Nine Months 2015 NK Lukoil PAO Earnings Call

Nov 30, 2015 AM EST
LKOH.MZ - NK Lukoil PAO
Nine Months 2015 NK Lukoil PAO Earnings Call
Nov 30, 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
   *  Igor Kozyrev
      Lukoil OAO - Deputy Chief Accountant

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Conference Call Participants
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   *  Olga Belenkaya
      - Analyst
   *  Alexander Nazarov
      - Analyst
   *  Alexander Kornilov
      Alfa Bank - Analyst
   *  Artem Konchin
      Otkritie - Analyst
   *  Ildar Khaziev
      HSBC - Analyst

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Presentation
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Editor   [1]
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 (Audio in progress)

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 Andrey Gaidamaka,  Lukoil OAO - VP, IR   [2]
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 ...development. He is also member of the Board, and he is the second-largest shareholder in the Company.

 We also have Alexander Matytsyn, who is the Chief Financial Officer of the Company; and he is the best person to ask any financial questions on the cash flows, and on the issues regarding debt, and so forth.

 We also have a very good team of the accounting team. It's Igor Kozyrev, Deputy Chief Accountant; Sergei Epifanov, the Head of US GAAP and IS, I understand, going forward, reporting; and [Jack Lovinsky]. We also have the best team to have any accounting questions that you might have.

 My name is Andrey Gaidamaka and I'm Vice President in charge of investor relations. We will be also joined by [Yama Schat] on investor relations team.

 We are still waiting for a couple more analysts to arrive. I just want to tell you a couple of housekeeping questions. We will have -- we do have simultaneous translation. We will have a webcast. And we will be taking questions both from the phone lines and Internet.

 But I would greatly urge everyone listening to this phone call, to this conference call, to use Internet because we are sitting in a fairly large hall and it's fairly difficult, physically, to hear the questions from the phone lines. We will try to take them, but it's better if the audience sends the questions via Internet.

 With this, and without further ado, I would like to open the floor to Mr. Fedun for the presentation of the financial results.

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 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [3]
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 (interpreted) Thank you for being with us today. Thank you for coming to our office.

 In light of the recent events that have happened in the past few months, we try to spend as much time in Russia as possible; and this particular presentation will also be made from Russia. But the Q4 2015 financial results will be delivered in New York, because we hope to be as close to our investors and shareholders as possible.

 Well, I'll brief you on the main financial results in Q3 2015. The first slide, please. This is the forward-looking statement. Well, I hope that you are all familiar with the forward-looking statements; I'm not going to read them out to you.

 Next slide, please. As for the main events in the first nine months of 2015, they are as follows. The liquid hydrocarbon production growth has increased by almost 4%; and, first and foremost, the reason is the stable production in Russia.

 In addition to that, we increased the oil production in Iraq. In the ninth month, we produced a total of $2.3 billion worth of oil.

 In addition to that, we discovered a deep water offshore gas field off the coast of Romania. We have not always been successful in exploration projects abroad, but finally we have been able to discover a gas field.

 Another good piece of news is that we confirmed the oil in place at the [Rakushechnoye] oil field. It's a small oil field, it's almost a satellite field of the Filanovsky field, but, nevertheless, it's important.

 We've been waiting for Russia and Kazakhstan to sign a protocol on the joint development of the Tsentralnaya structure in the Caspian Sea for quite a long time. There were lots of collisions because of the offshore fields. Strategic things took place. Ultimately, the oil in place was calculated in a proper way. And we actually don't expect any obstacles towards developing this field internally.

 In addition to that, we keep on upgrading our refineries based in Russia, which will allow us to face the tax maneuver in a proper way. And I will brief you on the dividends payments in greater detail.

 In addition to that, the free cash flow is increasing, which is another positive piece of news.

 As for the main financial results, they are shown in this particular slide. The net income is $2.318 billion. The adjusted net income is $2.769 billion, so the EBITDA increased to more than $10 billion. In other words, the debt-to-equity ratio is decreasing.

 And the free cash flow and the sales of subsidiaries and equity method affiliates accounted to $3.3 billion, which is a great financial result.

 As for the macroeconomic dynamics and tax environment, slide 6, please, the macroeconomic and tax environment are as follows. You can see all the indices. Looking to the crude prices, and petroleum product prices are in the red, they decreased significantly.

 As for the positive factors, the tariffs have declined, and in US dollars they did not increase. The Russian ruble inflation amounted to 10.4%.

 It's only natural that export tariffs and the mineral extraction tax reduced following the plunging crude oil prices.

 The ongoing crisis that we are in has been partially offset by the fact that we have quite a flexible taxation system. And back in the year of 2000, I was one of the authors behind the current taxation environment. We tried to come up with a new taxation system, following the 1998 crisis; and basically, as you can see, unlike our counterparts, who face quite stable taxes each and every year, we, on the contrary, are in a favorable condition because of the flexible approach.

 In addition to that, the experience that we gained back in 1998, and the year of 2008, is something that we capitalized on. The Russian ruble devaluated, thus, all the exporting companies are, to a certain extent, in a favorable condition.

 Let's now focus on our forecasts for the future. The rivalry between OPEC and independent producers will go on. And the ends justifies the means. And information warfare is something that we're going to see in the future, as well.

 [Fargos] is a good example. As you can see, the data was published in September 2015. As you can see, the OPEC increased its production by 1 billion barrels per day, while the independent producers had to curb their production by 0.9 million barrels per day.

 But as you can see here, the situation is more dramatic. Canada is growing, it's not reducing; however, it had to freeze a number of large-scale projects, focusing on shale oil and gas production. And the surplus that we see now is 800,000 barrels per day; but nevertheless, taking the current global surplus, is slightly more than 1% to 2% of the overall global production, according to [various] sources.

 And the hysteria around the crude prices cannot be explained by these statistics. The only question is who do they play against? The most popular hypothesis is that the major victims are expected to be the so-called tight oil producers, or unconventional oil and gas producers.

 While the US-based producers were expected to have experienced the major difficulties, the additional 3 million barrels were produced by tight oil producers. They announced that they would increase the production to 6.5 million barrels per day; and, actually, this is what the struggle is all about.

 The Q2 reports have been confirmed by Q3 reports. 80% to 85% of all the payments from the operating income are allocated to pay back the debt. In other words, without incurring additional debt, the tight oil producers will not be able to survive. As you can see, their cash flow has almost halved, while their accumulated debt has increased.

 Even if the basic rate is increased because of China but the US will still have a problem, owing to the tight oil producers. Even a slight increase in the basic rate will increase the payments to be paid out by the tight oil producers; and almost 100%, or 100%-plus, of their income will have to be allocated for paying back the debt.

 High operating efficiency is something that they count upon. But operating efficiency depends on two things, squeezing the suppliers, and, secondly, drilling the so-called sweet spots; in other words, the most productive intervals and reservoirs in their oil fields. They measure everything in acres, as opposed to hectares, and the [four players] have a product cost of $35 to $40 per barrel of oil equivalent.

 However, if we take in to account the entire oil field, and if we calculate everything, then the production costs will be $85 to $90 per barrel of oil equivalent.

 After drilling the sweet spots, they will have to shift their attention towards the margins, and their efficiency will no longer be that obvious.

 But one of the companies, Energy XXI, published a report reading that $970 million of debt had to be written off. They are selling off their assets; no one is surprised about that. For Russians, it's almost next to impossible to understand that.

 Wood Mackenzie published a report on the so-called reserve-based loans. This is the system that they use. And there are two statements. The first statement is that RBL cannot be used for analyzing financial results. And the second statement is that we're only considering RBLs, otherwise all the Company's tight oil producers will have to be considered bankrupt.

 Another factor that we had to take in to account is the hedging system. No matter how strange it might seem, but US banks and other financial institutions spend about $150 million to $160 million per day. It compensates to oil majors, to oil producers, the hedge risks.

 And tight oil producers hedged 52% of their production at an average price of $82 per barrel. The average price is $35 per barrel. The WTI prices are $42 per barrel. And that goes to show you what the [miracle's] all about: someone has to shoulder the burden.

 However, in 2016, the average share of hedged production will decrease to 35%, and the price will still be quite considerable, $67 per barrel. In 2017, the situation will be aggravated even further. So my theory is as follows: as soon as tight oil producers will have to resort to high hedging prices, because they will have to pay back their debts to the banks, and the Arab countries will need to have their budgets in place, they will start facing problems.

 And this resembles the crisis of 2008 when the mortgage system was inflated in the US. They used it as collateral, and then a second collateral, and then actually FRS, the financial reserve, had to come to the rescue. I think the situation will repeat itself. Out of the 37 tight-oil producers, most of them have almost defaulted on their debt.

 Fortunately, or unfortunately, I don't know, because these are all counterparts, I would put it this way. The current stability that we are observing with regards to tight oil or unconventional oil producers is only maintained by the hedge funds and finances that they receive from the banks.

 The situation will change throughout 2016; the situation will change quite dramatically. And in all likelihood, at least I don't see any economic reasons for maintaining the surplus of production in OPEC. US financial institutions will no longer be willing to finance the loss-making production in the US.

 I don't know when the situation will reverse, but there is no doubt, at least in my mind, that it will happen in late 2016, that's the worst case scenario; or even earlier, in the best-case scenario.

 But we are conservative in our estimates. We believe that the average oil price in 2016 will be $50 per barrel.

 As for the main operating results, they are shown in this slide. The liquid hydrocarbon production abroad has been increasing. The exports of crude oil have been increasing, because the so-called tax maneuver is increasing the profitability of production and decreasing the profitability of oil refining. So our refined oil exports are decreasing.

 I think it would be more profitable for the budget if we sold refined products, as opposed to crude. But the current situation makes it more profitable to export crude oil.

 As for production, international production has increased quite significantly, while in Russia it has stayed at the same level without being curbed. The next slide shows you the reasons for this stable oil production in Russia.

 Production in Western Siberia is decreasing; and the reason is in the dotted squares. If the [net] back from one barrel in Western Siberia was $15 at a price of $50 per barrel, in Timan-Pechora it was $21 per barrel, and in the Caspian it was even higher than that. In other words, it's much more profitable to increase production in other regions, as opposed to Western Siberia. And the growth is seen in the regions with the better logistics and higher production rates of more profitable oil.

 This slide gives you the benchmarking of our Company with our competitors. Our financial results are stronger, due to efficient management, tax system, and Russian ruble devaluation. The latter two allow us to accumulate a positive free cash flow. At the same time, our CapEx decreased in US dollars, and slightly grew in Russian rubles. In other words, we still maintain our strong position.

 The next slide gives you a comparison with oil majors. One of the agencies published the roadmap of sustainability of oil majors to show which companies will be able to survive even low oil prices. We are the second best company. But naturally, this is a purely theoretical research. It was done by an independent international agency.

 As for OPEC, in US dollars OPEC keeps on declining, despite the fact that we spend quite a large amount of money in US dollars because we need to operate abroad. And I personally believe that we physically reduced the amount of our operations abroad: that's one of the reasons. And the second reason is the devaluation of the Russia ruble.

 Next slide, please: lifting costs per barrel of oil equivalent. As you can see, the costs have decreased considerably. Save for the West Qurna-2, it's $3.67 per barrel of oil equivalent. And given the fact that the Russian ruble-to-US dollar exchange rate decreased by 40.3%, the lifting costs decreased by 35%; and the inflation rate is 10%. [5%] minus inflation shows you the efficiency that we have been able to demonstrate in the Company.

 Sales general and administrative and transportation expenses, they have all been curbed. The trend is quite clear. And naturally, we are grateful to the Russian Government for the fact that the tariffs have been frozen, I mean the tariffs of the natural monopolies, which allows both Lukoil and other producers that account for the larger share of the gross domestic product to survive under the current conditions.

 The next slide gives you the structure of CapEx. In US dollars, the CapEx decreased by 26%, and increased by 4% in Russian rubles.

 In segments, we have reduced our refining and marketing because we are completing the large-scale project of upgrading our refineries, which will allow us to survive both the tax maneuver and a decreasing refining margin that we are seeing across Russia. This involves three or four power generation. We have almost completed the program that we have developed and the segment is already showing a growing profit.

 The CapEx structure shown here, out of $7.4 billion that we've spent, 61% has been spent in Russia, and 39% has been spent abroad.

 Our production costs are slightly higher because, like I said, we also operate abroad, unlike our Russian counterparts. And all the costs we incur abroad are either in US dollars or in euros. But we are as efficient as our Russian counterparts.

 The same holds true for oil refining. Only 15% of our refining capacities are based abroad, and that's why they also have a slight impact on the results.

 Slide 21, please. These are the main financial results. Despite the overall reduction, as you can see, the EBITDA has increased by 2% quarter to quarter. That's a unique situation. The primary reason is that we have recovered some of the costs in West Qurna-2. And like I said, it's reverse hedging of sorts, because the production rates are growing in West Qurna-2.

 When the Iraqi Government developed the program, they focused on the maximum profit. But the prices were high back then; then the prices dropped, which means that we, as a contractor, are in a more favorable situation in light of the ongoing crisis.

 The net income reconciliation is shown on the next slide. The positive factors include changes in the taxes, excise and export, due to changes in OpEx; changes in transportation expenses; changes in SG&A expenses; and others. Well, as you can see, they are highlighted in green. And the sales of hydrocarbons have reduced considerably, thus the net income in the first nine months of 2015 has reduced.

 As for the cash flow reconciliation, it's as follows. The cash flow increased by almost $1 billion. Thus, if you ask me a question if we have enough money to pay our dividends, the answer is, yes: and the financial results of Q3 confirm that.

 Despite the ongoing crisis, we are financially stable. And I guess Alexander will give you more details on that. If you have questions on that, I can [telephone Sarah outside]. As compared to our competitors, we are quite in a stable situation.

 Let's go back to slide 5, and I'll brief you on the dividends. Actually, we have already announced that we will increase the dividend payment by RUB5, as compared to those of Q2.

 As for the forecast for the end of the year, we also expect the dividends to increase; but I will not disclose by how much, because we have our concerns. Much will depend on the crude prices in Q1 2016, because the majority of players want to [see] the bottom, and then they would want to increase the crude prices.

 But, by and large, the budget for 2016 envisions higher dividends; but I will not disclose the exact figure. Naturally, I'm talking about dividends in Russian rubles.

 If the oil prices go up, naturally, the dividends in US dollars will also go up. But if the oil prices go down, we are not ready to shoulder additional exchange rate risks.

 Let's go back to slide 25. Sorry for that, but I had to cover the cash flow first, and then go back to the dividends.

 A very important thing we did is a detailed field appraisal of the Rakushechnoye field. The initial data was that it was a gas field, but after further appraisal we saw that there are almost 300 million barrels of oil in place. And naturally, we will primarily focus on producing oil, but we will need to do additional appraisal on this field.

 We plan to drill 46 wells in the Caspian Sea next year. We are looking forward to the results of the drilling jobs, and we hope that we will discover a number of other plays that will increase our potential.

 I'd like to stress that the Filanovsky field, which has already -- which is under development, will be commissioned in early 2016. We expect spudding to be done in early 2016 and be completed -- the drill work to be completed in late 2016. And naturally, it will increase the profitability for the shareholders and the Company. All the oil reserves in place should be multiplied by 3.

 I have already mentioned the fact that Russia and Kazakhstan have signed an agreement on the Tsentralnaya field development. We will start developing the program for developing this field. The recoverable reserves amount to 1 billion barrels of oil equivalent with the most of the reserves being liquid hydrocarbons. The potential is huge, and our expectations are also quite high.

 Throughout 2016, we will interpret the results. And in 2017, the stakeholders will evaluate the further appraisal program and development program for this field.

 As for the [Alabaschan] field, again, this field has been discovered only recently. We have recently approved and confirmed the recoverable reserves. The initial oil in place is not that much, on the face of it: it's only 42 million barrels. But the average production rates, daily production rates, are 1,700 barrels. In other words, the potential is huge.

 And, in addition to that, we expect to discover both reef and below-reef plays that will further increase recovered reserves at the [Hetinska] field. In 2016, we will start developing this field; and in 2017, we expect to produce more than 2.5 million tonnes of oil and gas, as well.

 The infrastructure is already there. The export pipeline is [holding to] the Transneft transportation system, both with regard to oil and gas. A total of 48 wells have already been drilled; and actually, this 48 wells are ready for production. And naturally, it will reverse the negative dynamics that we are currently seeing in Western Siberia.

 The Bashneft-Polus project is being developed. It -- we own 25% of the joint venture. We have won all the court hearings in 2015, and we expect to go ahead with this project later on.

 Jointly with Bashneft, we will do exploration on the six blocks outside [Vorkoda]; and we have the 50/50 system there. Our expectations are quite high in terms of discovering oil this year. No-one has ever done exploration in that region before.

 The Imilor field, this is a tender we won against Rosneft, indeed, at a high cost, but the initial production rates have been increasing since 2014, throughout 2015.

 The Imilor field potential is about 3 million barrels of oil equivalent; but according to the best-case scenario, the oil reserves could be much higher. In addition to that, the assets that we procured last year are being developed. [They come] oil increased its production by more than 77%, and we keep on drilling this field.

 Another important asset is the (inaudible) field. As you can see, in the past year we have increased the production by almost 20%. The production plateau will be 45,000 to 50,000 barrels of oil equivalent per day.

 The same positive dynamics hold true for the Korchagin field. The daily production rate increased by almost 16% and it will soon reach the production plateau. The Korchagin field development benefits have been extended until 2022, which will establish a favorable environment for developing this field.

 A couple of words about the offshore Romania gas field. It so happened that we shared this license block with ExxonMobil. We drilled a couple of wells in this field, but the wells were not efficient enough. However, the recently drilled wells showed that there was more than 1.3 billion cubic meters of commercial gas in place.

 And given the fact that ExxonMobil discovered almost the same amount of gas in the Dolphin field, which is right next to our license block, we might see that this is quite a profitable commercial license block.

 In Romania, gas prices are being commercially regulated, just like in other EU member states; thus, we believe that this particular field is expected to be quite efficient.

 We plan to drill yet another exploration well that will probably help us estimate more accurately the reserves in place. Then, we will conduct negotiations with some counterparts on joint development of the field.

 The West Qurna-2 development, by the way, Bloomberg has recently published an article devoted to development of this field. Bloomberg believes that it's quite a positive project in terms of supplying crude to our Sicily-based refinery. It will ensure vertical integration and additional profits for our Group.

 In Basra, crude is sold at a huge discount of almost 10% compared to the Brent oil. Initial oil refining is quite profitable. I will show you later on what our refining efforts in West Europe look like.

 We have already recovered a total of $2.3 billion worth of costs incurred. And naturally, we are quite grateful to the Iraqi Government for the fact that, despite the economic hardships, they stick to the plan and they deliver their promises on oil shipments, of compensation oil.

 We expect to recover all the investments by the end of the year. After that, we will self-finance a number of projects, such as construction of an export pipeline and a second pipeline. In addition to that, we have already successfully drilled a well in license block 10, jointly with a Japanese company.

 The plays in West Qurna-2 have been confirmed in license block 10 as well, which also shows that it's an interesting project. And given the low oil prices, this project is quite efficient for the Company.

 As for Uzbekistan, Mr. Alekperov and President Karimov of Uzbekistan have recently met to discuss this particular project. We are currently negotiating the financial aspect of this project. It's a large-scale project in that supplying gas to China, primarily. And, as you can see, the gas production increase by almost 26% in the first nine months of 2015.

 Despite the fact that this project requires a large investment, we hope that we will be able to secure quite favorable conditions for developing this particular field.

 And now let me say a few words about downstream, or refining, in particular.

 The year of 2015 is the last year of almost all our major investment projects in oil refining. Just a week ago, we commissioned the delayed coker in Perm.

 We also commissioned a vacuum gas well hydrocarbon in Volgograd; a catalytic cracker in Nizhegorodnefteorgsintez; a gas processing unit in [Bodemosk]; a residue hydro cracker in Burgas. In other words, almost 90% of the job have already been done before the crisis broke out, which will allow us to survive the crunch.

 The downstream segment demonstrates stable operating income in 2015.

 One of the questions we received was, is downstream profitable in Russia? It is extremely profitable, despite the fact that given the tax maneuver conditions, as you probably know, the efficiency of the downstream sector decreased by 30% just because of the export dues.

 The fact that the mineral extraction tax remained the same and the export dues remained the same, the downstream sector is still quite profitable in terms of operating income.

 What's going to happen in 2016? I believe that the situation will not change that much, but there are lots of questions as far as the year of 2017 is concerned.

 20% of Russian refineries are no longer profitable under the current conditions. Starting from 2017, all Russian refineries will be loss-making, because most of them are small-sized refineries with a low oil conversion ratio and they produce too much fuel oil. These small refineries will either have to be shut down, or I don't know what's going to happen to them.

 The margin will remain quite high, though. According to our calculations, in 2017 we might experience a slight shortage of gasoline.

 In the first nine months of 2015, our international refining facilities were quite efficient, while in 2014 we suffered losses; but now, we show a profit of $460 million. The first reason is a higher margin of the oil refining. Well, the oil prices are going down, the refining margin is going up; that's the beauty of being a vertically integrated oil company.

 In addition to that, like I said, we've been getting the compensation oil from Iraq, and we can refine this oil at our own facilities.

 And, in addition to that, we have almost completed the upgrading project of our Bulgaria-based refinery.

 Just a couple of words about the Nizhny Novgorod refinery, if I may. The catalytic cracker 2 was commissioned in October, and we expect an additional EBITDA of $150 million per annum.

 The Perm refinery is currently the most efficient refinery based in Russia. Naturally, we will keep on refining -- upgrading our other refineries, but as of now, it's the best refinery.

 The Nelson index increased to 9.3, the oil conversion is 93%; in other words, the Perm refinery is quite comparable with European refineries. The EBITDA of this refinery will be more than $300 million per annum. The investments amounted to just over $1 billion.

 Another important event that I'd like to touch upon is the planning of a strategic partnership agreement with Gazprom. We signed an agreement on a number of large-scale projects; for instance, the Yamal project, Gazprom was quite (inaudible) to delivering on its commitment.

 We have been able to strike initially beneficial conditions under this contract. And, in addition to that, we agreed on supplying own gas to the Sosnogorsky gas processing unit. Simultaneously with that, we will get gas for the [Yurgeneft] facility.

 We also signed a contract on supplying gas from the North Caspian to the [Bodiansky] gas processing plant; in other words, we don't have any problems with gas supplies. Naturally, it's a low-margin project, but, nevertheless, it's quite interesting for our Company.

 Just a couple of words on the corporate governance achievements. In 2015, Lukoil won the prize of the World Finance Magazine for the Best Corporate Government in Russia. Naturally, it's a great honor for us to have won this award, because we did our utmost to win the prize.

 As for the environmental safety, by the way, the climatic climate is being held in Paris, and we reduced the atmospheric commissions by 11% throughout the year. We will keep on reducing the emissions, because we want to achieve a gas disposal ratio of 95%.

 And we've been reducing the wastewater discharge by 26%. And we reduced the number of fines that we have to pay out to the Ministry of Environmental Protection.

 In conclusion, let me sum up. [We will] try to increase the profit for our shareholders by paying out higher dividends to them. We will grow our production.

 In Russia, we'll try to offset the Western Siberia production decline. We'll keep on working on the West Qurna-2 project, and we will keep on running efficient projects in oil and gas refining.

 And Lukoil enjoys quite strong financial positions.

 Thank you very much for your attention.

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Questions and Answers
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Unidentified Company Representative   [1]
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 (interpreted) Let's start with questions from the audience. Thank you for coming. It's a pleasure to have you here.

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Unidentified Audience Member   [2]
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 (interpreted) In 2015, you mentioned that if the worst comes to the worst then the dividends would be decreased. But actually, you lived up to your commitments as far as the dividends in 2015 are concerned. Is it going to be the same in 2016?

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Unidentified Company Representative   [3]
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 (interpreted) Well, based on the budget approved by the Board, I can say that the answer is yes.

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Unidentified Audience Member   [4]
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 (interpreted) And my second question is as follows. You are reducing your investments in Western Siberia, but you are increase your investments elsewhere. Do you think that this CapEx distribution will help you maintain the production in Russia at the same level, because you will see a huge plunge in the Western Siberia? But that depends on what your main objective is: to produce oil or to ensure profits. What is the priority?

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Unidentified Company Representative   [5]
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 (interpreted) I believe that we need to maintain the strong financial situation in the Company.

 We are not decreasing our investments in Russian ruble. But if you are limited in your financial resources, and you probably know that the new tax initiatives, the oil producers have to pay additional RUB40 billion in taxes, that's almost $1 billion, naturally, that means that we need to cut certain costs. And we reduce the investments in to low-profit projects, primarily.

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 Olga Belenkaya,  - Analyst   [6]
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 (interpreted) Olga Belenkaya. Thank you for your presentation. I have two questions. What do you think about the increasing spread between [Urals] and Brent? You said that discount for the Iraqi oil is 10%. What are your expectations for the future?

 And, if you could, would you please explain the following. If you sell other crudes, not Urals, at the Varandey terminal for instance, how much is the discount?

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 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [7]
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 (interpreted) Let me start with your last question. All the contracts are linked to the Brent prices. Naturally, lighter oil is either more expensive or the discount is not that significant. I don't remember what the price for the Varandey crude is.

 As for the spread, this is the price war for securing the share in the market. OPEC is producing more than they quoted -- allow OPEC member states to do; thus, high sulfur oil is something that they produce.

 And Saudi Arabia and other OPEC member states can only increase their production rate by producing more high sulfur oil, thus, they need to sell it at a discount. Their transportation expenses are higher as opposed to Russia because we have already built our pipelines, thus, for them, such efforts are less profitable.

 As for the future, I have no doubt that as soon as the OPEC reduces the production rates, at least to the level of the quotas agreed, the oil will have to be supplied to Asia. There is no need for them to supply their crude to Europe. Their top priority are Asian markets.

 They are not making losses in Europe, but nevertheless Europe is not a top priority for Saudi Arabia and OPEC countries, as opposed to China and other oriental markets. The spread will only develop on the -- depend on the quality of the crude oil.

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 Olga Belenkaya,  - Analyst   [8]
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 (interpreted) Thank you. Let me ask you a second question. In your presentation, you mentioned that you planned to drill four to six wells in the Caspian in 2016, and you also plan to drill a gas well in offshore Romania. What's the overall amount of exploration work scheduled for 2016? And how much money did you allocate for the exploration and appraisal in 2016? What's the share of exploration and appraisal in the overall budget?

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 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [9]
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 (interpreted) Well, usually we allocate 10% of the upstream budget to exploration and appraisal. Sometimes it's less, sometimes it's more, depending on the situation, and the project at hand. But on average, we allocate 10% of the upstream budget for exploration and appraisal.

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Unidentified Audience Member   [10]
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 (interpreted) I have two questions. The first one is as follows: would you please go back to the Western Siberia production? The decrease is quite sharp and dramatic, so the question is, given the low oil prices, when do you expect the stabilization of oil production in Western Siberia?

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 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [11]
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 (interpreted) In 2017, we will commission the Hetinska field, that's 2.5 million of production; and the Imilor field is 1.5 million [of production]. I believe that these two fields will offset the decline that we are seeing, so I believe that in 2017, the trend will be reversed, even if the oil prices stays the same.

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Unidentified Audience Member   [12]
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 (interpreted) What about mature sales? Production rates of mature sales keep on going down.

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 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [13]
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 (interpreted) Well, you need to use enhanced well recovery to increase production at mature sales. But given the current tax environment, it's not expedient.

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Unidentified Audience Member   [14]
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 (interpreted) If the tax doesn't depend on the -- when the tax is no longer dependent on the financial results, but rather on the production rates, then it will up to you decide whether to use enhanced well recovery.

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 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [15]
------------------------------
 (interpreted) Well, I envy our US counterparts because with the average tax rate for tight oil producers in the US, it's 3%, they don't have any profit, thus the tax rate is 3%; but in Russia, it's [57%].

 Would you please go back to slide 13? Like I said, as soon as we start developing two fields I mentioned, so stabilize the production in Western Siberia, we expect the Imilor field -- and, as you probably know, the Imilor field is in the [midst] of experimental project of the Finance Ministry. And the excess profit tax will be tested on this field.

 The Imilor field and the Hetinska field are beyond the polar circle, thus, it will be a high-profitable project for us. Like I said, we will spend money only on high-profit projects.

------------------------------
Unidentified Audience Member   [16]
------------------------------
 (interpreted) My second question is about the financial results. Lukoil spent $2.5 billion to get an asset which costs $1 billion less. The report said that it was an option. Would you please explain what the situation was all about?

------------------------------
Unidentified Company Representative   [17]
------------------------------
 (interpreted) Let me take the floor. It was a five-year instrument to buy back shares from the market. We bought the shares back from the market for the past years, and the closure date is a technical date. After the five-year period was over, we needed to close the [date]; thus, the price was the procurement price -- average procurement price in the five-year period, based on the financial results.

 The initial buyout was done when ConocoPhillips issued its shares. And ConocoPhillips sold its shares, and it had 20% of the shares. The price was $56 per share back then. But then, it slowly bought out shares from the market. And, like I said, the average price per share was $59.6. If it was $60 per share, we would be in the profit. But these shares are automatically considered to be equity, thus, the Company would neither incur losses nor make any profits on that.

 We expected to use these shares as a natural hedging tool if we had to pay back the convertible bonds, as the convertible bonds didn't have a ceiling, and they had to be paid back at a price of $74 per share. But all the bondholders only got their money back. When in late July we paid out $1.5 billion to bondholders, the price per share resulted in the figure I just announced.

 [Nearly], we didn't give you an accurate explanation, and it's only natural that you ask this question, why do you buy a share at $59.6 per share if the market price is $39 per share? But we initially announced that it would be a buyback of shares from the market.

 It happened many years ago, and you might not recall, but one of the reasons we did that was because we were unclear whether we could have more than 10% in the balance of the Company. Would it be considered to be a Russian company, or a foreign company; would it be able to get access to certain license blocks in Russia? That was one of the reasons for the restructuring. But now, these shares are in our balance.

 And, by the way, the legislation is changing and the quasi treasury shares will not have the right to vote. Not a problem for us, but you can't really sell 16% of your shares in the market: you need a transitional period to do that. And we always take in to account the ongoing legislation.

------------------------------
Unidentified Audience Member   [18]
------------------------------
 (interpreted) Could you please give an official explanation, because large shareholders have lots of questions about this issue? I would personally like to ask you to give an official explanation to large shareholders?

------------------------------
Unidentified Company Representative   [19]
------------------------------
 (interpreted) Well, like I said, this tool had to be closed at this particular date. Our auditors recalculated the average price, and the average price is something that we show in our balance: that's a simple explanation.

------------------------------
 Alexander Nazarov,  - Analyst   [20]
------------------------------
 (interpreted) Alexander Nazarov. Thank you for your presentation. I have a question about Iran. What do you think about the Iraqi contract? And is it aligned with the current contract? And how aligned is it with your strategy to buy foreign assets?

------------------------------
Unidentified Company Representative   [21]
------------------------------
 (interpreted) Well, it goes without saying that Iran is one of the top three countries for Lukoil. We're already operating in Iraq.

 Iran is the third country with largest reserves, by the way, and around a block which consists of three sub-blocks, which we're all aware of, is quite interesting. And this year there was a conference held in Tehran, and they discussed just these issues.

------------------------------
 Alexander Nazarov,  - Analyst   [22]
------------------------------
 (interpreted) Well, we're still confused about the Iranian proposal. The only thing which is clear is that it's not going to be a buy back. You will not drill 29 wells, get the money and get out. It will be a hybrid between production sharing and a service contract, as we are seeing in Iraq, in other words.

------------------------------
Unidentified Company Representative   [23]
------------------------------
 (interpreted). [Yes,] this was an amount of money in oil equivalent for developing a field. But they now see what is happening to Iraq. Iraq has to give out a lots of compensation oil, given low oil prices.

 They are looking in to a product production sharing agreement to insure themselves against low oil prices, but they told us that they would get back to us in March 2016. Our representatives attended the Tehran-based conference. We're still looking in to the Iranian proposal.

 Well, the only thing I can say now is that we are making a huge step forward. But the constitution of the Islamic Republic of Iran prohibits the resources and reserves to be enjoyed by anyone but the Islamic Republic of Iran, so we don't know what's going to happen.

 For each and every field, we will have to sign a separate agreement. But I think the situation will be quite similar to what we are experiencing in Iraq.

------------------------------
 Alexander Kornilov,  Alfa Bank - Analyst   [24]
------------------------------
 (interpreted) Alexander Kornilov, Alfa Bank. Your CEO said that the investment program will be reduced by 20 -- 12% to 14% in 2016. What exactly are you going to cut in 2016?

------------------------------
Unidentified Company Representative   [25]
------------------------------
 (interpreted) Well, we will reduce the amount of drilling jobs in Western Siberia because these are low-profit projects for the Company. We have a jigsaw diagram; and primarily, we will cut the projects that we're implementing in Western Siberia.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [26]
------------------------------
 (interpreted) Artem Konchin, Otkritie. I have a question about Iraq. (inaudible), in your comments you mentioned that you were trying to agree on a higher commercialization per barrel. But I'm primarily interested in what's the cumulative CapEx, as compared to the $2 billion to $3 billion that you have managed to recover in Iraq? How much capital is still at risk?

------------------------------
Unidentified Company Representative   [27]
------------------------------
 (interpreted) Well, I'm not going to comment on the first question because the negotiations are still underway. I will brief you as soon as the negotiations are over.

 As for the -- well, we still have to recover $400 million out of $5 billion. But by the end of the year, we expect to recover almost all the entire CapEx.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [28]
------------------------------
 (interpreted) Your CapEx was almost $5 billion?

------------------------------
Unidentified Company Representative   [29]
------------------------------
 (interpreted) Well, the overall CapEx in Iraq was $5 billion. By the end of the year --

------------------------------
 Artem Konchin,  Otkritie - Analyst   [30]
------------------------------
 (interpreted) You have to add CapEx and OpEx --

------------------------------
Unidentified Company Representative   [31]
------------------------------
 (interpreted) Artem, hold on a second. By the end of the year, we will have $1.69 billion to recover.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [32]
------------------------------
 (interpreted) Are you saying that it's at risk?

------------------------------
Unidentified Company Representative   [33]
------------------------------
 (interpreted) Well, I don't believe that this capital is at risk, but next year we expect to breakeven.

 So, in other words, this year you will not be able to recover the entire CapEx. But the problem is that we accumulate more OpEx with each passing day. Ideally, you would recover everything at the end of the quarter, but throughout the previous quarter you incurred additional costs.

 Let me clarify something, where do we see that in the cash flow statement? That's EBITDA; it's EBITDA.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [34]
------------------------------
 (interpreted) Costs recovered, given the policy in place. Correct me if I am wrong, Igor and Sergei, but compensation oil is part of production, which is reflected as income and EBITDA. Yet -- so, in other words, first you issue an invoice for the services; after that, the invoice is were paid by oil deliverers. The oil is transferred to Group, and we only get the cash when the -- when oil is exported.

 It's a multi-stage process. You have issued an invoice, not paid invoice, received oil, sold oil, so, like I said, it's a multi-stage -- it's multi-stage process reflected in different lines in the balance.

------------------------------
Unidentified Company Representative   [35]
------------------------------
 (interpreted) Yes, we supply crude to ISAB refinery, but the cycle is quite long.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [36]
------------------------------
 (interpreted) So, in other words, the figure you showed us is in EBITDA?

------------------------------
Unidentified Company Representative   [37]
------------------------------
 (interpreted) Well, we don't reflect the -- this cash; it's just part of the cash flow and EBITDA.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [38]
------------------------------
 (interpreted) Well, the figure you demonstrated in your presentation is $2.3 billion per quarter, right?

------------------------------
Unidentified Company Representative   [39]
------------------------------
 (interpreted) No, it's not per quarter; it's for the first nine month of 2015.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [40]
------------------------------
 (interpreted) So is this figure the key motive recovering costs over the year, or is it also linked with the internal prices?

------------------------------
Unidentified Company Representative   [41]
------------------------------
 (interpreted) Well, this is also a carry over from -- carry forward from 2014. This is the amount of oil we physically received from Iraq, because this is oil but you are talking about cash flows and accruals.

 Like I said, by the end of the year we will have about $1.6 billion still to recover, and we expect to breakeven next year.

 The oil price has plunged considerably by more than 40%, and there is a discount on this oil. And the Iraqi Government allocates seven tankers to us; that's a lot. It's important for them, and it's important for us, to go ahead with the project to show that such projects really work.

------------------------------
 Artem Konchin,  Otkritie - Analyst   [42]
------------------------------
 (interpreted) In slide 13, you have data on Western Siberia and Caspian. What about the Volga and other regions?

------------------------------
Unidentified Company Representative   [43]
------------------------------
 (interpreted) But in the previous presentation, we have specified all these figures. If you want us, we can provide you with additional information.

------------------------------
 Ildar Khaziev,  HSBC - Analyst   [44]
------------------------------
 (interpreted) Ildar, HSBC. I have a question on slide 39. You have a beautiful diagram there showing the international downstream contribution comparision of nine months of 2014 and 2015. Did you include in this figure the [evaluation] of the reserves? What if the oil prices go back up, then your EBITDA in oil refining will be almost zero?

------------------------------
Unidentified Company Representative   [45]
------------------------------
 (interpreted) No, this is operating margin in downstream.

------------------------------
 Ildar Khaziev,  HSBC - Analyst   [46]
------------------------------
 (interpreted) What's the impact of the retail sales, because you have a large retail network?

------------------------------
Unidentified Company Representative   [47]
------------------------------
 (interpreted) Well, it's not large. We have only 2,000 gas stations. This year, we expect the retail network to breakeven; and we will see the free cash flow, because all the costs will be recovered.

------------------------------
 Ildar Khaziev,  HSBC - Analyst   [48]
------------------------------
 (interpreted) But you include it in to the accounting report of the entire Group?

------------------------------
Unidentified Company Representative   [49]
------------------------------
 (interpreted) Of course that is included. In compliance with the GAAP, we don't include that. But if you need these figures, we'll be happy to provide them to you separately. Why do you need these figures?

 Ildar Khaziev (interpreted) Well, after you reconcile these figures you will have --you will see that the impact will be quite significant.

------------------------------
Unidentified Company Representative   [50]
------------------------------
 (interpreted) Well, all operating company, the (inaudible) is the owner of the crude supplied to the refineries. Well, the refineries are similar to processing centers, so we don't have a separate line on that.

------------------------------
 Ildar Khaziev,  HSBC - Analyst   [51]
------------------------------
 (interpreted) Actually, reassessing the reserves would have been significant for [PF4]. But oil prices were not as volatile in 2015 as in 2014, and the written off reserves in Q4 were not as significant. But what if oil prices go back to $85 to $90, then the EBITDA will be almost zero.

------------------------------
Unidentified Company Representative   [52]
------------------------------
 (interpreted) Well, this is a cross-section of the refinery. This is what they have to deal with. If the oil prices go down, the margin in the oil refining is going up.

 Second, plus a large company was created just because the owners believed that the downstream margin will always be high, but now it's almost bankrupt, if I'm not mistaken.

 Large US companies show that 40% to 60% of the profits in Q2 resulted from the downstream sector, but in Q3 they only saw flat figures. Almost all companies showed negative figures in Q3.

 The Russian downstream profit -- profits in Russia increased by $3.44 billion, so almost every refinery increased its margin by $1 billion. But this is not the case for this year.

------------------------------
 Ildar Khaziev,  HSBC - Analyst   [53]
------------------------------
 (interpreted) Right. What are the forecasts for production rates at the Filanovsky field for 2016 and 2017?

------------------------------
Unidentified Company Representative   [54]
------------------------------
 (interpreted) We expect production to start in 2016.

 And as for 2017, I would be rather unwilling to give any forecasts for 2017. We expect to reach the plateau in late 2017 in the Filanovsky field: maybe the oil prices will already increase by that time (inaudible).

------------------------------
Unidentified Audience Member   [55]
------------------------------
 (interpreted) (inaudible). You mentioned that one of the factors that is favorable for US-based tight oil producers is consistent with the fact that they squeeze their suppliers. What's the situation in Russia? Do you think we're going to see the same thing? Maybe oil majors will squeeze their suppliers, thus forcing them out of the market; or they will see underinvestment in to their assets, and, thus, we will all see a deficit of suppliers.

------------------------------
Unidentified Company Representative   [56]
------------------------------
 (interpreted) This is a free market. This is exactly what's going to happen. For instance, one of the national companies doesn't even pay to suppliers, but they keep on working because they have nothing else to do.

 Like I said, our expenses grew by 5% in Russian rubles, which means that we have maintained almost all the contracts in Russian rubles that we signed in the past given the inflation rate of 11%. But naturally, we tried to put some pressure on our suppliers.

 I'm sorry, if you don't have any financial questions, I'd like to leave. Thank you. Leonid knows everything much better than I do.

------------------------------
Unidentified Audience Member   [57]
------------------------------
 (interpreted) I had a question about production. In December 2015, you're expected to [wire] your agreement with China. Would you please dwell on that?

------------------------------
Unidentified Company Representative   [58]
------------------------------
 (interpreted) Well, Eurasia is delivering on its commitment under -- countersigned in Russian rubles.

 We are quite satisfied with the way Eurasia operates. The negative thing is that Schlumberger did not buy out Eurasia. But the negotiations are still underway, so I don't think it makes any sense to comment on that. But naturally, we'll try to maintain the efficiency of our production efforts.

 As far as [Yarega] is concerned, you have to talk to people from Yarega.

------------------------------
Unidentified Audience Member   [59]
------------------------------
 (interpreted) (inaudible) [from the capital]. In slide 20, you showed a CapEx structure, and you have a breakdown in to exploration and production. What's the share of Greenfields, and what's the share of Brownfields? And how significantly will the structure change in 2016?

------------------------------
Unidentified Company Representative   [60]
------------------------------
 (interpreted) Well, Greenfields a 3 billion-plus account for.

------------------------------
Unidentified Audience Member   [61]
------------------------------
 (interpreted) Is it going to change in 2016?

------------------------------
Unidentified Company Representative   [62]
------------------------------
 (interpreted) No, it will stay the same. Because we will commission the Sosnogorsky field and the [Bodiansky] fields, the share of Greenfields will remain basically the same.

------------------------------
Unidentified Audience Member   [63]
------------------------------
 (interpreted) And I have a clarification to seek about the CapEx. Will the geographical breakdown remain the same, I mean in 2016 and 2017?

------------------------------
Unidentified Company Representative   [64]
------------------------------
 (interpreted) Well, the CapEx breakdown will change in West Qurna because CapEx will be frozen for 2016; but, at the same time, CapEx will increase in Uzbekistan.

 Did I answer all the questions?

------------------------------
Unidentified Audience Member   [65]
------------------------------
 (interpreted) Sberbank Asset Management. I have a rather technical question. Given the fact that you have quite a number of treasury bonds in your balance, do you consider total or partial rejection of this package? And what's the timeline, if the answer is yes?

------------------------------
Unidentified Company Representative   [66]
------------------------------
 (interpreted) Well, we are constantly playing with this idea to pay back some of the treasurers, but the Central Bank has issued us with clear instructions on how it is to be done, and what needs to be done in terms of accounting, whether this process will affect all other aspects. Legal issues are still undecided, thus, it is difficult for us to understand what needs to be done.

 All the offshore companies that were -- that acted as holding companies of Russian companies, we're the only ones that paid back the treasury bonds. But this is the major risk. Naturally, we do play with ideas like that all the time.

------------------------------
 Andrey Gaidamaka,  Lukoil OAO - VP, IR   [67]
------------------------------
 (inaudible) 2015. This is something that Mr. Kozyrev will take a question.

 We also have a question from Pavel Kushnir from Deutsche Bank on equity link note, but that was answered, in quite detail, by the CFO of the Company. So, Pavel, we do consider your question to be answered, because it was asked by one of your colleagues here in the audience.

 And we also have a question by [Lena Maladeva] from Goldman Sachs about production levels at Korchagina, [Sosnogorsky], and so forth. But as Mr. Kozyrev answers the first question.

------------------------------
 Igor Kozyrev,  Lukoil OAO - Deputy Chief Accountant   [68]
------------------------------
 (interpreted) The answer is quite simple. This quarter, we experienced significant exchange rate gaps and we needed to take them in to account. When the exchange rate goes down, we incur additional taxes, thus, we have excess profits that are taxable; thus, the basic rate is higher when the profit goes down.

------------------------------
 Andrey Gaidamaka,  Lukoil OAO - VP, IR   [69]
------------------------------
 Good answer. Any other questions?

 Well, I would like to make one announcement to everyone. We see it as very, very important. Right now, the voting is happening, the voting in Lukoil emergency general meeting. And it is very important for the Company to make sure that the clients, the investors, our shareholders do vote this time, and also make sure that you talk to your custodians and talk to Bank of New York.

 We did send out a very detailed explanation. The Central Bank did change voting procedure. Now we do need your registration numbers, and we need your place of registration, in order for your vote to be processed.

 I know there were some questions about dividends in the audience. We are ready to pay dividends. You just need to come to collect them. It would be very interesting situation, probably one of the first in the history of the financial world, where the Company would like to pay dividends but investors do not show up to vote and, hence, that can be put under threat. It's very important.

 Again, please talk to your corporate governance people, and please talk to Bank of New York Mellon. If you do need, please contact us.

 But please do vote. And please do fill out the part of the voting registration card, the voting card of Bank of New York, which does state -- and please state your registration number of your company, and the place of registration. These are two things that need to be filled out.

 Or need to be, additionally, sent to Bank of New York under separate procedure if you're voting through Broadridge, and if you're not able to provide those numbers.

 It is all in our instructions. It is all in our website. If you click on our website, there is an important information, just as you come to Lukoil website, pertaining to EGM; click on it, there are all the explanations. There are people standing by to give you explanation from Bank of New York, from Lukoil, and also from D.F. King, the voting solicitors that we hired for this situation.

 But let's not have a situation where the Company is willing to pay dividends, but the shareholders will not receive them because they did not vote at the shareholders meeting. Because then, we might have a situation where our quorum will come under threat if we don't get enough voting from the ADR holders and, hence, we will not be able to pass the resolution on dividend payment.

 So I really would like everyone to pay very close attention to this; and when you guys talk to the investors, you need to tell them this.

 With this, I will pass back to Mr. Fedun for closing remarks.

------------------------------
 Leonid Fedun,  Lukoil OAO - VP, Strategic Development   [70]
------------------------------
 (interpreted) Thank you for your attention. I hope that we did manage to answer all your questions.

 By and large, I'd like to mention that, despite the ongoing crisis, the Company enjoys quite sustainable financial positions, and we are quite active. Our investments in Russian rubles have increased. And I am quite upbeat about the oil market, because I believe that I do understand what is happening right now.

 Maybe I was not that clear on the depth of the pockets of US companies, but now I do understand how deep their pockets are. Like I said, $150 million are spent by financial institutions on a daily basis in the US. As soon as the situation stops, the market will become healthier, and our Company will experience faster growth rates and generate cash. Thank you.

------------------------------
Unidentified Company Representative   [71]
------------------------------
 (interpreted) Thank you very much. We are now finishing our webcast.

------------------------------
Editor   [72]
------------------------------
 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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