Fitch Ratings says that the Russian government's recent decision to widen and accelerate tax cuts for the country's oil industry is a broadly positive step for the creditworthiness of issuers in the sector, and helps to support the current Positive Outlooks for OAO LUKOIL (BBB-(BBB minus) /Positive Outlook/F3) and OJSC OC Rosneft (BBB- (BBB minus)/Positive Outlook).

The Russian government announced late last week that it would reduce oil export duties from October 1 2008 to allow Russian oil companies to collectively save approximately USD5.5 billion in the wake of declining oil prices. "Fitch sees any moves by the government to ease the tax burden on the country's oil sector as a positive credit development," says Jeffrey Woodruff, Senior Director in Fitch's Energy and Utilities team in London. "The oil and gas industry is an important part of the Russian economy's growth engine, so these measures to ensure its long-term health can only enhance the credit profiles of leading industry participants," Mr. Woodruff continued.

This latest decision follows on from an estimated USD4.0 billion in oil sector tax cuts announced by the government in March 2008, and forms part of the government's broader USD130 billion rescue package that was implemented in the wake of the global financial crisis. Crucially, Fitch notes that the tax cuts for the oil industry are being put ahead of proposed tax cuts in the country's value-added tax (VAT), highlighting what the agency sees as the importance the government places on the sector. The Russian Duma has already approved increasing the tax threshold to USD15 per barrel from USD9.0 per barrel (where the current oil extraction tax begins to take effect), and Fitch understands that there are discussions underway for Russia's Ministry of Energy to propose raising this threshold further to USD25 per barrel from 2010.

Fitch believes that a restructuring of the country's tax thresholds for oil could prove particularly favourable to the industry, especially in a lower oil price environment. Such tax breaks are expected to cost about 0.5% of GDP according to Kremlin economic advisor Arkady Dvorkovich. Additionally, Fitch's Sovereign group does not currently expect to change Russia's Long-term foreign and local currency Issuer Default Ratings of 'BBB+' with Stable Outlooks (see "Fitch: Financial Pressures Build on Russia and its Banks", September 17, 2008 for more information).

Other tax measures reported in the government's package to be implemented by 2010 include: a more favourable depreciation regime, postponement and restructuring of back tax claims, and tax holidays for exploration and development of new regions. In total, the changes could save the Russian oil industry about USD16 billion per year according to the Russian Ministry of Energy's press service or roughly equal to the short-term debt of both LUKOIL and Rosneft combined as of June 2008.

The Russian oil industry has been the focus of much discussion on world oil markets as its production growth has stalled in 2008 at approximately 9.8 million barrels per day, after seeing double digit growth in the early part of this century. Russian crude producers began to call for tax cuts early in 2008 to encourage exploration and development and thereby help to kick-start production growth again. It is estimated by industry participants that in the current oil price environment, Russian companies pay between 80-90 percent of their profits in taxes and tariffs, which limits their funds for capital expenditure. Fitch also notes that an additional benefit to the proposed tax cuts could be a reduction in additional borrowings and a reduction of leverage for Russian oil companies, as the need for external financing is replaced by tax savings.