Archive

No. 3, 2004

Alexander Volzhsky

SUCCESS POTENTIAL


The Annual General Meeting of JSC LUKOIL shareholders confirmed the Company's course toward joining the club of world oil and gas majors

The Annual General Meeting of LUKOIL shareholders was held on June 24, 2004, in Moscow to approve the Company's 2003 performance report and review the initial results of the first stage in the implementation of LUKOIL's Strategic Development Program until 2013.

Result-oriented activity

LUKOIL President Vagit Alekperov gave a report on the Company's performance in 2003 and further development prospects.

He noted that last year was one of the most successful ever in the Company's history. LUKOIL is currently in second place in the world in terms of proven reserves of hydrocarbons. Over last year, the Company's reserves have grown by 4% and now exceed 20 bln. barrels of oil equivalent. Compensation for the hydrocarbon production volume by the increment in reserves brought about by prospecting works stood at 195%.

In 2003, LUKOIL's subsidiaries and affiliates produced 81.5 mln. tons of oil (79.8 mln. tons in 2002), including 78.6 mln. tons on the territory of Russia. Oil production was carried out at 311 fields. In 2003, 14 new fields were put into operation.

Last year, geologists discovered 13 new oil fields, one gas condensate field, one oil and gas field, and 14 oil pools at previously discovered fields. The main increase in reserves was in the Nenets Autonomous Area, on the Caspian shelf, and in Western Siberia. LUKOIL's increase in hydrocarbon reserves was 169.7 mln. tons of oil equivalent, providing not only for recovery compensation, but also for a significant rise in oil and gas reserves of the Company.

The main increase in reserves of gas and condensate was in the Caspian Sea. As of January 1, 2004, the residual recoverable reserves of category ABC1 amount to 2.47 bln. tons of oil, 0.77 bln. tons of gas condensate, and 1.03 bln. m3 of natural gas.

Implementation of the Comprehensive Program for optimizing oil development and production in 2003-2005 made it possible in 2003 to raise the average daily production rate to 224,000 tons, against 213,000 tons in 2002. Moreover, in the fourth quarter of 2003, the average well production rate was sustained at 10.1 tons a day (9 tons a day in 2002). The utmost production rise was achieved by JSC Naryanmarneftegaz and JSC LUKOIL-Komi.

In 2003, the Company produced 5.7 bln. m3 of gas, which is 11% more than in 2002, including 1.3 bln. m3 of natural gas.

Oil exports rose by 10% over 2002 to reach 37.7 mln. tons.

In 2003, LUKOIL refined 43.5 mln. tons of oil, including 42.3 mln. tons at its own refineries. Russian-based refineries processed 34.3 mln. tons, operating at 83.2% of production capacity, while refineries located abroad produced 8 mln. tons of petroleum products.

In 2003, the Company's gas processing plants turned out 2.1 bln. m3 of oil gas, the output figure of petrochemical facilities topped 1.76 mln. tons (1.63 mln. tons in 2002). The company exports petrochemical products to over 50 countries.

Exports of petroleum and gas processing products by the Company amounted to 13.5 mln. tons (against 14.2 mln. tons in 2002).

The Company's sales network includes 201 tank-farm facilities with a total reservoir capacity of 3 mln. m3 and 4,599 gasoline filling stations. The Company's retail network in Russia consists of 1,456 owned and leased and 276 franchised gasoline filling stations. In 2003, 2.4 mln. tons of petroleum products were sold through the retail network in Russia, 1.24 mln. tons in Europe and the CIS countries, and 2.44 mln. tons in the United States of America.

Last year, the Company supplied the Russian market with 18.6 mln. tons of petroleum products, or 9% more than in 2002, this including 6.9 mln. tons to wholesale and public consumers.

In 2003, implementation of LUKOIL's 2002-2003 Environmental Safety Program was completed. As a result, the Company's environmental impact specific indices were much lower than the average figures for the industry as a whole. Last year, the Company adopted an environment-friendly program of the companies in the LUKOIL Group for 2004-2008 which includes about 400 measures worth a total of 34.5 bln. rubles. The priority aim of this program is to improve the system of waste management, as a result of which, by 2008, the waste accumulated over previous decades at the Company's affiliates and branches will disappear and the volume of new waste accumulations will be significantly less.

In 2003, the Company focused on raising the economic efficiency of projects and adjusted the development targets, prioritizing further improvement of the financial results, higher profits and a rise in the Company's value. As a result, the capitalization of LUKOIL went up by over 50%, and the volume of share trades and depository receipts rose by over 60%. Efforts to strengthen LUKOIL's financial position and corporate governance resulted in the Company achieving Moody's BA2 credit rating.

The results of the Company's operations also testify that the 2001-2003 goals for restructuring the LUKOIL Group have, in general, been attained. The main part of the restructuring program, envisaging a cut in the number of organizations through reorganization by way of takeover, sales outside the Group or liquidation, was fulfilled.

In 2003, the Company made a record net profit of $3,701 mln., which, in turn, allowed dividend payments to be raised by 34% over 2002.

The most important component of LUKOIL's financial policy remains precise fulfillment of all tax obligations. The overall volume of tax payments in 2003 rose by 36% to approach the $6.5 bln. mark. Consequent to decisions taken by the the Government of the Russian Federation in 2003, a further increase in the tax burden is anticipated, which will naturally require the Company's management to seek new reserves for tax optimization.

The development vector

In his report, Vagit Alekperov stressed in particular that the Company invariably acts in the interests of Russia, specifically investing in the development of new oil and gas fields. At the end of 2003, the LUKOIL Board of Directors approved the Company's Strategic Development Program until 2013. This document outlines the ways and means for the Company joining the world club of oil and gas majors over the next decade. Achieving this goal will require that a whole series of narrower tasks be resolved. One of these, in particular, is sustaining steady production growth rates over the long term. According to leading analysts oil production at operating Russian fields will go on rising until 2008. Any further growth may be provided for only by new oil provinces, which the Company is persistently developing today. On the territory of the Republic of Komi, the Nenets Autonomous Area and the Arkhangelsk Region, for instance, lies the Timan-Pechora oil- and gas-bearing province. The strategic importance of its reserves is explained not only by their volume, but also their convenient geographical position. The northern fields of Timan-Pechora are located on the Barents seacoast, so its oil and gas may, in the future, be supplied not only to Europe, but also North America.

The special pride of our Company is the discovery of a new oil- and gas-bearing province in the northern Caspian. Just a few years ago, it was believed that the main reserves of hydrocarbons were concentrated in the Azerbaijan, Kazakhstan and Turkmenian sectors of the Caspian Sea. This not only weakened Russia's positions, but also increased the overall instability in the region. Over the past five years, LUKOIL has discovered five major oil fields in the Russian part of the Caspian, with total reserves of over 80 mln. tons of oil and 650 bln. m3 of gas. The appearance of new geological information has allowed Russia, Kazakhstan and Azerbaijan to achieve the delimitation of their marine borders in practically no time.

Baltic offshore oil production in the Kaliningrad Region is of enormous significance for the economic and energy security of this area. During the elaboration and implementation of the project for developing the Kravtsovskoye (D-6) oil field, LUKOIL experienced certain pressure not only from Russian "greens", but also the European Union. In order to eliminate the possibility of any formal grounds for objections, the Company undertook unprecedented measures to ensure the environmental safety of work in the region. As a result, Russia's influence in the region was strengthened, and the world community had to recognize the fact that the Russian company was capable of creating a modern infrastructure for offshore oil production quickly, with high quality and without the slightest harm to the environment.

It should be stressed that, today, the total volume of the Company's recoverable reserves in the above regions have already exceeded 1 bln. tons of oil and 1.5 trln. m3 of natural gas. By 2010, it is estimated that over 60 mln. tons of oil equivalent will annually be produced there.

The Bolshekhetskaya Depression fields, located in the north of the Tyumen Region, will constitute the backbone of the Company's gas business. Initial gas production will begin there as early as 2005. By that time, gas pipeline will have been constructed to transport LUKOIL hydrocarbons to Gazprom's trunk pipeline system. This example clearly shows that, while the media discuss conflicts between Gazprom and the independent gas producers, the companies themselves are easily finding a common language. This is because the tasks facing the two key companies of the Russian fuel and energy complex are mutually complementary. JSC Gazprom needs additional sources of crude for supplying Russian consumers, while LUKOIL needs a guaranteed sales channel for the hydrocarbons it produces.

Responding to the call of the times

In 2003, LUKOIL exported 48% of the crude oil produced on the territory of the Russian Federation. Given the favorable price situation, the rise in exports helped the Company increase its revenues by $2.5 bln.

According to expert estimates, however, by 2005, Russia may come up against a deficit of transportation capacity for exporting oil, so the current state of the Russian transport infrastructure dictates the urgent need for LUKOIL to find solutions to this problem, including by its own efforts. The commissioning, on June 16, 2004, of the transshipping complex in Vysotsk (Leningrad Region) is a good example. In the initial stage, its capacity will be about 5 mln. tons, and subsequently be boosted to 12 mln. tons. In term of most of its features, the Vysotsk transshipping complex is superior to any similar facilities in the Baltic region.

The Company is currently continuing to implement a series of projects to expand its own transportation capacity. In particular, this applies to increasing the aggregate throughput capacity of the Vysotsk (Leningrad Region), Varandey (Nenets Autonomous Area) and Izhevskoye (Kaliningrad Region) terminals to 29 mln. tons.

There is another major project in which LUKOIL is willing to invest its funds Р construction of the Western Siberia - Murmansk oil pipeline system, to supply substantial amounts of hydrocarbons to the markets of Western Europe and North America. This project is in the national interests of both Russia and the leading developed countries in the world, which will thus become much less dependent on supplies of oil from the Middle East.

A strategic priority for LUKOIL is to increase sales of its products. Achievement of this goal presupposes an expansion of refining capacity outside the Russian Federation, as well as a considerable rise of retail sales in the regions in which the Company has its own refineries.

In 2003, LUKOIL carried out targeted efforts to bring costs under control. Operating costs rose by 6% over this period, while the real strengthening of the ruble against the dollar amounted to 20%. The share of costs per barrel of oil produced remained virtually unchanged at $2.61.

To enhance the management efficiency of the Group and administrative costs control, LUKOIL is continuing to reorganize its corporate structure. Serious steps have been taken to improve the system of corporate management. In 2003, the number of "independent" members of the Board of Directors was increased. Three committees were set up under the Board to deal with strategy and investment, audit, and human resources and compensation. In the near future, it is planned to complete the formation of regional production, refining and marketing centers. In 2004, service units for drilling, construction and transport complexes are to be moved outside the Group.

At the meeting of shareholders, the Board of Directors of JSC LUKOIL was elected as follows: Vagit Alekperov, President of JSC LUKOIL; Mikhail Berezhnoy, General Director of NPF LUKOIL-Garant; Alexander Braverman, President of the non-profit organization Russian Marketing Association; Valery Graifer, General Director of JSC RITEK; Oleg Kutafin, Rector of the Moscow State Academy of Law; Ravil Maganov; Richard Matzke, former Deputy Chairman of Chevron; Sergey Mikhailov, Chairman of the Board of Directors of the Management-Center governing company; Mark Mobius, General Director of Templeton Asset Management; Nikolay Tsvetkov, President of NIKoil Finance Corporation; and Igor Sherkunov, Chairman of the Board of Directors of JSC Investment Group Capital. At the meeting of the newly elected Board of Directors held after the annual general meeting of shareholders, General Director of RITEK Dr. Valery Graifer was elected the Board Chairman.

The results of LUKOIL's performance in 2003 show that it is a modern, mobile and transparent company, developing much more dynamically than many of its foreign colleagues. The Company's management is working consistently to implement its Strategic Development Program. By 2013, LUKOIL intends to increase its net profits to $6 bln., its rate of return on capital to 17%, and its average annual income for shareholders to 18%.

The guarantee of achieving all these goals is the efficiency and dynamic development of the Company on the basis of social responsibility, strict fulfillment of its tax obligations, and constructive cooperation with the government authorities.




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Oil of Russia, No. 3, 2004
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