state-owned enterprises. But this week has brought several indications that China is increasing its purchases of Russian oil.

  • Reuters last week written about “Silent” but record increase in Russian oil sales to Chinese companies. China is expected to import an average of 1.1 million barrels per day of Russian maritime oil in May (up from 750,000 barrels per day in April and a daily average of 800,000 through 2021).
  • The main customers are not small refineries but large Chinese state companies – Unipec and Zhenhua Oil, a unit of Chinese defense conglomerate Norinco.
  • Chinese imports started to rise in April, Bloomberg reported. And China is not only interested in oil. According to Chinese customs statistics, the month of April saw Russian oil, LPG and coal purchases increase by 75% to $6.4 billion.
  • China is also considering buying cheap Russian oil for its strategic reserves, according to at Bloomberg. Officials are apparently discussing this issue – with little involvement from the oil companies. China does not disclose the size of its reserves, but Bloomberg estimated it has room for around 60 million barrels.

However, Chinese companies may not be willing to risk secondary sanctions from the United States indefinitely. And, even now, Russia is forced into big discounts. According to Reuters, “Chinese” spot prices for a barrel of Urals crude are currently below $70 – significantly cheaper than the price at which Russian oil is sold in Europe.

Why the world should care

Even if the EU oil embargo never happens, it is clear that Europe is considering moving away from Russian oil. And that means Russia is in a tricky position: dependent on oil and gas revenues from a single customer who doesn’t hesitate to exploit its position.

A new owner for Russian McDonald’s

The new owner of McDonald’s – after the American fast-food company left the Russian market amid the “special military operation” – is a Siberian businessman, Alexander Govor. A former co-owner of coal mining company Yuzhkuzbassugol, Govor was forced to sell in the mid-2000s after two accidents killed 148 miners. Now Govor owns an oil refinery in his native Kemerovo region and his son, who worked for his father’s other companies for many years, is a deputy in the local parliament from the ruling United Russia party.

  • McDonald’s announced its exit from Russia on Monday, confirming speculation that it will sell its 850 restaurants (which employ 62,000 people).
  • Four days later, McDonald’s mentioned that its Russian restaurants would be bought by GiD de Govor. The company already has experience operating the McDonald’s franchise (as of March 2022 it was Operating 25 McDonald’s branches in the Siberian cities of Novosibirsk, Berdsk, Tomsk, Kemerovo, Barnaul and Krasnogorsk).
  • Govor, 61, was born in the southwestern Siberian city of Novokuznetsk. He started as a miner and in 1997 rose to the position of general manager of one of the largest local mines (operated by the state mining company Kuznetsugol). In 2000, Govor and two other managers transferred their shares to a new company, Yuzhkuzbassugol, in a murky deal typical of Russian business at that time. The state corporation was declared bankrupt, and 50% of the shares of the new company went to the administrators of Kuznetsugol (director Vladimir Lavrik, Govor and banker Yuri Kushnerov). Another 50% stake was acquired by major metals holding company Evraz, of which billionaire Roman Abramovich later became a majority shareholder.
  • In the mid-200s, Evraz began talks with Lavrik, Kushnerov and Govor to buy their stake, but they failed to reach an agreement. Then, in the spring of 2007, two serious accidents happened in the Yuzhkuzbassugol mines. On March 19, a methane explosion killed 110 people at the Ulyanovskaya mine, then, on May 24, 38 people died at the Yubileynaya mine. At Ulyanovskaya, the mine manager and several senior managers were found guilty security breaches.
  • After the explosions, the veteran governor of the Kemerovo region, Aman Tuleyev, announcement he would insist on a change of ownership. On the same day, Evraz said he would buy out the 50% stake held by Lavrik, Govor and Kushnerov. The deal valued the partners’ shares at $871 million.
  • Families of miners killed at Ulyanovskaya received 1 million rubles in compensation. But parents later complained that they had only received 800,000 rubles and that the remaining money had been deducted to buy “Italian coffins”.
  • Govor invested his payment in petrochemicals: together with Kushnerov he created Neftekhim served, which built a refinery in the Kemerovo region. In 2021, Neftekhimservis generated revenues of over $1.3 billion. He also owns the Park Inn by Radisson hotel and the Grand Medica chain of private clinics in Novokuznetsk.
  • the governor’s son, Roman, work at the Yubileynaya mine then held various positions in his father’s enterprises. In 2018 he was elected deputy of the Kemerovo Legislative Assembly for United Russia. At the beginning of March, Govor Jnr published a video in support of ‘Military Special Operation’ on Instagram, along with the comment: ‘We’ve been putting up with it for too long…I’m calling on all of us to come together and get through this tough time! We have lived under sanctions for so long and we will continue to survive!
  • Govor senior also has ties to United Russia. In 2007, he and Sergei Neverov, then a parliamentary deputy from United Russia and later secretary of the general council of the party, created a charitable fund in favor of mountaineering. In 2006, Govor and Neverov were part of a group of 16 climbers from the Kemerovo region to travel to Tanzania plant the region’s flag and leave a piece of coal at the top of Mount Kilimanjaro.