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Edited Transcript of LKOH.MZ earnings conference call or presentation 27-Nov-19 1:00pm GMT

Q3 & 9M 2019 NK Lukoil PAO Earnings Presentation

Moscow Dec 17, 2019 (Thomson StreetEvents) -- Edited Transcript of NK Lukoil PAO earnings conference call or presentation Wednesday, November 27, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexander Palivoda

PJSC LUKOIL - Head of IR

* Alexander Kuzmich Matytsyn

PJSC LUKOIL - First VP of Economics & Finance and Member of Management Board

* Pavel Zhdanov

PJSC LUKOIL - VP of Corporate Development & IR

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Conference Call Participants

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* Alex Robert John Comer

JP Morgan Chase & Co, Research Division - Research Analyst

* Andrey Gromadin

Sberbank CIB Investment Research - Analyst

* Grigoriy Myasnikov;Ronin Europe Limited;Chief Trader

* Henri Jerome Dieudonne Marie Patricot

UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst

* Igor Kuzmin

Morgan Stanley, Research Division - Equity Analyst

* Ildar Khaziev

HSBC, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to LUKOIL's Third Quarter and 9 Months 2019 Results Conference Call. My name is Seb, and I will be the coordinator for today's conference. (Operator Instructions)

I will now hand you over to Alexander Palivoda, Head of Investor Relations, to begin today's conference. Thank you.

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Alexander Palivoda, PJSC LUKOIL - Head of IR [2]

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[Interpreted] Thank you very much, and good afternoon, ladies and gentlemen. Thank you for joining us today for this conference call on LUKOIL's results for the third quarter and first 9 months of 2019. On today's call, we have Mr. Alexander Matytsyn, CFO; Mr. Pavel Zhdanov, Vice President for Corporate Development and Investor Relations; and our colleagues from Accounting.

Before we go about our presentation, I traditionally would like to draw your attention to the fact that certain statements during this call will be forward-looking statements, which is related to various risks and uncertainties and other factors. As a result of which, the actual performance results may tangibly differ from the statements heard. A more detailed information, you can find on the slide. And let me pass the floor over to Alexander Matytsyn.

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Alexander Kuzmich Matytsyn, PJSC LUKOIL - First VP of Economics & Finance and Member of Management Board [3]

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[Interpreted] Thank you, Alexander. Good afternoon, ladies and gentlemen.

Despite the decrease in oil prices, our performance remained strong. This was especially evident in the third quarter, which saw EBITDA and free cash flow before changes in working capital stay flat and made a 17% drop in oil prices and a slightly appreciated rubles. At the same time, the free cash flow and EBITDA before changes in the working capital remained at the same level. An important role is played here by a vertically integrated business model of the company, the high discipline in capital allocation as well as our continuous work to improve efficiency and business development.

The hydrocarbon production continues to grow despite external limitations in terms of production of oil in Russia compared to 9 months of last year. This growth was almost 2% through the development of our gas projects.

The production structure is improving ahead of our plans. The share of high-margin barrels in our production reached 31%, thanks to a successful development of growth project as well as introduction of the NDD tax at the beginning of next year. The amount of refining grew compared to 9 months last year by 3%, including -- because of almost a 7% growth quarter-on-quarter, which enabled us to achieve the maximum profit in terms of refining margin growth. We also continue to improve our product basket. The output of lighter products grew. And down to the record level, we decreased the production of fuel. And the development of the premium sales channels continued to achieve results about macroeconomics.

The oil ratings still remain volatile in terms of greater risks in terms of the slowdown and the demand of oil continued to depress oil prices. Compared to 9 months in 2018, the decline in oil prices was by more than a half, compensated by the ruble devaluation. The inter-quarter picture is less positive because the exchange rate almost didn't respond to the oil prices going down.

The crack spread for middle distillates elapsed to the refining margin [growth] compared to the second quarter of this year. And I would like, at the same time, to note that there is a high level of uncertainty remaining with respect to the MARPOL effect upon the price spreads. Specifically, at current times, we see reasonable spreads for the high-sulfur fuel oil without improving the spreads for the middle distillates. We are very mindful of this situation and undertake necessary activities to expediently manage the product basket and further reduction of the high-sulfur basket.

Despite the decline of oil prices compared to the second quarter, the EBITDA practically didn't change. The decline of profitability in upstream in greater ways was compensated by the EBITDA growth in downstream. Compared to 9 months in 2018, the downstream segment became the main driver behind growth in EBITDA, including because of a high quality of our refining capacities. At the same time, the EBITDA within the upstream segment demonstrated the high sustainability towards the oil price decline, thanks to the growing asset improvement of the structure and reducing the average cost for recovery. The decline of our cost is the result of the purpose-specific program aimed at improving our efficiency. Apart from production costs, our drilling and refining costs also went down as well as G&A. Almost all line items within the cost list that we control are either at the level or below the level of 2016, which points to a high efficiency of activities we are undertaking.

On a separate note, the dynamics of the free cash flow, which is the core high-level KPI of the company, which affects the compensation of the management, this particular figure grew almost 1.5x compared to level 19 months -- 9 months in 2018 amounting to RUB 517 billion or USD 8 billion. The quasi-dynamics is very strong. Growth is almost by 30% incremental.

We are maintaining a very stable leadership efficiency compared not only to the Russian oil companies but, notably, are above some international peers. The free cash flow per barrel of recovery in third quarter is -- was where we sat and absolutely directed in the history of the company, which was $15 per barrel. Invariably, we are trying to achieve improving not only our financial operations but also the standard corporate governance to comply with the best sector in practices, new principles of the capital return, which have been endorsed by the Board of Directors in the middle of October. Let me remind you that these new principles assume switching to opportunistic buyback of shares and allocating almost 100% of the adjusted cash flow towards the payment of dividends. This kind of approach enables one to considerably increase payments to shareholders without restricting the investment potential of the company.

Yesterday, the Strategy Committee and -- of the Board of Directors considered the new draft of the dividend policy regimen, which is based upon these new principles. This issue has been included into the agenda of the Board of Directors meeting, which is planned for December 12. As you may know, these principles have already been applied when coming with the recommendation of an interim dividend payment for 2019, which is going to be discussed and endorsed at the forthcoming shareholder meeting. The advantage of the new principles is in an absolute transparency of calculations.

Another quarter comes by, and you can conclude yourselves how much dividends you will be due. For example, third quarter is RUB 120 per share. So in 9 months, this is already at RUB 312. And this particular figure is very close to the current market consensus guidance for the whole of the dividend covering this year. In the fourth quarter, we also intend to come up with a free cash flow outcome.

Similarly, I would like to draw your attention to the fact that 2019 is a transitional year since in the course of the year, RUB 244 billion have been allocated towards the share buyback. According to the new principles, this particular amount is deducted when estimating the dividend payment. Without the buyback, these dividends would have been much higher. So the difference is more than RUB 350 per share, meaning to say that the dividend yield of the company shares adjusted by buyback for the 9 months of 2019 amounts to 11%, which is considerably higher than many of our competitors can demonstrate. And this value is going to be topped by the results of the fourth quarter. One should also remember that this business is continuously growing. On top of the higher dividends to date, our shareholders are also enjoying much higher cash flow in the future, meaning to say that the total yield comes up to be much higher. So that is why we believe that the current LUKOIL share prices is considerably below the fair level. And we hope that the market will appreciate the efforts of the company, including the recent changes in the capital return policy. On our side, we will continue to work to implement our long-term strategy aimed at raising the shareholder level of the company.

Thank you very much. Let me pass the microphone over to Pavel Zhdanov.

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Pavel Zhdanov, PJSC LUKOIL - VP of Corporate Development & IR [4]

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[Interpreted] Thank you, Alexander. And good afternoon, dear ladies and gentlemen. Let me tell you about the upstream segment results.

In third quarter, we encountered the worsening of the market environment, which negatively affected the results of our stream. The average Urals net price went down by 11% compared to Q2 of the current year. At the same time, the average exchange rate in ruble didn't change but the negative effect in terms of the tax time lag. As a result, the average oil net price went down by 9% compared to the previous quarter. Compared to the 9 months in 2018, the environment dynamics was a bit better because the decline of the oil price by 9% was, to a much extent, compensated for by the ruble devaluation. As a result, the oil price net went down by 4% only.

The average daily production of hydrocarbon without taking into account the West Qurna-2 within 9 months in 2019 amount to 2.3 million barrels a day, which is 1.6% higher compared to the similar period in 2018. The production growth primarily is the result of the international gas project development as well as a slight oil production hike in Russia because of the changes of the OPEC+ conditions within the course of 2018. Let me remind you that because of OPEC+, we were forced to reduce our oil production in Russia in the beginning of 2019, which negatively affected our total production increase. Against the external restrictions, our continuous aiming for the improving of the structure of the production remains to be valid. So compared to the first 9 months in 2019, our new projects and the type reserves grew by 10% and 13%, respectively. As a result of the high marginal battle share in the total hydrocarbon ARPU increased by 5 percentage points, exceeding 31%.

On the additional contribution into improving this indicator was the launching of the NDD tax regime in the beginning of this year. The EBITDA within the upstream segment demonstrated a mixed kind of a dynamics. The decline of -- in Russia, year-on-year and quarter-on-quarter is related to macro parameters worsening. At the same time, one should note quite a moderate reduction of EBITDA in Russia compared to 9 months of 2018, which amounted to a little bit over 2%.

Such good dynamics compared to the oil price dynamics is brought about to greater volumes of oil production and its improved structure. Overseas, the effect from the oil production and oil prices going up for gas compensated for the negative oil price decline. As a result, the EBITDA in our overseas projects grew compared to the 9 months in 2018 by 13%, while the inter-quarter growth was at 2% level. The deterring factor was the decline of EBITDA in our Iraqi project, which is the West Qurna-2 because of capital investment being reduced.

We continue to successfully operate within our assets as part of the windfall profit tax. The aggregate production of oil in our 9 license areas included into this particular regime as a result of 9 months this year was 3.5 million tonnes or 6% from our total production of liquid hydrocarbons in Russia. The capital spend within this particular license area, total exceeded RUB 24 billion. The intensity of these capital investments, I mean, the value of the spending per barrel of the current output is twice as high as the average one for other company. We're actively bringing into the development the previously unprofitable reserves. Specifically, in terms of the key group of the windfall tax within the material fields in Western Siberia, we increased our daily drilling grade by 31%, while the oil production grew by 7% compared to 9 months of 2018. At the same time, I would like to note that we have considerably -- advancing in terms of ahead of our plan for this time of the year. So the windfall tax creates the new life for the brownfields, provides them with the transportation transformation and raise their traction in terms of capital investment into them.

Now specifically about the regions and projects.

In the Western Siberia, we continue to effectively manage our output volumes based on the external limitations as part of the OPEC+ deal. In the first quarter of this year, we have reduced the drilling volumes of the amount of optimization. It needs to reduce the production of our oil in Russia down to the established levels. Starting from Q2, we have been gaining our output in order to go back to the normal daily rate of drilling in our production to maintain the brownfield output as well as to develop our green projects and the windfall tax assets. We continue to improve the efficiency and the development of the technology. Specifically, we're actively involving the horizontal wells and the [3-tier] structures. The number of such wells have doubled compared to 2018.

In the North Caspian, we have grown our oil output 9% year-on-year, thanks to the further completion of the Korchagin and Vladimir Filanovsky fields. A slight decline of the production in this region in Q3 was related to a planned maintenance at the Korchagin field, combined with the planned maintenance in other liberated assets. In June, as part of the third phase of the Filanovsky field, we have completed the superstructure of the conductor facility at the previously installed foundation. In August, we started drilling the first well by using the floating rig. In November, we started producing from the new well, which is the 2 whole wells with a smart completion with a starting recovery almost 1,000 tonnes of oil a day. The conductor block enables to bring into the production the western part of the field and to provide for maintaining that output at the design level, which is 6 million tonnes a year. We similarly continued our drilling program for the second stage of the Korchagin field.

In the third quarter, for the block conductor at that particular field, we have launched a new horizontal well. Within 9 months of the current year, the oil production at that particular field grew by 22% compared to similar period last year.

Within the program of completion of the Grayfer field, which is former Rakushechnoye, at works, there is an ice-ascending [zenith] platform as well as the dormitory and the arctic corridor. Based on the end of the third quarter, the construction readiness of that particular platform is about 25%. In as far as the residential module, 50%. In the third quarter, we have concluded the contract for the marine operations and the laying of the marine pipelines. Let me remind you that, that field is going to utilize the infrastructure of the Filanovsky field.

And as far as the high-viscose oil production projects in Timan-Pechora, which was part of the Yaregskoe field development, the carbon layers of the Usinskoye field, we were able to increase production by 18% compared to the 9 months in 2018. We continue to expand the infrastructure and operational facilities, which provide for further production growth. As a result, based on the results of the 9 months at these fields, we have launched new steam-generating capacities as well as completed the assembly and installation work for the second line of the Yaregskoye pipeline.

I would separately note our successes in achieving the ARPU production with the low probability reservoirs in Western Siberia. At the Imilorskoye field from the beginning of the year, we have commissioned to operation 78 oil production and 17 (sic) [18] injection wells. The production growth was 46% compared to 9 months of the 2018 year.

At the Vinogradov field, the production growth throughout the similar period was 30% since the beginning of the year. That particular field, we have commissioned operation 21 well. Towards the end of the year, there will be 34 production wells that we will commission.

And as far as the production of the gas overseas is concerned, in Uzbekistan, within 9 months of 2019, production grew up to 10 billion cubic meters as LUKOIL share, which is 9% greater than the similar period last year. In Q3, we still -- we're living with limitation in terms of the gas intakes in Gissar from the Shurtan gas processing plant, which belongs to Uzbekneftegaz and to tweak the gas to commercial condition.

At that plant, we have conducted maintenance work, which, in October, enabled us to bring back the stock production to the design level based on the results of the third quarter. The average gas production at the Gissar project grew by 7% quarter-on-quarter. The production with the Kandym projects in October also regained its design level after a slight decline following maintenance work. So throughout the full year, in Uzbekistan, we expect the production of 14 -- more than 14 billion cubic meters in our share.

Let me now pass the floor over to Alexander Palivoda.

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Alexander Palivoda, PJSC LUKOIL - Head of IR [5]

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[Interpreted] Thank you, Alexander. I will tell you about the Downstream segment results. In Q3, we have witnessed further improving environment and refining after a very weak first quarter. The benchmark margin in Europe grew by 24% quarter-on-quarter, which was assisted by a notable growth of crack spread for middle distillate, and specifically for diesel fuel. The Russian benchmark margin was following suit of the European one. In Q3, the average daily refining throughput at our refineries considerably grew compared to the previous quarter being at about 7%. And that was related both to the planned maintenance in the second quarter in a number of our refineries as well as with the additional loading of capacities against a favorable environment. Compared to the 9 months in 2018, the amount of refining grew by 3%. At the same time, the biggest contribution was made from the Russian refineries, thanks to the additional loading of the Nizhny Novgorod refinery.

The overseas refineries grew refining throughput growth 2% year-on-year against the greater volumes going towards the Bulgarian refinery after the maintenance program completed in 2018. The output of the lighter products in Q3 at the Russian refineries grew by 2 percentage points compared to the previous quarter, and this growth was conditioned by the maintenance done at the Perm refinery during the second quarter as well as the optimization of various installations being operated at the Nizhny Novgorod refinery. Within 9 months, the lighter product output at the Russian refineries, spreads didn't change, which conforms to our plans. At the overseas refineries, the output of the lighter projects in Q3 went down 2 percentage points after a considerable growth in the previous quarters. That decline is because of the heavier field -- oil being refined at the Bulgaria and in Italy. At the same time, the overall increase of the light products at the overseas refineries grew by 5%, with the Burgas refinery making the biggest contribution against the refining volumes growing 23% year-on-year as well as from the ISAB refinery as a result of the input optimization.

Despite the refining growing in -- as far as the fuel oil is concerned, if you take a look at the 9 months of data covering 2019, it went down by more than 300,000 tonnes, while its output went down 10%. At the same time, the Q3 output in oil -- fuel oil was a record low in 9%, which is 3 percentage points lower quarter-on-quarter and reflects our high level of readiness for the MARPOL. We continue to grow our refining product sales through the premium channels, which is an important element of our long-term strategy in downstream. Considering the 9 months' results, the jet fueling was growing variably as well as we also grew the premium motor fuels and industrial lubricants as well as bunkering. The decrease of the retail sales of the motor fuels in Russia can be explained by the high base effect in 2018 because then, as you may recall, we had a very high consumer demand for the motor fuels from vertically integrated companies. It should be noted that the decline of the retail sales is compensated for by better economics, including growth of income from sale of the nonfuel products and services. The most effective channel of our oil distribution in third quarters was their deliveries to our Russian refineries. The improvement of the external environment in refining has conditioned the total improvement of the margin in supplies of oil into Russian refineries, with the subsequent sales through our own channels, including the premium ones. The difference between the profitability of oil deliveries to our own refineries and the exports considerably improved during third quarter. The growing refining volumes, together with the improvement of the product basket, considerably strengthened the positive effect from the environment upon the downstream results. So the growing volumes of deliveries to our own refineries in Russia, as a consequence, led to a slight decline of the exportable amounts.

The favorable external environment, together with a continued improvement of our operational performance, enabled us to achieve the EBITDA growth within downstream segment by quarter compared to the second quarter of the year. At the same time, the EBITDA of the Russian downstream grew almost by 30% against a considerable growth of volumes and an increase of the output of lighter products. The deterring factor here was a slight worsening of the results in petrochemicals and the retail segments as well as the seasonal decline of revenues in the power industry.

The EBITDA of our overseas downstream grew by 14% quarter-on-quarter. Apart from the refining margin growth, it was also assisted by the profitability growing in international trading and in improving results of the retail sector. Another deterring effect from the financial results in this sector was in effect because of nonaccountability of the hedging contracts as part of our international trading transactions.

Throughout 9 months, the EBITDA considerably grew while -- both in Russia as well as in the overseas markets. In Russia, that was 1.5 percentage growth, which is explained by a growing margin as well as the refining throughput growing as well as an improvement of the retail results. Oversees, this growth was 30%, and it is related to a great -- growing margin of international trading, growing volumes in refining and a better structure of our project baskets. And so these baskets overweigh the negative effect from the low refining margin comparing it to the 9 months of 2018. We continue to work over implementing our specific projects in refining in Russia, which are aimed at raising the output of lighter products as well as the development of the bitumen business.

In terms of the delayed coking unit at the Nizhny Novgorod refinery, we are currently performing work to construct the reinforced concrete constructions as well as installing various equipment as well as installing and assembling the heavy tinkering, as you may know, and technology units because that is the biggest and most comprehensive projects amongst all that we're currently working on. Though the completion rate of this particular project already exceeded 50%. As part of the isomerization unit construction at the very same refinery, we have now completed preparing the foundation. We also continue with the installation and assembly. So at this point in time, all of the necessary equipment have been fully contracted. The completion ratio for this project is 1/3.

As far as the bitumen operation modernization, the design documentation has been completed and submitted to the government environmental impact assessment. We're also now finishing the polymer bitumen viscose unit, and we are preparing ourselves to start construction work at the site. As part of the construction of the deasphaltization unit at the Volgograd refinery, we have completed the underground communications at the foundation level. We are also -- do the assembly and installation of the steel work, installing equipment, the ramp and various piping. The -- most of the technology equipment has been passed over to the installation. The completion ratio for this particular project is exceeding 30%.

Now shortly, a few words about the main drivers behind the dynamics in our financial performance. In Q3, the price sector and the volume basically came out to be evenly negative upon our revenue dynamics, which result went down 8% compared to the previous quarter. The sales volume going down can be explained by the reduced trading volumes as well as accumulating commercial stocks overseas. These drivers were partially compensated for by the season growth in terms of our refined product sales in Russia. We continue to demonstrate [proven] dynamics in as far as different line item of expense are concerned. Specifically, our average production costs year-on-year went down and reflected -- this decline was reflected both in our efficiency improvement program as well as the application of the IFRS 19 standard. So considering the 9 months, the average cost of production went down 2% year-on-year as far as Russian assets are concerned and 2% in dollar domination in our overseas assets. And as far as optimization of production cost control, we have achieved impressive results. Specifically, in Russia, if one is to take a look at our current average cost for production, they nominally, today, have gone back to the level of 2016. And that is despite such things as the power tariffs going up as well as other inflationary factors.

In refining, the results are even more impressive. Considering the results of 9 months of 2019, it was possible to reduce the average cost for refining at the Russian refineries by 8%, while the European assets almost by 13% in dollar denomination.

In as far as the EBITDA is concerned, despite the worsening of the macroeconomic environment, this figure went down almost by 1% compared to the previous quarter, and it was 382 -- RUB 328 billion, the EBITDA downstream growth by RUB 8.3 billion, or 25%, compared to the second quarter enabled us to fully compensate for the decline of EBITDA in upstream, which is an excellent demonstration of the vertical integration effect, yet again, demonstrating high resilience of our financial performance in terms of the financial volatility.

We'd also like to note the positive effect from the commercial and general administrative expenses being reduced, which went down 2% compared to the 9 months in 2018. And currently, it is 10% below the level of 2016 if we are to take a look at it without the accruals from the long-term incentivization program, which is a noncash program.

And as far as the net profit is concerned, despite a slight decline in our EBITDA position, the net profit grew quarter-on-quarter, and its growth was 5%, which was assisted by a reduction of the effective profit tax rate, which comes from the further -- as well as the greater profit coming from -- as part of the optimization in our international operations. The capital spending of the company didn't change as opposed to the second quarter being at RUB 109 billion. The inter-quarter dynamics of the capital spending is traditionally being defined by the schedule of payment to our contractors and suppliers. So you can see absolutely different dynamics within individual subsidiaries and projects.

Within 9 months of 2019, capital investments went down by 7% year-on-year, which is explained by reducing investment into our Uzbekistan gas projects because of the fact that we have completed our core construction effort as well as the reductions that come from completing another stage of implementation of our 2 Caspian fields, Filanovsky and Korchagin. In the fourth quarter, we traditionally expect our capital investment level to grow.

As far as the free cash flow is concerned, it has grown by 29% quarter-on-quarter, amounting in absolute terms to RUB 209 billion. The main driver behind this growth was the change in the working capital. Specifically, during the second quarter, the working capital, as you may recall, grew by RUB 27 billion, while, in the third quarter, on the contrary, it went down by 13 following the oil price decline. So without taking into account the working capital effect, the free cash flow demonstrated a moderate dynamics, growing by 3% quarter-on-quarter, which was related to a slight increase in operational flow.

Our financial position continues to remain very solid. So the total won by the end of the third quarter is RUB 621 billion. Out of this amount, RUB 135 billion is allocated to the effect from the application of the IFRS 16 standard. The leverage that we have towards the end of the reporting period, again, remains traditionally low and is 0.1.

Before, together with our colleagues, we announce the Q&A session, I would like to draw your attention to certain changes in our targets for 2019. And as far as the hydrocarbon production is concerned, we would expect the value to be up to the upper threshold from 0.5% to 1% growth. And I would like to emphasize here that despite the various external limitations, the original plan is what we expect to fully complete. In August, during our conference call about the second quarter results, as you remember, we adjusted it downward, I mean our expectations for the capital investments without taking into account the West Qurna-2 Iraqi service projects from RUB 500 billion down to RUB 470 billion, RUB 490 billion range. Based on the results of the 9 months period and taking into account with the high probability, we expect that our actual spending will be even lower than the lower threshold, which is below RUB 470 billion.

And I would also like to underscore that we have continued working to improve the quality of our disclosure, having added into our MD&A additional disclosure to itemize our revenue from the sales of refined product, itemizing it in between different types. I'm sure that you would find it useful.

Thank you very much for your attention. We are ready now to begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the English line from Alex Comer at JPMorgan.

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Alex Robert John Comer, JP Morgan Chase & Co, Research Division - Research Analyst [2]

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Just a quick question. The working capital benefited from lower oil. I mean was there anything else in there? And as we go into the fourth quarter, is it -- what is your expectation for working capital in the fourth quarter? I think you also gave us some guidance on CapEx for this year. I mean assuming there's no change in OPEC+ run through 2020, is there any chance you can give us a guidance on what your CapEx would be in 2020? Those are my questions.

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Unidentified Company Representative, [3]

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[Interpreted] As far as our expectations and the evolution of the working capital is concerned, clearly, it will depend upon volatility. So we would like to refrain from giving you any guidance about it. But as far as the CapEx expectations for next year are concerned, it was not an indication that we said that midterm plans are going to be discussed by the Board of Directors at the beginning of December. So before the specific plans are endorsed, we are not in a position to disclose it. But what we can say, nevertheless, that the investments will definitely grow compared to the level of this year because new elements have appeared like the windfall profit tax on the international projects. And we continue to stem from our basic level of annual investments, which was USD 8 billion in accordance with our long-term strategy.

So at this point in time, we may voice the expectations for CapEx at a level about RUB 550 billion without taking into account West Qurna for 2020. But a lot shall depend upon the OPEC+ dynamics.

Taking into account the current understanding of the situation, we're not planning any changes to take place within the first half of the year. For the second half of the year, we are planning additional investments, which we may do depending upon how OPEC+ unfolds.

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Operator [4]

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Our next question comes from Ildar Khaziev from The Russian line at HSBC.

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Ildar Khaziev, HSBC, Research Division - Analyst [5]

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[Interpreted] I've got a question about the refining margin. Previously, you mentioned that in the course of the fourth quarter, it went down in Europe. So is there any connection between the refining margin in Europe and in Russia? Not always obvious. Could you possibly comment which way the margin is going in Russia? Because Russia accounts for a big part of your business.

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Unidentified Company Representative, [6]

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[Interpreted] Thank you very much for the question. The refining margin in Russia, as is known, is based, to a certain extent, upon the normal base kind of a margin, which is specifically defined by the spreads for the refined products in the European markets and certain elements related to the specificity of the Russian tax sanction added on top and the way the market is developing whatever we are -- I mean the internal market here, whatever we are seeing in terms of pricing because various time lag effects emerge and so on and so forth. So whatever we are seeing right now, we all note that both the preparation for and because of the uncertainty that everybody is seeing in the market in terms of the way the MARPOL is going to be implemented next year. We need to note that the market is quite unbalanced, and the spreads for the high-sulfur fuel oil do jump around. So we don't see that the spread is responding to the diesel fuel in the meantime. So most probably, it will happen in the future. But the fact of the matter is that the European refining margin present is going downward, while the Russian margin is always following suit.

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Operator [7]

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The next question comes from the English line from Henri Patricot of UBS.

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Henri Jerome Dieudonne Marie Patricot, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [8]

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I have 2 questions, please. The first one, can you come back on the increase on production drilling in West Siberia and what's driving this increase? And any impact in terms of the CapEx intensity?

And secondly, I wanted to ask about the recent announcement of your acquisition in Abu Dhabi. I want to know what made that asset of particular interest to you. And you've also signed an agreement for a broad partnership with ADNOC. So I was wondering if we should expect more upstream activity in the country. Or are you also looking at downstream potentially?

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Unidentified Company Representative, [9]

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[Interpreted] And as far as the Western Siberia is concerned, as you may know, this region, which is where the bigger part of our production comes from the brownfields with many being characterized by a very high water cut, and as we many times stated previously as part of our production management in order to comply with the levels set forth by the OPEC+, the Western Siberian fields, amongst others, are being used as a balancing factor. And so during the strategy presentation we did in 2018, we voiced our ambitions and plans to reduce the decline rate at the brownfields in the Western Siberia, down to 2% to 3% range. And if you take a look at the actual figures, which, through, let's say, the third quarter or the 9 months of this year, we have demonstrated, we are looking even better because the decline rate is about 2%. And it is important to see that as part of the overall flexibility in a sense of preparing ourselves for additional capital investments into additional production growth, we have prepared a number of projects. And as far as the permitting is concerned and documentation and having the base infrastructure in some places. So we do identify Western Siberia being very -- having a good potential in improving our production profile. Right.

And as far as acquiring a share in the Ghasha project in Abu Dhabi is concerned, this acquisition is following the format of our strategy of acquiring the high-quality class of assets in the region that LUKOIL views as fitting its strategic interest. So having a very high-class reserve base and highly skilled operators so that it's fully conforming to our strategy.

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Henri Jerome Dieudonne Marie Patricot, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [10]

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Should we expect more activity for you in Abu Dhabi in upstream and maybe downstream?

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Unidentified Company Representative, [11]

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[Interpreted] At this point in time, we are not looking at any additional projects in Abu Dhabi because within this particular project, there is an allowance of foreign expansion, which we, as shareholders, may participate if this is decided by the consortium. So there are no new project that we could just mention right now.

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Operator [12]

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Our next question comes from the Russian line from Igor Kuzmin at Morgan Stanley.

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Igor Kuzmin, Morgan Stanley, Research Division - Equity Analyst [13]

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[Interpreted] I would like to ask a question regarding to the guidance for 2020 that you've spoken about. And I do understand that the figures may still change, but, let's say, in a simplified matter, if I run a parallel between 2018 and 2020, I mean looking over 2019 with a maximum from RUB 470 billion and in 2020, it's RUB 550 billion, not including the Iraqi project. Could you possibly guide us towards what kind of the free cash flow dynamics you may expect in 2020 against the kind of CapEx levels that you've referred to? I do understand that it may depend upon whether OPEC+ gets extended or not. But nevertheless, let's say, if the extension scenario is probably the RUB 550 billion and taking into account, so cash flow per 1 barrel, will it grow? Will it remain at the same level of '18, 2019? Or maybe one could expect certain decline further in the future.

And my second question, you mentioned that you've got several projects up your sleeve, which if -- is conditioned by anything you may launch in 2020.

Could you comment what kind of projects are these?

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Pavel Zhdanov, PJSC LUKOIL - VP of Corporate Development & IR [14]

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[Interpreted] This is Pavel speaking. As you may know, in terms of the free cash flow guidance, we're not giving it because with the help of your assumptions, you may arrive at certain understanding. As far as CapEx is concerned, yes, additional CapEx is being done into the projects, which are expected to generate additional profitability so against all odds being equal -- I mean there are a lot of odds, saying that against all things being equal, we do expect that the profitability won't go down. It will grow there. So as far as the additional projects are concerned, related to the OPEC+ being terminated, well, these are not projects. These are activities related to drilling, optimization, new wells, new pads and various optimization activities, which we may expedite and start investing into them as long as the limitation from OPEC+ are lifted. So these are the kind of optionalities, which require investments into them, which we may start applying in the second half of the year if the OPEC+ stops.

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Operator [15]

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Our next question comes from the Russian line from Grigoriy Myasnikov at Ronin Europe Limited.

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Grigoriy Myasnikov;Ronin Europe Limited;Chief Trader, [16]

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[Interpreted] I've got a couple of questions. The first question, over next year, you are planning to grow your investments. And what is the internal rate of return that the company is planning for its investments if, I mean, there are any internal expectations?

And my second question is about the fourth quarter results this year. Is there any expectation, any guidance in terms of the EBITDA and the profit, I mean, as long as the current environment stays unchanged?

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Unidentified Company Representative, [17]

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[Interpreted] From the point of view of our investment process, we are using -- to use a single rate, which is 15%. And as far as our financial performance guidance for Q4 is concerned, bear in mind that there are too many drivers, which might affect such things as the cash flow. Again, we're not voicing any guidance.

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Operator [18]

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Our next question comes from the Russian line from Andrey Gromadin from Sberbank.

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Andrey Gromadin, Sberbank CIB Investment Research - Analyst [19]

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[Interpreted] I have 2 little questions. Could you please explain what are the projects that your CapEx growth primarily fall upon? If I heard you correctly, this year is going to be less than RUB 470 billion. For the next year, I mean, the base scenario, and actually, we are talking about EUR 550 billion.

And my second quick question about downstream, if I may because it's quite a difficult situation, let's say, with the high-sulfur products. Let's say, in the worst-case scenario, could you try and predict up to which level you can reduce the production of fuel oil, bunkering fuel and the vacuum gas oil next year if you have to?

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Unidentified Company Representative, [20]

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[Interpreted] As far as the first part of the question is concerned related to the additional increase of CapEx, like we previously stated, there is a whole set of initiatives, which are linked to investing into the Russian upstream. And these are the windfall profit tax that we're going to invest into, irrespective of various limitations and additional investing, into the production drilling, which may be or may not be depending upon the various OPEC limitations and the existing assets production dynamics. Additional investments in the upstream overseas, which, again, may happen or may not happen, depending upon the time frame within which the final investment decisions are being made by the operators into them as well as minimum additional investments into the evaluation of the investment opportunities in downstream projects, which emerge in the light of the government initiatives to incentivize investments into the Russian refining and Russian gas chemicals sector, I mean, the projects with a high payback and with a -- and a short implementation period.

As far as the MARPOL is concerned, the second topic that you raised, it's not a straightforward situation. We feel that we're well prepared and that we have an established plan of action in case the spreads change following different scenarios. Already now, we have started implementing most important activities. And if the environment remains as negative as it is now already towards the end of the Q4, if we compare it to the results of Q3, we would expect, in a preliminary way, a decline in the production of high-sulfur fuel oil from the European refineries by 30%, while the Russian refineries by approximately 20%. So recently, by way of example, we also issued the press release that we started the production of the bunkering fuel with the sulfur content half a percentage at the Volgograd refinery. And so this type of fuel is based upon the kind of the fuel oil that refineries produce, and it contains 1% of sulfur. So this is the -- for blending purposes.

And as far as the 2020 is concerned, then we see the opportunity to reduce the higher-sulfur fuel oil output from our Russian refineries by about 1/4 as opposed to the level that we will arrive towards the end of 2019, while at the overseas refineries, it will almost go down twofold. And again, the preliminary estimation of what we can achieve in terms of the fuel oil output within the whole basket, if, for the starting point, you consider the 9 months of 2019 where these figures are at about 10%, we see the potential to reduce it further by down to 7%, 8%, which we believe to be a very good outcome, which would enable us to really maintain ourselves being efficient in a very broad range of things.

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Unidentified Company Representative, [21]

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Dear colleagues, we understand that we don't see any requests for questions in the line. So I'd like to thank everyone for participating at our quarterly conference call and hear you next time. Thank you.

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Operator [22]

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Ladies and gentlemen, thank you all for joining today's conference. You may now disconnect your lines.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]