We are, already, not so much an oil company as an energy business

Izvestia.ru
Kirill Kravchenko

Interview with NIS General Director Kirill Kravchenko

Izvestia.ru

NIS — Naftna Industrija Srbije CEO Kirill Kravchenko explains why, while his company’s business is in oil production, it also sources its electricity from wind turbines

In the seven years it’s been operating in Serbia, JSC Gazprom Neft subsidiary Naftna Industrija Srbije (NIS) has managed to overcome a legacy of governmental mismanagement to become a market-leading company in the region. NIS CEO Kirill Kravchenko gave Izvestia his views on the company’s prospects in the Balkans, its relationship with government, and the impact of the low oil price.

— Gazprom Neft’s 2008 acquisition of a controlling stake in Serbia’s most significant oil company, Naftna Industrija Srbije (NIS), was the most significant Russian investment in the Balkans. Given the state of the company at that time, that money might have been better invested in oil production in Russia. What use was NIS to Gazprom Neft?

— The company had just adopted a strategy that was focussed on expanding the business abroad, envisaging at least 10 percent of production, and around 30 percent of retail sales, being generated outside of Russia. So we were analysing various assets, and this one looked promising: NIS is made up of various assets with considerable potential for growth, despite longstanding management by government having given rise to various problems.

— And which of these were the most pressing?

— Under the terms of our agreement with the government, in addition to paying for a controlling interest we had two major obligations — to invest $500 million in modernising the company’s refining facilities, and to manage the transition to producing Euro-5 standard fuels as soon as possible. I was having to deal with the considerable debt accumulated prior to our acquisition, and a high level of ongoing losses, so the main objective was to get the company to break even. Once things started picking up, the decision was taken to develop NIS as a vertically integrated oil company, covering the full cycle from extraction to the sale of consumer products — and, ultimately to turn it into a market leader in the Balkans. Altogether, investment in the company thus far stands at €2.5 billion.

— Excluding funds invested in the purchase of the company itself? The purchase of a 51-percent interest in the company amounted to €400 million, but you bought another 6.15 percent. How much did you invest, altogether?

— Having purchased a controlling interest, about another €40—50 million was spent on buying additional shares on the open market. Altogether, we paid something in the order of €450 million for the assets we hold today. At the time of our purchase on the open market, a proportion of the company’s shares had been distributed among all citizens of Serbia — a unique situation in Europe — meaning there were more than 2.5 million minority shareholders; we had to come up with a way of buying these shares.

We made a public offering, with shares available through various sales channels: for example, five percent of shares were purchased by post, but 15 percent of shares remained on the books, which meant we were still left with 2.3 million shareholders. It’s true some shares were purchased by investment funds in the United States and Europe, but these amount to less than one percent. Since increasing our holding in 2011 the share price has gone up by more than 50 percent. Which says much about how managerial improvements in the company are perceived, and much about the business’s performance.

— And the capital invested in the company — what was that spent on?

—Most of it was spent on oil production, and on increasing reserves, which had been allowed to run down prior to our acquisition. Now, reserves are increasing for the sixth year running, having gone up 50 percent since our purchase, with production having increased almost two-fold [amounting to 1.6 million tonnes of oil equivalent (mtoe) in 2014].

— The company’s asset portfolio involves not just production and refining capacity, but also power generation — a somewhat rare occurrence in Europe and Russia.

— Yes, we’ve been involved in this business since about 2011, when the decision was taken to diversify into electricity generation; we’ve initiated some projects in cogeneration (the generation of heat and power from gas) at small fields, and we are also involved in what’s known as “green energy”, using geothermal and wind power. Which is in line with trends in European energy development.

— Why would an oil company take up with green energy?

— For two reasons, really: the first is purely historical — the company had geothermal stations in place prior to our arrival. The second reason is to do with regulation: in Europe the choice was between paying heavy fines for CO2 emissions, or taking the initiative ourselves in moving to more ecological forms of generation. Analysis indicated that it would be more profitable for us to create one big wind farm.

Serbia’s natural environment is conducive to this. So to describe us as just an oil company now isn’t correct — we are, already, not so much an oil company as an energy business. Our current problem, in fact, is what’s happened with the crisis in the oil price, and we believe that a comparatively high price is not likely to come back any time soon; for that reason, our main focus now is on our own operational efficiency internally.

— What’s your prognosis regarding the oil price?

— It changes all the time, but we’ve now reduced our three-year medium-term forecast to $46 per barrel.

— But you are, nonetheless, going to continue investing in energy? In June an agreement was signed on establishing a company for the construction of a thermal power plant (TPP) in the Serbian town of Pančevo. What are you getting involved in that project for?

— Here in Serbia we also produce gas, and it’s more convenient for us to monetize this by selling energy, rather than fuel. So it was the logical next step to move from small generation to major — all the more so since our customers now include not just our refinery in Pančevo, but also the petrochemicals complex [NIS is a minority shareholder in the HIP PetroHemija company], also located there. It’s economic logic, plus it gives us additional stability, when the oil price is galloping ahead. Nonetheless, we don’t take on full financing alone in this sector, but only with partners. We also have some newer projects in the pipeline, but these are just at the negotiation stage. For example, we invested 10 percent of the total €140 million investment in the Pančevo TPP, for a 49-percent holding.

— Is the oil price having a major impact on the company?

— Not a major impact. The key figure for us is EBITDA [earnings before interest, tax, depreciation and amortisation] which, for the last half-year, stood at €200 million. Yes, that’s a little bit lower than previously, but better than what’s shown in the business plan. Investments since the start of the year have reached more than €100 million, and under the recession scenario we expect to reach €350 million by the end of the year. The company’s net profit last year was $260 million.

— And do you have any longer-term plans for achieving key targets — the unstable oil price notwithstanding?

— In terms of our immediate plans, if we’re talking about strategy to 2030, then we will be investing, on average, €400 million every year across various business areas, with 60 percent planned for what we call “upstream” (i.e., production) and 40 for “downstream” (i.e., refining).

— And small generation plants, you’re doing these on your own?

— On our own, with our own investments and our own property.

— What’s your market share in terms of the country’s electricity market, currently?

— Not much, thus far — less than five percent: but our objective is to reach 20–25 percent. We’re the second-biggest producer for now, with EPS, the major state generation company, commanding a 90-percent market share. Although, it has to be said, they specialise in coal, whereas we are producing from gas.

— But there are environmental demands for less coal-fired generation throughout EU Member States: and Serbia, as it happens, is striving to be admitted.

— Yes, coal generation in this country accounts for up to 70 percent, but this sector is coming under pressure and, obviously, this figure will go down.

— Do you expect this to have an impact on the growth of your own market share?

— We plan to increase generation regardless of this. The issue for us is that Serbia’s power market is well connected with those of other countries: and on that basis, we will be investing in new generation. We currently sell electricity to Bulgaria and Romania, for example.

— The Serbian government is the second largest shareholder in the company, holding a 29.8-percent share. Experience suggests that government appointees to management or the board of directors are typically motivated by political rather than economic or commercial factors in taking major decisions: with the company’s operational efficiency and performance suffering, as a result. And how do you manage relations with government, when it’s represented on your board of directors? Indeed, at the very beginning, Gazprom Neft’s appearance in Serbia as part of the political system was viewed as somewhat ambiguous.

— Of course arguments arise, but we are always able to find a compromise. In all of the past six years we’ve never once had to have a revote at a general meeting of shareholders. We’ve always been able to find a way of achieving the optimum solution for all parties, bearing the interests of the Serbian state in mind at all times.

— Nonetheless, in the summer of 2014 the Serbian authorities initiated an investigation into the privatisation of NIC, subsequently explaining their position on the basis that they were unhappy at payments made by the company into the state budget.

— Regardless of how a company with government involvement works, it remains the government’s responsibility to collect as much tax as possible. That’s a fact of life, and is in no way dependent on the country. Our tax liabilities are calculated on the basis of a minerals replacement tax (also known as a “royalty”) fixed under the terms of an international agreement — this is common practice. And when the prime minister announced that it would be good to receive more, we tried to step up our operations — but that’s all we can do. We currently finance 15 percent of Serbia’s budget: and in 2009, the year in which our acquisition was finalised, that proportion was closer to seven percent. It should be borne in mind that, thus far, we have invested far more in the company than we have ever received from it. Our position is that you have to give a reasoned response on any issue, and then any problem can be resolved — if the parties are motivated by economic interests, and assuming they listen to each other. Anyway, thus far, we’ve been able to resolve all difficulties and don’t have any major problems.

—You don’t think, with the collapse in the oil price, this claim might come up again at the end of the year?

— The board of directors includes three representatives from the Government of Serbia, representing different parties. They are fully aware of all details and performance date regarding the company’s development in today’s complex environment, and have all the information they need to make informed decisions.

— And how do you get on with Serbia’s Minister of Energy and Mining, Alexander Aleksandar Antić?

— We’ve worked out an effective way of working together, meeting practically every week. And there are regular meetings with both the Prime Minister and the President.

— And what do government leaders, in general, think about partnership with Russia? The thought occurs that their attitude to us is somewhat double-edged: on the one hand, the Serbian government cannot ignore the fact that a significant majority of Serbian society has a positive attitude to Russia; on the other — Serbia wants to join the EU, and some of those in government are trying to sacrifice relations with Russia as part of that process — reflected in the contradictory statements of Serbian government officials regarding the Turkish Stream project.

— Serbia has not imposed any sanctions on Russia, despite its wish to join the European Union. Our two countries have stood together over many centuries, and this is an important factor. There’s no doubt that closer relations between Russia and Serbia are on the up, all the more so since the country is endeavouring to expand potential cooperation with countries in Asia and the Middle East. In my opinion, the imminent integration of Serbia with Europe will do our own relationship nothing but good. And the best option in this process would be to harmonise relationships with Russia and the EC, steering a middle course and protecting Serbian strategic interests.

— In general, do you feel yourselves to be a Russian or a Serbian company?

— Hard to say; we have a common language, Serbian, but we often have to communicate in English, since we have extensive business dealings in neighbouring countries. We’ve worked hard at popularising Russian as well and, having started proactively engendering this among senior management; it’s now gradually gaining popularity among employees.

We do have a number of foreigners among us — our management includes representatives from about 25 countries: but, altogether, of our 11,000 employees, foreigners amount to about 150 — of which about two thirds are Russian specialists. We impose very demanding recruitment standards on these — 90 percent have international experience, English is obligatory, and their first year involves studying Serbian language and culture.

— And differing mentalities don’t impact operations?

— My feeling is that we’re actually very close to the Serbs, and we’re all focussed on the same, concrete outcome, as a group. It’s not like that in western countries — for example, Americans and Germans are focussed, predominantly, on individual success. Serbians have the ability to work hard and play hard. This brings us closer together.

— Do you spend much of your time here, in Serbia?

— More than 70 percent: my family live here, and I spend up to 20 percent of my time in those countries in which we are developing business; the rest of my time is spent in Russia.

— How much does the company commit to charity and corporate social responsibility (CSR) projects?

— We have four key areas of investment in CSR initiatives, all together. We invest heavily in young people in Serbia, and are proactive in recruiting young professionals — the average age of our employees has gone down, from 49 to 37. Our second and third initiatives are both focussed on sport — we support sports of completely different kinds. For example, we’ve been sponsoring the Partizan basketball club for the past seven years, and the Red Star football team for the past five; we’ve also been supporting the European Touring Car Cup champion, Dušan Borković, as well as the Serbian Tennis Association. Some funds are allocated to culture and local communities; we’re currently supporting more than 600 initiatives, having last year allocated $1 million, across 164 projects. I should mention the example of an initiative by Gazprom Neft employees who — with their own money — helped victims of the floods in Serbia in 2014.

It’s also worth mentioning our support for Russian culture — for example, through Russian language courses for Serbs. Also, in recent years the company, together with Emir Kusturica, has been running the excellent “Bolshoi” Russian—Serbian classical music festival in Mokra Gora, attended by both seasoned performers as well as young people from our two countries. A major milestone in the preservation of Russia’s and Serbia’s historical legacy was the company’s financial support of the “Russian necropolis” — the final resting place of those émigrés forced to leave Russia after 1917, and left to live out their days in Serbia. This site also includes the Iverskaya Chapel and a memorial to Russian soldiers killed in the First World War. It is highly symbolic that alongside the Russian memorial stands a memorial to Serbian fighters killed in World War Two.

— You manage one of Europe’s most significant filling-station networks in Serbia and neighbouring countries, under the Gazprom brand. How do you plan to develop this further? Do you intend to extend your coverage by taking over competitors?

— We manage this brand across four countries — Serbia, Bosnia Herzegovina, Romania and Bulgaria; in the first two we are market leaders in terms of sales per station. We have 410 filling stations in total, of which 80 percent are in Serbia, and 20 percent are abroad. There’s no question that coverage throughout these four countries will increase, and that we’ll be discussing moving into other countries; if necessary, we’ll consider taking over competitors. Ultimately, the priority markets for us are those that offer a logistical advantage in terms of our refinery in Pančevo.

— As well as Gazprom, your company portfolio also includes the NIS Petrol brand. How do you decide which brand to open a new filling station under?

— When we took over management there were eight filling-station brands. Gazprom is a premium brand, and NIS Petrol a mass-market one. That’s common throughout Europe for companies like ours. There’s a market sector in which people are prepared to pay more for additional services and better quality, and that’s where we’ve introduced the Gazprom brand. It accounts for about 30 percent of our filling stations.

— Gasoline prices in the EU are falling, and gradually getting closer to those in Russia. What impact is this having on your sales?

— Tax policy in EU countries means the cost of filling up is unlikely to get even close to Russian levels any time soon. Nonetheless, fuel costs have come down. This has had a direct impact on demand — we’re seeing 20—25-percent growth in Bosnia and Bulgaria, and up to six percent in Serbia. Price drops notwithstanding, our market — in the “green” sector — is showing a positive trend.

— As it happens, Russian refineries are in the process of switching over to Euro-5-standard fuels, although the government is discussing a delay to this being universally introduced, worried that refineries won’t have time to adjust. But if it does happen, and there’s a shortage, will you help Russia out with supplies of gasoline?

— Absolutely not — we’re too far away geographically, and sheer logistics wouldn’t allow us to do so, in any case.

— How is business going in neighbouring countries? Do you have problems with government authorities?

— We always try to find a common language. And, moreover, all three branches of our business — production, filling stations, and distribution — are active in these regions. We’re active in sales and distribution everywhere; in retailing, thus far, we’re only active in three — Serbia, Romania and Bulgaria; and we have E&P projects in Bosnia, Romania and Hungary.

— You’re currently only active in E&P onshore: you don’t have any plans for moving offshore?

— No, that’s not really what we specialise in — offshore demands major investment.

— The falling oil price has, already, forced Russia’s LUKoil to abandon certain of its African projects. You’ve also got holdings in assets on that continent, in Angola.

— This is a historical asset; we’ve got minority holdings in three blocks, but everything’s fine there, and we’re staying. There’s another very exotic asset in Turkmenistan, in oilfield services, but we’re considering whether to get out of this due to the business environment and the way orders are concentrated in our own region.

— Is this in any way related to the oil price?

— It’s down to a whole range of factors; there has been, of course, a sharp drop in the oil price, resulting in a reduction in orders. But we’ve strengthened our activities in Eastern Europe quite considerably, and have started drilling much more. We’re in the process of deciding whether to bring drilling crews back here, or whether to deploy them in other regions, where we’re likely to have orders.

— And what’s going to happen to your non-core assets — the kind you don’t usually see in an oil company — Ozone-brand hotels and restaurants, Yazak bottled water?

— We didn’t proactively go into these businesses: we acquired them as part of the deal with NIS. We used to have a lot more hotels, restaurants and serviced accommodation. Maintenance of these is, in part, the result of our obligations under union agreements. But this business isn’t really interesting to us, and we’re looking for co-investors for these, ready to hive off part of these assets — all the more so in the current economic crisis.

— If relations between Russia and the EU carry on getting worse, would you allow the entire company to be sold?

— I don’t see any reason for our relations with government to get worse so — no.