No. 4, 2011

Vagit Alekperov ,
President of LUKOIL


LUKOIL meets its 20th anniversary with new strategic initiatives

In November, LUKOIL reaches its 20th anniversary, a jubilee celebrated not only by the Company but also by the entire oil and gas industry of contemporary Russia. Looking back at the path covered, it may now be asserted that LUKOIL chose the right route. Over the past two decades, the Company has achieved considerable successes. Despite the fierce competition, it has become a global energy holding, ranking alongside the world leaders, and today actively advances national interests in the world arena.

Yet the celebratory mood must not nurture complacency, since, in today's rapidly changing world, the leaders of the oil and gas industry are facing more and more new challenges. And LUKOIL, which has been accustomed since its inception to work for the future, is already seeking solutions to these tasks.

LUKOIL is celebrating its 20th anniversary by developing new ambitious plans. At the end of this year, the Board of Directors plans to review the Company's development strategy, which covers the period up to 2021 and envisages investments of over $100 billion. More than half of this sum will be allocated to the exploration and production business segment, as the Company's projects in Iraq, Central Asia and on the Caspian will require major capital investment over the coming years.

In accordance with the existing long-term development plans, LUKOIL is counting on achieving an increase in hydrocarbon production, which has slowed down in recent years for objective reasons relating to natural aging of fields in the traditional production regions. In addition, the Company plans, over a period of ten years, to treble gas production by investing about $12 billion and bringing production up to 40 billion m3.

The draft development program for the geological exploration and production business segment for 2012-2021 envisages a growth of the share of gas production in total hydrocarbon production throughout the Company from 20% in 2011 to over 35% in 2021.

In Western Siberia, in the Bolshekhetskaya Depression, LUKOIL is currently developing the Nakhodkinskoye field, producing over 8 billion m3 of natural gas a year. In 2012, a well-head gas compressor station is to be started up here. The plan for 2013 is to build a system of trunk gas pipelines to collect gas from the Pyakyakhinskoye, Yuzhno-Messoyakhskoye, and Khalmerpayutinskoye fields. To maintain production at the Nakhodkinskoye field, in 2014 the Company intends to start up a booster compressor station.

The draft development program for the "Geological exploration and production" business segment also anticipates the main increase in natural gas production in the Republic of Uzbekistan, where LUKOIL, as an operator, is implementing the "Khauzak-Shady-Kandym-Kungrad" and Gissar Production Sharing Agreement projects. The Kandymsky gas refinery complex with the annual capacity of 8 billion m3 is planned to be commissioned for the purpose of refining the gas from these projects.

In addition, the Company intends, in consideration of the macro-economic conditions, to increase the utilization level of associated petroleum gas and to assess the prospects for develop shale gas production projects in Russia. To start with, however, LUKOIL will endeavor to study closely the situation with respect to production of this type of energy resource in Eastern Europe.

In the refining and sales business segment, over the decade, the Company intends to invest $24 billion, most of this sum being invested over the next three years. In particular, LUKOIL plans to continue modernizing the Volgograd Refinery, to speed up installation of a hydro-cracking unit at the Nizhny Novgorod plant, to build yet another catalytic cracking unit there, and to renovate the aromatic hydrocarbon production unit at LUKOIL-Permnefteorgsintez.

LUKOIL also intends to develop actively the electric power segment, a relatively new one for the Company. Several key tasks for this sector of the Company's business may be identified: to make energy supplies to LUKOIL enterprises more reliable and economical, to optimize the costs of energy resources and develop commercial electricity generation. At the same time, in the electricity generation sphere, the Company is counting not only on traditional technologies. LUKOIL is already developing hydro, solar and wind power in Russia, Bulgaria, Serbia, Romania, and Uzbekistan and plans to expand the geographic coverage of this business.

The Company will also continue work on creating a unified scientific design complex. This is essential for achieving the technological level of the global oil leaders on the basis of innovative development, a search for and introduction of progressive new technologies, more efficient design solutions, development of technical competencies and knowledge management. For this purpose of fulfilling these tasks, a special subdivision LUKOIL-Engineering has been set up within the Company, uniting all the corporate scientific research and design centers.

LUKOIL's plans include ensuring a stable growth of dividends, which in 2010 amounted to 17% of net profit. In the medium term, shareholders' incomes will be ensured by implementing highly efficient overseas projects, in particular in Uzbekistan and Iraq and on the shelf of the Caspian Sea.

Indeed, responsibility towards shareholders is one of the main principles by which LUKOIL is governed in its operations. In general, the corporate business ideology envisages three levels of responsibility: before the shareholders, before the Company's employees and before the government.

Part of the social aspects of the Company's activities is secured in the programs for industrial safety, improvement of working conditions and labor protection, prevention and elimination of emergency situations. These spheres of activity are also acquiring growing significance for the Company because hydrocarbon production is gradually moving to regions and water areas with especially vulnerable ecosystems.

Another socially significant document is the Agreement between the Employer and the Trade Union Association. This determines the main principles of the reciprocal obligations between the Company and its employees in the social and labor sphere, as well as the general conditions governing salaries and occupational safety, benefits and guarantees, protection of the labor, socio-economic and professional interests of the personnel. In the summer of 2011, LUKOIL and the Company's International Association of Trade Union Organizations, representing over 150 thousand employees, signed a protocol on prolonging this agreement for another three year term.

As for social responsibility at the national level, for LUKOIL this is manifested in close cooperation with all the regions in which the Company's enterprises operate, timely remittance of funds to the federal and local budgets, and implementation of a multitude of charity and socially significant projects. Such an approach is of particular importance considering that, in many areas, LUKOIL's are the core enterprises of cities and the Company bears particular social responsibility there.

It is no exaggeration to say that, like the majority of Russian fuel and energy complex companies, LUKOIL is a guarantee of social and economic stability in the country. It is the fuel and energy complex that was, once again, the life-belt for the Russian economy in 2008-2009, allowing sufficient funds to be accumulated and an "airbag" to be created, softening the fall. It was also reliable insurance for the country's economy in 2009-2010, helping it to get back on its feet.

The following figures show how important the oil and gas element is in the Russian economy. Last year, LUKOIL paid almost 800 billion rubles in taxes into the federal budget, this constituting roughly 10% of Russia's budget revenues and a quarter of its oil and gas revenues.

This, though, is not the end of the Company's mission in relation to the country as a whole. By actively implementing international projects and acting in alliance with world leaders, LUKOIL is becoming, for Russia, an effective instrument for asserting the country's economic and geopolitical interests, is endeavoring to improve Russia's international image, receiving in exchange support from the government in its economic activities abroad.

It is precisely the importance of LUKOIL's socio-economic role that largely explains the active dialogue conducted between the Company and the authorities. The government lends an ear to the main proposals made by the Company. One such initiative is connected with using LUKOIL's fields in the North Caspian as a pilot project for applying added income tax. This proposal is currently under consideration by the Ministry of Finance and is expected to receive government support. After all, Yu. Korchagin and V. Filanovsky fields are ideally suited to such an experiment, since they are being developed within the local infrastructure, exports going via the Caspian Pipeline Consortium system.

There are some situations, however, when it is not that easy to find common ground with the government. This applies, for instance, to the attempts by various agencies, given the absence of an effective economic mechanism and incentives to modernize refineries, to regulate the petroleum product market "manually". LUKOIL has to keep proving that precisely this will bring the sale segment to the verge of profitability, since 60% of the price of gasoline within Russia already consists of various taxes. If production, refining and logistic costs are added, the price of gasoline will give the oil companies only 10% profit and the gas filling stations - 6%.

So some of the Company's statements actually fall on deaf ears. In particular, within LUKOIL, it is deemed incorrect and unjust to divide Russian companies into state-owned and privately-owned ones when access to fields, such as offshore ones, is concerned. The difficulties in gaining access to the shelf appear even stranger considering that LUKOIL has already accumulated significant and truly unique operating experience in this sphere.

This problem could be resolved by a legislative formulation of a new term - "national company". In other countries, this term is applied primarily to major state-owned companies but LUKOIL proposes a different definition and other criteria. A national company might only be a company registered on the territory of the Russian Federation and paying taxes to the Russian budget. Moreover, the amount of these taxes should be substantial - maybe a minimum of 5% of state budget revenues.

Other criteria could also be taken into consideration. For example, financial stability, trading in the company's shares on Russian stock exchanges, or the level of social responsibility judged from the proportion of the revenues from entrepreneurial activities on the territory of the country spent on social projects. Maybe other ideas on this will appear during discussions with the government, the public and members of parliament. The main thing is for the form of ownership not to be decisive since, paraphrasing a well-known American industrialist, it may be said that what is good for a "national company" is good for Russia.

LUKOIL is, in general, open to everything new and even strives to see not only risks in the crisis trends currently manifesting themselves in the global economy but also new opportunities for development. In particular, a possible second wave of the financial crisis could result in a reorientation of the world economy from the speculative financial sphere to real production, which might be used for developing the Company. Replacement of the political elite in a number of "oil" countries may open up new cooperation prospects for the Company, and this is of some significance for LUKOIL, which is presently actively developing new countries for its business - Ghana, Cote d'Ivoire, Vietnam and Sierra Leone.

Nor does LUKOIL ignore the forecasts of a possible change of world economic leaders. In particular, the Company is already now looking at Southeast Asian markets as very promising, in view of their truly impressive economic development and rapid growth of demand for energy resources.

In accordance with some scenarios, one of the consequences of the crisis could be a fall in living standards in developed countries and an associated drop in the demand for energy resources. Yet this could easily be compensated for by a rise in demand in other parts of the world, such as Southeast Asia.

We need to be ready for a fall in oil quotation rates, too, possibly in connection with political factors entailing a drop in the price of oil as a so-called risk premium and also with economic ones. The fact is that, in its struggle with economic problems, the USA might be compelled to resort to more radical means than "quantitative mitigations," leading to an inflow of speculative capital to the oil market and a rise in energy resource prices.

In the foreseeable future, experts predict that the very global structure of energy production and energy supplies might also change. Gas will increasingly oust oil in the battle for energy leadership. According to the International Energy Agency, almost 7.5% more gas was consumed in the world last year than in 2009. Specialists anticipate a further annual growth of 2.5%, which is double the similar figures for oil.

In the next few years, a substantial increase in gas production is expected in the world, with Russia, Qatar, Australia and Nigeria accounting for this. At the same time, liquefied natural gas will be in growing demand. Experts estimate that, already in 2010, demand for it was 25% greater than in the previous year. It now accounts for about 9% of total world energy resource consumption.

Production of shale gas has caused a genuine revolution in the energy sector in recent years. This source might will fit into the structure of the world energy sector of the 21st century. Even now, at least a quarter of the gas produced in the USA comes from shale.

The share of alternative energy resources is also growing in the global energy balance but changes in this sphere will be gradual. In the developed countries of the West, the share of unconventional energy resources may increase quite rapidly but alternative energy will play only an insignificant role for a long time yet in the energy balance of the developing countries.

So, despite all the trends listed above, hydrocarbon crude is predicted to remain the predominant resource at least until 2050. Oil will remain the leader for the next decade and the strategic goals LUKOIL sets for itself will also remain unchanged. They consist in maximizing profitability, raising efficiency and developing robustly.

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Oil of Russia, No. 4, 2011
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