On the Way to the Strategic Objective

Kirill KravchenkoInterview with Kirill Kravchenko, Director General of Oil Industry of Serbia, Moscow, May 31, 2010. Gazprom Magazine

- Kirill Albertovich, what are the year-end results of the oil production division of NIS? What are its development prospects?

- Oil and gas produced by NIS-Naftgas amounted to 922.1 thousand tons of reference fuel (t. r. f.), which exceeds the corresponding figure for 2008 by about 7%. This is the first time in the last 17 years that production growth has been recorded. In the current year, we are planning to increase production volumes by as much as 12% to 1.124 million tons, and in the period to 2014, according to the company's strategy, the production level should increase by another 40%. In addition, the company produced 11.243 thousand tons of liquefied petroleum gas at the plant located in the city of Elemir. Our oil service unit’s activity has also notably increased. Today, NIS specialists are working not only for their company, but are also acting as a contractor for the Serbian government and Srbijagas in the Balkans. Thus, in April they finished construction of the Gospodjinci-Banatski Dvor gas pipeline. And, say, in Turkmenistan, NIS is actively cooperating with the British-Arabian company Dragon Oil.

Raw Material

- With regard to future prospects, it should be noted that we are face with the task of estimating and expanding the NIS resource base, because, unfortunately, nobody has been doing this seriously. For example, we have data proving the possibility of discovering new hydrocarbon deposits in Serbia. In particular, in the southern parts of the country, no proper exploration has ever been carried out with a view to discovering oil and gas resources. That is why, in the production sector, we intend to focus our efforts on geological exploration.

As early as this year, specialists of NIS and Gazprom Neft will start drilling prospect wells which we calculate will increase the company’s resource base by 8% to 13.46 million tons. By the way, this is the first time in 20 years that reserves have been increased. You could say that NIS, at least in terms of exploration and production, is growing by the hour. For us, this is extremely important because this is Serbian oil, whereas today, over 80% of the raw material processed by the company is imported.

Who provides supplies of imported raw material to the company’s refining facilities?

- In 2008, the key suppliers of crude oil were Gazprom Neft, Glencore and Vitol. Last year they were joined by the Moil Coal trader. We mainly import Russian export mixtures called Urals and Rebco to Serbia; they are noted for high sulfur content and a relatively high level of dark fraction yield during refining. But there are light grades too, such as Russian Siberian Light and Libyan Es Sider.

The main transit terminal for supplies is the Croatian port of Omishal where oil is brought by tankers. Our oil refineries (OR) in Novi-Sad and Pancevo receive raw material via the JANAF oil pipeline.

What are the results of operations of NIS’s refinery sector? What is being done to improve quality of output oil products?

- Last year, the refined volume was 2.621 million tons of oil, which exceeds the preceding year’s figure by 3%.

Refining

- We have fulfilled all the tasks set for the company in the oil refining sector. However, it should be remembered that modernization of the Serbian plants has only just begun and we should not expect any breakthroughs in the quality of their operations. However, this does not mean that we’re not making any headway. In 2010, optimization of OR operations in Novi-Sad and Pancevo will be finished, along with setting up integrated production facilities based on them controlled by a single planning model. Thus we intend to modify the scheme and structure of production to provide increased output of oil products with high added value while retaining refining volumes at the same time. First of all, this concerns Euro-5 class diesel fuel (DF), the output of which will increase by 32% and also gasoline complying with EC requirements – an experimental gasoline production line has already been launched into operation. This is in line with our plans for increasing our share in domestic consumption in Serbia to 70% in two stages. At the same time, production of oil residue and coal tars will be reduced to a level corresponding to the level of domestic consumption in Serbia.

We are expecting a qualitative breakthrough in refining after commissioning the mild hydrocracking complex at the plant in Pancevo in the second quarter of 2012. Most of the oil products of our product line will be brought into compliance with the strictest EC standards. This will enable NIS to achieve one more strategic goal – performing up to one-third of our operations beyond the Serbian border. Refining volumes will accordingly increase considerably.

- How much could they grow?

- By at least half as much again, but everything will depend on the domestic market situation and export opportunities.

- Could you give us some more details about implementation of the NIS investment program? What has already been done and what still has to be done?

- In compliance with the purchase-and-sale contract for 51% of NIS shares, Gazprom Neft promised to invest at least 548 million Euros in development and modernization of the Serbian company.

Investments

- The bulk of investments – over 396 million Euros – will be spent on construction of hydrocracking and hydrotreatment units in Pancevo under a contract with CB&I Lummus. This project is of vital importance for us – it will not only enable us to increase the depth of oil refining and change over to production high-quality fuel brands, it will also reduce the cost of refining and the environmental load.

In September, 2009, we started to implement the project. As of January of the current year, 8.7 million Euros had been spent on design and exploration work, and the total cost of the contracts concluded for equipment supply exceeded 164 million Euros. The key tasks for 2010 within the project are completing the procedures for choosing suppliers, registering the company’s property, executing the required permits and technical documentation and establishing a pool of subcontractors. Gazprom Neft is planning to spend about 215 million dollars this year on continuing modernization of the OR in Pancevo. At the same time, we plan to invest about 118 million dollars more of NIS’s own funds in production projects and sales network development.

- How did the NIS sales network function in 2009?

- Until 2011, NIS will actually enjoy a privileged position in the Serbian oil product market. Actually, the company only partially controls it now. For example, restrictions on imports of Euro 5 class DF and liquid hydrogen gas to the country have been lifted. The factor of the economic crisis cannot be overlooked, as it has had a serious impact on sales of oil products produced by NIS.

Sales

- Nevertheless, our company remains the chief supplier to the state, i.e., the army, police, health care organizations, national energy infrastructure facilities, and municipal heat supply system. Furthermore, other Serbian fuel market participants purchase oil products, the import of which is still prohibited, from us. In 2009, NIS supplied 2.248 million tons of fuel to the domestic market; the retail sales volume totaled 587 thousand tons.

- Does the company supply oil products only to the Serbian market?

- Under current conditions, exports remain our channel for the sale of process surpluses and products not in demand in the domestic market. That is why today volumes of our foreign trade transactions in this direction are small. In 2010, we are planning to export about 200 thousand tons of oil products. But it is obvious that after modernization of our OR, the situation may change drastically. The strategic goal of NIS is leadership in the fuel market of South-Eastern Europe. Therefore, expansion of the company’s influence beyond Serbia is of great interest to us. We are already doing strategic marketing in this segment and holding preliminary negotiations with potential partners. I think we can be more specific about this later when the company obtains technical capacities for an active breakthrough into retail markets of adjacent countries. The chief goal until 2014 is doubling sales of light oil products via our own sales network.

- Does NIS have partners in the region?

- We supply LUKOIL’s operating Serbian retail chain with gasoline and cooperate closely with Zarubezhneft in lubricant production – we obtain base oils from a plant controlled by this company in the Bosnian town of Modriča; using these oils as a base, we turn out a whole line of products under the NISOTEC trademark. In addition, we have signed a memorandum of understanding with Zarubezhneft – we’re planning to start joint search and exploration of hydrocarbon fields in the Serbian Republic of Bosnia and Herzegovina. But this is far from our only project in the region; there are a number of others. It should always be remembered that we have rivals here with whom we compete - these are MOL, OMV and LUKOIL, which have extensive retail chains in Serbia and in the Balkans in general. The competitive situation will become more difficult for us after liberalization of the Serbian fuel market, which is scheduled for January 1, 2011, but we believe we’re up to the challenge.

- What do the development plans of the company’s sales chain assume?

- Sales chain development is one of the strategic areas for NIS to 2014. By reorganizing the corresponding divisions, we intend to increase the company’s share in the wholesale segment from 60% to 75%. We also hope to acquire at least one-third of the retail market, of which we now have 23% at most. For example, modernization and construction of about 40 gasoline filling stations is planned for the current year; in addition, the stations will be fitted with equipment enabling customers to fill tanks with liquefied petroleum gas.

Vital Issues

- NIS as a whole will actively work on improving the efficiency of the sales system.

- Gazprom Neft has become an NIS shareholder; has it solved the financial problems?

- Last year we managed to reverse the trend of accumulation of losses by the company. In the period from February until December 2009, NIS’s net profit was 2.7 billion RSD (RSD exchange rate as of the beginning of the current year was 1 EURO=97.36 RSD). Regrettably, we did not manage to compensate for first quarter losses caused by the impact of the global financial and economic crisis, and as of the end of the year, we were in a loss situation. However, compared with the 2008 figures, losses were considerably reduced – down to 4.4 billion RSD. Speaking of the 2009 results, it is worth mentioning that the financial report will show a figure of 37.6 billion RSD; the reason for this is that the figures will be corrected in compliance with IFRS. In particular, 4.3 billion RSD is a reserve for property disputes – the point in question is 113 thousand tons of crude oil from the JANAF oil pipeline worth 2.7 billion RSD; this oil was in the company’s balance sheet; however, in fact it was expropriated by Croatian authorities back in the early 1990s. Other NIS property that was in its balance but turned out to be third party property was likewise written off.

In addition, “bad” debts of state companies to NIS accumulated between 2005 and 2008 had to be written off as losses – the debts totaled around 12 billion RSD. A substantial amount was written off due to a property value adjustment (14.5 billion RSD), and the remaining funds went to ineffective consulting, shares of bankrupt companies which were the property of NIS, etc.

We expect the current year will become profitable for NIS for the first time in the last several years. The key role in this will be played by our cost-cutting measures, shifting the refinery product mix, modifying the structure of sales and enhancing our own oil production.

- What other issues are the most vital for the company at the moment?

- The process of transforming of NIS from CJSC to OJSC and entering the Belgrade stock exchange scheduled for June of the current year is still an issue of critical importance. But the most important thing is successful implementation of the above-mentioned projects, which is really necessary for maximum preparation for liberalization of the Serbian oil market January 1, 2011. Generally speaking, the company’s plans and tasks for 2010 may be described as intensive fitness – healthy life style, quitting bad habits, weight reduction, and sports. If we were speaking about a person, that’s how we would speak about our priorities. But we are speaking about a company and a business process, so here we should use another word – effectiveness.

The interviewer was Denis Kirillov