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Edited Transcript of LKOH.MZ earnings conference call or presentation 29-Aug-19 1:00pm GMT

Q2 & H1 2019 NK Lukoil PAO Earnings Presentation

Moscow Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of NK Lukoil PAO earnings conference call or presentation Thursday, August 29, 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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* 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

* Karen Kostanian

BofA Merrill Lynch, Research Division - Head of EEMEA Energy Research & Head of the Russian Research Department

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the LUKOIL Second Quarter Half-Year 2019 Results Conference Call. My name is Jazz, and I'll be your coordinator for today's conference. (Operator Instructions)

I would like to inform you that questions from the press will not be accepted. 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] Good afternoon, ladies and gentlemen, and welcome. Thank you for joining us on this conference call dedicated to Q2 result of 2019.

Now joining us today is Alexander Matytsyn, our Vice President and CFO; Pavel Zhdanov, Vice President and Head of Corporate Development and Investor Relations; and Alexander Palivoda, Head of Investor Relations, myself; Vyacheslav Verkhov, our Senior Accountant; as well as our leading accounting teams.

Now before we move on to the presentation, I would like to draw your attention to the fact that some of the statements and comments are what we call forward-looking statements involving risks, uncertainties and other factors that may cause our actual results to seriously deviate from the expressed or implied as these forward-looking statements. For more details, please see the slides.

And now I'd like to hand it over to Mr. Alexander Matytsyn. Please, sir, you have the floor.

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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 very much, Alexander. Good afternoon, Ladies and gentlemen.

Now the second quarter and the first 6 months of 2019 has proved to be very successful for LUKOIL. Despite external limitations, LUKOIL has been outperforming companies in terms of hydrocarbon production, which has increased by nearly 3% compared to the first half 2018. Now the product slate is also improving so the share of high-margin barrel's exceeding 31%. Now -- and we are ahead of schedule on this one, and this has to do with the target developments and also moving on so-called additional income tax for number of our sales. Our refining is up 2%. Also, the product mix is improving, such as the light product yield is up 6% at our European refineries. The sales from premium channels continues to grow at double-digit rate.

Now speaking of macro environment, after a rapid recovery in the first quarter of 2019, so the crude prices have been declining since May on the backdrop of growing risks of global economic slowdown. Now as a result and average international prices were rising on -- quarter-by-quarter, but the net price in rubles was sliding due to the tax-lagging effect and, of course, the U.S. dollar depreciation. Now although international prices were lower than the first half of 2018, so the net price in rubles actually increased due to a devaluation of the ruble. Now refining margin greatly improved on a quarter-by-quarter basis in both Russia and Europe, mainly through crack spreads, higher crack spreads on gasoline. So as compared to the first half of 2018, refining margin has declined -- decreased, actually, by 20% in Europe due to deterioration of crack spreads, gasoline and diesel fuel.

Now I'm pleased to announce that our quarterly EBITDA hit a new record high, which is RUB 330 billion, and thanks to, of course, in small part, to our increasing downstream profitability. So as a result, despite lower oil prices, our first half EBITDA is up 22% on a year-by-year basis, which is RUB 630 billion, which is mostly driven by effective business development and efficiency improvement. So we continue to implement our efficiency improvement program on a cost per meter drilled, barrel lifted and ton refined. So we see a decline on a year-by-year basis. As far as sales as well as general and administrative expenses, including incentives programs, they remain flat in -- on a year-by-year. That's why -- and IFRS 16 introduction also helped to reduce costs.

Now despite growing capital expenditures, our free cash flow generation in the second quarter has actually increased by 11% on a quarter-by-quarter basis on a -- to RUB 308 billion for the 6 months, which is USD 4.7 billion for the first half of 2019, which is 1.5x above the previous year. Now -- and upstream segment was the key contributor. Now although crude oil prices remain relatively sluggish, so LUKOIL is still generating considerable strong free cash flow by leveraging on a highly efficient vertically integrated business model, which is proven to be highly efficient and sustainable.

Now it is worth mentioning that LUKOIL is not only maintaining its long-standing leadership among Russian companies but expose us to passing some of the global peers in terms of EBITDA performance and free cash flow. Now with that said, our EBITDA per barrel produced stands at USD 23 in the first half and hit actually a record high of USD 25 in the second quarter, which is the best evidence that our focus on better production mix, our selected downstream projects, our premium sales channels as well as, of course, our continuous OpEx and CapEx control is paying off.

Now speaking of distribution and shareholders, now as for the shareholder returns, we, as you know, completed our buyback program, which is USD 3 billion in August, having purchased over 37 million shares in open market, which is about 5% of our target capital. Based on a strong free cash flow, we actually managed to complete this program much faster than initially planned. Yesterday, we actually canceled 35 million shares following a decision made by the Shareholders' Meeting in June, which is just below the number of shares repurchased so far. Now we also stand another USD 1.6 billion on repurchasing 19.5 million shares from minority shareholders under our public tender offer.

Now having said that, since 2018, I've spent a total of USD 4.6 billion purchasing shares, which is 50% more than the size of our recently completed buyback program, which is about 10% higher than the half of the incremental free cash flow we generated between January '18 and January -- and June '19. So we are ahead of the announced policy targets in terms of return of capital to our shareholders. And we are currently in the process of finalizing a new buyback program, so -- which is all the way through 2022, which is part of the 3-year schedule. And official announcement is pending and will be coming soon. We are also strongly committed to pursuing this policy to -- and strongly committed to our guidance.

Now in conclusion, I would like to also emphasize the ongoing improvement in LUKOIL corporate governance program. So in particular, our Board of Directors was, as you know, reshuffled in June. Now 6 out of 11 directors are independent. So the share of independents are now exceeding 50%. And we are far ahead member -- number of the Russian companies and, of course, ahead of all oil and gas Russian companies on this indicator.

So thank you. I'd like to pass it on to Pavel Zhdanov.

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

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[Interpreted] Thank you very much, Alexander, and good afternoon, ladies and gentlemen. I will cover the upstream segment.

Now speaking of price and tax environment, so the segment showed mixed results in reporting period due to highly volatile price environment. So the average Urals crude prices is up 8% on a quarter-by-quarter basis but the tax lag effect, coupled with a 2% ruble appreciation, made the ruble-denominated net price drop by 4%, which is negative, of course, affecting our financial performance in the second. Now the average Urals crude price in the first half of the year is down 4% on a year-by-year basis, but the ruble lost 10% of its value, driving up the net price in rubles and positively affecting financial performance of the company.

Now in terms of operating highlights, so the average hydrocarbon production exceeding the West Qurna-2 project reached 2.4 million barrels per day in the first half of 2019, which is 2.8% higher than the first half of 2018. That the increase was mostly driven by international gas projects as well as the oil production ramp-up in Russia due to change in OPEC+ agreement in 2018.

Now as far as the external limitations, of course, I think the growth rate could've been higher if it wasn't for the external limitations, and this is obvious in the case in the second quarter, of course, when hydrocarbon production dropped 2.3x on a quarter-by-quarter basis due to external factors. And specifically, I'm talking about the changes in OPEC+ agreement in late 2018 and lower gas output in Uzbekistan, which is mostly again driven by external technical limitations and constraints. We continue to focus on better production mix and also keep increasing the share of high-margin barrels. Now compared to the first half of 2019, the production on new projects and hard-to-recover reserve increased by 15% and 21%, respectively.

Now the upstream EBITDA is actually up 14% year-on-year to RUB 470 billion. Now the growth is supported by a better production mix, coupled with high volumes, so the TAI introduction on some fields and reduction in per barrel lifting costs. As I mentioned earlier, so the net price in ruble, of course, surge on the back of the weaker ruble, also improving results. Now the EBITDA from our international operations grew by more than 30%, which is greatly boosting our financial performance in the segment. So this impressive growth was mostly driven by, of course, high gas production in Uzbekistan and Azerbaijan as well as high rising gas prices. Now upstream EBITDA stayed pretty much more or less the same on a quarter-by-quarter basis. However, production volume shrinked and the net ruble price on oil dropped. So the Russian operations were supported also by better production slate and, of course, an introduction of the TAI. In outside Russia, the negative effect from lower gas prices in Uzbekistan was partly offset by high EBITDA on the West Qurna-2 project in Iraq as a result of the growing CapEx.

Now a couple of words about the tax on additional income, or TAI as we call it. Now I would like to touch upon this. And in the first half of this year, our 29 TAI projects produced a total of 2.43 million tonnes of oil, which is 6% from the total liquid hydrocarbon output in Russia. So the third group plays a key role, and you can clearly see in our results in the first half 2019. So we increased our production drilling operations by 30%. So -- and the oil price -- oil production output grew by 8% on a year-by-year basis. Now -- and also we see positive effect on the upstream segment from introduction of this new tax regime.

Now let's talk about specific regions and projects. The Western Siberia. So we continue to manage our production volumes at our mature fields in Western Siberia despite external limitations. In the first quarter, we actually scaled back on the drilling operation as well as workover operations to reduce oil production in Russia as required. And in the second quarter, we actually are back in terms of our operation drilling, so -- to maintain the production level in the region. So consequently, in -- after 6 months, our production in the region only declined by 0.4% on a year-by-year compared to 1.8x declined at mature fields a year earlier. So I'd like to also remind you that we originally planned to reduce production by 2% to 3% at mature fields. So we are ahead of our target on these indicators. So that means that we are hugely successful so -- and we see a strong potential for the increase in production should the external limitations be lifted.

So we're also pushing on our cost optimization program, so streamlining our projects and improving our drilling technologies. And our drilling cost per meter drilled declined by 8% on a year-by-year at multi-bore and -- so basic horizontal wells. Now -- and this is absolutely key to deliver our strategic priorities and to improve our production profile at mature fields now through the development of those additional reserves from our very extensive resource base.

Now speaking of North Caspian, this is a top priority. And in the first half of 2019, so we increased production by 14% year-on-year in this region. We also successfully completed the main drilling cycle so -- under Phase 2 of Vladimir Filanovsky field development, so with a 3 high rate production wells, which is to be commissioned in the first 6 months of 2019. Now -- and that construction installation mostly over at Phase 3 after field, so we have started drilling for the first production well. So -- and the first production plant, we have embarked on further drilling of the well stock as per the field development plan. So I would like to also emphasize that at the Korchagin field, we are successful so -- where oil production has increased by 30% on a year-by-year basis as a result of Phase 2 completion. So as far as Rakushechnoye field, so the shipyards have been built. It's the ice-resistant stationary platform. It's a living quarters platform and cross-weight connection. Now as of the end of the second quarter, so the ice-resistant stationary platform, is 14% complete. Now the quarters are 36% complete. Also, we have to bring procedures to build underwater waste and offshore operations.

Now let's talk to -- and talk about Timan-Pechora heavy crude oil. Now speaking of that, so the development at Yaregskoye field and Permian reservoir at Usinskoye field actually helped us to increase our high-viscosity oil production by 18% on a year-by-year to 2.4 million tonnes. We continue to expand our infrastructure and production facilities. As far as Yaregskoye field, so we plan to put the second line of the oil pipeline into operation by end of this year and to also expand its oil -- the capacity to 3 million tonnes per year. And on the 6 months of this year, so the Usinskoye field commissioned 18 production wells as well as 18 generation capacity with 20 tonnes of steam per hour. We're also optimizing our drilling cost there.

Now we also continue to develop our low permeability reservoirs in Western Siberia, hard-to-recover reserves. Now with past 6 months, so the total increase in production at Imilorskoye and Vladimir Vinogradov fields reached 38% on the year-by-year basis. Now the first 6 half, now we see 45 production wells and 13 injections wells, so putting operations at Imilorskoye fields, so with the production output increased by 42%. Now over the same period, so we also commissioned 14 production wells at Vinogradov fields, where the oil production is up by 29%. Now as part of our ongoing cost-cutting effort, we successfully pilot batch drilling technique and the technique which has helped us actually reduce drilling time by 10%.

Now let's talk about Uzbekistan gas project. In the first half of this year, so LUKOIL share of gas production in Uzbekistan is up by 18% to 7 billion cubic meters. So this growth was mostly thanks to the second train of the -- at Kandym gas processing plant, of course, which was launched in April of last year. Now the second quarter saw a decline due to scheduled maintenance at Kandym plant as well as limitations in gas intake from the Gissar project to -- from the Shurtan gas processing plant as a result of repairs. Now the Shurtan plant is owned by Uzbekneftegaz and also is engaged in Gissar project and into treatment marketable gas. Now the plant will remain dormant. And as for now, so we see a decline basic of 5 billion cubic meters due to this. And we expect it to recover, of course, as the repairs progress. Now at the same time, our production at Kandym is well ahead of target, which will mostly offset, of course, the production loss at Gissar.

Now we also expect to close a deal with New Age to acquire 25% interest stake in Marine XII, which is in Republic of Congo. Now this project is fully in line with the M&A strategy. So -- and this project, of course, has tremendous potential in terms of explored reserves, our infrastructure and is fully in line with our technology, core competence and expertise. The project is already generating positive free cash flow, which is sufficient to fund our output expansion going forward. And the project operator is Eni, which is our strategic partner.

So with that, I'd like to pass it on to Alexander Palivoda.

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

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[Interpreted] Thank you very much, Pavel. Welcome, ladies and gentlemen. So -- and I will cover the downstream segment.

Now in the second quarter, we saw a better price performance for our downstream segment. So in Europe, we see the benchmark margin rose by 18 -- 19% on a quarter-by-quarter basis mostly due to crack spreads with gasoline recovered after a very unusual winter. This was largely, of course, due to seasonal maintenance at Europe refineries as well as a seasonal rise in demand for gasoline in the United States during spring and summer. So -- and this effect was partly offset by tighter crack spreads for diesel fuel, naphtha and fuel oil. Now in Russia, the benchmark margin in U.S. dollars is up more than 2x following a very sluggish first quarter of 2019. Now -- and this growth was mostly driven by lower feedstock costs, also higher wholesale prices on domestic market as well as rising crack spreads for gasoline in international market, causing export netback and the price damper, of course, for gasoline, too. Now I would like to also point out the fact that the price damper was negative in January through February of 2019 as crack spreads for gasoline remained low, also keeping, of course, gasoline prices relatively low.

Now in the second quarter, so average daily refining throughput remained virtually flat on a quarter-by-quarter basis. Now -- and at the same time, our refining throughput in Russia dropped by 3% mostly as a result of scheduled maintenance at our Perm refinery. Now our European refineries actually increased, thus offsetting the decline in Russia. So we're talking about more than a 5% increase. The growth was mostly due to higher capacity utilization in Bulgaria following refinery maintenance program in Q1 2019 as well as disruptions to feedstock supplies in the first quarter, which is caused mostly due to adverse weather in the Black Sea ports.

Now -- and both Russian and European refineries increased their throughput by 2% in the first half of this, driven by high capacity utilization, so in Russia's Nizhny Novgorod refinery and, of course, our refinery in Bulgaria. So -- which is the Burgas refinery. Now despite scheduled maintenance at our Perm facility, our light product yield in Russia generally remained flat on a quarter-by-quarter basis at 69% after we improved the hydrocracking process at our Volgograd refining facility. Now all these refineries enhanced the light product yield in the second quarter from 75% to a very impressive number of 79%, thanks to a better feedstock mix and also processing lighter oil blends. Now despite higher refining throughput, the first half of 2019 saw a decline in total fuel oil output by 129,000 tonnes, which is down to 11% in terms of yield.

Now speaking of sales channels, now our premium sales channels was key and is part of our sales strategy, part of our downstream sales strategy. Now in the first half of this year, our sales of bitumen and also plane refueling and ship bunkering were growing at double-digit rates. Our sales of premium lubricants for motor engines and industrial use of -- have also continued to grow. Now retail sales of motor fuels fell by 4% on a year-by-year basis due to a high business factor in 2018 when vertically integrated companies enjoyed surge in consumer demand for motor fuels. Also, important to point out that the decline in sales was offset by better economics in our retail business, including (inaudible) from nonfuel goods.

Now oil supplies to our Russian refineries remained the most efficient distribution channel so far. Now the second quarter saw a better price environment for Russian downstream segment, now -- thus enhancing our integrated margin on oil supplies to Russian refineries and for the sales through our channels, including the premium channels. Now oil supplies to our Russian refineries declined in the second quarter entirely due to scheduled maintenance. Now the decline gave a boost to exports with international volumes being largely processed by our European refineries.

Now let's talk about downstream EBITDA. Well, despite the favorable market environment, the downstream EBITDA in Russia dropped by 8% on a quarter-by-quarter basis mostly due to negative effect of carried away inventories of oil and refined products in the second quarter of 2019, so as opposed to a positive material effect in the first quarter. So also refining throughput was due to scheduled maintenance, coupled with seasonal decline in revenue from power generation. And these negative factors were partly offset by high refining margin and better results from retail business performance and petrochemicals.

Now in contrast, downstream EBITDA outside Russia actually showed strong growth mostly due to the impact of hedging contracts, of course, and hedge counting as part of our international trading business. In the first half of this year, so higher oil prices actually resulted in a loss recognized as of our reporting date in relation to hedging of unsold crude oil and refined products, which is dragging down on a Q1 EBITDA basis. Now in the second quarter, however, so we see profit from sales of this oil and the product volumes. They contributed positive to the EBITDA growth. So on quarterly difference is exceeding RUB 25 billion.

And I would like to also point out that the overall impact of hedge accounting of EBITDA is close to 0. Now this positive quarter-by-quarter basis impact of hedge accounting was actually partly offset by the carryover effect of inventories at refineries, which was positive in first quarter and negative in the second quarter. So downstream EBITDA actually is up in the first half of this year in both Russia and abroad. So in Russia, it is back due to higher margins and processing volumes, better products made and robust results in retail business. It's actually more than 30% increase outside Russia due to, again, higher processing volumes, better product slate as well as stronger profitability in trading operations. Now -- and lower refining margins in Europe constraint, of course, the EBITDA growth.

Now speaking of new projects, we are working on implementation of selective downstream projects in Russia with a view to enhance lighter product yield and also promoting our bitumen production as a premium business. Also, as for the delayed coker in Nizhny Novgorod, so the work is underway on installation of steel structures. Also shipments of plant and equipment started by order. Now the project is 42% complete. As to the isomerization unit, also in Nizhny Novgorod, so the work is underway to construct that, and the project is 25% complete with the furnace installation. As to the bitumen expansion plans, we are also getting ready to submit our project documentation for environmental test and to receive a positive statement from the government. So we are getting ready to start construction. As to our Volgograd refinery, we are building a deasphaltization unit. So we are currently under construction in terms of the underground utilities, pipelines, furnace foundation and existing racks. And so we are also receiving our shipments of equipment, and the project is currently 25% complete.

Now very briefly about our financial highlights. Now our quarterly revenue increase is mostly due to higher trading volumes in oil and petroleum products and also due to sales of inventories accumulated during the first quarter. And while the price factor was a far less -- had less effect, now inventories were also an important driver on the -- behind this quarterly growth in the second quarter. So we talked about 1.3 million tonnes of oil in petroleum products accumulated in the first quarter.

Now also speaking of operating costs, now our operating costs have improved strongly in both upstream and downstream segment, very, very positive trend. So -- and on a per unit cost, we see a decline. So a lot of that due to IFRS 16 standard, which we discussed in details in the previous call, and also due to our efficiency improvement program. So in terms of the 6 months, we see that on a unit lifting cost basis, we're down by 4% in Russia and by 7% in our overseas assets. Now excluding the IFRS 16 effects on a per unit cost, we see a decline by 1% and 2% on a year-by-year, respectively, which is again due to improving our efficiency and optimizing controllable costs. Now in Russian downstream business, we see also a decline by 1%, but the European refineries actually demonstrate a 5% decline. Now the IFRS 16 effect in downstream is insignificant, mostly negligible, so -- now we're talking about real business factors and real cost cutting.

Now our EBITDA is up 11% on a quarter-by-quarter basis to RUB 332 billion, which is a new record. Now the key drivers are mostly improvement in refining margins in Russia, positive accounting effects from hedging and global trading as well as sales of oil and petroleum product inventories accumulated during the first quarter. Now the last factor is reflected in the illumination line in the EBITDA breakdown in operating segment. Now also note that the inventories and hedging factors are recurrent. It's not a one-off. The second quarter additional EBITDA that came from sold inventories and hedging cost, these offset the EBITDA that we lost in the first quarter. So -- which means that the -- that in the 6 months, this effects offset each other.

Now the net profit rose by 21% on a quarterly basis, which is a 21% increase, yes. So -- and another driver of net profit was the decrease in effective income rate, so -- which is 19% versus 22% in the first quarter. Now again it's a one-off effect. It's a revision of regional income tax rate.

Now let's talk about the CapEx situation. So capital expenditures are standing at RUB 108 billion in the second quarter, which is a 10% quarterly growth. The increase in the upstream is mostly due to, of course, the scheduled payments to suppliers, contractors as well as the commencement of the second development phase of West Qurna-2 project in Iraq. In the first half of this year, so our CapEx spend just declined by 10% on a yearly basis. So we scaled it down due to our investments in Uzbekistan, given the completion of the main construction works and also, of course, the completion of yet another phase at our 2 Caspian fields. Now as usual, of course, we expect increased capital expenditures in the second half of this year.

Now let's talk about cash flow. Rising CapEx, our free cash flow before changes in working capital increased by 3% on a quarterly basis and standing at RUB 189 billion. So this RUB 27 billion growth in working capital was due to an increase in trade receivables, again due to trading volumes. Now on top of that, our free cash flow before changes in working capital reached RUB 373 billion in the first half of this year, which is 50% increase on a year-by-year basis.

Now also in the first half of 2019, we actually distributed a total of RUB 200 billion to shareholders, and 1/3 of that was spent on buyback. So we also spent over RUB 56 billion on debt repayment and servicing. Now our financial standing is very strong. So our total debt stands at RUB 620 billion as of the end of this first half of this year, including RUB 142 billion due to IFRS 16. So our leverage is at 0.1x as of the end of the reporting period.

Now finally, before we move on to Q&A. I would like to also mention our 2019 plans. Now initially, we planned for our hydrocarbon production to grow by 1%, assuming that the external limitations will be lifted in the mid-2019. So we expect to boost our daily liquid hydrocarbon output in the second half of this year. So despite external limitations were still in place, we believe that our plan we're talking about 0.5% to 1% increase, again due to incremental gas volumes. So -- and in terms of the CapEx, original plan was RUB 500 billion. Now that's excluding the West Qurna-2 in Iraq. Now since the production limitations remain in effect, we expect lower capital expenditures, somewhat lower in the range of RUB 470 billion to RUB 490 billion.

So -- and that's all from me. Thank you very much, and we are ready to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the Russian line from the line of Igor Kuzmin from RUS (sic) [Morgan Stanley].

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Igor Kuzmin, Morgan Stanley, Research Division - Equity Analyst [2]

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[Interpreted] Igor Kuzmin, Morgan Stanley. So a couple of questions for you. My first question, if I understand correctly about the shares that are still -- or the subsidiary level that you have again bought back as part of the open offering, so just trying to figure out what's going to happen to the shares. Is it my understanding that there's an intention to actually cancel the shares? But if your intention is strong, then what will be the procedure for canceling these shares? Now -- and the second question specifically on liquid hydrocarbon production in Russia. So what trend are you expecting on an annual basis in 2019?

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Unidentified Company Representative, [3]

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[Interpreted] Thank you very much, Igor from Morgan Stanley. Now as to our intention, the intention is there. And as to the procedure and details of that, so we're not ready to comment on that. So we'll come back to you on that. So as to the liquid hydrocarbon, so we expect flat on a year-by-year basis in Russia.

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Operator [4]

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The next question comes from the line of Ildar Davletshin from the Wood Company (sic) [Wood & Company] on the Russian line. The next question comes from the line of Karen Kostanian from Bank of America on the English line.

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Karen Kostanian, BofA Merrill Lynch, Research Division - Head of EEMEA Energy Research & Head of the Russian Research Department [5]

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My question is you are indicating that the next size from the buyer tender timeline of buyback is going to be determined soon. But in several meetings that we had previously, you have indicated that you are also contemplating potentially increasing the dividend payout. I just wanted to see if there is any update on changing the mix between the buyback and the dividend policy and if there's any consideration or increasing the payout in line with other Russian oil companies.

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Unidentified Company Representative, [6]

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[Interpreted] Thank you very much. Indeed, we are keeping track of what's happening with other Russian companies. We believe that the existing dividend policy also coupled with buyback is one of the best offerings out there in terms of capital distribution, and we are actually underway to offer interim dividends. And the Board of Directors will take place in October, so -- and the announcement will be made in due time.

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Operator [7]

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The next question comes from the line of Ildar Khaziev from HSBC on the Russian line.

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Ildar Khaziev, HSBC, Research Division - Analyst [8]

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[Interpreted] Just a couple of questions. First on the upstream. Could you please remind me on your outlook for liquid in production in Azerbaijan and Kazakhstan? And also in the gas, just I -- please remind me on the output numbers.

The second question is quite technical. So you said that the new IFRS 16 actually led to a reduction in capital costs on production. So did it also have any effect on the working capital?

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Unidentified Company Representative, [9]

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[Interpreted] As to the first question on production for our projects outside Russia, on liquid hydrocarbons, so the outlook for 2019 specifically is an incremental increase. We're planning an incremental increase.

Now as to the actual gas production as you see, the production volumes are growing strongly, mostly through Uzbekistan. So we are planning, as of the year-end, a significant increase in gas production, again due to Uzbekistan. And we're planning to also increase our total output for the company, so the 1%.

Now as to any specific project plans, Azerbaijan project second stage is currently underway. So they're ramping up production for Kazakhstan also very successful. So a very optimistic outlook as to the future periods all the way to the year-end.

On the second question of yours, the IFRS 16 standard, well, true. It had an effect, of course, on operational cost classification, and it also affected SG&A, transport cost, et cetera. It had multiple effect. So -- and of course, it does affect the free cash flow, for sure. So a reduction in operational cost and other items, of course, will directly translate into better number on the free operating cash flow, and it also has some marginal impact on capital cost. Again, due to IFRS 16, we see a minor decline. But generally, there's a positive trend, positive effect on the free cash flow. So -- by the way, it's -- we fully disclosed it in our public statements. You can always drill down and look at the specific numbers. We provided granularity.

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Operator [10]

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

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Henri Jerome Dieudonne Marie Patricot, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [11]

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Yes. I have 2 related financial questions and then one more operational. So wanted to follow up on the previous comments around the buyback and the way it's set up currently, 50% of excess cash flow. We should be thinking about that figure going up in the future, given the fact that you have more limited [operating investments] in Russia with the OPEC+ production constraint.

And related to that, you said in the past that you would like to go into a net cash position. And given your strong free cash flow generation, looks to me that you'll be in such a position at some point next year. So would you return to some net debt position to be thinking about a special dividend or perhaps another tender offer as the one we've seen this summer, to buy back a bigger chunk in one go?

And finally, just a question on downstream side of the business. You mentioned lighter crude slate in the second quarter. I was wondering if we should expect any changes on the crude slate and the price mix in the next few quarters, in particular in light of the much wider spread between clean and dirty products in the past few weeks.

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Unidentified Company Representative, [12]

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[Interpreted] Thank you much, Henri, for the question. So we're planning to continue on the strategic policy when it comes to capital distribution that we stick -- that we announced. So all details will be provided to you in the shortest time possible. Now as to the balance, once again, we confirm that what we've said multiple times, we're not planning a net cash position, and we are taking it to account in our 3-year business plan.

And on the third question, due to, of course, changes in the spread situation and also due to difference between prices on light and heavier oil and also the petroleum product spreads, we can very flexibly change the actual slate of products. Now -- and again, it's a process that is happening in real time. So we're very flexible on that. It's a well-function [Technical Difficulty] expect to change it Technical Difficulty that we use for refining. And again, the top priority here is to maximize our margin, maximize our profit and refine margin.

So if there are no further questions, with that, I'd like to thank you for joining us today on this conference call. And have a very nice day. Thank you.

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Operator [13]

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Ladies and gentlemen, thank you for joining today's conference. You may now replace your handsets.

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