PJSC LUKOIL
Q3 2021 Earnings Call Transcript

Published: 24 Nov 2021

[Operator:]

Good afternoon, ladies and gentlemen and welcome to the LUKOIL's Third Quarter and Nine Months 2021 Results Conference Call. My name is Molly and I'll be your coordinator for today's conference. For the duration of the call your lines will be on listen-only. However, at the end of the presentation you will have the opportunity to ask questions. [Operator Instructions] Please ask questions during the Q&A session in the corresponding language; in Russian for the Russian line, and in English for the English line. I would like to inform you that questions from the press will not be accepted. I will now hand you over to Alexander Palivoda, Head of Investor Relations to begin today's conference. Thank you.

[Alexander Palivoda:]

Thank you. Good afternoon, ladies and gentlemen. Thank you for joining us today for this conference call on LUKOIL's results for the third quarter and nine months of 2021. On today's call, we have Mr. Alexander Matytsyn, CFO; Mr. Pavel Zhdanov, Vice President for Finance, as well as our colleagues from the accounting team. Before we move on to the presentation, I would like to draw your attention to the fact that some of the comments during this call constitute forward-looking statements involving risks, uncertainties, and other factors that may cause our actual results to be materially different from what is expressed or implied by these forward-looking statements. You may find more detailed information on the slide. Now, I would like to hand over to Mr. Alexander Matytsyn.

[Alexander Matytsyn:]

Thank you, Alexander. Good afternoon, ladies and gentlemen. In the third quarter, the market environment continued it's recovery, which alongside an increase in production volumes had a positive impact in our financial performance. Higher oil prices were underpinned by fast moving recovery and demand which led to a decline in global oil inventories on the back of strict OPEC+ compliance. Additional support for oil demand came from record high prices for other energy sources. Amid the easing of external limitations, we kept ramping up oil production in the third quarter; our average daily oil production in Russia was up 3% quarter-on-quarter, and surpassed by 1% the previous year's level for the nine months period. In the nine months of 2021, total hydrocarbon production added 2.5% year-on-year on the back of recovering gas production overseas. Refining margins went back to the pre-crisis levels in the third quarter. We swiftly responded to the improved market environment, and in the third quarter, recovered our oil refinery capacity utilization back to the average 2019 level. In the third quarter we hit all-time highs with EBITDA and free cash flow. The strong performance was driven by superior quality of our assets, effective cost control and operational flexibility, which enabled us to quickly grow production volumes as the market environment became more favorable. EBITDA for the third quarter totaled RUB355 billion, as a result EBITDA for the nine months doubled year-on-year. Free cash flow totaled RUB222 billion, and more than doubled quarter-on-quarter. This remarkable improvement was driven by strong increase in working capital in the second quarter. The increase in free cash flow before changes in the working capital amounted to 10%. Let me note that in contrast to previous periods, our third quarter results saw almost no impact from one-off or carrying over factors, in other words, our results [Technical Difficulty]. We decided to capitalize on the extremely favorable debt markets environment, and an activity successfully placed to [indiscernible] with maturities of 5.5 years and 10 years for a total of US$2.3 billion. This is the largest ever single placement for the company. In except [ph], the Board of Directors recommended paying an interim dividend for 2021 in the amount of RUB340 per share, falling in line with our existing dividend policy. We keep improving our sustainable development management system as we recognized it's importance for the effective implementation of the company's strategy and LUKOIL investment story. One of our recent achievements has an improved position in the transition pathway initiative or TPI rating which assesses the quality of the climate management. Over the past year, the company also climbed up in other leading sustainability ratings. We always keep going beyond what we have achieved and are currently focusing on improving our practices in the areas of human rights, supply chain management and other important aspects of sustainable development. In conclusion, let me remind you that until the end of the year, we are planning to complete our long-term strategy update which will be presented in the first quarter of 2022. Thank you. Now, I'd like to hand over to Pavel Zhdanov.

[Pavel Zhdanov:]

Thank you, Alexander. I will now present our results in the upstream segment. Let me begin with the price environment. In the third quarter, the average Urals oil price went up by 6% quarter-on-quarter. However, the Urals net ruble price dropped by 2% quarter-on-quarter due to the positive effects of the tax lag declining almost to zero, and due to ruble appreciation. In the third quarter, the company continued to recover on it's oil output and the Group's hydrocarbon production, excluding West Qurna-2 exceeded 2.1 million barrels of oil equivalent per day, up 3.2% quarter-on-quarter. As external limitations on oil production related to the OPEC+ deal were eased up and gas production in Uzbekistan recovered after scheduled maintenance in the second quarter. We also carried on with our priority projects. For the nine months of 2021, their share in the title ad [ph] grew by one percentage point. As part of oil production management under external limitations, we continue to increase oil production at Tara [ph] mature fields in Russia as instructed by the Ministry of Energy. In the third quarter, oil production in Russia increased by 3.7% quarter-on-quarter, recovering by nearly 90% in November as compared to May 2020. The relaunch of shut-in wells was fast with no extra material costs or technological challenges. As at the beginning of November, our spare capacity in Russia stood at around 30,000 barrels per day, which means we are close to it's full utilization and we'll employ additional drilling to ensure further production ramp up. As a reminder, we started to gradually increase drilling volumes in Russia as early as in the second quarter of 2021. If the favorable environment persists and external production limitations are further lifted, we plan to keep expanding our drilling program further to deliver stable output growth. The upstream segment was the key contributor to our EBITDA growth in the second quarter. The segments EBITDA was up by 11% quarter-on-quarter despite lower net oil price and ruble figure for the Russian upstream segments increased by 7%; the growth was due to output recovery and superior production mix. Upstream EBITDA outside Russia went up by 38% quarter-on-quarter driven by higher gas production in Uzbekistan and higher gas prices, coupled with stronger EBITDA of the West Qurna-2 servicing project in Iraq on the back of high costs. For the nine months our upstream EBITDA increased more than two-fold year-on-year. The growth was driven mostly by the Russian upstream segment, thanks to higher oil prices, ruble devaluation and the positive tax lag effect. Abolished tax incentives for high viscosity oil projects were headwind; EBITDA outside Russia went up by 71% supported by a rise in oil prices and increased gas production in Uzbekistan. Now, let me move on to our key projects. We continued production drilling in the Caspian Sea to maintain production at the Vladimir Filanovsky and Yuri Korchagin fields at the project level. In the third quarter, the Vladimir Filanovsky field saw the launch of another high rate intelligent 240-AML five wall [ph] with an initial flow rates of over 13,000 barrels of oil per day. As part of the Valery Grayfer field development, we finished cabling works and are now laying subsea pipelines, shipyards are completing the construction of top signs of fixed ice-resistant and living platforms. They are almost 90% complete and slated for offshore installation in the second quarter of next year. As for the D33 field in the Baltic Sea, we received an approval of the Russian State Expert Review Panel for the design documentation and signed contracts for the construction of key facilities, supply of core equipment, and field infrastructure development. The manufacturing of offshore platform jackets and topside, along with onshore vax [ph] have now started. We continue to show impressive results in developing low permeability reserves. As our key fields in West Siberia, we are running an intensive and extensive drilling program with 146 wells drilled in the nine months and production up by 14% year-on-year. We keep working to enhance the efficiency of field development. Thanks to the optimized, well-designed rollout of unique technologies and individual approach to each well, we have been able to ramp up drilling speed while drastically cutting per unit drilling costs. At the Imilorskoye field, in the third quarter, we increased the drilling speed of multi-haul [ph] wells by over 40% year-on-year, reducing the per unit drilling costs by almost a quarter over the same period. In the third quarter, the Sredne-Nazymskoye field saw the horizontal well drilling speed increase by a third year-on-year, with a per unit drilling cost dropping by nearly a quarter. Our advanced expertise in developing low permeability reserves provides us with new opportunities for our asset portfolio expansion. In September, we signed an agreement with Gazprom Neft to create a joint-venture based on the assets of Gazprom Neft subsidiary, Meretoyakhaneftegaz; the JVs geological reserves totaled over 1 billion tons of oil and around 500 billion cubic meters of gas. A considerable portion of the reserves lies with the [indiscernible]. Our participation in the joint venture is fully in line with our strategy to focus on investments in Russia and tap into hard to recover reserves. In the nine months of 2021, high viscosity oil production in Timan-Pechora was up by 2% year-on-year to reach 4 million tons. In the third quarter, however, daily production fell by 4% due to scheduled maintenance at the Usinskoye field. Let me remind you that before the start of this year, we work to consistently increase output as the Yaregskoye and Usinskoye fields by making considerable investments in these projects. This year we had to have a significant downscale of our investments, as a result of council tax initiatives, still we maintain a dialogue with the Government and hope for a decision to reinstate tax incentives for this category of reserves so that we continue their full scale economical efficient development. Let me move on to our projects abroad. I would like to start with our gas project in Uzbekistan. You may remember that in the second quarter, we conducted scheduled maintenance at production facilities which led to a temporary decline in output from our gas projects in the country. In the third quarter, production recovered back to the level of Q4 2020. For the nine months 2021, Uzbekistan project saw over 76% or nearly 80% increase in production compared to the same period of 2020. Our production target for 2021 is around 14 billion cubic meters of gas, which is in line with the pre-pandemic level. In October, we signed an agreement to acquire an interest in Shah Deniz gas project in Azerbaijan. Please be reminded that we currently hold a 10% share, and that has been the case since 1996. As the Caspian region is of strategic importance for LUKOIL to increased share in Shah Deniz project which was growing and it's strong access to sales markets naturally complements our portfolio of Caspian production assets. On top of that, a larger share of guests in our production mix is perfectly aligned with our climate strategy. With a value of US$2.25 billion, the deal will be closed subject to conditions precedent, including approvals from our partners from the consortium. Yesterday we announced the discovery of the new oilfield block at -- our new oilfield at Block 12 offshore Mexico after drilling the first exploration well. According to preliminary estimates, the initial oil in place reaches 250 million barrels. So in mind, we are the project operator with 60% share, while any holding -- who holds the remaining 40%; earlier successful wells were drilled at Block 10. Having said that, we successfully carry on with buildup of new production cluster in the region. Now, let me hand over back to Mr. Alexander Palivoda, who will present our results in downstream.

[Alexander Palivoda:]

Thank you, Pablo. In the third quarter, the refining market environment continued to rapidly recover. In Europe, the benchmark margin added 1.5% -- sorry 1.5 times -- 1.5 times quarter-on-quarter driven by an increase in the crack spreads of light products, primarily diesel fuel on the back of declining global inventories, and demand growth caused among other things by high gas prices. As a result for the first time since the beginning of the pandemic, crack spreads for diesel fuel returned to their historical range. The margins also reflected their high Urals discount [indiscernible] Brent crude oil. The Russian benchmark refining margin nearly doubled quarter-on-quarter, even exceeding the pre-pandemic levels. This came as a result of both, the growth of European benchmark margin and higher export due to differentials. In the third quarter, we continued increasing capacity utilization to refineries flexibly responding to improvements in the market environment. The average daily refining throughput grew by 9% quarter-on-quarter to reach the 2019 average. Our domestic refineries increased their average daily throughput by 7% quarter-on-quarter as the capacity utilization at Perm and Nizhny Novgorod refineries recovered after their maintenance in the second quarter of this year. The increase in utilization was offset by scheduled maintenance at Okhta [ph] and Volgograd refineries. At European plants, average daily refining volumes grew more significantly by 12% quarter-over-quarter, as although overseas facilities and increased utilization. The biggest contributors in absolute terms were the ISAB refining facility in Italy which optimized utilization amid improved market environment and the Burgas refinery in Bulgaria which recovers capacity after maintenance in the second quarter. Our production slate also improved. Like product yield, our domestic refineries added 2 percentage points quarter-on-quarter, mainly as a result of optimization measures driven by better market environments and stronger demand. Meanwhile, fuel oil yield remained flat despite higher throughput volumes. The third quarter daily sales of motor fuels at our overseas filling stations reached the pre-pandemic Q3 2019 levels while domestic retail sales even surpassed the numbers for the period. Aircraft fueling in the airport's where we operate continue to actively recover in the third quarter, demonstrating robust quarter-on-quarter growth. While in the second quarter, daily jet fuel sales went down 30% compared to the same period of 2019, the gap reduced to less than 20% in the third quarter. In the third quarter improved refining margins led to a considerable increase in the Russian downstream margin which is the difference between the netback for oil to be refined and sold in Russia through all sales channels and export netback. The maximized capacity utilization resulted in lower oil exports despite high production volumes, yet exports of oil subject to lower rate export duty remained flat quarter-on-quarter. As for our financial performance in the downstream segment, EBITDA remained virtually flat quarter-on-quarter. The downstream EBITDA in Russia grew by 27% quarter-on-quarter, mostly on the back of high refining margins and throughput volumes. The growth was constrained by a weaker positive inventory effect at our refineries and weaker results of petrochemical and retail businesses. Downstream EBITDA outside of Russia declined by 57% quarter-on-quarter, fully offsetting the growth in Russia, mainly due to weaker results of international trading business and lower positive inventory affect at our overseas refineries. The impact of these factors was partially offset by accounting specifics of hedging operations in our international trading business, higher refining margins and throughput volumes, as well as improved results in the retail segment. In the nine months of 2021, downstream EBITDA nearly doubled year-on-year with a bulk of this growth coming from operations in Russian. The EBITDA in Russia was driven mostly by stronger refining margins and throughput volumes, a positive effect from inventories at refineries and better results in the petrochemical segment though partially offset by weaker results in retail business. Downstream EBITDA outside of Russia was up 91% on the back of a positive inventory effect at refineries, improved performance of the retail segments and high throughput volumes. This year we are completing several refinery upgrade projects in Russia. As a reminder, we have already launched a number of secondary units, including the asphalting unit in Volgograd, as well as hasemerization [ph] unit and polymer bitumen binder production unit in Nizhny Novgorod. These projects are set to contribute to a better and wider product slate along with quality improvements. By the end of the year, the Nizhny Novgorod refinery plans to complete the construction of a delayed coker. Now that construction and installation operations are almost driven [ph], we keep testing process pipelines and equipment. The launch of the delayed coker will bring our fuel oil yield down to below 4%. In August, we started a project to construct a catalytic cracking unit at the Perm refinery, which will enable the Group to increase the output of high octane motor gasoline and commence production of polymerization grade propylene to be used as feedstock at our petrochemical facilities. I would also like to note that the delayed coke in Nizhny Novgorod and the catalytic cracking unit in Perm are conducted under the agreements with Russia's Ministry of Energy providing for an investment agreed increment in the reverse excise tax on petroleum feedstock. Now, let me briefly outline the major drivers behind our financial performance in the third quarter. Higher sales volumes were the key factor driving revenue, and this comes in company with high prices; so we have a revenue increase of 18% quarter-on-quarter. And then again, has both, own production and larger trading volumes. Our EBITDA hit an all-time high of RUB355 billion, up 5% quarter-on-quarter; I have already spoken in detail on EBITDA drivers for each segment. I would also like to note that EBITDA increase was dragged by the effect of inventory release in the second quarter as we sold part of our inventory back then, hence the contribution of this driver in the third quarter was immaterial. Let me once again remind you that for the first time since the beginning of the pandemic, our quarterly results are almost no impact from one-off or carrying over factors owing to the normalized market environment. The company posted a net profit of RUB192 billion, nearly flat quarter-on-quarter. EBITDA growth was partially offset by the effective income tax rate rising from 17% to 20%, which was due to entry group asset sales as we streamlined our business in the second quarter. The profit growth was also constrained by higher depreciation on the back of rising production volumes. Free cash flow in the third quarter hit an all-time high of RUB228 billion, up more than two-fold quarter-on-quarter. As the working capital expanded by about RUB100 billion rubles in the second quarter, in the third quarter the working capital change was minimal, only extending at RUB6 billion. Free cash flow before changes in the working capital to RUB234 billion, up 10% quarter-on-quarter. Rather [ph] behind this growth was stronger operating cash flow on the back of rising business margins driven by an improved market environment, and also higher production and throughput volumes. Before I conclude, let me briefly talk about our expectations for this year. Given the existing decisions of the OPEC+ members to increase oil output, expect hydrocarbon production to grow by about 4% here in the year [ph], excluding the West Qurna-2 project in Iraq. In downstream, we expect our refining volumes to grow by upto 5% year-on-year. As for our investment activities, we expect the 2021 capital expenditures, excluding the West Qurna-2 project to be within RUB450 billion. The lower figure compared to our previously announced plans is explained by the savings achieved and partial cost transfer to 2022. With it's unique set of competitive advantages, LUKOIL continues to boast a strong and appealing investment story in the global oil and gas sector. Thanks to our superb flexibility and high quality asset mix, we have been able to maximize the benefits from the market recovery, transforming it into shareholder returns using our effective dividend policy. We are optimistic about the prospects for oil demand and believe that we are in a position to continue developing our business across the board in terms of quantity and quality, with due account for climate change and sustainability agenda at large. We plan to present the company's updated strategy in March of next year, along with the fourth quarter financial results. Thank you. Now, for your attention, and we are ready to take your questions.

[Operator:]

[Operator Instructions] I would like to remind you that questions from the press will not be accepted. Please ask questions in the corresponding language; in Russian for the Russian line, and in English for the English line. You will be advised when to ask your question. The first question comes from the Russian line from Karen Kostanian calling from Bank of America. Please go ahead.

[Karen Kostanian:]

Yes, thank you for this presentation, gentlemen. Congratulations on your great results. I have two questions; one pertains to the high viscosity oil. Now, when are you expecting an outcome from your arrangements with the government? And if this agreement is achieved, by how much would you intend to increase your CapEx and the output of oil in the fields in question? And my other question pertains to dividend from Gazprom Neft. I'm not sure but whether you have mentioned that, when are you expecting the first oil to be coming?

[Alexander Palivoda:]

Okay, let me handle your first question. On November 11, 2021, the Russian Prime Minister, Mr. Mishustin, signed the government instruction to the Minister of Finance and the Minister of Energy. In Q1, the two ministries are to prepare proposals of how high viscosity oil fields should be treated. Several options have been discussed currently; one option suggests that from 2022 onwards high viscosity oil could be involved in production again. But the company is working at the same time to fast-track that timeframe. We could be assisted, if OPEC+ quota as increased was less of a constraint so that we could increase the total oil output. At this point in time, I cannot provide you with any further details; hence it's too early to discuss the CapEx. We have a CapEx plan but then it will depend on the decision made by the government. What's most important is that there is a decision pending; so in Q1 we'll see some parameters defined, and then we'll be able to discuss those. This definitely improves the situation as compared to situation of totally cancelled tax incentives.

[Alexander Matytsyn:]

And regarding your second question -- that's Mr. Matytsyn speaking. We have not provided any of the parameters. The JV with Gazprom Neft to be closed in early next year, and a lot of work is still pending to prepare the production plan; we will update you accordingly. Thank you.

[Karen Kostanian:]

Thank you.

[Operator:]

The next question comes from the Russian line from Angelina Glazova calling from JPMorgan. Please go ahead.

[Angelina Glazova:]

Good afternoon. Thank you for an opportunity to ask a question, and I have a quick question on your CapEx. Now, if you could please share an indication for some indicative CapEx for 2022. Previously you mentioned a number of around RUB500 billion, but now you have suggested some of the CapEx from this year will be transferred into next year. So, can you update the next year's figure? Thank you.

[Pavel Zhdanov:]

Mr. Pavel Zhdanov speaking. Considering our CapEx outlook for 2022, we are finalizing our budget for 2022, and the Board of Directors is to approve it in December. The basic CapEx target is RUB550 billion, excluding this current too [ph]. And again, we have the flexibility depending on the market environment we can further update this number next year.

[Angelina Glazova:]

Thank you.

[Operator:]

The next question comes from the Russian line, from the line of [indiscernible]. Please go ahead.

[Unidentified Analyst:]

Yes, good afternoon. Thank you for the presentation. I have three questions; and all related to upstream only [ph]. Could you suggest when the Grayfer field is expected to be launched? That's question one. My question two is a follow-up to Karen's question on the JV with Gazprom Neft. Can you confirm whether or not the JV will include some of the fields already launched by Gazprom Neft on it's own as part of their natural gas? And my third question has a more philosophical nature. Now, if one assumes that the market environment is favorable price wise, and the OPEC+ constraints are lifted with no negative developments of the taxation side. So, what would be your estimate of the production growth potential for LUKOIL in Russia? I understand that your strategy may be different from the actual opportunities that you see in the market but what's your thinking? What's your organic growth of production based on these inputs? Thank you.

[Pavel Zhdanov:]

Pavel Zhdanov speaking. On question one, the Valery Grayfer field is expected to be launched at the end of 2022; that's our estimate. Second question, well, one field -- the Natazuski [ph] field has been launched; that's the anchor field, and there is a number of other fields which were dependent of the JV to be launched further. Regarding the production growth potential, if I follow your question, you are asking about specific plans of production growth rather than some exit plans because if you consider our resource base, that's long scale, and our mid-term and long-term plans are there with major changes to those plans, given the constraints of the OPEC+ agreement. That agreement is still in place, and we cannot know for how long these would last in the future. However, as part of our mid-term plan, we would intend to ramp up back to the pre-crisis production numbers. In terms of daily flows, that would be next year; in terms of the full year, that would be 2023. We have very specific plans on how to grow further from that level onwards, based on the pre-crisis plans to 83 million to 84 million tons within three years in Russia.

[Unidentified Analyst:]

Thank you very much.

[Operator:]

The next question comes from the English line, from the line of Ronald Smith calling from BCS. Please go ahead.

[Ronald Smith:]

A question on the delayed coker at Nizhny Novgorod. Once it's launched, it looks like you're finishing it very quickly. How long will it take to ramp up to full capacity? In other words, how long will the deep-testing period be? Thank you.

[Pavel Zhdanov:]

Pavel Zhdanov speaking. Construction is going to be finished [indiscernible] in Q1 2022; so we would expect the unit to ramp up to the design capacity in the first half of the year.

[Ronald Smith:]

Thank you.

[Operator:]

The next question comes from the Russian line, from the line of [indiscernible]. Please go ahead.

[Unidentified Analyst:]

Good afternoon. Thank you very much for the presentation. My question relates to your CapEx for 2021, this year. As you have suggested a number of upto RUB450 billion excluding the West Qurna-2 projects. However, in your accounts, I see the nine months number standing slightly above RUB280 billion, maybe you could realistically assume a number of upto RUB400 billion rather than RUB450 billion. And how much of the costs have been transferred over to the next year; is that about RUB50 billion? Thank you.

[Pavel Zhdanov:]

Pavel Zhdanov speaking. Indeed, some of the costs have been transferred. And we suggested it would be somewhat more than RUB20 billion. So, we still maintain our guidance, and then there is the savings, of course. So we would still maintain our guidance for 2021 at RUB450 billion, there is seasonality, and one would suggest that Q4 will be slightly higher.

[Unidentified Analyst:]

Thank you.

[Alexander Palivoda:]

Alexander Palivoda speaking. We see there are no further questions on the line. Thank you for taking part in this call. So, see you next time.

[Operator:]

Ladies and gentlemen, thank you for joining today's conference. You may now replace your handset.