Q1 2012 Novatek OAO Earnings Conference Call (IFRS)
May 15, 2012 AM CEST
Thomson Reuters StreetEvents Event Transcript
E D I T E D V E R S I O N
NVTK.MZ - Novatek PAO
Q1 2012 Novatek OAO Earnings Conference Call (IFRS)
May 15, 2012 / 01:00PM GMT
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Corporate Participants
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* Mark Gyetvay
Novatek OAO - CFO, Member of Board of Directors
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Conference Call Participants
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* Oleg Maximov
Troika Dialog - Analyst
* Geydar Mamedov
Goldman Sachs - Analyst
* Karen Kostanian
Bank of America-Merrill Lynch - Analyst
* Lev Snykov
Greenwich Capital Moscow - Analyst
* Ilya Balabanovsky
Renaissance Capital - Analyst
* Pacha Brodina
VTB Capital - Analyst
* Eveni Gorgeoros
VGB Asset Management - Analyst
* Zena Pasola
Granite Investments - Analyst
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Presentation
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Operator [1]
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Good day and welcome to the Q1 2012 Novatek financial results conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Oleg Maximov, an Oil & Gas Analyst at Troika Dialog. Please go ahead, sir.
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Oleg Maximov, Troika Dialog - Analyst [2]
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Thank you, operator. Good afternoon and welcome. I'm Oleg Maximov from Troika Dialog. And this is Novatek first quarter 2012 financial results conference call. With us today as usual is Mark Gyetvay, Novatek's Chief Financial Officer and Member of the Board of Directors. Mark, please start with your presentation. Thank you.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [3]
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Thank you, Oleg. Ladies and gentlemen, shareholders and colleagues good evening and welcome to our first quarter 2012 earnings conference call. I'd like to thank everyone for joining us this evening and again extend our sincere gratitude to Troika Dialog and Oleg Maximov for organizing and hosting our earnings conference call.
Before we begin with the specific conference call details, I would like to refer you to our disclaimer statement, as is our normal practice. During this conference call we may make references to forward-looking statements by using words such as plans, objectives, goals, strategies and other similar words which are other than statements of historical facts. Actual results may differ materially from those implied by such forward-looking statements due to known and unknown risks and uncertainties and reflect our views as of the date of this presentation. We undertake no obligation to advise or publicly release the results of any revisions to these forward-looking statements in light of new information or future events.
Please refer to our regulatory files included in our annual review for the year ended December 31, 2011, as well as any of our earnings press releases and documents throughout the past year for more descriptions of the risks that may influence our results.
For tonight's conference call, I want to focus on a few crucial points that emerged recently regarding the Ministry of Finance's proposed changes to the mineral extraction tax, or MET, as well as what is our position regarding this important topic. However, I will not go into depth or engage in a debate that is purely speculative because we are currently formulating our position in this important area.
As you can appreciate, the proposed changes in the MET of this magnitude obviously raises concerns about the government's intention on increasing the economic rent for all gas producers in Russia. But the proposed changes were considered significant, especially towards the independent gas producers with a different revenue and commodity pricing model. It is also important to frame this discussion in terms of facts, not market speculation, because as of today, the Min Fin's position is just that, a position that is subject to further review and discussion prior to final decision.
We completely understand anyone's concerns regarding these proposed punitive tax changes. And equally important, we understand investor sentiment towards Russia country risk and the negative impact these types of changes imply to further investment opportunities in Russia. Everyone wants some measure of predictability rather than irrational behavior. And you can also appreciate this point from our perspective as we invest significant capital in field development, infrastructure and processing complexes.
We have never avoided discussing these types of issues in any of our investor meetings or conference calls, and we don't plan to shy away from addressing these types of topics today. Unfortunately, everyone must understand that this particular topic, MET, but for that matter tariff changes to gas prices and transport charges are considered non-controllable by the Company and we purposely separate and disclose this fact in our analysis of operating expenses.
What we can do and what we will continue to do is to lobby our position on these matters. And I can assure everyone tonight, we have not lost this ability as some analysts have speculated in regards to this topic. Conversely, we are actively involved in the discussions and will attempt to position our arguments accordingly to minimize any significant impact to our operating cash flows.
We strongly disagree with the Min Fin's position regarding the principal way of calculating and assessing the MET rate and we believe a different position will be adopted once it becomes law. Therefore, it is too premature for us to speculate at this point what the impact on our EBITDA will be in 2015, so we'll let the analysts make these particular assumptions.
Increasing the net rate only in relation to the domestic gas market is not a correct position, and we believe a different methodology will be adopted, which will at least take into account inflation and transport tariff increases.
While on this important topic, I would like to remind everyone this evening, as I have done in my investor meetings, that when we deal with the topic of taxation, we do not view this issue as one-dimensional, but rather, we assess the impact as three-dimensional, pricing, transport and tax, and try to frame our analysis within an argument along these lines. Our aim is to minimize the negative impact on our netback realizations and we believe we have done a good job today achieving our aims.
Another important to mention that seemed to be overlooked in the speculative plans meeting is our goal of moving closer to the end consumer, implying that the transport tariff is also key in these discussions on preserving our netback margins. In fact, if you analyze our operating expense categories, you will know that transportation in general represents 78% of our non-controllable expenses and approximately 51% of our total operating expenses. Within the specific transportation category for natural gas, it represented about 80% of our transport expenses, which shows you why this single category is important in managing our netback margins.
Without question, we were surprised by the significance of the many analysts' negative write-downs of EBITDA for 2015, which implies to us that our comments regarding domestic gas price tariffs is not being heard, or worse yet, ignored.
I have made it absolutely clear on many investor meetings, as well as our Strategy Day presentation in London, that our position vis-a-vis domestic gas prices is contrary to what I believe many analysts use in their models. Moreover, I mentioned that on our full year 2011 earnings conference call that we do not anticipate significant changes to gas MET paid by the independent producers. Since these percentage increases were already approved in the Russian budget and that we should get some indication for the range of MET discussions as we approach the next three-year budget period.
It is also quite frustrating to read many ill-advised commentary on questioning the fundamental assumptions and forecasts for our business model. We have a clear and enviable track record of delivering quality results and negating these facts with purely speculative conjecture is beyond comprehension.
You should not confuse matters that are controllable from those that are non-controllable. The government's imposition of additional tax burden on an industry sector is a troublesome issue to all of us, but is an issue that is not controllable from the single entity, but rather requires a collective and insightful lobby and effort by many. And we will continue to take an active role in these efforts.
Another recent topic that has emerged from these MET discussions is the possibility of eventual export rights according to independent gas producers. The correlation of topics is reasonable to assume, but again quite premature to speculate.
While on this topic, I would like to clarify a point that was unfortunately disclosed in an analytical report during one of my private group meetings without my permission, but was purely framed as a question from an investor to me where I provided some theoretical export options. My response to this question was not implying that we already had some insight into potential or imminent export rights, but merely, tried to explain that there are some theoretical options to consider and we will explore all possible avenues to increase our operating cash flows and improve and/or enhance our netback margins.
I can state that we have been dealing with the possible resolution of the import/export question, and if the proposed MET rate increase is put into effect where deliveries to the Russian domestic market, based on domestic pricing and supplies, we will act more insistently on obtaining a positive decision, allowing us to export natural gas with the aim of resolving this question in 2013.
In the event that the principle of calculating the MET rate increase will be implemented as proposed by the Min Fin, we may revise our long-term strategy toward increasing our equity stake in LNG projects on the Yamal Peninsula, and accordingly adjust our equity stake in Yamal LNG project, despite the fact that we are currently negotiating with several companies and we have moved forward significantly in the negotiation process.
We will also consider increasing the output of LNG on the Yamal Peninsula at the expense of developing assets on the Gydan Peninsula in order to minimize the negative impact on Novatek's operating cash flows due to an increase in our netback obligations. Therefore, this is not a simple and straightforward discussion, and we will continue to present our position that addresses all of the relevant points.
During the first quarter we began purchasing and reselling natural gas in the Russian domestic market from natural gas purchased from SIBUR Holdings, a related party, as part of a long-term purchase contract that we previously disclosed.
In addition, we also completed our first quarter of market and natural gas through our wholly owned marketing subsidiary, Novatek-Chelyabinsk, post the acquisition of Gazprom Mezhregiongas Chelyabinsk, which was completed in December 2010, which significantly increased our sales in this important consumer region. We sold approximately 40% of our total sale volume to end consumers to this region in the reporting period as compared to 17% and 30% in the first and fourth quarters 2011 respectively, or by approximately 5.1b cubic meters of natural gas.
We will continue to penetrate and expand our gas sales to regional markets as part of our overall commercial marketing plan. And we will utilize our existing infrastructure and marketing subsidiaries to facilitate these goals, as outlined in our Strategy Day presentation.
The first phase of SeverEnergia's Samburgskoye field was launched recently towards the end of April, which essentially fast-tracked the field's production by utilizing our existing infrastructure at the Yurkharov to Purovsky unstable gas pipeline and our processing capacity at the Purovsky plant. We will provide additional updates on the field's performance during subsequent conference calls. But presently, we are producing approximately 6m cubic meters of natural gas and roughly 800 tons of gas condensate per day.
We plan to launch the second train, or line, during the fourth quarter, thus increasing the field's overall productive capacity by another 6m cubic meters per day and approximately 800 tons of gas condensate according to schedule.
The increase in SeverEnergia's total production will also correspond with our plans to expand our overall processing capacity at the Purovsky plant by 6m tons done in two stages at 3m tonne upgrades in 2013 and 2014. We are also planning to expand the Yurkharov-Purovsky unstable gas pipeline to accommodate the additional volumes of expected gas condensate from these fields.
In addition, during the first quarter we began developing the oil layers at both the East-Tarkosalinskoye and the Khancheyskoye fields, which increased our crude oil production by 44,000 tons year on year, and by 15,000 tons quarter on quarter. Although the overall volumes of 99,000 tons represented less than 1% of our total production on a barrel of oil equivalent during the quarter, it is still accretive to our earnings because the field's location, north of the 65 parallel and the corresponding zero MET exemption which became effective on January 1, 2010 -- 2012, excuse me.
We continued works on a number of different projects during the first quarter and spent approximately RUB7.5b on capital projects, representing the increase of 18.6% year on year and a decrease quarter on quarter of 22.2%. Specifically we increased our capital spending at the Ust-Luga transshipment and gas fractionation plant and ongoing drilling activities at East-Tarkosalinskoye field, particularly relating to our crude oil development activities.
Of particular note during the quarter was the significant decrease of 29% in the Yurkharovskoye field's capital spending program, which is consistent with our previous comments that this important field is moving closer towards maintenance capital unless a decision is made to expand the field's production capacity beyond the approximately 4b cubic meters we plan to add by year end 2012.
These three capital projects aggregated 69% of our total capital spend during the period. And we are still forecasting a total capital expenditure program for 2012 at roughly RUB50b. If there are any revisions in this capital program, we will update everyone on subsequent conference calls. But as of today, there are no changes to our forecasted capital expenditure program.
One particular capital project of interest to investors is our Yamal LNG. And I can confirm we are working in accordance to the project time schedule outlined in December at our Strategy Day presentation.
We received the initial FEED study from the engineering consortium, led by CDNI Alumnus and are currently preparing tenders for long lead items this summer. There are some additional works needed to finalize this lead study, which we plan to finish over the next couple of months. The procurement of long lead items is one of the critical paths to ensure a timely completion of the project. And in April a team of specialists held a series of meetings in London with potential LNG contractors to explain the project, go over some of the requirements in the FEED study and discuss the tender process for long lead items.
We expect to finalize some of the EPC tender contracts this month and the remainder in the third and fourth quarter 2012 for long lead items. And once the FEED study is completed around June, we will submit the report to the relevant bodies of the Russian government for expert review with the aim of making the final investment decision by year end. There is a defined process that needs to be adhered to and we are proceeding accordingly.
We continue to hold discussions with potential partners on the farm-out of an additional interest in Yamal LNG. But I want to make it absolutely clear that the farm-out is not crucial and we will continue to study our options. We have the main strategic investor Total already in the project and we are moving ahead according to the timetable we have outlined for the project. But as I've already stated, we will consider this whole process in light of the MET discussions and make a decision which we feel is in the best interest of the Company.
We are proceeding forward with works at the port facility during the winter construction season this year and next to ensure that the facilities are available to accept materials for delivery when required. Ongoing works continue at the airport facilities, housing complex and fuel depots, to name a few. And we have already delivered the first new rig built by Euromast to the field site, and another custom drilling rig is currently being fabricated. We project the drilling of the initial production wells to commence sometime in the third quarter 2013.
Another important announced we made during the quarter was the Memorandum of Understanding we signed with Gazprom, whereby we will endeavor to work together to develop resources on the Yamal and Gydan peninsulas. Specifically, we agreed to form a joint venture, owned 75% by Gazprom, 25% by Novatek, whereby Gazprom will contribute its Tambei fields and we will develop these fields and potentially expand the overall production of LNG, utilizing the port facilities at Sabetta by another 20m tons per annum. Although discussions are quite early at this point, we raised the possibility at our recent Strategy Day presentation by indicating the potential to raise the overall level of LNG produced on the Yamal peninsula to 25m to 30m tons per annum.
The second part of this announcement was the formation of another joint venture, equally owned at 50% each, whereby we, Novatek, will contribute our recently acquired licenses at the Uttrenneye licensed area to the joint venture, located on the Gydan peninsula. And we will jointly develop this important field with the aim of connecting this area to the [Amberg] pipeline infrastructure owned and operated by Gazprom. The gas produced on this field will be delivered to the Russian domestic market.
We have established working groups between our respective companies and have begun working on implementing these projects. But the ultimate decision regarding the pace of work and the timing of projects will rest on the outcome of the MET discussions. Depending on the outcome of the MET discussions, one option will be moved forward with the projects that have export potential rather than projects delivering natural gas to the Russian domestic market. We will keep our various options open while these discussions are underway.
Moving forward, I would like to briefly discuss the operational and financial results achieved in the first quarter 2012 before opening the session to questions and answers.
Our natural gas and liquids production, excluding purchases and inventory movements, increased by 9.3% and 5.5% respectively during the first quarter 2012 as compared to the prior year, which is trending slightly higher than our full-year forecast on a percentage basis. We have maintained a strong production trend for natural gas in April 2012 and early May during the traditional trough period. In fact, our natural gas production for the month of May -- for the month of April was approximately 20% higher year on year and relatively consistent with the prior month's production runs, although this fact was missed, or overlooked during the MET frenzy.
For natural gas, we had strong production growth from our three core fields led by an 11.5% growth in production from the Yurkharovskoye field, or by approximately 900m cubic meters. We also increased our purchases of natural gas from our joint ventures, amounting to 1.4b cubic meters, representing an increase of 2.8% as well as commencing purchases from third parties, totaling 900m cubic meters as compared to no volumes purchased in the first quarter of 2011.
As for natural gas sales, we increased our volumes sold year on year by approximately 2.1b cubic meters, or by 14.7%, and quarter on quarter by 471m cubic meters or by 3%. The biggest change in our natural gas sales was the distribution of the volume sold between end consumers and wholesale traders. In the first quarter we significantly increased our percentage of natural gas sold to end consumers from 51% in the first quarter 2011 to 76% in the current reporting period, an increase of roughly 25%. In comparison to the fourth quarter 2011, we increased our proportion of sales and consumers from roughly 57% to the current 76%.
The change in our natural gas sales mix is important for a number of reasons, but essentially meant that we achieved a higher realized average price, stronger netback realizations, excluding residential sales, of approximately RUB79 per thousand cubic meters or $2.61 per MCM based on current exchange, and was able to effectively control our production profile by maintaining the customer relationship.
Moreover, we significantly increased our sales volume to the Chelyabinsk region, representing 40% of our end customer volumes sold, which also contributed to the higher average realized price and improved netback margins. The more we transport gas to end consumers, the higher our overall costs incurred to transport natural gas. And this was clearly demonstrated through the higher transport costs year on year and quarter on quarter as reported in our operating expenses. But it's important to note that some of our best netback margins are achieved closer to the point of production.
Our average realized prices for end consumer sales during the first quarter 2012 decreased slightly by two-tenths from 1% in comparison to year on year, and was slightly higher than those realized quarter on quarter. For ex-field or wholesale trader sales, our average realized price increased year on year by approximately RUB11 per MCM or by eight-tenths of 1%, and were slightly higher by 1.1% with the prices we received for this category sales quarter on quarter. As a reminder, we had no tariff increase for our natural gas pricing during the first quarter 2012. And the effective date of raising tariffs by 15% is schedule to be July 1, representing essentially a 7.5% year-on-year increase when implemented.
We continue to achieve a higher margin differential between end consumers and ex-field netbacks, excluding trading activities and sales to residential customers as compared to the prior year, which continues this pricing dynamic achieved prior to the economic crisis, although we cannot be certain that these trends will remain consistent or continue to fluctuate period on period. Our overall netback margins for natural gas sold during the current reporting period increased by RUB99 per 1,000 cubic meters or by 7% as compared to the prior year, and increased slightly by eight-tenths of 1% quarter on quarter. The increase in our netback margins was primarily due to our sales mix and our geographical regions.
We also decreased our overall distance to transport natural gas to end consumers by approximately 2% and 6% year on year and quarter on quarter respectively, averaging approximately 1,800 kilometers during the first quarter 2012. The geographical markets representing at least 10% of our sales volumes were the Chelyabinsk and Perm regions, which were different from the more comparable reporting periods, which generally had four regions of at least 10% sales, including Moscow, Barenberg, Perm and Chelyabinsk. We ended the first quarter 2012 with an inventory balance of 32m cubic meters versus 760m cubic meters of natural gas in underground storage facility at year end, representing a reduction of approximately 728m cubic meters as compared to the beginning of the year.
For liquids, we managed to increase our liquid production year on year by 5.5% and quarter on quarter by 2.1%, led by the production growth at our Yurkharovskoye field and our East-Tarkosalinskoye field, with the Yurkharovskoye field accounting for about two-thirds of our liquids production, which has been relatively consistent over the past few periods.
Although we managed to increase our production of liquids during the reporting period, our overall sales of stable gas condensate was lower year on year by 4.7% and quarter on quarter by 10.4% due primarily to a buildup of inventory movements between reporting periods. We do not recognize revenues until such time as the product reaches its intended destination. And our inventory movements fluctuate period on period depending on loading schedules and ports of destination.
In the first quarter we had four tankers in transit in the Asia Pacific region, representing approximately 240,000 tons in waterborne transit which are generally recognized in the following period. This is purely a revenue timing issue.
Stable gas condensate continued to represent the largest portion of our liquid sales, although volumes sold during the first quarter were down relative to volumes sold year on year and quarter on quarter with a decrease of volumes sold principally due to inventory in transit. During the first quarter, we sold 624,000 tons versus 724,000 tons in the corresponding period, and 847,000 tons in the first quarter of 2011.
We increased the volumes of LPG sold in the first quarter by 3.9% year on year and 5.3% quarter on quarter.
Crude oil sales importantly was also up by 66% and 12.2% relative to the first and fourth quarters 2011, but as I previously mentioned, represented less than 1% of our total sales volumes for the period. Our overall liquid hydrocarbon volumes in inventory aggregated 449,000 tons at period end versus 371,000 tons year on year and 325,000 tons at year end, of which 352,000 tons represented stable gas condensate in the inventory.
Commodity prices remained robust in the first quarter 2011 and were primarily driven by double digit growth in euro and Brent benchmark prices. Our average export netbacks on a US dollar basis for stable gas condensate and LPG volumes sold during the period increased by approximately 7.1% and decreased by 2.7% respectively despite increases in both export duties during both periods and a slight decrease in average transportation expenses. In comparison to the fourth quarter, our average for netbacks for stable gas condensate increased by 29.4%, largely due to an increase in our average contractual price by 12.7% and a slight decrease in the export duties, which was offset by increases in both our rail and transport tariff costs.
For stable gas condensate, we sold 624,000 tons, realized an average net debt price per tonne of $513 per tonne in the first quarter as compared to $479 per tonne in the corresponding period, and $397 per tonne in the fourth quarter. During the first quarter we dispatched 15 tankers of stable gas condensate from the port of Vitino, of which six tankers were destined for the European markets, two tankers were destined to the United States, and the remaining seven tankers destined to the Asia Pacific region.
Our Purovsky plant operated at 79% of its rated capacity, with a total plant output reaching 986,000 tons, comprised of 749,000 tons of stable gas condensate, 232,000 tons of LPG, and 5,000 tons of methanol products. On the total barrel of oil equivalent basis, we increased our first quarter production to 104m barrels of oil equivalent versus 96m barrels of oil equivalent in the prior reporting period, representing an average total hydrocarbon per day of 1.139m barrels per day, an increase of 7.3% year on year.
We had no major surprises to our operating costs during the first quarter relative to the continued growth of our revenues. Our total operating expenses increased in absolute terms from RUB23.4b to RUB31.9b, an increase as a percent of revenues from 52% to 59%, largely due to the significant increase in transportation expenses and third party purchases.
Operating expenses in the fourth quarter amounted to RUB28.9b, which was relatively consistent as a percentage of revenues as compared to the current reporting period.
As expected, the most significant changes in our operating expenses for the comparative periods was a relative increase in our transportation expenses, which is explainable by the overall growth in our end customer sales combined with the annual tariff increase as compared to the prior year. During the first quarter we significantly increased our sales to end consumers on a volume basis by 72% and 38% as compared to the first and fourth quarters respectively.
During the first quarter we managed to reduce our transport costs on a per unit basis for delivery for natural gas with an average transport rate per thousand cubic meters declining by RUB135 per MCM or by 11.2% in spite of significantly higher proportions of end customer sales in the period.
For liquids, we had a reduction in our transport costs by tanker, which was largely driven by the increase in goods in transit and, to a lesser extent, the geographical mix of our sales volumes.
We continue to effectively manage and control our G&A expenses as a normal course of business, although these expenses continue to fluctuate period on period in its controllable expense category due primarily to semi-annual and annual bonus payments and accruals, charitable contributions, consultant services and business travel expenses, among other line items.
The main increase in our G&A expenses was attributable to employee bonus accruals in the amount of RUB188m, an increase in our overall employee headcount and the acquisition of the Chelyabinsk gas trader and the salary indexation of 9.6% effective from July 1, 2011.
At the end of the first quarter, the Company had a total headcount of approximately 4,645 employees, of which 1,338 employees, or 29% represent employees classified under the general and administrative category. Although our total headcount increased year on year by approximately 890 employees, which was representing additional employees acquired from the regional gas trader and an increase in employees hired to work at our regional distribution subsidiary.
We had a significant increase in our exploration expenses quarter on quarter of approximately RUB717m, which was largely attributable to the expensing of geophysical works, primarily seismic activities, during the reporting period. The primary change year on year was also due to the expensing of seismic expenses that occurred, which is required by the successful efforts accounting policy. In the previous year, we also wrote off unsuccessful exploration wells at our [Elarech] and Raduzhniy license areas.
As a result of the factors enumerated above, our EBITDA and net profit margins continued to remain robust in the respective reporting periods, achieving levels of approximately 45% and 39% respectively for the first quarter 2012, which is consistent with our overall financial guidance.
Our balance sheet and liquidity position continue to remain strong throughout the reporting period as we reduced our overall net debt position from RUB69.4b in the first quarter 2011 to RUB48.1b in the current period.
Our net debt position stood at RUB71.7b at year end. All of our liquidity and credit ratios weren't threatened throughout the period and we ended the first quarter with a cash and cash equivalent position of RUB27.7b, or approximately $940m.
We remained cash flow positive during the reporting period. And in the first quarter, with a record level of free cash flow for the Company, based on recorded results at RUB16.4b or 28% higher than the prior year, we will continue to fund our capital expenditure program through internally generated cash flows and have the ability to meet all of our debt obligations and liabilities when they mature or become due for payment.
In conclusion, we ended the current reporting period where we left off full year with a record financial and operational result and a strong platform for growth. As we harness the energy in the far north, we will no doubt encounter new challenges, yet the opportunities are enormous for us to continue expanding our resource base, our production profile and our global reach.
Despite the uncertainties concerning the ongoing discussions relating to MET for natural gas, we remain steadfast in our investment program and our commitment to deliver superior risk reduction returns. And we strongly believe the position advocated by the Min Fin is not a correct position to support ongoing development activities and foster an attractive investment environment for Russia. Investors want predictability in the markets where they invest, and we also want the same level of certainty as we embark on a new challenge in capital projects to ensure future production growth and supply sources of energy. We will continue on our lobbying efforts to ensure that our position is heard.
I would like to sincerely thank all our valued shareholders for the positive support you have provided to us despite the recent periods of market volatility and speculative commentary. We will continue to keep everyone appraised of these important matters, as has been our market practice. And we look forward to meeting you directly at investor meetings and conferences in the upcoming months.
I would like to end this portion of the conference call and now open the session to questions and answers. Thank you very much.
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Questions and Answers
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Operator [1]
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(Operator Instructions). And we will take our first question from [Yaka Ashikov] of Goldman Sachs. Please go ahead.
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Geydar Mamedov, Goldman Sachs - Analyst [2]
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Hello, Mark. This is Geydar Mamedov of Goldman Sachs. I have two questions if I may. The first one is in relation to Yamal LNG. If I understood correctly from your comments, you have mentioned that if the Ministry of Finance proposal to raise the mineral extraction tax on independent gas producers is adopted then you might reconsider the strategy in relation to the Yamal LNG and might decide to keep the higher stake than before -- higher than you planned before, i.e. higher than 51%. Is this understanding correct?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [3]
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Yes, that's correct.
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Geydar Mamedov, Goldman Sachs - Analyst [4]
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And the second question is in relation to the export taxes or pipeline export taxes. Are there negotiations currently going on between Novatek and the government in relation to the potential pipeline export taxes at all, or this is just something that Novatek will consider if the Ministry of Finance goes ahead and the government and the cabinet minister goes ahead with the approval of the increase in the MET?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [5]
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As we mentioned, we are definitely looking at this position. And once we come up with more definitive information, we will disclose it. But at this point I don't want to speculate.
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Geydar Mamedov, Goldman Sachs - Analyst [6]
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Okay. Thank you very much.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [7]
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You're welcome.
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Operator [8]
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And we will take our next question from Karen Kostanian of BofA. Please go ahead.
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Karen Kostanian, Bank of America-Merrill Lynch - Analyst [9]
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Hi, Mark. Thank you very much for the presentation. I also have two questions. My first question, we are, as we see the data coming out from Europe and also domestically in Russia, we might admit that we are actually in pretty stagnant gas markets right now, and given the economic projections are not as high as they were in 2007/2008 for both markets, we might be facing a pretty small growth environment in the gas consumption for the next couple of years.
My question is as we see from several monthly data Gazprom's production is declining, your production is increasing at the same time. Do you think this situation is sustainable and do you see any threat to your gas production goals that you stated during your strategy presentation? That's my first question.
And the second question I just wanted to clarify. You said that you disagreed with the pricing projections that, if I understood you correctly, that the analysts have in their models for Novatek. Could you clarify are we basically too bullish, too bearish here, or what is -- what have we missed? Thank you.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [10]
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On your first question, again, it's -- when you look at the, as you said, in the next couple of years, a relatively short-term view, and you're absolutely correct. EU is still going through its problems and overall demand is stagnant, as you rightly pointed out. But the also conversal (sic) out of that particular argument is that EU production, indigenous production, is still declining rapidly. So we believe that there is opportunity for continued expansion of natural gas sales in the European market. And, as we know, the Asia Pacific, particularly China, etc., and the imports of LNG to Japan are booming at this particular point.
In terms of our strategy presentation, yes, we have not -- we stick by those numbers of doubling our gas production by 2020. We have not revised them. There's no need to revise them at this particular juncture. And since we don't invest in short-term projects, it's important for us to continue looking at making these capital investments over a long period of time. So we're sticking to the strategy that we've outlined in December and no modifications to that at this particular point unless we have the MET issue, which then will obviously change and we'll come back and revise that accordingly.
In terms of the pricing that I said on the second point and part of your second question is that it's obvious, it's obvious to us. When I see the dark of 20% to 25% EBITDA adjustments to people's models for the year 2015, you've obviously got to question what pricing assumption people are using in their model. And I'm afraid to say that we still see and I still hear commentary that are being conveyed to investors that the pricing model proposed by some analysts, I'm not saying all of the analysts, but some analysts, are much higher than the ones that we've outlined in our strategy presentation. I think we were absolutely clear in stating that our 125,000 -- $125 and $150 was a range.
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Operator [11]
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Pardon the interruption. Can everybody stay online until the speaker dials back in, please?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [12]
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Okay. I will dial back in. Thank you. One second, everybody. Can you hear me?
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Karen Kostanian, Bank of America-Merrill Lynch - Analyst [13]
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Yes, Mark, I can.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [14]
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Can you hear me? Hello?
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Operator [15]
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Yes, I can hear you clearly.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [16]
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Okay. Thank you. Sorry about that. I was saying -- did you hear my answers to any of the questions or shall I repeat what I said?
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Karen Kostanian, Bank of America-Merrill Lynch - Analyst [17]
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Yes, right, thanks.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [18]
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On the first point, sorry about that, I just said that the economic situation in Europe isn't obviously understood by everybody and growth of natural gas consumption is slowing, although the other element, the converse element of that is the rapid decline in indigenous production. And we know that Asia Pacific market, notably China and LNG to Japan, is actually booming in this particular time period. So we believe that there should be no revisions to our long-term forecasts outlined by 2020, whereby we stated in our strategy presentation that we plan to double our natural gas production by that particular time.
On the second point you raised is the question on pricing. And it becomes obvious to us, as I mentioned, that the write-offs, the EBITDA margin or EBITDA reductions of 20% to 25% by 2015 clearly, clearly implies to us that there's obviously a difference in pricing assumptions. And I hear that from time to time from my meetings with investors. Now I'm not accusing or stating that all analysts are advocating a higher price, but obviously some are.
And what we clearly state and I clearly stated in our strategy presentation that the Company position vis-a-vis natural gas, we don't believe in this export pricing parity base. We said that market liberalization will be between $125 per thousand cubic meters and $150 per thousand cubic meters. However, it could spike up from time to time, but that's basically the relative range we believe is acceptable for consumption growth in Russia.
So that obviously implies that our pricing model is quite different, is more conservative than those being used in the -- by other analysts, because I just don't see any significant write-downs to our earning EBITDA relating to those orders of magnitude to 20% to 25%. That's my point.
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Karen Kostanian, Bank of America-Merrill Lynch - Analyst [19]
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Thank you, Mark.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [20]
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You're welcome, Karen.
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Operator [21]
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And we will take our next question from Lev Snykov of Greenwich Capital Moscow. Please go ahead.
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Lev Snykov, Greenwich Capital Moscow - Analyst [22]
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Yes. Hi, Mark. I have a question on exports as well. I think it's probably safe to assume that at some point in the future everyone will be able to export gas independently from Gazprom. But if we're talking about, let's say, one to two years horizon, and I understand it's premature probably to talk about that, but maybe you have any thoughts you could share. Do you think it would rather be an agreement with Gazprom as an export agent which is obviously what you have done already in the past with respect to offshore projects, or you could actually target the European customers and you could actually be able to sign contracts with European customers on your own? Do you think this could be -- do you think a later option could be considered as well?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [23]
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I mentioned previously on my last earnings conference call that I confirmed that we were in the process of negotiating contracts with end consumers in Western Europe. At that specific time we did not have anything finalized and we said that's coming from our trading -- our trading group and Novatek Gas & Power. So that's one option.
I don't -- I'm not -- we're not here to speculate. We're not here to talk about something that's not defined yet. So what I'm just saying, as I mentioned in the text, we are in the process of looking at this seriously. You've seen my comments. You've heard some reports that came out today. We are working very closely on looking at all the options to increase our operating cash flows and enhance our netback margins. And one of those avenues is obviously the export route.
Now can we use that agency agreement? That is one of the options that could be proposed. But I would say, at this point, it's too premature. And I would just wait until we get some more definitive answers coming up and we will definitely disclose that because obviously, as everybody can appreciate, that's a very strong catalyst for our stock.
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Lev Snykov, Greenwich Capital Moscow - Analyst [24]
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Mark, and just a follow-up question. Obviously I'm not talking about big politics, but rather the --- your own present company view on this. Do you think you could consider an option whereby you would be -- you would assume any further obligations, let's say with respect to maybe some social obligations or with respect to upgrading the transport infrastructure if you are given the rights to export gas, or this is something you wouldn't want to deal with.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [25]
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We already have some social obligations. This is not something that we're not familiar with dealing with. We have social obligations in the Yamal Peninsula that we've undertaken as a result of our development activities in the Yamal Peninsula. We have social obligations we've taken in the areas where we operate because they're remote areas. So we have a history of providing our fair share towards the social elements in the areas in which we operate and we'll continue to do that. So I'm not advocating or believe that there will be significant increases in those particular expenses.
And then the second part of your question, again, this is a question of law because the trunk pipeline system is owned and operated by Gazprom. We make investment into field infrastructure pipeline. And if we need to look at options beyond that, we would probably consider those in light of potential expansion of our sales. But that again is something that's premature and I don't want to speculate at this particular point.
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Lev Snykov, Greenwich Capital Moscow - Analyst [26]
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Okay. Well thank you very much.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [27]
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You're welcome Lev.
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Operator [28]
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We will take our next question from Ilya Balabanovsky of Renaissance Capital. Please go ahead.
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Ilya Balabanovsky, Renaissance Capital - Analyst [29]
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Mark, first of all, thank you for the presentation and congratulations on excellent 1Q result. And just one very quick question from me. Are you looking to increase your 2012 full year production guidance from prior 6%, 7%, in light of the extremely strong production terms that we've seen from you over the first four months of the year? Thank you.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [30]
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I would say again it's one of those questions that's a little -- this is a little more short-term, okay. Let us get through the first -- we got through the first quarter, very strong results, as one would expect. In the second quarter, in our trough period, yes, the first month and a half has been very good. Let us get through a little bit more on the second quarter and then I'll address that point in our second quarter earnings conference call, as I usually do in the past.
I just need to see where we are, relative to the trough path to determine what we believe will be our full year production because when we plan out, we plan that dip and there could be various different movements along that dip. It could be less. It could be equal to what we're doing in the first quarter. And obviously that implies that there's potential for a stronger production profile than those proposed by us at our planning stage when we give out this guidance. So I will address that question specifically on the second quarter conference call because it would give me more visibility and discussions with the second half of the year, since we've gone through the first trough area, okay? This is the explanation on that point.
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Ilya Balabanovsky, Renaissance Capital - Analyst [31]
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Thanks a lot.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [32]
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Okay, thank you. Thank you.
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Operator [33]
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And we will take our next question from [Eveni Gorgeoros] of VGB Asset Management. Please go ahead.
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Eveni Gorgeoros, VGB Asset Management - Analyst [34]
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Hello, Mark. My question is related to the last news about access to bear markets, which you plan to get. And the question is actually additional supply of gas could bring this balance to the bear markets and it could bring more harm than benefit for Russian gas industry. So how do you justify the benefits of giving access to experts for independent producers to Europe which could bring this balance to the market? Thank you.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [35]
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You're welcome. I think you have a very, very valid point there. And that's why I wanted to say it's premature to discuss because all these factors have to be considered in determining what is -- what is additive to Russia rather than cannibalizing Gazprom sales. And I think that's a very, very important issue that has to be dealt with in any discussions about export rights for independents. The last thing you want to see is complete chaos in negotiating with various customers in Western Europe. And I don't think that's the intent. So that is a very important point. And that will obviously come out when these discussions crystallize a little bit more. But I'm glad you raised that.
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Eveni Gorgeoros, VGB Asset Management - Analyst [36]
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Thank you. I hope then there will be some points that we'll discuss on the benefits which t his can give for this to both parties because now it looks more like cannibalizing sales, other than creating new markets in Europe.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [37]
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No, I think that will become more clear when we start moving forward a little bit with these discussions, okay. And I'm sure that when that point comes in time, you will see the rationale and the benefits of this.
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Eveni Gorgeoros, VGB Asset Management - Analyst [38]
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Thanks.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [39]
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You're welcome.
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Operator [40]
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(Operator Instructions). And we will take our next question from Zena Pasola of Granite Investments. Please go ahead.
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Zena Pasola, Granite Investments - Analyst [41]
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Hello. I want to go back to the competitive situation in Russia, especially within three to five year horizon, not immediate. We hear you plan to increase production. We hear Lukoil and Gazprom who is gas producers or oil companies. What do you think makes Russia fundamentally different from the US, another big gas producer who now has the gas -- too much -- produces too much gas at the moment, especially in light of the fact that export infrastructure in Russia is extremely focused on Europe and there is very little what could be done, in terms of physical facilitation.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [42]
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First of all, I think you have to consider that there's -- the US -- it's not a very comparable discussion to talk about the US market and Russia. They're completely different, in terms of the industry structure. In the United States, you have many, many companies delivering natural gas on an open market and various intermediaries, like third party pipeline access, master limited partnerships, etc., gas traders, so it's a completely different industry structure.
However, with that said, obviously what you refer to is the growth in gas in the United States as a result of the shale development. Now keep in mind this year was probably more of an anomaly in the United States than what was expected due to the warm weather. And the only reason why we have this so-called glut, which is obviously driving the price down is the fact that we have too much gas in underground storage in America, which needs to be worked off. Outside of that, the gas markets were relatively balanced, although prices were driving down.
In Russia, it's completely different. It's a market controlled by one dominant player. There's a series of independents led by Novatek. There's the oil majors that are obviously trying to monetize their gas. And everybody has a defined program in place. However, what I've been saying to our investors at meetings, etc., and I will continue saying this, is that Novatek, first and foremost, is a natural gas producer. And we focus primarily on the development of natural gas. It is not secondary to our business.
The second point I want to make is that if you were to assume that everybody completes every project in which they say they would do, we would have a glut in all commodities and that just does not happen, from a practical perspective. So what we have done, we have assessed in our strategy presentation that we delivered in December, in London -- we have assessed, like we have done in the past, even during the IPO and post the IPO, when we were involved with the Russian government in terms of building and providing inputs into the gas balance.
We look at all these factors. We look at the transport structures. We look at the other producers. And based on those factors, we believe that Novatek is best positioned right now to continue adding on gas to the Russian domestic market. And eventually, we'll start seeing other producers start adding production on. But right now I believe we have up until about 2015, 2016, etc., we have a competitive advantage, due to development of our gas fields, the structure, where we're located on the pipeline, to continue growing our market share. And that's what we plan to do. And that was what was outlined in our strategy presentation to 2020.
Next question.
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Operator [43]
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We will take our next question from (inaudible) from (inaudible) Asset Management. Please go ahead.
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Unidentified Participant [44]
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Hello, Mark. Congratulations once again. It was good to see you last time around. Very, very quickly, if I was to ask you to give me an indication of profit per the unit of gas condensate, and profit per unit of oil and profit per unit of -- profit per unit for gas, what would those numbers be for the first quarter? And how do they stack up, relative to first quarter of last year?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [45]
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Can you repeat the first part of your question because you're kind of breaking up a little bit there?
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Unidentified Participant [46]
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Okay, sorry. Mark, profit per thousand cubic meters of gas -- I mean cash profit per thousand cubic meters of gas, 2012 first quarter versus 2011 first quarter. And profit per barrel of oil or gas condensate, if you want, for lack of a better word.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [47]
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Okay. Well first of all, we don't separate that out. We do everything on a barrel of oil equivalent. And unfortunately, I don't have that data in front of me right now. But the way -- the simple way to do that is just take the cash cost out. So you just have to remove the differentiation. And I'm sure some of the analysts have done that in their analysis. But right now, we're trending about, like I said, 45%, 46% EBITDA margin on our sales. And you would just have to move out the -- obviously the depreciation and non-cash charges. But I don't have that information, sorry, right in front of me. (Multiple speakers).
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Unidentified Participant [48]
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(Multiple speakers). The reason I was asking this is to understand do you have any reason to believe that this number would deteriorate further in the space number, in terms of per unit profitability, to deteriorate whatsoever for the next three years or do you expect that to increase because you're getting a tariff increase? And I presume the MET increase is less than the increase in tariff.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [49]
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Well the aim is to balance all those. That's the big question we're dealing with now. That was the whole point. The aim is to balance these particular items, so that the overall impact to us is not a negative or a contraction in the margins. So if you look at what we did for -- we had an example in our strategy presentation whereby we believe with the tariff program in place today and the shift away from OCO traders to the end consumers, we felt that we should get approximately 10% to 12% margin enhancements, given the current structure in place. That's for natural gas.
Now obviously, with the MET discussions, the transport tariff discussions, etc, pricing discussions, they all have an inter-related connection to this question you're asking. All I was trying to bring out in the presentation is that if you look at the tax side of the question, if you look at the price then, we're still, if you stripped everything out, prices are still rising higher than the level of taxation. And we should still be able to see some netback improvements, although it may be on a slower pace.
But transportation -- the point I was making on the transportation side is that that is a much more significant cost component to us in terms of our natural gas business.
On the liquid side, the uncontrollable portion for us is the -- obviously the benchmark pricing. And if the benchmark pricing stays in a reasonable range of $90 to $100, which I believe will probably be the range for the upcoming year, we should do fine on our netback margins on liquid sales. But it depends on also regions. The way I answered it also in the first quarter, more or less on this particular point, is that if you look at the benchmark prices we use, for say the liquid side, and again, we don't split it up between gas, liquids, etc We kind of blend it all in. But just what I tried to explain on the first quarter, if you look at the difference, in 2010, we had about a $0.50 per barrel difference over the course of the year between Brent and WGI. But in 2011 that was almost $20 difference. And so when we sell our condensate to customers, to the United States, we want to make sure that we're not selling it at a lower price. So we kind of used a 50/50, 50% Brent price, 50% WGI price. So it all plays into the dynamics of the market with the aim of enhancing rather than contracting the margins.
But these are discussions that go on with our commercial trading groups on a daily basis. So we're dealing with this on an ongoing basis. And all we're, doing from the reporting side is trying to dispose of it. But the aim is that we hope within the next couple of years we don't see margin contractions based on the plan that we've put in place. And we believe that the taxes will not materialize, as discussed.
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Unidentified Participant [50]
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Sorry, last question on this part. Mark, is your profitability on -- I know it's a very difficult question to answer -- do you think your gas condensate is a more profitable product than the gas itself? The reason I'm asking this is as you had mentioned that the growth in the volume of liquid will double, more or less, in the next three years versus the growth of about 40% on gas output, do you think that should have a favorable impact on your margins?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [51]
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Assuming that the oil pricing environment stays relative against -- then the answer is yes.
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Unidentified Participant [52]
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Okay. Thank you very much.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [53]
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You're welcome.
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Operator [54]
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And we will take our next question from [Pacha Brodina] of VTB Capital. Please go ahead.
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Pacha Brodina, VTB Capital - Analyst [55]
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Thank you. Hi Mark. Thanks for the presentation. And I have two follow-up questions, if I may. First, when do you expect all the discussions from the negotiations from MET transportation tariffs and so on to be finalized, if you have any timeline in mind? You mentioned that it can be probably resolved in some one month horizon if I heard correctly.
And the second question, I just need your estimates on export netback price in Russia in 2015. Did you say that it should be something like $150 or I misheard?
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [56]
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This is where we come, unfortunate, with all the confusions. What I said before on MET is that discussions are going on. It will be finalized some time this year. It's not going to be finalized in the next month. But there's discussions. We believe over the course of the summer, when we go up to the next level of the new government being formed, etc, we'll revert back to this. So it's not going to be done in a month. And we need to make sure that it's done correctly, not expediently, and being something wrong. So we're going to obviously lobby strongly on the MET question and it's not just a timing issue. I think that this will be resolved over the course of the remainder of this year. If we have any news to report, we'll obviously report it in the upcoming conference calls.
On the second point, what I'm saying is that if you look at the trends and again, we had a slide in our strategy presentation that looked at if you followed a netback export parity model, our assumptions would be that, one, you would have higher tax ramps and, two, you would have higher transportation costs. And we said that we do not believe that that would be the model adopted.
And what we're saying -- what I'm saying now, if you take these 15% increases that are being proposed, and you extend them out to 2015, 2018, that range or whatever, if they decide to go even further than that, he point is that we're presently about $90, given an exchange rate, on an MCM basis, delivered. And we're saying that we believe that an acceptable price in the Russian domestic market that continues to facilitate demand growth is reasonable and absorbable in the Russian market, is around $125 to $150. That is our own forecast. Obviously it could change. That's what we believe is the acceptable range in the Russian market. And that's what we think will be the price by the time this liberalized market occurs, whether it's 2015, 2018, somewhere in that range of pricing models.
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Pacha Brodina, VTB Capital - Analyst [57]
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Right, thank you.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [58]
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You're welcome.
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Operator [59]
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(Operator Instructions). And there are no further questions in the queue.
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Mark Gyetvay, Novatek OAO - CFO, Member of Board of Directors [60]
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Okay. I'd just like to end the call and thank everybody. And I look forward to seeing and discussing these issues which obviously are important in more detail in the upcoming months. I believe there is a series of investor meetings, conferences that we'll be attending and we'll be glad to discuss this. And once we have some more information, rest assured everybody we will actually go out and state our position in the market.
But again, I'd like to thank everybody for attending this conference call and look forward to seeing you soon in the upcoming months. So thank you very much.
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Operator [61]
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That will conclude today's conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.
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