Q3 & 9M 2017 NK Lukoil PAO Earnings Presentation

Nov 30, 2017 AM EST
LKOH.MZ - NK Lukoil PAO
Q3 & 9M 2017 NK Lukoil PAO Earnings Presentation
Nov 30, 2017 / 01:00PM GMT 

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Corporate Participants
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   *  Alexander Palivoda
   *  Pavel Zhdanov

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Conference Call Participants
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   *  Alex Fax
   *  Alexander Kornilov
      Aton LLC, Research Division - Senior Analyst of Energy Sector
   *  Andrey Polischuk
      Raiffeisen Bank International AG, Research Division - Financial Analyst & Oil and Gas Analyst
   *  Artem V. Konchin
      Otkritie Capital International Limited, Research Division - Senior Research Analyst
   *  Igor Kuzmin
      Morgan Stanley, Research Division - Equity Analyst
   *  Ildar Davletshin
      Wood & Company Financial Services, a.s., Research Division - Analyst
   *  Olga Danilenko
   *  Ronald Paul Smith
      Citigroup Inc, Research Division - Director and Senior Russian Oil and Gas Analyst

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Presentation
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Operator   [1]
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 Good morning and good afternoon, ladies and gentlemen, and welcome to the LUKOIL conference call. My name is Josh, and I will be your coordinator for today's conference. (Operator Instructions) I would like to inform you that the questions from the press will not be accepted.

 I will now hand over to Alexander Palivoda, head of Investor Relations, to begin today's conference.

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 Alexander Palivoda,    [2]
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 Thank you, Josh. Good afternoon, ladies and gentlemen, and it's our pleasure to welcome you today on LUKOIL's Third Quarter 2017 Financial Results Conference Call and Webcast. Thank you for joining us.

 On today's call, we have our Head of Capital Markets and M&A, Mr. Pavel Zhdanov. We have also Mr. Sergey Epifanov from the accounting team as well as Evgeniya Bitsenko from our Investor Relations team. Mr. Zhdanov will start today's call with a general overview of the results and a more detailed discussion on the upstream segment, and I'll follow with the downstream and financial details.

 As usual, there's going to be a questions-and-answers session. You can ask your question either by phone or using our webcast Q&A interface.

 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.

 And now I would like to hand over to Pavel Zhdanov.

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 Pavel Zhdanov,    [3]
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 Thank you, Alexander, and thank you all for joining our conference call on such an important day for the oil and gas industry when OPEC meeting is being held. So far, the OPEC-Russia agreement has been complementary to our relentless focus on value-over-volume approach due to its contribution to the increased share of high-margin projects in our overall production. The output from such projects is ramping up as planned and sometimes even faster, which has a meaningful positive impact on our financial results.

 Our average daily hydrocarbon production in the first 9 months of this year, excluding West Qurna project, increased by more than 2% year-on-year, driven by our gas projects. We are very pleased with these dynamics as it is better than our annual plan and guidance we gave you earlier. Our downstream results were also very strong as we increased refinery throughput volumes, maximizing benefits from record-high refining margins in Europe and our continuously strong margins in Russia. Despite higher throughputs, we managed to further improve light product yield at our Russian refineries to a new record of 71%.

 Our solid operational performance in the third quarter of this year, further supported by recovering oil prices, record-high refining margins and weak ruble, have led to very strong set of financial results across all of our business segments. For example, quarterly EBITDA of our Russian refineries hit another record for the past several years on the back of the secured product slates. Our stringent cost control was another important factor for the strong financial performance. The measures that we've been undertaking are yielding positive results as we see improvements across several lines of expenses in our P&L.

 As a combination of all these factors, in the third quarter of this year, we achieved all-time record consolidated EBITDA of RUB 221 billion, which is 24% higher quarter-on-quarter, while our EBITDA for the first 9 months of this year is 11% higher year-on-year. In dollar terms, this year-on-year growth was even more impressive at 30%.

 In addition, our efforts on debt structure optimization resulted in meaningful reduction for -- of the weighted average cost of debt.

 Our free cash flow-generation profile remains very robust. We generated 11% higher free cash flow quarter-on-quarter with substantial contribution from our downstream business. Our core free cash flow-generation capacity was exceptional. We delivered RUB 81 billion in free cash flow in the third quarter of this year, excluding changes in working capital and West Qurna project. This is 40% higher than in the second quarter and a record high since 2011. Such an outstanding performance is based on our strong business fundamentals, high investment discipline and a very well-balanced investment program as well as our vertically integrated business model and continuous management effort in optimizing the business and controlling the cost base.

 For the first 9 months of this year, we generated RUB 3.6 billion in normalized free cash flow, and this is before inflows from divestment of assets. This is more than sufficient to cover a continued delivery on our progressive dividend policy. At the end of October, the Board of Directors recommended the interim dividend for 2017 in the amount of RUB 85 per ordinary share. This is 13% higher than last year's interim dividend, and the growth is 4x faster than the Russian inflation. In dollar terms, the growth was an impressive 24%.

 2017 marks the 19th consecutive year of dividend growth for LUKOIL, and we offer among the highest dividend yields in the global energy universe on a full year basis. Our business is a combination of strong operational profile, low leverage and one of the most attractive dividends in the industry, predictable, transparent, steadily growing, fully covered with free cash flow. So we believe that such a unique investment story deserves much better market valuation.

 By the way, as you know, our strong profile has recently been reassessed and rerated by Fitch and S&P. As a result, we are currently rated 2 notches above the sovereign by these 2 agencies.

 Today, we are working on our long-term strategy update, which we plan to present to the market in London right after our full year financial results in March next year. The update, as we expect, will shed more light on our already quite clear business development path. Our focus remains on sustainable business growth, strong free cash flow generation, cost control and growth in distributions to shareholders.

 With that, I would like to proceed with more details on our upstream results. The macro environment during the third quarter was very supportive. Price for Brent was steadily growing since mid-August and, by the end of the quarter, reached the highest level since mid-2016. The average price during the quarter was $52 per barrel, 5% up quarter-on-quarter. In addition to the higher oil price, the Russian ruble weakened against the dollar, which resulted in the oil price in ruble terms increasing over RUB 3,000 per barrel or 9% quarter-on-quarter and to more than RUB 3,400 per barrel by the end of September.

 Upward oil price trend resulted in a positive export duty lag effect, which further supported the increase in crude oil export netbacks in dollar terms to the highest level since mid-2015. Recovering oil price environments improved returns on our high-margin barrels, which are generally more sensitive to the oil price dynamics compared to our standard production. At the same time, relatively weaker ruble materially improved returns on the standard barrels produced from our mature fields in West Siberia and other regions.

 Our average daily hydrocarbon production for the first 9 months of this year, excluding West Qurna project, increased by 2.3% year-on-year, driven by the development of gas projects, while our crude oil production remained capped by the OPEC-Russia agreement. We are keeping our crude oil production in Russia flat since May 2017 at approximately 1.64 million barrels per day. However, production structure continues changing as we deliver rapid production growth from our high-margin projects and simultaneously reduce production at our less productive mature fields.

 The share of our 5 key high-margin fields grew more than twofold over the last 12 months. This is a result of our excellent operational execution and ability to properly manage our investment priorities.

 Among the outstanding achievements, I would like to mention 30% quarter-on-quarter production growth at our Yaregskoye heavy crude oilfield in Timan-Pechora, one of the key high-margin projects for us. Supportive market and structural changes in our production mix were equally important for achieving 37% quarter-on-quarter increase in EBITDA from our upstream operations.

 On the gas side, we continued posting double-digit production growth rates. Our projects in Uzbekistan took the lead and became main growth driver for the third quarter 2017 as we achieved amazing progress with building and launching new production facilities. The shift towards bigger share of international in gas is very beneficial for our financial performance due to inherently better returns from international gas production compared to gas volumes produced and sold domestically.

 Moving now to the more detailed discussion of our key projects. To begin with, we are pleased to report that the major 2017 drilling goals set for the Filanovsky projects in the Caspian Sea have been fully accomplished. We are putting to operation 3 horizontal production wells, including 2 smart bilateral wells as well as 2 injectors. With the launch of the sixth production well in October, we exceeded the daily production rate of 120,000 barrels, which is already in line with the designed peak-plateau level. However, this level is going to be sustainable only post the launch of the production from the second platform. So according to our plans, the first full year of production at plateau will be 2019.

 As far as 2017 and '18 are concerned, we expect some outperformance in our production plans due to the faster-than-planned drilling and completion of the wells as well as construction works. The field's current daily production accounts for approximately 7% of our total crude oil output in Russia but its contribution to our upstream EBITDA in Russia is at least 3x bigger.

 More the second field development phase are progressing very well, slightly ahead of schedule. Assembly works on the ice-resistant platform, including the drilling package, have been completed, with necessary testing also successfully finalized. Accommodation module with the connecting bridge have been assembled and currently are undergoing testing. During the fourth of this year, we commence the driving of the marine risers, and we are about to start drilling the first well.

 At our second Caspian Sea field, Korchagin, we continue our record progress with the construction of the wellhead platform, which we plan to tow to the installation points next year. Platform jackets have already been installed in the sea, and we have recently completed the testing of the pipeline connection to the main platform. The new platform will allow us to resume drilling activity of the field next year in order to increase production.

 On our next development projects in the Caspian Sea, Rakushechnoye field, we are now in the very latest stage of the FEED, which we plan to finalize early next year to proceed with the final investment decision. And we already started working on a contracting strategy for the long-lead items.

 Now moving to our onshore fields. In the first 9 months of this year, Yarega heavy crude oilfield in Timan-Pechora will put onstream 14 new production wells with counterflow SAGD technology, including 6 wells in the third quarter. We also added 8 production wells and 10 steam injectors in the third quarter as part of the mining development program in the field. To support the growing needs for the steam injection, we added another steam-generation unit that expanded our daily steam-generation capacity by 100 tonnes to 1,300 tonnes per hour overall. Through the remainder of the year, we plan to add another unit with 200 tonnes per hour of steam-generation capacity to ensure that we realize and improve the potential of the existing production wells.

 As a result of our efforts, we delivered 30% daily production growth quarter-on-quarter and achieved another record production rate of 26,000 barrels per day in November. We expect the field to produce approximately 1.1 million tonnes of crude oil this year, which is 20% up year-on-year.

 In addition to Yarega field, our portfolio of heavy crude oil projects with production upside potential was recently complemented by the Permian reservoir or the Usinskoye field, which is also located in Timan-Pechora. The field is producing since 1982 and represents a great example of our ability to rejuvenate our upstream asset base through the development and efficient application of cutting-edge technologies. Our successful track record and technological expertise in heavy crude production as well as state support in the form of special tax rates enabled us to return the Usinskoye field to production growth path. The Permian reservoir of the field is divided into several blocks where various thermal recovery methods are being applied.

 Through 9 months of this year, we launched 18 new production wells and 4 steam-generation units with overall capacity of 96 tonnes per hour, and we are now producing more than 45,000 barrels per day from this reservoir. We also tested new, promising flow simulation techniques. The resource potential is huge so we expect to continue gradual production growth in these projects. Together with Yarega field, these 2 projects contribute approximately 5% to our daily crude oil production in Russia and we have a combined potential to approximately double this year in the future.

 Moving now to our core West Siberian region. Our 2017 liquids production plan for the Pyakyakhinskoe field, which we launched last year, remains unchanged at 1.5 million tonnes. We actively developed the field with the application of the most advanced drilling techniques, including multilateral wells. Out of 16 new wells that we launched in the field in the first 9 months of this year, 13 had multi-bore horizontal design. Daily crude oil flow at the field continues growing and amounted to 33,000 barrels per day in October. After the launch of gas production in the field in the beginning of the year and quick ramp-up to approximately 10 million cubic meters per day, we are right on track with our annual plan of approximately 3 billion cubic meters of gas output at the field.

 Other fields in West Siberia that are mostly mature and operate under the standard regime add a balancing effect in order for us to comply with external production limitations. To avoid any impact of the cuts on our longer-term production profile, we continued with the pre-OPEC drilling plan. At the same time, we are doing much less well workover operations, such as fracs, to offset incremental production from new drilling. In the first 9 months of the year, we increased production drilling volumes in the region by 26% year-on-year. To remind you, our annual plan was 10% to 15% increase in drilling volumes.

 We expect to be in the upper range of our plan because drilling of new wells is more important for our longer-term production profile than workovers. However, if the OPEC agreement is extended today, we'll most probably review our drilling plans for next year and accelerate our drilling activity compared to current levels. As part of our strategy update work, we put special emphasis on the efficient monetization of the enormous resource potential of our mature provinces and primarily West Siberia.

 Now let's move to our international projects. Gas production ramp-up accelerated at our 2 major projects in Uzbekistan. In the third quarter of this year, our daily gas production in the country increased by 32% quarter-on-quarter and impressive 67% year-on-year. We launched gas treatment facility with annual capacity of 4.4 billion cubic meters a year, a gas pretreatment unit and 6 gas gathering stations as part of the Gissar project, which enabled us to fully unlock the upstream potential of the projects. It took us less than 3 months to ramp up production at the project to the design level of approximately 14 million cubic meters of gas per day. This was achieved by launching 26 early-completed production wells.

 Kandym project is truly a positive surprise as we have already started testing the first train of the gas treatment complex with physical gas wells. Even more, we are now running tests at full capacity and have great chances to start the industrial production by the year-end. This is at least 6 months earlier than initially planned, which is an amazing success in our performance on such a complex project. The construction of the second train of the complex is also ahead of schedule with 74% completion as of now. So we are firmly moving towards plateau production in Uzbekistan earlier than planned.

 Our international gas project is another source of high-margin barrels for us as pricing terms are much better than for our Russian gas business. The share of gas produced in Uzbekistan increased to 6.1% in our total hydrocarbon production in the third quarter of this year as compared to 3.8% 12 months ago.

 A few words on Iraq. We are progressing well with the negotiations on the terms of the next field development stage. The Iraqi government recently decided to eliminate the P factor so our remuneration fee is now back to normal level. And our financial exposure to Iraq remains particularly flat at approximately $0.5 billion.

 With that, I'll pass the word now to Alexander Palivoda.

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 Alexander Palivoda,    [4]
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 Thank you, Pavel. So I'll continue with our downstream operations. The macro environment in the third quarter of 2017 was very supportive for the results of our downstream operations both in Russia and Europe. In Russia, the refining margins normalized in the third quarter of 2017 post peak level in the second quarter, and the dynamics was driven by the higher crude oil export netback, wide negative fuel oil crack spread and negative export duty lag effect. However, the impact from these factors on our Russian refinery margins was less profound due to the significantly better product slate than Russia's average. In addition, our forward oil price trend resulted in major positive inventory effects. Our retail margins was enhanced, driven by strong demand in Russia.

 In Europe, we witnessed quarterly European benchmark refining margins close to the highs last seen in 2015. This was driven by hurricanes in the United States and unplanned refinery shutdowns in Europe leading to the increase in the diesel fuel crack spread. Our European refineries were also supported by the positive inventory effects.

 Netback of petroleum product basket produced at our Russian refineries continued steadily growing in the third quarter on the back of better domestic and international prices. We increased our refinery throughput volumes by 5% in Russia, maximizing benefits from the supportive macro environment. Our crude oil export volumes slightly decreased quarter-on-quarter while the share of crude oil exports on the special export duty rates continued growing, driven by the successful development of our high-margin projects.

 We continue enhancing performance of our Russian refineries. At our biggest, Nizhny Novgorod, refinery, we continued changing the throughput mix towards higher content of lighter feedstock and also performed some other optimization measures. As a result, refining depth increased by 2 percentage points quarter-on-quarter and light product yield was raised by 1 percentage point.

 At the Perm refinery, we substantially increased throughput volumes by 20% quarter-on-quarter post primary distillation unit repairs in the second quarter. And still, we were able to keep light product yield at meaningful 70% level. At Volgograd refinery, post reaching the design parameters of the hydrocracker complex in the second quarter of 2017, we kept the utilization rate at an optimal level in the third quarter and delivered further improvement in the light product yield. Ukhta, our least complex refinery, continued delivering amazing results of ongoing throughput mix and volumes optimization. In the third quarter, it posted another record-high refining depth and light product yield.

 And we are very pleased with the weighted average performance of our Russian refineries. Our consolidated light product yield hit another record and reached 71.3%. That actually exceeds our annual target of 70%. This result is primarily based on the best-in-class quality of our refining capacities post modernization as well as active optimization measures and increase in gross supply volumes of non-crude feedstock in between our refineries. These volumes increased by more than 20% quarter-on-quarter.

 And we discussed at the previous calls our new potential projects for the construction of a delayed coker facility at Nizhny Novgorod refinery. And earlier today, we announced that we took final investment decision on this very attractive project. The coker unit itself is similar to the one that we have already built and successfully operating at our Perm refinery. It is of same capacity of 2.1 million tonnes per year. So working on documentation for the new facility is a much rapid process, and we expect the construction works to be more efficient on the back of the already -- recent expertise.

 In addition to building the coker unit, the project also involves construction of hydro treatment, gas fractionation, hydrogen and sulfur units. So in effect, this will be a major heavy-residue processing complex, which will not only enable us to convert heavy feedstock into coke and light products but also enhance efficiency and product quality of other processes at the refinery. We expect that the launch of this new complex will result in light product yield growing by at least 10 percentage points while the share of fuel oil and vacuum gas oil will decline by more than 15 percentage points.

 On the group level, it means that all production of fuel oil and vacuum gas oil at our Russian refineries will halve from current levels. The new complex will take us approximately 3 years to build, so scheduled launch is in 2021. We have already received all the necessary approvals from the government and started working on contracting the long-lead items.

 Now a couple of words on our European refineries. Most of our European refineries reported improvements in key performance indicators in the third quarter. The total throughput increased by 7% quarter-on-quarter, following maintenance works at ISAB and Ploiesti plants in the second quarter, which certainly improved the weighted average light product yield to 77.4%, driven by the optimization of feedstock mix through the reduction of the share of fuel oil in favor of crude oil processing. Especially, this was seen in the light product yield dynamics at Zeeland refinery that improved by 4 percentage points to 75%.

 Better product slate in Ploiesti was the result of processing in the third quarter of semi products accumulated during the turnaround works performed in the second quarter. ISAB refinery was back to its normal operations post maintenance in the second quarter. And we did some maintenance at Burgas, which resulted in lower light product yield.

 Now on marketing. Our performance in the retail business was very strong in the first 9 months of 2017 on the back of healthy retail margins in Russia and our focus on high-quality fuel and service. Our marketing efforts in retail enabled us to increase the domestic retail sales volumes by 4% year-on-year. We continue delivering double-digit growth in high-tech EKTO-branded motor fuel sales. In addition, our overall gross margin on nonfuel sales in Russia increased by 12% year-on-year, which is significantly ahead of inflation, which implies that the growth was mainly driven by the volume expansion.

 Internationally, our retail sales volumes decreased year-on-year due to the lower amount of retail stations following a series of divestments in 2015 and 2016, which was done to achieve a better level of vertical integration. We also increased volumes of airplane refueling, driven by growth of international traffic. Our bunkering fuel sales volumes grew by impressive 35% year-on-year as we continued expanding our share on the Baltic Sea market, driven by our unique product offering.

 Now a little bit more detail on the quarter-on-quarter dynamics of our financial results. For revenues, key growth factors were high hydrocarbon prices and weaker ruble. Sales volumes mix changed in favor of bigger share of petroleum products, driven by higher refinery throughput and lower crude oil trading volumes. There was also a structural change in petroleum product sales volumes, which resulted in material growth of the average realized price for petroleum products.

 Our quarter-on-quarter EBITDA dynamics was very strong across all key business segments. In the Russian upstream, EBITDA increased by impressive 40%. Key factor was higher export netback, which was driven by growth in oil price, weaker ruble and export duty lag effect. Other positive drivers for EBITDA were bigger share of high-margin projects in the overall production mix, lower lifting costs and also one-off mineral extraction tax return of approximately RUB 4 billion.

 Our international upstream EBITDA increased by 20%, and the key driver was growth in gas production volumes in Uzbekistan. And we expect this growth factor to persist in the midterm as we are rapidly increasing production volumes in this country. Among other growth factors was RUB 2 billion higher EBITDA from the West Qurna-2 project on the back of the cancellation of the P factor.

 Our EBITDA in the Russian downstream increased by 12% quarter-on-quarter despite lower benchmark refining margins. And the primary growth factor was inventory effect at our refineries due to the upwards crude oil export netback trends. Among other drivers were higher throughput volumes and better product slate, and these factors again were partially offset by lower benchmark refining margins in Russia retail performance quarter-on-quarter was also very strong on the back of higher margins and sales volumes.

 Our international downstream EBITDA practically tripled quarter-on-quarter, mainly driven by better performance of our European refineries on the back of strong positive inventory effect, representing a reversal of the negative effect we've had in the second quarter. Other drivers were record-high margins and growth in throughput volumes. These positive factors were partially offset by the hedging effect related to our international trading business.

 And I'd like to elaborate on this in more detail. In the third quarter, we reflected RUB 24 billion loss from hedging contracts related to our international trading business due to upward oil price trend, and most of this loss is covered by the respective gain on physical volumes sold. However, RUB 7 billion is an uncovered loss, which results from accounting specifics as it relates to volumes hedged but unsold as of the end of the quarter. So the respective gain on these physical sales volumes will be reflected in our Q4 results.

 Now to continue with other EBITDA factors. On the corporate level, we had lower EBITDA because of the effect of share-based compensation program. And you most probably noticed large negative elimination effect in the third quarter. Most of it relates to upstream volumes which was sold to downstream but then remained unsold to third parties as of the end of the period. And it means that this EBITDA again will be realized when we sell the volumes. [Such is a one-off] item which is primarily driven by dynamics of our inventory of crude oil and products as well as hydrocarbon prices.

 On operating expenses, the overall number increased by RUB 10 billion quarter-on-quarter, driven by 3 key factors. The first and the biggest factor that added RUB 5 billion is related to crude oil processing at the Canadian refinery. To remind you, we concluded this contract at the end of last year. As part of our trading business development, 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 does not have any exposure to refining margins but earns a fee and also generates additional income on trade flows. What we reflect in our operating expenses are actually the refining margin that we earn but which is then paid back to the refinery such that these expenses have neutral impact on our bottom line because they are actually offset on the revenue side.

 Second factor were our refining expenses at European refineries grew by RUB 2 billion due to the relaunch of secondary processing units post maintenance works in the second quarter as well as weaker ruble. The third factor was the increase in our international hydrocarbon extraction expenses, which was primarily due to the startup of new facilities as part of the Gissar project and related growth in production volumes in Uzbekistan.

 We are very pleased with the dynamics of our lifting costs in Russia as we managed to actually reduce per-barrel cost quarter-on-quarter. This reduction is a result of shutting down high-cost wells at our brownfields, driven by the OPEC-Russia agreement and also growing production at our Filanovsky and Pyakyakhinskoe greenfields, which benefits from lower-than-average lifting costs due to high flow rates.

 SG&A. The main factor behind SG&A dynamics was again the effect from share-based compensation program, which resulted in approximately RUB 3 billion quarter-on-quarter increase in our costs. As we explained at our previous calls, this is directly linked to the dynamics of our share price performance and dividend accruals. I would like to note here that the current share-based compensation program expires at the end of this year, so there will be payment made in 2018 on the second part of the compensation plan, which equates to the difference in weighted average share price on Moscow Exchange in 2017 and 2012 multiplied by the number of assigned shares of approximately 19 million. So these expenses have already been accrued, and there will be no impact on the P&L from this payment. And it's important that at least 50%, 1/2 of the payments should be used by the management to purchase LUKOIL shares on the open market.

 Another factor behind SG&A dynamics in the third quarter were labor costs outside of Russia that were driven mainly by ruble depreciation. And the quarter-on-quarter decline in our crude oil transportation expenses was due to significant reduction of trading volumes, increase in crude oil supplies to own refineries as well as lower international marine freight rates. We also continue to increase transportation volumes through own transportation infrastructure, which is obviously cheaper than third-party infrastructure. And we increased such exports by [2%] quarter-on-quarter and 16% year-on-year. Lower expenses on refined product transportation are driven by volume redirection from exports to more profitable domestic market.

 Now a couple of words on net profit. As we discussed at the previous conference call, in the second quarter, we booked a material gain from the sale of our diamond business. This gain became the primary reason for lower net profit in the third quarter. And the second-biggest factor was continued volatility of the ruble-to-dollar exchange rate, which resulted in foreign exchange loss in the third quarter compared to a huge foreign exchange gain in the second quarter.

 Our average net monetary position in foreign currency decreased by 17% as a result of replacing some of the ruble loans by loans in U.S. dollars. And we are currently working on optimizing the intra-group capital structure so we expect that the net monetary position should decline substantially as a result of this work, which should materially reduce the impact of the fixed-rate volatility on our net profit in the future. Net of the gain from divestments in the second quarter and the fixed effect, our net profit actually increased by 1.5x quarter-on-quarter.

 On capital expenditures, we continue to execute very stringent control and reinvested RUB 119 billion in the third quarter, which is 5% less quarter-on-quarter. The decline is driven by seasonality factors and payment schedules. It's worth noting here that our capital expenditures in the fourth quarter -- last quarter of the year are usually higher due to the same factors, so you should expect this cost item to increase in the fourth quarter of 2017.

 We continued generating robust free cash flow, which amounted to RUB 91 billion in the third quarter, including RUB 7 billion of working capital release. Our free cash flow before working capital changes increased by 58% quarter-on-quarter as a result of much higher cash flow from operating activity and slightly lower CapEx. Most of our free cash flow generation during the third quarter was used to pay out final dividends for 2016.

 Our balance sheet remains very strong with a relatively flat net debt position. As a result of high EBITDA, our net debt-to-EBITDA ratio further decreased to 0.42. And our cash position as of the end of the third quarter covers approximately 3 years of our debt repayment schedule.

 Our next major payment is $1.5 billion of eurobonds maturing in April of next year. And before that, in the very beginning of 2018, we will pay out interim dividends in the approximate amount of RUB 60 billion, subject to the Extraordinary General Meeting of Shareholders approval. And there also will be a payment on the share-based compensation program, which I mentioned above.

 So as a result of our debt portfolio optimization implemented in the first half of 2017, we substantially reduced our weighted average cost of debt and interest payments. And as Pavel mentioned, our credit rating has been recently raised by Fitch and Standard & Poor's to above sovereign, which would further reduce our cost of debt.

 I will stop here and pass the word back to Pavel.

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 Pavel Zhdanov,    [5]
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 Yes. Thank you, Alexander. Before opening the line for questions, I would like to provide an update on our 2017 key targets. We would like to upgrade our total hydrocarbon production growth target from the previous range of 1% to 2% to approximately 2.5%, excluding West Qurna projects. The new target is based on stronger-than-planned performance of our gas projects in Uzbekistan. Along with this, we delivered strong production growth at our key high-margin projects in Russia. And all in all, we expect their share in our total hydrocarbon outputs to double year-on-year.

 We now expect our refinery throughput volumes in Russia to increase 3% to 4% as compared to the previous range of 4% to 5%, driven by unscheduled repair works at our Perm refinery early this year. And we should achieve light product yield at our refineries in Russia of approximately 70%.

 We expect our capital expenditure not to exceed RUB 550 billion this year compared to our initial guidance of RUB 550 billion to RUB 600 billion. This is due to stronger-than-expected ruble as well as optimization measure.

 So thank you. And with that I would like to open the floor now for Q&A.

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Questions and Answers
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Operator   [1]
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 (Operator Instructions) Our first question comes from the line of Ron Smith from Citi.

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 Ronald Paul Smith,  Citigroup Inc, Research Division - Director and Senior Russian Oil and Gas Analyst   [2]
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 Quick question. You're talking about the drilling increase which has been visible in the data anyway. It's, in particular, in West Siberia. What is the target for production out of West Siberia for liquids for the next 1, 2, 3 years? Are you looking to merely slow down decline rates or to stabilize or even potentially regrow production there outside of the greenfields? And of that drilling, how much has been going into Imilorskoye, please?

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 Pavel Zhdanov,    [3]
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 I guess it's difficult to give you longer-term guidance considering the external limitations. But the initial plan was to increase the production drilling volumes to stabilize the decline rates at the mature brownfields in West Siberia in the range of 3% per year. But clearly now, as we have explained, we're trying to use this sort of balancing production volume, considering the increase in volume of the higher-margin barrels in our production mix. So it will be also a function of our future drilling plans next year, depending on the situation.

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 Alexander Palivoda,    [4]
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 And on the second part of the question like on the Imilor field, they're currently finalizing the development plan, like full-scale development plan. Because right now, as you know, the field is developing pilot mode. There's a limited production of 1 million tonnes per year. And there is no finalized plan for full-scale development yet, so it'll be done closer to the year-end.

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Operator   [5]
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 Our next question comes from the line of Ildar Davletshin from Wood & Company.

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 Ildar Davletshin,  Wood & Company Financial Services, a.s., Research Division - Analyst   [6]
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 And my question is around this stock compensation scheme and perhaps treasury stock, if there is any relation to that. So could you just explain or provide some color on the technical details on that scheme. So from next year, what would happen? You would distribute like compensation in cash and then some managers will buy shares? Or it will be actually the shares distributed? So will it impact the total shares outstanding? And then separately, on the treasury stock, do you plan to use it in your compensation scheme? And if not, what's the general outlook or the plan for the treasury stock? Would you consider canceling them at some point?

------------------------------
 Pavel Zhdanov,    [7]
------------------------------
 Yes. Thanks, Ildar. So your first question regarding the existing long-term motivation plan, which expires this year, remember, we had introduced it in 2012, so it will expire end of this year. To remind you how it works, people were entitled with a specific number of stock units and people received, the top management, around 700 people, every year, bonuses equal to the dividends paid on those shares. Upon expiration of the program, the participants will receive the stock appreciation between the average price in 2012 and 2017. And we have accrued this liability throughout the period, okay? This payment will be made in cash in the first quarter of next year. And according to the rules of the program, the recipients need to use 50% of after cash -- after-tax receipt to purchase shares of LUKOIL in the open market and to hold them. So talking about the potential new program. We are discussing this with the Board of Directors. They'll most likely approve the new program at the next board meeting on the 14th of December. So we will be able to update you on that after that. And talking about the plans on the treasury shares. We are carefully studying the matter at the moment as part of our strategy and development. So hopefully, we'll be able to update you at some point when we have approved it internally and with the board.

------------------------------
 Ildar Davletshin,  Wood & Company Financial Services, a.s., Research Division - Analyst   [8]
------------------------------
 All right. And maybe just on the first part of the question. So what is the time period for the managers to convert half of their compensation into shares? Again, is it like a 1-month window, like a quarter?

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 Pavel Zhdanov,    [9]
------------------------------
 After they receive cash.

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Operator   [10]
------------------------------
 Our next question comes from the line of Andrey Polischuk from Raiffeisen Bank.

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 Andrey Polischuk,  Raiffeisen Bank International AG, Research Division - Financial Analyst & Oil and Gas Analyst   [11]
------------------------------
 I have a question on Korchagin field. Did I get you right that you are planning to increase production at the field next year? If I remember, previously, you were expecting just to extend your plateau level. So could you tell us which is production level currently at the field and maybe some guidance on the next year?

------------------------------
 Pavel Zhdanov,    [12]
------------------------------
 Currently, the production volume is around 1 million tonnes this year, and we plan to increase it to 1.4 million in 2019.

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 Andrey Polischuk,  Raiffeisen Bank International AG, Research Division - Financial Analyst & Oil and Gas Analyst   [13]
------------------------------
 And for how long are you going to keep this new level?

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 Pavel Zhdanov,    [14]
------------------------------
 3, 4 years probably, unless we book some further drilling activity on the field.

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Operator   [15]
------------------------------
 Our next question comes from the line of Alexander Kornilov from Aton.

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 Alexander Kornilov,  Aton LLC, Research Division - Senior Analyst of Energy Sector   [16]
------------------------------
 In regards to your '17 -- '18, sorry, outlook, in case -- if the OPEC deal is prolonged and extended until the end of 2018, will it affect any of your plans for the greenfield development, i.e. the production at Filanovsky field, Pyakyakhinskoe field and so on, so forth? So are you planning to curb somehow your production plans in case the deal is extended?

------------------------------
 Pavel Zhdanov,    [17]
------------------------------
 No, this will not impact our plans on the greenfields, and we'd continue as planned. So as I mentioned, the balancing volume would always be less efficient, mature fields.

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 Alexander Palivoda,    [18]
------------------------------
 So it's actually the same strategy which we've been following during 2017. No changes.

------------------------------
 Alexander Kornilov,  Aton LLC, Research Division - Senior Analyst of Energy Sector   [19]
------------------------------
 So essentially, this means that you're going to have a bit more production from the Western Siberia, right, in case the deal is extended in order to balance in accordance with the gas requirements. Is that right?

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 Alexander Palivoda,    [20]
------------------------------
 As far as we are growing -- anyway, year-on-year, we are growing production at Filanovsky and other high-margin fields. And in case production limits persist, yes, the balancing factor will be mature fields in West Siberia, southern part of Timan-Pechora.

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Operator   [21]
------------------------------
 Our next question comes from the line of [Ekaterina Smyk] from Bank of America.

------------------------------
 Unidentified Analyst,    [22]
------------------------------
 I have 3 questions. First, when do you plan to provide details on your further new project development? Will you provide that in the strategy presentation that you plan to hold in March 2017 (sic) [2018]? Or it will happen like later in 2018? Then the second question is, supposing that the OPEC agreement is lifted, given that you have been continuing drilling in Western Siberia, what would be the impact of this agreement lifting on your brownfield production? Will we see some increase in production? Or you have been continuously drilling just to ensure the longer-term sustaining of production brownfields? And the third question is regarding your capital guidance for 2018.

------------------------------
 Pavel Zhdanov,    [23]
------------------------------
 Yes. So if I understand your first question correctly, in terms of further light on the future projects, yes, we hopefully will be able to present to you more detail as part of the strategy day, which we hope to have some time in March. Talking about the possibility of changing the production targets should the OPEC limitations be lifted, well, first of all, I'll remind you they will be in place regardless of today's decision until the end of March anyway. So should those be lifted, we were ready to recoup the volumes which we cut over a short period of time. So -- but let's wait and see what the decision will be today, okay? So in terms of the CapEx guidance for next year, we don't want to give it to you now because we need to finalize our plans and approve them at the board meeting in the middle of December, but we can tell you that it will be lower than this year mainly because of the reduction of CapEx in Uzbekistan.

------------------------------
Operator   [24]
------------------------------
 Our next question comes from the line of Artem Konchin from Otkritie Capital.

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 Artem V. Konchin,  Otkritie Capital International Limited, Research Division - Senior Research Analyst   [25]
------------------------------
 Just wanted to find out the status of your plans to dispose of some downstream in Europe. Looking at very strong margins in the third quarter, does it still make sense? And where are we standing at the moment regarding this potential transaction?

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 Pavel Zhdanov,    [26]
------------------------------
 We don't have any plans to dispose of assets in downstream at the moment. If you refer to the information about possible strategic alternatives for LITASCO, then, on this particular one, there's been no decision so far. We're considering various strategic alternatives, but I don't expect any decision anytime soon. Yes, everything else stays as is.

------------------------------
Operator   [27]
------------------------------
 Our next question comes from the line of Olga Danilenko from Prosperity.

------------------------------
 Olga Danilenko,    [28]
------------------------------
 My question relates to dividends. I know you have a very well-articulated dividend policy. However, I -- just looking at the results for the 9 months of 2017, I can see that your net income more than doubled. I can see that you just mentioned that the CapEx for the year will be RUB 500 billion instead of RUB 550 billion to RUB 600 billion. So we also have a new variable, that OPEC -- extended OPEC agreement can potentially be until the end of 2019. So my question relates to -- you have considered internally the possibility to increase dividend payments as a result? And my second question relates to taxation system. If you may elaborate a little bit. There have been some discussions on introduction of tax on the financial result in Russia. The latest news suggests that the introduction of this tax for the new fields can be delayed into 2019. So do we have the same information? What are your expectations with regards to tax system in Russia?

------------------------------
 Pavel Zhdanov,    [29]
------------------------------
 Yes, yes. Olga, it's Pavel here. So on your first question, I'm sure you know the answer. Clearly, our first priority is to invest in sustainable business -- projects that we have. We would like to find the right balance between growing the business and distributing excess capital to shareholders. And so far, I believe what we have been doing is well received by the market. We will continue discussing the plans going forward. We will be able to shed more light on our capital allocation plans after we approve the strategy later this month. So stay with us. And we're doing our best to take right decisions on the capital allocation, yes. On your second question regarding the tax initiatives, potential delay, yes, we have the same information with hope it will not change much. The initiative, as we know, has been approved. It will be delayed 1 year, but everything else is pretty much as planned.

------------------------------
Operator   [30]
------------------------------
 We have another question on the line from Ron Smith.

------------------------------
 Ronald Paul Smith,  Citigroup Inc, Research Division - Director and Senior Russian Oil and Gas Analyst   [31]
------------------------------
 What -- could we turn back to West Siberian production because we've had several comments now on it? Could you please clarify, are you currently producing below capacity in West Siberia in your fully taxed brownfields? And if how much? In other words, if the OPEC deal was to come off tomorrow, how much production could you return to the field? And how quickly could you do it, 3 months, 5 months, 6 months?

------------------------------
 Pavel Zhdanov,    [32]
------------------------------
 This has been discussed. We answered this question, yes. We have reduced our production by 45,000 barrels a day, as you know, as part of those production cuts. So as we mentioned earlier, we should be able to recover those should the limitations be lifted. It's not only West Siberia. It's across the portfolio but in the brownfield, mature fields.

------------------------------
 Ronald Paul Smith,  Citigroup Inc, Research Division - Director and Senior Russian Oil and Gas Analyst   [33]
------------------------------
 I understood the number. I wasn't certain if that was all -- a purposeful reduction or some of it was natural declines. That was the clarity I was looking for.

------------------------------
Operator   [34]
------------------------------
 Our next question comes from the line of Igor Kuzmin from Morgan Stanley.

------------------------------
 Igor Kuzmin,  Morgan Stanley, Research Division - Equity Analyst   [35]
------------------------------
 I have a quick question about the upcoming or planned maintenance either at the domestic refineries or at the international refining assets within the next 12 to 18 months. Is it possible just to indicate if there's any major sort of potentially outages planned and then for how long and what capacity has been sort of affected and whether it's going to affect the utilization rates?

------------------------------
 Alexander Palivoda,    [36]
------------------------------
 Actually, we are right now finalizing our plans for 2018. And at the moment, we are not ready to provide any kind of specific detail. But like -- maybe like ballpark understanding is that we're going to have some maintenance specifically at our Russian refineries next year, which might reduce some throughput volumes and maybe some other indicators. But again, it's not finalized yet and might change. So we'll just update you later on that.

------------------------------
Operator   [37]
------------------------------
 The next question comes from the line of Alex Fax from Sberbank CIB.

------------------------------
 Alex Fax,    [38]
------------------------------
 What's the CapEx figure for the delayed coker at North Sea?

------------------------------
 Alexander Palivoda,    [39]
------------------------------
 We answered a similar question at one of our previous calls. What we said is that like the coker unit itself will cost us approximately $600 million, which is less than what we spent on the same unit at our Perm refinery. But again, what I explained earlier is that we're going to build this whole complex which will include some other pieces of infrastructure and some other facilities. So combined cost for the complex is estimated at approximately $1 billion.

------------------------------
Operator   [40]
------------------------------
 Our next question comes from the line of Alexander Kornilov from Aton.

------------------------------
 Alexander Kornilov,  Aton LLC, Research Division - Senior Analyst of Energy Sector   [41]
------------------------------
 I apologize, my question has already been answered. Thank you.

------------------------------
 Alexander Palivoda,    [42]
------------------------------
 There are no further questions from the line and from the Internet. So thank you, everybody, for participating, and goodbye.

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Operator   [43]
------------------------------
 Ladies and gentlemen, thank you for joining today's conference. You may now replace your handsets.




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