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Edited Transcript of GAZP.MZ earnings conference call or presentation 29-Nov-19 12:00pm GMT

Q3 2019 Gazprom PAO Earnings Call

Moscow V-420 Dec 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Gazprom PAO earnings conference call or presentation Friday, November 29, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexey Finikov

Gazprom PJSC - Deputy Head, Finance and Economic Department

* Andrey Zotov

Gazprom PJSC - Acting Department Head, Gazprom Export

* Elena Mikhailova

Gazprom PJSC - Head of Department 105

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Conference Call Participants

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* Karen Kostanian

BofA Merrill Lynch - Analyst

* Alex Comer

JPMorgan - Analyst

* Kirill Tachennikov

Broker Credit Service - Analyst

* Igor Kuzmin

Morgan Stanley - Analyst

* Mikhail Rosseev

Gazprom PJSC - Deputy Chief Accountant

* Alexander Burgansky

Renaissance Capital - Analyst

* Henri Patricot

UBS - Analyst

* Ildar Khaziev

HSBC - Analyst

* Evgenia Dyshlyuk

Gazprombank - Analyst

* Timothy Riminton

Barclays - Analyst

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Presentation

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [1]

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Good afternoon. This is Alexey Finikov speaking, Deputy Head of the Finance and Economic Department at PJSC Gazprom. Our conference call today is dedicated to the disclosure of the third-quarter 2019 IFRS results. We have with us Deputy Chief Accountant, Mr. Mikhail Rosseev, as well as key leadership of PJSC Gazprom departments, as well as representation from Gazprom Export and Gazprom Neft. The presentation for this conference call is available at our website.

Before we begin, I would like to direct your attention that page 3 of the presentation contains a disclaimer regarding potential forward-looking statements that could take place during this call.

I would like to start discussing the financial and operating performance of Gazprom [grade] in the third-quarter 2019 by defining the microenvironment in which we had to operate. In the third quarter, we saw a slight downward movement on the oil price as well as significant downward movement on the gas price at European hubs. This imbalance in the third quarter between the supply and the demand side for gas resulted in a significant fall of the prices to the lowest level within the last decade.

However, as the winter season is stepping in, a more balanced situation of the market has resulted in much higher spot prices in October and November this year. The hub prices for day- and month-ahead delivery have restored to comfortable levels, as we saw back in March this year, standing at $180 to $190 per thousand cubic meters, and we expect further upside looking forward.

Even in this pricing environment, Gazprom maintains high competitive edge and leadership in the market. It must be noted that thanks to the structure of our long-term contracts portfolio, average realized prices by Gazprom when selling gas to European offtakers were significantly above the spot prices in European gas hubs. On top of that, the low pricing environment resulted in significant increase of the volumes delivered in 2019.

Flipping over to page 5 to consider our key financials. Q3 is traditionally the weakest quarter for Gazprom, given the seasonality; and given the market environment and the pricing environment we saw in the third quarter, the financial results could be considered satisfactory. Despite the significant slump in European gas prices or sales, our revenue for Gazprom mainly went down by 16% in ruble terms, mostly thanks to selling gas domestically and in the sales markets, as well as thanks to our generation and heat generation.

Our key metric, EBITDA, in the third quarter went down by 44% year on year. Given the negative developments in the European gas markets, profit attributable to shareholders went down by 45% to RUB212 billion. Given the peak of our investment cycle, our CapEx in the third-quarter 2019 went up by 9% year on year.

In the third quarter, we saw a significant reduction of short-term bank deposits which are registered as other current and noncurrent assets in our financials. The total amount of deposits went down by RUB96 billion in the third quarter. Further in the presentation, I'm going to give you more insight into the impact of this change on our financials.

Given the analytical adjustments by the amount of the change in deposits, the free cash flow of the group was still negative at minus RUB166 billion, mostly related to the increase of inventories; and, hence, the working capital, as the underground storages were filled with gas. The negative free cash flow resulted in the increase of net debt for the group by 19% in ruble terms. Also in the third quarter, we paid record high dividends to Gazprom shareholders in the amount of RUB370 billion, also affecting the net debt.

Flipping over to page 6, the key driver pushing revenues down in the third quarter 2019 was smaller average [delight] price in Europe while the volumes shipped also somewhat declined. The average realized price of Russian gas in the European market in Q3 2019 went down by 32% year on year. It must be noted that spot prices in European gas hubs went down much higher, by more than 60%. This gap comes thanks to the structure of our long-term gas sales portfolio. The slight reduction in gas volumes also pressed negatively on the gas sales.

Now on the Russian market, we saw a completely reversed picture. The prices went up with increased volumes. Our revenues in the third quarter went up by 15% year on year. In the former Soviet Union markets, the dynamics was mixed with the prices down by 17%; the volumes were up, thus pushing the revenue up by 3%.

Over to page 7, some impact also came from the oil business. In the third-quarter 2019, sales of oil, gas condensate, and the petroleum products in ruble terms went down by 8% year on year. We also saw reduced profitability in oil and gas condensate as well as refining year on year. Despite that fact, the oil business is still generating a significant [quarter of] free cash flow. Sales of heat and electric power in the third-quarter 2019 was up by 9% as heat generation was increased. The utilities business of Gazprom also keeps generating a positive free cash flow.

Page 8 gives you the dynamics of Gazprom group's capital expenditure. We have the peak of our CapEx now, and we are approaching the launch of our key investment projects. Hence, the capital expenditure in ruble terms in Q3 2019 went up as expected by 9% to reach RUB436 billion. So that's plus 9% year on year. While extending that across the year, extrapolating that across the year, based on the results of Q3, we see a number of less than $26 billion in total. Please be reminded that our adjusted CapEx program for 2019 [stiffs] CapEx number RUB3 billion less as compared to the original CapEx plan as endorsed at the end of last year.

Over to page 9. As always, I would like to direct your attention to the need to adjust our financial by the amount of bank deposits. This is required in order to account for the numbers correctly. Page 9 gives you the number of bank deposits, which are registered as part of other current and noncurrent assets on Gazprom group's balance sheet, which went down as of the end of Q3 by RUB96 billion year on year to reach RUB391 billion or USD6 billion. The reduced short-term deposit amount has resulted in higher cash flow from operations which is also reflected in the change of working capital line.

Page 10 explains adjusted free cash flow breakdown in nine-month 2019, taking into account the change in short-term deposits. Our adjusted free cash flow as at the end of nine months stood at minus RUB7 billion. In the third quarter we saw a significant increase of gas inventories in underground storages, thus pushing down on the cash flow from operations as at the end of nine months. Given the challenging pricing environment in Europe, maintaining the free cash flow at a level close to neutral was insured by a moderate increase in the CapEx.

A few words about our debt metrics. In the third quarter, the total debt remained pretty much flat, standing at USD59.3 billion. The reduced cash and cash equivalents as well as bank deposits resulted in the increase of net debt in the third quarter.

The following factors were at play: negative free cash flow, payment of record high dividends unsurpassed by any Russian public company, RUB370 billion. And then again, we had an influx of RUB138 billion which are the proceeds from the sale of quasi-treasury shares. As you can see, given the adjustments by the amount of deposits, our net debt as of the end of Q3 stood at USD38.3 billion. The net debt to EBITDA ratio in dollar terms remains at a level comfortable for the company: 1.1, that is.

Over to next page. Adopting the new dividend policy is set to become one of the key developments for Gazprom in the course of this year. The financial block has prepared its proposition to be discussed at the Management Committee meeting on December 5. Then we would expect the Board of Directors to endorse it by the end of December.

We target a payment of 50% of adjusted net income from our IFRS statement, and that level is going to be achieved step-by-step across several years. The increase of the dividends is going to be financed through high volumes of free cash flow which will be positively affected by the end of our investment peak and the extra earnings coming from the new key projects. For example, on December 2, which is the start of next week, we're going to launch the Power of Siberia Project. That's a hallmark project to deliver gas to China.

Concluding my presentation, I would like to mark the following in highlights: that even though the market environment in the gas market is challenging, Gazprom still maintains leadership in its key markets, and also produces sustainable and resilient financial results which serves to prove our high competitive edge and very strong fundamentals, including low net production cash costs as well as a well-developed transport infrastructure and a portfolio of long-term contracts.

The major investment projects we are currently running are going to further reinforce the strategic position, as well as the financials of Gazprom Group which is set to be reflected in the dividends as well.

Thank you for your attention. We are ready to take your questions now.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Karen Kostanian, Bank of America.

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Karen Kostanian, BofA Merrill Lynch - Analyst [2]

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Thank you for the presentation. I have a couple of questions. My first question relates to page 12 of the presentation. How should we read that? You are saying that Gazprom Group is set to pay 50% of its IFRS-based net income in 2023, seemingly, based on the results of 2022. Earlier you had suggested a payment of 50% net income as early as 2021.

My other question relates to your CapEx which is set to come down following the investment peak. What's your CapEx guidance for 2020 then?

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [3]

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Well, the financial block has put forth the following proposals to the Management Committee which is set to meet on December 5. We are to reach the 50% IFRS net income payout in 2022 based on the results of 2021, taking the adjusted net income for that year.

And the second question of yours is going to be handled by Mr. [Sergey Ruptov].

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Unidentified Company Representative [4]

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Indeed, 2019 is our peak year in terms of CapEx, given the implementation of our priority development project. In 2022 once the peak has been behind us, we're going to see a somewhat reduced CapEx. In December this year, that CapEx plan is still to be endorsed by the Management Committee as well as the Board of Directors. But our target is RUB1.1 trillion.

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Operator [5]

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Alex Comer, JPMorgan.

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Alex Comer, JPMorgan - Analyst [6]

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Thanks for the opportunity to ask a couple questions. Firstly, just in terms of gas pricing and volumes for this year as a whole, I wonder if you would like to give us an estimate. Clearly we're close to the end of the year. It looks to me like you won't reach the previous target at half year.

Secondly, just so we're clear on this dividend progression, the information you've given is 50% in 2022 but we don't know what's going to happen between then and now. So is it likely that dividends will come down if earnings are weaker? Just want to be clear, if we have weak earnings, will you cut the dividend from where we stand next year?

And then also in the event that your free cash flow doesn't come through as expected, are you happy to leverage the balance sheet up to pay these dividends? And if so, do you have a leverage target?

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Andrey Zotov, Gazprom PJSC - Acting Department Head, Gazprom Export [7]

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Good afternoon, and let me comment on the pricing side first. Our average realized price across the portfolio of long-term contracts has been growing since 2016, sustainably. However, in 2019, given the increased supply side on the market with extra volumes of LNG, the price has taken its place where it should be. And the weighted average price across the portfolio in the course of this year is going to be at the target level of $202 to $205 per thousand cubic meters.

We wouldn't expect major fluctuations in that number up until the year of 2021, other than any seasonal adjustments. Once the liquefaction capacities have been fully commissioned on the market, analysts and market agencies agree that the prices are set to grow, be it spot prices on the hub's LNG, pipeline gas, whatnot.

Now the volumes. Our current daily delivery volumes are such that we wouldn't expect the target to -- not to be met. So in 2019 our target stands at 198 billion cubic meters across the year, and it is obviously going to deliver. For 2022, given what has been said, we don't expect any major slump in that number.

Now regarding the second question of yours: on December 5, just like I said, the Management Committee of Gazprom is set to meet to discuss the proposals put forth by the company's financial block regarding the dividend policy. Just as we said, in 2022 we are going to hit 50% of our gross net income, but that is going to be achieved gradually and the steps are to be defined by the Management Committee in their meeting. We are not ready to comment on our proposals so far, but once the Management Committee has decided they are going to issue a press release and disclose this information to the investment community.

As to the level of dividends, we are responding to requests of the investors again, and are going to link that dividend level to the financial performance and the financial results delivered by the company. So in 2020, we are going to pay dividends based on 2019 results.

As to the possibility for us to be paying the dividend in question, I can say the following. (technical difficulty) to 2020, thanks to the successful delivery of our key investment projects. And then again, as explained in the presentation, our debt is currently at a very comfortable level. So we are confident that we will be able to meet our commitments to the investors.

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Operator [8]

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Kirill Tachennikov, BCS.

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Kirill Tachennikov, Broker Credit Service - Analyst [9]

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Good afternoon, and thank you for the opportunity to ask questions. Indeed, your net income is going to be adjusted, based on the results of 2019 by at least the FX losses that you have incurred across the year, and also following the [evaluation] of your assets as an exercise. Now could we expect that the dividends paid based on 2019 results could be less than the ones paid in 2019, based on the 2018 results?

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Unidentified Company Representative [10]

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Thank you for your question. As explained previously on numerous occasions, our proposal for the new dividend policy is to have net income adjusted by the non-cash items which could have their play up or down depending on the situation and the results of a particular year.

This list of adjustments or items by which the net income is going to be adjusted is going to be exhaustive. So that would be a complete list as part of the new dividend policy, and transparent to the investors. But that list is going to be fully communicated following the session of the Management Committee on December 5.

Commenting specifically on our dividends to be paid in 2020 based on the results of 2019, as explained with a new dividend policy in place, we going to move away from the original policy of targeting the absolute amount of the dividend, or paying no less of the previous year. We are going to pay a dividend that is exposed to the company's financial results.

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Kirill Tachennikov, Broker Credit Service - Analyst [11]

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Another quick question then regarding the price environment. What is your price target for Q4 2019? The price in the third quarter this year stood at $170 per thousand cubic meters. Would you expect that to come further down in the fourth quarter, given there is a lag between the spot prices on the one hand and Gazprom's contract portfolio price?

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Andrey Zotov, Gazprom PJSC - Acting Department Head, Gazprom Export [12]

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Well, I could maybe reiterate the idea that the weighted average realized price in the full year of 2019 is expected to stand at $202 to $205 per thousand cubic meters. So that means that regardless of the apparent slump in the third quarter, the price in Q4 is set to move up somewhat.

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Operator [13]

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Igor Kuzmin, Morgan Stanley.

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Igor Kuzmin, Morgan Stanley - Analyst [14]

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Thank you for this opportunity to ask my four questions. My first question is about your dividend policy. Would you consider proposing to the Management Committee to include the proceeds from quasi-treasury share sales into the dividend calculation for next year?

My second question regards your volumes guidance, exports volumes guidance for the full year of 2020.

My third question is about your CapEx for 2020. Could you specify the CapEx for the group, not just Gazprom's gas business?

And my fourth question is about your working capital movements in the course of the fourth quarter this year. What is to be expected?

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [15]

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As to the dividends, the dividends next year are going to be based on the results of 2019, just like I said. And that means that the sale of quasi-treasury shares is going to make way into our financial results of 2019; and, hence, get to the investors in the form of dividends in certain parts, of course.

And then again, I look to Mr. Andrey Zotov from Gazprom Export for the second question about the export volumes.

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Andrey Zotov, Gazprom PJSC - Acting Department Head, Gazprom Export [16]

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Well, I wouldn't take us on 2020 alone. Let's rather think about a midterm stint of three, four, or five years ahead. Let's consider the market niche that the pipeline gas by Gazprom could take on that market. Now all forecasts from the marketing agencies that are available to date demonstrate that the gas demand is set to grow by at least 2022, possibly onwards.

This includes a broad demand for LNG as well as pipeline gas. The LNG is going to operate at its optimum starting as soon as next year, and that is 60% to 70% capacity utilization at the regasification terminals. And then again, we know the position of our competitors supplying pipeline gas from Norway and Algeria.

So we would say that Gazprom's market niche in that 194 billion cubic meters to 204 billion cubic meters per annum; but, in fact, we would expect 2020, 2021, and 2022 to be at least on par, if not above the 2019 levels. In response to this question, I only comment in our exports to Europe, excluding exports to China.

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [17]

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The approvals for our capital expenditure programs is underway and nearing completion but not fully completed and endorsed as yet. So before that happens, I can only say that our CapEx for the group is set to come somewhat down.

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Mikhail Rosseev, Gazprom PJSC - Deputy Chief Accountant [18]

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Well, as of today, we are unaware of any [tax] that could have a significant impact on working capital changes in the course of Q4 this year. Well, at the same time, we have such factors at play as the gas prices, or the FX ruble to the dollar, or the volumes of our inventories or sales from inventories. And all these drivers are extremely hard to forecast. So let's try to wait and see until the end of Q4, and see where the working capital stands.

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Igor Kuzmin, Morgan Stanley - Analyst [19]

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Well, just a quick question to clarify your answer on my first question regarding the dividends. The sales of the quasi-treasury stake is not going to impact your net income as far as I understand; it is going to be reflected only in the changes of the cash flows. So would your net income incorporate those changes as well through adjustments that are going to take place, or have I somehow misinterpreted your answer?

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Mikhail Rosseev, Gazprom PJSC - Deputy Chief Accountant [20]

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Well, you are quite right in your interpretation. In terms of accounting, the transaction that took place only saw a change in the capital as equity moved (technical difficulty). And also the proceeds from the transaction ended up as cash balances on our accounts. So the net income line in terms of profit attributable to shareholders is not going to be affected by that transaction directly. However, the cash balances from cash and cash equivalents which are going to be the money from which the dividends are going to be paid, and in this regard we will see the exposure.

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Operator [21]

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Alexander Burgansky, Renaissance Capital.

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Alexander Burgansky, Renaissance Capital - Analyst [22]

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Thank you for the presentation, and I would like to ask two questions. My first question is about your average mineral extraction tax for gas in the third quarter 2019, and also the full-year guidance of MET, let's say, per thousand of cubic meters. And also the second question: are you expecting positive free cash flow based on the full-year 2019 results?

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [23]

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Yes, we [indeed that] the free cash flow based on the full-year 2019 results is going to stay in the blacks, in the positive area.

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Elena Mikhailova, Gazprom PJSC - Head of Department 105 [24]

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I don't think we can produce the stats for our MET gas -- MET tax payable across nine-months 2019. However, I can tell you that for the full year of 2019, our average MET rate is hardly going to be any different from the one we had in 2018.

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Operator [25]

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Henri Patricot, UBS.

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Henri Patricot, UBS - Analyst [26]

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Thank you for the presentation. I have two follow-up questions on non-gas pricing and volumes. The first one is could you give us a sense of the latest split between spot sales, the floor sales, anything that's still oil price linked?

And secondly on that topic: if you've been selling forward for 2020, what sort of prices and volumes have you locked in so far for next year?

And final question on Nord Steam 2, if you could give us your latest expectations for the (technical difficulty) and the ramp-up profile for the project. Thank you.

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Andrey Zotov, Gazprom PJSC - Acting Department Head, Gazprom Export [27]

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Regarding your question about the volumes, as mentioned previously in the years of 2020, 2021, and 2022, we don't expect any deduction of our exports to Europe as compared to the 2019 levels. On the pricing side, this must be calculated across the portfolio. As mentioned previously, our average realized price for 2022 would be expected at the level of $202 through $205 per thousand cubic meters. In 2020, that's not going to be really different from the above number; while in 2021 and 2022, we expect some certain growth driven by those factors which were mentioned previously on this call.

Our long-term gas contract portfolio is established in such a way with volume breakdown. Like 17% of all contracts have oil-linked formulas, 11% are directly exposed to the spot prices, and the remainder is about either fixed price or contract in negotiations or the so-called hybrid pricing model when we have an oil link that is capped by a certain floor or certain ceiling defined by hubs.

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Unidentified Company Representative [28]

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The Nord Steam 2 project still has some work outstanding. The Chairman of Gazprom's Management Committee, Mr. Alexey Miller, mentioned about five weeks are required to cover the daily inspection alone. But we shouldn't forget it's nearly winter now and weather comes into play as well. Experts from Nord Steam 2 AG, together with external consultants, are working on and within different options that are available.

As to the ramp-up part of your question, this doesn't depend on the startup date alone. For a number of reasons, there will be demand for Russian gas on the European market regardless of the Ukrainian transit citation, whether there is an agreement or not.

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Operator [29]

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Ildar Khaziev, HSBC.

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Ildar Khaziev, HSBC - Analyst [30]

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Good afternoon. Thank you for this opportunity to ask questions. I have a very quick question regarding your payroll expenses. What's the upside, year on year? Because we hear that there is a certain increase in change involved. So what's the payroll increase year-on-year to be expected in the course of 2020?

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [31]

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The payroll step-up for next year is planned in line with the deflator index of 3%.

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Operator [32]

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Evgenia Dyshlyuk, Gazprombank.

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Evgenia Dyshlyuk, Gazprombank - Analyst [33]

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Good afternoon. I have two questions. My first question concerns Nord Steam 1 capacity utilization constraint, whether that could be removed and whether that's realistic and how fast this could be done? What's your vision of utilization? And the other question is about the Ukrainian transit. Should the contract be extended, what would be the cost across 2020?

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Unidentified Company Representative [34]

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So you're probably referring not just to Nord Steam 1, but rather Nord Stream 1 plus OPAL system. Well, we are considering our options because Nord Stream plus OPAL have proven reliability and efficiency operating operationally and financially. So we are interested in maximizing their capacity utilization. To our knowledge, back on November 20 this year, the Ministry of Energy for Germany filed an appeal with the -- against the European First Instance court decision of September 10 of this year which imposed the constraint in the first place. So we're monitoring the situation and keep considering our options.

As to the Ukrainian transit cost side, well, that is going to depend on A, volumes; and B, pricing. But neither of these have been defined in negotiations as yet. So discussions continue. And once the metrics have been defined, we'll be able to assess our cost for next year.

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Operator [35]

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Timothy Riminton, Barclays.

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Timothy Riminton, Barclays - Analyst [36]

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Thanks very much for taking my question today. I have a few for you. Firstly, could you give us an idea of what sort of net leverage level you'd be comfortable taking the business to, if it came to that? You mentioned CapEx earlier of RUB1.1 trillion. Can you confirm if that's just for the gas business? And do you expect sales volumes to China next year through Power of Siberia, and what sort of level do you expect these to be? Thank you.

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [37]

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Well, we would be comfortable with any net leverage at a level below 2.0. However, our forecast for the upcoming years demonstrate that we could hardly exceed 1.5. The RUB1.1 trillion of CapEx mentioned previously today -- yes, we can confirm that's for gas business.

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Andrey Zotov, Gazprom PJSC - Acting Department Head, Gazprom Export [38]

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Let me explain the contracted volumes. We have the numbers in our contracts with the Chinese partners of 5 billion cubic meters for 2020, 10 billion for 2021, and 15 billion for 2022. And these need to be adjusted because of that amount, it's only 85% that they actually need to uptake. So you can do the math on your own. We do not have any experience with the Chinese as yet, because next year is going to be our first year of operations. So we'll see the actual take-up volumes, and then we'll see by then.

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Operator [39]

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Alex Comer, JPMorgan.

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Alex Comer, JPMorgan - Analyst [40]

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Just a quick accounting thing. Obviously you're going to bring onstream Power of Siberia and Nord Stream 2. I was just wondering if you could give us some idea of what will happen to your depreciation when those products come on in 2020 and also in 2021. And then also whether there will be any impact on your interest line from not capitalizing interest. And obviously the reason I ask that is that the dividend is now very sensitive to the P&L; so those numbers will, as I understand it, impact the dividend payment.

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Mikhail Rosseev, Gazprom PJSC - Deputy Chief Accountant [41]

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Indeed, the two projects that you have just mentioned are going to have an impact on the depreciation line. But please be reminded, however large in scale these two projects are just a smaller part of the united gas transportation system we operate across the continent. This could hardly have any material impact on the depreciation line. And again, the depreciation line, per se, is just an insignificant share of the operating expenses overall. So I would hardly envisage how the depreciation increase could have any material impact on the dividend.

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Alexey Finikov, Gazprom PJSC - Deputy Head, Finance and Economic Department [42]

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Thank you for your participation on the call. Thank you for your interest in Gazprom's operations. And as usual, we would like to thank Mr. Konstantin Golota of IB Translations for his work as interpreter.

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Editor [43]

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Statements in English on this transcript were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.