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Overcharging the profit of the domestic gas producers: Who wins and who loses

The supplementary taxation applied to domestic gas producers for the profit gained following the liberalization of the natural gas market has stirred great discontent on the market, amplified following the parliament decision in mid-June to increase this tax. However, the problem will be settled this autumn, because Romanian President Klaus Iohannis has rejected the Government Emergency Ordinance no. 13/2014 amending the appendix to the Government Ordinance no. 7/2013 on the charge on extra revenues, derived from the deregulation of prices in the natural gas sector. Besides, the debates on OPCOM exclusivity in gas trading have been postponed for September this year.

Upon the request of the Committee for Industries and Services, the Chamber of Deputies decided to amend the law for the approval of Government Ordinance no. 7/2013 in the sense of increasing the tax level from 60% to 80% for selling prices of natural gas exceeding RON 85/MWh. G.O. no. 7/2013 read that only a supplementary tax of 60% on the extra profit was to be applied to the difference between the reference price set at RON 72/MWh and the one reached after each price increase. The Committee for Industries and Services with the Chamber of Deputies justified this increase in the supplementary taxation by the fact that gas producers have already increased prices by more than 20% after April 1, when the market liberalization came into force, as producer prices were being set by demand and supply.
The arbitrary setting of the reference price at RON 72/MWh and maintaining it, given that the market prices fluctuated below this level last year, has opened the door to Russian gas imports.
“The supplementary taxation was enforced in 2013 as a temporary measure for the economic crisis. Now, in 2017, the tax has been increased (from 60% - editor’s note) to 80% and it is for an indefinite period. It is a new measure that penalizes domestic producers against Gazprom. It is a tremendous discrimination of Romanian producers against external producers,” says Harald Kraft, elected president of the Romanian Petroleum Exploration and Production Companies Association (ROPEPCA).

HOW WAS THE 80% LEVEL REACHED

The increase of the supplementary taxation to 80% was included, in early June, by the Committee of Industries and Services with the Chamber of Deputies, in the report on the draft bill for approval of GO no. 7/2013, the draft being subsequently voted by the Chamber, decisional forum in this case. “The tax (...) shall be calculated by applying 60% and 80% respectively on the supplementary revenues (...) of which the royalties relating to that income are deducted, as well as investments in the Upstream segment. The percentages for calculation are: a) 60% of the supplementary income for prices up to RON 85/MWh, included; b) for prices exceeding RON 85/MWh a level of 80% on the supplementary income, on the difference between RON 85/MWh and the price applied,” the commission report reads. Another amendment to the ordinance is the permanence of the supplementary tax.

HOW TO CALCULATE THE SUPPLEMENTARY TAX

According to the proposals by the Committee for Industries and Services, OPCOM, Romania’s electricity and gas market operator, would remain the only trading platform. The amendments to GEO 64/2016 on the gas market, decided by the Industry and Services Committee, stated that gas producers would have to publicly offer and trade, transparently and on a non-discriminatory basis, on the centralized natural gas markets, all the natural gas produced, except for the quantities used for their own technological consumption. Also, all the quantity produced or imported could be traded on a single wholesale market, whereas the direct bilateral contracts between producers and suppliers, traders or consumers could disappear.
In a joint mid-June report by the Committee on Industry and Services and the Budget, Finance and Banks Committee with the Chamber of Deputies, an amendment was introduced in the original draft bill for the approval of GEO no. 25/2017 amending the appendix to Government Ordinance no. 7/2013 on the levying of the tax on supplementary income derived from the deregulation of prices in the natural gas sector. In particular, the proposed amendment introduces progressive taxation on producers’ supplementary income, the reason being “to collect the funds needed to support the social protection programmes for the vulnerable consumer.” Therefore, according to the modifications to article 2, paragraph 2, the tax is amended as follows: “The tax stipulated in paragraph (1) shall be calculated by applying 60% and 80% respectively on the supplementary income, as determined in accordance with the appendix that forms an integral part of this Ordinance, of which the royalties related to such income are deducted, as well as investments in the upstream segment. The tax calculation percentages are: a) 60% of the supplementary income for prices up to RON 85 lei/MWh, included; B) for prices exceeding RON 85/MWh a percentage of 80% of the supplementary income resulted from the difference between RON 85/MWh and the price applied.”

The formula for calculating the supplementary income is detailed in the appendix to GO no. 7/2013 and is adjusted by the Chamber of Deputies amendments as follows:
Depending on the price level, the following calculation formulas are to be applied:
1) If PMPC is less than or equal to RON 85/MWh, the formula is:
Tax on supplementary income due = 0.60 x (VS - royalty x VS - VI)
VS = (PMPC - PRC) x VGC,
2) If the PMPC is higher than RON 85/MWh, the formula is:
Tax on supplementary income due = IVS1 + IVS2, and
IVS1 = 0.60 x (VS1 - royalty x VS1 - VI)
VS1 = (85 - PRC) x VGC
IVS2 = 0.80 x (VS2 - royalty x VS2)
VS2 = (PMPC - 85) x VGC
where:
VS - supplementary income, calculated at PMPC up to RON 85/MWh;
VS1 - supplementary income, calculated at PMPC of RON 85/MWh;
VS2 - supplementary income calculated at PMPC exceeding RON 85/MWh; IVS1 - Tax on supplementary income due, calculated at PMPC of RON 85/MWh;
IVS2 - Tax on supplementary income due, calculated at PMPC exceeding RON 85/MWh;
VI - the amount of upstream investments in the period for which the supplementary income tax is due;
PMPC - the weighted average price of natural gas sold from its own domestic production;
PRC - the purchase price of natural gas from domestic production for household and non-household customers in 2012, i.e. RON 45.71/MWh, adjusted by the CPI rate in 2014;
VGC - gas volumes of domestic production sold;
CPI - consumer price index published by the National Statistics Institute in Romania.

In addition, by the changes made, the time limit for the application of the supplementary income tax is also eliminated. Article 7 of Government Ordinance no. 7/2013 is repealed, introduced by Government Emergency Ordinance no. 99/2016, which provides that “the supplementary income tax set by this ordinance shall apply to supplementary income earned up to and including December 31, 2017,” which means it is a permanent tax on supplementary income. The initial version, adopted in early May by the Senate and backed by the government, provided only a 60% tax with a modified calculation formula. By these legislative changes, adopted overnight and without thorough substantiation, Romania succeeds to position itself against the European current in terms of enforcing tax on gas companies. Recently, a Deloitte study highlights that in Romania, contrary to the European trends, natural gas is charged more than oil. “The effective tax rate for Romgaz, the major natural gas producer, was of 22.5% in 2015, whereas for OMV Petrom, which also produces oil, the tax rate was 14.7%”, the study reveals.
The net profit registered by Romgaz dropped by over 14% last year, to RON 1.02 billion, following the fall in turnover by almost 16%, to RON 3.4 billion, due to the 24% decrease in the gas output. The main reason for these financial results was the strong increase of gas imports. The company’s gas output dropped by 24% to 4.219 billion cubic meters and gas sales fell by 17%. For this year, the state budget anticipates a 7.48% increase in revenues from the tax on supplementary incomes following the deregulation of gas prices, despite the fact that its enforcement and continuation have very high costs.

SINGLE STOCK MARKET

Another hot topic, turning OPCOM into the single wholesale gas trading platform, was not well received by the Competition Council, the president of this institution saying that the authority disagrees with the elimination of the Romanian Commodity Exchange (BRM) from the centralized natural gas market in Romania, claiming that both trading platforms, OPCOM and BRM have to be maintained. In fact, the European Commission too did not agree with the intention filed by the Industry and Services Committee, saying such issue raises problems. In its reply, the European Commission considers that it is not advisable to move the trading on OPCOM, given that BRM is currently a more liquid market, whereas the granting of exclusive rights to OPCOM raises competition concerns. The Commission also considers that trading 100% share of gas production on the stock market may be excessive.
Under the industry’s pressure, but also due to the warning received from Brussels, the Chamber of Deputies plenary decided to re-send the bill on the amendment of the Law on Electricity and Natural Gas to the Commission for Industries and Services, in order to regulate the extraction of natural gas on the territory Romania and its trading through a single stock market, namely OPCOM. Debates on this subject will be resumed by the new parliamentary session. The intention of the parliamentary committee to remove the BRM from the game, by shifting all gas transactions on a single stock market, generated dissatisfaction of the BRM representatives, which threatened to bring the Romanian state to court at international forums if the parliament approves the proposed amendments.

ROPEPCA EXPECTS PREDICTABILITY

The Romanian Petroleum Exploration and Production Companies Association (ROPEPCA) argues that unpredictable and excessive changes to the tax framework are likely to jeopardize both the local petroleum industry and the investment climate, by sending negative signals to the entire business environment about the lack of stability and credibility. ROPEPCA has repeatedly stated that by applying the additional tax only to domestic production, it will be disadvantaged against imported sources. Given the dependence on a single source of import - the Russian Federation - this form of discrimination directly affects the national energy security. This trend is also confirmed by the latest figures published by the National Statistics Institute: Romania imported 537,000 toe of natural gas usable in Q1 2017, by 332% more than in the similar period of 2016, while local production is falling, the companies being forced to close wells. “The liberalization of natural gas prices is not a phenomenon justifying an additional tax, but represents the implementation of an objective assumed by Romania at European level to move to normality for a free market and in the single European market context. Moreover, the increase of the quota is not justified in relation to the current level of taxation of the Romanian industry.”
According to the Deloitte study, while the average effective tax rate of royalties and other similar taxes on income have increased in Romania from 15% in 2014 to 17.5% in 2016, the average level of taxation in Europe (excluding the Groningen deposit in the Netherlands which has a special tax regime) has fallen from 9.3% in 2014 to 7.9% in 2015.
“In recent years, ROPEPCA has been permanently open to consultations with the authorities on a new tax framework applicable to the petroleum industry. Any unannounced change without consultations and analysis, such as the Parliament’s intention to increase and extend indefinitely the supplementary taxation of income following the liberalization of gas prices, disregards the dialogue over the past four years and calls into question the credibility and stability of the Romanian business environment,” Mark Wagley, acting chairman of ROPEPCA, said in mid-June.
“Besides the amendments to enforce the tax on supplementary revenues, following the deregulation of the natural gas market, we are also worried about the recent talks on the obligation for natural gas producers to sell the entire domestically produced quantities exclusively on the trading platform for an indefinite period of time, an obligation included in the amendments proposed to amend the Law on Electricity and Natural Gas no. 123/2012. In this regard, we consider that the proposed obligation is a restriction on bilateral trade agreements agreed through direct negotiation, on cross-border natural gas deliveries agreed through direct negotiation, in fact a ban on direct bilateral gas trade with suppliers, traders and consumers in other Member States, on natural gas exports and on the producers’ right to dispose freely of the natural gas produced, as well as discriminatory treatment of domestic gas producers against the foreign ones to whom these obligations do not apply,” he added.
The ROPEPCA argue that by this tax, domestic producers are disadvantaged against the Russian gas giant Gazprom, who exports to the Romanian market without paying this supplementary tax and without being forced to sell all its production on the stock market. How much favoured are the Russians by the decisions of the Bucharest authorities can be seen by looking at statistical data. Last year, the natural gas imports from the Russian Federation exploded, increasing by 629%, after they became cheaper than the domestic production. If early last year imports covered 5% of the market, their share reached 25% at the end of the year.

ANRE'S POINT OF VIEW

“ANRE does not have the information on which the allegation of the increase in the selling price of natural gas is based, allegation brought by the Industry and Services Committee with the Chamber of Deputies to the producers. Regarding the price formation of natural gas from domestic production, as of April 1, 2017, according to the provisions of the Law on Electricity and Natural Gas no. 123/2012, it is freely floating on the competitive market, as a result of commercial gas transactions between economic operators on the basis of freely negotiated contracts or transactions on the centralized markets (BRM and OPCOM),” ANRE states in a point of view sent to Petroleum Industry Review. “Regarding the Government Ordinance no. 7/2013 on the tax on supplementary income obtained following the deregulation of prices in the natural gas sector, this has already been amended by Emergency Ordinance no. 25, dated March 30, 2017, to revise the content of the appendix to the Government Ordinance no. 7/2013 on the introduction of the tax on supplementary income obtained following the deregulation of prices in the natural gas sector, published in the Official Gazette on March 31, 2017,” the ANRE reply also reads.

ROMGAZ DEMANDS FAIR COMPETITION

“As of April 1, 2017, the market is free, and producer prices are set by demand and supply. Romgaz no longer has administered prices, the price being modified according to the market demands, and here we are primarily talking about centralized markets. In 2016, Romgaz paid RON 291,440,195 (tax on supplementary income – editor’s note). Consistency and predictability are needed in fiscal policy, which is recognized and affirmed in all environments,” Romgaz says. “The taxes, required for the functioning of the entire state apparatus, should be structured not to choke the taxpayers or to prevent fair competition. The best example in this regard was the price situation for domestic gas vs. the price of imported gas, which was overcharged,” Romgaz said in a reply to Petroleum Industry Review.

OMV PETROM'S POINT OF VIEW

“The natural gas market must operate according to the same principles as any free market. On a free market, price developments are determined by the supply-demand ratio. This market regulation mechanism allows optimal use of resources in any field, not just regarding for natural resources. It stimulates investment on a healthy basis from an economic viewpoint and encourages consumers to streamline their consumption. The functioning of this market in competitive conditions and with the protection of the consumer is regulated by ANRE,” OMV Petrom representatives say.
“After April 1, we witnessed convergence of wholesale gas prices for household consumers towards the wholesale price of non-household customers, for which the market had already been liberalized in 2015. For transactions on centralized markets, no information is available on the final customer (household or non-household), manufacturers are no longer visible. The price development is determined by the demand-supply ratio. The current level of wholesale prices of all participants on the two stock markets is around RON 70-72/MWh, a level envisaged also by the latest version of the liberalization calendar. In Romania, gas prices follow the trends on European markets, but they are below the quotations on the main stock markets. For example, at CEGH in Austria, prices now exceed EUR 16.5/MWh (RON 75),” OMV Petrom’s reply to the editorial office reads.
“The wholesale purchase price for household customers will be reflected in the final regulated price after a certain period of time, according to ANRE norms for establishing the final price for natural gas on the regulated market. The regulated final price is also influenced by other elements such as the regulated tariffs for distribution, transport and storage, which, according to market information, have a share of over 50% in the final price. Given that the actual price of gas represents less than half of the price charged to final customers, a hypothetical 20% increase in these prices would translate into an increase of less than 10% in the price charged to household consumers,” the viewpoint further reads.

INCREASE OF THE TAX ON SUPPLEMENTARY INCOME IS POSTPONED

“Given the specific, temporary and extraordinary reasons for enforcing this tax, we believe that its regulation should follow the same temporary nature. Considering the particular importance of the regulatory framework for the oil and gas sector’s performance, we believe it is essential to define a predictable and stable fiscal and legislative framework, conducive to the creation of long-term business plans, for continued investment and for the stimulation of new investments,” the Head of State said when deciding to postpone the promulgation of the law on supplementary taxation of the domestic gas producers for the profit gained following the liberalization of the natural gas market. Also, in order to meet social objectives, the president believes that this law should provide a transparent mechanism, based on the principle of equivalence between taxation and the protection of vulnerable consumers.

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