Q1 2017 NK Lukoil PAO Earnings Presentation (IFRS)

May 31, 2017 AM EDT
LKOH.MZ - NK Lukoil PAO
Q1 2017 NK Lukoil PAO Earnings Presentation (IFRS)
May 31, 2017 / 12:00PM GMT 

==============================
Corporate Participants
==============================
   *  Alexander Kuzmich Matytsyn
      PJSC LUKOIL - First VP of Economics and Finance
   *  Alexander Palivoda
   *  Pavel Zhdanov

==============================
Conference Call Participants
==============================
   *  Alexander Kornilov
      Aton LLC, Research Division - Senior Analyst of Energy Sector
   *  Andrey Polischuk
      Raiffeisen Bank International AG, Research Division - Analyst
   *  Henri Jerome Dieudonne Marie Patricot
      UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst
   *  Igor Kuzmin
      Morgan Stanley, Research Division - Equity Analyst
   *  Ildar Khaziev
      HSBC, Research Division - Analyst
   *  Karen Kostanian
      BofA Merrill Lynch, Research Division - Head of EEMEA Energy Research and Head of the Russian Research Department 

==============================
Presentation
------------------------------
Operator   [1]
------------------------------
 Hello, ladies and gentlemen, and welcome to the LUKOIL Full Year and 1Q 2017 Conference Call. My name is Courtney, and I'll be your coordinator for today's conference. (Operator Instructions) I would also like to inform you that the questions from the press today will not be accepted. I would now hand you over to your host, Alexander Palivoda, Head of Investor Relations, to begin today's conference. Thank you.

------------------------------
 Alexander Palivoda,    [2]
------------------------------
 Thank you, Courtney. Good afternoon, ladies and gentlemen, and it's our pleasure to welcome you today on LUKOIL's First Quarter 2017 Financial Results Conference Call and Webcast. Thank you for joining us. On today's call, we have our Chief Financial Officer, Mr. Alexander Matytsyn; Head of Capital Markets and M&A, Mr. Pavel Zhdanov; our colleagues from the accounting team, Mr. Igor Kozyrev and Mr. Sergey Epifanov as well as Evgeniya

 Bitsenko from our Investor Relations team. Mr. Matytsyn will start today's call with a general overview of the results followed by a more detailed discussion by Pavel Zhdanov and myself. As usual, there is going to be a questions-and-answer session, so you can ask your question either by phone or using your -- our webcast Q&A interface. Please bear in mind several minutes message delivery time lag for online questions.

 As a routine procedure, I have to draw your attention to our cautionary statement. Some of our comments during this call constitute forward-looking statements that involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. We continue with gradual improvement of our financial and operational disclosure, and the most important addition to our latest MD&A is a detailed breakdown of EBITDA by segments as well as a breakdown of SG&A expense. Please note that we have also adjusted our gas production statistics to comply with our proved reserves date. We plan to proceed with further enhancements, and the feedback is very welcome. Thank you. And now I would like to hand over to our Chief Financial Officer, Mr. Alexander Matytsyn.

------------------------------
 Alexander Kuzmich Matytsyn,  PJSC LUKOIL - First VP of Economics and Finance   [3]
------------------------------
 Thank you, Alexander. During the first quarter, we observed stronger oil prices supported by the agreement of OPEC and certain non-OPEC countries, including Russia, to cut production volumes. Crude prices have been fairly stable throughout the quarter with Brent averaging $54 per barrel as compared to $49 for the previous quarter and $34 as a year ago. We expect that the recent decision to extend production cuts will support further rebalancing of the market. However, we continue to use conservative assumptions in our business planning process, which helps us comfortably navigate through the challenging environment.

 In the reporting period, in addition to higher oil prices, our upstream business was also supported by the positive impact from the tax changes as part of the tax maneuver. On the negative side, ruble continued its depreciation, which fully offset the increase in dollar-denominated net price. However, this has not prevented us from enhancing our financial performance in the Russian upstream, as we continued changing our production mix towards larger scale of high-margin balance. Depreciation of the ruble also affected the results of our international upstream business in ruble terms.

 In the downstream, benchmark gross refining margin in Russia in ruble terms was 15% lower quarter-on-quarter due to higher export duty rate on back products and the now increase in the excise tax rates. The retail margins in Russia were also negatively hit by repeated increases in the excise tax rate. As we discussed at our previous calls, product slate of our refineries is much better than the Russia average due to timely completion of the refinery upgrade program. Hence, our margins are less sensitive to negative macro and fiscal change. This factor enabled us -- our downstream business in Russia to continue delivering strong financial performance in the first quarter with relatively limited quarter-on-quarter decline.

 In dollar terms, our EBITDA amounted to $3.5 billion, which is record-high result for the last 7 quarters and represents an increase of 37% year-on-year and 22% quarter-on-quarter. Such good results were achieved despite limits on our production and relatively unsupported macro and fiscal environment. We have also posted record-high free cash flow in ruble terms for almost 5-plus years of RUB 66 billion before changes in working capital and the West Qurna-2 project. This reflects the fundamental strength of our business model and current transformation of our production mix.

 Our strong balance sheet enables us to be very flexible in managing our working capital to pursue new business opportunities and maximize efficiencies of our downstream operations, including our trading businesses which was the key factor behind additions to working capital during the quarter.

 I am also pleased to report that we continued delivering on our progressive dividend policy, as the Board of Directors recommended total dividend for 2016 in the amount of RUB 195 per share. This represents a 10% increase in ruble terms, which is twice higher than Russia ruble inflation for the past year. In dollar terms, the increase is a significant 22%. This is our 19th consecutive year of dividend growth, and we offer among the highest dividend yields in the global energy universe. We believe that our track record and our good prospects deserve better appreciation by the market through the higher share price as we offer one of the most attractive dividends in the industry, not only in terms of payout and yield but primarily in terms of predictability, transparency and cash flow coverage. Going forward, our focus remains on a sustainable cash flow generation and growth in the distributions to shareholders. We are confident that our significant reserve base and competitive business model will continue serving as a foundation for the solid business performance in 2017 and beyond.

 With that, I would like to pass the call to Pavel.

------------------------------
 Pavel Zhdanov,    [4]
------------------------------
 Thank you, Alexander. I will now elaborate on our upstream results. Our average daily hydrocarbon production in the first quarter, excluding Iraq, remained practically flat year-on-year and quarter-on-quarter supported by higher gas output. At the same time, liquids production was approximately 1% lower. This minor decline was driven by external limitations on Russian crude oil producers due to OPEC agreement. We have been gradually reducing our liquids production in Russia from January through May to stabilize it at 45,000 barrels per day, below October's level. This reduction was sourced from our lower-margin fields in traditional material regions, while production at our high-margin greenfields, such as Filanovsky and Pyakyakhinskoye, continued to grow in accordance with the plan.

 Growth of the share of high-margin barrels in our overall production mix contributed substantially to our financial results, which you can clearly see in our Q1 numbers. It also enhances our exposure to higher oil prices as new barrels have up to 4x higher sensitivity.

 Moving now to the more detailed discussion of our key projects. The development of the Filanovsky field in the Caspian Sea continues as planned. Since the beginning of the year, we completed our 1 new production well and are currently producing from 4 wells. Quarter-on-quarter, average daily production growth was 27%, and we increased production rate at the fields to more than 90,000 barrels of oil per day, which represents 3/4 of the planned plateau level. As we mentioned at our previous call, the fourth well drilled at the field has a bilateral horizontal design and is classified as TAML 5 in terms of complexity. We're about to complete the fifth well, which has the same bilateral design. We expect this new well to further increase the field's daily production rate and get us closer to the peak's daily production level.

 It's worth mentioning that we're continually increasing the drilling speed at the field, which provides us with additional savings. Notably, the drilling speed at single-bore wells improved by almost 20% and the speeds at more complex bilaterals outpaced the speed at which the first single-bore well was drilled. We reiterate our production guidance for the field for 2017 at approximately 4.4 million tonnes of crude oil. Till the year-end, we plan to drill 1 more production well and 2 injection wells.

 We're also progressing well with the construction of the field's second development phase. We're currently finalizing the installation of ice-resistant platform's topside and assembly of the drilling rig. We've also started preparation works related to laying necessary connections from the new platform to the riser block. To remind you, the new platform will enable us to achieve sustainable plateau production at the field in 2018.

 At our Korchagin field, we are progressing with construction of the wellhead platform which will allow us to resume our drilling activity at the field in 2018 in order to extend the plateau production level. This month, we transported the wellhead platform jackets to the site and are about to start installation works.

 Moving now to our onshore fields. Among the notable developments of the first quarter of 2017 was the launch of gas production at our Pyakyakhinskoye field. We achieved a quick production ramp-up and reached planned 2017 production rate of approximately 10 million cubic meters per day with 28 producing gas wells. We are right on track to produce approximately 3 billion cubic meters of gas to the field this year. The increase in daily oil production from the field was impressive 30% quarter-on-quarter, which was a result of putting more wells into operation. Out of 6 new wells that we launched at the field during the first quarter, 5 were multibore horizontal wells. This well design is a promising technological solution for enhancing results at other fields in our portfolio.

 Our 2017 liquids production plan for Pyakyakhinskoye field remains unchanged at 1.5 million tonnes.

 Other fields in West Siberia that are mostly material and operate under the standard tax regime were the main source of production cuts driven by OPEC agreement. To avoid any impact of the cut on our longer-term production profile, we decided to continue with our drilling plan, which is targeted at substantial reduction of the production decline rates in the region. As a result, we boosted production drilling volumes by 53% year-on-year and launched 46% more new wells than last year. The share of horizontal wells also remained at high levels.

 To reduce the production rates, we have been shutting down existing low-margin wells and doing less workovers, primarily in West Siberia, and also increased the number of geological tests, primarily in Timan-Pechora. Such tests require shutting down the wells but expand our reservoir knowledge. Following recent extension of the production cuts, we started analyzing necessary actions for its implementation. We might add some additional solutions to prevent our production from growth, but we will certainly continue ramping up our high-margin greenfields, and we will most probably continue executing our drilling plan.

 Another priority project is our Yaregskoye heavy oil field in Timan-Pechora. We continued working on ramping up production of the field but witnessed temporary production decline in the first quarter due to shortage of natural water resources for steam generation because of exceptionally dry summer last year. The recent launch of a water treatment unit significantly reduced our reliance on natural water resources as we're currently able to recirculate water that is being produced with crude oil. As of today, we have almost recovered daily production rates at the field and plan further growth at this high-margin project by adding new steam-generating units and drilling new wells. In the first quarter, we put onstream 16 new injection wells and almost completed construction works at our new energy center which will reduce our reliance on external energy supplies.

 Now let's move to our international projects. In the first quarter, we increased our daily gas production in Uzbekistan to almost 16 million cubic meters per day, representing 4% increase over 2016 average daily rate. Several days ago at Gissar project, we launched the first train of a new gas treatment unit, which debottlenecked the output from the already drilled wells and enabled us to immediately double daily gas production. We continue with the construction works on the second chain, which we plan to launch this year. We target approximately 13.5 million cubic meters daily production by the year-end. Since the beginning of the year, we also launched 2 gas-gathering stations and 8 wells.

 Our Kandym project is also progressing well. The gas treatment complex is now more than 60% complete. So the progress since our last conference call is 10%. We also launched 3 production wells at this project.

 Now let's move to our West Qurna project. During the first quarter, production at the field remained at approximately 400,000 barrels per day, representing plateau level for Phase I, which we plan to maintain throughout the year by drilling 2 new -- 12 new production wells. We've substantially reduced our financial exposure to this project over the last 18 months and expect it to remain around $500 million throughout the year. There was a quarter-on-quarter decline in our remuneration, which was in accordance with the service contract due to lower-than-target production volumes. We continue our negotiations with Iraq on better terms for this project.

 At Block 10, we confirmed the existence of a large oil field by successful drilling of the second exploration well. We will continue exploring the field by drilling third well. As we noted at our previous call, the remuneration fee at Block 10 is approximately $6 per barrel, which is substantially more attractive than in West Qurna project.

 With that, I'll pass over to Alexander Palivoda.

------------------------------
 Alexander Palivoda,    [5]
------------------------------
 Thank you, Pavel. I'll continue with our downstream operations. Despite the negative effect of tax maneuver in the first quarter of 2017, oil allocation at our domestic refineries was in most efficient direction. Our stronger-than-benchmark refining margins in Russia, driven by timely modernization of our refineries, enabled us to increase refinery throughput year-on-year in order to maximize EBITDA. Quarterly dynamics was driven by the maintenance works at our Nizhny Novgorod refinery and throughput optimization at Ukhta. The decrease in domestic crude oil sales volumes and increase in exports was mainly driven by volumes redirection due to lower demand from domestic customers.

 Operating results of our refineries in Russia continued to improve. Overall throughput volumes increased by practically 5% year-on-year. Small reduction at the Ukhta refinery was a result of our efforts to enhance product slate by high utilization of conversion facilities. This enabled us to achieve a 2 percentage points increase in refining depth and more than 50,000 tonnes reduction in fuel output at this refinery.

 Throughput decline at Nizhny Novgorod refinery was due to planned maintenance. We also did some maintenance during the quarter at our Perm refinery which negatively impacted this light product yield. Overall, we achieved 5 basis points increase in light product yield at our Russian refineries year-on-year and increased this indicator to 65% with the Volgograd refinery being the primary contributor.

 At Volgograd, light product yield grew by 8% year-on-year due to the launch of a hydrocracker complex in 2016. We expect this refinery to contribute most, with further positive change of our product slate, as we will continue to increase utilization of this newly-built hydrocracker.

 The operating results of our European refineries in the first quarter of 2017 were mostly affected by maintenance works at Burgas and Ploiesti plants. Despite this factor, we were able to maintain light product yield at the level of fourth quarter 2016 and improved it by 4% year-on-year, the latter was primarily driven by lower fuel processing volumes at our refinery in Italy due to changes in spread and flexible feedstock management. Our refining business continues being a substantial free cash flow generator as we completed the upgrade program and constantly enhanced our product slate.

 Late last year, as part of our trading business development, we concluded a processing contract with a Canadian refinery. The refinery outsourced to our international trading subsidiary, LITASCO, its commercial activities related to refining operations, including supply of crudes and offtake of products, stock management and hedging. LITASCO doesn't have any exposure to refining margins but earns fees and generates additional income on trade flows.

 Moving now to our marketing business. Excluding retail networks in Europe divested in 2016, our retail sales volumes increased by 7% year-on-year, both in Russia and internationally, which was the result of our proactive marketing and advertising campaign as well as an active loyalty program. The increase in sales volumes enabled us to offset, to some extent, lower retail margins in Russia, which was due to retail prices lagging the wholesale markets following growth in excise tax rates.

 We continued expanding sales volumes of our premium ECTO branded fuel, which increased both in Russia and internationally practically by one quarter year-on-year. Nonfuel sales at our retail stations also continued growing in Russia and internationally, with revenue increasing by approximately 5% and 4% year-on-year, respectively.

 Sales of our premium motor and industrial oils posted a growth rate of approximately 12%, resulting from our efforts in developing B2C and B2B channels.

 We increased bunker fuel sales by impressive 1.6x, thanks to developing sales in Baltic ports. Moreover, we raised retail jet fuel sales in the airports of Russia by 8%.

 Now briefly on our financial performance. Our quarter-on-quarter revenue dynamics was driven mainly by increase in the international refined product sales volumes by 12% as a result of higher exports and international trading volumes. Benchmark price increase was partially offset by ruble appreciation and temporary increase in the share of back products due to the maintenance works at secondary refining units at some of our European refineries. We also reduced our domestic crude oil sales volumes by more than 2x as a result of volume redirection to exports due to lower demand from local customers.

 One of the factors behind growth in our overall sales volumes was inventory buildup in the fourth quarter 2016. This inventory buildup factor also had a positive impact on our quarter-on-quarter EBITDA dynamics.

 As we started disclosing EBITDA by segments, I would like to dedicate some time to the quarter-on-quarter segment analysis. Our core Russian upstream, apart from generally positive effect from base rate -- base tax rates changes and negative effects from the ruble appreciation, was materially impacted by the lower positive effects but due to lag effect and one-off mineral extraction tax refund in the fourth quarter. The latter factor contributed approximately RUB 6 billion to this segment's EBITDA in the fourth quarter of last year. It's worth mentioning that growth at our high-margin fields contributed more than RUB 4 billion of incremental EBITDA quarter-on-quarter.

 International upstream was primarily driven by lower volumes of compensation crude oil from the West Qurna-2 project and, as we discussed at our previous call, the volume of compensation crude oil currently depends on the amount of our recurring capital and operating expenses and remuneration fee. Net of West Qurna EBITDA -- net of West Qurna project, our EBITDA was flat quarter-on-quarter as a result of higher oil price being fully offset by ruble appreciation.

 In the domestic downstream, on the refining side, we did very well as we managed to practically fully compensate for negative macro and fiscal changes by modernization-driven improvement in our product slate.

 On the retail side, the quarter was weaker due to retail margin squeeze caused by another increase in excise tax on diesel and growth in wholesale prices driven by lower expenditures on motor fuel.

 We had one material one-off factor negatively impacting quarter-on-quarter EBITDA dynamics of our Russian downstream. This relates to the new deep conversion complex at Volgograd, which took time to get to design technological parameters, and this resulted in accumulation of expensive inventories at the end of last year which was sold in the beginning of 2017. This inventory effect resulted in higher EBITDA in the fourth quarter 2016 and lower numbers in the reporting quarter. On a normalized basis, EBITDA of our Russian downstream in the first quarter is approximately RUB 4 billion higher than actual.

 Dynamics of our international downstream was primarily driven by the effect of hedges, related to our international trading business. On a normalized basis or net of hedging effect, EBITDA in this segment was approximately flat quarter-on-quarter.

 And other factors impacting our consolidated EBITDA were lower operational SG&A expenses, and on the negative side, we had higher transportation tariffs.

 Now more detail on our expenses. Our per barrel lifting cost in Russia increased by 2% quarter-on-quarter and 9% year-on-year. We continued delivering better dynamics of lifting cost in Russia due to growing share of production from new fields and larger amount of new wells. We also reduced per barrel expenses at our refineries by 11% quarter-on-quarter on the back of cost-optimization efforts and the positive impact from refinery upgrades, as we replaced it by the additives by own production. The decrease in transportation expenses to supply our refineries by 9% quarter-on-quarter was driven by ruble appreciation and optimization of supply logistics at our international refineries as well as lower throughput volumes domestically. Other expenses dynamics was mainly attributable to seasonality factor.

 The main factor behind our SG&A dynamics was downward adjustment of the accruals related to the employee share-based compensation program. The compensation under the program, as disclosed in our financial statements, is directly linked to the dynamics of our share price, which was, as you know, declining in the first quarter of 2017. The international components of SG&A decreased mainly due to ruble appreciation.

 On the transportation side, our transportation expenses dynamics was driven by the increase in transportation tariffs in Russia. Starting from January 1, 2017, pipeline tariff was raised by 3% and railroad tariffs, both for crude oil and petroleum products, was increased by 6%. In addition, there was an increase in export volume of both crude oil and petroleum products by 4% and 18%, respectively. The quarter-on-quarter dynamics of our profit attributable to shareholders was impacted by foreign exchange effect as well as finance and other expenses. We have a positive net monetary position in foreign currency, which is a result of our intergroup loans denominated in foreign currency, in different functional currencies at different subsidiaries. Due to ruble appreciation during the first quarter of 2017, the ruble value of the monetary position decreased, and we booked RUB 42 billion of noncash foreign exchange loss. And this is opposed to RUB 26 billion of noncash loss in the last quarter of 2016.

 Our finance cost decreased by RUB 4 billion, and this was driven mainly by ruble appreciation, which resulted in lower interest payments in ruble terms. We had no impairments in the first quarter of 2017, and this added approximately RUB 9 billion to profit compared to the previous quarter.

 Our depreciation for the period was flat with West Qurna-2 project now constituting less than 3% of the total depreciation charges.

 Capital expenditures for the first quarter of 2017 amounted to RUB 130 billion, which is some 7% lower quarter-on-quarter. And the quarterly dynamics was mainly driven by our upstream segment. And the biggest factors were Uzbekistan and Caspian projects where CapEx declined due to works and supply schedule and some seasonality as well. Specifically, in Uzbekistan, we were receiving quite a lot of the prepaid equipment, and thus reduced our capital expenditures with no impact on the amount of construction works.

 Lower capital expenditures in the downstream business were driven by less maintenance works as compared to the previous quarter.

 Our operating cash flow in the first quarter 2017 decreased by RUB 63 billion quarter-on-quarter, and this was mainly due to the change in working capital, primarily driven by our international trading business, which, as you know, is based on pursuing real-time opportunities, and it also depends on market trends. And it's worth mentioning that in case with trading operations, it doesn't make much sense to analyze separate items of the working capital as they're often interlinked. And you can clearly see that overall change in our working capital during the quarter was less material than a single change in payables. We see this as a normal fluctuation given the scale and size of our trading business.

 Operating cash flow before changes in working capital increased by RUB 19 billion, and this resulted in the subsequent increase in the free cash flow to RUB 67 billion.

 And I would like to mention again and to state again that first quarter of 2017 is a record quarter in terms of free cash flow generation for the company in ruble terms before working capital changes and West Qurna-2 project, and that's for almost 5-plus years.

 Our balance sheet continues to be strong, despite the increase in net debt which was due to neutral free cash flow after working capital and distribution of interim dividend, we had like positive impact from the EBITDA increase which resulted in relatively unchanged net debt-to-EBITDA ratio at approximately 0.6.

 We also continue to optimizing our debt portfolio.

 What we did is, we replaced ruble-denominated bank loans by dollar-denominated facilities at lower interest rates. In the first quarter 2017, we paid RUB 35 billion of ruble-denominated loans prior to maturity, and we attracted approximately the same amount which was $500 million of new debt in dollar terms.

 So with that, I'll stop, and I'll hand over back to Pavel.

------------------------------
 Pavel Zhdanov,    [6]
------------------------------
 Yes, thank you, Alexander. Just to finish the presentation and before opening the line for questions, I would like to reiterate that LUKOIL delivered exceptionally strong set of quarterly results in a challenging environment. Going forward, we continue focusing on the project execution and controlling the things we can control.

 We're also very pleased to report that last week, we closed the sale of our noncore diamonds business for more than RUB 80 billion in cash. This is yet another great example of excellent project execution and our ability to create value for our shareholders, even outside of our core business.

 In the light of OPEC decision, we would like to adjust our production guidance for 2017 to reflect the extension of the cuts. As we will keep our daily liquids outputs in Russia at current level throughout the remainder of 2017, we're now expecting our total hydrocarbon production, excluding Iraq, to increase by 1%, 2% this year, driven by gas. Our production profile at key growth projects is not going to be affected by production cuts and the share of high-margin barrels will continue to grow, providing the basis for the solid financial performance. And we will put all the efforts to ensure diligent project execution.

 Our capital expenditure guidance for 2017 remains unchanged. At current exchange rate, our investments during the year are expected to be in the lower range of our guidance of RUB 550 billion, RUB 600 billion. We intend to continue our path of sustainable cash flow generation. As such our commitment to shareholders remains strong and -- as demonstrated by a reliable and growing dividend. We remain optimistic about our future performance.

 With that, I would like to open the floor for Q&A, please.

==============================
Questions and Answers
------------------------------
Operator   [1]
------------------------------
 (Operator Instructions) The first question comes in from the line of Karen Kostanian.

------------------------------
 Karen Kostanian,  BofA Merrill Lynch, Research Division - Head of EEMEA Energy Research and Head of the Russian Research Department    [2]
------------------------------
 This is Karen Kostanian from Bank of America. I have 2 questions. Now that you have launched majority of your new greenfield projects, your balance sheet is in a good shape and you're highly free cash flow generative. Could you update us where you will be concentrating your future exploration activities? And my second question is about operating expenses. Now that oil production is stabilizing, oil prices are slightly higher, are you experiencing in your negotiation with supplier, particularly drilling companies, any pressures on your cost basis? And what do you expect your operating expenses to be this year? How much higher?

------------------------------
 Pavel Zhdanov,    [3]
------------------------------
 [Audio Gap]

 As you know, this is all in Russia. And internationally, the biggest component will be in Iraq on Block 10. Regarding operating costs, we continue to negotiate with all the suppliers to maintain costs unchanged, regardless of the factors that you've mentioned. So our target is to stay within the rate of Russian inflation. That's our target for the operating cost growth for the year.

------------------------------
Operator   [4]
------------------------------
 The next question comes in from the line of Alexander Kornilov.

------------------------------
 Alexander Kornilov,  Aton LLC, Research Division - Senior Analyst of Energy Sector   [5]
------------------------------
 I have 2 questions, actually. First of all, in regards to your financials statements, apparently, you have experienced pretty big working capital outflow in the first quarter and I assume the key reason for that was the accounts payable. On my numbers, it's down RUB 115 billion. Could you please elaborate on what was the reason behind that, the key reason, and what kind of dynamic should we expect down the road towards the year-end? And secondly, in the recent past, there had been some information in the media regarding the LUKOIL's asset optimization, and your management discussed potentially selling some portion of your retailing stations in Russia. And then you also considered, according to media, the potential sale of Ukhta refinery. Could you please say what kind of plans you have now?

------------------------------
 Pavel Zhdanov,    [6]
------------------------------
 Thank you for your question. So regarding your first question about the working capital changes, as Alexander has mentioned in his presentation, this is mainly the results of the new business opportunities in our trading business, which required more working capital employed by the business, which is all employed by those new business opportunities. Part of that increase will be released gradually over the next reporting period. So to answer your second question about the portfolio optimization, yes, we continue to review our portfolio, and we have done quite a bit of optimization in the past couple of years. The assets that you mentioned, retail in Russia and Ukhta, we're not planning to sell. They will stay in our portfolio.

------------------------------
Operator   [7]
------------------------------
 The next question comes in from the line of Henri Patricot.

------------------------------
 Henri Jerome Dieudonne Marie Patricot,  UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst   [8]
------------------------------
 Two questions for me. The first one's on your production. You mentioned that you've kept drilling despite this cap on your -- the production on the monitor. I was wondering if you can give us an indication of how quickly you could ramp up when the production cap is lifted next year? And secondly, can you give me -- give us an update on the timing of the -- some agreement for the second phase of West Qurna-2? And whether we can expect to have an update on potentially other projects in the Middle East some point this year?

------------------------------
 Pavel Zhdanov,    [9]
------------------------------
 Well, to answer your question, how quickly, the answer is quickly. So we continue our drilling plan, as we explained. The exact timing I cannot tell you, but yes, we can resume the production very quickly. But also the plan is to continue the exploration drilling, so that we can deliver on our targets to reduce the declines in West Siberia to 2% by 2019. So that's the main reason behind continuing the drilling program. So regarding the timing on West Qurna second phase, we cannot give you any guidance here. As we mentioned, we plan to continue maintaining the current production level until we have clarity on our negotiation with the Iraqi side on the contract. And regarding other opportunities in Middle East, I guess, you mean the -- our business development activity in Iran and some other areas. So the -- Iran is a very attractive region, and we have knowledge of the geology in the country. We've made certain discoveries in the past. So we have competency to work there. We have certain competitive advantage. But at the moment, we are, as many others, waiting to see what the country will offer to oil companies in terms of economics of those potential contracts. So let's wait and see.

------------------------------
Operator   [10]
------------------------------
 The next question comes in from the line of

 [Olga Danilenko].

------------------------------
 Unidentified Analyst,    [11]
------------------------------
 I would like to clarify -- I have 2 questions. First, I would like to clarify on EBITDA dynamics in the international and downstream segment. And I really appreciate that you have enhanced the disclosure standards in MD&A. So as Alexander just mentioned, the EBITDA would have been flat for the international business quarter-on-quarter, if not the hedging which occurred. As far as I can see in the financial -- in the MD&A, you only provide the data for first quarter of 2017 and first quarter of 2016. So I would appreciate if you can share the data for fourth quarter of 2016, so that we can estimate what the EBITDA would have been in first quarter 2017, excluding the hedges. And my second question also relates to refining. You mentioned the new processing scheme at Canadian refinery. I just wanted to understand a little bit more details on why you decided to do this processing scheme and how significant this transaction is?

------------------------------
 Pavel Zhdanov,    [12]
------------------------------
 Yes, Olga, regarding your first question about the EBITDA for international downstream for the fourth quarter of 2016, it's in our presentation on Page 5, which show both quarters, the first quarter and the last quarter of 2016. So have a look there. Regarding this latest refining initiative, well, as Alexander mentioned, it's not such a big deal as it sounds. It's not even a refining initiative, it's a trading initiative. And as we mentioned, it's a pure commercial function that LITASCO is doing for this particular refinery, earning a fee and making certain other profits on the trading flows. So it's not a big business.

------------------------------
Operator   [13]
------------------------------
 The next question comes in from the line of Andrey Polischuk.

------------------------------
 Andrey Polischuk,  Raiffeisen Bank International AG, Research Division - Analyst   [14]
------------------------------
 I just have one question on the gas assets? Could you please update us on your CapEx guidance? Is it unchanged on $1.6 billion? And if I understand currently, you're free cash flow negative for the project. And maybe you can give us guidance when you expect to be free cash flow positive and what is your maintenance CapEx for gas assets?

------------------------------
 Alexander Palivoda,    [15]
------------------------------
 Thanks Andrey for this number. Our CapEx guidance remains unchanged, that's $1.6 billion to $1.7 billion for 2017. You're absolutely right that the project is free cash flow negative this year, but we expect that with the production ramp-up which is -- which already started, by the way, as Pavel mentioned during his presentation that we just launched this first train at -- of the Gissar gas treatment units and we are ramping our production quite rapidly. So we expect our production next year to increase substantially. And then this gas treatment facility at Gissar will be followed next year by the launch of the first train of the Kandym gas processing plant which will also result in some incremental production growth in the country. So obviously, this should have a positive impact on the operating cash flow generation. And we expect that the projects will run out from this negative free cash flow zone as soon as next year. And maintenance CapEx is in the range of several hundreds of millions of dollars for the project.

------------------------------
Operator   [16]
------------------------------
 The next question comes in from the line of Ildar Khaziev.

------------------------------
 Ildar Khaziev,  HSBC, Research Division - Analyst   [17]
------------------------------
 I have a couple of questions on Uzbekistan, too. First, there have been reports in Interfax, I think, about China catching gas imports from Uzbekistan from this year. Could you comment whether these reports are accurate? Or whether it's seasonal or not or maybe there is something else going on. And also in relation to this project also, do you have a view on how the Chinese pipeline gas netbacks have changed relative to LNG import netbacks, and whether this has any implications to your future revenue stream?

------------------------------
 Pavel Zhdanov,    [18]
------------------------------
 Yes, thank you, it's Pavel here. So regarding your first question regarding export from Uzbekistan to China, we have also seen the statistics, of course. You know very well that this is not unusual. This is totally seasonal. It happens every year, and it also happened this year. I mean, this is completely expected. We do not sell to China directly, as you know. We sell to Uzbekneftegas. So for us, doesn't really matter what's -- how they export the gas and to some extent in which direction. So I mean, what happened is totally expected and totally seasonal. So regarding the pricing, I can't answer your question how it has changed regarding the LNG alternative, but I'll -- we don't disclose the pricing formulas but some prices are oil linked and they have not changed materially over the past quarter.

------------------------------
 Ildar Khaziev,  HSBC, Research Division - Analyst   [19]
------------------------------
 And quick follow-up question. Where are you going to export to your gas liquid from the gas plants?

------------------------------
 Pavel Zhdanov,    [20]
------------------------------
 Yes, well, the plan is also to export them via the same marketing arrangement that we currently have, so there is a market for those as well. I can give you more details if you're interested about the possible direction.

------------------------------
Operator   [21]
------------------------------
 The...

------------------------------
 Pavel Zhdanov,    [22]
------------------------------
 Okay, we'll...

------------------------------
Operator   [23]
------------------------------
 Sorry, go ahead.

------------------------------
 Pavel Zhdanov,    [24]
------------------------------
 Yes, looks like there are no further questions from the line.

------------------------------
Operator   [25]
------------------------------
 Okay. So the next question coming through is from the line of Igor Kuzmin.

------------------------------
 Igor Kuzmin,  Morgan Stanley, Research Division - Equity Analyst   [26]
------------------------------
 I just want to have a question. I would like to clarify, for your foreign downstream operations, do you have any hedging exposure in terms of the crude as well as the products? If yes, how far forward do you hedge?

------------------------------
 Alexander Palivoda,    [27]
------------------------------
 We're -- thanks Igor for the question. So the answer is that we are only hedging our trading operations, which are implemented by LITASCO, our international trading subsidiary. So these are very short hedges and the duration usually matches the review time for crude oil and products.

 Okay. As far as there are no further questions from the line, I'd like to thank everyone for participating on the call and goodbye.

------------------------------
Operator   [28]
------------------------------
 Ladies and gentlemen, thank you for joining today's call. You may now replace your handsets.




------------------------------
Definitions
------------------------------
PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the 
Transcript has been published in near real-time by an experienced 
professional transcriber.  While the Preliminary Transcript is highly 
accurate, it has not been edited to ensure the entire transcription 
represents a verbatim report of the call.

EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional 
editors have listened to the event a second time to confirm that the 
content of the call has been transcribed accurately and in full.

------------------------------
Disclaimer
------------------------------
Thomson Reuters reserves the right to make changes to documents, content, or other 
information on this web site without obligation to notify any person of 
such changes.

In the conference calls upon which Event Transcripts are based, companies 
may make projections or other forward-looking statements regarding a variety 
of items. Such forward-looking statements are based upon current 
expectations and involve risks and uncertainties. Actual results may differ 
materially from those stated in any forward-looking statement based on a 
number of important factors and risks, which are more specifically 
identified in the companies' most recent SEC filings. Although the companies 
may indicate and believe that the assumptions underlying the forward-looking 
statements are reasonable, any of the assumptions could prove inaccurate or 
incorrect and, therefore, there can be no assurance that the results 
contemplated in the forward-looking statements will be realized.

THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION
OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO
PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS,
OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS.
IN NO WAY DOES THOMSON REUTERS OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER
DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN
ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S
CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE
MAKING ANY INVESTMENT OR OTHER DECISIONS.
------------------------------
Copyright 2018 Thomson Reuters. All Rights Reserved.
------------------------------