Full Year 2014 NK Lukoil OAO Earnings Call (US GAAP)

LKOH.MZ - NK Lukoil PAO
Full Year 2014 NK Lukoil OAO Earnings Call (US GAAP)
Mar 03, 2015 / 12:00PM GMT 

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Corporate Participants
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   *  Leonid Fedun
      LUKOIL OAO - VP, Strategic Development
   *  Alexander Matytsyn
      LUKOIL OAO - SVP, Finance

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Conference Call Participants
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   *  Ildar Davletshin
      Renaissance Capital - Analyst
   *  Farid Abasov
      Standard Bank - Analyst
   *  Craig Pennington
      T. Rowe Price - Analyst

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Presentation
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Unidentified Company Representative   [1]
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 Ladies and gentlemen, good afternoon, thank you very much for attending Lukoil full-year 2014 financials presentation. Bank of America, welcomes you and it's our pleasure to present today Mr. Leonid Fedun, who is a member of the Board and Vice President for Strategic Development; Mr. Alexander Matytsyn, who is the Senior Vice President for Finance; Mr. Andrey Gaidamaka, Vice President Investor Relations; Mr. Igor Kozyrev, Deputy Chief Accountant; and Mr. Maxim Madzhlisov Head of IR; and Sergei Epifanov, who is the head of US GAAP Financial.

 Without further ado, I will pass the word to Mr. Leonid Fedun. Thank you very much.

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [2]
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 (interpreted) Good afternoon, ladies and gentlemen, I'm very grateful for finding this opportunity to speak [at] the presentation.

 Every year we (inaudible) with you. We have this long-standing tradition of good interaction with the investor community and our Company. The current year (inaudible) from the true we try to meet with you and answer any questions during the difficult times and now during the favorable times.

 Obviously, it's much nicer to meet with you during the favorable times, but during the difficult times it's more useful, more valuable I would say.

 The main event last year, despite the difficult economic situation developing or taking shape all over the world, we increased our production by almost 6.3%. We virtually launched and it has broken even our largest investment project for the last decade in Iraq, over 400,000 barrels per day.

 We started to receive the compensation for the historical cost of the last non-developed field in Western Siberia, the Imil oil field with the reserves over 1 billion barrels.

 Also the event was first time in the history of the Company, one of the rating agency S&P confirmed our investment rating, despite the decrease in the sovereign rating of Russia, which is a certain trust -- obviously, a sign of trust towards our Company.

 Our Company, in 2015 and 2016, is the last year of the large investment cycle, which started in 2012. Over this period we invested significant amount of money, around $80 billion. The return from it we'll see -- we'll start seeing -- well, we're already seeing it, despite the profit [net] other financial big cash flow.

 (Technical difficulty) is by more than 40% compared -- same for 2015 and 2016 we will complete -- virtually complete the re-equipment of all our refining capacity also investment accumulated and accrued investment around $5 billion. We expect that the positive effect on EBITDA will be around $2 billion per annum.

 Also, in 2015 we launch Filanovsky field, our largest investment project, pertaining to the development of our offshore field, which will generate significant cash flow since that field is -- has significant tax breaks -- tax allowances.

 If we look at -- overall, at our financial performance indicators net, not adjusted, income went down by almost 40%. Adjusted net income has decreased by 30%. EBITDA virtually stayed the same. But the free cash flow, that increased by almost 50%.

 So although it's not that significant but this free cash flow that our Company enjoys against the falling crude prices and complicated, difficult macro-economic situation tells us that the oil and gas industry in Russia has accumulated the experience of getting out of difficult economic situations and is flexible to adapt to any difficult economic conditions.

 The level of debt is very comfortable for the Company -- at a very comfortable level for the Company.

 The key question for the Company, which is understandable, is the question of dividend. We are maintaining our current position: that the dividends compared to 2013 will be increased. The first interim dividend that we have paid out at the beginning of this year was higher by 20% than the dividends for 2013.

 I would like to draw your attention that the dividends were paid out during the most difficult times when crude was rapidly declining and no one -- there was total instability and volatility in the market that reached the level of $40 per barrel.

 So, currently, we don't see any dramatic events or things that would preclude us from paying out the dividends that we targeted -- the Board of Directors targeted for the payout. They will be significantly for the better compared to 2013 dividend.

 I have mentioned already that the Company is maintaining a relatively efficient financial system. We're quite confident in our financial position. EBITDA -- net debt to EBITDA, debt to capital is at a very comfortable level.

 This year we expect to repay around $2 billion-worth of debt and currently we don't see any obstacles on the way to redeem -- repay the debt. It will not affect our capacities or capabilities to pay out our dividend.

 Traditional question is the sanctions -- the issue of sanctions; the journalists and investors first and foremost ask this question. Therefore, I answered this question at our last meeting. I have to reiterate three types of the sectoral sanctions which cover the whole oil and gas industry of Russia.

 Arctic shelf exploration and production, we don't have projects like that. Even more so, you know our position, we think that this project might become interesting after the year 2013 potentially.

 Deep water exploration and production, we don't have such -- projects like that in Russia. The foreign projects, international, in the Baltic and the Caspian Sea they do not fall under the sanctions. So, they are outside of the sectoral sanctions.

 The restrictions on shale oil and conventional oil fields? Yes, we faced certain difficulties in this respect because our partner, Total, they stopped our joint activities, so our joint ventures.

 But our Company is pressing on with that work and the share of unconventional shale oil in our total production is not more than 0.5%. Nevertheless, we are carrying out pilot projects and we think we can independently and actively develop this field.

 Overall, for Russia, the use -- the work with shale oil is day of tomorrow -- the day is the future.

 We have more efficient capabilities with the oil that is hard to recover, so-called hard to recover oil; first and foremost the [Achim] field, it's not -- the traditional oil [is] crude already, but it's not shale yet. It's difficult to recover them, very high cost of extraction; a lot of work has to be done, but we also offered a lot of tax breaks.

 Imilor field, quite a lot of reserves are in Achim deposits and, as we are going to show you, we started the development of the field.

 Another important factor that has to be understood from the point of view of our financial situation, it's the mechanism of the tax system of the Russian Federation. As you can see, the main beneficiary of the high crude prices, obviously the main beneficiary is the Russian Federation.

 When the crude price went from $100 to $40 per barrel, the revenue of the government went down by 60%, whilst our Company saw the decrease by a mere -- only 33%. Therefore, the Russian companies are not that sensitive to the drop in the crude prices as our international investors.

 I've mentioned before, at a price of $20 per barrel, we don't -- we will not have to pay any taxes. Therefore, $20 per barrel, with the exchange rate of US dollar and ruble at around RUB100, it's still possible for us to carry on our business and to exist.

 Another so-called effect, we call them Kudrin's scissors effects, it is pertaining to the mechanism of appointing the taxes or introducing the taxes. The State impose the taxes, monitoring the results of the previous months, and therefore the taxes are introduced with a lag of 1.5 months.

 Therefore, when the price of crude is going down, the companies -- the Russian companies suffer, because they have to pay higher taxes and proportionately to the current crude prices. But if the crude price is on the up, as it happened in the first quarter, then we have the reverse positive effect since we get the revenues from the higher crude price and, at the same time, we pay lower taxes.

 So, really, the fourth quarter was difficult, was hard, just because the Kudrin scissors were working towards cutting down our revenues, the profit, significantly, by 10%/12% cutting of our revenue. When the crude price is going up, the effect of the Kudrin scissors is reversed.

 Another important factor is the so-called mechanism for the devaluation of the Russian ruble. The third crisis it's been experiencing and this mechanism works quite well.

 When the crude price drops the budget also decreases and it obviously affects the value of the ruble. It weakens, it devalues and this leads to the decrease in our CapEx and OpEx, and consequently to the increase of cash flow.

 I would like to reiterate that approximately 80% of our revenues are derived in hard foreign currency and around 80% of our expenditure is in rubles.

 Therefore, what's the difference of 2009 crisis from 2014/2015 crisis? The difference is that in 2014, the Russian Government effected several correct measures. They draw the lessons from the 2009 crisis. Immediately, the ruble was devalued, which allowed to build in the fat into the system for the exporters and the companies also who cover the domestic demand through the replacement of imported goods.

 It was at a lightning speed over RUB1 trillion was transferred to the banking system, to all the banks, including the banks that worked with Lukoil; and also, several measures to subsidize the domestic demand, the so-called program for scrapping the old cars in Russia.

 All of this allows us to be fairly optimistic to look at the future of the Russian industry, including the oil and gas industry.

 A couple of words about the crude price, our forecast. If you remember, four months ago, we talked about the fact that the price war that was organized by Saudi Arabia and OPEC, it is drawing to a successful end.

 We see several tangible direct and indirect signs of this taking shape. The number of drilling rigs in the world, especially in the US, is going down dramatically.

 First and foremost, it will affect the production of shale -- the so-called shale oil, since the depreciation of wells for unconventional oil takes -- it goes down very quickly and the drop constitutes around [60%] in the first year -- constitutes around [60%].

 So that small growth in the American market that we observed currently this year, it is to do, first and foremost, with the operation of the wells that were drilled last summer. But now, starting from April, the number of producing wells will be going down.

 By the third quarter, we will see the reduction, in my opinion significant reduction, of production in the States. Not just in the States, today we observe a drastic fall in drilling all over the world.

 In Southern America -- South America, the decrease in the total number of wells is less, but it's still less by 30%. We see that in Northern Africa, the volume of work is going down. The North Sea is quite difficult and obviously in Russia. All the Russian companies decreased CapEx for this year with different -- various intensity

 We see that starting from the second half of the year, the number of drilling teams will be going down in Russia. This will affect from 5 million tonnes to 20 million tonnes of crude will go down -- will be decreased in Russia. This will obviously affect the pricing.

 By the end of the year, for my own part, I won't be surprised if I will see the crude price at the level of $100.

 At the same time, the task -- or the aim of OPEC, or the objective, was not to keep the price low, but to create volatility in the crude market. High volatility does not allow medium and small companies to borrow funds for extensive drilling. The large companies cannot plan the expansion or to enter into very difficult, call it, sophisticated projects in the Arctic or deep-water drilling.

 Therefore, the market will become balanced quite soon and we will see the increase in price. Although the volatility will carry on, we will not have such a quiet life as in 2012, 2013, 2014. It's a thing of the past, because the volatility will be maintained artificially in my opinion.

 Another issue, many are trying to draw conclusions or parallels between the 1980s crisis and the current crisis. In that ancient history, I wrote one of the articles, the analysis of the crisis of the 1980s, so I'm quite au fait with that situation, with that crisis.

 There's a drastic difference between that price war, led by the Saudi Arabia, in order to increase their share on the market, which it lost after the oil embargo at the beginning of the seventies and the current situation. And you can easily see that on the right-hand side of this slide.

 At the beginning of the 1980s, the largest projects started in the North Sea and in Alaska, Prudhoe Bay. Also, Russia was actively increasing their production of oil. But if you can see that the price difference for those projects was around $8, which is significant per barrel. But it's laughable with the price difference that we observe nowadays.

 So at that time, it required a lot of time to [cure] -- on the one hand, to destabilize the market and to stabilize it, since the game with the cost of recovery was very difficult, very hard.

 Now when the competitors, its exhausted fields, very mature brownfields in the North Sea or difficult to develop shale fields, to take out of action the producers of those fields; it's much easier. And it's also easier to restore the price parity.

 In the 1980s, actually, the major loser was the Soviet Union, because the oil industry lost around 50% of its production by the beginning of the 1990s. There are three principal differences between the Soviet and the Russian industries.

 First of all, the Soviet industry was totally -- under the total government control, under the State. Total State regulation, pricing, sale, everything else was totally controlled. It was a non-flexible currency regime. The ruble was unofficially pegged to the dollar. If I'm not mistaken and if you remember correctly, at that time RUB1 was worth only $0.60.

 The third thing is there was no access to the global technologies. Now it's drastically different. The [sector] is privatized for the majority of -- although there are State places, very flexible foreign currency.

 System, which I mention, last but not least, you know that all the leading contractor operate in Russia. You may have heard Schlumberger is preparing to acquire our largest drilling contractor, Eurasia Drilling. These three principal differences tell us that the comparison of the current crisis and the 1980's crisis is totally incorrect.

 As far as the macroeconomic environment situation is concerned, you can see it on this slide. It is in the year 2014, we had a substantial worsening of consideration. And especially in the last quarter of 2014, with the price war, basically all the factors, with the exception of lowering of taxes as a factor, are all negative ones.

 Main operating results on the following slide. Getting the compensatory oil from Qurna, from Iraq, this share of our production has dramatically increased in our foreign operation block decreasing of export, which we were witnessing for the last couple of years, probably just about to finish, because we will see the growth of crude oil export with the decreasing of workloads for our refineries -- domestic refineries.

 This diagram illustrates the major production growth factors and parameters, the compensatory oil we receive in Iraq. Also, you can see the growth is happening in three other regions: in Volga region, the Ural region, and Timan-Pechora region. This growth compensates this natural decrease, which we're witnessing in the Western Siberia.

 As far as operating plans for 2015, ruble-wise they are basically being no change here. There is no change even with all this operational cost and CapEx, which, nominally speaking, are happening abroad. If we not denominate in rubles they play the opposite.

 The costs in Qurna -- expenses in Qurna they grow in rubles. But as far as the dollar denomination is concerned we expect that 20% to 25% -- our CapEx will decrease by 20% to 25%. With this, we don't expect any major change in oil production levels.

 This is actually the main advantage for Russian companies in comparison to our foreign colleagues, where the oil price drop automatically leads to the capital expenses, both OpExes and CapExes, as far as the OpEx are not regulated for them. While we -- Lukoil, with the devaluation process we manage to manage both of the processes.

 The year of 2014 was extremely successful from the point of view of geology and exploration. As you can see here we have discoveries of 14 new fields, starting from the Baltics up to Gdansk Peninsula, to (inaudible) -- Gdansk Peninsular and to the (inaudible) Sea.

 It's been quite extraordinary for our geologists. This year was quite extraordinary for our geologists. All this gives us assurances that the geo-base, which our Company has, is providing sustainable growth in future. Altogether 815 million barrels of oil equivalent were discovered, mostly oil.

 The most important fact for the Company is focusing on currently is increasing the recovery rate. Say, for example, one year ago we were talking about 19% and within two years we have reached a level of 20%, while our operating plan is to double it in all range of regions, in Kaliningrad and Volgograd we have already achieved and over-achieved this rate.

 We expect that with new technologies, this ratio of (inaudible) is quite realistic and it will allow us to increasingly involve up to 6 billion barrels of oil additionally, which is a huge -- a gigantic, amount, which actually testifies to the fact that we are okay, as far as resources are concerned.

 The only issue is to apply correct technologies and apply engineering and exploration in developing these fields.

 Some major financial results in comparison to quarter 4 of 2014, quarter 4 is presented here in this slide, so you're probably all aware of that. We already publicized them -- made them public, and we'll comment on them further.

 The main impact on our financial results were coming from so-called non-material, non-cash, write offs. There was quite a range of them. The first part of them was economic, and the other one is so-called non-economic one.

 In terms of non-cash, non-economic write-offs, it's writing off more than $100 billion in Ukraine. Those assets we're planning to sell were blocked, because of political reasons by the Ukrainian regulators, regulatory authorities. This is because of that simple reason; we're unable to actually utilize them. It's also extremely difficult to operate in the current economic situation in Ukraine.

 A significant impact on our reporting was, in fact, the (inaudible) Astrakhanskaya field write-off, with a substantial gas reserve, almost 1.5 trillion of cubic meters of gas. It was quite challenging, a difficult field with -- basically, with the lots of serum concentration.

 The plan was for us to start exploration and developing it in 2016. But after the ruble devaluation the gas prices dropped significantly in Russia.

 On top of that, because of the specifics of Gazprom marketing position, what we're witnessing the decrease of gas export to Europe.

 What we can see: that up to 2020 we have a certain pause in gas sector developing in Russia. We're expecting by 2016 to reach a certain parity between the prices; while now we can expect this parity not before 2020 when new two major projects will be launched within Russia and China, [Alti] project and (inaudible) [Siri], and Yamal LNG project, the other one, which is implemented by Novatek.

 All this will allow to improve the market. We can expect 2020/2021, we can achieve the price -- we expect the price parity in the market. Then we'll just come back to the developing our gas program. But so far we're just making a certain pause in this development.

 Saudi Arabia block, some major explorations done, roughly 85 million of metric tonnes of gas condensate and approximately 150 billion cubic meters of gas were discovered at so-called tied-gas, tied to oil and those initial contract agreements we had with Saudi Aramco, they're not actually -- they don't actually satisfy the economic opportunities for the developing of this field.

 For three years we've been having negotiations with Saudi Aramco and the Saudi Arabia Government. But, generally speaking, we're quite positive. We believe that in the next year we'll most likely be able to find the figures beneficial for both sides which will allow us, for us to start developing this field and for Saudi Arabia to start making use of this gas.

 As you probably know, for -- the Saudis actually burn crude oil to, actually, make drinkable water, which is a waste of money basically, but it's -- the negotiations takes quite a lot of time.

 Another write-off is our [Usinsk] refinery, exact compact and small refinery based in Timan-Pechora region in Komi Republic providing for local market. They have no export opportunities.

 Naturally, with the oil price drop and in taxation maneuver it becomes -- efficiency becomes low. This refinery were operated as a marginal will be launched with the corresponding prices or we put it hold when necessary.

 Our operating expenses are presented here on this slide. I would like to reiterate that quarter 4 hasn't really had a full impact of the devaluation effect. We will be able to see this effect, the devaluation effect, in our reporting in the first quarter of the current year.

 Some major transport and commercial transportation expenses, you see that transport expenses decreased dramatically. Commercial expenses decreased as well. But taking into the consideration the bonuses by the results of the year, they're still roughly at the level of last year.

 Effective cost control in our production. As you can see lifting costs dramatically, quite substantially, decreased; without taking into consideration Western Qurna, has decreased has decreased by more than 23%.

 Why have we moved Western Qurna out of the bracket? Because there is no need for us to analyze our operating cost, because they're 100% completely compensated by the contract of this product-sharing agreement signed with the Iraqi Government.

 All companies who are in crisis say that they try to use more efficiently the existing capacities, operational capacities. We are not an exception here. We say that we try to improve the efficiency of our drilling, first of all.

 You can see here that within the last three years the speed, the rate of drilling of horizontal wells has increased by 23%. If we talk percentage-wise, which are actually on par, almost on par, with the things we see in North America, for example.

 I can probably say that both Lukoil and Schlumberger were the record-making in the rate of drilling horizontal wells. The longest horizontal well in the world was drilled in Korchagina field with the inclination of 10 kilometers; before the longest horizontal well was drilled in Sakhalin.

 Now we're number one, which is officially reflected in our main drilling provider -- supplier. Schlumberger is reflected. All methods used globally, they are used in our Company as well.

 As far as our CapEx structure is concerned, year 2014 was the main year for our investment expenses. Initially we were planning to spend around $20 billion. We actually spent less, $15 billion plus, which is where we had the devaluation effect, applying resources in a rational way.

 I've already mentioned, in 2015 we complete our major investment, main investment cycle. All the major -- all the projects we were planning to launch: refinery projects, Western Qurna, Filanovsky fields will be launched, will start making profits for the Company. Currently, the flow which we receive from Qurna with [$3 billion] this year, allows us, as a Company, to have some sustainable free cash flow.

 Our capital expenditure structure is presented on this slide. As you can see, we've illustrated the way the CapEx has decreased in quarter 4 against all the plans we had for 2014. Take for example, in upstream a decrease of 20% and roughly, approximately 23% in downstream sector, just within the two quarters of last year, of 2014.

 Our major growth regions and growth projects for the next year, we will continue in Timan-Pechora field, Denisovskaya Depression. We will soon announce a major field continuing in Western Siberia in [Imilorskoye], [Vinogradovskoye] field, in the Western Caspian Region, completing our investment cycle on Filanovsky field.

 Starting from 2016 we'll start commercial production of crude oil and naturally continuing our operations in Iraq.

 Basically, the next slide illustrates the growth of production in Timan-Pechora region. Basically, within four years the growth is around 27%, again, because of new discoveries.

 Our major victory was that -- the fact that we managed to defend, together with the -- in our dispute with Rosneft our joint license -- joint -- for (inaudible) [field], our joint license with Rosneft is -- that, I would say, it was a major political victory, political act for our Company. We proved that this is absolute equality in Russia for State-owned and non-State companies.

 In the Ural, we continue our operations, though all the experts believe there is no future in that. But still, because this region has been explored and developed for the last 40 years, but still, you can see that we continue increased production there. The production will continue growing in 2016 as well, as we hoped -- as we expect.

 A major event was launching -- developing Imilorskoye field in Western Siberia. It's a huge field, which we received as a result of a tender. As you remember, it was a quite challenging competition with Rosneft. We won that tender, and for -- we already achieved -- received first oil. Because it's extremely important for us to amortize these huge expenses we incurred on this field.

 What is important that the government, the State, has agreed that, for the experiment of so-called mineral extraction tax, including this field, which would allow us to significantly improve the economics, and to pay back the expenses we paid for obtaining it and developing it. It's a huge field with geo reserves more than 5 billion of barrels for this particular field. The issue is about the rate of extraction, and our engineering capacities.

 I already mentioned gas in my presentation. It is extremely important for us to -- for Gazprom to build these export gas pipelines, especially Alpi gas pipeline, as this pipeline is a competitor for the European gas direction, and all this additional gas volumes produced in the Russian Federation.

 The Russian Federation will be directed to the Chinese market as a whole, by -- we expect to export the same volumes of gas to China, 130 million to 140 million of cubic meters, as comparable to European directions. Those volumes could be monetized and provide additional profit for our shareholders.

 Filanovsky field development, everything is moving. The works are progressing. All the groundwork has been completed and assembled. We expect, by the end of the year, this field will start the operational drilling.

 As you see from the tax point of view, this field, and the efficiency of the development of this field, is very important to our Company, since it generates significant cash flow.

 West Qurna 2. In 2014, we shipped 19 tankers with our compensation oil. As a reward, we received 380,000 bpd. The current production (inaudible) is around 380,000 barrels per day.

 The first two months, despite certain difficulties with the crude prices, we produced everything according to the schedule. All the compensation oil from Iraq, which is very important to our Company.

 Moreover, we are carrying -- continuing the negotiation to build an export pipeline, which will go to Basra, in order to increase the export capacity, and not to create the tension that currently exists in export infrastructure.

 Additionally, the deliveries of crude to Basra, to our own refinery, will be very efficient for us. You see the discounts that are given today, because Qurna crude is closer to Basra heavy, and it reaches around $7.5 per barrel. We derive additional margin when we refine it at our own capacities.

 A lot of discussions -- there was a lot of discussion in Russia, discussing this so-called tax move. I will remind you that the government offered to -- suggested to drastically reduce export duties, and to increase the duties on fuel oil, on heavy products, which negatively reflected on the refining efficiency, but increased the efficiency of exporting.

 Therefore, the companies that managed to upgrade on time, they fall outside of this tax maneuver. But those who are lagging behind, they will end up in a difficult financial situation.

 We believe the investment that we invested into our prime refining assets, they allow our Company to withstand both the tax maneuver and the decrease of crude prices.

 Although we are not going to hide away from the fact that, in January, the refining margin in Russia, it was very low, sometimes even negative. Low crude price, a low demand for fuel at the beginning of the year; it all affected it. But overall, we believe that refining is one of the key sources of revenues for our Company.

 The next slide actually shows the effect of the tax maneuver on our refining volumes. It's about [2,016] heavy residues, which is not profitable to refine today. So it's going down virtually by half. The increase of gasoline and diesel fuel, which are very liquid and high efficient products will increase by around 26% -- by 26% and 33% respectively.

 A couple of words about environmental safety. We adhere to the policy to preserve the name of the most environmentally-advanced company in the Russian Federation. We are very proud of the name and we are not decreasing the level of investment, targeting the environmental safety.

 Overall, the main objectives for 2015, main targets, are as follows. Although we are optimists regarding the crude market, nevertheless, we believe that the Company should safeguard all the efficiencies, the investment programs, dividends payout. Even if the oil price falls to $40 per barrel, we are increasing our dividend payouts, even despite the write offs, which could take -- it could be even up to 50% of profit, we're securing competitive dividends.

 Investment program, optimize investment programs. Reduce operating costs. We believe that we will maintain the oil production at the level of 2014. In 2015, it's the end of our investment cycle from 2012 to 2015. The investments will start paying back. They will be amortized and depreciated; that will increase the overall efficiency of our performance indicators.

 Thank you for your attention.

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Unidentified Company Representative   [3]
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 Ladies and gentlemen, we had a very busy all-encompassing presentation today, but I would like to give more to the questions. I really would like to tell you that some of you have busy schedules afterwards, but I think right now it is a unique opportunity to ask all the questions posed to Mr. Fedun, who is a (inaudible) and shareholder in the Company; and Mr. Matytsyn, who is the CFO of the Company. That's all the questions that are first hand, so I would encourage you to seize this opportunity to the maximum.

 And of course, we'll give preference to those that are here in the room, even though we have more than 100 people hanging on the phone lines and on the Internet.

 I would appreciate that those that are hanging on the phone lines do send questions via Internet. It's just easier to manage, for us, in a big room.

 With this, I'll open the questions on the floor to Q&A.

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Questions and Answers
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Operator   [1]
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 (Operator Instructions).

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 Ildar Davletshin,  Renaissance Capital - Analyst   [2]
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 Ildar Davletshin, Renaissance Capital. [Better to ask in English or in Russian]?

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 Ildar Davletshin,  Renaissance Capital - Analyst   [3]
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 (interpreted) Let's go into Russian since I'm from Russia. I have three questions. One is very optimistic.

 We had an optimistic slide on the investment program, decrease by 20%/25% in dollars. I would like to clarify this decrease is due to currency fluctuations -- to changes, or the change in the volume of work. And the volume of work -- scope of work, how much will be for refining -- in refining, in production, what the shareholder (inaudible). This is the first question.

 The second question, dividends, you said around 50%. Did I understand correctly that we're talking about 2014; up to 50%, $3.10, [3.] --? Yes that was the question.

 The third, Eurasian Schlumberger deal. Schlumberger is the largest supplier of services, do you see any risk exposure if they go through with that transaction? There were articles in press.

 What's your position about changing the -- potential changing the ownership of Eurasia?

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [4]
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 (interpreted) The first question was to do with the reduction of the CapEx. Realistically, according to the plan, the real reduction, 90%, is due to the devaluation, although if you have seen the last year results, there were volume reductions as well.

 The first quarter, well, we maintained certain drilling volumes at the level of last year in the first quarter. It's to do with the fact that it's very profitable to do the drilling, because the rate from the contractors, they are in rubles. They haven't indexed them, and they can't index them at the moment. Therefore, the more volume of expenditure will be at the beginning of this year for drilling.

 The remaining articles of the budget items, or the budget proportionally -- I don't want to reveal our (inaudible), but they are being reduced proportionately.

 Dividends, I said we are not afraid by the figures -- from the figures, even despite the write-offs, even if they reach 50% of the (inaudible). I can't give you the exact value, because it's all in dollars so you can't -- no one from you can tell about the fate of the ruble and dollar. What if it jumps again tomorrow and the ruble will -- the dollar will be RUB70 again? What's going to happen then? Or it's going to be RUB50?

 We know that our budget has the capacity to pay certain significant amount in rubles, and there is an expected -- expectation -- a potential expectation of the ruble-dollar [shift]. That's all I can tell you.

 Third question, Eurasia drilling, I am very positive -- look positively at the deal between Schlumberger/Eurasia Logistics. Schlumberger has a lot capacities potential, and hopefully the government will not put any bureaucratic red tape obstacles to prevent that deal.

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Unidentified Audience Member   [5]
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 I've got three questions, thank you. The first one is -- relates to the sanctions impact on production. Specifically, even though you've provided assurances about how the Company would be able to maintain existing production under the current sanctions regime, how long do you see that continuing? And what are the factors that could potentially impact existing production, say, one year or two years down the line if the sanctions aren't removed. That's the first question.

 The second question relates to a meeting that was recently reported in the press, taking place between Mr. Alekperov and President Putin, apparently with respect to Lukoil's possible access to the Arctic Shelf. I'd like to know if you had any thoughts or any color you could provide about whether the tone of discussion with the government over Arctic access has actually changed in your favor?

 And thirdly, clearly from the information today and from past presentations you're approaching the end of an investment cycle at the end of 2015; and you've got quite a generous dividend policy standing alongside it. How should we think about 2016 dividends onward, considering the cash flows that will be coming into the Company? Thank you.

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [6]
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 (interpreted) Sanctions. We have a separate slide. As I said before, for our Company we believe that the sanctions, they are not very pleasant from the moral point of view, because all the sanctions, someone tries to restrict you or limit. There's no real effect on the economics of our Company; there is none.

 Arctic shelf, I've always been pessimistic in this area. The last event that took place during the last crisis, it showed that arctic shelf is the thing over very, very, very distant future, not just distant future, because the presence of gigantic reserves, albeit very expensive but recoverable oil and shale oil, and all other carbons.

 It seems the attempts are futile to take the exposure investment operations in the arctic in difficult conditions irrespective whether it's from the Russian western side or the Falkland Islands, anywhere.

 All deep drilling -- deep-water drilling will be the main thing that suffers from this, because deep-water drilling is expensive and risky. We lost billions of dollars, over $0.5 billion, in Western Africa in deep waters in the last five years. There were no major new discoveries in this respect.

 So the presence of large reserves, of non-traditional, non-conventional reserves gives the companies a choice whether to expose and win or not to expose and win. Obviously, they will choose not to risk and to win. Non-conventional reserves will be developed only when the crude price will be very high.

 The Arctic fields, they demand the same condition. Therefore, from the moral point of view, it would be positive and correct to remove that ban. But, from the point of view of the influence on the future activities of the companies, the issue will only be discussed starting from 2025.

 Dividend. Let's live through the 2015. Yes, I'm -- who is a pessimist? A pessimist is a very well-informed optimist. I am a very well-informed pessimist. I believe that the oil sector with the prices -- well, it's not coincidental the situation with the prices. It's all well prepared in advance.

 Therefore, most likely, by 2016 we'll have a more positive plan situation with the prices and we'll have more realistic opportunities to pay out dividends. But let's live through 2015.

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 Farid Abasov,  Standard Bank - Analyst   [7]
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 Farid Abasov, Standard Bank. I have two questions, if I may. One is concerning the cash compensation for West Qurna. I notice there was no significant cash inflow in 2014 for the CapEx that you inferred to the project. Could you please give us some color on what to expect in 2015? I'm not talking about marginal remuneration fees, but rather the CapEx in cash.

 And second is regarding the cost inflation in the services industry. Obviously, Q1 is not going to be representative. But how do you see the cost indexation with your subcontractors going forward? Do you expect it to be in line with Russian official inflation; or you would actually expect some escalation by the end of 2015? So any numbers would be really helpful. Thank you.

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Unidentified Company Representative   [8]
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 Mr. Matytsyn (inaudible).

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 Alexander Matytsyn,  LUKOIL OAO - SVP, Finance   [9]
------------------------------
 I'll simply try to answer (inaudible) already last year, 2014, for the fourth quarter we already received in cash $1.3 billion from West Qurna-2. Also, we have got crude for roughly $1.3 billion, total. That means totally we already reimbursed $2.6 billion, roughly, and we expect this quarter that it's going to be additionally $1.7 billion of compensation.

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Unidentified Company Representative   [10]
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 (interpreted) Second question (inaudible).

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 Farid Abasov,  Standard Bank - Analyst   [11]
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 Contractors and subcontractors.

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [12]
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 (interpreted) The contract companies suffered most of all, because they all declared that they demand the reduction in cost and the competition amongst the contractors is fierce.

 I've told you before that we are planning the maximum volume of drilling for the first quarter, despite its financial burden, because we still have the contacts which were executed before.

 So they have to drill at a loss at the moment based on the normal logic, but they have to drill because that's their contractual obligations, knowing that the cost of these services will go up, the prices will go up.

 But since our contactors, 70% of their cost is in ruble, there is no direct correlation between the increase in dollar exchange rate and the cost of the contractor services will not take place. Most likely -- well, we think that overall the contractual services over the year from 10% to 15%.

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Unidentified Audience Member   [13]
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 [Zak] (inaudible), [HBK]. You mentioned that you expect the oil price to rebound possibly to $100 per barrel. I'm wondering what ruble price that implies for you, what you expect the path of ruble prices to be, because, as you mentioned, the lower ruble is certainly (inaudible) to your cash flow (inaudible).

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [14]
------------------------------
 (interpreted) A good question. Indeed, yes, indeed, ruble is backed to oil price. Basically, from RUB3,300 to RUB3,500 per barrel has traditionally been this range. But all players, and all the market players are interested not to have these direct correlations between the healthy oil price and strengthening of rubles.

 If we take, for example, the crisis of the start of the current century, if the start of the crisis, the ruble devaluated twofold. The strengthening rubles only happened by 20%. That's what we actually expect. The devaluation weak ruble is extremely good for the economy.

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Unidentified Participant   [15]
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 (interpreted) I've got a couple of questions to Caspian fields.

 Firstly, your Filanovsky field, still within the very favorable taxation regime which actually was promoted or pushed through by Rosneft for their partners to be comfortable operating on the Artic and other regions. But the only beneficiary -- you are the only beneficiary from this offshore tax regime.

 Do you see any risks for this taxation regime to change in the Caspian region? If not, do you potentially look into other fields in the Caspian area of Europe? Still got many licenses for exploration and development, starting from 2016 onwards. Thank you.

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [16]
------------------------------
 (interpreted) Thank you. I do not expect for the taxation regime to be -- which was recently launched, will be abolished. This doesn't make sense. Especially, you mention that this is the first recently launched field. There's another one, though, it's Prirazlomnoye field. This is exactly where Gazprom Neft operates and they're comparable, but ours is bigger.

 In addition, you shouldn't forget that we have some good exploration in the Baltics. They're modest but they're quite efficient and important under this regime.

 Yes, indeed, then, for 2016, 2017, the Filanovsky field will be a good milking cow for our Company's budget. It's with the very expedient amortization for this field.

 New fields in the Caspian area, Caspian region, most likely we'll start exploration drilling in for Filanovsky satellite, as far as we have got some good exploration there, discoveries there.

 As far as the other fields, Central field and Hvalynskoye field, those are joined with Kazakhstan. As far as Hvalynskoye field, by the end of the year we have to have all the decisions and agreements concluded with Kazakhstan and, after that, starting nominally from 2016, we can start developing this field.

 As far as Central field is concerned, we need to complete exploration there. But all the licenses have been confirmed and this is just another measure of nearest future.

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Unidentified Audience Member   [17]
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 (interpreted) Apologies, to follow up, all this Central and Hvalynskoye field will be subject to what this new taxation regime?

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [18]
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 (interpreted) No, the whole inter-governmental [in] purchase sharing agreement within this field.

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Unidentified Audience Member   [19]
------------------------------
 (interpreted) Thank you.

------------------------------
Unidentified Audience Member   [20]
------------------------------
 (interpreted) Thank you. Can I ask another question?

 As far as West Africa is concerned, I would like to ask. I think it's half a year ago, we had some information, you have some discovery in Ghana. The Company promised to provide further details for that discovery.

 Do you have it available now or, generally speaking, do you see this region used to have a plan to drill 10 wells, explore three pilot wells and how many have you drilled so far?

 And, generally speaking, do you plan to stay in the region or slowly and gradually exiting the region? Thank you.

------------------------------
 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [21]
------------------------------
 (interpreted) Unfortunately, we're not successful in Africa and basically all others.

 Yes, indeed, we discovered 11 fields in Africa, but all these fields are quite small. They were fine for shallow water but they don't work for deep water, because all -- none of those fields with more than 1 million barrels. This is kind of threshold and you probably saw in our reporting, we wrote off $0.5 million for this unsuccessful operation.

 In future, as far as future is concerned, we change our strategy. We entered two existing projects with the possibility of extensions, in order to secure -- to insure our own risks and in case there is a new exploration, to get -- new discovery, we get some additional profits. If not, then at least we have recover our investments.

 But generally speaking, my position is as follows. After the current crisis, the increase for deep water discoveries, exploration, will substantially decrease for all of the players.

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Unidentified Company Representative   [22]
------------------------------
 From the room?

------------------------------
 Craig Pennington,  T. Rowe Price - Analyst   [23]
------------------------------
 Craig Pennington, T. Rowe Price. When you presented in November, you spoke of an unchanged or small growth in the US dollar dividend, assuming an exchange rate -- within the 40s, I think, I can't remember exactly, off the top of my head.

 On the slides today, are you suggesting that management's goal for an unchanged or small growth in the US dollar dividend at a ruble exchange rate of RUB55, which is what you've used in the presentation? You said that was unchanged. Am I right? Is that the correct interpretation or is that an incorrect interpretation? Thank you.

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 Leonid Fedun,  LUKOIL OAO - VP, Strategic Development   [24]
------------------------------
 (interpreted) Yes, indeed, we, based on the -- we try to preserve, to keep the dollar component of the dividends. But everything will depend, no matter how I try, it all depends on the dollar's behavior. If the scenario we're looking will sustain, we'll try to do that. We'll try to perform it. If one day, the exchange, the ruble dollar to dollar exchange rate changes, then just it looks like I violate my promises. But that's why I will be very careful here. We'll be trying to keep sustained the adequate dividend level.

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Unidentified Audience Member   [25]
------------------------------
 Would it be possible to hedge already dollar dividend? Or you expect ruble to strengthen if we could keep cash in ruble terms?

------------------------------
 Alexander Matytsyn,  LUKOIL OAO - SVP, Finance   [26]
------------------------------
 The Company doesn't want to be involved in the ruble-dollar hedging at. First of all, the volume of this hedging is not significant enough, sufficient to cover all our expenses and revenues in [US].

 But we have put a natural hedge, [actually]. We have put over 60% of our revenue in that currency, in US dollars, of course. That's why, for us, we don't see that it will reasonable to do any hedge, especially just a part of it, just dividend hedge.

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Unidentified Company Representative   [27]
------------------------------
 Do we have any more questions?

 Well, I would like to ask one last time if we have any more questions coming from the room and, if you don't, I would like to thank you all for participating and turning up in such numbers. It's always a pleasure to see you.

 We will have some refreshments served and have an opportunity to talk a bit more in the lobby.

 I would like to also thank all the participants that helped to bring this event together. Thanks a lot to Merrill Lynch, Bank of America Merrill Lynch. In this kind of tough times, we hope that you will maintain good coverage of the Company and a fair assessment of our capability. Thank you.

------------------------------
Operator   [28]
------------------------------
 Ladies and gentlemen, this concludes the Lukoil presentation. If you would like to hear any part of this presentation again, recording will be made available shortly. Thank you for joining. You may now disconnect your lines.

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Editor   [29]
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 Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.




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