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Edited Transcript of GALP.EP earnings conference call or presentation 29-Jul-19 10:00am GMT

Q2 2019 Galp Energia SGPS SA Earnings Call

Lisbon Aug 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Galp Energia SGPS SA earnings conference call or presentation Monday, July 29, 2019 at 10:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Carlos Nuno Gomes da Silva

Galp Energia, SGPS, S.A. - Vice Chairman & CEO

* Filipe Crisóstomo Silva

Galp Energia, SGPS, S.A. - CFO & Executive Director

* Pedro Dias

Galp Energia, SGPS, S.A. - Head of Strategy & IR

* Thore Ernst Kristiansen

Galp Energia, SGPS, S.A. - Executive Director & COO

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Conference Call Participants

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* Alessandro Pozzi

* Alwyn Thomas

Exane BNP Paribas, Research Division - Analyst of Oil and Gas

* Biraj Borkhataria

RBC Capital Markets, LLC, Research Division - Analyst

* Christopher Kuplent

BofA Merrill Lynch, Research Division - Head of European Energy Equity Research

* Flora Mericia Trindade

CaixaBank, S.A., Research Division - Analyst

* Irene Himona

Societe Generale Cross Asset Research - Equity Analyst

* Jonathon Rigby

UBS Investment Bank, Research Division - MD, Head of Oil Research and Lead Analyst

* Joshua Eliot Dweck Stone

Barclays Bank PLC, Research Division - Analyst

* Matthew Peter Charles Lofting

JP Morgan Chase & Co, Research Division - VP

* Michael J Alsford

Citigroup Inc, Research Division - Director

* Oswald C. Clint

Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst

* Thomas Yoichi Adolff

Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director

* Yuriy Kukhtanych

Deutsche Bank AG, Research Division - Research Associate

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Galp Second Quarter 2019 Results Call.

I will now pass the floor to Mr. Pedro Dias, Head of Strategy and Investor Relations. Please go ahead, sir.

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Pedro Dias, Galp Energia, SGPS, S.A. - Head of Strategy & IR [2]

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Good morning, ladies and gentlemen. Welcome to Galp's Second Quarter Results Conference Call. Today, Carlos will start with an overview of the quarter and a quick update on Galp's operations and strategy execution. Filipe will then go through the results. At the end of the presentation, we'll be available to take any questions you may have. Thore is here with us as well.

I would like to remind you that we may be making several forward-looking statements. Actual results may differ due to factors included in the cautionary statements available at the beginning of our presentation, which we advise you to read.

Carlos, the floor is yours. Thank you.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [3]

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Thank you, Pedro, and good morning to you all. I will start with the key messages of our performance during the quarter. Operational cash flow was robust during a very challenging refining period. Free cash flow in the quarter actually more than covered the dividends paid, and that already considering the 15% dividend increase.

We have experienced a quarter-on-quarter improvement across all businesses and mostly supported by the upstream ramp-up performance helped by higher oil prices, better refining performance despite weaker margins [comparators], as you all know, and the robust performance from the commercial activities.

Let me briefly go through the performance of our divisions, and I will start with E&P on Slide #5. So the work interest production was flat quarter-on-quarter, and this was as expected. Galp's output benefited from the ramp-up of 2 units, of the unit #9, which has started in February in Lula North; and the unit #8 that is also ramping up in Lula Extreme South. All in all, if we look at Brazil, Brazil has contributed with around 98,000 barrels per day as we had some of other units undergoing maintenance during the quarter, and that was mostly planned.

As you also know, our production in Brazil reflects now the Lula unitization stake adjustment from 10% to 9.2% and is in place since April 1. On a quarter-on-quarter basis, this unitization impact around 5,000 barrels per day.

Moving to Angola and where Kaombo South has started in April and the unit ramped up very nicely, already producing over 100,000 barrels per day. In Iara, works are progressing, and production start-up is expected by the year-end from the Berbigão and Sururu fields. In Carcará, with the ANP approval, we have completed the acquisition of the remaining 3% stake in BM-S-8. We are currently performing DST in Carcará East and advancing with the concept solution with the submission for the first development phase of Carcará. In Mozambique, we are proceeding with construction works in Coral South, in South Korea, as you know, and are currently analyzing and optimizing the EPC proposals for the Rovuma LNG development with the goal of taking FID later this year. Overall, our upstream performance has been consistent with our plan.

On a shorter-term outlook, Galp continues to see good progress with the ramp-ups in Brazil and Angola, very much aligned with what we had planned. Production is expected to pick up during this third quarter, and we are currently producing at above 120,000 barrels per day. We are maintaining our guidance for the year within the range between 8% and 12% growth year-on-year, but of course, the positive results to date make us to the right-hand side of that range.

Moving to our downstream businesses on Slide #6, and as you all know, this was a challenging quarter for European refiners. Galp's margins were pressured by weaker middle and light distillates cracks together with the lower sourcing optimization opportunities during the quarter. Having said this, our margins were up quarter-on-quarter, giving our own operational restrictions during the Q1. After the collapse during the beginning of June, margins in the North Atlantic recovered only at the very end of the quarter. Galp's realized margins have been above $4 per barrel during July, and we expect them to stand at least around these levels during the second half of the year.

The IMO bunker fuel regulation should start having a positive impact on the demand and product pricing during the Q4, and we will be ready for it.

Just a word on the Q3 planned maintenance. We will stop our atmospheric distillation unit in Sines this August for between 40 to 50 days, which should not compromise the operational availability of the conversion units and their respective margins. So I underline that part, the conversion units will continue to work at the optimal levels. During this stoppage, we will also perform some works related with $1 per barrel initiatives.

Moving to the downstream activities more related with our commercial business. So in oil, marketing has been consistently resilient and solid quarterly results are being supported by higher volumes sold into a healthy Iberian market. The Gas & Power business has had a particularly strong quarter driven by the ability to capture market conditions and the flexibility to optimize our sourcing basket. It also benefited from a better performance of the natural gas and electricity commercial activities.

The strong first half performance is taking us close to what we were planning for the full year. Even expecting lower seasonal demand and margins during the second half, we should expect the initial estimates for the Gas & Power EBITDA, which normally stands at between EUR 100 million and EUR 150 million. We are also working to secure a competitive long-term gas and electricity sourcing basket. After adding LNG volumes from United States to our portfolio, we have now agreed the sourcing of 2.5 bcms per year of pipe gas from Algeria, effectively extending for up to another 10 years the contracts currently in place. Mozambique will also play a role within our supply basket, with Area 4 partners securing the offtake for the Rovuma LNG project.

Moving to Slide #7 and to highlight Galp's path and our investment case. Our performance execution on a year-to-date basis provide us the confidence that we will deliver according to what we have guided to you, if not better. Galp is set to reach EUR 1 billion free cash flow soon and remains focused on a continuous value-creation path for many years to come. This will be achieved by extracting value from our current outstanding portfolio and as well as from selective additions, if accretive. We will remain very selective with our capital allocation decisions, and we are well aware of the current market sentiment in favor of shareholders distributions. The projects we are considering will prioritize the efficiency, the resilience and the complementarity of the existing business with lower carbon also in mind. The discipline of our portfolio decisions will also take into consideration our financial position at any time and the longer-term returns of such projects having in mind the 15% average capital employed return we aim for.

We are still planning to provide you with high-level strategic guidelines in October on the quarter's results day for the third Q. The team will be there in London and available to meet you afterwards. Our annual Capital Markets Day will resume in early 2020, most likely together with the full year 2019 results presentation. By then, we will have the outcome of the bid rounds in Brazil, which have now been postponed to November.

So Filipe, the floor is now yours to go through the financials. Thank you.

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Filipe Crisóstomo Silva, Galp Energia, SGPS, S.A. - CFO & Executive Director [4]

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Thank you, Carlos. Good morning. I'm on Slide 9. You see EBITDA was EUR 615 million in the quarter. This includes the positive effects from IFRS 16. E&P EBITDA was EUR 408 million, that's down year-on-year with a lower oil prices more than offsetting the higher production and the stronger dollar.

Refining & Marketing EBITDA was EUR 142 million, also down year-on-year driven by much lower refining margins. The Galp refining margin last year was $6 per barrel, and it was down 50% to only $3 per barrel this last quarter.

Gas & Power, however, had a strong quarter with EBITDA up EUR 23 million year-on-year. This reflects a favorable sourcing basket and a stronger gas and electricity commercial activity in Iberia. Below the line, I would highlight the negative swing in financial results. This is driven mostly by EUR 23 million in operating lease interest coming from IFRS 16. The implicit tax rates on the P&L has now come back down to 45% as the downstream contribution improved quarter-on-quarter. Net income under RCA was down year-on-year and up quarter-on-quarter to EUR 200 million. Under IFRS, net income was supported by nonrecurring of EUR 14 million and a positive inventory effect of EUR 17 million.

Moving to cash flow on Slide 10. Cash flow from operations in Q2 was a healthy EUR 613 million despite the weak refining contribution and Brent, which was $5 lower than last year. Net CapEx was EUR 223 million, and 2/3 of this is related with our upstream activities and includes the payment of EUR 77 million for the 3% stake in BM-S-8. Group free cash flow in the quarter was EUR 342 million, covering the dividends paid to Sinopec in Brazil and EUR 296 million of dividends paid to the Galp shareholders.

Now just a reminder that our free cash flow includes all operating lease payments that is deemed interest and principal repayments, with IFRS 16 neutral at the free cash flow level.

On Slide 11, here on 11, we map our February guidance versus what was achieved so far and the updated guidance for year-end. So on EBITDA, we expect an acceleration of the operational performance for the rest of the year. We anticipate to get to above the upper limit of the previous EUR 2.1 billion, EUR 2.2 billion range. Now this considers a revised assumption of $65 for Brent and refining margins for the full year of around $4 per barrel. This compares with the $5 to $6 range that we had expected earlier this year. We also fine-tune our CapEx estimate down to about EUR 900 million. So all in all, free cash flow generation is expected to remain strong and certainly better than what we had expected earlier this year.

We're now happy to take your questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question, and it's -- from the line of Biraj Borkhataria from RBC.

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Biraj Borkhataria, RBC Capital Markets, LLC, Research Division - Analyst [2]

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Two quick ones, please. First one, could you run through in the second quarter the key difference in the P&L tax and the cash tax? And what we should expect for the second half of the year? And then second question on the downstream. It looks like marketing was -- the implied number for marketing looks particularly strong this quarter. Is there anything to read into that? And again, how we should think about it going forward.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [3]

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Biraj, I will take the second question and Filipe will go through the first one. So effectively, the demand is still increasing in Iberia. Middle distillates, strong increase, more in jet fuel, the marine fuels and also gasoline. More stable in diesel. Looking to the second half of this year, we continue to see that the market is highly supportive. And we anticipate that our marketing oil activities will continue to be strong and positive going forward. Filipe?

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Filipe Crisóstomo Silva, Galp Energia, SGPS, S.A. - CFO & Executive Director [4]

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Biraj, I think it's important that -- to remind that we are taxed in the different jurisdictions based on IFRS results, so RCA only shows part of the picture. And it's also quite relevant that you look at our first half and to remind you that in Q1, we took the unitization adjustments in our IFRS numbers. So that's a EUR 200 million hit as a reflection of the extra production we took when we had 10% of Lula versus the new 9.2% stake. So this has gone to the tax P&L in Brazil. Thank you. Looking forward, we're not changing our guidance, so IFRS on a cash basis, we're guiding to about 40% tax rate and 50% in the P&L rate, and this will converge over time for the next 2 to 3 years. Thank you.

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Operator [5]

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Your next question comes from the line of Oswald Clint from Bernstein.

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Oswald C. Clint, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [6]

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First question, just on the EBITDA guidance. Obviously, you're revising it up a little bit but kind of leaving the numbers open. You spoke about your production guidance being probably towards the right-hand side of the range, but I just wanted to get your sense of whether you look at market estimates and see consensus EBITDA of $2.4 billion for this year and consider that achievable or perhaps that's too optimistic at this stage of the year, please? That's the first question.

And then secondly, just talking about the next growth cycle, the post 2020 period, and obviously Transfer of Rights still coming up. I just want to get your latest thoughts on is -- in the next growth cycle, it could be upstream if you win the Transfer of Rights or it can equally be downstream or it could be chemicals. So are all options open at this point, and we'll hear later post the Transfer of Rights? And ultimately, Carlos, do you think if it is downstream or chemicals, you can really, let's say, pitch a particular investment in those areas at 15% hurdle rates?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [7]

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Oswald, in relation to the EBITDA, so effectively, the consensus is within our range because we are saying above EUR 2.2 billion, and we do see market conditions to achieve the consensus. Now being prudent in the approach because part depends on us. I think we do think and we are confident that operational-wise, we will have conditions to be above EUR 2.2 billion and to be close by the consensus. But we do need also to have then the right environment for that. And we have already anticipated that, for instance, refining margins will be higher. And we do see they will increase, definitely, due to the IMO impact. In a small statement, yes, we will see room space to align with the consensus.

The next growth cycle and all the options that we haven't opened, so clearly, we will continue with our financial discipline and finding projects that could continue to complement our portfolio. We have a great portfolio basis to start, and I think we have still room space to continue to extract value from that portfolio. For the next decade, we do see to make this company to grow above 10% per year. But of course, we are looking at alternatives, and those alternatives should include many different options, the ones that could allow us to adjust and to adopt our midstream infrastructures to the new demand or the evolution of the demand in the -- of the market demand. Possibly less keen about oil to petchems. It's something that less keen on that, but continuously looking at profitability projects that could achieve the return that we are aiming for. So the 15% continues to be our target.

Within the portfolio and the different alternatives for this new cycle, the new energy solution, the ones related with renewable energies, will also have a relevant position in our portfolio even though, all in all, if we will compare our capital allocation going forward, most of the resources, most of the CapEx allocation will be for the upstream activity. And that should continue to be with adjustments, of course, with discipline, but that should continue to be our primarily focus of capital allocation. Thank you.

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Operator [8]

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And your next question comes from the line of Flora Trindade from CaixaBank.

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Flora Mericia Trindade, CaixaBank, S.A., Research Division - Analyst [9]

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Just following up on your previous answer and considering the good free cash flow performance in the quarter, the cut in CapEx, the expectation of EUR 1 billion free cash flow in 2020. Are you considering any potential buyback in line with what other companies are doing in the sector? Or do you prefer a dividend increase? And also, is this dependent on the bid rounds outcome in Brazil? Just can you help us understand your rationale on this matter?

And then just secondly, a short question on the potential truck driver strikes in Portugal during August. Do you have any contingency plan? What -- do you have any expectation of potential impact?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [10]

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Flora, thank you for your 2 questions. The first one, we are entering, clearly, in the new cash cycle. And that will bring us a good program to have, which means we have continuously to find projects with high quality that fit our strategy following financial discipline. So entering in alternative solutions like buy back shares or other identical alternatives, I think is a conclusion that we will not be capable to find additional projects that could be value accretive for our shareholders. So we are sensitive with the sentiment of the market to have more shareholder remuneration and distributions. But we are also aware that the best way to bring value for our shareholders is to target and to find projects that could clearly continuously to create value. So I think probably, we will stand in a balanced position where we will be capable to do both, to continuously increase our dividend policy and to find value-accretive projects with the right and adequate strategic fit and with the right earnings or profitability.

About the strike, the truck drivers' strike that is announced for this August, of course, we have a contingency plan. That is already prepared. But the contingency plan will depend on the duration of this possible strike. We have identified all the sensible -- or the sensitive clients, and we have also identified all the relevant positions that should be continuously supplied. And we have also part of our network included in the emergency network, and that's addressing clearly all the priority entities that during this period should be supplied. But again, Galp is preparing to react to a strike that has nothing related with us, and that is more experienced in the country. It goes to the other supply chains like food retailers, like the known food retailers, so it's a more broad one. Let's hope that we will be fully prepared, and the strike will be abandoned sooner or later. Thank you.

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Operator [11]

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And your next question comes from the line of Thomas Adolff from Crédit Suisse.

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Thomas Yoichi Adolff, Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director [12]

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Two questions from me as well, please. Just firstly, on Mozambique, I believe there's a slight delay to the budgeted time line for FID of Mamba LNG. Perhaps you can explain what is driving that. Are you unhappy with the cost estimates? And are we starting to see some signs of tightness with the contractors? And then secondly, just kind of portfolio-shaping moves. What are your plans for the remaining stake in the ramp business? And how strategic is Angola and upstream to you?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [13]

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So Thomas, Mozambique, so it is one of the relevant projects where Galp is involved. So where we are today, today, we are analyzing, as we speak, we can say. We are deep diving on the proposal that we have for the EPC in order to see how we can optimize those proposals and how we can move forward. Important here is to say that we have already some of the most relevant milestones with a tick in the box as it is the case of the marketing, it is the case of financing, it is the case of the relationship between the parties in what respects to governance, its upstream activities that are progressing with good faith. And this part of the EPC is already undergoing. It's one of the most relevant ones. And we hope, as I mentioned during my previous statement, that up to the year-end, we will be in conditions to take a positive FID.

In what respects to your second question about regulated assets, these are good assets. It's clearly an operation that we have prepared to be part of a possible asset rotation in our portfolio. And we only will consider that if projects with the strategic fit for Galp and with -- value accretive, being capable to be captured by us. So we will continue to be a shareholder within GGND. We have recently increased our shareholding in one of the local distribution companies where we take almost the total of shareholding, allowing us to integrate and to merge in GGND. And we have that based on the cash available at GGND level, so it was nothing impacting Galp; and we will continue with this approach. So it's a good business. It's behaving very positively, and we will consider it as a global portfolio management at Galp level. Thank you.

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Thomas Yoichi Adolff, Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director [14]

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And Angola, please?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [15]

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Thomas, I'm not sure. What did you ask, please?

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Thomas Yoichi Adolff, Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director [16]

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How strategic is Angola and upstream for you? Yes.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [17]

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It's strategic related result, so it's a network that is relevant for our commercial activities, but it's not critical neither core in the company. So it's -- being a regulated asset...

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Thomas Yoichi Adolff, Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director [18]

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No, no, no. Angola and upstream, I'm referring to.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [19]

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Angola. Angola, upstream. Okay. So Angola, upstream. Angola is one of the 3 strategic pillars of the company in what upstream relates. Therefore, what I can tell to you that it is and it will continue to be. If you ask if Angola is providing us today with many potential alternatives, the answer is unfortunately, no. But we will see. From the downstream point of view, it's completely different because downstream, our activity is relatively small, and therefore, the impact in the company is almost irrelevant. Thank you.

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Operator [20]

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And your next question comes from the line of Joshua Stone from Barclays.

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Joshua Eliot Dweck Stone, Barclays Bank PLC, Research Division - Analyst [21]

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I've got 2 questions, please. First, if you could talk specifically about the Transfer of Rights bidding round in Brazil, how you're looking at that opportunity? And if you -- if there's any more clarity on the potential terms of the license?

And then secondly, on the Gas & Power division, you talked about a normalization of earnings and also a new basket of the gas, including volumes from the U.S. and Algeria. What would you say is an appropriate run rate of earnings to assume given those themes?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [22]

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So Josh, bid rounds in Brazil, so the main question here or the main statement here is that we will approach Brazil in a very careful way. So the excess of ToR, somehow, is impacting Galp because one of the parts or one of the assets that will be offered is precisely the one related with Atapu. There is then a second one, which the impact is smaller, is related with Sépia. And those 2, of course, impacting Galp, we have to analyze carefully the terms and conditions of these options. Brazil start to be relatively expensive. You can see by the bonus that have been released by the regulator. And therefore, we have to do it in a prudent way ensuring at least 2 or 3 elements that are relevant for us that we will be able to have reasonable returns, that we will be capable to implement strong partnerships and that we'll get the access to assets with the right size. So the complexity of this negotiation is clearly a challenge for the result of the option. And that's the reason why we are prudently approach even though we have this interest of seeing what is going on in 2 of our assets and looking at what might be the future development of those 2 assets.

In what relates to the gas business, so what we are observing in Europe is that the prices are historically low. And on this declining has to do with some market share fighting that we are observing from different locations, and Europe is being clearly the center of that dispute. So prices are so low that it seems that suddenly, cargoes, LNG cargoes could reach United States at a reasonable price. So putting United States being possibly in the neutral level of import/export.

So going forward, what do we see? We do see that being the inventories relatively high and the price is completely undistressed. The second half will be much more challenging for Gas & Power business especially for gas. And Galp will continue to work. You should remember that we have always the possibility to arbitrate between long term and spot prices, but complying with the long-term contract's quantities in an annual basis. So we do see a second half less promising rather than it was the first, even though we have already flagged that we might land above our right and limit of the range that we will always use as a guidance for the yearly result. Thank you.

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Operator [23]

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And your next question comes from the line of Michael Alsford from Citigroup.

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Michael J Alsford, Citigroup Inc, Research Division - Director [24]

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A couple of questions if I could, please, just on your guidance for the year. So on refining, you talked about a $4 per barrel refining margin for Galp for the full year '19. You've realized about $2.70 for the first half, so it implies a pretty decent step-up in the second half. So could you maybe explain how much you expect from market effects in the second half and how much you expect to sort of benefit from the investments you're making into the refining system for the second half?

And then just secondly, on CapEx. You've obviously reduced your CapEx guidance. I just wondered whether you could tell us sort of what's driving that? How much is just related to the delay to the Mozambique FID and how much we expect that to go into 2020?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [25]

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So Michael, guidance on the refining margin, clearly, the market or the margins are recovering. And you may remember that, as you mentioned, that we have been more positive, anticipating that the differentials of the middle distillates will impact the market sooner than later due to the IMO regulation. It has not been the case, but kind of it's like a tsunami has already happened and the wave has been formed and no one is looking at that. So sooner or later, we will see the margin going up.

On saying that is around $4 per barrel, we may see the second half slightly above the $4 per barrel. This is the guidance and this is the assumption that we have taken for providing you with the guidance for the full year. As I mentioned before, to Oswald, effectively, if the market could raise and could be better, we will be much better in terms of the full year. The investments and the works that we are doing today in -- or we will do this August in our Sines refinery will tend not to affect relevantly the margins since the conversion unit will continue to work at the optimal condition due to the market framework. So all in all, we are seeing a second half much better than the [first] one, and specifically the fourth Q has to be much better, where we will have the full season working properly.

In what CapEx guidance respects, we are pointing in a revision that is lower than our initial of the year. Part of that is related with Mamba. We anticipate that we might be spending at a higher base than we are doing today, not necessarily due to the fact that we were taking the FID earlier, but of course, it has also to do with other areas of the company, including with Brazil. So it's a mix. It's a combination, and we do think that will be around -- would be slightly lower but around EUR 0.9 billion. So that gives you an idea of where we will be by the end of the year. Thank you.

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Michael J Alsford, Citigroup Inc, Research Division - Director [26]

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Carlos, and just a follow-up then. So you'd expect next year's CapEx to be still around 100 -- the EUR 1 billion mark, sorry, and it wouldn't be higher than that given, say, timing effects of Mozambique?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [27]

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So we will go to that in detail in the near future. But one can see that most likely, we will be around numbers that we have provided to you, so EUR 1 billion a year is the guidance that we have for our annual CapEx, and you should consider that. There's no indication for having a different approach. Thank you.

(technical difficulty)

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Pedro Dias, Galp Energia, SGPS, S.A. - Head of Strategy & IR [28]

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Sorry, guys, I think we are having some technical issues. We will resume the call as soon as possible.

(technical difficulty)

Excuse me, we are just trying to find out what's going on in technical terms and we'll get back to you soon.

(technical difficulty)

Hello, we are still trying to find out what is exactly happening with the call.

(technical difficulty)

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Operator [29]

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Your next question is from the line of Irene Himona from Societe Generale.

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Irene Himona, Societe Generale Cross Asset Research - Equity Analyst [30]

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I hope you can hear me. I had 2 questions, please. Firstly, upstream unit production costs, which, in the second quarter, you say that excluding the benefit of IFRS increased about $1 to $8.70. I wonder if you can give us some guidance, please, for second half or full year unit production cost and the same for unit upstream DD&A? And then secondly, back to the cash cycle, Carlos, as you said, it's a nice problem to have. And I'm just trying to sort of understand the urgency to reinvest the free cash flow in a scenario where near term, 2019 to '20, let's say, you don't win Brazil or you cannot find some other cash accretive project, are you prepared to see the balance sheet deleveraging materially until such time as you may identify the right projects? In other words, would it bother you to sit on cash?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [31]

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So first of all, thank you, Irene, and a warm welcome to this call. And apologies for these interruptions, technical problems. In the digital era, we are less digital somehow. Thore will go through the first question about the production cost. So taking and picking up the cash cycle and the reinvestments in our organic growth, so you should -- one should bear in mind that the CapEx that we have point out for the future is what we call a risk CapEx. I mean if we look at the upstream projects, we are considering a certain probability of them to be succeeded. So if -- we will put hands in the best case scenario, we might have a clearly -- a requirement in terms of CapEx to develop those projects that will succeed. That's the reason why having a financial strong position is important to us to guarantee that we will be able to develop the full portfolio, the full Galp's portfolio. Anyway, the second level, if we will not be capable or if it will not be possible to find additional accretive projects, clearly, we will not start to spread our money, and we have to reinforce and to give back to the shareholders the money that we will be not capable to redeploy, which I hope that myself with the team will be capable to do precisely the opposite, and find those fit for purpose and with strategic alignment projects that could bring us returns, continuing this company to progress and to succeed. So Thore, can you elaborate on...

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [32]

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Absolutely. Thank you, Carlos, and thank you for the question. The increase in the production cost on a unit basis is related to the fact that we are starting up new units, and that is the simple and straight answer. As these units are getting up to plateau production, you will see that the unit cost will also then to start to come down again. So this is a normal behavior, and its aim is related to the DD&A. When it comes to guiding going forward, for this year, you will have to expect that the level that you saw in the second quarter should come somewhat down during the rest of the year as the ramp-up continues and there will be no unit coming on-stream before -- towards the end of this year.

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Operator [33]

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Your next question comes from the line of Jon Rigby from UBS.

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Jonathon Rigby, UBS Investment Bank, Research Division - MD, Head of Oil Research and Lead Analyst [34]

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I have 2. One is just thinking about the perimeter that you have or you enjoy in terms of reinvestment, and I'm thinking about a few things, one is what you think your balance sheet capacity is, whether you think the sort of 2x EBITDA number continues to be a figure that we should think about as the upper limit of the gearing you'd like to get to? And then the second is, clearly, if you make additional investments, they bring with them additional CapEx but probably not a huge amount of production for a while, maybe some. And so I just wondered whether you could give me some kind of indication about where you think the company, all equal, should be cash-neutral going forward, just so that we have some idea about the way you would think about new investments and the commitments that they bring with them? And then the second one is just a point of detail is -- or clarification. If and when you FID Mozambique this year, is there a relatively big cash call that comes on the point of FID, which will maybe sort of disproportionate to the ongoing CapEx that comes with the FID announcement?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [35]

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Jon, thank you for your questions. So from the balance sheet point of view, I'm looking at our self-defined covenant of the times EBITDA to debt. The principle is that in our industry that is quite volatile, it's important to have a safe zone from financing point of view. As I mentioned before, we are entering in a level where this company has been deleveraged, which was planned a couple of years ago, so we are clearly complying with it -- what we -- was our plans. And from organic cash spending point of view, we still have a few projects, a few assets inside of our portfolio that will require CapEx for the coming years. You mentioned the balance between reinvesting with new CapEx and longer-term production. So it's something that we have to continue to look at due to the fact that we are not desperate or anxious to capture new projects just to guarantee new production. We still have it in our plan for the next decade. What is important is that we can find additional accretive projects that could continue to allow us to evolve with the same growth and value profile in the next -- in the new cycle. So from the cash neutrality point of view, from the organic point of view, I think we are clearly balanced. If we will find additional projects, we have to consider that at the light of the portfolio management being by exchanging long-term production with short-term production, looking at different assets that we have and considering that for asset rotation, so it's portfolio management, if you allow me.

In what relates to the FID of Mozambique, we should not consider a relevant cash call from -- a front payment, let's say, apart of the one that are related with financing the projects. And that is in line with what we have planned and there should not be any surprise in that respect. Thank you.

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Operator [36]

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And your next question comes from the line of Matt Lofting from JPMorgan.

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Matthew Peter Charles Lofting, JP Morgan Chase & Co, Research Division - VP [37]

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Two, please, if I could. I mean, firstly, just coming back to some of the earlier comments around strategic growth opportunities and balancing that against cash return. Could you clarify, Carlos, what you analyze is the right sort of range of investment for Galp in the ToR if the terms are right, and calibrate it either or against where that could take up in net debt-to-EBITDA terms against the 2x ceiling or sort of the scaling of CapEx or a more holistic view on capital allocation? And then secondly, on CapEx, I didn't fully follow the earlier answer. To what extent is lower full year '19 guidance structural or really a function of Mozambique phasing between 2019 and 2020? Put it a different way, is there really an underlying cut here on a cumulative 2019/'20 basis?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [38]

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So Matt, Brazil, Brazil is not just ToR. It's ToR amongst our asset that will be offered in the auctions to come. So you have to excuse me. I will not answer in details in what respects, what would be the dimension for -- it's not a secret, but it's part of the game. But you know our size. You know our perspective. I think we consistently have been playing in a certain dimension. So you know that primarily, it's important to have financial discipline and find out the right economics to expose ourselves because in some cases, it seems to be exchanging future barrels for today's dollars. Let's see if it is value in between. In what relates to CapEx, let's put that also in a context, it's a fine tuning. We are guiding you that it is not EUR 1 billion but a lower CapEx perspective going forward. If it was higher, we should also just -- do the same. So please consider this as a fine tuning, nothing else.

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Operator [39]

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And your next question comes from the line of Christopher Kuplent from Bank of America.

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Christopher Kuplent, BofA Merrill Lynch, Research Division - Head of European Energy Equity Research [40]

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I've got 2 questions as well and they're on guidance, and I appreciate you're going to have your investor day in maybe half year's time, but if you can maybe respond to a bit of impatience. You've changed your own '19 guidance, and I wonder on EBITDA, first of all, whether that has any bearing on how you think about 2020? You've obviously raised the underlying oil price assumption. I believe your existing EUR 3 billion plus EBITDA guidance for 2020 has already been based on $65 Brent, but would you make any comment, please, on refining margin guidance behind that EUR 3 billion guidance for next year? You've obviously made quite a significant change for your underlying 2019 assumptions. And also, perhaps comment a little bit about Gas & Power EBITDA, which seems to be running potentially ahead of guidance for this year, whether you can see the same happen next year. And I'll leave it there.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [41]

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So Chris, as you correctly mentioned, factories are better than expected this year even though we've had a challenging context, so it should happen the same for the next year. So we are not seeing any rounds different from being consistent with what we have guided to you for 2020. And therefore, we hope we can do at least what we have guided you for 2020, if not better.

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Christopher Kuplent, BofA Merrill Lynch, Research Division - Head of European Energy Equity Research [42]

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Sorry, just if I can double check, the earlier communication you gave us on 2020 and the refining profitability environment, you said at that time, I think it was February, that profitability should be slightly higher than in 2019. Now 2019 seems to come down -- seems to have come down than your expectations. Does that not impact how you think about 2020, too?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [43]

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Yes, you're right, so we have adjusted, as you noticed, our refining, not our Refining & Marketing, due to the margins that were not there before. Anyway, we are seeing the market going forward more strong. And if you look to the futures, clearly, the market is there, and therefore, we are not seeing any rounds for being lower or inferior of what we have guided for 2020. And again, refining business by itself is being less and less weighted in the global EBITDA, so this will be much more contribution from the higher areas and mainly from the upstream activities.

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Operator [44]

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And your next question comes from the line of Yuriy Kukhtanych from Deutsche Bank.

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Yuriy Kukhtanych, Deutsche Bank AG, Research Division - Research Associate [45]

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Yes, 2 questions please, both on downstream. It is still important for your cash flow, I believe. First question on the arbitrage opportunities in the Atlantic Basin. Gasoline [and that's, of course, was too] very important for your refining business, so I'm just wondering if you still see these opportunities, if you still see the market to sell profitably gathering to the East Coast, especially in light of the recent supply disruptions? The second question on the marketing, please. You mentioned that demand is growing in Iberian Peninsula, but it is not reflected in your volumes, which are down more than 5% year-on-year. So if you could just elaborate a little bit more on how profitability in marketing worked in the second quarter? And what drove that profitability apart from volumetric changes on the market?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [46]

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Thank you, Yuriy. Arbitrage in the Atlantic Basin, so you know that we had several initiatives related with export and swapping products mainly and starting by Iberia, which is an important source of supply optimization. The second element, as you know, is related with our both gasolines on United States that allow us to capture a premium over European gasoline, and we do see that this will continue in the coming quarters, not foreseeing the coming years. In what respects to the arbitrage, there's something that might happen. We have this as a base case, which is the increasing of the middle distillate spreads. Actually, looking at the IMO regulation, looking at the inventories of fuel oil, it will be a market requirement to be more demanding on marine diesel on very low sulfur fuel oil. And the impact in the middle distillate cracks, the positive impact on middle distillate cracks is something that will allow us for sure to capture part of that. I hope and it seems to be the case that during the fourth Q, we will have our full refining systems working properly. We have already anticipated some deliveries to a few clients, and that could be one of the key elements for the margins increasing the fourth Q. The volumes in Iberia, what I can tell to you is that we are being more selective, so demand is growing. The volumes of Galp sold to direct clients, they are also growing. In the other segments, we are being very selective because it's not a volume-driven commercial strategy, it's a value-driven commercial strategy, and therefore, it's important is that we can follow clearly the segments where we can capture more value. Thank you.

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Operator [47]

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And our next question comes from the line of Alwyn Thomas from Exane BNP Paribas.

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Alwyn Thomas, Exane BNP Paribas, Research Division - Analyst of Oil and Gas [48]

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Just a couple of quick ones for me. Firstly, on your investment plans regarding low carbon, I haven't seen that many material moves from you guys as yet, but I know you're planning to spend 5% to 15% of the budget in coming years. Any sort of color on where you might be looking any projects, in particular, that could start to ramp up a little bit on the CapEx side in the next -- in the near term? And then I see -- if I'd just turn your attention to exploration. I mean excluding the barrel payment in the second quarter, your exploration spend this year has been pretty low. I was just wondering what your plans are for drilling further appraisal in your Carcará assets, but also Uirapuru, when do you expect that to be drilled? And other sort of key wells to be watch for the next sort of 12 months or so, if you could help me that, Thore.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [49]

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Alwyn, so low carbon, you're right, what we have provided to you is our guidance of 5% to 15% and levers. I mean net for typology of projects, we have also to consider that they are project financeable, most of them. So we are building a set of portfolio of solar PV projects. We have a few of them already under development, so let us to go more in details in the coming future to allow you to know where we will stand. Anyway, our plans are clearly to increase our renewable power generation capacity in a way that we will progressively -- could balance our commercial electricity business in a way that we will be fully integrated as we are in other businesses. Exploration CapEx, we have several activities. I will pass through to Thore to go further in depth of those. Anyway, we have many of the initiatives in Brazil, in Namibia and São Tomé. But I will pass through to Thore to elaborate on that. Thore?

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [50]

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Yes. Thank you, Carlos. On exploration, what is to look for there, the next things that will happen is actually we do a DST on Guanxuma, so we will take to the rig that has not been drilling Carcará North to Guanxuma and then do the DST. Secondly, it is an ambition that we will spud the first well in Uirapuru during the first quarter of this year. This is still not confirmed, but that is the ambition. And then we are continuously maturing our position in São Tomé and Príncipe and in Namibia -- São Tomé and Príncipe, we are now very, very good seismic acquisition that was done. We are very close to conclude with our partner at the first drillable prospect, and that there is a possibility that we can spud and drill the first well there during the course of -- end of next year or 2020, early 2021. And we're going through exactly the same process in Namibia, de-risking and analyzing seismic data both in PEL82 and PEL83. For the time being, it is too early to forecast any drilling activities there, but we are maturing the [director]. Thank you.

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Alwyn Thomas, Exane BNP Paribas, Research Division - Analyst of Oil and Gas [51]

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And if I could just follow-up on the low-carbon investments. Carlos, are you -- would you consider adding some existing power generation through inorganic activities? I mean I know this year your peer Repsol has obviously done that, and it's a reasonably large acquisition in that area. I was wondering whether you feel that perhaps you need some critical mass in terms of customer base in order to sort of springboard that side of the investment?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [52]

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Alwyn, we have a different approach because we have a starting point where we have already a client base for our business, and therefore, we are much more focused on the upstream of that activity, meaning to be capable to generate to previous elections, so we may consider some inorganic moves. Anyway, they should be with a small scale and more related with the acquisition of portfolio projects rather than to be exposed to a big transaction. We also consider other instruments but not with the dimension that you have referred. Thank you.

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Operator [53]

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We will now take our last question, and that question comes from Alessandro Pozzi from Mediobanca.

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Alessandro Pozzi, [54]

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I have 2 questions. The first one is on Lula. I remember you previously indicated the recovery factors just above 30%. I was wondering if you can maybe give us an update on the potential upgrade in the recovery factors there going forward? And also, second question is on the scrubber uptake, we've seen that increasing over the last year or so. I was wondering if that is going to change, a little bit, your view on the impact of IMO in 2020? Or it's a duration?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [55]

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So Alexander, thank you to you and to all of you to waiting at this moment. So Thore will take the first question about our recovery factor targets and the work that is being done towards that. So scrubbers, what can I tell to you is that it's according what we have expected, so we are not seeing too many. But where we are observing is that some of the big companies, they have considered that scrubbers is one of the possible and economic solutions, which means that the market will continue to have a portfolio of different fuel, marine fuel specifications so it will be a combination as anticipated. And that will take time in the market up to a full conversion. Thore, can you elaborate on the recovery part, please?

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [56]

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Yes. Thank you very much, Alexander, for your question as well. Our ambition if Lula remains, as they have been stated before, our long-term ambition is to get the recovery that is above 40%. Correctly, right now, we have identified measures so that will -- can bring us to around 31% and then it is a systematic day-by-day, year-by-year work in order to find ways to improve. (inaudible) Our focus has been so far to bring up to units that is now producing in Lula. Second ambition then, we then keep them unplugged (inaudible) press as long as possible. That would then include looking for infield drilling opportunity so that you can maximize the plateau period level. Over and above that, we have nothing new to say to the market for now. Thank you.

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Pedro Dias, Galp Energia, SGPS, S.A. - Head of Strategy & IR [57]

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Well, ladies and gentlemen, apologies again for the interruption. we hope you have found this update useful. And I remind you that the IR team is always available for any additional clarifications. Have a great day, and good holidays. Goodbye.

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Operator [58]

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Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you all for participating. You may now disconnect.