No. 4, 2009

LUKOIL is consolidating its foothold in the Black Sea and Caspian regions

In 2008-2009, LUKOIL substantially increased its presence in the South Caucasus and Turkey. This period witnessed a significant growth of gas production under the Shah-Denis gas condensate project, in which the Russian oil industry leader alone has a 10% interest. The Company has also expanded its business on the fuel markets in Azerbaijan, Georgia and particularly in Turkey, and the aggregate LUKOIL investments in the economies of these countries total $2 billion.

Realizing Azerbaijan's gas potential

Commercial production of gas under Stage 1 of the Shah-Deniz gas condensate project was launched at the end of 2006. In subsequent years, gas and gas condensate production under this project was steadily rising, to reach 7.1 billion m³ of gas and 1.8 million tons of gas condensate in 2008. This year, it is already planned to produce 7.5 billion m³ of gas and 1.9 million tons of gas condensate at Shah-Deniz.

When Stage 1 of Shah-Deniz attains its projected maximum output of 8.6 billion m³ of gas and 2 million tons of gas condensate a year, this will allow the project partners to export 6.6 billion m³ of gas a year to Turkey along the South Caucasus pipeline. In addition, under Stage 1, Azerbaijan will get over 1.5 billion m³ of Shah-Deniz gas a year to satisfy its own energy requirements, after meeting its contractual obligations to Turkey.

The Government of Azerbaijan will soon authorize Stage 2 of the Shah-Deniz project. The projected maximum volume of production under Stage 2 will amount to 8.6 billion m³ of gas and 2 million tons of gas condensate a year.

Successful implementation of Stages 1 and 2 at Shah-Deniz will enable Azerbaijan and its partners under project to export over 13 billion m³ of gas and more than 4 million tons of gas condensate a year, as well as to expand the number of countries importing Caspian gas.

In this context, the agreements reached in Baku between Russian President Dmitry Medvedev and President of the Azerbaijan Republic Ilham Aliev on 29 June this year are of fundamental importance. As Alexey Miller, Chairman of Gazprom's Managing Board, announced after the Baku talks, the Russian gas giant "is put on the list of potential buyers of Stage 2 gas of the Shah-Deniz project" and that "all other things being equal, Gazprom will be given priority among other prospective buyers of the Stage 2 gas".

Yet this is an outlook for the gas market for a period 7 to 9 years from now, a space of time the project participants will need to bring Stage 2 up to the designed maximum. On June 29, Russia, represented by Gazprom, and Azerbaijan, represented by the State Oil Company of the Azerbaijan Republic (SOCAR), agreed both on gas co-operation under Stage 2 of Shah-Deniz, and on deliveries of at least 0.5 billion m³ of Azeri gas a year beginning from January 2010. The deliveries will be made through the Mozdok-Kazi-Magomed pipeline out of the total amount of gas produced in Azerbaijan, including the country's share of the gas from Stage 1 of Shah-Deniz. On June 29, in Baku, the Presidents of Russia and Azerbaijan assessing the agreement signed between the head of Gazprom Aleksey Miller and the President of SOCAR Rovnag Abdullaev said that these deliveries would be of mutual benefit.

The gas supplied northwards by SOCAR from 2010 will be purchased by Russia at prices that are commercially attractive to Azerbaijan. This, considering the absence of transit costs of northwards exports, will be of additional economic benefit to Azerbaijan.

The huge hydrocarbon potential of Shah-Deniz, with its estimated reserves of 1.2 trillion m³ of gas and over 200 million tons of gas condensate, will make it possible, once Stage 1 and Stage 2 production volume reaches the designed targets, to ensure stable energy supplies to the fuel markets of Azerbaijan and other countries for nearly 70 years.

Under the LUKOIL trademark

The mutually beneficial co-operation between LUKOIL and SOCAR, based on the bold and foresighted policy pursued by the President of LUKOIL Vagit Alekperov and the Company's Board of Directors of resuming, in the early 1990s, the former ties between oil companies of Russia and Azerbaijan, became an economic bridge between the two friendly countries. Since then, LUKOIL has occupied strong positions in Azerbaijan's oil and gas production sector, in small wholesale and retail sale of petroleum products and in a number of other production and commercial areas, with the overall volume of the Company's investments in the economy of Azerbaijan topping $1 billion. After Stage 2 of the Shah-Deniz project is completed, this sum might reach $3 billion.

Let me remind you that the first LUKOIL gasoline filling station in the South Caucasus region appeared in Azerbaijan in 1995, and the Company's fuel storage facility (one of the most technologically advanced in Azerbaijan), with an annual transshipment

capacity of 120,000 tons of petroleum products, was opened in Baku in 2000. Gasoline filling stations with LUKOIL's brand name have now become an integral part of the Azeri fuel market: they are operating in Baku, on the Apsheron Peninsula and in the Khachmazsky and Gusarsky districts (northwards freight and passenger traffic), and their number totalled 29 by the end of 2009.

Operations on the Azeri fuel market have their own specifics. First, the only major wholesale supplier of fuel to the home market is SOCAR. Second, wholesale and retails prices of petroleum products in Azerbaijan are regulated by the state: since January 8, 2007, the price of a litre of 95 octane gasoline has been set at 0.6 Manat ($0.74, at the currency exchange rate in the autumn of 2009), and that of a litre of diesel fuel at 0.45 Manat ($0.55). Given the annual growth in gasoline, diesel fuel and lubricants consumed in Azerbaijan, the increase in the number of gasoline filling stations, and the stability of the wholesale and retail prices for fuel, and of the country's currency unit - the manat, the key to successful business on the Azeri fuel market are sound management and quality servicing. Some of the gasoline filling stations belong to one of the five companies, but most of them belong to individuals.

In 2008, the capacity of the Azeri fuel market topped 3 million tons of petroleum products. The only imported product are motor oils, with over 10,000 tons of imported motor oils being sold in Azerbaijan every year, including those

produced by refineries belonging to LUKOIL, ВР, Shell and other companies.

Since 2002, lubricants produced at LUKOIL refineries have been sold in Azerbaijan. Over the seven years, LUKOIL's sales of its own oils on Azerbaijan's fuel market have increased 23-fold, to reach almost 1,400 tons in 2008.

The fuel market in Georgia operates on different, more liberal principles. First, on the Georgian fuel market, which, in 2008, had a capacity of about 0.7 million tons, imported gasoline, diesel fuel, lubricants and other petroleum products are sold. For instance, petroleum products are supplied for LUKOIL gasoline filling stations in Georgia by the Company's refineries operating in the Black Sea region. Second, the retail prices of petroleum products on the Georgian fuel market are supply- and demand-driven. At the beginning of the second half of 2009, for instance, due to the rise in oil prices on the world market, the price of super gasoline reached 1.42 lari ($0.83) a litre and of diesel fuel 1.29 lari ($0.76), meaning that retail prices for fuel were 12-38% higher in Georgia compared to Azerbaijan.

Strategic partnership with Turkey

In 2009, Russia and Turkey made a fundamental step forward in developing their bilateral economic co-operation. During the August visit by Prime Minister Vladimir Putin to Turkey, 15 intergovernmental agreements and 7 special protocols envisaging broader co-operation between the two countries were signed, above all in the energy sector. Turkish Prime Minister Recep Tayyip Erdogan stressed, when summing up the results of the visit by Prime Minister Putin to Turkey, that the two countries were reaching the level of strategic co-operation.

It should be noted in this context that LUKOIL has been successfully and dynamically operating on the Turkish market for several years now, thereby making its own weighty contribution to development of economic co-operation between Russia and Turkey.

The Turkish fuel market is very capacious owing to the constantly growing vehicle fleet, reaching almost 13.9 million by the beginning of 2009, including 6.8 million motor cars. As a consequence, the sales volume of petroleum products in Turkey in 2008 exceeded 19 million tons, which is 5 times more than the aggregate fuel market capacities of Azerbaijan and Georgia. In addition, the retail prices of fuel are relatively high on the Turkish market. In 2007, for example, a gallon of Euro-Super gasoline cost $1.85, rising to almost $2 in 2009.

In spite of the strong competition, LUKOIL is consistently expanding its operations in Turkey, in whose economy the Company has already invested over $750 million. As a result, by the end of 2009, the number of gasoline filling stations owned by LUKOIL in Turkey exceeded 750 (more than 70 of these carry the LUKOIL brand name) and the monthly sales volumes reached 30,000 tons of gasoline, diesel fuel and motor oils. Let me stress that LUKOIL now has gasoline filling stations in all Turkish provinces.

It should be noted that demand on the Turkish fuel market is met mainly by the country's own petroleum product production: Turkey has four refineries belonging to the Tupras company: in Izmit (with a capacity of 11.1 million tons of crude oil a year), in Izmir (11.2 million tons), in Kirikkale (5.6 million tons) and in Batman (1.1 million tons).

However LUKOIL gasoline filling stations in Turkey sell petroleum products produced by the LUKOIL refineries located in Volgograd, Odessa, Burgas and Sicily, meaning that LUKOIL Eurasia Petrol abides in practice by the Russian oil major's principle of "from well to wheel". In 2008, the volume of LUKOIL petroleum products supplied to Turkey exceeded 618,000 tons.

In Turkey, the LUKOIL petroleum products are delivered by tanker to the Company's own terminals, whence the gasoline, diesel fuel and black oil are transshipped.

Let me note that LUKOIL acquired its first terminal in Turkey (with a total reservoir capacity of 10,000 m³) in November 2006. At the present time LUKOIL already has nine terminals in the country, with an aggregate reservoir capacity of about 270,000 m³. Another - tenth - LUKOIL terminal will come on line after all the necessary work has been completed.

LUKOIL is operating equally actively in the Turkish bunkerage business. At the launch of its bunkerage operations in Turkey (2004-2005) LUKOIL Eurasia Petrol sold shipping companies about 80,000 tons of fuel a year, whereas last year, the respective figure was over 150,000 tons (during bunkering, ships are offered the full range of fuel services, including diesel fuel, black oil and lubricants).

LUKOIL Eurasia Petrol is planning to  gain stable control over 10% of the Turkish fuel market. And this will contribute greatly to attaining the strategic level in the energy partnership between Russia and Turkey.

Turkey's gas market is also growing dynamically. In 2009, the share of gas in the Turkish energy consumption mix reached 25%. The gas-consumption forecast for 2010 is 44 billion m³ and for 2020 63 billion m³. Liberalization of Turkey's gas market will open up for LUKOIL prospects for working in this sector of the Turkish energy sector, too. LUKOIL can supply up to 5 billion m³ of gas a year to Turkey, thereby covering about 10% of the demand on the country's gas market.