Q2 & H1 2017 Novatek PAO Earnings Call (IFRS)
Jul 27, 2017 AM CEST
NVTK.MZ - Novatek PAO
Q2 & H1 2017 Novatek PAO Earnings Call (IFRS)
Jul 27, 2017 / 01:00PM GMT
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Corporate Participants
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* Mark Anthony Gyetvay
PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board
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Conference Call Participants
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* Geydar Mamedov
Goldman Sachs Group Inc., Research Division - Equity Analyst
* Henri Jerome Dieudonne Marie Patricot
UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst
* Olga Gemilemkov
* Pavel Kushnir
Deutsche Bank AG, Research Division - Research Analyst
* Stella Cridge
Barclays PLC, Research Division - Research Analyst
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Presentation
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Operator [1]
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(Operator Instructions) Good day, and welcome to the NOVATEK Second Quarter and First Half of 2017 Financial Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Mr. Mark Gyetvay. Please go ahead, sir.
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [2]
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Good. Thank you, Katie. Ladies and gentlemen, shareholders and colleagues, good evening and welcome to our second quarter and first half 2017 earnings conference call.
And before we begin with the specific conference call details, I would like to refer you to our disclaimer statement, as is our normal business. During this conference call, we may make reference to forward-looking statements by using words such as our plans, objectives, goals, strategies and other similar words, which are other than statements of historical facts. Actual results may differ materially from those implied by such forward-looking statements due to known and unknown risk and uncertainties, and reflect our views as the date of this presentation.
We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements in light of new information or future events. Please refer to our regulatory filings, including our annual review for the year ended December 31, 2016, as well as any of our earnings press releases and documents throughout the past year, for more descriptions of the risks that may influence our results.
Commodity prices continued to be volatile in the second quarter, and we expect this to be the case throughout 2017, despite ongoing efforts by OPEC and non-OPEC members to balance supplies with demand. Obviously, the consequences of this volatility has led many oil and gas analysts to adjust their financial models downward and cut earnings estimates across the boards for companies operating in the global oil and gas space, including NOVATEK.
As I mentioned on my last conference call, we manage our business through these commodity cycles and attempt to achieve the highest risk-adjusted margins for the hydrocarbon product stream we market both domestically and internationally.
I understand it is frustrating for many investors to ride out these cyclical markets and, quite frankly, we are equally frustrated, but our focus remains on cost control and project execution. It has been a hallmark of our success. We generated strong cash flows for the first half of 2017 despite the commodity price volatility, and we remain committed towards achieving our strategic aims and transitioning NOVATEK to a preeminent global gas player.
On the first quarter conference call I outlined a series of exploration and development activities to address the decline in production from our legacy assets, and I would encourage you to revert back to this transcript, available on NOVATEK's website portal, as we provided a lot of new information on upcoming projects.
We will launch the first train of Yamal LNG this year, which will contribute to production growth in 2017 and beyond, as well as develop lower producing zones like the Jurassic layers. Many of the current exploration and development projects outlined during the first conference call, such as the North-Russkoye development, are expected to begin contributing production towards the latter part of this decade rather than offering an immediate fix. Discussions are also being held to potentially acquire producing assets in the general vicinity of our existing asset base; but as is customary policy, we can only elaborate on this point once a deal, if any, is consummated.
Tonight, I would like to provide an additional update on recent development and exploration activities. A 4-stage hydraulic fracking on well #135 at the West-Yurkharovskoye field was performed during the week of our last conference call, and I did not have the final results at that time to provide an update. Subsequently, we completed 3 of the 4 fracking stages as the testing result indicated positive production potential from the Jurassic layers with initial well flows of approximately 500,000 cubic meters per day of natural gas and about 100 tons of gas condensate.
Our geologist and production teams are now preparing the field's Jurassic layer development plan, and during the first stage we will drill one more exploration well, as well as 4 new wells utilizing the drilling pad of well #135. Drilling will commence in 2018 and we will deliver 2 drilling rigs to the site this upcoming winter season.
It's premature to provide exact production and cost estimates on this conference call, but the initial success of well #135 targeting the Jurassic layer allows us to continue developing deeper Jurassic zones at our other assets. Preliminary estimates indicate that the West-Yurkharovskoye field could potentially contribute between 1 billion to 2 billion cubic meters of natural gas, as well as additional condensate.
We also completed the drilling of well #305 at the North-Russkoye field and achieved a commercial flow of gas condensate, with preliminary flow rates of 200 million cubic meters of natural gas, with a condensate gas factor of approximately 400 grams per 1,000 cubic meters from -- or, excuse me, per cubic meter, from the Jurassic layers. We completed the preparation stage for wells #306 and #307, targeting the deeper Jurassic zones, and will soon commence drilling activities at the field, as well as drill our first Jurassic layer well at the South-Tambeyskoye field in 2018. The North-Russkoye field is expected to commence production around late 2018-early 2019, with full field ramp-up by 2020.
In other development news, we plan to drill 5 new wells at the Yurkharovskoye field, targeting the Valanginian layer on the eastern portion of the reservoir. The completion of these new wells will slow down the decline rates at this important legacy field. In 2018, we will also drill our first well at the Nyakhartinskiy license area after completing and running and interpreting of 3D seismic in 2016. Our development plan called for connecting the field to the primary infrastructure of the Yurkharovskoye field by completing a 90-kilometer pipeline, with production estimated to commence around 2020.
At the Samburgsky license area, we completed the drilling of well #6001 with a horizontal length of 1,750 meters, targeting the Achimov level, and achieved a gas condensate factor of roughly 800 grams per cubic meter. Although we believe this high gas condensate factor is not sustainable, it does confirm very positive liquid production dynamics in the field and ensures sustainable liquids plateau through 2030. We have decided to expand the gas condensate preparation unit by 1 million tons per annum as a result of this production flow, and expect this work to be completed in 2019.
By the end of the second quarter, we achieved approximately 4.1 million cubic meters of associated petroleum gas from the Yarudeyskoye field, thereby revising our full year production outlook on the field from 1.2 billion cubic meters to 1.5 billion cubic meters. We also believe, with the higher flow rates at the field as well as the successful results from our exploration efforts, we can extend the plateau in this field to 2020.
In the second quarter, we started 2 new compressor stations at Nortgas and at the Samburgsky field. As we have previously stated, one of the reasons for production declines is a decrease in reservoir pressure, so the launching of the compressor booster stations will partially compensate for these natural declines.
If we take Nortgas as an example, commercial natural gas production began on the Eastern Dome in October 2013, shortly after we acquired our equity stake in the asset, which was launched about a year ahead of its schedule. In June 2017, we launched a new compressor station at the Eastern Dome to compensate for downhole pressure losses and maintain production at the field. In addition, to offset these production declines, we will drill approximately 7 new production wells in the Eastern and Western Domes over the next several years and plan to utilize existing well bores to produce from new upper zones once the current producing zones deplete.
In the first half of 2017, we have reconsidered all of our exploration activities and have decided to bring forward some of our work, specifically the running and processing of 3D seismic as well as some exploration drilling. Obviously, this type of work is preliminary to implementing a development plan, so we will only begin to see positive results, if any, by the end of the decade and beyond.
During the first half of 2017, we ran 992 square kilometers of 3D seismic as well as 15.7 thousand meters of exploration drilling, representing an increase of 305% and 79% respectively as compared to the corresponding periods. There are just one of the examples we are doing today to initiate some remediation work at our mature fields, drill deeper to producing layers such as the Jurassic zones, refocus efforts on expending some of our exploration activities and assessing potential M&A opportunities, to name a few.
Now I would like to shift my focus to our LNG activities. At Yamal LNG, overall project completion is 85% as of June 30 versus 80% at the end of the first quarter, and the first train is now 94% complete versus 91%, with commissioning at various stages already underway. I know everyone is waiting for us to provide the exact launch date for train #1, but the startup and commissioning process is currently proceeding as planned and our focus today is on ensuring a smooth and successful launch to a very complex project. We are committed to launch LNG train #1 by the end of 2017 as originally planned, and we remain on budget in terms of overall project cost.
We have drilled 87 production wells, significantly exceeding the well stock for LNG train #1 and fast approaching the 93 production wells needed to supply feedstock for LNG trains #1 and #2. Moreover, we have delivered 30 out of the 32 modules required for LNG train #2 and have already installed 22 of these modules. 24 of the 32 modules required for train #3 are presently in transit to Sabetta and 3 modules have already landed to the site. As I mentioned previously, the cryogenic heat exchangers for all 3 LNG trains are on-site, with this important equipment component already installed on LNG train #1.
With the rapid progress made so far on the project, we have decided to expedite the official launching of the LNG train #2 by approximately 3 months earlier in 2018, and LNG train #3 by approximately 6 to 9 months in the first half and second quarters of 2019. The accelerated launches of both trains #2 and #3 allows us to discuss with the external financing banks the possibility of distributing cash early to service shareholder loans.
At the end of March we successfully docked the first Arc7 ice-class tanker at the Sabetta facility, as I previously reported. Subsequently, this ice-class tanker was formally named after the late CEO of Total, Christophe de Margerie, in June. As of today, 9 LNG tankers are being built, including 2 that are fully completed and in a stage of testing and 2 other tankers put into water for outfitting and cargo containment construction. In addition, it was announced in June that Mitsui OSK, or MOL, had ordered 4 new conventional LNG carriers to deliver transshipment cargoes for the Yamal LNG project.
NOVATEK is pivoting its strategic focus more towards the global LNG markets than on our traditional or legacy domestic market. The move towards becoming a preeminent global gas player underscores our new strategic plans and will guide our investment programs for the foreseeable future. I will announce the date and location of our upcoming Strategy Day during the third quarter conference call in October.
I would like to spend some time now to briefly discuss what we are doing on some of our other LNG projects. By now, everyone has heard us discuss our next LNG project called Arctic LNG 2, which is based on the prolific hydrocarbon resources of the Utrenneye field, located on the Gydan Peninsula. Presently, we own 100% of this project, but most likely will form a strategic partnership to share project risk and seek external financing similar to the structure executed at Yamal LNG.
The Utrenneye field has approximately 1.5 trilling cubic meters of natural gas under the Russian reserve classification C1-C2 and is technically larger than the South Tambeyskoye field. We have completed all preparatory works and have begun drilling production wells, which we estimate will produce slightly greater than 30 billion cubic meters per annum, along with the corresponding liquids -- enough natural gas resources to commission 3 LNG trains with a capacity of 6 million tons per train or 18 million tons of LNG annually. The huge onshore conventional natural gas resource base provides a plateau life on the field that is sufficient to yield attractive returns for shareholders. We are presently holding discussions with various potential partners for this project.
We recently signed a front-end engineering design contract, or FEED, with a newly-formed company called LNG NovaEngineering, which is a joint venture comprised of TechnipFMC, Linde and the Design and Research Institute for Gas Processing, or NIPIGAS. We anticipate that the FEED will take about 18 months to finalize, so roughly it should be concluded by the end of 2018. If this timetable is met, we expect the final investment decision in 2019, with the first LNG train startup towards the end of 2022 or beginning of 2023.
Arctic LNG will be based on utilizing gravity-based platform structures, or GBSs, that will be designed by Saipem and built and fabricated at the Kola Yard located in the Murmansk region of Russia. Our goal is to localize the fabrication and building of these GBS platforms at the Kola Yard while maximizing the use of Russian-produced equipment where economically justified.
Although early in the design and engineering process, our goal is to significantly reduce the LNG liquefaction cost by at least 30% to make Russian LNG competitive at any point in the world. We have -- already have some of the lowest feedstock costs in the world, so we believe this cost competitiveness is crucial as we can reasonably estimate the cost of competing LNG on the market.
Each LNG trail will be situated on separate ice-protected platforms installed along the coastal area, and by the end of August or September we will have completed the majority of the research work for the designated platform locations.
It is not possible to really discuss the Arctic LNG 2 project or our other LNG projects without mentioning the Kola Yard based in the Murmansk region. The Kola Yard will build and fabricate the gravity-based structures as well as the other major units for future LNG projects. The Kola Yard will become an integral link in our LNG value chain, as this allows us to control and directly monitor the cost of building and fabricating these models -- modules, excuse me, as well as significantly reducing the logistical cost of transporting modules to the project site after testing.
Initial construction began in June, with the first contracts signed for digging and blasting operations. The first phase will entail preparing the site and building the dock walls. We have received the necessary governmental approvals and anticipate that the first phase will be completed by 2019.
It is envisaged that this -- there will be 2 docks where the GBS platforms will be produced. We'll be able to install all the LNG equipment on the platforms at the yard, with only field production, tie-in lines and commissioning done on-site. The second phase will be approved next year and will entail building the top-side plant modules.
The Kola Yard is one major step to meet the challenges of reducing capital costs on future LNG projects, and we plan to invest approximately RUB 40 billion to RUB 50 billion over the next 3 years.
We recently acquired a 51% stake in CryoGas-Vysotsk LNG project, which involves the construction of a medium-tonnage LNG plant located in the port of Vysotsk, including a pipeline link to the St. Petersburg-Vyborg-Russian border. The LNG plant will include 2 production trains with a capacity of 330,000 tons each, or 660 (sic) [660,000] tons in total, and it is estimated that we will launch the facility towards the end of 2018. Capital expenditures are presently estimated to be approximately RUB 50 billion, and we will have the capacity to expand with a second LNG train of equal capacity, and we will consider this potential expansion in 2018 or 2019.
Our wholly owned subsidiary, Arctic LNG 1, recently won the state tender to acquire the Gydanskiy license area, containing approximately 4.7 billion barrels of oil equivalent under the Russian resource classification of C and D for a onetime payment of RUB 2.3 billion. The license area is located approximately 80 kilometers from the Utrenneye field and, according to our estimates, a 3- to 4-year time frame will be sufficient to conduct all the exploratory activities, meaning that this license area will be ready as potential LNG feedstock around 2021 or shortly thereafter.
Three-dimensional seismic activities were recently concluded at the North Obskiy license area, and we will begin soon to prepare works to commence drilling of the first exploration well in 2018. We are very optimistic about this license area for future LNG developments, as the seismic results confirm a large hydrocarbon structure.
License acquisitions are integral to maintaining a successful exploration program and a pipeline for future projects. We will continue building our resource capabilities in both the Yamal and Gydan peninsulas to support our LNG ambitions, and over the past couple of years have added a series of new license areas to our asset portfolio. License acquisitions are a normal course of business and we will participate in the upcoming new tenders towards the end of August.
A couple of Memorandums of Understanding, or MOUs, were recently signed that support our strategic move into the global LNG markets. Specifically, we signed an MOU with Fluxys at the St. Petersburg International Economic Forum to pursue mutual cooperation in developing LNG marketing, optimizing LNG logistics as well as other potential LNG projects, like small-tonnage LNG plants, to facilitate the transition of transport fuel towards clean-burning gas. Our aim is to create market opportunities to secure future LNG demand, and this underscores our recent decision to join the Society for Gas as a Marine Fuel and the SEA/LNG Association. We believe there is a good market opportunity to secure future demand in the conversion of marine transport fuel from bunker fuels to LNG.
During the second quarter of 2017, we spent approximately RUB 8.1 billion in our capital program on a cash basis versus RUB 7.2 billion in the corresponding year, representing a 12% increase period-on-period. Our focus on capital expenditures has shifted more towards new future LNG projects such as Arctic LNG 2, North Obskiy license area, the Kola Yard and the future developments like North Russkoye as well as some remedial work at East Tarkosalinskoye and Yarudeyskoye fields. We also spent capital on the new West Yurkharovskoye development activities, and it is likely that these capital expenditures will increase on this field as we move into a development drilling program.
We plan to invest approximately RUB 40 billion in total capital expenditures in 2017, allocating funds between legacy assets, new development activities and infrastructure work for new LNG projects. For the 6 months ended June 30, total capital invested aggregated to RUB 18 billion for capital expenditures, license acquisitions and right of use assets, mainly time-chartering of marine tankers, as compared to RUB 16.1 billion spent in the corresponding period.
Total oil and gas revenues in the second quarter 2017 was RUB 128 billion, representing an increase year-on-year of 1.2% and a seasonally adjusted quarter-on-quarter decline of 16.9%. Our oil and gas revenues continue to be impacted negatively and/or positively by fluctuating benchmark commodity prices and the translation of our export liquid volumes by movements in foreign currency exchange rates.
Specifically, our natural gas sales volumes and corresponding revenues were impacted by seasonal fluctuations in demand between the first and second quarters 2017, and decreased quarter-on-quarter by 4.4 billion cubic meters, or by 23% on a volume basis, and by RUB 13 billion, or by 19%, in revenues. On a year-on-year comparison, our natural gas sales volumes increased by 2.3% while our natural gas revenues increased by RUB 3.9 billion, or by 7.6%, reflecting a shift in our mix towards end customers and a higher netback price in the reporting period.
Average natural gas prices to end customers increased by 3.8% year-on-year, largely due to the geographical mix of our sales at more distant locations, which in essence also increased our average transport tariff by 8.8% and resulted in a slight increase in our average netbacks of less than 1%. We managed to improve our average netbacks quarter-on-quarter by 2.6% by selling more volumes to end customers, although overall sales volumes were down 23% due to seasonal factors.
Our liquid revenues decreased quarter-on-quarter and year-on-year by 15% and 3% respectively, driven by a number of factors such as volatile commodity prices, changes in the Russian ruble versus U.S. dollar, and lower sales volumes.
Our liquid volumes sold declined 1.6% year-on-year, largely due to the decreased gas condensate sales, which were slightly offset by crude oil volumes recognized in the current period from the prior weather delays at the port loading facility in the first quarter and higher refined product sales. The decline in gas condensate output was mainly attributable to the Yurkharovskoye and Khancheyskoye fields during the reporting period. We also recognized 114,000 tons from changes in inventory balances in the second quarter as compared to the 31of March.
It's important that declines in liquid output from our producing fields did not affect our ability to maximize risk-adjusted margins at the Ust-Luga complex, as this facility operates at approximately 120% of its nameplate capacity on an annualized basis. Our goal to maximize our revenues and risk-adjusted margins through the sale of finished products at the Ust-Luga complex.
In the current reporting period, our naphtha sales were down 15%, largely due to the 13.3% Russian ruble appreciation against the U.S. dollar. Other refined products were stronger and grew by 27%, although the Russian ruble appreciation affected the currency translation of these dollar-denominated sales to the international markets. We realized weaker product sales quarter-on-quarter on the majority of both our domestic and export sales.
The Ust-Luga complex is a key component in our liquids value chains, so I'd like to state this evening that we are close to making a positive investment decision to expand the processing depth of the plant to convert heavy fuel oil into lighter fractionated products. It is estimated that this expansion project will cost approximately RUB 20 billion and be completed in 2019. Upon completion, we estimate that the deeper conversion may increase our netbacks by an additional 20% to 25% as compared to current margins.
At 30 June, 2017, we had 92,000 tons of naphtha in transit to the Asian-Pacific region, which was lower than prior year by 23,000 tons, but 60,000 tons higher than the year-end. Total liquids in storage were 699,000 tons versus 670 (sic) [670,000] tons in the second quarter. We finished the current reporting period with 611 million cubic meters of natural gas in the underground storage, a decrease of 223 million cubic meters from year-end. Our underground storage was significantly lower than the volumes stored at the end of the second quarter 2016 by 1 billion cubic meters, reflecting stronger current sales and our decision to reduce purchases to meet customer demand.
Our operating expenses were again consistent with our overall business trends and there were no major surprises during the reporting period. The movement in our operating expense categories were consistent with our business operations quarter-on-quarter and year-on-year, and reflected a change in higher transport cost for natural gas as well as lower purchases of unstable gas condensate and natural gas products from our joint ventures and other suppliers. Purchases of hydrocarbons represented 33% of our total operating expenses during the quarter.
Taxes other than income tax increased effective January 1 for both crude oil and gas condensate as the base rates increased by 21% and 18% respectively. Our selling, general and administrative expenses decreased during the reporting period largely due to lower accrued bonus payments and a slight decrease in headcount, which was partially offset by the annual salary indexation on base salaries and the corresponding increase in social contributions.
Other major cost trends were relatively similar on a comparative basis, with a large change in inventory between periods with the withdrawal of natural gas in the period and the recognition of sales from liquids in transit.
Our balance sheet and liquidity position remained very strong in the second quarter 2017, as well as further improvements in all of our credit metrics. We generated RUB 31 billion of free cash flow despite an increase in our capital expenditures on the back of reasonably strong operating cash flows. Free cash flows for the first half of 2017 totaled RUB 75 billion versus RUB 57 billion during the corresponding period. We have sufficient cash flows to fund our operations and pay our obligations and debt service as they become continue. Our net debt position RUB 114 billion at the end of the reporting period, as we repaid debt according to repayment schedules or before maturity.
In conclusion, our financial and operational results were good, and consistent with our expectations for the period, especially between seasonality periods. Volatility in both the commodity and foreign exchange markets continue to affect our results either positively or negatively, but we are not unique in this situation as these movements, particularly relating to commodity prices, affects all oil and gas industry players. Therefore, the key to our business success is controlling our operating expenses and capital costs and delivering on project execution. I believe we have achieved these results.
We are now a step closer to formally launching our LNG project and transitioning NOVATEK into a global gas player. The transformational move will catapult us into the global spotlight as more interest will be focused on us in terms of our future LNG projects as well as our global marketing initiatives. We will outline our global LNG plans at our upcoming Strategy Day as our portfolio of assets for future projects has increased with the recent acquisition of the Gydanskiy license area.
Global LNG demand is growing. In 2016, LNG growth was roughly 7%, and the data so far in 2017 shows continued demand growth. In the first half of 2017, volumes of LNG sold were approximately 142 million tons, or approximately 9% higher as compared to the corresponding period in 2016. We see more and more countries entering the LNG markets as potential new sources of demand. Consensus forecasts from research institutes and consulting firms, as well as major LNG producers, having the collectively estimated that LNG growth will outpace the average growth of natural gas through 2030 and beyond, and these external forecasts support our own internal assessments of the natural gas markets through these periods.
But there was a decision last night by Petronas to cancel its LNG project in British Columbia and, following this decision, news reports indicating a growing list of scrapped or terminated projects because of the worldwide glut in natural gas. Unfortunately, many of these LNG projects were predicated on uneconomically high commodity prices and were simply uneconomical to provide adequate returns to sponsors. We have already seen this scenario play out in the Australian LNG market as cost overruns, project delays and the recent governmental decision to limit exports of natural gas created a negative market sentiment towards LNG that fits very well in a negatively biased news world.
Our goal is quite simple. We aim to become a significant player in the global LNG markets by utilizing our prolific low-cost resource base in the Yamal and Gydan peninsulas. As I mentioned earlier, cost competitiveness will be a key driver to unlock global LNG demand, and this is one of the major reasons we will focus on localizing construction and LNG module fabrication at our Kola Yard.
Our ability to source long-life, low-cost conventional natural gas from our prolific hydrocarbon resource base, combined with our goals of reducing the cost of liquefaction with the building of the gravity-based structures, will make our LNG projects competitive globally. When you combine these factors with our ability to also monetize the liquid components in our natural gas stream, what emerges is a unique LNG story comparable to the competitiveness of the LNG projects from Qatar.
Despite a weaker quarter, I believe we delivered another set of strong financial results during a volatile commodity period, the appreciation of Russian ruble against the U.S. dollar and euro as well as demand seasonality for natural gas. Our free cash flow generation was again robust and this trend will continue throughout the remainder of 2017. It should be clear to everyone by now that our business model is generating sufficient cash to support our business goals and growth initiatives, as well as to meet all of our debt obligations and liabilities as they mature.
We have taken steps to slow down the rate of production decline at our legacy assets by drilling to lower producing layers, implementing remediation steps and increasing exploration expenditures on our license areas. The information presented tonight supports those steps, and time is required to realize the fruits of these investments.
I would like to thank everyone for your continued support of NOVATEK and our investment story as well as your time to attend tonight's conference call. I would now like to open tonight's call for questions and answers. Thank you.
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Questions and Answers
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Operator [1]
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(Operator Instructions) And we will take our first question from George Gorbatov from Goldman Sachs.
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Geydar Mamedov, Goldman Sachs Group Inc., Research Division - Equity Analyst [2]
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Mark, it's Geydar speaking from Goldman. I had a quick question about the cash allocation in the coming 12 to 18 months. So if we look at your CapEx guidance for 2017 and the financial results for the first half of the year, it looks like, assuming that there is nothing major happening in the second half of the year, you are going to generate a pretty decent free cash flow for the full year, in excess of RUB 100 billion. And obviously you have the big projects ahead that you're planning to execute, and you'll be looking for partners there. But it's interesting to hear how you're thinking about this free cash flow and allocation of that. Shall we assume that you're just going to keep it on the [downshift] with the plan of spending [a bit] further on your new projects, or you have any other type of source within the company on the allocation of this free cash flow?
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [3]
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Geydar, thank you very much for your question. We will continue to pay out, as part of our dividend policy, 30% of our IFRS net income, adjusted for the one-off and non-cash items. We plan to increase the dividend payouts as a means of the growth in the company's financials. But we're not really adjusting the policy at this particular point. We have a series of projects that I tried to enumerate in the first quarter conference call as well as tonight. That's going to require the use of capital. So I would fully anticipate, given the new development plans, that we should see an increase in capital expenditures over the next couple of years to meet the development of these projects. So I would say that we're probably reverting more back to what we were a couple of years back, in that sort of RUB 60 billion-type arrangement. But it's kind of premature at this particular point, and we'll update that more or less on the strategy presentation when we do it by the end of this year. And also, as I mentioned too, there's always the possibility of acquisitions. Given the fact that it may be difficult to attract financing externally, which is what we have done on previous years, we might have to use some of the cash that we have on our balance sheet to meet these acquisition costs. But right now, there is none on the table that I can speak of today. So the -- there will be some call on this cash in the future. But we are generating substantial cash to fund all of our operations, pay our debt, as I mentioned, and I think you just need to wait till the strategy so we kind of give you a better outline of what we plan to do over the next 3 to 5 years in terms of some of the capital allocated to these new projects that we're working on.
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Geydar Mamedov, Goldman Sachs Group Inc., Research Division - Equity Analyst [4]
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Thank you. And if I may ask just a second question here, as you launch Yamal LNG train #1, and obviously the first cargoes start going to the clients, you will start getting the first cash flow from the project. What is the right way of thinking about the allocation of that cash flow? Is it going to be spent and disbursed on the -- paying out the debt, or there will be some kind of split between paying dividends to the shareholders and paying the debt? And I'm speaking, the cash coming from the train #1 only. I understand as you add trains there would be enough cash for both.
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [5]
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Well, I think as I mentioned just a second ago, I think we don't look at individual as -- on a train by train basis. We're going to look at this as a total project. And I think one of the things that, as I mentioned, and I think Mr. Mikhelson mentioned it earlier in the week also, was the fact that if we expedite some of these trains #2 and #3, these were really not considered in the financial models that were provided to the banks. But I think we should expect that we'll have received additional cash quicker, that would be allowed to provide cash to the shareholder loans, as I mentioned. But the plan is, we have a repayment schedule for our external financing. We think that, given that plan, when that starts, we ought to be able to start shareholder repayments by 2019. That's -- if we talk about it just as it is today, that's really the plan in place -- start paying back shareholder loans in 2019.
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Operator [6]
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Our next question is from [Olga Gemilemkov].
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Olga Gemilemkov, [7]
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I have 2 questions. For 2018, can you possibly make a range guidance? Nothing specific, but maybe depending on the projects. You mentioned some new projects like this RUB 20 billion investment in Ust-Luga deeper facility and also this Kola shipyard. So maybe you can name the range which we can potentially expect in terms of your CapEx. And a broader question: for the next maybe 5 years, how do you approach the split in between your currently producing assets and some other expansion projects like LNG, et cetera? So maybe some rough estimate of what could be the split in between the capital expenditures.
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [8]
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Olga, I appreciate your -- I really appreciate your question. But you're really impinging upon the information that we will provide at the upcoming strategy presentation. Right? Because that's really what we're going to be looking at in terms of providing the market with guidance in what our plans are over the next couple of years, including even, like I said, out to 5 years and probably further. What I attempted to do over the first conference call and the second conference call was just to provide you with an outline of what we're planning to do in terms of reducing some of the production declines that we see at the legacy assets. Because we have received many questions through our investor meetings and we have read many analyst reports on the same topic, and so I wanted to demonstrate to everybody in these conference calls that we have steps in place to mitigate or even to decelerate that rate of decline. At the same time, obviously, I've been saying that we're not ex growth, and we're going to be undertaking a series of new projects that are in our asset portfolio. But those are the projects, such as North-Russkoye or even further, the North-Russkoye cluster, which is a -- bigger than just the one field, and we'll outline all of this stuff on the strategy presentation. Now if I go into too much information or depth, then I -- then it makes no sense to have this big presentation that outlines all these plans. So I'd really like to say that I provided you with some guidance. It wasn't meant to provide you with a year-on-year CapEx outline or even to give you forward guidance for 2018; it was meant to show you that we do have plans in place, we are working on them, we do have projects that we'll be investing in, in the next couple of years, so I -- to really answer your question, Olga, I would appreciate if you can be patient and wait till we have this conference -- this strategy update conference later in the year.
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Operator [9]
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And we will take our next question from Pavel Kushnir from Deutsche Bank.
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Pavel Kushnir, Deutsche Bank AG, Research Division - Research Analyst [10]
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Mark, I have a question about your second quarter general and administrative expenses. In the previous 3 years, you always had spikes in this expense item. So your costs increased in the second quarter then dropped in the third quarter. We see that in the second quarter 2017 you had about the same G&A cost quarter-on-quarter. So no similar spike to what we see -- what we saw in the past. So my question is whether we should expect some increase in your G&A costs in the third quarter or fourth quarter of this year.
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [11]
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Boy. Probably not much, Pavel. It's -- they obviously fluctuate. I think one of the things that we have always had some misconnect, or disconnect, excuse me, between the -- what the analysts, et cetera, have been forecasting and what we actually show, is the fact that on July 1 we usually have salary adjustments. So we usually have this period of time where we have -- comparing one set of numbers, and then all of a sudden that same set gets increased by this sort of -- by this base adjustments, through salary, and then it has all the social contribution elements that go along with that. The other thing is also, the company has grown over time and we've added a substantial amount of new employees both on the administrative side as well as we did in the operational side with the launching of some of these new projects. But I think in general it's probably fair to say that we probably will have just a minor -- nothing really major is forecasted to increase in the second half of the year.
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Operator [12]
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And our next question comes from Henri Patricot from UBS.
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Henri Jerome Dieudonne Marie Patricot, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [13]
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Just want to follow up on the comments that you made on Nortgas. I think production -- gas production was down 20% year-on-year in the second quarter. So I was wondering if you can give us more details as to where the [evolution] will be, thanks to this new gas compressor, and then with the new wells that you will be drilling, that the decline rate drops to 10% (inaudible) less production at the second quarter level.
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [14]
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Henri, I appreciate your question again, just like everybody else's questions; but it's kind of premature to give you an exact number or to tell you that it will be less than the 20%. I mean, we've taken the remediation steps, and I think it's best to just wait to see what the results happen over the remainder of the year. Now I believe we will be able to show some demonstrable improvements as the year progresses. But I think it's more important to understand is that we have 2 domes here. The -- and we have the old legacy dome that was a -- because this asset, it was acquired as already a producing asset and the -- well, we would have said the greenfield element of it would have been the Eastern Dome. So the Western Dome, which has been producing for many years already, is already at various stages of decline. Now we've just started with the compressor -- beginning that booster compressor station on the Eastern Dome, and we believe that this will be able to maintain some of the levels of production. But I think -- more importantly, I think what I outlined today is that there's been a decision that we will drill 7 additional wells into this particular, both Western Eastern Dome formations. And once we have depleted all those layers -- producing layers, the plan is to move up the well bores and start capturing some of the smaller formations using existing well bores. So I think it's best that we wait a little bit to see what the results come out. And even (inaudible) [what I'm] talking about, it's not even just a quarter. I think, let's wait to see what it looks like at -- by the end of the year, and hopefully we'll see some improvement in the deceleration of the declines at this particular field.
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Operator [15]
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(Operator Instructions) And our next question comes from Stella Cridge from Barclays.
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Stella Cridge, Barclays PLC, Research Division - Research Analyst [16]
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I was wondering if I can ask a question about Arctic LNG. So it sounds like it would be quite a large project, in the same way as Yamal LNG, and I may be quite early to ask this question, but in terms of the financing structure what would you be thinking at this stage? Would it perhaps be a similar structure as to the way that Yamal LNG was funded -- perhaps a combination of shareholder loans with some borrowing which could be proportionally guaranteed by shareholders. That would be my question. Any comments would be really helpful.
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [17]
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I would say that the structure on all of our future LNG projects, not only Arctic LNG 2, would be -- will be based on probably a similar model that we did with Yamal LNG, whereby we bring in partners into the field at carry cost as well as the financing structure. It's typical. I think we just need to wait until we have some of our discussions and make a decision before we can actually show you what we're doing. But that's the goal. The goal is to sell down the interest and minimize some of the risk to NOVATEK, but at the same time also bring in value or create value for the shareholders based on the fact that now that we have Yamal LNG complete, and the licenses, et cetera, all are carrying the tax concession terms and all have the export terms already embedded in the license, and that wasn't there when we did the Yamal LNG project. So I think in due course, now that we do the GBS -- and that's part of the reason why I would say that NOVATEK will maintain 100% of its interest, and we will fund the FEED work so that we can maximize the amount of value creation to our shareholders. And so, yes, the structure will be similar. We will sell down, and it'll be a combination of financing. But one of the things that we'll require from the other partner is to bring in financing sources. And so, I -- but I can't give you anything definitive right now because we haven't sold any interest down yet. So I think this is a question that we would have to revert back at another future date, but I would say that it would be similar to what you saw at Yamal LNG. Okay? Thank you.
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Operator [18]
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And I am showing no further questions at this time. (Operator Instructions)
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Mark Anthony Gyetvay, PAO NOVATEK - Deputy Chairman of the Management Board, CFO and Member of Management Board [19]
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Okay. I have no further questions, and I would just like to thank everybody for again attending tonight's conference call. And we at NOVATEK wish that you have a wonderful summer months. I know many people are on holidays right now, and have a safe travels wherever you go, and we look forward to seeing you in probably September and beyond, as our conferences become busier -- as our schedule becomes busier to meet up with investors on these sort of conference events. So again, thank you very much, and we appreciate all your support, and have a safe summer. Thank you.
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Operator [20]
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Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect.
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