Archive

No. 1, 2005

Alexander Volzhsky

A STRATEGY OF INGENIOUS


The LUKOIL Group's 2005-2014 Strategic Development Program: implementation right on track

JSC LUKOIL, a leader of Russia's economy, last year retained its first place in the country's oil industry, as illustrated by its strong financial performance, capitalization growth, capital market borrowings, and market liquidity of its securities.

Open to investment

As noted by leading international and Russian analysts, high demand for LUKOIL's shares during last year was maintained, among other things, by the fact that the Company published quarterly and half-yearly U.S. GAAP consolidated financial reports.

Concurrently JSC LUKOIL was ranked 6th among largest Russian companies giving way mostly to telecom's sector. Compared with 2003 LUKOIL improved its results with an increase of 2 ranks.

In 2004, Standard & Poor's (S&P) rated LUKOIL number one Russian oil company in terms of information transparency and number six among Russia's top 50 companies, mostly after telecommunications companies. Since 2003, LUKOIL climbed up two notches in the information transparency rating list, too.

The total Company's transparency score reached 64%. As it was noted in the survey Russian companies with best level of transparency follow disclosure standards approaching the best international practices. (Thus, for example, the composite transparency score for UK companies calculated in 2003 reached 71%).

In its survey, S&P used public information only, analyzing corporate annual reports, web site information, and reports submitted to regulators. Information disclosed was analyzed by the following major criteria: ownership capital, shareholder rights, financial information, operations, management, and executive compensation.

S&P analyzed information disclosure primarily from the standpoint of international investors. Therefore, it reviewed the availability of information not only in Russian, but also in English. The survey questionnaire included 89 questions about the ownership structure, investor relations, financial and operations information, the board of directors and management structure and procedures.

"LUKOIL's leading position in the survey conducted by Standard & Poor's demonstrates the Company's transparency to our shareholders and investors and proves its high level of standards in corporate governance", Leonid Fedun, Vice President of LUKOIL, said.

Comprehensive growth

In 2004, LUKOIL's operations were characterized by a stable growth of upstream operations and an adequate development of downstream and petrochemical sectors, which provided for an optimum business diversification.

Net profit after taxes of LUKOIL Group companies reached around $4 billion, 60% higher compared with 2003 (not including the sale of the Company's share in Azeri-Chiraq-Guneshly project). The Company's stock prices rose 30% in 2004.

Overall production (including subsidiaries and international projects) totaled 86.3 million tons of crude oil, as compared with 81.5 million tons in 2003. The average daily well production rate has increased to 10.7 tons with an average annual well water level stabilized at 76.5%. Gas production went up 8.9% and exceeded 6.2 billion m3.

In 2004, LUKOIL refineries processed 43.8 million tons of crude oil, which is 1.5 million tons more compared to 2003. The depth of refining at the domestic refineries was increased from 73.5% to 75.3%. The depth of refining at the overseas refineries was increased from 66.6% to 69.8%.

Throughout at the Company's gas processing plants reached around 22 billion m3 of associated gas which is 5.7% more compared to 2003. Investment spending of the LUKOIL Group totaled $4.1 billion in 2004. This makes LUKOIL one of the largest investors into the Russian economy.

With a major focus on expanding its hydrocarbon resource base, LUKOIL is practically the only Russian oil company that invests heavily into geological prospecting in frontier regions such as the northern part of the Caspian and the Timan-Pechora oil- and gas-bearing province. LUKOIL's strategy in the Nenets Autonomous Area is to expand prospecting and exploration investment. Geological prospecting helped to generate a hydrocarbon reserve increment of about 120 million tons of oil equivalent, including 71 million tons of oil and gas condensate and 49 billion m3 of gas. The increment in reserves is 1.3 times the amount of oil and gas produced.

The Company's petrochemical plants produced 1.86 million tons, 4.9% more compared with 2003.

Retail sales through LUKOIL's filling stations went up 17% and totaled 2.8 million tons. The average daily retail sales at LUKOIL stations went up 16.7% and amounted to 6.3 tons.

These are impressive figures, but it is also important to note the strong focus of LUKOIL managers of all levels on financial performance in 2004 - no mean accomplishment. The Company aims not just to increase its hydrocarbon resource base, oil production and refining volumes, but also to ensure strong economics in its upstream and downstream operations and thereby optimize shareholder returns.

At the end of 2004, the LUKOIL Managing Board approved the Concept for the Development of Air Bunkerage Business. Air bunkerage operations are to grow as part of the LUKOIL Group's 2005-2014 Strategic Development Program. The concept is intended to expand the aircraft fuel market and develop a full-fledged network of bunkering stations. Last November, LUKOIL commissioned a new bunkering station at the Volgograd airport. The facility has two 2,000 m3 fuel tanks and is equipped to receive fuel from the Volgograd Refinery by rail or pipeline. At present, a specialized subsidiary, LUKOIL Air Bunkerage Company, supplies more than 20 Russian airports with aircraft fuel. LUKOIL is the only Russian company that produces JET A-1 fuel to the IATA standards. In April 2004, LUKOIL fueled a Lufthansa airliner with JET A-1 produced at the LUKOIL-Nizhegorod-nefteorgsintez Refinery in Kstovo (the Nizhny Novgorod Region) - the first foreign airline company to be filled by Russian-produced jet fuel. LUKOIL has plans to start producing JET A-1 fuel at the LUKOIL-Permnefte-orgsintez Refinery in the latter half of 2005 and at the Refinery of LUKOIL-Volgogradneftepererabotka in the third quarter of 2005.

Last year, the LUKOIL Managing Board also approved a Safe Operations Policy for LUKOIL's Subsidiary-Operated Sea and River Terminals. At present, the Company is implementing the Program for Improving and Developing Level-One Offshore Crude Oil and Petroleum Product Spill Response Resources and Facilities. Under that Program, the LUKOIL Group spent more than 9 million rubles on spill response facilities in 2004.

The deciding factors

On October 22, 2004, the LUKOIL Board of Directors met in Odessa, Ukraine, to approve the LUKOIL Group Strategic Development Program for 2005-2014, an updated version of an earlier program approved on November 21, 2003. The program had to be updated as Russian and international macroeconomic and market forecasts for 2005-2014 were refined, the Company expanded operations into new regions and developed innovation activities, and competition in international markets was enhanced. The Strategic Development Program sets long-term priorities and is designed to increase return on capital employed (ROCE) and market capitalization figures.

The Program's general priorities are to increase the value of hydrocarbon resources, notably gas, to expand the Company's shares of the established petroleum product markets and to gain competitive advantages for LUKOIL branded products, to ensure ROCE of 15-17%, to enhance management accounting efficiency, to optimize management structures, and to benefit from strategic partnership synergies.

The year 2005 will be crucial to the Program's implementation. Financially, LUKOIL's medium-term goal is to increase its ROCE to the level of its major international competitors, despite the greatly increased tax burden.

It is planned to increase the hydrocarbon resource base of the Company by 130% of production, the production target being at least 90.2 million tons.

The 2005 target for crude oil production by subsidiaries, including interest in dependent companies and foreign projects, is 90.2 million tons, which is 4% higher than expected production in 2004.

LUKOIL also plans to produce 8.4 billion m3 of gas in 2005, including 3.7 billion m3 of natural gas and 4.7 billion m3 of associated gas. Gas production is to exceed the 2004 figure by nearly 30%. The growth will mainly be provided by the development of the Nakhodka gas field in the Yamal-Nenets Autonomous Area. LUKOIL's goal is to increase gas production to 44.5 billion m3 by 2014.

In downstream operations, a significant increase of crude oil exports is planned. With crude oil supplies to LUKOIL's foreign-based refineries, the Company plans to export a total of 49 million tons, up 11% from the 2004 expected volumes. In 2005, LUKOIL intends to increase its retail petroleum product sales by 19% in Russia and by 50% outside Russia, as compared with the 2004 expected figures.

LUKOIL's strategic priorities are to enhance the depth of refining and to produce more high-octane gasoline at its domestic refineries, and to launch new refining facilities for those purposes.

As for LUKOIL's refineries outside Russia, it is planned to increase crude refining capacity to 11 million tons, up from 8.4 million tons in 2004. Much of the growth will be provided by the re-commissioning of the Ploesti Refinery in Romania after an upgrade, which is planned to refine 2.4 million tons of crude oil in 2005.

LUKOIL-Neftekhim, the Company's petrochemical subsidiary, should increase its production of petrochemicals to 1.75 million tons in 2005, which will be 8.3% more than in 2004.

In corporate management, efforts will continue to implement the main terms of a strategic partnership with ConocoPhillips, as one of LUKOIL's priorities. The Company will also pursue its restructuring program to optimize operations and reduce the number of LUKOIL Group entities, especially, noncore assets. The number of entities co-owned by LUKOIL Group companies is to be reduced from 293 to 105 in 2005-2006.

There is every reason to feel confident that achievement of the targets set will enhance the Company's position as the leader of Russia's fuel and energy sector and a strong player among the world's oil majors.




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Oil of Russia, No. 1, 2005
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