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Edited Transcript of GALP.EP earnings conference call or presentation 22-Oct-19 10:30am GMT

Q3 2019 Galp Energia SGPS SA Earnings Call

Lisbon Oct 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Galp Energia SGPS SA earnings conference call or presentation Tuesday, October 22, 2019 at 10:30:00am 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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* 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

* Giacomo Romeo

Macquarie Research - Analyst

* Irene Himona

Societe Generale Cross Asset Research - Equity Analyst

* Jason Gammel

Jefferies LLC, Research Division - MD & Senior Equity Research Analyst

* Jason S. Kenney

Grupo Santander, Research Division - Head of European Oil and Gas Equity Research

* 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

* Sasikanth Chilukuru

Morgan Stanley, Research Division - Research Associate

* Thomas Yoichi Adolff

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

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Galp Third Quarter 2019 Results and Strategy Update. (Operator Instructions) I must advise you that the call is being recorded today, Tuesday, the 22nd of October, 2019.

I shall now hand over to your speaker for today, Mr. Pedro Dias. Please go ahead.

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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 the conference call for Galp's Third Quarter of 2019 Results and Strategy Update. Carlos will go through the presentation, and we will be available to take your questions at the end. Filipe and Thore are also here with us today.

As always, 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. Thank you.

Carlos, the floor is yours.

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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. Thank you for attending to our call of our 3Q results and strategy update. So today, I will start with a reference to Galp's recognition for the eighth year running as an industry leader for the Dow Jones Sustainability Index. Galp ranks #1 in Europe, ranking thirdly globally, and this is the result that encourages us to continue to pursue the best practices in our activities. And of course, I'm grateful to see our team and our strategy recognized once again.

So now to the results. And starting with the free cash flow, which was solid during the first 9 months and already cover the full year dividend distributed to Galp shareholders, and we think that we would be comfortably meets the guidance we provided you with earlier this year. I will go through the performance of our divisions, and I will start with downstream on Slide #5.

So during the Q3, we performed the planned maintenance in our Sines crude distillation unit as we have anticipated to you. We used the opportunity to implement additional energy efficiency initiatives, which are part of our additional $1 per barrel program. We are now already able to capture $0.70 per barrel in our refining margin.

We also have an upset during September, drove by a lower-than-expected utilization rate in our conversion units. The units are now running in normal conditions, but September throughput and refining margins were affected. And you see that -- you saw that in our results. Considering the lower-than-expected performance year-to-date, we may stay slightly below the anticipated $4 per barrel margin for the full year. October margins have been until now between $4 and $5 per barrel, and we see upside potential from the pre-IMO period, which is upon us.

On this matter, Galp is fully prepared to supply compliance fuel according to the IMO specs. Oil marketing and Gas & Power provided, once again, I emphasize, solid results, maintaining its important and resilient cash contribution. During the quarter, we have established PPA, which is a Power Purchase Agreements, correspond to around 10% of our current electricity sales based on renewable solar photovoltaic generation projects. This is part of our strategy related to our powered business integration, aiming at providing our clients access to efficient and environmentally sustainable energy solutions.

Moving to upstream on Slide 6, you see that working interest production was up quarter-on-quarter, benefiting from the ramp-ups in Brazil and Angola. In Brazil, we have one more unit at plateau only 10 months after its start-up in Lula Extreme South. In Lula North, the Unit No. 9 is already ramping up nicely. In lara, the FPSO #10 for Berbigão and Sururu is expected to start production in about a month or so. We are currently producing around 130,000 barrels a day. And under normal circumstances, we could get to or even beat the high end of our full year guidance that we have provided to you in a range between 8% and 12% growth year-on-year.

On 4 coming projects, we have an additional unit for Atapu. We have FPSO #11 and another one for Sépia this 12th FPSO which are expected to see first oil in 2020 and 2021, respectively.

Still on pre-salt exploration activities, the high potential with Uirapuru wildcat is expected to be spud before year-end. On Mozambique front, construction of the Coral South FLNG is progressing according to plan. Importantly, key EPC contracts have been awarded for the first phase of the large Rovuma onshore project to allow us to advance the preparatory works ahead of the project's final investment decision in the first half of the next year. First gas for Coral is expected for 2022 and 2025 for Rovuma onshore.

Now on Slide #8, we can see the results. So group EBITDA was EUR 619 million in the quarter, down year-on-year, driven by lower contribution from refining, which more than offset the stronger upstream performance. Net income was considerably down year-on-year driven by refining and noncash entries below the line. Here, we have currency translation adjustments related to IFRS 16 lease obligations in Brazil and mark-to-market of derivatives to cover natural gas prices risk.

On cash flow in -- on Slide #9, you can see that year-to-date free cash flow amounted to about EUR 700 million, covering the full year dividend payments to Galp's shareholders. This was supported by the robust operational contribution with net CapEx amounting to EUR 564 million, where the CapEx for the full year should stand below our previous guidance that has been provided to you of around EUR 900 million. This cash generation continues to support our strong financial position with the net debt-to-EBITDA standing at 0.8x.

I will now go over the strategy update starting by Slide 11. The capital allocation guidelines are consistent with our trajectory. We will primarily focus on very selective investment program not only in the upstream but all across the energy value chain. We will pursue the integration with lower carbon energy solutions allowing to adapt to customer needs and reducing our carbon footprint. We will maintain our focus on value creation, so we will continue value-driven company and sustainable long-term growth, doing this, at the same time rebalancing growth investments with the progressive shareholders' distribution.

On the CapEx side, we will be focused on extracting additional value from our large and promising asset base while exploring new value opportunities around it. This means developing our outstanding upstream portfolio and continue to optimize efficiency, costs and recovery rates. Any portfolio addition would be to maintain or to enhance our differentiated upstream value proposition.

On Mozambique LNG projects, we will, of course, and this project has a key role in increasing the weight of the gas in our portfolio. We are also increasing our commitment to low carbon power generation. We are gradually developing a renewal power generation business, which will provide a natural edge to our commercial business. All in all, equity investments in renewables and also in new businesses should account for 10% to 15% of our net investments in the coming years, provided project returns are according what we expect.

On the downstream, the plan is to further improve the performance of our midstream and commercial activities. In refining, we will continue to increase the competitiveness, efficiency and suitability of our system in line with demand patterns and regulatory changes. These are primarily incremental projects. Larger potential projects may be considered if and when and only when we get confident on the sustainable value creation to Galp. Required returns from this project should run competitively with other portfolio projects.

Still on the downstream, we are progressing on building a natural gas and LNG portfolio, which could be leveraged by our Mozambican equity gas production. On the commercial side, we intend to grow and leverage on our Iberian client base with an integrated offer where the client is at the center of our strategy and organization. We are currently reshaping our multiproduct organization to that purpose. Overall, over 40% of our planned net CapEx is meant to capture the opportunities coming from the future energy demand patterns while reducing our carbon footprint.

Our priority is to create sustainable value across all businesses and increase portfolios resilience for the next decades. Project returns will, of course, vary considering their characteristics, namely size, risk profile and financing structure, but the competitiveness of our future investments will remain aligned with the group's ROCE targeting of 15%. We also keep our commitment to remain below 2x net debt-to-EBITDA and will rotate the existing assets if required to create space to fund inorganic opportunities.

Now on the shareholders' distribution. We are now targeting a dividend per share increase of 10% per year for the next 3 years. This underpins the confidence we have on our planned resilience. CFFO, on Slide 12, you can see that is expected to grow at an average of 8% per year up to 2022 even though it should be more front-loaded. This is very much in line with what we have guided before even if we are now assuming lower refining margins going forward.

During that period, and we are focusing in the next 3 years, net CapEx is expected to range between EUR 1 billion and EUR 1.2 billion per year on average. This includes room to accommodate the now the largest Mamba trains and/or buy versus leave decisions for upcoming FPSOs and new projects on top of our organic base. Around 70% of our investments are grow our company, the benefits of which to come beyond the presented time frame.

To conclude, I would like to retain the key message that you can find on Slide 13. Galp has a unique and distinctive asset base, highly competitive and resilient to different macro conditions. This is our unique profile. Our commitment is to continue to reinforce our portfolio to generate sustainable growth for the long-term, being part of the ongoing energy transition and gradually reduce the carbon intensity of our activities. We will be selective in additional investments, and those will be contingent to attractive returns and to meeting our commitment to keep a strong balance sheet. And we will continue our differentiated investment to grow the company, balanced with a competitive shareholders' return, assuming now a 10% annual increase dividend per share.

So we are 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) Our first for today is Biraj Borkhataria from RBC.

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

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I have 1 for Thore and 1 for Carlos. On Brazil and the ramp-up at Iara, is there any reason that the latest FPSO the pace of the ramp-up, would be different to the 10 months you achieved in the latest one at Lula?

And then second question is for Carlos. In the context of your capital allocation and shifting towards gas, what are your latest thoughts on Transfer of Rights and doing more in Brazil? Obviously, it would probably be a higher return, but it doesn't tick that transition box. So any thoughts on that would be appreciated.

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

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Biraj, thank you. I would take the second question as you asked. So effectively, we are looking at Brazil and carefully analyzing the bill rounds forthcoming. We have, what we can say, a kind of an insider in some of the areas, namely the ones where we are already. But this is a very competitive round and with demanding terms and conditions as some of our industry players already mentioned. So we are looking to this very carefully. We will keep our financial discipline even though from the strategic point of view, it makes all the sense. But the terms and conditions are really demanding. That's what I can comment to you. So I will pass now to Thore.

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [4]

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Thank you, Biraj. What I can say is that in our plans, what we have used in Galp, we're using 15 months for the ramp-up. You are very correct on pointing out that for the last -- latest FPSO actually, we reached plateau in 10 months. So there might be a slight opportunity for some improvement on the next FPSO going to Iara, Berbigão and Sururu, more specifically, but that is what we are factoring into our plans. We stick to our 15 months, and that is the base case for it. And then we work hard to do those.

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Operator [5]

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Our next question for today is from Flora Trindade from Caixa bank. Okay. I think we'll go to our next question. (Operator Instructions)

The next is from 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 [6]

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First question is on production and the realization in upstream. I noticed your realization in the third quarter improved a little bit from a discount of $7.80 to $7.30, and I wondered whether you're starting to see realizations improve on your medium sweet crude from the Lula field.

And then secondly, just on your statement, the statement on production currently at 130,000 barrels per day. Where can production go to once FPSO #9 in Brazil and Kaombo Unit 2 both are at plateau production?

And then maybe finally, just coming back to the point you made earlier on, on terms and conditions as far as the transfer of right is concerned. In your presentation, you've highlighted that your aim is to keep a group ROCE, return of capital employed, of about 15%. Now when we consider Mamba LNG, that isn't going to generate the 15% return. That was stated by 1 of your neighbors in Mozambique, and I wondered whether the transfer of right opportunity actually meet that 15% threshold.

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

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Thomas, I will take the two other questions and related production for Thore. So in terms of realization price, we have, in the past, continuously highlighting, that we did see Lula medium heavy sweets grade to increasing their valuation in the market as the IMO were approaching. So effectively, what we are observing is that Lula is clearly trading today above Brent, and we see still room space to continue to increase that trend.

In what respects to the return on capital employed, effectively, new additions to our portfolio has to be consistent with this target. You have mentioned specifically Mamba LNG. I will not enter in details, but I only can tell you that I don't review myself on the comments that you have mentioned, whatsoever, and we are looking at Mamba LNG as one of the most competitive projects around the world from itself, and we are comparing with United States greenfield or brownfield projects, and on addition, with the location. So I think that Mamba will clearly contribute for this return on capital employed over time. And more important, you should also bear in mind that there are some common facilities that are being developing today that will be used and shared by future trains. So all in all, we are confident that Mamba will play an important role on this.

Passing to Thore but not before saying to you that for the realization price is also important, not just quality of the Lula but also the liquidity that is increasing in the market. And both, together, they are really contributing for that. So I will now pass to Thore to speak about the production.

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [8]

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Thank you, Thomas, for your question. We will come back to you with a more precise update in the beginning of next year when we have our fourth quarter outlook with respect to production and what's the production target we can go for the next period. We are in the midst of the process of now consolidating the numbers, putting them together, so I will be a little bit careful today to be too permanent. But what I can say is that on days where things are going really well, we now have a production capacity that gets very close to 140,000 barrels per day. But this is operation, and things are not always going well every day. That's not where it is. So there will be continuous effects that you need to factor in. And as you know, in our plans, we expect the production efficiency in the order of around 90%. But we will come back to you with better numbers, and we'll present numbers in February, March.

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Thomas Yoichi Adolff, Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director [9]

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Did you say 140 kbd, just to clarify, on good days?

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [10]

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Yes. So it's very close, yes.

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Operator [11]

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And we have Flora back from Caixa Bank.

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Flora Mericia Trindade, CaixaBank, S.A., Research Division - Analyst [12]

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Yes. Hello? Hello? Hello? Can you hear me?

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

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Yes, Flor. You can go ahead.

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Flora Mericia Trindade, CaixaBank, S.A., Research Division - Analyst [14]

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Sorry, I have some technical issues here. Just on the EUR 1.2 billion limit of CapEx you mentioned, are you saying this is an internal limit, so you won't go beyond this? Because you mentioned also tradition has a possibility to -- can you just give us an idea of what kind of assets could be in this list for rotation?

And also if you can just clarify, I assume you are not telling us whether you will go for the TOR plus bid or not, so I will skip that one. And just wondering if you could just give us an idea of the -- what kind of renewable energy businesses are you looking at. I assume it's greenfield, but can you just give us some color here? You just mentioned that -- the potential CapEx, but can you give us details on technologies and the locations?

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

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Okay. Flora, thank you. Trying to answer to you, to your questions in a -- with a single answer. So effectively, our CapEx allocation is, on average, within that range, and we will not see any [thinner] on average, first. And secondly, we are not seeing any chance to overpass that level, to be above the high -- the right side of the range. That said, how we will split and what are the main consideration that we should take on going forward. We -- I have already mentioned the TOR, so I will not mention more. It's undergoing process. The only thing that I would like to emphasize is terms and conditions are demanded -- demanding, and we will always look at value over any volume or other variable decision.

In terms of the new transition or the renewable, we are looking preferably to solar PV but not disconsidering other technologies. So we are not excluding, for instance, wind or any other technologies. But clearly, our primarily focus will be solar PV, where we are already developing a set of internal projects in Galp that will play an important role on hedging and complementing our power business that clearly is without no power production. And we are speaking about greenfield projects, so mainly in this case.

So looking for the most important assets that we have to develop internally and that also will play an important role for the energy transition, clearly, is our Mozambican gas project. So that will take an important part of this CapEx. And of course, another portion is related with Carcará. Carcará is the new kid in town, if you would like to say that, that will have us involved and actively work on for the next coming years. Still different stages. So the first stage, which is in development concept, is progressing quite well, with some decisions recently taken towards that project. Second phase, still in the early stage, and we have to work in more in detail. But Carcará is another relevant project.

Finally, a word to say that we are clearly committed to cost reduction and to increasing on recovery factors by using different techniques that we have already shared with you many times. And to clearly extracting more value from the existing set of assets is something that is for us important. At the same time, we are putting new units on the production in Iara field, in Sépia in the coming years. So that's what I have to say to you. Thank you.

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Flora Mericia Trindade, CaixaBank, S.A., Research Division - Analyst [16]

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Just on the assets rotation, I don't know if you can just share your thoughts on what could be included here.

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

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Flora, as you may understand, we are not commenting on possible divestments. So we will speak about real things and nothing that is hypothetical. The only thing that I think it is important for all of us is understanding that our commitment for organic and, if any, unorganic projects we'll claim is to stand within this range. And we will consider at the time and based on real opportunities and the returns alternatives to take decision. Thank you.

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Operator [18]

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Our next question for today is from Jason Gammel from Jeffries.

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Jason Gammel, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [19]

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I just had a couple on the downstream if I could, please. You made the comment during the presentation that Galp was going to be fully prepared to supply compliant bunker fuel for the new IMO regulations. I was wondering if you could reference that to the fuel oil production during the third quarter that was 18% of your yield, and how much of that would currently be compliant with IMO standards?

And then the second, and I think closely related question, is that your crude slate during 3Q was 91% medium and heavy. How much flexibility does your distillation capacity have to lighten up that slate if the economics of fuel oil relative to diesel were really close on that heavy fuel oil?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [20]

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So Jason, thank you for your questions. Effectively, we are really prepared for compliance fuel oil that we will start to supply the market during November month. You have also to bear in mind that during the third Q, we're in a special operating mode with our crude and distillation unit and stoppage, and therefore is hard to take conclusions for the yields that come from that.

Flexibility and yields are the 2 points that you have mentioned, starting by the flexibility. We have been using more medium heavy sweet crudes rather than sour due to the fact that sweet crudes were very competitive comparing with the sour. And the reason why behind that is the fact that the sour crudes were not discounted as previously anticipated. So they were, one can say, more expensive than it should to be more competitive with sweet. So we still have some flexibility. We have between 20% and 30% to increase our sweets in our crude basket diet. But in average, you can consider that we stand between 60% and 70% sweet and 30%, 40% sour going forward.

In what relates to yields, we have flexibility to produce compliant or high fossil fuel oil contents. Here, the decision, which will be based on a pure economic approach, and therefore, where we are preparing ourselves is to have flexibility to use the different feedstocks to allocate them to 1 or to the other or to both according to the economics. I hope this clarifies your question. Thank you.

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Jason Gammel, Jefferies LLC, Research Division - MD & Senior Equity Research Analyst [21]

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Yes. That's very helpful. And just a quick follow-up, please. Are you actually seeing demand for low sulfur fuel oil already in the market yet given that we're getting pretty close to the end of the year?

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

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The answer is yes. There's plenty of demands in the market. And we do see for the coming years that demand will decrease, but it will stay over there. So again, our decision, it will be based on pure economics. So we will tend to be -- to use more conversion and desulfurization or less depending on the economics.

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Operator [23]

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Our next question for today is from the line of Giacomo Romeo from Macquarie.

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Giacomo Romeo, Macquarie Research - Analyst [24]

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Carlos, just 2 very quick ones left for me. The first one is back to Europe, 10% to 15% investments in renewables indication. Just wondering the sort of -- is the focus over this will be the Portugal or broader Iberian peninsula or if you will be considering the investments outside of Europe and whether, you talk about 10% to 15%, you're looking at levered or unlevered?

And the second question is just on -- back to your -- to the concept of asset rotation. Given that we haven't seen any asset rotation from you in the recent years, is this -- would these happen only if you were to go above the EUR 1.2 billion as a sort of -- to make sure that you remain within that financial constraints? And how would you consider the rebalancing of the portfolio? Is it driven by exposure to type of hydrocarbon, rebalancing of original rebalances? Just wanting -- just want to understand a little bit more in terms of what is behind this statement?

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

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Giacomo, thank you for your questions. So from the renewables point of view, simple and straightforward. We will start where we have our client base. So we will start in Iberia. This is levered CapEx. And I think if there is a strategic advantage, it's precisely to increase our upstream of the electricity precisely where we have already a relevant base of clients.

You have also addressed the asset rotation. So we have done a few but small asset rotation in the recent years. The biggest one was early in this decade when we have divested 30% on our Brazilian subsidiary. And the reason why for doing that is to ensure that we will have the full resources to develop the amazing asset that we have at that time.

So we didn't done many asset rotations because we do think that we were the best owners for the time being on the assets that belongs to our portfolio. Going forward, effectively, we cannot limit ourselves that we will only do asset rotation if we will go beyond EUR 1.2 billion, but it depends. It depends, but what is our commitment is we will keep within the range of a net investment between EUR 1 billion and EUR 1.2 billion, maximum. And if that implies asset rotation, we will do it. And if we will do it, it's because we do see more value for the company going forward than with the existing portfolio. I hope this answers to your questions. Thank you.

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Operator [26]

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(Operator Instructions) The next is from Michael Alsford from Citi.

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Michael J Alsford, Citigroup Inc, Research Division - Director [27]

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I've just got a couple, please. So just firstly, on the cash flow growth target of 8%, 18 versus 22, I was just wondering whether you can give us some underlying assumptions as to how you see cash taxes evolving? I'm assuming that's partly the reason for why you sit at the more front-end loaded cash flow growth in the guidance. And I guess if you could maybe relate to that, what's the spending level that you're expecting particularly around Brazil, I guess, to get us to that cash tax number? That would be my first question.

And then just secondly, just on the downstream, I appreciate you mentioned the larger potential investments you're doing more work on, but I was wondering whether you can give a little bit more color as to what type of projects you're thinking about. What could be the strategic nature of those in order to get more sense as to potential CapEx involved?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [28]

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So Michael, good to listen to you. I will ask Filipe to go throughout the cash flow and the spending level. I will take the CapEx question. So effectively, I mentioned that in the downstream, we might see inorganic CapEx. What I can tell to you is that we, until now, we have been analyzed several options for optimize our refining system and to make it competitive and adequate to product specifications. We have rolled out some of those projects. We don't have a specific one.

What we are looking at is how we can deepening and extracting value from our midstream, increasing our conversion and increasing the quality of the products and evaluation of the products that we have in our midstream system. So we are still analyzing feasibility and expected returns. And I don't think we will have anything close by in the next year or so. So we have just considered because it's a 3 years' plan. And within this time frame, it might appear, but we don't have a specific one now to consider. So I will now pass to Filipe.

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Filipe Crisóstomo Silva, Galp Energia, SGPS, S.A. - CFO & Executive Director [29]

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Michael, in all likelihoods, and this is to answer why is it front-loaded, the cash growth, because in all likelihood, 2020 will be a very good year for us given how much equipment we have been deploying over the last few quarters. So production has a significant increase next year. We also had a pretty tough refining environment during 2019, so you would expect 2020 to be much stronger also on the downstream front. On -- taxation does not really play a role on this, so we're still looking at overall cash taxation in the mid-40s% on a cash basis going forward.

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Operator [30]

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Our next question for today is from Joshua Stone from Barclays.

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Joshua Eliot Dweck Stone, Barclays Bank PLC, Research Division - Analyst [31]

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I've got 2 questions left, please. One, just the CapEx for this year. It seems to be trending a bit below where we thought. So I wondered if you can help [guide] us where you think 2019 CapEx will end up?

And then a follow-up on the refinery investment. I appreciate you're not looking to make a decision within the next year, but what do you think a likely budget that could be attributed to that or the sort of things you're looking at? How big would we be looking?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [32]

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Josh, so what we have for this year, and you see part of this CapEx plan for 2019 being below, what do we have appointed has to do, one of the elements is precisely with our Mozambican projects that the FID will only be taken in the next year. And therefore, part of that is a delay. These are rolling up CapEx spending.

Mamba is, I would say, a CapEx that has to consider not only the -- for the upstream activities but also the midstream and the -- and all the common facilities. We do see Mamba raising in terms of global CapEx in the mid-20s of -- mid-$20 billion, I'd say, so being a competitive, as I mentioned to you, a competitive project. But the other projects or the other CapEx is more allocated to refining. We still have some maintenance refining and also some downstream activities, which we should bear in mind that typically, when we put midstream with commercial activities, we should stand, on average, between EUR 250-or-so million a year. So effectively, Mamba, Carcará on one side, our downstream together with the midstream in Iara and accelerating our renewable projects gives you a global perspective on where we'll stand in terms of CapEx for the year to come. Thank you.

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Joshua Eliot Dweck Stone, Barclays Bank PLC, Research Division - Analyst [33]

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Sorry, so I didn't -- if I could just quickly follow-up. I didn't -- just the 2019 CapEx as opposed to -- I don't know if that was for next year, but is there a budget for this year?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [34]

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'19, as I mentioned to you, it stands below EUR 0.9 billion. So it's the number that we are working with.

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Operator [35]

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The next question is from Irene Himona from Societe Generale.

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Irene Himona, Societe Generale Cross Asset Research - Equity Analyst [36]

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My first question on the plan, the 3-year plan, if you were to run the numbers using not $65 to $70 Brent, but let's say, $10 lower, $55 to $60, which is what we are looking at right now, on the same CapEx, on the same dividend commitment, how shall we think about the CFFO growth? So what happens to the 8% growth and then net debt-to-EBITDA ratio? That's my first question.

My other question is specific to Q3 upstream. And firstly, unit production cost in Q3, excluding IFRS, and $3.30. Can you just remind us of your guidance on the new basis of those unit cost in the medium and longer term, please?

And then also in Q3, I note E&P net income from associates crashed from EUR 17 million the quarter before to just EUR 3 million. Was that just the price effect? Or was there anything else in there?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [37]

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Irene, I call your attention for Slide 12 in what CFFO relates. You see that we have done a kind of a sensitivity analysis, and you see that there is for a $60 a barrel decrease in the CFFO. One can consider that it is above 80%. We can have a 6% in rough terms, a CFFO increase. So I think that's response to your question. And you see that the margins that we are using and -- but we have also here, this CFFO is net of taxes, and therefore, there's more flexibility on that.

In terms of production cost, we have 2 effects here. And just to simplify, and Thore can complement me if needed. We have 2 units ramping up in Brazil, and therefore, the dilution costs have clearly increased, which means that the operation cost are decreasing. And that's effectively one of the key elements.

Another one has to do with reserves review of 2018, so that we have saw our reserves increasing. And therefore, from the technical cost point of view, so this is not on the OpEx, I'm speaking now about DD&A, that's adding the technical cost, that also allowed to dilute the same CapEx for more volumes. And from the DD&A, we also see a decreasing. So all in all, OpEx plus DD&A, which ends in technical cost, are clearly impacted by those 2 elements.

You also have the opposite in Angola, which has less contributed because we have 2 units in comparable basis that were running -- were ramping up. One is already at plateau at (inaudible). Kaombo South is still ramping up, which means in comparable terms, we have more costs in the system, and therefore, in Angola up to the stabilization at plateau level. We still see some increasing. But once we have full production, the dilution will come, and it will apply at the same that I have mentioned through to Brazil.

I don't know if Thore would like to complement.

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [38]

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Just for the, I think, the second part of her question was on the outlook and the money [considered] outlook for production cost. Expect that to be around about where we had on third quarter. We will continue to benefit from the ramp-up effect. But on the other hand, there is currently in the plan somewhat more work, overwork that is planned for the quarter. So it's around $3.3, $3.5 per barrel should be sort of good guidance for the fourth quarter.

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Operator [39]

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Our next question for today is from the line of Matt Lofting from JPMorgan.

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Matthew Peter Charles Lofting, JP Morgan Chase & Co, Research Division - VP [40]

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Sticking to the points around the capital allocation. When I look back at the last couple of years, the dividend increase has also been around 10% to 15% as a range, but it's probably questionable how relevant a benchmark that is as Galp enters something of a fresh cash cycle 2020 and beyond. So can you discuss and help us to understand how the 10% CAGR has been calibrated to 2021?

And secondly, given the sort of the planning deck around long-term $70 Brent and also higher refining margins, can we expect that Galp can prioritize that 10% dividend growth also on the lower macro scenarios?

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

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Matt, so from the balancing between dividend and the capital allocation, so first, we should bear in mind that Galp continues to be a growth company, growth for value, and therefore, we still are in one of our phases of continuing to add projects to our portfolio that will bring value for this company in the next decade, all over the next decade. So that said, how did we get the dividend target that we have announced today and have to be subject to shareholders approval?

We have looked at a balance growth in terms of what is our cash flow generation and what is our dividend increase, and you see that are quite in line. We are speaking about the CFFO growing of around 8% per annum and the 10% on dividend growth. So it was one of the key rationales without any major considerations. But of course, keeping a strong balance sheet, keeping our financial discipline and ensuring that we allocate that CapEx to value creating projects. So all in all, and trying to simplify a more complex analysis, I would say it's a balance between CFFO and dividend growth. So I will pass now up to Filipe to take the second part of your question.

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Filipe Crisóstomo Silva, Galp Energia, SGPS, S.A. - CFO & Executive Director [42]

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No. Matt, I would just add that dividend visibility is quite high even under various harsh macro scenarios. Because our -- and if I go back to Slide 12, you see how insensitive our cash flow from operations would be with the different Brents. And again, we have an integrated portfolio, so the refining and the downstream tends to do better in a lower Brent environment. You also have -- taxation plays a big role in the upstream, so as -- if Brent prices come down and a there's a very significant cash outflow, that will not be around.

And same for working capital, also very sensitive, positively sensitive to declining Brent prices. So yes, we see cash flow from operations resilient over the next few years, and that should not jeopardize our dividend policy. Also bear in mind that we have a very significant minority in Brazil, where most of our production comes from. And our minorities would take a similar hit on the dividend distributions and share the pain with us in an adverse scenario. Thank you.

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Operator [43]

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Our next question is 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 [44]

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Just a couple of questions left for me. Firstly, I just wanted to get a quick update on where the unitization process is with Berbigão and Sururu and whether we should expect that to happen before production starts up at the end of the year?

And secondly, just coming back to CapEx and budget, specifically on the exploration budget. Yes, well, firstly, give or take on how you much expect to spend on exploration each year and whether there's a -- given the projects you have in the portfolio, your plans to be part of the energy transition, should we expect the exploration expend to gradually step down on that basis, particularly in frontier areas?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [45]

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Alwyn, I think Thore is keen to answer to your question.

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [46]

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So when it comes to the unitization process on Berbigão and Sururu, we do not expect that, that will be finalized this year. So we're looking for this to be accomplished by during the course of next year.

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [47]

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Exploration cost?

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Thore Ernst Kristiansen, Galp Energia, SGPS, S.A. - Executive Director & COO [48]

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And on exploration, yes, we are not giving any guidance when it comes to solely exploration spend. What we have, and as Carlos also highlighted very much in his introductory remark, we are very excited that we are going to spud with Uirapuru now in this quarter. That is, for us -- was a very sweet win in -- to that recent -- or quite recent Brazilian bid round. Very excited to spud that. And then we continue to mature our positions in São Tomé and Príncipe and in Namibia. And we might spud our first well in São Tomé and Príncipe towards the very end of next year, beginning of 2021.

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Operator [49]

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(Operator Instructions) The next is from the line of Sasikanth Chilukuru of Morgan Stanley.

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Sasikanth Chilukuru, Morgan Stanley, Research Division - Research Associate [50]

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Most of my questions have been answered, but I have a couple related to Slide 12 once again. It does feel like -- looking at that, it does feel like the cash breakeven for the dividend right now for the next 3 years is around $60 barrel or $5.5 to $6 per BOE on the refining side. I just wanted to confirm again that -- whether should the macro be significantly lower either on the oil price or in the refining margins. You would probably be looking to raise debt to cover the dividend or increase your net debt levels? Or will it be committed expense of CapEx?

Also just following up with the same slide again. Does this strategy effectively rule out a chunky disposal of any cash-generating entity beat in upstream or the downstream?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [51]

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So I think in the Slide 12, you'll see that, yes, you're right that we have a relevant part of our CapEx that is allocated for growth, and that reveals in which side we are and what are the framing of and the typology of our CapEx allocation. In what relates to the divestments, I have already mentioned that to Flora previously. So we cannot comment on which kind of assets specifically we will consider. What we have to look at is based on real and tangible situations. We have to look at those that are better fitting our portfolio and decide at that time. So you might anticipate one or the other because it's -- I have already mentioned that in the past. We have done in the recent years some divestments, mainly in regulated assets, but I prefer not to enter and comment on the divestment problem, which we don't have. And that has to be solved at the life of the value creation for the company.

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Operator [52]

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Our next question is 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 [53]

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I think these are all just confirmatory questions, I think. But if you wouldn't mind, can you remind us why exactly you've chosen this new refining margin assumption into the 2020s? What's changed in terms of your outlook? Because I think your oil price outlook hasn't changed, the 70 you'd mentioned before.

And then another go about your CapEx. Can you perhaps tell us how much has been committed already? We're obviously aware of a number of very important growth projects. But as you already said, there is refining. There is chemicals. I'm guessing that a lot of that EUR 1 billion-plus a year has not been committed yet. Any light you can shed on that, please?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [54]

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So Christopher, refining margins, our looking forward, what has changed? So as the IMO is approaching, we are fine-tuning and we are looking at sweet and sour spreads. We are also looking at different cracks, mainly the middle distillate and also the very low sulfur fuel oil that is now pricing above Brent, which is almost surprising. And therefore, we have reviewed our assumptions downwards in what respects to refining margins due precisely to this effect. So previously, we were addressing or we were guiding between $6 and $7 per barrel. Now where we're seeing it, this could be -- could stand slightly below, between, $5.5 and $6. That's what it is in the footnote in Slide 12. This is the basic assumption.

And by the way, again, for Galp, we have both contributions only. We have positively contribution. It is slightly positive in refining going forward. But it is strongly positive in the upstream, taking in consideration more liquidity on Lula grade, and at the same time, how the sweet crudes are being priced in the market. And I think that's it. That's the point that we have raised.

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Operator [55]

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Our next question is from Jon Rigby from UBS.

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Jonathon Rigby, UBS Investment Bank, Research Division - MD, Head of Oil Research and Lead Analyst [56]

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One question. So the sort of acknowledgment in the strategy that you're now discussing that the balance sheet is starting to look pretty strong, you're obviously well below 1x EBITDA on your net debt. So my question is if when applying the criteria for investment, you find that you don't see anything large enough or significant to make an investment in, what will you do with that excess balance sheet capacity? And when does gearing on the downside start to become an issue for you in terms of your capital structure?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [57]

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Jon, so we don't see our balance sheet as an issue by the opposite. In our days, thanks to a disciplined financial decision and the execution mode that we entered in the last couple of years, we clearly have, today, a starting point that is really strong. Looking into the future...

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Jonathon Rigby, UBS Investment Bank, Research Division - MD, Head of Oil Research and Lead Analyst [58]

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Sorry to interrupt, but that was my point. Is the balance sheet is getting a lot stronger and you're sort of acknowledging that you have inorganic opportunities that you may consider to invest in. But what if you don't?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [59]

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Yes. So let's see. We will not burn money. To clarify and go directly to the point, if we will not find projects according to the risk profile and the returns that we expect, and that's the reason why the commitment of our rollout of 15% is important for us, of course, we have to distribute to the shareholders.

Hopefully, we will be able to continuously to make this company grow and having that in a well-balanced way, so bringing value to the shareholders, but at the same time, that we will complement that with distribution to the shareholders. That's the only comment that I have to say. Filipe would like also to complement. Go ahead, Filipe.

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Filipe Crisóstomo Silva, Galp Energia, SGPS, S.A. - CFO & Executive Director [60]

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Jon, if -- the guidance we're giving you is a metaphor. It's a framework on where we will operate. And within that, you'll have multiple possible scenarios. One thing, if you do the math, if we bid for first oil rights, if we do more downstream investments, if do more renewables, if we do Carcará and Mamba oil at the same time, it will be more than $1.2 billion. So it will be a combination of some of these investments. There would be rotation if need be within the envelope. So we are not giving your granularity on specific investments. But for distribution to shareholders, this is the long-term CapEx from what you should be thinking about.

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Operator [61]

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Our final question for today is from the line of Jason Kenney from Santander.

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Jason S. Kenney, Grupo Santander, Research Division - Head of European Oil and Gas Equity Research [62]

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I was just wondering what portion of your refining output is hedged in 2020 and at what level and if you've had any challenges with that strategy considering the review of margins and your assumptions?

And then secondly, can you just remind us of the mark-to-market adjustment features that we could potentially anticipate over the coming months and the natural gas, has that played out now?

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Carlos Nuno Gomes da Silva, Galp Energia, SGPS, S.A. - Vice Chairman & CEO [63]

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Josh -- Jason, sorry. We have for 2020 hedged around 10% of our refining throughput. And with a comparable, no, it's not a straightforward calculation, but it's a comparable margin that stands between $5 and $5.5 per barrel. And we have only, as I mentioned to you, hedged around 10%. Filipe, would you like to speak about the mark-to-market?

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Filipe Crisóstomo Silva, Galp Energia, SGPS, S.A. - CFO & Executive Director [64]

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Yes. So on hedging, we've had this similar issue before. So we have an imperfect accounting treatment of the risk protection that we're effectively building. So we have clients that have asked us for natural gas under certain formula. We source it differently. We cannot -- accounting-wise, we cannot match it. So we have some P&L volatility that hedges out and goes to 0 at the end of the contract. So it's wider this quarter. It will close as we approach next year.

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Operator [65]

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Thank you very much. There are no further questions. I will now hand the call back to Mr. Dias for closing comments.

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Pedro Dias, Galp Energia, SGPS, S.A. - Head of Strategy & IR [66]

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Thank you, ladies and gentlemen. We hope you have found this update useful. And I remind you that the IR team is always available for additional clarifications you may need. Have a great day. Thank you.

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Operator [67]

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Thank you very much, sir. Ladies and gentlemen, that does conclude the call for today. Thank you all for participating. You may now disconnect.