Q1 2015 NK Lukoil OAO Earnings Call
Jun 10, 2015 AM EDT
LKOH.MZ - NK Lukoil PAO
Q1 2015 NK Lukoil OAO Earnings Call
Jun 10, 2015 / 12:00PM GMT
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Corporate Participants
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* Andrey Gaidamaka
LUKOIL OAO - VP, IR
* Leonid Fedun
LUKOIL OAO - VP, Strategic Development
* Dmitry Timoshenko
LUKOIL OAO - VP, Business Development, Upstream
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Conference Call Participants
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* Pavel Kushnir
Deutsche Bank - Analyst
* Alexander Nazarov
Gazprombank - Analyst
* Maxim Moshkov
- Analyst
* Pavel Sorokin
Morgan Stanley - Analyst
* Ildar Davletshin
Renaissance Capital - Analyst
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Presentation
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Andrey Gaidamaka, LUKOIL OAO - VP, IR [1]
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Good day, ladies and gentlemen. Thank you, colleagues, ladies and gentlemen, for joining us here today in these challenging times.
Today we're presenting to you first quarter financial results. Mr. Leonid Fedun is going to present these results. I don't think he needs any additional introduction but he's one of the biggest owners of the Company, he's VP for Strategic Development.
We also have here today Mr. Matytsyn, Senior VP on Finance. We also have here today Mr. Timoshenko, and we have some news on a deal, a deal with a Chinese company. And myself, my name is Gaidamaka, Mr. Gaidamaka. I'm VP on Investor Relations.
We have here with us today accounting block, Mr. [Kablaminski] and accounting block representatives are here today to answer your questions, should they arise, on accounting.
We also have here Mr. Krasovsky and Mr. Madzhlisov, representatives of Investor Relations Department.
First and foremost, we are going to make a presentation. Then we'll have a Q&A session. We'll take questions from the floor. We'll also have a video and audio conference; it's on air right now, so we can get your questions from IR lukoil.com.
Please forward your questions via Internet. We'll try to give you an opportunity to speak out and to ask questions on the telephones, although it's a bit challenging technically-speaking. We would prefer to take Internet questions from those who are on air with us today.
And now, I'd like to give the floor to Mr. Fedun.
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Leonid Fedun, LUKOIL OAO - VP, Strategic Development [2]
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Good day colleagues. Ladies and gentlemen, thank you very much for joining us here today. It so happens that this meeting is something that I preferred to Spartak's press conference where they present coaches; the business comes first, definitely.
So, first quarter of 2015, this is our disclaimer. This presentation is going to contain forward-looking statements.
Liquid hydrocarbon production grew by 7.8%. Russian production stabilized. By executing plans for the project, West Qurna-2, the amount of compensations amounted to $600 million.
Lukoil is about to pay highest in history dividends, RUB154 per share, so we fulfil the promises that was given to our shareholders.
We launched our heavy residues processing complex in Burgas; that actually improves the economics considerably.
We made a large commercial discovery in the Baltics Sea that changes our understanding of this region quite considerably.
And we also announced today that we have achieved agreement with Sinopec on regulating our [debate] and $1.067 billion will get to our -- will lead into our free cash flow.
This is our net income. Net income is quite low, as you can see. The reasons are very well understood and, yet, we preserved $2.8 billion of EBITDA and, most importantly, our free cash flow is more than $700 million.
As far as dividends are concerned, you all remember the promise made by the management of the Company to keep the dividend payments at the levels of 2014, despite the dollar fluctuations. We are still abiding by this promise and we are going to pay the dividend the middle of August of this year; they're going to arrive on the shareholders accounts. Our free cash flow since this year allows us to do it quite freely.
Going a little bit ahead of myself, our focus for next year, we're reasonably optimistic in terms of developing our Company and in terms of dividends alike.
Just a few words about oil market. Obviously, our income depends on macroeconomic parameters, this being, first and foremost, the price of oil. This is something that you just have to look at. I actually read comments by analysts, not very favorable ones, when I commented that oil is going to be $60/$65 per barrel. The sceptics were not right however; I was right.
My understanding is that today's market is something that you can quite easily calculate this price, all the economic alternatives and options. We are actually -- OPEC and oil shale industry are trying to win over from each other. OPEC has 10 people on their side. Shale oil has one and the result is pretty predictable.
In this respect I find it possible to pre-calculate the situation in the market, so we are reasonably optimistic for oil prices 'til the end of this year.
Why are we optimistic? Let me explain to you. Shale industry, as of today, is, well, without making too loud an announcement, is in a heavy state and something that keeps it alive is the privileged -- very privileged access to money. It's very much like mortgage crisis, when money would give away money -- banks would give away money without any [characterization]; very much like that. This is what we see in shale industry.
Hedging shale is what covers the Company as well. In particular, 1 million barrels of oil is hedged at average price of $90.5. This is the weighted average price, while the current price is much lower.
So, having this hedging at their disposal, and it's around 20% of shale oil production, it allows shale oil production to survive. However, in 2016, only 300,000 barrels would still have hedge shields allotted to them, and the hedge would be $98.
OPEC knows this calculation and they do know that providing WTI of around $60 in view of 20% hedging is de facto having around $75 per barrel. It's like the lowest effective limit for the so-called sweet spots.
When hedges are going away next year, they go down three times the weighted average price to provide for stable inflow for OPEC, and to keep shale industry at the same time on the verge of bankruptcy would be around $75 per barrel. This is the reason we are reasonably optimistic about the oil prices.
We expect this oil price movement to happen; $75 per barrel for our Company. For Russian industry is more efficient and much better, and we can count to have much higher income in the third and fourth quarter. Subsequently, we are going to have quite enough of cash reserves, although we can still survive at $40 per barrel, like we said.
There is another factor that can accelerate things. Revisiting [RBL], reserve base loan parameters, the monies that American companies give, using as collateral the in-place oil. It's a 12 months' shifting rate. In September or August, companies will have to have around 9 billion barrels of proven and also proven -- developed reserves. So it decreases the opportunities for attracting finance. It increases the amount of corporate default.
Hopefully this would lead to accelerated [hard situation] in the market. However, our Company is staying quite conservative forecasts of oil; $60 per barrel, this is what I mean. My expectation though is that oil price will get to $75 or even higher, depending on corporate bankruptcies and defaults, and how many would go for Chapter 11.
So far, the development is just according to our forecast. War is going on, not our war, so we are just waiting on and keep developing.
This slide is here to illustrate how to retain the potential. All companies out there decreased CapEx. Formerly, if you calculated in dollars, we decreased it as well, but we're a Russian Company and 90% of our investment is in rubles, and you can see that investment, in the first quarter of 2015, went up. As did other Russian companies, by the way, and this is why the trend for liquid hydrocarbon stabilization is still there.
Most probably the third and the fourth quarter of 2015 we'll see contractors revisiting the agreements, and at around 10% inflation would [challenge] them. Anyhow, billing would go down in the Russian Federation in general. And so, probably, stabilization would lose its momentum a little bit.
Yet Lukoil, according to our view, has to keep the production level, and we expect to keep the production level in 2015 and increase the FCF.
On the face of it, it looks like mutually exclusive tasks, but yet on the results of our first quarter, they come to life -- they come to fruition.
Macroeconomic and tax environment. Well, this slide illustrates itself; speaks very visibly for itself. In the first quarter, the [crude receivers] as we called, they were cutting off our revenues. The true growth only began end of first/beginning of second quarter.
So, in the second quarter 2015, the lag in mineral extraction tax and the exports tariffs would be more positive for our Company.
The main operating results are given on slide 9 of this presentation. Tax [removal] definitely gives its results. You can see oil exports, crude oil exports going up more than a quarter, as you can see. At the same time, we decreased exports of product.
From the point of view of the government, the sale of products is better; it's more lucrative than crude oil, but this is the position we take. As the tax removal goes on, as the exports (inaudible) for heavies, heavy oil would go up, we'll have decrease in refining year on year and crude oil export would grow. This would be done for the sake of retaining the domestic market premium over the export.
Daily production went up, as you can see, mainly thanks to the compensation oil that we get from Iraq.
Here is the next slide to confirm what I just said. West Siberia keeps going down still, and so we'll launch Imilor next year, and [Gdansk Straits] in Yamal. Only then we expect stabilization from this region of ours.
International projects are contributing mostly, and yet Timan-Pechora, Volga and Urals are growing as well and this is a very positive factor.
If you now look at our forecast for 2015, our expectation is to still keep up with the trend in production. We do not expect neither decrease or increase in oil production, and that is despite the serious market movements.
At that, the task is to create free cash flow that would allow us to cover all the dividend payments we planned for the future.
Yet another factor that is going to tell on our free cash flow is the agreement with Sinopec. We announced this agreement, as you might well remember, back in April this year.
Then we had an oil price crash and our Chinese partners were very sad about it, let's put it this way, because they calculated the economics using $100 per barrel and when it went down to $47. But now, the situation has stabilized and we had mutual desire to meet halfway, so the agreement has been achieved and it's more than $1 million at around 10% discount, not very big.
Obviously, we need to get all the necessary approvals once again from Kazakhstan Government. But since we already have achieved preliminary agreements, we hope to get this [approvement] and hopefully we will get this money on our accounts until the end of this year. It's also a very important contribution to our free cash flow.
Operating expenses. Looks pretty; all our OpEx went down as you can see and quite considerably. The effect of ruble devaluation is demonstrated vividly here. It keeps the oil companies [offload], despite the taxation system that is quite tough.
You can see here the comparison with 2008/2009, and we definitely control costs very intensively. We don't want to index the cost of our contractors. Yes, they are in tough situations, but they don't have any other options; they have to work with us, so they have to live with the decrease in their revenues.
This is the principle by which we [live] and this is something that gives us flexibility. The moment oil goes down, the ruble goes down as well, this is the deviation that allows for oil companies further development.
Same goes to SG&A and transportation expenses; almost all of them went down quite considerably.
CapEx structure is given on the next slide. Lukoil is currently finalizing its investment cycle into refining into downstream. It's very timely, and I'm going to try and show it.
Out of $2.4 billion, around $2 billion are spent on E&P, and this is only right, because this is really the main source of profit for our Company.
Next slide is here to demonstrate what we invest into downstream and what we invest in upstream. E&P went down by 27%, E&P investment, while the refining went down much more, 40-something-%, 43%. We are only going to support the existing infrastructure.
Main finance results. You can see sales going down 35%; income from operating activity and the income before income tax, around 60%; net income, around 60%. So what's behind the net income dynamic?
It's demonstrated on this slide. You can see OpEx going down, transportation expenses going down, decrease in currency translation loss and yet, we also have revenue decrease since the price went down 50%.
Another negative factor is the growth in depreciation/amortization, around $300 million, which is also a negative factor when we calculate net income. The $300 million is something that analysts probably failed to take into account in their analysis.
And yet, we have positive dynamics in free cash flow. In the first quarter 2015, by the end of the first quarter, you can see that nothing has really changed in free cash flow; it's around $3 billion, which is a cash cushion, a cushion that allows our Company to live through this turbulent time.
Our next slide is here to illustrate our robust financial position. Lukoil keeps nice debt to capital ratio and that net debt to EBITDA ratio. We have money to develop, Mr. Matytsyn will probably refer to it as well. We signed an agreement with Sberbank. We have a revolver credit of RUB90 billion, so in case we have any problem with cash, we'll have an opportunity to use this.
The main happenings of the year. Federal law change: the federal law 121. On procedure for making foreign investment in economic companies having a strategic significance for the countries [the sense] and security of the State.
Our amendment that we lobbied into this federal law allowed us to work in the Baltic. We made this discovery before this law was in place, but we couldn't obviously announce it.
Now, we can announce that we discovered several fields with recoverable resource or around 300 million barrels of very good oil around D6. You all know that the Baltic Sea is in the white zone of offshore projects. It has export tariff privileges and mineral extraction tax privilege.
That's why on the next slide you can see that one barrel of oil from Baltic is equal to three barrels of Western Siberian oil, economically speaking, because you can see that the projected level of net income is going to be more than 3 times higher than in the Western Siberia. So we plan to activate, to accelerate our production and, hopefully, we'll commission our fields in the Baltic Sea one by one.
Some of them are up to 100 million barrels. They are in shallow seas. There is no problem in getting the equipment. We have a plant in Kaliningrad to build the fixed base production platform. Let me thank the Ministry of Defense to carry out exploration and production in the zone that previously was released to the zone for Baltic Sea military training purposes. Thank you very much to them.
This is a very positive thing. Indeed, this is a great contribution potentially in increasing the revenues and income of our Company.
Just a few words about other projects that we have in the pipeline. You can see here that (inaudible) field in the North keeps producing quite actively. You can see that production went up by 16.2%.
Next slide illustrates what goes on the Vinogradov field. Once we mentioned that we are going to work on hard-to-recover tight oils and Vinogradov field is a brilliant illustration.
It is really hard to recover this kind of oil that you wouldn't be able to recover using regular, so it's very much, [analysts], very similar to North Dakota. It's multistage hydraulic fracturing of horizontal wells that allows us to work effectively here.
You can see oil production going up around 5 times and this field has huge potential. It demonstrates that Lukoil is great at developing sales with hard-to-recover oils now that we have the privileges.
Even at $60 per barrel of oil price, this field is highly economic since this is not shale oil; this is Achimov formation. So economically efficient, even at current economic conditions.
Korchagin field increases production around 13% despite certain difficulties related to high gas/oil ratio. Currently, we are preparing ourselves to launching the second train of the so-called conductor block that would allow us to increase production even more by 1 million tonnes per annum. So we keep developing our Korchagin field quite successfully and thanks to the privilege, it's very economical.
Samara-Nafta, we expected Samara-Nafta potential to be higher than the ones that were laid as bases for the price. So in just one year for this group of small oil fields situated in a well-studied European zone and of Russia with developed transportation infrastructure, the production there grew by 9% to 10%.
We carried out around -- we had around seven smallish 1 million to 3 million tonnes' worth discoveries but, yet, they're very effective in a region with highly-developed infrastructure, and it's ready for us to operate. So we count that Samara-Nafta productions will be on the grow field. Now it's called, what, [Retac]; now it's called Retac.
Imilor field, it was a very difficult site with Rosneft. We had to pay handsomely and we started to produce from the facility, you can see production on the graph, around 300,000 tonnes. It is the production that is going to grow quarter on quarter.
Besides, we expect the Duma to introduce amendments into the law on tax on financial results or additional income, whichever name they take. Anyway, in the pilot project, Imilor field is there and this project guarantees 16% return, almost like in America. It's better there, they don't pay taxes and they get cash [influx] from the banks. But we also will have an opportunity, hopefully, to develop this field quite effectively.
Kama-Oil, our other new pre-salt kind of -- new acquisition that pre-salt field, you can see that production went up by 1.8 times in one year.
Just a few words about with downstream. A tax removal, the notorious tax removal, made the margin very uncomfortable, so to speak, and for [low nothing] index plans, even negative. The hydro-skimming ones, I mean.
We invested into refining and, thank God, in 2015, we already were finalizing this cycle. This year, we are commissioning coke for 2.1 million tonnes per annum in perm. In Volgograd, next year, we're about to launch, if I can get oil hydrocracking with capacity of 3.5 million tonnes. CDU is commissioned; will allow to increase the capacity up to 14 million tonnes per annum by 5 million tonnes.
Plus, cat reforming for 2 million tonnes, the second train for cat cracking is something to be expected in the second quarter of 2015.
So, despite margin going down, the high complexity plan still keep the margin; not increasing it but keeping it. So those were timely and right project to carry out.
Something we take pride in as well is the residue hydrocracking unit in Burgas, Bulgaria. Burgas Neftochim that will allow us to go from fourth quartile to the second quartile on Solomon's study and become a plant, a refinery, of proper standing that would give us profit. We expect a bigger -- to grow more than 200 million per annum.
Only those plans that are in first and second quartile will be able to compete with the Persian Gulf plants, like three plants in Saudi Arabia and one launched in Abu Dhabi, only if we are in first and second quarter. It's 130 million tonnes running capacity. The diesel will be sent to Europe and simple European refineries will end their life and only Burgas will be there to stay alive and keep a competitive advantage thanks to logistics.
And thus, we'll be able to cope with the challenge presented to us by the supply of diesel from Gulf of Mexico.
What about that margin of Lukoil Russian refineries in 2015? Despite the change in macroeconomic conditions and despite the tax removal, we'll stay at the same competitive level.
First and foremost, thanks to the fact that we are cutting on our sales of fuel oil. We're cutting and cutting and cutting on it and, by the end of 2016, the amount of fuel oil is going to cut 3 times, around 6 million to 7 million tonnes. This would be the total amount of fuel oil.
Next slide gives the new West Qurna-2 development. The Arabian oil is sold at a discount so sometimes we use this oil for our own refining. Otherwise, we get this oil to Asia and also to US and to our refinery in ISAB.
In the first quarter 2015, compensation volume amounted to $600 million. Production was around 300,000 barrels per day, with 400,000 barrels per day, but there are constraints. From time to time, the [Trawler] Ministry of Iraq just restrains production, because either Basra doesn't live up to it or -- and so we keep talking to the government.
You probably know that the Prime Minister of Iraq came to the Russian Federation and met the President of the Russian Federation. The agreement achieved was that in the third quarter, they're going to increase compensation volume by 5 million barrels to comply with all the agreements and compensate all the expenses, including the investment made in 2015, which is a very important point to make.
So this project is still on the go; it's still effective. We are also looking into other options out there.
Lukoil is still an environmentally safe company. Not only do we sell the cleanest fuels, called eco in the Russian Federation, we also cut on dirty discharge; atmospheric pollutant emission; water consumption of our needs, and this allows us to save on fines by the way. Apart from staying environmentally friendly, it's also economically right.
Main conclusions. The task is to keep a high level of dividend payments; optimize on operating and capital expenditures; stay highly efficient in developing new fields; to keep realizing our impaired cost compensation plan on West Qurna-2; run efficient projects in oil and gas refinery sector in time and within the planned budget; and keep our strong financial position.
Which speaks [absolutely] of the fact that, yes, we are surviving and we are still in sound health and sound memory, despite the challenging times. And we do hope that the experience we have accumulated in the four previous crises lets us do everything in timely manner and everything right.
We'll be happy to answer your questions now. Yes, please?
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Questions and Answers
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Pavel Kushnir, Deutsche Bank - Analyst [1]
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Pavel Kushnir, Deutsche Bank. Could you please speak in greater details about your Caspian project? You mentioned that in Korchagin you'll have a second train to increase the production by 1 million tonnes of oil per annum. When you are planning to launch it? And when do you think the sales is going to work fully and completely?
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Unidentified Company Representative [2]
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We expect that the privileges will still be in place -- the privileges on Caspian fields, will still be in place. After August, we're going to have another meeting and we expect that it happens at around 17/18.
By the end of this year, we are planning to finalize drilling at Filanovsky field. By the end 2016, we are going to start the planned production, since production rates are very high, around 5,000 -- 3,000 barrels, and only several wells are okay to get to the planned production levels on Filanovsky field.
We made a handsome discovery. We discovered a new structure, it's called [Rakushka] or [shale]. This is the continuation of the trend that started with Filanovsky field. Since we still have the privileges and since this is a highly efficient field, this field is going to be launched by 2021 rather than 2029, as planned earlier.
We're also going to have a meeting on [Khvalynskya] field, to understand how to transport gas to the territory of Kazakhstan, and together with our Kazakhi partners, and Total is going to speak on their behalf.
This is going to be a very interesting project. We also have certain ambitions in terms of exploration. We are going to drill three exploration wells for two structures where we expect to get commercial discoveries for oil.
As far as gas is concerned, we've decided to delay gas production as at the domestic prices; this project is not good enough for us. So we prioritize oil production. All the volumes that were planned for gas are now working for oil.
Caspian Sea is still main source of our [invest]. And the strategy that is going to be presented by the end of year will have all the parameters, all figures in it in terms of production. But I'm saying that the Baltics and Caspian offshore is our high priority for development.
Yes, please?
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Alexander Nazarov, Gazprombank - Analyst [3]
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Alexander Nazarov, Gazprombank. I have one short technical question on financial results. When forming free cash flow, accounts receivable going down played a very considerable role, not through trading receivables by the way. What's going on? Is it a one-time event or do you expect it to reverse?
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Unidentified Company Representative [4]
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Okay, let's go by one, if you don't mind. The trade account receivables also plays a role. Our foreign companies went down on accounts receivables -- on their trade operations. First quarter effect is that in MET, mineral extraction tax, the rate goes up and so our accounts receivables go up as well. This is what give us the change in cash flow.
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Alexander Nazarov, Gazprombank - Analyst [5]
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Do you think it's going to stay at this level?
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Unidentified Company Representative [6]
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In MET it's going to be paid back. But in -- with our chain of sales, it goes back and forth.
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Alexander Nazarov, Gazprombank - Analyst [7]
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Okay. I also have a more strategic question about dividends for 2015. Could you please give us any idea, in percentage of net income or EBITDA for dividends for 2015?
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Unidentified Company Representative [8]
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We have constraints in announcing the amount of dividend, and once we were warned by the regulators not to do it. Our British regulator warned us in particular that we're not supposed to give any forecasts that are not confirmed by auditors.
All I'm saying is that we are still optimistic in terms of keeping the dividend at the 2015 level in the year 2016. And, I try to explain why we're optimistic; it is because our oil price forecast is conservative and yet realistic.
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Unidentified Audience Member [9]
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(inaudible). In operating activity and CapEx, the drilling volumes it's around 1% and you say that CapEx is going up by 19%, so what are you spending on? The drill contractors are asking more money or --?
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Unidentified Company Representative [10]
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As far as drilling volumes are concerned, they increase quarter on quarter, if you compare against the previous quarter I mean.
As far as tariffs, they didn't go up and thing is that now we have more things going on related to construction of more expensive horizontal wells. The number of horizontal wells is increasing, and those are complex design wells with multistage, multi-zone fracturing.
Plus, this CapEx includes the CapEx on Filanovsky field.
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Unidentified Audience Member [11]
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But Filanovsky is ruble CapEx.
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Unidentified Company Representative [12]
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Yes but there is a dollar [sensitive] to it as well, because all the bases are being constructed on the territory of the Russian Federation and contracts have been signed in rubles.
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Unidentified Audience Member [13]
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Okay. Thank you.
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Maxim Moshkov, - Analyst [14]
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I have a question on West Qurna. In view of the complicated situation, what's your opinion of the second stage?
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Unidentified Company Representative [15]
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We have contractual obligation.
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Maxim Moshkov, - Analyst [16]
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You compensate all money and then you go on with the second or third stage and even pipeline.
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Unidentified Company Representative [17]
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The most important thing is to get the money back from launching this whole project. As soon as we get this money back, it will be like breathing in and out, inhaling effect.
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Maxim Moshkov, - Analyst [18]
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You invest [RUB100 million]; you get [RUB100 million] back.
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Unidentified Company Representative [19]
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Yes, we're interested to increase production, because our fee depends on the extraction. It's not huge, but when you have 1.6 barrels then even a small fee is considerable.
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Maxim Moshkov, - Analyst [20]
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We see Bashneft and Gazprom Neft and you decrease refining and prefer exporting crude oil.
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Unidentified Company Representative [21]
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Obviously, first quarter is not very illustrative, because there is a seasonal effect in that.
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Maxim Moshkov, - Analyst [22]
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Still my question is: what are foreseeing in the second quarter? And yet the prices at the filling stations are not --yes, well not very considerably; they are growing not very considerably. So looks like downstream in Russia is doomed.
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Unidentified Company Representative [23]
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All I'm saying, I don't expect a premium of gasoline. It's not going on, although oil price is going up and ruble is getting better. We warned a government the tax removal would lead to drying out of refineries. All the simple refineries would die out, would close down, like in Europe.
It would survive for what, one quarter, three quarters. You may survive losses for one year, but not for your whole life. You have to be in the third, or at least second quartile, to have margins that make [us] happy.
It's around 60 -- 70 out to 150 million tonnes. How long it will take to go out, like one year, two years, three years nobody knows, and when it stops happening that's when fixation might probably change.
This is how it works. At this point, our task is to stay very efficient despite the changes in macroeconomic environment, as well as tax environment, that's why we increase this efficiency.
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Maxim Moshkov, - Analyst [24]
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You mentioned that war between shale oil and OPEC, but Russia is not a side, right?
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Unidentified Company Representative [25]
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Increasing the crude exports by 60 million tonnes will definitely lead to other changes in the market.
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Maxim Moshkov, - Analyst [26]
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But what is the lifting cost?
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Unidentified Company Representative [27]
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It's [$3.5].
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Maxim Moshkov, - Analyst [28]
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What is the listing cost in North Dakota, do you know?
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Unidentified Company Representative [29]
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I will tell you, [$47], [$52] plus $18 with transportation costs.
We don't want to give away our share in the market; I think Russia is behaving very adequately.
I am still very pessimistic. I'm saying that Russia has to drill 300 million and will drill 17 to 18 million and production assumes to go down at some point.
Right now, we have new fields, we have privileges; all that, but sooner or later we are not drilling enough and this will go down. And then they'll have the added income tax or something, but by then Russia will be behind, and when it happens this year or next year, nobody knows.
Generally speaking, we are very adequate; oil companies in Russia are very adequate. Our oil is competitive, our crude oil is competitive with only Arab oil ahead of us, but they have their own markets. We go for Europe and China mainly.
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Maxim Moshkov, - Analyst [30]
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So it would have been wrong to change some?
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Unidentified Company Representative [31]
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Those who have lifting costs higher, higher than $50 per barrel, should go away from the market, not us.
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Unidentified Audience Member [32]
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I am from HSBC I have a question; you have trade, a high volume of trade operations. There is this opinion that the oil price growth was thanks to the financial transactions, rather than changes in supply/demand balance, what's your standing on this?
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Unidentified Company Representative [33]
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All supply/demand changes are on the level of -- on tolerance corridor when you only have plus or minus 1 million tonnes; it's not big.
The crisis was artificial. Artificial, because nobody's in fact reacting to (inaudible), Islamic State, or (inaudible) [Strait] getting close, or (inaudible) Strait. It's just a price war very much like what (inaudible) made happen in the end of 1890s.
The Arab's do try it. They are very good at keeping their market share, after all American investors went out of investment funds, Arab capital went in, so their playing with both hands.
They have pricing side, and they manage the supplies and they create a landscape that's needed, while political will of Mr. Obama is that, as he said, that we want to punish Russia, and that's what's going on; so there you go.
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Pavel Sorokin, Morgan Stanley - Analyst [34]
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Pavel Sorokin, Morgan Stanley could you give greater details on the agreement with Sinopec, do you have all the conditions?
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Unidentified Company Representative [35]
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Our VP, Mr. Timoshenko, our VP on business development in upstream segment is going to speak on that.
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Dmitry Timoshenko, LUKOIL OAO - VP, Business Development, Upstream [36]
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The agreement is signed, we have a new acquisition contract in place. The price is there; you all know the price.
For the period while this deal is being closed all the arbitrage hearings are the same. We don't go on with it, and this was related to the non-closure of the [privacy] section.
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Pavel Sorokin, Morgan Stanley - Analyst [37]
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So when do you expect the money in your account?
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Dmitry Timoshenko, LUKOIL OAO - VP, Business Development, Upstream [38]
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Obviously, the deal asks for certain contingency, certain conditions to be in place, the approvals from Kazakhstan party, and we also need to live up with the formalities in China. There are certain requirements to the Chinese companies, so our counterparty has to abide by those as well.
Our expectation is middle of August to December. This is the time when there -- when we expect to get the money in our account, and finally close the deal in this respect.
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Ildar Davletshin, Renaissance Capital - Analyst [39]
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I'm from Renaissance Capital, my name is Ildar.
I have a question on Filanovsky field. Just for clarification next year in terms of production from Filanovsky field, you are going to start right? Do you have any understanding how much you are going to produce?
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Unidentified Company Representative [40]
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4.5 million, this is by the end of the year.
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Ildar Davletshin, Renaissance Capital - Analyst [41]
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Right, and about gas, what about gas/oil ratio there, and what about the plan together with Gazprom, or probably you're going to use it for power generation or something?
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Unidentified Company Representative [42]
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Happily gas oil ratio is very low at Filanovsky field; we don't have a lot of associated gas there unlike Korchagin.
We're also launching a gas processing plant in (inaudible), and this is going to process gas from Korchagin field, while Filanovsky doesn't have major amount of gas to be processed.
In terms of production we expect around 4 plus million tonnes.
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Ildar Davletshin, Renaissance Capital - Analyst [43]
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By the end of the year?
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Unidentified Company Representative [44]
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Yes, by the end of the year. I mean this is per day, but by the end of the year.
We need to start up the well first, and carry out production tests and some of them will be highly productive, others not very productive.
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Ildar Davletshin, Renaissance Capital - Analyst [45]
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Will three wells be enough, or do we have to drill some more?
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Unidentified Company Representative [46]
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There is some degree of uncertainty, and we'll see what happens. Obviously, now that we still have the privileges we want to grow production to the maximum.
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Ildar Davletshin, Renaissance Capital - Analyst [47]
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In [mass] media there were information -- there was information about delays?
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Unidentified Company Representative [48]
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Yes delays do happen with contractors; one State company got our money while that company used it to buy shares of another commercial company.
So our treasury totally changed the system of working with our contractors. Now, all payments are being made using certain parameters, certain conditions. Our engineers promise, not guarantee obviously, but promise that they [leave] up by the tasks. Around 300 people are there already, all the platform phases are already there in place.
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Ildar Davletshin, Renaissance Capital - Analyst [49]
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In terms of dividends, apart from 2015, midterm you had a very clear goal, and you actually run ahead of it; more than 15% growth in dividend in rubles, great result.
So let's say in the next three years to five years, are you planning a growth in rubles, and is it going to be related to net income?
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Unidentified Company Representative [50]
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You know when I talk to the foreigners, they get it. They totally get it. Let me explain it to you, we don't know the exchange rate. Two years ago if I would tell you that dollar is going to be worth RUB60 nobody would believe me, yet it happened. So there is a high degree of uncertainty in currency exchange. Central Bank is managing it. They think that -- they want -- they go for budget profit for the Russian Federation; that's what they're having right now.
Oil price, on the other hand, in order to pay out the dividends we need to have enough of free cash flow. So I brought to you my calculations. I think that the oil would go up to $75. If we see Chapter 11 instances in the shale industry, then a backwards return to $100 per barrel price.
This is my scenario. This is how I see it. Whether I'm right or wrong we'll see in the first quarter of next year. Lukoil's position is that dividends have to grow irrespective of everything.
That's why I'm saying I'm reasonably, conservatively, optimistic. I'm actually very interested in dividends, just like everybody else here, because their bonuses are tied to dividends. (Laughter). Yes, obviously we are.
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Unidentified Audience Member [51]
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I have a question on European refining. What's your standing on the first quarter of 2015?
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Unidentified Company Representative [52]
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Just like other refineries. I already gave you the example of Burgas; it's going to be very well because it's left the risk zone to enter the zone of reasonable [IRA] level, and it's competitive now.
I have -- we make use of certain oils, including the cheap oil, the cheap feedstock from Basra, gas from Basra, including the compensation oil, some heavy oil that we get from Mexico, from Canada. It allows to keep returns high.
The level is sticking however. Oil refining in Europe will go up just like chemical industry, much machine building industry. But they say okay, okay, plants close down, environments will be better. And we say we understand that around EUR1 trillion will go away with it. Well, they'll print some more money. Most probably only the highly efficient, environmentally friendly, plants will survive.
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Unidentified Audience Member [53]
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And in order for the margin to stay competitive you would want to close down around 100 million tonnes of European refining.
When we were buying ISAB we were told that ISAB would be in the 10 of the refineries that were going to be closed last. So you don't want to sell. Well, who wants to buy? I would sell everything. I don't see the buyers just as yet.
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Unidentified Company Representative [54]
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This is your second question. Do you have a first question somewhere?
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Unidentified Audience Member [55]
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I only have one question. Getting back to hard to recover reserves. Very pragmatic question is what's the production from unconventionals right now?
And what's your standing in the context of fighting over the market shale and all that? Don't you think that Russia, and your Company in particular, want to concentrate on the reserves where turnaround cycle is shorter, and where access to money is of more importance than access to reserves.
Well, you have the technology. And it would be more reasonable than to invest into Caspian or Arctic or Baltic project zones, and numerate them together.
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Unidentified Company Representative [56]
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Arctic is totally different.
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Unidentified Audience Member [57]
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But in Russian context, yes, for you Arctic is totally different [perceptually].
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Unidentified Company Representative [58]
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No I don't think so. 1 tonne of oil produced in the Baltic equals to 3 tonnes of oil produced in Western Siberia. In Western Siberia -- it's on slide 23 by the way, and in Western Siberia production is going to go down.
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Unidentified Audience Member [59]
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Is it because of a physical property?
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Unidentified Company Representative [60]
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No, it's because of leasing peculiarities, and tax privileges. Even without the privileges, the D6 doesn't have any privileges whatsoever. We have there [gushing] oil flow. Water cost started to increase very late. And transportation cost is very low; negligible I would say even. And the properties of oil it's light, premium, oil. So I don't agree with you at all.
In terms of unit costs, in terms of investment, it's very, very, efficient. Just like Caspian, which has the privileges, but it gives us the returns of greater than in Western Siberia.
As far as hard-to-recover ores are concerned, we're only working with the hard-to-recover oils that give us high efficiency, even at $40 per barrel, because of the risks.
So yes we have the potential, but not at any price. When we have this new law that is now being discussed, on additional income, then we will see. When it comes, we'll see.
The taxation model on offshore, if it's like hard to recover, well if it's hard to recover in the already existing logistics, it would be better than working with offshore, where you have to construct a platform.
But you have to just play by the rules of the game that's out there. There is tax relief for 10 years, so you need to launch the production in 10 years, and get your money back, right, that's what we're doing.
If you don't mind, our last question, I will take one last question.
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Unidentified Audience Member [61]
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I have a question on ISAB. From what I know, this -- you had losses, or zero profit on this. And you're saying that European refining is going away. Does it mean that ISAB is going negative as well? Why are you saying that this oil would go to Europe rather than Asia?
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Unidentified Company Representative [62]
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ISAB is a Sicily refinery. At this [Sicilian] refinery, while margin was going down, we were suffering same issues just like everybody else.
There is a program to restructure and to decrease our OpEx. It used to be just processing, processing center, and now it's a profit center. All the costs is something that creates loss for Italian economy, so what we are trying to do is to optimize the cost structure.
We try to interest the governments, both the Italian Government and Sicilian Government, more, so that they'll probably give us more favorable conditions.
We increased its efficiency through acquiring -- there was this contract they will pay to a major power generation plant that used to belong to Japanese company, we bought it at zero. Not because we are great, but because the rules of the play were changing in selling the electric energy.
But the idea is that it does decrease the delivery price, and we no longer had the fixed cost for residue of [stay-in] production. That would be more expensive in terms of money.
So on each contract we tried to make it as effective and efficient as possible, and market helps us there. European refining markets helps us there. But all the plans related to that is they're trying to get the opportunity to optimize it and we're trying to do it.
Now, package it to other assets, probably that would be of interest. Like Mr. Fedun has mentioned, the prospects are very vague in European oil refining, so we're looking into all the opportunities.
Our main task is to decrease costs and decrease OpEx, getting positive results. We created a special group, Mr. Fedun mentioned it in passing, that delivers special feed stocks, out of actually 15 feed stocks to this refinery. That allows us to optimize the processes and to get the optimum yield.
So looking at each element of the jigsaw puzzle we optimized. It's not that this optimization gave us [food] immediately. We know that it was the prices going down, and the differential between oil and petroleum products. But anyway, we keep working and trying to get to the average value that exists in this market, and keep going like that.
At this, I thank you for your attention in one hour; hopefully we answered all your questions. If you have any additional questions, please free to address our Investor Relations department. We're actually still here.
With this, we end the conference call. Thank you very much.
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Editor [63]
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Statements in English on this transcript were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.
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