Bulgarian refinery Lukoil Neftohim Burgas, owned by the Russian giant Lukoil, has finally promised to pay taxes in Bulgaria from next year on. However, this is contingent on the Bulgarian state breaking with Brussels on certain key issues, and upholding the enterprise's huge profits.
Notwithstanding the short-term benefit of Lukoil paying 700 million extra in taxes, several weighty questions remain regarding the future of energy. How will Brussels look on Bulgaria continuing to export Russian oil products? Are European sanctions going to stop the import of Russian oil? Is Bulgaria actually going to get paid by Lukoil? What will happen to the market held almost entirely by the Russian oil company?
Lukoil can no longer bypass tax loopholes
From January 1, 2023, the Russian enterprise promises to transfer its entire economic activity to Bulgaria. This means it will no longer bypass laws by doing financial reporting to foreign subsidiaries (such as Lukoil Benelux) and it will do what it used to: buy, refine and sell in Bulgaria. And here we should note that Lukoil was still reporting losses and did not pay taxes even when it was doing business entirely in Bulgaria.
This year, due to the much cheaper Russian crude oil, the Russian group has been making huge profits, which are now going to subsidiary Lukoil Benelux and to the owner of the assets in Bulgaria, Litasco (a subsidiary of the Russian giant). But the new agreement changes things completely. They have to get taxed in Bulgaria, not in the Netherlands or Switzerland.
Oil giant will pay substantial tax in Bulgaria
The new policy towards Lukoil was announced after a meeting in the Council of Ministers between government representatives and the management of Lukoil in Bulgaria. Deputy Prime Minister Hristo Alexiev claims that the new agreement means that all intermediaries in the "financial chain" will now be left out of the equation.
Government calculations showed that after the new regulation taxing excess profits is applied, Lukoil Neftohim Burgas should contribute BGN 100 million to the state budget this year. Next year, if the current situation is maintained, about BGN 700 million (for 2021, the profit tax paid was only BGN 3.5 million). The funds will go to compensate for energy poverty in Bulgaria.
But this can happen only if the refinery is allowed to export oil products (in the EU, for example) during the two years of the exemption granted to Bulgaria in relation to Russian oil deliveries. Lukoil has threatened to close down if this condition is not met and this could prove a crucial sticking point.
Lukoil's insistence on exemption
The chairman of the management board of Lukoil Neftochim Burgas Ilshat Sharafutdinov categorically stated that the plant cannot function in the presence of restrictions on exports. "We need an exit, if there is no exit - we will fill our warehouses and just stop working. That's it," he said.
By the end of the year, the refinery is expected to have processed 7.1 million tons of oil, and according to Sharafutdinov, about 50-55% of the plant's output will have been exported. "This is not related to the low consumption in Bulgaria, but to the fact that there are products that have no consumption in Bulgaria at all," he adds.
Local consumption has the potential to consume the diesel produced at the refinery, but not quantities of gasoline and boiler fuel, the market estimates. Fuel for refueling ships and planes would also be a problem because it is accounted as exports.
The Bulgarian caretaker government supports the export of oil products. The cabinet has already released for public discussion a proposal to revoke the Petkov cabinet's decision to ban the export of Russian oil and fuels after December 5. It contends that the Brussels ban applies to the export of Russian oil and oil products, and not on products produced from oil in Bulgaria.
The EC position
Brussels thinks differently. In response to Bulgarian media, a European Commission spokesperson stated: "Due to the specific geographical exposure for Bulgaria, a special derogation from the ban on the import of crude oil by sea transport and petroleum products was provided for a limited period. The purpose of the derogation is to supply Bulgaria with oil due to its specific situation and not to sell it to other member states or third countries. This is also clarified in the Commission's guidelines, including when the oil has been processed."
The guidelines state that EU operators and national authorities must carry out appropriate due diligence before purchasing fuels from other Member States that benefit from the exemptions provided. When purchasing, they must ensure that the goods do not originate in Russia, are not exported from Russia, or are not petroleum products derived from crude oil originating in, or exported from, Russia.
Confrontation with Brussels?
Representatives of the caretaker government, however, continue to unofficially claim that Brussels' regulation is not comprehensive and that further talks are planned with the European Commission. But even if the export ban is revised, the will of Brussels is clear. Obviously, Bulgaria does not want to confront the European Union. Therefore, if talks take place, they are more likely to center on sales to non-EU countries.
Logic says that three things are likely to happen. First, the Council of Ministers should vote on the cancellation of the previous decision made by Kiril Petkov's cabinet, prohibiting exports after December 5, which must happen before that date. Second, parliament will have to vote on changes to the Corporate Income Tax Act, which says that companies operating with crude oil, natural gas, coal and oil refining must pay an additional top-up tax of 33% on the weighted average profit for the last four years. Third, the supervisory board of Lukoil Neftochim Burgas must vote on the abolition of the current work scheme of Lukoil and begin the new work method - from the beginning of next year.
Is someone going to pay BGN 700 million?
Currently, the revenues of the refinery are constituted by a processing fee, which covers the production costs and brings profit (68.1 million BGN for 2021). After the changes are enacted, the Russian company expects a huge increase in revenues. The expected benefits for the state are mooted to be about BGN 700 million (or about BGN 2 billion profit for the refinery itself).
The current equation is based on a profit tax of 10% and an additional 33% tax from the top above the weighted average profit. According to unofficial information, the figure is based on the maximum production capacity of the refinery and the average monthly price difference between the Urals and Brent grades per barrel, which in the past year exceeded $30 in certain months, and was $23 in mid-November.
There are still some imponderables to consider. The most unpredictable part is the dynamics of the markets in the coming year and whether the price differential, as well as the high current margins in processing, will be preserved. On a different note, the refinery exports 50-55% of the production, which goes through the exporter subsidiary Litasco. This, according to information from the market, sells mainly to markets such as Turkey, Asia, Africa and Latin America. There is no guarantee that the refinery can secure high margins there.
"After changing the business scheme of the enterprise, we must realize that it is important to preserve the macroeconomic conditions - such as we have today," Sharafutdinov pointed out.
Before the war, and when the previous arrangements were in place, the refinery operated at a huge loss: BGN 254.5 million in 2018; BGN 80.3 million in 2019; BGN 508.6 million loss in 2020, which Sharafutdinov explained by citing the economic reality and the negative margin at that time.
Is there still no alternative to Russian oil?
The two-year exemption was designed to reduce Bulgaria's over-dependence on Russian oil. Since the beginning of the war, due to the price collapse of Russian raw materials, the exact opposite trend has been observed, with the refinery switching to 100% Russian fuel, and the import of finished non-Russian fuels has become almost economically impossible for competing players.
From Sharafutdinov's words, it became clear that the plant plans to work with the Urals raw material as much as possible over the next two years. Clearly, the caretaker government has failed to negotiate requirements for the refinery to gradually expand the percentage use of other oil in the mix going forward.