Q3 & 9M 2013 Novatek OAO Earnings Conference Call (IFRS)
Nov 08, 2013 AM CET
NVTK.MZ - Novatek PAO
Q3 & 9M 2013 Novatek OAO Earnings Conference Call (IFRS)
Nov 08, 2013 / 02:00PM GMT
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Corporate Participants
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* Mark Gyetvay
OAO NOVATEK - CFO
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Conference Call Participants
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* Charles Evan Sloan
Egerton Capital - Analyst
* Karen Kostanian
Bank of America - Analyst
* Timur Salikhov
BCS - Analyst
* Max Moshkov
UBS - Analyst
* Alexander Nazarov
Gazprombank - Analyst
* Alexander Kornilov
Alfa-Bank - Analyst
* Artem Konchin
JPMorgan - Analyst
* Geydar Mamedov
Goldman Sachs - Analyst
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Presentation
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Operator [1]
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Thank you for standing by, and welcome to the NOVATEK Third Quarter and Nine Months 2013 Results Conference Call. (Operator Instructions).
Today's speakers are Mark Gyetvay, CFO, and Alexander Palivoda, Head of IR.
I must advise you that this conference is being recorded today on Friday, November 8, 2013.
Let me hand the conference to your first speaker today, (Inaudible), senior oil and gas analyst of Sberbank CIB. Alex, over to you.
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Unidentified Participant [2]
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Hello, and welcome. We are going to get a running start straight into the weekend today with NOVATEK's conference call. With us we have Mark Gyetvay, the CFO, and Alexander Palivoda, the Head of IR.
I now hand over to Mark.
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Mark Gyetvay, OAO NOVATEK - CFO [3]
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Ladies and gentlemen, shareholders, and colleagues, good evening, and welcome to our third quarter earnings conference call. I would like to thank everyone for joining us this evening and again extend our sincere gratitude to Sberbank CIB for organizing and hosting an earnings conference call.
Before we begin with the specific conference call details, I'd like to refer you to our disclaimer statement, as is normal practice. During this conference call, we will make reference to forward-looking statements by using words such as our 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 revise 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 filings, including our annual review for the year ended December 31, 2012, as well as any of our earnings press conference releases and documents throughout the past year for more descriptions of the risks that may influence our results.
For tonight's call, I would like to deviate somewhat from our traditional format by highlighting some of the major points that were discussed at our strategy presentation in London in early 2011, not to regress but, largely, to remind our shareholders that some of our key projects discussed during that event were recently launched during the second and third quarters of 2013.
I believe it is relevant to spend a few minutes to circle back to this presentation because, over the past 12 to 18 months, most, if not all, of our investors and, certainly, the majority of analysts covering NOVATEK, followed their primary attention on external events such as mineral extraction, tax debate, as well as domestic pricing issues.
Considering the nature of these external items to our operating revenues and margins, it is quite understandable that many questions were directed towards us regarding these important topics. But, unfortunately, many investors and analysts moved their focus away from the Company's strong fundamentals, and this was notable when we began discussing the upcoming new fields and process complex launches.
During that event, we outlined our respective timeline for the launch of various new fields that were either acquired recently or a part of our ongoing exploration activities; namely, the timely launches of the first and second stages at the Samburgskoye field at SeverEnergia and the recent launch of the Eastern Dome at Nortgas.
We also recently launched the first and second processing units at our Ust-Luga Complex, for a total processing capacity of 6 million tons, as well as the first two additional processing trains at the Purovsky processing plant to increase our processing capacity of unstable gas condensate from 5 million tons to 8 million tons.
We are currently working on the next two processing trains at Purovsky, which, when completed in early 2014, will increase our total processing capacity to 11 million tons per annum. Relative timing of our processing capacity expansion projects is correlated to the expected time and the launch of new, wet fields, and, hence, an increase in our liquids volumes.
Moreover, we recently launched first production at the Urengoyskoye field, which is part of our Olimpiyskiy license area with annual production capacity of approximately 1 billion cubic meters.
Why is this relevant? Firstly, our capital commitments to expand our processing capabilities corresponds to the expected increase in volumes of unstable gas condensate from our fields and joint ventures, as mentioned during our strategy presentation. We forecasted a tripling of our liquids productions up to the end of the decade.
Secondly, over the next couple of years, we will continue to launch a series of new fields, either core fields like the Urengoyskoye and the Yakhinskoye field at SeverEnergia or smaller satellite fields like the North-Khancheyskoye and the (inaudible), as well as the Termokarstovoye field, which is part of Terneftegaz joint venture with Total and the Yarudeyskoye oilfield at Yargeo.
Collectively, these new fields will comprise the lion's share of our expected production growth over the next two to three years and highlights that the growth model of NOVATEK is clearly intact with visible production growth translating into increased earnings, dividends from our joint ventures, and operating cash flow generation in the foreseeable future.
The other important point I wanted to stress regarding the aforementioned projects before we revert back to the respective quarterly results is a clear track record of successful project execution. We have delivered on our projects on time and within the proposed budgets. We are committed to delivering the results outlined in our strategy presentation, and I cannot underscore the importance of this point, as it is quite obvious to everyone that there were plenty of recent external factors that could have easily distracted our attention from our core business.
We are focused on our core business activities, and this is a strong testament to the commitment and direction of senior management, as well as the dedication of each and every one of our trusted employees at NOVATEK and our subsidiary companies. We take these issues very seriously and spend a huge commitment of time driving the business towards the goals and objectives we have established for the group. The continued success of NOVATEK is predicated on delivering on our growth prospects, as well as our underlying focused project execution and cost control.
Moving forward, I would like to provide a brief update on the Yamal LNG project, as well as some of the other noteworthy news flows during the reporting period.
In October 2013, (Inaudible), Russia's main state export agency, issued a positive opinion on the engineering and design documentation package for the seaport facilities construction, including the (inaudible) channel in the Ob River. This essentially means that Yamal LNG now holds all the necessary state approvals for the construction of facilities required for gas production, treatment, liquefaction, as well as shipment of LNG and stable gas condensate.
Also in October 2013, the Russian state enterprise Rosmorport completed the dredging a four-kilometer channel and a harbor at Sabetta Port. Overall, 11 million cubic meters of soil has been excavated, which essentially increased the sea depth to 11.5 meters, allowing tankers with 9-meter drafts to use the port facilities 12 months per year.
In addition, with the completion of this dredging operations, an official order was issued by the captain of the seaport of Sabetta allowing winter navigation for the first time at the port. This official order, combined with the completion of two material offloading berths, will allow the receipt of approximately 170,000 tons of construction materials to be delivered during the winter navigation period.
We have now laid 6,700 concrete slabs, or approximately 1,600 meters of airstrip, representing approximately 70% of the work activities for the landing strip, and we expect this portion of the work to be completed this winter season. The airport facilities and communication networks are currently being built, and we will soon begin the work activities related to the construction and installation of specialized airport equipment, such as the radio, meteorological, and air traffic control equipment. The airport is expected to be formally commissioned sometime in early third quarter of 2014.
Presently, we have roughly 1,500 people onsite working on various infrastructure stages of the project. And, to date, 43 kilometers of road, approximately 27% of the total, were backfilled. 27 kilometers of power line, approximately 16% of the total, were built.
In terms of living quarters, nine buildings have already been built, and another eight buildings are currently under construction.
We anticipate that EPC contractors Technip and JGC will employ approximately 6,000 employees, while Enterpose and Vinci, contractors for the LNG storage tanks, will employ approximately 1,200.
The LNG plant construction site is currently being backfilled.
During the winter construction period, we estimate completing the pilings for the LNG tanks, the eight living quarters, backfilling the 50 kilometers of road, one more well drilling pad, backfilling of the EPC contractor site, and the construction of eight bridges.
In terms of production drilling, five well pads have already been prepared and two drilling rigs are currently drilling wells on the South Tambeyskoye field. We have completed drilling of eight production wells, representing 100% of the planned drilling activities for 2013, and five production wells out of eight completed have been tested and confirmed the field geology, as well as exceeding the estimated, planned flow rates.
We have completed the first round of tenders for shipping, and seven out of the initial eleven shipping companies have been short-listed for the second round tender. We expect to receive their proposals for the second round by the end of November. The tender for the trans-shipment services is also at the final stages, and we will provide additional updates once completed.
Most of the offers for the construction of the LNG plant have been received according to the open-book tender process, and we are currently evaluating the proposals. We expect this evaluation process to be completed in the nearest future, and we will continue to provide status updates once this process is completed.
A binding contract to sell a 20% stake in Yamal LNG was signed with CNPC on September 5, and we estimate the closing date around December 1, subject to the receipt of all necessary regulatory approvals. At the time of the signing, there was also a commitment made regarding an offtake agreement with CNPC and their help in securing Chinese commercial banks' participation in project financing.
On October 22, a (inaudible) agreement was signed with CNPC for the delivery of at least 3 million tons per annum of LNG delivered ex-ship, or DES, terms for a period of 15 years with possible supply extensions with the LNG price indexed to the Japanese crude cocktail.
We have stated many times in the past that it was important for us to secure a partner in the project with the ability to provide us with a commercial market. We have accomplished this objective with the upcoming entrance of CNPC to the Yamal LNG project.
We are currently in discussions with the China Development Bank, the Industrial and Commercial Bank of China, the Bank of China, and the China Construction Bank for their active participation in the external project financing transaction for Yamal LNG. We have already had a series of constructive meetings with the Chinese banks, and they are presently doing their due diligence on the project. We anticipate that the final documentation for participating in the project financing will be executed simultaneously with all of the other lending participants in the project finance package, including but not limited to foreign export credit agencies, international and Russian commercial banks, and other financial institutions. This process is ongoing, and we will provide additional updates on future earning conference calls.
As part of the ongoing marketing activities, I would like to confirm that Yamal LNG and Gas Natural Fenosa recently announced the conclusion of an LNG offtake agreement, which stipulated that Gas Natural will purchase 2.5 million tons of LNG per annum, the equivalent of roughly 3 bcm for a period of 25 years at prevailing LNG prices in the relevant Spanish market. As of today, we have collectively contracted approximately 70% of the overall estimated LNG production according to HOAs or binding contracts subject to our final investment decision. The progress to date in our LNG marketing efforts confirms the willingness and receptivity of buyers towards our project and the necessary precondition, the project financing.
Another question on the minds of many investors has been the government's plans to liberalize the LNG export markets.
The Russian government has recently approved the amendments to the export law at the end of October, and a package has now been sent to the State Duma on November 6. Essentially, direct export rights will be granted to projects which have special terms in their production license stipulating construction of an LNG plant or supply of LNG gas produced for liquefaction. This means that the Yamal LNG project and our fields located on the Gydan Peninsula all qualify for direct export rights according to the approved amendments.
In addition, according to Energy Minister Novak, to coordinate LNG flows, the Ministry of Energy plans to request information on directions, volumes, prices, and customers. We expect the Russian government to issue a special order on this in the near term.
More importantly, though, there are no restrictions placed on us to market LNG to the eastern and western markets.
President Putin also recently issued an order to relevant ministerial bodies to consider zero mineral extraction tax and export duties for our Gydan Peninsula fields subject to liquefaction of produced gas on the Yamal Peninsula. This order, again, confirms the Russian government's support for our projects and their commitment to expand Russia's role in the global LNG markets.
We continued our ongoing exploration activities, both drilling and seismic work, at our subsidiaries and joint ventures during the period, where, presently, no new fields or deposits were discovered in the third quarter.
In terms of production drilling, for the year to date ended September 30, we drilled 117 production wells at our subsidiaries and joint ventures, of which 17 wells are currently being finalized. We plant to drill approximately 172 wells for the full year 2013.
In October 2013, the Eastern Dome of the North Urengoyskoye field developed by Nortgas was formally launched. 18 production wells have been completed at the Eastern Dome, and the field's infrastructure includes a gas treatment plant with annual capacity of 6 Bcm, gas gathering networks, and a gas and gas condensate pipeline to the Western Dome of the field.
With the official launch of the Eastern Dome, the Nortgas joint venture is expected to achieve peak natural gas production of more than 10 billion cubic meters and 1.4 million tons of gas condensate in 2014. The formal launch is another significant accomplishment by the Company to fast track the development and production of natural gas and gas condensate from the Eastern Dome by almost one year earlier than the field's original development plan, since we acquired our equity stake in Nortgas in late November 2012.
At SeverEnergia, we continue to move forward with our development plans at both the Urengoyskoye and the Yaro-Yakhinskoye field with the expected field launches in the second quarter of 2014.
The SeverEnergia joint venture is expected to be a major contributor of our near-term gas and gas condensate production growth through 2015, and it is obviously a point of recent news flow with our express interest to increase our equity stake in the joint venture.
At the Urengoyskoye field, we have completed the drilling of 25 cumulative production wells, the construction of the gas and gas condensate pipelines and electricity lines, and we are approximately 90% complete with the installation of equipment for the gas treatment facility.
As mentioned on our last conference call, the successful drilling of horizontal wells in the (inaudible) formation has resulted in our decision to review the overall development plan by replacing vertical wells utilizing hydrofractures with the drilling of larger-bore, horizontal wells. We expect a new development plan will reduce the overall number of wells required to exploit the field; thus, less capital expenditures, as well as increase in the flow rates per well drilled.
At the Yaro-Yakhinskoye field, we have completed 20 cumulative production wells but are at various stages of completion on field infrastructure activities. For example, the backfilling of well pads, roads, and areas for gas treatment and other units is approximately 70% completed. The condensate pipeline of 56 kilometers is roughly 55% complete. Works are currently underway to complete the 20-kilometer gas pipeline. We have ordered equipment for the gas treatment facility, and some of the equipment has already arrived on the site, while other pieces are currently being fabricated at a factory.
At our Termokarstovoye field, we have completed the backfilling of well pads, roads, and areas for all the units onsite and have begun both piling work and production drilling. Seven production wells have been completed out of the total planned production wells of 22, which have indicated higher flow rates than initially planned for those wells tested. We are targeting an earlier launch of the field, in 2015, rather than the initial launched field expected in 2016.
As mentioned on prior conference calls, the Company has decided to increase our capital commitments for the development of crude oil layers or fields in our asset portfolio to capitalize on the recent changes to the tax legislation, which exempts mineral extraction tax for all crude oilfields developed above the 65th parallel. This exemption includes all of our crude oil development activities and accounts for the significant production growth in our crude oil output over the past two years.
Specifically, we have increased our investment commitment to the East-Tarkosalinskoye field, which essentially accounts for the majority of the present growth in our crude oil output but, more importantly in my opinion, will be the capital investment over the next three years at our Yargeo joint venture, a strictly crude oilfield development. We estimate spending approximately $1.5 billion during this period, of which we are responsible for 51% of the capital costs. But the field's crude oil output is forecasted to peak at approximately 3.5 million tons per annum, which would be subject to zero mineral extraction tax until the year 2022.
We have not begun development drilling at the Yargeo joint venture but have mainly concentrated construction efforts on the field's infrastructure-related work like backfilling the construction site and building the associated gas and crude oil pipelines. During 2014, we plan to drill 15 production wells and proceed with the construction of an oil treatment facility and complete the associated pipeline construction work. The field is expected to be launched in 2015.
At Ust-Luga, we completed the construction activities and began commission and tests at the second-stage fractionation unit in October. The second stage includes a stable gas condensate fractionation unit with a nameplate capacity of 3 million tons per annum and an additional deepwater berth. We now have total nameplate processing capacity of 6 million tons per annum, and we expect the plant to be operating at full capacity after the launch of the Yaro-Yakhinskoye field, which more or less translates to the middle of 2014.
During the quarter, the Ust-Luga Complex processed 714,000 tons of stable gas condensate and produced 718,000 tons of refined product output, which included the reprocessing of all spec products accumulated in June. Twelve tankers, including two tankers via the Arctic Ocean's northern sea route, with 562,000 tons of naphtha, four tankers with 73,000 tons of jet fuel, and four tankers with 55,000 tons of gasoil and fuel oil were sold during the quarter.
In October, the Ust-Luga Complex processed 309,000 tons of stable gas condensate versus 265,000 tons in September, the output of marketable, refined products increasing from 264,000 tons in September to 305,000 tons in October, or by approximately 16%.
As we ramp up throughput volumes, we will effectively increase our processing efficiencies and reduce our per-unit cost to process it. Therefore, we will need a few more quarters of operational data to provide meaningful, comparative information, as well as understanding the cost dynamics as we reach full operational capacity.
Nonetheless, the formal commissioning of this complex, combined with the increased margins we receive for our refined gas condensate products, contributed to the overall strength in our liquid earnings for the reported period.
I would like to make a few brief remarks on some macroeconomic matters.
The Russian government achieved its stated aim of increasing the regulated gas tariffs by 15% in 2013 through a series of price adjustments throughout the year. The third quarter results were the beneficiary of a 15% price increase effective July 1 and another 3.1% price increase effective August 1 to offset the 3% reduction effective April 1. More recently, on October 1, the government increased the gas tariff by another 1.9% to essentially achieve the stated 15% increase in 2013 relative to 2012.
We expect the domestic gas price to remain flat at the August/September 2013 levels [or imply] a year-on-year growth of 8% versus 2013 price levels. This essentially means that we expect a 1.9% decrease effective January 1, 2014 to achieve their aim of maintaining the August/September 2013 price levels.
We would also like to point out that there are present discussions on eliminating the plus or minus 3% adjustment quarter; again, implying flat prices for 2014.
Looking ahead, we are modeling domestic gas price tariff increases at inflation for 2015 and 2016.
The new MET gas formula approved by the State Duma on September 20 is expected to come into effect on July 1, 2014. And, as previously stated, we believe the end results of these discussions were consistent with our expectation and lobbying efforts.
There are also present discussions surrounding the reduction of the marginal export duties for crude oil and refined products in 2014 to 2016. Although positive to us based on initial discussions, we prefer to take a position of wait and see before providing any comments on these discussions at this time.
As for gas production, we have been experiencing unseasonably warm weather in November relative to this time of year. However, this is not the first time we have experienced warmer weather, but it does have an impact on our planned daily gas output. Our production guidance for the year is based on the assumption of normal weather patterns. And an extended period of warm winter weather during the traditional peak season could impact our full year guidance. But it is too premature to provide any revisions to our full year guidance at this point. But I wanted to raise this point to make everybody aware of the current weather situation.
For the nine months ended September 30, our natural gas production was up by 8.9% year on year, while our liquids production was up 12.7% year on year. The actual results to date are slightly higher than our guidance for natural gas but much higher than our initial guidance for liquids. In October 2013, our natural gas production was up 10.4% year on year, and our liquids production was up 7.1% year on year.
At this point in time, we are maintaining our overall production guidance for 2013. We will provide our production guidance for 2014 later in the year after we conclude our business planning for 2014.
In terms of capital expenditures, we are still maintaining our overall guidance of RUB60 billion for 2013. Aggregated capital spent is approximately RUB48 billion for the nine months 2013, inclusive of RUB45 billion on core capital projects and approximately RUB3 billion on acquisitions of mineral licenses.
Our Yurkharovskoye field accounted for approximately 31% of the capital spend for the nine months ended September 30 with the ongoing work on construction of a new booster compressor station, which is expected to be completed by the latter part of 2014.
In addition, we had a notable increase in capital outlay for the processing expansion at the Purovsky processing plant, which we will continue into 2014 as we complete the third and fourth train additions.
We will also provide our capital expenditure guidance for 2014 at a later date.
We delivered another set of strong financial and operational results for the third quarter and nine months ended September 30, 2013 relative to the year-on-year comparative results, primarily due to increased volumes for both natural gas and liquids and reasonably strong commodity prices for our production sold in the reporting period. We delivered robust natural gas and liquids production growth consistent with our annual guidance, reported double-digit earnings growth, and generated strong operating cash flows to fully fund our capital expenditure program. And, during the third quarter, we reverted back to reporting positive free cash flows.
In terms of sales volumes, we significantly increased the proportion of our natural gas sales to end customers year on year to approximately 90% from 65% and remained relatively consistent quarter on quarter. This change was largely driven by new sales contracts concluded in 2012, as well as the acquisition of an 82% equity stake in Gazprom mezhregiongas Kostroma in December.
During the third quarter, we reported total gas sales to end customers of 12.9 billion cubic meters, which represented an increase of 48% year on year and remained relatively [flat] quarter on quarter. Within end customer sales, power companies and large industrial customers represented roughly 96% of our sales volume delivered, or approximately 86% of our total gas sales for the quarter.
Total natural gas sales for the reporting period aggregated 14.4 billion cubic meters, representing a year-on-year growth of 6.6% but slightly down, 1.5%, quarter on quarter. The decrease on our quarter-on-quarter total sales volumes was largely attributable to a decrease in ex field sales to smaller, regional traders, as well as increased injections into the underground storage facilities.
We had a change in a regional mix of our gas deliveries as a result of these new contracts. We increased our sales volumes year on year by approximately 2.3 bcm to the city of Moscow and the Moscow region, as well as increased our sales volumes to Kostroma region by 685 million cubic meters during the reporting period. Geographical regions representing greater than 10% of our sales volumes included the Chelyabinsk, Perm, and Moscow regions and the city of Moscow. As a result of the changes in our regional sales mix, we had a notable increase in our average distance to market to approximately 2,240 kilometers, representing an increase of 282 kilometers year on year and 56 kilometers quarter on quarter.
We reported a significant increase in our transportation expenses for natural gas during the current reporting period due to the higher proportion of end customer sales, the increase in the average distance to market, the change in the purchase arrangement with Sibor, and a transport tower of growth 6.4% August 1.
We also achieved reasonably strong netbacks for our natural gas sold during the reporting period due to the regulated tariff increases and our regional mix of sales. Our average netbacks for natural gas sold to end customers increased by RUB370 per 1,000 cubic meters, or 22%, as compared to the third quarter 2012 and by RUB427 per 1,000 cubic meters, or 26%, quarter on quarter.
Our average ex field sales price increased by approximately 22% year on year and 25% quarter on quarter, largely due to the gas tariff increase, as previously mentioned.
We are pleased with the strong gas pricing we received for both end customers and ex fields in the current reporting period, and we achieved a reasonably good margin differential between the netbacks received for end customers and the price at the well head applied to a larger proportion of sales to end consumers.
With the commissioning of the Ust-Luca Complex in June 2013, we began to process a transition and sell in, primarily stable gas condensate, to sell in a slate of refined products fractionated from the stable gas condensate as raw material feedstock to the plant. During the reporting period, we sold 1.4 million tons of liquid hydrocarbons, representing a 27% increase over the comparable year-on-year and quarter-on-quarter reporting periods. The increase was mainly driven by the reduction of liquid volumes in transit, or the initial buildup of raw materials at the Ust-Luga Complex, as well as an increase in crude oil production and the purchasing of stable gas condensate from our joint ventures.
At quarter end, we had approximately 494,000 tons of liquid hydrocarbons in storage or transit, including approximately 185,000 tons of stable gas condensate in storage at Ust-Luca and approximately 172,000 tons of naphtha and products in storage and/or in transit.
On a total boe basis, we increased our third quarter production to approximately 103 million boe versus 94 million boe in the prior reporting period, representing an average total hydrocarbon production per day of approximately 1,116,000 barrels per day for a combined increase of 9.4% year on year.
We continued to effectively manage our overall operating expenses during the third quarter, and the significant increase period on period of RUB17.5 billion, or 59%, was primarily due to an increase in our transportation expenses, taxes (inaudible) income, and the purchase of natural gas and liquid hydrocarbons. As previously mentioned, we had a significant increase in end customer sales, which includes transport costs, as well as the change in regional markets, essentially a greater distance to market. For taxes, the increase was essentially attributable to the significant increase in natural gas MET tax rates in July of roughly 60% year on year and 52% quarter on quarter. We also significantly increased our purchase of natural gas from our joint ventures in Sibor, as well as increase in our purchases of stable gas condensate.
There were no material surprises in our G&A expenses to highlight during the comparable reporting periods.
Our balance sheet and liquidity position continued to remain strong throughout the reporting period, although we increased our total debt position from RUB135 billion at June 30 to RUB141 billion at September 30 through the use of our existing credit facilities.
We were cash flow positive during the third quarter of 2013 and ended the quarter with free cash flow position for the Company of RUB9.7 billion, which is lower than the prior year but takes into account a significantly higher capital expenditure program in the current 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 come due for payment.
I would like to thank everyone for attending tonight's earnings conference call and again reiterate the importance that delivering our projects on time and within budget. Project execution is a crucial element to maintain credibility with our investors.
Moreover, I would like to stress the importance of the recent field and processing launches, as these projects underlie the foundation for continued growth for NOVATEK in terms of production, earnings, and cash flows. So the comments on NOVATEK being ex growth are unfounded.
The recent release of IHS Herold's global upstream performance review again confirms NOVATEK's top position as one of the lowest-cost producers in the global oil and gas industry. We ranked number two in the worldwide survey under both finding and development costs and reserve-replacing cost categories, and this marks the seventh consecutive year that NOVATEK is ranked amongst the top five global oil companies in these important industry metrics over three-year periods.
We ended the third quarter with above-consensus earnings, EBITDA, and net income, and we are very pleased with the strong financial and operational reports during the third quarter.
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). Charles Evan Sloan, Egerton Capital.
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Charles Evan Sloan, Egerton Capital - Analyst [2]
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I have a few questions, starting off just on the crude oil, which is obviously becoming a bigger business line for you. I appreciate the larger scale coming on stream with your joint venture, and I think you mentioned 2015. But you're also ramping up East-Tark. Can you give us kind of some clarity on how the crude oil production is going to ramp from 2013 to 2016 and the profitability of those barrels just for understanding?
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Mark Gyetvay, OAO NOVATEK - CFO [3]
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Okay. I believe, Charles, on the overall growth in crude oil, it's estimated to be up about 5 million tons per annum by 2015/2016 period of time. In terms of overall profitability, I mean, it's just subject to the crude oil prices at that given particular moment in time. So I really can't give you a definitive answer on that other than say that we would not have made this investment without the question of this being a very profitable business for us, aided, obviously, by the tax concessions given for zero MET for fields above the 65th parallel. I mean, you're just going to have to follow this on a quarter/quarter basis. But crude oil is obviously becoming a much more significant business for us, and that doesn't even take into consideration, potentially, the future growth in crude oil out of the SeverEnergia assets.
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Charles Evan Sloan, Egerton Capital - Analyst [4]
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It seems that that 5 million tons is pre-SeverEnergia assets.
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Mark Gyetvay, OAO NOVATEK - CFO [5]
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Correct.
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Charles Evan Sloan, Egerton Capital - Analyst [6]
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And then, on the -- I appreciate this is something you might not be able to comment on in too much detail, but you said that the 3-million-ton offtake agreement with the Chinese will be kind of benchmarked on JCC. Would that be similar to existing energy contracts in the region with -- ? Or how is it indexed? I mean, should I just assume it's similar to other contracts in that region?
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Mark Gyetvay, OAO NOVATEK - CFO [7]
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It's going to be referenced off that benchmark price, and it should be consistent with LNG demand in that market as we speak today. So it's standard terms, consistent with that particular region, as well as the product going into the European markets. It will be basically standard LNG terms and conditions referenced off some kind of benchmark.
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Charles Evan Sloan, Egerton Capital - Analyst [8]
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And final question. Can you give us an update on the timelines of the final investment decision?
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Mark Gyetvay, OAO NOVATEK - CFO [9]
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Yes. It's -- like I said in the presentation, we're currently now reviewing all the final, open-book tender questions, and we expect that we will make that decision before yearend.
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Charles Evan Sloan, Egerton Capital - Analyst [10]
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Thank you very much.
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Operator [11]
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Karen Kostanian, Bank of America.
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Karen Kostanian, Bank of America - Analyst [12]
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Just a question from me. Would you be able to comment about the situation around SeverEnergia, whether negotiations are ongoing for the Eni stake and whether, as newspapers are actually reporting, there is also a negotiation ongoing for the Enel stake which Rosneft supposedly purchased? Thank you.
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Mark Gyetvay, OAO NOVATEK - CFO [13]
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Generally, we don't speak and discuss rumors that are speculative in the market. All I can tell you is that, yes, we are interested in that asset, and we will continue negotiating for a stake in that particular asset.
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Karen Kostanian, Bank of America - Analyst [14]
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Thanks.
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Operator [15]
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Timur Salikhov, BCS.
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Timur Salikhov, BCS - Analyst [16]
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I've got a couple of those. The first one is regarding CapEx for the Yurkharovskoye field. Could you, please, advise in the best way to model the field's CapEx after the Company launches the booster compressor station next year?
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Mark Gyetvay, OAO NOVATEK - CFO [17]
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Yes. Going forward, I would say you probably have similar CapEx for the next year or two and, then, I would say, dropping down to maintenance capital, probably a third of what you're seeing being spent today.
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Timur Salikhov, BCS - Analyst [18]
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Okay. That's very clear. Thanks.
And my other question is regarding the use of cash flows. I've seen a stable macro. NOVATEK is expected to churn more and more cash flow going forward. And, on my numbers, cumulative free cash flow over the next three years could total something like $6 billion or $7 billion. I've seen $3 billion paid in dividends. How does the Company plan to spend the rest of the cash flows?
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Mark Gyetvay, OAO NOVATEK - CFO [19]
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If you look at our ongoing activity, we have operations to fund, the Yargeo transaction in terms of that field. We have, eventually, capital being spent on the Gydan Peninsula. So there's activity that we have in the forthcoming three- to five-, five- to seven-year horizons that we would need to be spending funds.
If we accumulate a certain balance of cash that is in excess of where we need to spend, I think we may consider revising the dividend policy. But, at this particular point, it's too far in the future to speculate on that.
But we do and we will have uses of cash for the foreseeable future as we continue some of these other big field developments and would think, particularly, related to either the expansion of LNG processing capabilities on the Yamal Peninsula, as well as the development of the Gydan fields.
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Timur Salikhov, BCS - Analyst [20]
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Okay. Understood. Thanks very much.
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Operator [21]
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Max Moshkov, UBS.
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Max Moshkov, UBS - Analyst [22]
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I have just three questions, if I may. The first one is -- what is your estimate for (inaudible) tests for producing sales based on the formula put by the government for the next year?
The second question -- if you'd elaborate a bit on the SeverEnergia production-sharing agreement -- how future production will be shared (inaudible) shareholders just to understand it in more detail.
And the last question. Given this LNG (inaudible) export monopoly -- [diminish] the projects with monopoly, when we should expect production strategy update from NOVATEK? And would you prioritize Gydan fields; i.e., would you consider liquefaction on the production from Gydan fields, given this development? Thank you.
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Mark Gyetvay, OAO NOVATEK - CFO [23]
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Okay. Let me just go back. On the first question, the first part of your question, MET for next year, I would say that we're -- if you look at -- you got to take this in consideration for twofold for 2013. 2013, we have seen two rates. So you have to combine those two rates because you have a rate up until July 1 and then the additional increase in the formula.
So, on average, we have a blended rate in 2013 of approximately, say, RUB350. And we expect that number, given the new formula, again, in July 2014 to go up about RUB459; so, an increase of RUB100 to RUB109 based on the new formula. But that, again, would be consistent with our expectations of the tariff in that given particular period of time.
The second question you asked was on SeverEnergia. Can you repeat that question again? I'm trying to understand what you're trying to get, what kind of information.
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Max Moshkov, UBS - Analyst [24]
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Yes. I'm trying to understand what is the production-sharing agreement for the (inaudible), not just for (inaudible) but for (inaudible) of SeverEnergia -- how shareholders -- I mean, (inaudible) development (inaudible) -- and how they will share production (inaudible).
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Mark Gyetvay, OAO NOVATEK - CFO [25]
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The agreement with SeverEnergia -- 100% of the gas is now offtake by Gazprom and 100% of the liquids by NOVATEK. I don't see that changing. That's for current and going future.
And your third question related to --
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Max Moshkov, UBS - Analyst [26]
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The third question about the update on the production strategy because a lot is going on with oil plants and with Gydan sales. So when we should expect you to make an update?
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Mark Gyetvay, OAO NOVATEK - CFO [27]
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I'm working on that. We started working on that this past week, and I suspect we'll probably view the springtime as the next update because that will give us a chance now to more or less get the Yamal LNG, FID, everything in decision moving forward. It will then also show us the launches of these two new fields coming on at SeverEnergia, et cetera. And then it gives us a little, probably, more clarity of what's going to go on a little more in the future on Gydan. But I'm expecting that we'll have an update.
Now, what I just want to say to everybody tonight -- our goal is to maintain the strategy as we present it. That's what we're working towards. What we probably would do -- we'd just provide some updates, given a change in formulas that we've seen being proved, the change in (inaudible). We may be able to get some more clarity on the marketing for LNG between regions, as well as an update on some of the field developments post the December 2011. But I'm looking at the springtime on that, Maxim.
------------------------------
Max Moshkov, UBS - Analyst [28]
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Okay. I think it will be really helpful. Thank you very much.
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Operator [29]
------------------------------
Ildar Davletshin, Renaissance Capital.
Unidentified Participant) Hi. This is (Inaudible), Renaissance Capital. One question from me.
You've managed to grow your netbacks at over 23% year on year and even higher than that quarter on quarter in the third Q while the markets have grown by 15%. And I understand that it's the result of improvement of regional mix of sales, et cetera. But can you -- ? How much room do you see for additional growth beyond tariffs going forward?
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Mark Gyetvay, OAO NOVATEK - CFO [30]
------------------------------
Again, it's a difficult question to answer at this particular time. (technical difficulties)
Sorry. There's a fire alarm.
When we're expecting to continue moving forward with our moving down to the end consumer markets in these particular regions -- it's just very difficult to give you with any clarity other than what is the expected growth rate in the transportation tariff. What's the expected effect on the inflation-adjusted prices, et cetera? I would say that we're probably reasonably in an order of magnitude of what we're showing now. But I can't give you any certainty on those numbers. It's just hard (inaudible).
Unidentified Participant) Maybe breaking this out -- (technical difficulties) --
Maybe breaking this out into pieces, do you expect to see an increasing share of end customers? Right now, you're almost at 90%. So maybe you will switch to like, say, 100% (inaudible) customer or almost 100%. And then, as a result of this, the netback will improve further.
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Mark Gyetvay, OAO NOVATEK - CFO [31]
------------------------------
I don't see us going to 100%. I mean, I think we're pretty comfortable with the 90/10 split we have now. And so I would assume that you should at least model what we have presently going forward. But I can't say that we'll preserve the same netback increase at the same orders of magnitude. It's just too hard to predict right now.
Unidentified Participant) Okay. Thank you.
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Operator [32]
------------------------------
Alexander Nazarov, Gazprombank.
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Alexander Nazarov, Gazprombank - Analyst [33]
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I have a more general question rather than other guys had.
Considering your long-term strategy talking about Yamal LNG precisely, you shouldn't ignore the shale gas theme. So could you, please, share us what's your view? What's NOVATEK's view on the shale gas outlook? What's the outlook for North American gas production and probably LNG exports in the future? What risks in this particular topic you consider in doing -- assessing your Yamal LNG perspectives? Thank you.
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Mark Gyetvay, OAO NOVATEK - CFO [34]
------------------------------
I guess it's a macro question on the industry. And, obviously, we look at the effect of the revolution that's happening in the United States. And it's obviously had a serious impact on production growth in the US. And then an offtake of some of the exports of coal to Europe -- and it's kind of impacted a little bit on the European demand side.
The question is not the shale revolution. The question is -- more specifically is how many of the proposed export projects that are on the drawing board in the United States will get approved by the Department of Energy, et cetera, for the export of LNG. And I think, as of today, there's about 30 or so applications, and I believe only two of them have been formally approved.
But I think the market should expect at some time in the future there will be exports come in of LNG out of the United States, maybe not in the same order of magnitudes. But, clearly, there will be some volumes coming out into the Asian-Pacific, European Basin markets. So we have to account for that in the overall supply side.
Does it have any risk on our projects? Probably very little right now. I mean, I think there's an impending shortage or tightness in the LNG markets, given some of the delays in some of the projects and the lack of any new [FID] projects that we see in the market today
So I think, given the fact that we are in a market -- we're seeing that there's strong demand for the LNG that we will be marketing once the plant begins processing and a sales process. We're seeing that there is a strong receptivity towards our projects. I believe we'll be able to have all our LNG contracted out and with minimal risks based on these export projects.
But it's something you have to consider, you have to look at, you have to understand. You have to understand the markets that are being delivered.
But I think the point that a lot of people miss in all these discussions is that, when you add the transportation, profit margins, et cetera, shipping costs coming from the United States to the Asian market, we're not talking about a dramatic change in the price. So what you're really looking at is not a negative effect on overall pricing. It's just that you may have some competition coming against a supply side -- a diversity supply question. And I believe that our project in that mix will be considered as part of this diversity (inaudible), although some people say it might be coming out of Russia. It will be coming out of Russia but from another player. So I think we'll fit into that sort of diversification supply side.
So I'm pretty confident we'll be able to move this (technical difficulties). I'm pretty confident we'll be able to move our supplies without any major risk.
------------------------------
Alexander Nazarov, Gazprombank - Analyst [35]
------------------------------
Okay. Thank you very much. Very helpful.
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Operator [36]
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Alexander Kornilov, Alfa-Bank.
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Alexander Kornilov, Alfa-Bank - Analyst [37]
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Actually, many of my questions have already been answered. I have only one left.
Could you, please, specify it -- ? You might have. It's really sort of public information. What is your sort of reference benchmark -- price benchmark for your contract with the Spanish firm you have recently signed? I'm talking about $2.5 million per annum, the contract you have signed last week with the Spanish firm. Thank you.
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Mark Gyetvay, OAO NOVATEK - CFO [38]
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Both are going to be referenced at a standard price in what we are seeing in each, respective market. There's nothing unusual about or magical about any of these contracts. I mean, they're basically using reference prices that are out in the marketplace.
And, at this point in time, we're not really going to talking about the pricing until we contract everything out. So I would say I would like to hold off on that comment, other than saying that you'll find out that it will be, basically, standard reference prices for these particular transactions and sales in the particular region where we're delivering the product.
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Alexander Kornilov, Alfa-Bank - Analyst [39]
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Fair enough. Thank you.
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Operator [40]
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(Operator Instructions). Artem Konchin, JPMorgan.
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Artem Konchin, JPMorgan - Analyst [41]
------------------------------
Just one question from me, surprisingly. In light of the increasing -- potential increasing gas-on-gas competition domestically, could you estimate, or, perhaps, do you have a firm number of the churn rate of the total market per annum? What is the, so to speak, average annual renewals or contracts up for grabs, basically, every year? Thanks.
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Mark Gyetvay, OAO NOVATEK - CFO [42]
------------------------------
Again, that's a hard question to answer when I'm not looking at sort of the portfolios of Gazprom, et cetera, determining what contracts are coming up for renewals at this particular point. So I would like to hold off on answering that question because I just don't have that number in front of me right now to even speculate.
But I do like to go back -- just to go back to the question on the pricing for a second because I -- it's not a question of trying to avoid providing any of this data. We've already said it's clearly going to be the indexation, the JCC, and a mix of NPB and Brent. I mean, that's going to be the standard pricing terms for these particular LNG contracts. I just want to make sure that, you know, we're not -- like don't want to disclose information. They are standard. There's nothing unusual. There's nothing of any huge discounts given in any of this pricing to secure these particular contracts. I just want to make that point. We say the Japanese crude cocktail, and, so far, Europeans will be based on a Brent or NPB index. So that's where the starting point of the contracts will be.
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Artem Konchin, JPMorgan - Analyst [43]
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Okay. I guess, thank you, in lieu of the other guy who asked that question.
And, for my part -- I don't know if maybe we can --
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Mark Gyetvay, OAO NOVATEK - CFO [44]
------------------------------
I would ask -- you can ask Gazprom what contracts are up for extension. But I just think that's too difficult to answer at this particular point because I --
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Artem Konchin, JPMorgan - Analyst [45]
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I would suspect that you might have some insight already into that, considering that you have to basically compete with them at some point in the near future.
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Mark Gyetvay, OAO NOVATEK - CFO [46]
------------------------------
I'm sure (inaudible), but I just don't have that information in front of me right now. I'm sure, if there's contracts up for renewal, they're already on top of that. I just don't have that information in front of me to be able to give you any comments.
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Artem Konchin, JPMorgan - Analyst [47]
------------------------------
Okay. Sounds reasonable. Thanks.
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Operator [48]
------------------------------
Geydar Mamedov, Goldman Sachs.
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Geydar Mamedov, Goldman Sachs - Analyst [49]
------------------------------
I have two questions. The first one is SeverEnergia. You mentioned that the key development program (inaudible) revision of the drilling program and drilling more horizontal wells versus vertical wells (inaudible) that leads to the potential reduction of the CapEx on the project. Is it possible to quantify in terms of the percentage of change versus the initial plan? What's the reduction in the total CapEx for the project?
And my second question is on Yamal LNG shareholder structure. Is it correct to think that it is not finalized yet and there will be another partner joining the project, reducing your stake to 51% from 60% currently? Thank you.
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Mark Gyetvay, OAO NOVATEK - CFO [50]
------------------------------
On the first question, what I said in the text of the presentation is that we are now currently revising the plan. So I can't give you that number at this particular point. We will provide you with that at a later date because then I'll be able to provide you saying -- here's the original plan, this was the number of wells drilling, and this is what we're going to change it to.
All I can say is that what we're seeing on an average, per-well basis is about 20% or 30% higher per well with an almost two-time increase in the output per well. And I'm pretty sure I talked about that briefly on the last earnings conference call. But the total number of wells to be drilled still needs to be determined. So they're revising that plan as we speak.
So, once we get that, then we'll be glad to give you that information on a future conference call.
In the second question, yes, we're still -- there are still negotiations being held for the particular sale. It's not as critical for us at this particular point, as you can appreciate. We have two major IOCs involved in a particular project. And, if it happens in the near term, we'll just make that announcement, like we've done on the other, previous two.
But, right now, there is still negotiations, and there's people still looking at it. But I can't give you any indication of will that happen soon or will it happen at all at this point.
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Geydar Mamedov, Goldman Sachs - Analyst [51]
------------------------------
Thank you.
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Operator [52]
------------------------------
There are no further questions at this time. Please, continue.
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Mark Gyetvay, OAO NOVATEK - CFO [53]
------------------------------
Okay. I just want to thank everybody. And we look forward to the next time we get a chance to speak or at one of our upcoming conferences.
But, if you have any questions specifically on any of the details that are provided throughout any of the presentation material that we put out in the marketplace, particularly as this issue has come up more recently with the liquid developments over the next couple of years, please, feel free to give us -- drop us a line at our IR Website, and we'll get back to you and specifically set up a call to discuss it.
But, anyway, thank you very much. And we look forward to addressing you in the future.
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Operator [54]
------------------------------
And that does conclude the conference for today. Thank you for participating. You may all disconnect.
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