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Edited Transcript of ROSN.MZ earnings conference call or presentation 21-Aug-19 1:00pm GMT

Q2 & H1 2019 NK Rosneft' PAO Earnings Call (IFRS)

Moscow Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of NK Rosneft' PAO earnings conference call or presentation Wednesday, August 21, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Artem Vladimirovich Prigoda

Public Joint Stock Company Rosneft Oil Company - Head of the Department - Planning, VP & Advisor To President

* Didier Casimiro

Public Joint Stock Company Rosneft Oil Company - VP of Refining, Petrochemical, Commerce & Logistics and Member of Management Board

* Eric Maurice Liron

Public Joint Stock Company Rosneft Oil Company - First VP of Production & Member of Management Board

* Oleg Ivanov

Public Joint Stock Company Rosneft Oil Company - Head of Gas Business Planning

* Otabek Karimov

Public Joint Stock Company Rosneft Oil Company - Global Head of Trade, Supply & Logistics and VP

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Conference Call Participants

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* Evgenia Dyshlyuk

Gazprombank (Joint Stock Company), Research Division - Director of Equity Research for Oil and Gas

* 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

* Thomas Yoichi Adolff

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

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the Rosneft Q2 2019 IFRS Results Presentation.

I will now hand over to the management team to begin.

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Unidentified Company Representative, [2]

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Good afternoon, ladies and gentleman. So on behalf of Rosneft, welcome to this conference call dedicated Q2 of 2019 financial results. Welcome, everyone.

So as you all know, in June of this year, during the shareholder meeting, we approved the record level dividend. So -- and last month, Rosneft has completed paying out final dividends for 2018 and, thus, fully committed its responsibility to current shareholders.

Now an increase in profit in the second half of this year is a great foundation for further increase in shareholder value. And just to inform you of the fact that yesterday, the Board of Directors of the company has recommended to pay dividends of RUB 15.34 per share for the first 6 months of 2019, which is a 5% increase compared to the previous year. So dividend yield, therefore, interim -- of interim dividend exceeds 3.7%.

I'll also take more attention to the fact that despite negative trends over the past several years -- several months, the company has managed to increase output of its hydrocarbons by 1.8% compared to the previous year, which is a direct impact of the efforts of company's management to increase hydrocarbon increase since the easing of external limitations in the middle of last year.

Now in the second half -- in the second quarter, the company has continued to generate considerable cash flow. So as of the 12 months, it amounts USD 17 billion with profit margin of 25% as we stand. And talking about cash flow yield, 25%.

Now today, during this presentation, we'll give an overview of operational and financial indicators for the second quarter as well as, of course, Q&A. Joining us today is Eric Liron, First Vice President of Production Department; Didier Casimiro, Vice President of Refining, Petrochemicals, Trade and Logistics; as well as other senior officers of the bank. So we also have Mr. Lazayev here, so Senior Geologist and Head of Exploration Department, et cetera.

Now just to point out the fact that this presentation also contains information about future events and outlooks.

Now for the reported period, external factors have made major impact on the performance of the company. As it was duly noted in the press release, mostly have to deal with limitations as per OPEC+ as well as issues with accessing the system of trunk pipelines of Transneft. Now another negative factor in the second quarter is, of course, a lagging effect of export duty. As you know that the duty increase has outpaced the actual sales price of oil and oil products. So the management continues to take every step to minimize the negative effect of these factors. Still, the results of the reported period are mixed due to these factors.

Now after 80% increase of average daily hydrocarbon increase in the fourth quarter of last year where the company had no external limitations, in the first quarter of this year, we see a decline of 0.6% and in the reported period 3.3% compared to the previous quarter. Now that said, we fully met our responsibilities as per OPEC+ in terms of production quotas. But that said, I have to say that Rosneft has a tremendous output potential which is currently curtailed by the OPEC+ equipment, which will be extended to Q1 2020.

On top of that, of course, we had issues with accessing the Transneft pipeline system. And since May 1 all the way to July 15, we had to actually reduce our production output by 1.7 million tonnes because of that. These limitations are one-off for the company. We continue to invest in both greenfield, mature as well as new assets.

And as you well know, in terms of our production development, we actively support our mature fields. And despite the depletion levels and despite the water cut, we believe that this problem is very successful. In particular, due to this additional investments stimulus for Samotlor field, we see an active increase in output, and we're adding new wells. And as a result, we see the oil production stabilizing at around 380,000 barrels per day. So in the previous years, before the investment program, it was declining on average about 5% per year. So as we speak, the production output for Samotlor is 380,000 barrels a day, which is similar to previous year.

And in 2018, this financial stimulus has managed to generate additional tax revenue for the federal budget due to additional MET and export duties. And considering the positive tax deductions, we are talking about extra RUB 20 billion in tax revenues in 2018 for the government.

Yuganskneftegaz, as you know, is the #1 largest production asset of Rosneft, so we have to acknowledge a considerable decline in production output at Yugansk due to our oil delivery limitations to Transneft pipeline. And as a result, for the reported period compared to the peak levels of last October, so the decline has exceeded 4%.

The key potential increase factor for Yuganskneftegaz will be, of course, Priobskoe deposit, Priobskoe field, and that effect can be implemented in full should the stimulus be provided. And this potential, I believe, will be implemented in full because -- thanks to the stimulus provided and approved by the government, similar to Samotlor field, and this stimulus were already approved personally by the President of Russia. Now as we speak, we have received positive opinion on the support measures from both Ministry of Natural Resources as well as Ministry of Energy. So we do expect final positive statement as to the amount of investment stimulus from both executive bodies. So we're currently finalizing the procedure. We believe that the final statement will come out as soon as possible.

Now for the stimulus to develop, hard-to-recover reserves for Priobskoe-licensed area in the form of tax deductions on the mineral extraction tax of RUB 46 billion annual will allow us for the next 10 years to additionally invest considerable funds to further develop this field, and this will provide positive effect for the Federal Budget as well as dramatically improved production output. We are absolutely sure that this guaranteed amount of investment will be a very positive force and very important source of tax revenue for the government budget.

So when it comes to the actual numbers of this investment program, from 2020 to 2029, we are talking about additional 70 million tonnes of oil due to this stimulus, and this will also provide additional tax revenue of RUB 660 billion and additional dividend stream of RUB 120 billion. So the multiple effect of this additional investment into related industries will amount to about RUB 5 trillion total.

So the company continues to develop its production assets. In terms of the current and future production assets, I would say that all the way to 2029, Rosneft is an undisputed leader in the Russian oil and gas industry. So we are very actively developing recently launched greenfield projects in all key areas, and we are ramping it up and reaching our rated capacities, such as, for instance, the West Erginskoye field was launched in Erginsky cluster. We're also developing infrastructure and ready for commercial production of Srednebotuobinskoye deposit, which will be the core element of the Kondinskoe oil and gas cluster in Eastern Siberia. Also to inform you that Rosneft is the only company bidding for the West [Irkutsk] field in the Krasnoyarsk region, so that's located in north of Krasnoyarsk region.

At the moment, probable reserves of oil and gas at that lot amount to over 500 million tonnes of oil equivalent with a dramatic upside potential provided with this additional exploration. So this is a strategic development for us. So the company will continue to develop this Arctic cluster, so trying to maximize production output and trying to maximize available synergies in the north of Krasnoyarsk region. We also believe that this project will be part of Vostok Oil, and our company, as you know, is currently actively developing this project.

So total production of hydrocarbons in Russia has increased -- from new fields has increased -- has exceeded 380,000 barrels of oil equivalent. So its share in total portfolio of the company is currently in excess of 8%. And considering new launches, by 2022, the share of new launches will increase by over 20%.

Now a couple of words about our foreign assets. I will definitely point out Zohr, offshore Egypt, which is the key contributor to production of gas in the first half of this year, so daily output exceeding 66 million cubic meters of gas. And all the way to the year-end, we're planning to increase average daily gas output to 76 million cubic meters of gas. And in the second half of this year, so also additional walls were commissioned at Yem-Egovskoye and Kamennoye fields for Nyaganneftegaz with very high gas factor.

Now just a couple of words about the downstream part of the company, about the oil refining. So we see a reduction in output, which has to deal with upgrades and also some additional supply and demand situation. I would say I need to point out a very important event that took place in July of 2019. So we completed a utility hookup of a -- of ESPO pipeline to the pipeline of Komsomolsk refinery, which is a very, very important utility hookup. From the logistics standpoint, it provides a major, major benefit. As you well know, previously, the transportation of oil was done by rail, which is about 10 days en route and daily output about 17,000 to 18,000 tonnes, and thus, creating a major en route stocks of about 3,000 oil rail cars, which was not good. So -- and -- so 3,000 oil cars daily en route stock. So after that hookup, now we managed to actually reduce that balance down to 0. So this dramatic -- this caused, of course, a dramatic reduction of overall cost by about 35% from the current level. So we believe that the cost reduction will be in excess of 35%, and that means that we'll also reduce the working capital by about RUB 2 billion due to better logistics, and this will also improve our performance of refining by extra 1 million tonnes of refining products per year.

Now in terms of financial results, in the second quarter, price recovery continued due to geopolitical instability, while -- and the prices were also supported because -- by OPEC+, which is still in effect. And the prices are back to Q4 of 2018, but basically, covering up the decline in Q1. And there are also one-off external factors that impacted the financial performance of the company, well, such as we fully implemented potential of production output due to OPEC+ limitations and also due to the contamination of Druzhba pipeline.

Now in the second quarter, the revenue is up 3% compared to Q1 to RUB 2.14 trillion. Despite the positive price environment, the company's EBITDA went down by 6% to RUB 515 billion due to sales capabilities because of the Transneft and due to increase. So in the first quarter of 2019, we had to write off a number of refining and retail assets and the net profit is up to -- up 1.5x to RUB 194 billion.

Now in terms of CapEx, so in Q2 compared to -- and the first half of 2019, they're pretty much at the same level as 2018, in line with the OPEC+ in June of 2019. So all the way to March 2020, there will be a further reduction in production output, so the company has adopted this adjustment, and therefore, reduced its output from RUB 1.1 trillion to RUB 1.3 trillion to RUB 1 trillion, RUB 1.1 trillion in 2019. Still, I would like to underline the fact that an increase in production output is one of the top priorities, and the company will continue to invest in the future to develop new assets as OPEC+ will mature and finally be lifted.

Now we believe that the financial standing of the company is very stable in terms of all key financial KPIs, and a top strategic priority for the company is to continue to reduce debt. So we've managed to actually reduce debt by over RUB 800 billion, which is about 14% since the beginning of the year. As of the second quarter, so the short end of the debt is still at the level of about 20% compared to 56% as of the end of 2017. So -- and in terms of debt-to-EBITDA, for the reported period, it's at 1.3x.

Now we also see that we managed to reduce the amount of advance payment and positive trend in terms of recovery in terms of PDVSA. So that was reduced by $2.3 billion to $1.1 billion. Also a reduction in advance payment is now improving compared to the previous periods based on terms and conditions on new contracts.

Now Rosneft will continue to operate and continue to maximize profit and free cash flow despite negative impact of outside factors and existing limitations, which we consider to be one-off.

Now a reduction of debt and improving dividend is one of our top priorities, so an increasing production output in midterm perspective as well as gas production output, including the high-margin barrel component, will help us stay ahead of our competition. We hope that as we fulfill our goals, the market will benefit and the price performance of our shares will also benefit from this.

So that's all from me. Thank you very much, and I'm open to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Ildar Khaziev from HSBC.

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Ildar Khaziev, HSBC, Research Division - Analyst [2]

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I have 3 questions. One, about the supplies of oil to Asia this year and increase in deliveries. Are these deliveries out of Russia? Or are these some transit deliveries? Or is it just China or other Asian countries? That's my first question?

My second question is about the German situation. So I know that one of the production assets was suspended, and I wonder if you will receive some insurance coverage on that. That's the second question.

And the third question, still don't understand and I'm looking at operational costs, the amount of operational costs in Q2. So the way I read it, the upstream and downstream amount actually exceeds the total amount of costs that you disclosed in your report. I wonder if this has something to do with some en route stocks effect.

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Unidentified Company Representative, [3]

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So Otabek Karimov will be able to answer that, so on the first 2 questions and also on the German refinery. Please.

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Otabek Karimov, Public Joint Stock Company Rosneft Oil Company - Global Head of Trade, Supply & Logistics and VP [4]

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Yes. Thank you very much. In terms of oil deliveries, we are talking about Russian oil delivered to mostly China, mostly china. And of course, we're also talking about other Asian destinations but, of course, the bulk is China, of course. And this is Russian oil, this is not a transit oil.

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

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And what particular refinery are we talking about in Germany and when, well, because it could be different things happening?

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Unidentified Company Representative, [6]

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I don't remember exactly, but I know there was an accident or something like that. We clearly see it in terms of refining volumes in Germany. So there was a decline. I know there was some sort of an accident. I could be wrong. Correct me if I'm wrong. Okay. Yes, please. Sure, go ahead.

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Didier Casimiro, Public Joint Stock Company Rosneft Oil Company - VP of Refining, Petrochemical, Commerce & Logistics and Member of Management Board [7]

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I can comment on that. Yes, no problem. So my name is -- I'm Vice President of Refining. I guess we are speaking about buyer oil at (inaudible). Indeed, a year ago, there was a major accident, and basically, that refinery was halted and it was nonoperational throughout the year, and that, of course, caused a decline in overall refining output. But 8 months ago, it was recommissioned out of whatever was left, and we're now trying to ramp up production. And from -- so reforming, fractionating as well as bitumen production units are already back online. So -- and in September, we'll also add a diesel capacity. So that's, I guess, the asset that we're talking about. So -- and this actually is the main -- the result of the previous decline. But again, we're now coming back to normal.

And in terms of insurance coverage, we will come back to that because, well, that's a separate issue, so we'll come back to you on that.

And something about operational costs in Q2 results, indeed. So Artem Prigoda, Vice President of Operational Planning. Please, Artem?

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Artem Vladimirovich Prigoda, Public Joint Stock Company Rosneft Oil Company - Head of the Department - Planning, VP & Advisor To President [8]

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Okay. So let's take it offline. We have an appendix. And the appendix is very, very detailed, so you can see the numbers in the appendix. I mean that will be the best way, okay?

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Operator [9]

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Next question comes from Henri Patricot from UBS.

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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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Two questions for me. First one on the downstream side of the business in Russia. Can you comment on the macro situation related to second half of the year with the changes due to damper mechanism, local pricing? What can we expect in terms of utilization and sales in the domestic market?

And then secondly just on the gas business. Can you provide bit of an update on production over the rest of this year and next year in terms of the targets because production was down slightly this quarter compared to the first quarter? I suppose there's some seasonality in there, but if you could update on the targets for the rest of the year, that would will be helpful.

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Unidentified Company Representative, [11]

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Thank you very much for the questions. When it comes to the damper that we received and the exceeding amount, I would address this to Otabek Karimov, please. And in terms of the gas business, very briefly, Oleg Ivanov. We have Oleg Ivanov here, so the financial -- the CFO of financial -- of gas business. We have very interesting development there, especially in light of Rospan project.

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Otabek Karimov, Public Joint Stock Company Rosneft Oil Company - Global Head of Trade, Supply & Logistics and VP [12]

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Yes. Hello, and just very briefly on that, as far as the damper, it was introduced in the Russian Federation to stimulate the fuel delivery to the domestic market and reduce the gap between the export parity and the domestic prices. So the damper, as we call it, there's a formula, actually, there's a price formula. So -- and that is then -- the companies when they deliver oil domestically then get a recovery. So again, the government is doing this to stimulate fuel supplies to the domestic market. But we are not exporting -- we, of course, supply both domestically and globally because we have our responsibilities to the government, so we do both regardless of the damper.

Total net effect is about RUB 9 billion, total positive net effect of these actions, RUB 9 billion.

Yes. And Oleg, please on the gas side.

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Oleg Ivanov, Public Joint Stock Company Rosneft Oil Company - Head of Gas Business Planning [13]

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Yes. Thank you very much. Well, as you can see from the presentation, the first half results, the production output for gas, pretty much on the same level compared to the previous year. We expect that in the second half of this year, this trend will continue and the production output will be similar to the first half. The Rospan project that we're planning to launch in 2019 so far has not had an effect on the production output. Well, the thing is that the Rospan project, the commissioning itself will be quite short and quick, so this will not affect on the production output. So we do expect a similar production output for gas as in 2018.

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Operator [14]

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The next question comes from Igor Kuzmin from Morgan Stanley.

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Igor Kuzmin, Morgan Stanley, Research Division - Equity Analyst [15]

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I have several questions. My first question is about the situation with the Druzhba pipeline contamination. So from what I understand, Rosneft has made, well, adjustments and also bears certain costs due to this contamination, this accident. So I was wondering about what numbers are we talking about in the Q2, what kind of damage, financial damage. And how will Q2 be different from Q3 and onwards? So do you have any plans to recover these costs due to this Druzhba situation? And if you are planning to recover this damage, so what kind of recovery can we expect? So that's the first question.

The second question that I have for you is the level of EBITDA that you have achieved specifically and then the free cash flow on that -- on the Indian assets.

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Unidentified Company Representative, [16]

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As far as the Druzhba situation, I will address it to Mr. Karimov, and in terms of EBITDA on (inaudible) Energy, I will have Artem Prigoda. Please, gentlemen?

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Otabek Karimov, Public Joint Stock Company Rosneft Oil Company - Global Head of Trade, Supply & Logistics and VP [17]

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Yes. Hello. Speaking of the Druzhba contamination accident that took place earlier this year, as of now, it is very difficult to fully calculate the damage. The problem is that the tankers carrying the contaminated oil that our counterparties are currently holding, the majority of them has not been -- is still in the tanks. So the claims have not been produced yet. So at this point, it is too early to calculate the full damage of that situation. So we, as a company, has shipped 8 tankers, as you know, and these 8 tankers were holding contaminated oil. So it is difficult at this point to fully calculate it. So it has several elements: first of all, the contaminated oil itself; secondly, a reduction in production output due to a choke in the Transneft pipeline because the contamination had reduced the throughput; and there's also a refinery impact in Germany because, well, Germany refineries had to actually buy oil from third parties because at that point, we couldn't physically deliver oil. So once we'll be able to calculate full damage and receive all claims, then, of course, we will produce the statements and then, of course, we will act upon this. I mean Rosneft has been a very high-quality supplier of oil, historically.

On my behalf, I would like to point out that this is a one-off reduction effect, which is Q2 of 2019. And I would add to what's been said that in the future, when it comes to damage calculations, so that is, of course, a legal issue and it has to be based on the actual claims made based on the terms and conditions of delivery contracts. So at this point, it is too early to -- on the Indian assets, I would address this issue to, yes, Artem?

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Artem Vladimirovich Prigoda, Public Joint Stock Company Rosneft Oil Company - Head of the Department - Planning, VP & Advisor To President [18]

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Well, as far as the Indian assets, despite worsening in the market conditions in 2019 because of the sanction situation when it comes to Iran and Venezuela. So the heavy oil that was used from those regions. Both general and financial performance compared to 2018 year-on-year is actually improving in this part. So we are improving our EBITDA, we are improving our net profit, we're improving net free cash flow. So we do expect that going forward -- so we will also ban using high-sulfur heavy fuel. And because we're going to reduce the output of these particular oil products, I guess, in terms of overall basket, we will win eventually.

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Operator [19]

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Next question comes from Evgenia Dyshlyuk from Gazprombank.

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Evgenia Dyshlyuk, Gazprombank (Joint Stock Company), Research Division - Director of Equity Research for Oil and Gas [20]

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I have 2 questions. My first question is, if I'm not mistaken, in the second quarter, Rosneft was planning to reduce debt by about USD 3 billion. So was this -- can you give me an update? Are you planning any down payments in the coming quarters on that reduction? That's the first question.

And speaking of the net free cash flow circulation, so operational cash flow has negative -- just negatively impacted the working capital number quite significantly. We are talking about RUB 250 billion. So should we expect a positive recovery from this situation going forward, just for my understanding, let's say? So should we expect a recovery as of the year-end?

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Unidentified Company Representative, [21]

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Thank you very much for this question. So let me answer this question. The thing is that the Q2 numbers, a lot have to do with the outside factors. And as it was stated in the press release and in my previous statements, the one-off situations were outside of our effect as these were mostly related to extraordinary events. Now this has to deal with the Transneft situation, this had to deal with the strategic decision on the OPEC+, which is outside of our control. Hence, the oil numbers, I mean, are worse and lower compared to our original expectations that we had in the beginning of the second quarter of this year, number one. Secondly, of course, that caused the cascading effect, such as an increase in working capital. So -- and this is specifically to limitation of access to our trunk pipeline of Transneft. And we, of course, believe that this was a one-off effect, and going forward, we will see a recovery. And we will see, of course, positive dynamics on working capital going forward. So yes, we do expect recovery, a positive recovery, but yes, because of the forward-looking guidance policy, I don't want to be overly positive. So I hope that this will happen, but yes.

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Operator [22]

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Next question comes from Thomas Adolff from Crédit Suisse.

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Thomas Yoichi Adolff, Crédit Suisse AG, Research Division - Head of European Oil & Gas Equity Research and Director [23]

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Just firstly a question of clarification, if possible. On the 1Q call, you've guided to a net debt reduction for the second quarter of between $2 billion to $3 billion and you didn't quite achieve that, so I just wanted to double check with you whether this is entirely attributable to the issues with Transneft as well as the reversal and the prepayments in Kurdistan.

And secondly, I just wondered if you can comment on what exactly you're doing in Kurdistan to see the prepayment be reversed.

And then finally, if you don't mind commenting on the operating environment in Venezuela? I can see that you're getting paid, but I just wanted to get an insight from you what is going on, on a quarter-on-quarter basis.

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Unidentified Company Representative, [24]

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Thank you very much for the question. And in terms of the net debt reduction that we were planning and the degree to which it's related to the accident that happened, as I stated previously, indeed, it was caused by that accident. So I confirm here, full stop, that it was the main contributing factor.

As to the Venezuela situation, we have Eric here from E&P. Please, Eric, floor is yours.

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Eric Maurice Liron, Public Joint Stock Company Rosneft Oil Company - First VP of Production & Member of Management Board [25]

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So thanks for the question. So the activities in Venezuela are continuing as before, just we're being hampered a little bit by the lack of dealer. And so we're finding other technical solutions to that. Dividends are being paid to our account as normal, and we're cleaning up a little bit our commercial debt with Venezuela. So the only problem is unpredictability due to the restrictions imposed on the company.

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Unidentified Company Representative, [26]

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And in terms of Kurdistan, this is an ongoing commercial activity business as usual. There have been several prepayments, and the down payments on the prepayments are -- is on schedule. So I mean the oil has been off-taken. So -- and we previously reported on Kurdistan, so pipeline concessions that we are now partaking and the delivery contracts are already covered. So other than that, it's all business as usual.

And that's all we have in terms of the Q&A. Thank you very much, and we'll be back in 3 months. Thank you very much, and have a very nice day. Thank you.

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Operator [27]

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There are no further questions on the line. Ladies and gentlemen, thank you for joining today's call. You may now disconnect your lines.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]