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The oil sector taxation system must become more flexible.

President of Gazprom Neft, Alexander Dyukov, talks about new assets, taxes, the Federal Antimonopoly Service (FAS) and Zenith.

June 29, 2010. Kommersant

Alexander DyukovToday Gazprom Neft is holding the annual general shareholders’ meeting. ALEXANDER DUKOV, Management Board Chairman of Gazprom Neft, talks about the assets of interest to the company, assets of no interest to the company, as well as the prospects of modifying the oil sector taxation system and problems with the Federal Antimonopoly Service.

Gazprom has started to transfer its oil field to the company; how are you going to pay for them?

- An individual transfer schedule has been drawn up for each field. The most progress has been made with the transfer of the Novoportovskoye and the Eastern part of the Orenburgskoye fields; we are planning to finish the transfer this year. Simultaneously, we are working out plans for prospective development of the fields. With respect to the Orenburgskoye field, Gazprom Neft has already received the authority of the sole executive body; a development program has been approved to 2014. The algorithm for transferring the fields is as follows: At the first stage, via additional issue, Gazprom Neft enters the capital of the license holding companies by paying the fee with available funds and then buys out Gazprom’s share in these companies.

- Earlier, you spoke about the possibility of an additional issue of Gazprom Neft shares in favor of Gazprom in order to pay for the fields. Have you rejected the idea?

- An additional issue is one of the tools that may be used in future.

- Will Gazprom Neft acquire the Prirazlomnoye offshore field?

- Yes, it will, after commissioning, which is scheduled for next year.

- Will Gazprom’s expenses be fully reimbursed?

- All transactions involving transfer of licenses and other assets, including investment costs incurred, will be totally market operations. Each field has already been or will be evaluated, and the fair market value will be established for them, which will serve as the basis for further calculations.

- One of the options for development of the Prirazlomnoye field provided for building an oil refinery. Is this a crucial project?

- We have doubts about the feasibility of the project, but this is one of the options that must be considered. However, I can already say that production volumes in Prirazlomnoye will be insufficient to make the project effective. The necessary condition is that all the oil produced in this region be involved in refining.

- Gazprom Neft complies with the requirements imposed by the law on offshore subsurface users. Did you request a state license?

- Work on the shelf is one of our strategic lines of development. We have so far filed two applications for sites on the Arctic shelf of the Pechora Sea.

- Will you attract partners?

- An individual decision will be made on each individual field. If the field development is technology-intensive or capital-intensive, then it will be advisable to attract partners.

- Is the company interested in increasing the free float, which is currently under 5%?

- For the company, increasing the free float via a share issue is a tool used to attract additional investments. However, at present, no such need exists, so increasing Gazprom Neft’s free float is not crucial.

- Will it increase marketability of the securities?

- Theoretically speaking, the higher the securities' marketability, the closer the company’s capitalization is to its fair value. However, if we hold an IPO or SPO, our major shareholder will have to return part of the income earned from the increase in the company’s value in future to increase the accuracy of accounting the asset price. In our opinion, such a high price for accounting accuracy is not justified. IPO and SPO will only be advisable if either the company or Gazprom needs additional investments. So far, there is no such need.

-In mid 2009, Tomsk officials said that Gazprom Neft would have the option to purchase the second half of Tomskneft from Rosneft in 2011. Is this true?

- A transaction made at the end of 2007 (Gazprom Neft acquired 50% of Tomskneft from Rosneft – “Ъ”) did not presuppose any options either in favor of Gazprom Neft or in favor of Rosneft.

- Are you discussing the purchase of any other assets? BP is facing serious problems today, and Gazprom is traditionally named as a contender for the British share in TNK-BP.

- We did not make any such proposal, nor did BP make such a proposal to us. It is quite likely that BP will be forced to sell part of the assets, but even if TNK-BP’s share ends up on the list, BP will not likely start with it. TNK-BP generates a considerable cash flow, but in this case, for a number of reasons, the cost multipliers used for TNK-BP are considerably lower than for other BP assets. That is why we believe in selling the share in TNK-BP share in the short run.

- What will be the plan for dividing Slavneft?

- Who said this would happen for sure? Periodically, we include this issue in our Slavneft agenda jointly with TNK-BP. The result was division of filling station chains in Belarus and Yaroslavl, Ivanovo and Kostroma regions. We are allocating development of the Messoyakhinskoye field to a separate project beyond the perimeter of Slavneft. The issue of division is now being discussed again, but this does not mean that the division will take place in the near future or in the medium term.

- In spring, Gazprom Neft completed a transaction to purchase Sibir Energy by purchasing the shares disputed by Shalva Chigirinsky and Ruslan Baisarov. Has Chigirinsky’s debt of $400 million to Sibir been repaid?

- Yes, it has.

- Are you prepared to give up 6% of Sibir Energy to the Moscow Government so they can increase their block to 25%?

- Yes, we are, we have already decided to sell.

- What is the price of the shares?

- Market price.

- Do you want to buy a stake in Pavlodar Oil Refinery?

- It’s an interesting asset. If we receive a proposal from its owners, we will consider it.

- Two weeks ago, Gazprom and Shell discussed the possibility of cooperation in Europe, including cooperation in refining. Are you interested in any of Shell’s assets?

- We are not negotiating with Shell about purchasing refining facilities owned by them. Shell has interesting assets in Europe but they are not for sale.

- And what about other companies, for example, Total?

- I can’t say that purchasing refining facilities in Europe is our first and topmost priority. We rather consider these as opportunistic projects. If an opportunity arises to purchase modern efficient facilities at a reasonable price, then a purchase is quite possible. But we won’t be upset if we don’t succeed in purchasing any oil refining facilities in Europe in the short run. Our priority is investments in oil and gas production projects, modernization of oil refineries, and expansion of a retail chain in regions where we have refining facilities, including the Balkans.

- When will the company join the Anaran project in Iran?

- We are in the process of negotiations. Agreements may be reached as soon as this summer.

- Did you adjust the development strategy?

- We regularly update it. It was last updated and approved by the board of directors last year. At the end of this year we are planning to perform the updating procedure again.

Are you expecting a modification of the oil industry taxation system?

- Certain changes have already taken place. The result is the company’s ability to mobilize extra investment resources and to overcome the trend of decreasing production which has felt over the last three years. However, there is still room for enhancing the efficiency by optimizing the taxation system. The RF Ministry of Energy understands this, and has started elaborating a master plan of development of the oil industry; one of the major tasks of the master plan is working out new tax regulations. The system must become more flexible. It would be simpler and better to start modernizing it with taxation of new fields. The major variant in question is an approach that allows a reduction of the export duty and introduction of a new taxation tool – the additional income tax, which is a tax not imposed on accounting income over a certain period, but is imposed on free cash flow. So far, this approach – reduction of export duties and introduction of an additional income tax – is just a good idea which has to be tested on a model, by running new fields through it in order to determine its right to live and definite parameters of tax regulations.

- What is the reaction of officials, the Finance Ministry, in particular?

- So far there is no opposition to this approach.

- When might the work be finished?

- Preparation of proposals and specific measures should become part of the elaboration of a master plan of the industry’s development. It is expected to be finished in autumn.

- Can the new taxation system fully replace the existing one?

- Not in the short term, for obvious reasons associated with administrative problems. Most likely, the tax regulations in the traditional fields will also be changed, but the changes will be insignificant. For them, introduction of the additional income tax is not possible yet and reduction of the export duty can only be accompanied by a MET increase, which will help to maintain budget revenue. A finer adjustment will be required for these fields, which will take more time.

After the position of the Federal Antimonopoly Service (FAS) which accused the oil companies of monopolism was supported by the Supreme Arbitration Court (SAC), are you prepared for reconciliation with the Service?

On the basis of statements made by the FAS, it is against conclusion of a final settlement agreement. We haven’t taken and are not planning to take any steps in this direction yet. We still consider the accusations made against us unfounded. The decision of the SAC to support the FAS in the dispute with TNK-BP is at least surprising. You don’t need to be an expert to understand that gasoline with an octane rating of 76 and 98 are not interchangeable oil products; nor are arctic and summer diesel fuels. The vessel fueling market and the housing and public utilities market are two different markets, like those of the Chukchi Peninsula and Kaliningrad. However, the FAS sees no difference between them. Therefore, a very obscure “cost-effectiveness criterion” may be applied and interpreted at their own discretion. To say nothing of the large number of procedural errors committed by the FAS. In this context, SAC’s support arouses concern. The service may completely stop bothering itself with collection and analysis of facts and substantiation of its position in court.

- You could give in to the FAS and start forming a sales price according to the suggested formula.

The netback logic of equal effectiveness of the export and domestic market proposed by the FAS is, in our opinion, unacceptable in terms of oil refining. The oil refineries in Omsk and Moscow were built with a view to covering demand for oil products in the mentioned regions – not in Rotterdam. In order to provide these products, oil refineries must be built there. And the fact that oil products partially produced in Russia are exported is a compulsory measure. One of the consequences of using the formula is reduction of the oil refinery load, because, if there is a move to price formation by the FAS formula, the oil refining netback will be worse than the oil export netback. A gasoline shortage is a consequence. Thirdly, redistribution of income from the sale of oil products is made in favor of the middlemen. Fourthly, the margin which is currently being sent for modernization of the oil refinery is withdrawn from oil refiners.

- How can an acceptable level of prices for oil products be determined then?

- As regards formula-based price formation, we have ideological differences with the FAS, and I am not sure if we will reach a compromise in the short run. Therefore, the only solution is development of an exchange trade tool.

- How much are you prepared to sell on the exchange?

- Although selling via an exchange per se is not useful for oil companies in terms of increasing the effectiveness of sales, we are prepared to increase exchange trade volumes and sell at least 10% of our oil products. All we want is for the FAS to first document and record the parameters of exchange sales - volumes, time period, types of oil products, markets - observance of which will guarantee that the Service will regard the prices established on the exchange as fair market prices.

- Will Gazprom Neft be able to change over to the new technical regulations in time?

- The only thing that worries me is the presence of a serious regulatory problem. When we speak of new standards for motor fuel, we nearly always mention the word “Euro”, whereas our Russian standard envisages the idea of “class” and there is a principal difference between the two. “Euro” does not regulate octane rating parameters in the fuel, whereas “class” does. In compliance with Russian technical regulations, starting from 2012, it will be prohibited to produce gasoline with an octane rating lower than 95. However, it is completely obvious that no radical upgrade of the fleet will take place over the remaining year and a half and, as a result, many drivers will have to “lay up” their cars, and the oil companies will have to export a considerable volume of high-octane gasoline not in demand in the domestic market. As a result, it seems advisable, as elsewhere in the world, to abolish octane regulation and make the process evolutionary. It is not up to the fuel producer, it is up to the driver and car manufacturer to choose the octane number they need.

- Are managers of SIBUR, where you head the board of directors, not prepared to return to the idea of buying out the company?

- The project is no longer critical. The process was initiated in 2008 by Gazprom Bank (major shareholder of the company – “Ъ”). The world economy was entering a crisis, and the banks were starting to face serious liquidity problems as early as in the beginning of 2008. Gazprom Bank was interested in prompt sale of the asset. At that time, the company’s management was probably the only buyer prepared for such a rapid transaction without performing the required procedures, checks, study of the company, and becoming familiar with the asset. But the financial market closed before the transaction was completed and now the bank no longer faces any liquidity problems.

- Do you consider a SIBUR IPO as a possibility?

- Not at the moment, as the company does not need to attract additional capital to finance the investment program. However, the IPO may be conducted in the future.

- You are president of the Zenith football club. What is the club’s budget?

- Zenith has the biggest budget of all Russian football clubs. Without considering the income received by the clubs from the sponsors, Zenith has the largest proceeds from merchandising, ticket sales and other activities – over $40 million US.

- And who is the shareholder?

- Gazprom group companies.

- UEFA wants to bring the clubs’ income in line with expenses; will this be a problem for Zenith?

- Actually, almost all Russian clubs, including Zenith, have income in line with expenses, whereas the share received from the shareholders and sponsors is higher than that of European clubs. But Russian football has considerable room for income growth. Profit earned by selling TV rights and the so-called proceeds on match days may be considerably increased. For comparison: -income of the Russian football premier league gained from selling TV rights are currently under 20 million Euros per year, whereas the Turkish championship will earn 270 million Euros from TV starting in the autumn.

- When will construction of the Zenith stadium in St. Petersburg be finished?

- We hope it will be finished by autumn next year.

- It has turned to be one of the most expensive clubs in the world per seat. Why?

- The construction is being financed by the city, so we don’t know what the budget is. But it’s built to be one of the most modern and comfortable stadiums in Europe. Applying the right to host the world championship and the need to bring the stadium into compliance with the new FIFA requirements has made the whole thing more expensive. Of course, one could build a cheaper stadium, but in just 5-10 years it will become worse than just ordinary – it will be outdated.

- To what extent will Gazprom finance construction of Okhta Center?

- Part of the area will be occupied by Gazprom group companies and the rest of the area will be rented out or may be sold. In this context, it is planned to attract financing from the group’s companies, banks and other organizations interested buying or renting the area in question. So far, I can’t tell you what the volume of financing from Gazprom will be.

The interviewer was Denis Rebrov