August 9, 2012
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Home / Issue Archive / 2012 / April #4 / Iraq, Caspian Investments to Fuel LUKOIL's Profits & Dividend Payouts

№ 4 (April 2012)

Iraq, Caspian Investments to Fuel LUKOIL's Profits & Dividend Payouts

   In March, LUKOIL presented its new development strategy covering the period through the year 2021. Its biggest news is that the dividends are set to grow by 300 percent over the next 10-year period. At the same time, the company has plans to make significant investments in various projects, primarily, in those outside Russia.

By Galina Starinskaya

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   As far as its Russian operations are concerned, LUKOIL will have to make up for last year’s decline in its oil output, something that was largely due to a geological miscalculation regarding its South Khylchuyuskoye field.

For the Benefit of Its Investors

   On March 14, LUKOIL President Vagit Alekperov and the company’s top management unveiled the company’s new development strategy for 2012–2021 to a conference in London, UK. Many analysts tend to view it as much too ambitious. However, that is not the view of the company’s head Vagit Alekperov who described the goals to be achieved over the next decade as being “unique”.
The strategy is designed to increase LUKOIL’s investment attractiveness and to assure a many-fold increase in the company’s payments to its shareholders (see chart). The company that was never known for making savings at the expense of its shareholder dividends now holds out the promise of a 300 percent increase in dividends in 2021 compared with those paid out last year. By the way, LUKOIL’s dividends for 2011 are set to grow by 25 percent to reach 74 rubles per share, with a dividend yield of about 4 percent.

   According to analysts at Gazprombank, the share of LUKOIL’s dividends may reach 30 percent of the company’s net profit by 2016 and 40 percent by 2021, provided that no major new projects are launched that could reduce the flow of available cash.

   BCS analyst Andrei Polishchuk believes that LUKOIL will not increase the share of income spent on dividend payments over the next two years. “It is quite possible that, with oil prices failing to rise, the company could have a negative cash flow. In that situation, rather than growing, dividend payments could even go down,” the expert warns.

   The company plans to increase shareholder value through the implementation of its upstream projects, including those outside of Russia, something that will require significant investments. For instance, $125 billion will be invested in its upstream projects, with $25 million to be invested in its downstream and sales projects. The company’s management believes that LUKOIL’s ongoing projects should allow the company to generate a disposable cash flow of about $100-110 billion, with $50-60 billion generated by its projects in the upstream sector. LUKOIL has no plans to increase its borrowing over the next 10 years. LUKOIL management believes that this strategy should make it possible to pay out high dividends to the company’s shareholders.

   “The company has developed some strong projects that are bound to produce good performance and the time is coming now to reward our shareholders for their investments,” said Vagit Alekperov. He was confident that further increases in shareholder payments would be possible due to more stable international crude oil prices (with crude priced at $100-110 per barrel), increased oil and gas production, better tax policies in Russia, stronger vertical integration, innovative developments at Lukoil and also due to the company maintaining its strong competitive positions in Russia and on the international market.

   Alekperov and others in the company’s top management are prepared to prove that LUKOIL’s stock is an attractive investment proposition by citing their own actions as an example. Over the past couple of years, they have engaged in vigorous buybacks of LUKOIL’s shares. At this point, it should be recalled that some two years ago, LUKOIL lost its main shareholder and partner ConocoPhillips of the U.S. (which decided only to keep its interest share in Naryanmarneftegaz). According to LUKOIL Vice-President Leonid Fedun, since that time, the company’s management has made an unprecedented stock buyback to a total of more than 10 percent of the company’s total stock.

More Oil and Gas

   Over the next 10 years, oil and gas production will remain the company’s main activity.
   According to the LUKOIL strategy, the hydrocarbon production volume is bound to reach 1.17 billion barrels of oil equivalent, an increase of 50 percent on the 2011 figures, with 17 percent of that volume generated by the company’s overseas projects. The oil recovery factor is set to reach 40 percent. The company has great expectations of its gas production projects. Under the plan, the share of natural gas in the company’s hydrocarbon production structure is to reach 27 percent by 2021 (see chart). Leonid Fedun further said that Russia was bound to remain Western Europe’s largest gas supplier, while planning to begin its gas deliveries to China in 2016–2017. “The growing Chinese economy is going to need a lot of natural gas. This is going to be a further growth driver on the gas market in Russia,” he said.

   According to LUKOIL, there is going to be a significant increase in hydrocarbon production by the company’s foreign projects. More specifically, West Qurna 2 field in Iraq will become one the company’s main investment projects in the next two years. LUKOIL has plans to invest $33 billion in that project which has estimated reserves of about 14 billion barrels.

Correcting Mistakes in Russia

   In Russia, LUKOIL’s most promising projects are those in the Caspian oil fields. According to Vagit Alekperov, the company will continue its exploration activities in the Caspian Sea area where it has discovered new hydrocarbon deposits, some of them holding large gas reserves. Production is expected to grow 12 times, with investments there totaling some $18 billion.

   It should be noted that last year proved to be somewhat less successful for LUKOIL in terms of its oil production. Alekperov acknowledged it saying that the company’s production volume had dropped by more than 5 percent for the first time in 20 years.

   The decrease was due to the depletion of its fields in Western Siberia and to a geological mistake made by Russian and American geologists at the Naryanmarneftegaz-operated South Khylchuyuskoye field in the Timan-Pechora basin. Prospective resources proved to be smaller than what had been expected by the company. About 30 percent of the estimated reserves failed to be proved. As a result, in 2011, the estimated reserves were reduced from 0.5 billion to 0.14 billion barrels. As a result, LUKOIL, with its 70 percent interest share in that project, and its U.S. partner ConocoPhillips, with a 30 percent interest share, had to write off $1.2 billion in losses.

   Over the next decade, the company hopes to stabilize its production rates in Western Siberia and to move gradually towards increased output rates.
According to Andrei Polishchuk, it has been for a long time now that LUKOIL has not had access to the newer large deposits in Russia, with the exception of the company’s interest share in the Trebs and Titov oilfields (Bashneft being their license holder), the access to which the company’s gained thanks to its extensive infrastructure facilities in Nenets Autonomous Region.

   “For the time being, LUKOIL will continue to develop the older fields where, through the introduction of high-tech solutions, the company can achieve higher oil recovery rates”, said the expert.

   However, the company is somewhat more pessimistic about the oil production prospects for Russia as a whole. After 2016, there may well be a sharp drop in production volumes unless the government changes its tax policies in that sector, said Vagit Alekperov explaining that the current system tends to discourage the development of new deposits. In many other countries, taxes are based on corporate profits, while in Russia they are based on oil output volumes. At the moment, the government offers favorable tax treatment to individual projects or fields only, with the oil companies wishing to see a more stable and predictable system in operation there.

   Moreover, the company considers as unjust the government’s policy of allowing access to the development of new fields on the Russian Arctic shelf only to the state-owned companies such as Rosneft and Gazprom. Time and again, LUKOIL has petitioned the government with a request to grant a national corporation status to all companies registered in Russia and duly paying their taxes to the government and to allow them access to the offshore projects in the Arctic.

   In Andrei Polishchuk’s opinion, since ConocoPhillips is no longer one of LUKOIL’s shareholders, it is important for the company to obtain a national corporation status. “For a number of reasons, Russian fields look more attractive and promising than those in other part of the world, even with all their heavy tax burden. For example, many foreign companies are eager to participate in projects in this country,” says Polishchuk. However, given that LUKOIL has decided now to focus primarily on its overseas projects, it needs a foreign partner to help it acquire assets and share risks, something that could be done, however, also on a project-by-project basis.

   Experts find it difficult to predict whether LUKOIL would succeed in implementing its ambitious action program. In the view of Andrei Polishchuk, the company’s declared objectives will be very difficult to achieve. “No one can say what the price of oil will be like by 2021. LUKOIL may still change its forecasts. Their strategies are only a reference point they will use in developing their activities over the next ten years,” he said.

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