Moscow. 28 February. (Interfax) — Following the publication of its 2017 IFRS annual report on Wednesday, Gazprom Neft’s finance director Alexey Yankevich talked to us about how the company is finding life under the terms of the OPEC+ deal, how it sees Russia’s financial market, and the new strategic objectives for Gazprom’s “oil” subsidiary.
— The company had previously published its provisional IFRS results for 2017. Do the final figures match these?
— The provisional results were disclosed the day before Gazprom’s Investors Day on 6 February. We’re publishing Gazprom Neft’s full financial accounts today. And yes, of course, the provisional and financial data match.
I’m not going to recite the figures. Briefly, Gazprom Neft’s 2017 year-end results show considerable year-on-year growth, across all key metrics: hydrocarbon production is up four percent, operating profit about 21 percent, net profit more than 26 percent, and retail sales 5.6 percent — and all of this in a far from straightforward market.
New production assets have been the key driver behind this growth, with the flagship project here being the Novoportovskoye field — although the Messoyakha and offshore Prirazlomnaya projects as well, to a large extent.
— And mature projects — what’s been the effect of their falling production?
— I don’t see any adverse effect — brownfield sites are still profitable. Those projects account for about 50 percent of profits from production, so they have a considerable role. Declining production rates at mature assets are metrics that are, to some extent, manageable, and can be regulated in line with the market situation. The company takes a view on how profitable it would be to invest more in new projects, under certain conditions, while letting production go at mature fields — or, conversely, how to reduce the decline in production, as far as possible, at brownfield sites. It all depends on what’s more effective in the short or long term, what’s going to deliver the greatest return on capital invested, and what conforms with strategy.
There’s no question that the main priority for us is developing new projects. Given the restrictions of the OPEC+ deal, new projects have taken on a particular importance for Gazprom Neft. We’ve invested extensively in launching these, and aren’t prepared to cut back on plans for development. So, due to the restrictions under the OPEC+ deal the company has stepped up the rate of decline at mature fields — but that’s OK. And if there’s going to be some genuine easing in capacity (OPEC+ quota reductions — Interfax) we think we’re in a position to recover this quickly.
— And how has the OPEC+ deal impacted Gazprom Neft’s financial results?
— It’s a win-win. No question. We’ve gained more through the higher oil price than we’ve lost on having to cut back on production. Demonstrating this is complicated, in absolute terms, but the benefits of optimising production to the max, and concentrating on high-efficiency wells, are obvious. Yes, volumes have been cut back at some brownfield sites, but, generally, the effect is positive — as has been shown by the high growth in the profitability of the upstream sector.
We might have to adjust the rate at which we move towards producing 100 million tonnes of oil equivalent (mtoe) by 2020, but the company still believes this goal to be achievable.
Added to which, the oil market is gradually starting to balance out. We hope — if this agreement (OPEC +) isn’t completely withdrawn soon — that quotas, one way or another, will be relaxed. There’s every reason for this. Gazprom Neft doesn’t expect the OPEC+ limitations to persist, in the long-term — we see it more as a medium-term issue.
— How far did the tax factor worsen the profitability of the refining business last year?
— There’s been an undeniable reduction in profitability in refining as a result of the tax factor. But cost control, improving operational availability, an effective modernisation programme and so on, together with other internal initiatives, have allowed Gazprom Neft to largely offset any negative external impacts. As a result — our refining business ultimately returned a net profit in 2017. Financial metrics in the refining business didn’t, obviously, grow at the same rate as those in production, but that’s mainly because Gazprom Neft implemented an extensive (and planned) refurbishment programme throughout its refineries in 2017.
— It turns out that production is now Gazprom Neft’s main profit centre. Are management happy with that state of affairs?
— All Gazprom Neft business areas are profitable at the moment. It’s just that, right now, most profitability is coming from production — about 70 percent of EBITDA. This has happened for a number of reasons — the main one being that we have, for a long time, been developing new upstream projects, and have now brought these into production, which has allowed us to increase profitability in that sector, specifically.
But Gazprom Neft is now facing no less serious changes in refining. We will gradually complete the modernisation of our facilities, improving their efficiency — as a result of which refining will, we expect, become a new driver of financial growth, in the future.
—"In the future" — when will that be?
— The refinery modernisation programme is set to run to
So, within three to five years, we think, the profit contribution from production and refining should be about 50:50. Or, maybe, 60:40 — as, essentially, is the case for many major vertically integrated oil companies (VIOCs). We’re not striving for some perfect balance. We have, above all, to be effective and well balanced in terms of market conditions.
— The company’s investment programme for 2018 is predicated on an oil price of $50. But prices are going up. At what oil price would the company be prepared to significantly change its business plan?
— When we drafted the 2018 business plan we based this on Ministry of Economic Development forecasts (at $43.5 per barrel for Urals and $45 for Brent crude), which turned out to be very conservative. It’s already obvious that the oil price is going to remain above $50 per barrel for the near future — I think it’ll average around $55 — 60 over the year. So, since the external environment turned out better than expected, Gazprom Neft intends to be flexible in budgeting.
We haven’t yet taken any major decisions on adjusting the investment programme, but we do have a reserve asset portfolio, which we can start up when conditions are right. It’s still only February, and too early to draw any general conclusions; discussions on potential adjustments to the investment programme will begin closer to end Q1. But nobody should expect any conceptual changes to the business plan, because any situation in which we delay — or, conversely — launch, a large number of projects isn’t likely to arise.
—And what does that reserve asset portfolio consist of?
— It’s a kind of reserve of business projects, at varying stages of readiness, launching which will depend on the company’s own internal forecasts, as well as on external factors. For example, in production this means licensing rounds and tenders for subsoil licence blocks — we can plan to take part in these, but we can’t know, absolutely, whether buying one asset or another will be economically justifiable. There are various options for speeding up the modernisation programme in refining. And there’s a range of projects in terms of product retailing.
— The issue of the company’s reserve financial fund came up recently ...
— It’s important to understand that this is, in large part, a management tool rather than an “investment fund” in the most fundamental sense. That is, we don’t set up specific financial accounts into which we invest a specific amount. The company will just proceed on the basis of the forecast oil price, and be guided by budgetary rule.
Periodically, two or three times a year, management will analyse the outlook for the company, and its macro-economic forecasts. If we see that cash flows are higher than planned, then that surplus might be used for either further investment projects, or to increase dividends, and we’ll put out appropriate proposals for shareholders’ consideration.
This philosophy relates to the fact that the macro-economic environment has become more volatile, and it’s difficult to plan the budget in one go. Gazprom Neft used to operate on that basis, in principle, until recently, but it used to just be called “adjusting the investment programme” — now it’s a formalised procedure, and has been given a specific definition — “budgetary responsibility”. Saying that, there aren’t going to be any fundamentally new changes to the way we work.
— Gazprom Neft is facing considerable outgoings in terms of meeting its debt obligations in 2018. Are there any plans to discharge any debts early? And what is the size of the investment programme planned for 2018?
— The company’s debt repayments this year are expected to be in the order of $2.5 billion. We’re reasonably comfortable with this, in principle. We have preliminary agreements in place with banks for most of this. But we’re always looking at alternatives, nonetheless (bank refinancing — Interfax), since the company has a good reputation on the bond market, and investors appreciate us. We placed about RUB70 billion in local bonds last year, so we hope to remain an active borrower in this market, in the future.
As regards early repayment ... We might do this, if we think market circumstances are right — as was the case last year, when the company completed a RUB200 billion refinancing, on better terms. We saw rates were going down, and didn’t want to miss out on that opportunity. I don’t know how dynamic the financial market’s going to be in 2018: we can probably expect rate reductions to slow down, in which case we’ll probably cut back on our activity a bit.
Borrowings in 2018 are expected to be around the same level as repayments. Most likely, our credit portfolio won’t change — we’ve no plans to increase it. The company’s total debt hasn’t increased in two years.
— How comfortable is the company with its current debt levels?
— Quite comfortable, we’ve ended up with a net debt—EBITDA ratio of 1.2 as at end-2017. This level should be broadly maintained to end-2018. For a rapidly growing company like ours, a net debt—EBITDA ratio of 1.2 is very good.
If we were to take Gazprom Neft as a standalone company, then we’d be able to increase the credit portfolio. But we’re part of the Gazprom Group, which has a more conservative policy and which doesn’t want our debt to increase. We’re following our shareholder’s wishes here.
Reducing Gazprom Neft’s debt portfolio makes no sense given the low net debt—EBITDA ratio and the company’s fundamental strength. But neither do we see any necessity to expand it — the oil company’s free cash flow is positive, and we’ve got enough funds of our own to finance the investment programme.
— And how do you find it, working with Russian banks? Or have you just found it easier to operate on the bond market lately?
— We have good relationships with all the banks. Although Gazprom Neft is a far from straightforward client, we always bargain hard and only accept very good rates. We work a great deal with major banks, but can get credit anywhere, and each time the terms — the length of the facility, the spread, and the rate — are closely evaluated. I think we’ll continue working quite actively with the banks, and bank credit, proportionally, will remain at the current level. Last year, more than half of our credit facilities were loans, and I think this will remain the case in 2018 too.
— Do you have any plans to go to the debt market any time soon?
— We’re considering options — it all depends on the market.
— What instruments do you invest any free liquidity in? And what delivers the greatest return?
— Gazprom Neft has been working hard on diversifying recently. Traditionally, this has been mainly through deposits, but last year we tried out an interesting instrument — short-term bonds with reputable banks. In particular, we acquired bonds with Vnesheconombank — and think this is a good idea, because, at a certain point, it delivers the best terms while maintaining the level of reliability. Reliability’s more important than returns, for us — although, that said, we do look for optimum income.
In addition to this, Gazprom Neft last year began conducting transactions in placing funds on deposit with a central counterparty (a new product offered by the Moscow Exchange). This was a new instrument for us too — we were convinced it was possible to make money on trading: this money is traded, better conditions are offered and, on that basis, you can get a slightly better return. The Moscow Exchange guarantees the execution of the transaction, and, all in all, it’s a reliable instrument, which Gazprom Neft will continue to use.
— And have you any plans to expand project financing? What projects are ready to be transferred to this strategy?
— We were able to conclude a very good deal on the Messoyakha project, under which Sberbank and Gazprombank extended a RUB100 billion project finance facility. We haven’t got any plans for major transactions of that kind, but this instrument is very interesting to us.
The Messoyakha deal was complicated, and took more than a year to put together, since it’s a joint venture, and the project itself is at any early stage of development, with potential geological risks. It still hasn’t moved into sustainable cash-flow generation. Gazprom Neft initially suggested project financing on Messoyakha, and we saw considerable interest from the banks, during that process: I could even say there was some degree of competition on this project.
It’s a bit premature to name other assets we’d like to transfer over to project financing — they’re all in the pre-planning stages.
— Vnesheconombank have announced that they’d be willing to offer project financing for Gazpromneft Catalytic Systems.
— We’re doing some work with them on this, but it’s only an optio n, at this stage. Although the banks’ involvement in this project is very interesting to us.
— What are the company’s criteria in moving an asset over to project financing?
— One criterion is how far it’s a standalone project — because if it’s integrated into the company’s core activities then it will be financed through internal sources. And the terms — how far such financing would be profitable for us.
The catalyst project, in particular, is a quite independent, and industry-wide project — we’re implementing it in the interests of Russia’s entire refining industry. It needs, obviously, not hundreds of billions of rubles, but more than RUB10 billion, that’s for sure. And here it’s certainly possible to agree good terms.
— State-owned companies are faced with having to pay dividends at 50 percent of net profits. If we assume Gazprom moves to that sort of pay-out, is Gazprom Neft ready to follow? How is it going to affect an oil company’s business?
— As I’ve already said, we’ve got a positive free cash flow, which is growing; we’ve also got a very manageable debt burden: so, in principle, Gazprom Neft has got the financial resources.
Dividend policy, though, is a different story — here it’s a question of balance. The most important thing for an investor is that they get a reasonable return — in terms of the size of the dividend, and an increasing share price. On that basis, in 2017, in terms of total shareholder returns — Gazprom Neft is in second (or maybe even first) place in the industry. So our dividend yield is at such a good level that increasing it sharply might not be the optimum solution. Better to approach this gradually.
Gazprom Neft continues to increase dividends, in line with the share price: on that basis, we’re already expecting an increase of more than 30 percent on 2016 for our 2017 results — even though 2016 was a record year. Hopefully our shareholders are content with us. But if there’s a conscious decision to pay dividends at 50 percent of profits, we’ll find a way. I don’t think such a decision will significantly impact Gazprom Neft’s business — we’ll just make some adjustments in terms of asset development, or rethink borrowings.
—What objectives has Gazprom set you?
— Gazprom Neft will remain a growing company for its shareholders, for some time. We’ve got the potential for further growth in the share price, and in terms of financial performance. Gazprom Neft’s EBITDA is now RUB500 billion — we won’t have a stab at RUB1 trillion just yet, but we can stay in the RUB500 billion—RUB1 trillion range quite confidently. And Gazprom, of course, is expecting further growth in key metrics, as well as expecting us to maintain our market-leading position in terms of efficiency, shareholder value, and IRR.
But Gazprom also expects technological leadership from Gazprom Neft. Gazprom has a lot of liquid hydrocarbons on its balance sheet and, since these tend to be non-traditional reserves, they’re harder to develop. To do that, the Gazprom Group needs a technologically advanced company, capable of monetising such reserves.
Gazprom Neft is currently working on a new version of its strategy to 2025, in which the focus is not so much on production growth and improving financial performance — we’re not going to be able increase production volumes indefinitely — as technological industry leadership. We’re working towards becoming the benchmark, technology-wise, initially in Russia and then worldwide. In refining, once we’ve finished modernising, Gazprom Neft’s plants will match global standards. We’re already, in many ways, leading Russia’s oil industry in terms of cutting-edge production technologies. I hope that we’ll reach a world-class level in terms of technology, in the future, applying new and effective technologies in bringing the most complex hydrocarbon reserves into development.