Lukoil’s operating results: analysis of financial condition and results of operations for the three-month periods ended September 30 and June 30, 2019 and the nine-month periods ended September 30, 2019.

The primary activities of Lukoil and its subsidiaries are hydrocarbon exploration, production, refining, marketing, and distribution.

Lukoil is one of the world’s largest publicly traded vertically integrated energy companies. Lukoil’s proved reserves under SEC standards amounted to 15.9 billion BOE (barrels of oil equivalent) as of January 1, 2019 and were comprised of 12.1 billion barrels of crude oil and 23.1 trillion cubic feet of gas. Most of Lukoil’s reserves are conventional. Lukoil undertakes exploration for, and production of, crude oil and natural gas in Russia and internationally. In Russia, Lukoil’s major oil producing regions are West Siberia, Timan-Pechora, the Urals, and the Volga region. Lukoil’s international upstream segment includes stakes in PSA’s (production sharing agreements) and other projects in Kazakhstan, Azerbaijan, Uzbekistan, Romania, Iraq, Egypt, Ghana, Norway, Cameroon, Nigeria, Mexico, the Republic of Congo, and the UAE. Lukoil’s daily hydrocarbon production in the first nine months of 2019 amounted to 2.4 million BOE, with liquid hydrocarbons representing approximately 77 percent of Lukoil’s overall production volumes.

Lukoil has geographically diversified downstream assets portfolio primarily in Russia and Europe. Lukoil’s downstream operations include crude oil refining, petrochemicals, and transportation operations, marketing and trading of crude oil, natural gas, and refined products, power generation, transportation and sales of electricity, heat, and related services.

Lukoil owns and operates four refineries located in the European part of Russia and three refineries located outside of Russia, in Bulgaria, Romania, and Italy. Moreover, Lukoil has a 45-percent interest in the Zeeland refinery in the Netherlands. Lukoil also owns two petrochemical plants in Russia and has petrochemical facilities at Lukoil’s refineries in Bulgaria and Italy. Along with Lukoil’s own production of refined products, Lukoil refines crude oil at third party refineries depending on market conditions and other factors. The throughput at Lukoil’s refineries in the first nine months of 2019 amounted to 1.4 million barrels per day, and Lukoil produced 0.9 million tons of petrochemicals.

Lukoil markets its own and third-party crude oil and refined products through Lukoil’s sales channels in Russia, Europe, South-East Asia, Central and North America, and other regions. Lukoil owns petrol stations in 18 countries. Most of Lukoil’s retail networks are located close to Lukoil’s refineries. Lukoil’s retail sales in the first nine months of 2019 amounted to 10.6 million tons of refined products.

Lukoil is involved in the production, distribution, and marketing of electrical energy and heat, both in Russia and internationally. In the first nine months of 2019, Lukoil’s total output of electrical energy was 13.4 billion kWh (kilowatt hours).

Key financial & operational results

Compared to the second quarter of 2019, Lukoil’s results were negatively affected by a decrease in hydrocarbon prices and a negative export duty and mineral extraction tax lag effect, which was almost offset by an increase in refining margins and throughput volumes, both in and outside of Russia, as well as higher international hydrocarbon production volumes.

Compared to the first nine months of 2018, Lukoil’s results improved due to increases in volumes of crude oil production in Russia and gas outside of Russia, an increase in the share of high-margin volumes in Lukoil’s domestic crude oil production structure (that now accounts for 31 percent of the company’s domestic production volume), the effect of the ruble’s devaluation, the implementation of a tax on additional income from hydrocarbon production at certain fields in Russia, as well as better profitability of Lukoil’s retail and trading businesses. Lukoil’s results dynamics was negatively affected by a decrease in international hydrocarbon prices and the European refining margins, as well as a lower positive export duty and mineral extraction tax lag effects.

From January 1, 2019, the company adopted IFRS 16 Leases reporting standards that had a positive impact on Lukoil’s EBITDA in the first nine months of 2019 in the amount of 26.5 billion rubles. The impact on Lukoil’s profit amounted to 3.4 billion rubles, and on Lukoil’s free cash flow to 35.0 billion rubles.

Lukoil’s EBITDA amounted to 328 billion rubles in the third quarter of 2019, a decrease of 1.3 percent against the second quarter of 2019. The EBITDA stood at 958 billion rubles in the first nine months of 2019, an increase of 14.5 percent relative to the first nine months of 2018.

Lukoil’s depreciation, depletion, and amortization expenses increased compared to the first nine months of 2018, mainly as a result of the adoption of IFRS 16 Leases standard, as well as due to an increase in gas production.

In the third quarter of 2019, the profit attributable to Lukoil’s shareholders amounted to 190 billion rubles, an increase of 5.0 percent to the second quarter of 2019. In the first nine months of 2019, the profit attributable to Lukoil’s shareholders amounted to 521 billion rubles, an increase of 13.2 percent to the first nine months of 2018.

Lukoil’s capital expenditures increased by two billion rubles, or by 1.4 percent, compared to the second quarter of 2019, and decreased by 24 billion rubles, or by 7.2 percent, compared to the first nine months of 2018. The year-on-year decrease resulted from the completion of major development stages at Lukoil’s upstream projects in Uzbekistan and on the Russian Caspian offshore.

Lukoil’s free cash flow amounted to 209 billion rubles in the third quarter of 2019, an increase of 28.6 percent compared to the second quarter of 2019. The cash flow amounted to 517 billion rubles in the first nine months of 2019, an increase of 50.8 percent to the first nine months of 2018. An increase to the second quarter of 2019 was mainly a result of changes in the working capital, and an increase to the first nine months of 2018 was a result of an increase in the profitability of Lukoil’s core operations and changes in the working capital.

The Lukoil group’s average daily hydrocarbon production decreased by 0.7 percent compared to the second quarter of 2019, mainly due to a decrease in gas production volumes in Russia and increased by 1.5 percent compared to the first nine months of 2018, driven primarily by growth in gas production volumes in Uzbekistan and Azerbaijan, as well as oil production growth in Russia due to changes in the external limitations of Russian companies’ production volumes.

In the third quarter and the first nine months of 2019, the throughput at Lukoil’s refineries increased by 7.3 percent compared to the second quarter of 2019 and by 2.8 percent compared to the first nine months of 2018.

The Lukoil group adopted IFRS 16 Leases as of January 1, 2019, which introduced a single, on-balance sheet lease accounting model for lessees. Under IFRS 16, a contract is, or contains, a lease if it conveys a right to control the use of an identified asset for a period of time in exchange for consideration. A lessee recognizes a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. There are recognition exemptions for short-term leases and leases of low value items.

The Lukoil group applied IFRS 16 using the modified retrospective approach by one-off recognition of non-current assets and financial liabilities of 162 billion rubles on January 1, 2019 measured at the present value of the remaining lease payments, discounted at Lukoil’s incremental borrowing rate as of January 1, 2019.

Primarily, the Lukoil group leases such assets as transportation (vessels, tank cars), land, drilling rigs, and other equipment, as well as storage facilities. The lease typically runs for a period of three to five years. Some leases include an option to renew the lease for an additional period of time after the end of the non-cancellable period.

The nature of expenses related to new assets and liabilities recognized for operating leases will now change because the Lukoil group will recognize a depreciation charge for right-of-use assets and interest expense on lease liabilities. Previously, the Lukoil group recognized lease expenses on a straight-line basis over the term of the lease and recognized assets and liabilities only to the extent that there was a timing difference between actual lease payments and the expense recognized.

The adoption of IFRS 16 in the first nine months of 2019 had considerable effects on Lukoil’s financial statements. Lukoil’s operating, transportation, and selling, as well as general and administrative expenses decreased by 4.4 billion rubles, 15.4 billion rubles, and 6.6 billion rubles, respectively. Lukoil’s depreciation expenses, finance costs, and income tax expenses increased by 23.6 billion rubles, 5.2 billion rubles, and 0.3 billion rubles, respectively. The Lukoil group also recognized a foreign exchange gain of 5.9 billion rubles related to certain lease liabilities in foreign currencies. As a result, Lukoil’s EBITDA increased by 26.5 billion rubles, Lukoil’s profit for the period attributable to the company’s shareholders increased by 3.4 billion rubles, and Lukoil’s free cash flow increased by 35.0 billion rubles. At the same time, Lukoil’s debt as of September 30, 2019 increased by 134.9 billion rubles.

Changes in Lukoil’s structure

In the second quarter of 2019, a Lukoil group company entered into a contract with New Age M12 Holdings Limited to acquire a 25-percent interest in the Marine XII license in the Republic of Congo (Congo, Brazzaville). In September 2019, the transaction in the amount of USD768 million was closed after all the customary conditions, including approval by the government of the Republic of Congo, were fulfilled.

In October 2019, a Lukoil group company acquired a five-percent interest in the Ghasha concession in the United Arab Emirates from the Abu Dhabi National Oil Company (ADNOC) for approximately USD190 million.

Int’l crude & refined products prices

The price at which Lukoil sells crude oil and refined products is the primary driver of Lukoil’s revenues. The dynamics of Lukoil’s realized prices on international markets generally matches the dynamics of commonly used spot benchmarks such as Brent crude oil price; however, Lukoil’s average prices are usually different from such benchmarks due to different delivery terms, quality mix, as well as the specifics of regional markets in case of petroleum product sales.

In the first nine months of 2019, the price for Brent crude oil fluctuated between USD53 and USD75 per barrel, reaching its maximum of USD74.7 in the middle of May and its minimum of USD53.2 in early January. The average price expressed in U.S. dollars decreased by 10.3 percent compared to the second quarter of 2019 and decreased by 10.4 percent compared to the first nine months of 2018.

Domestic crude & refined products prices

Most of the crude oil in Russia is produced and then refined or exported by vertically integrated oil companies. As a result, there is no liquid spot market for crude oil in Russia and no publicly available spot price benchmark. Domestic prices may deviate significantly from export netbacks and they also vary between different regions of Russia driven by the supply-demand balance on regional markets.

Domestic prices for refined products correlate to some extent with export netbacks but are also materially affected by the supply-demand balance on regional markets.

A substantial part of Lukoil’s revenue is either denominated in U.S. dollars and euros or is correlated to some extent with the U.S. dollar crude oil prices, while most of Lukoil’s costs are settled in the Russian rubles. Therefore, a devaluation of the ruble against the U.S. dollar and the euro generally causes Lukoil’s revenues to increase in ruble terms, and vice versa. Ruble’s inflation also affects the results of Lukoil’s operations.

Segments highlights

Lukoil’s operations are divided into three main business segments. The first is exploration and production, which includes Lukoil’s exploration, development, and production operations related to crude oil and gas. These activities are primarily located within Russia, with additional activities in Azerbaijan, Kazakhstan, Uzbekistan, the Middle East, Northern and Western Africa, Norway, Romania, and Mexico. The next segment is refining, marketing, and distribution, which includes refining; petrochemical and transportation operations; marketing and trading of crude oil, natural gas, and refined products; generation, as well as transportation and sales of electricity, heat, and related services. The third segment is the corporate segment, which includes operations related to Lukoil’s headquarters (that coordinates the operations of the Lukoil group), finance activities, and certain other activities, that are not primary to the Lukoil group.

Each of Lukoil’s segments is dependent on the others, with a portion of the revenues of one segment being a part of the costs of the others. In particular, Lukoil’s refining, marketing, and distribution segment purchases crude oil from Lukoil’s exploration and production segment. As a result of certain factors, benchmark crude oil market prices in Russia cannot be determined with certainty. Therefore, the prices set for inter-segment purchases of crude oil reflect a combination of market factors, primarily international crude oil market prices, transportation costs, regional market conditions, the cost of crude oil refining, and other factors.

Exploration & production

Lukoil’s upstream EBITDA decreased by 9.8 percent compared to the second quarter of 2019. In Russia, that change was mainly a result of a decrease in hydrocarbon prices and a higher negative export duty and mineral extraction tax lag effect. Outside of Russia, Lukoil’s upstream EBITDA increased following an increase in hydrocarbon production volumes.

Compared to the first nine months of 2018, Lukoil’s upstream EBITDA increased by 0.3 percent despite a decrease in crude oil prices. In Russia, this decrease in prices was partially offset by a bigger share of high-margin volumes in Lukoil’s production structure, an implementation of a tax on additional income from hydrocarbon production at certain license areas, and the ruble’s devaluation. At the same time, Lukoil’s domestic upstream EBITDA dynamics was restrained by an adverse change in export duty and a mineral extraction tax lag effect compared to the first nine months of 2018. Outside of Russia, Lukoil’s upstream EBITDA was positively impacted by an increase in gas production volumes, gas prices in Uzbekistan, and the ruble’s devaluation.

The decrease in the EBITDA of the West Qurna-2 project in Iraq compared to the second quarter of 2019 and the first nine months of 2018 was as a result of lower capital expenditures compensation.

In the first nine months of 2019, Lukoil’s upstream EBITDA was also positively affected by the effect of IFRS 16 adoption, which resulted in lower operating expenses.

Lukoil’s main oil producing region is West Siberia, where Lukoil produced 43.6 percent of its crude oil in the third quarter of 2019 and 43.5 percent in the first nine months of 2019 (43.5 percent in the second quarter of 2019, 44.3 percent in the first nine months of 2018).

The dynamics of Lukoil’s crude oil production volumes was mainly driven by external limitations as a consequence of an agreement of OPEC and some of the non-OPEC countries, including Russia, to cap production levels in order to stabilize the global crude oil market. During the first half of 2018, Lukoil’s production was limited in accordance with the first OPEC+ agreement valid until the end of June 2018. Lukoil increased its production in July 2018, when the parameters of the agreement were amended. In December 2018, the OPEC+ countries agreed to decrease crude oil production relative to October 2018 levels until June 2019, which subsequently was prolonged until March 2020. The Lukoil group limited production in Lukoil’s traditional regions (West Siberia, Timan-Pechora, and the Urals region) at the least-productive fields and fields with high water-cuts.

The active development of the priority projects was on track. Lukoil produced 4,751 thousand tons of crude oil at the V. Filanovsky field in the first nine months of 2019, an increase of seven percent, compared to the first nine months of 2018. In October 2019, production started at the third production platform of this field.

In the first nine months of 2019, crude oil production at the Yu. Korchagin field increased by 22 percent year-on-year as a result of the drilling program implemented at the field’s second development stage.

The development of the Yaregskoye field and the Permian layers of Lukoil’s Usinskoye field in Timan-Pechora, including the launch of new steam-generating facilities, led to an increase in the high viscosity crude oil production to 3.7 million tons, which reflects an 18-percent increase compared to the figure for the first nine months of 2018.

The development of projects in West Siberia also continued. The aggregate crude oil and gas condensate production at the V. Vinogradov, the Imilorskoye, and the Pyakyakhinskoye fields for the first nine months of 2019 increased by 17 percent year-on-year.

In Russia, Lukoil’s major gas production region is West Siberia (Bolshekhetskaya depression), where gas is produced from the Nakhodkinskoe and the Pyakyakhinskoe fields. Outside of Russia, the main gas production region is Uzbekistan, where Lukoil has shares in two production sharing agreements (PSAs). In the first nine months of 2019, Lukoil group’s gas production was 25.6 billion cubic meters, which was 4.0 percent higher year-on-year. The main driver of gas production growth was the development of projects in Uzbekistan and Azerbaijan. As a result of the launch of the second stage of the Kandym gas processing plant, Lukoil’s international gas production (including Lukoil’s share in affiliates’ production) increased by 10.6 percent.

The West Qurna-2 field in Iraq is developed under the service contract, signed in January 2010. In May 2018, a Lukoil group company and the Iraqi party signed a new field development plan, according to which crude oil production is planned to increase to 800 thousand barrels per day by 2025.

Refining, marketing & distribution

Lukoil’s refining, marketing, and distribution EBITDA was 24.9 percent higher than in the second quarter of 2019.

In Russia, Lukoil’s refining, marketing, and distribution EBITDA increased compared to the second quarter of 2019, largely as a result of higher refining margins and rising throughput volumes at Lukoil’s refineries, as well as a better product slate. Outside of Russia, Lukoil’s refining, marketing, and distribution EBITDA also increased, mainly as a result of higher refining margins, throughput volumes, and a better profitability of the retail business.

Lukoil’s refining, marketing, and distribution EBITDA was 44.3 percent higher than in the first nine months of 2018.

Compared to the first nine months of 2018, Lukoil’s refining, marketing, and distribution EBITDA in Russia increased largely due to higher refining margins and throughput volumes, as well as better profitability of Lukoil’s retail business. Outside of Russia, Lukoil’s downstream EBITDA increased due to higher trading margins, a better product slate, and the effect of the ruble’s devaluation despite lower benchmark refining margins.

Moreover, in the first nine months of 2019, Lukoil’s refining, marketing, and distribution EBITDA both in and outside of Russia was positively affected by the effect of IFRS 16 adoption, which resulted in lower transportation expenses.

Compared to the second quarter of 2019, refinery throughput at Lukoil’s refineries increased by 8.5 percent. In Russia, a quarter-on-quarter increase in throughput was due to scheduled maintenance works at the Perm refinery in the second quarter of 2019. Outside of Russia, a quarter-on-quarter increase in throughput was driven by scheduled maintenance works at the refinery in the Netherlands in the second quarter of 2019, as well as by a higher utilization rate of the refinery in Italy.

In the first nine months of 2019, refinery throughput at Lukoil’s refineries was 51.7 million tons, which is 2.8 percent higher year-on-year. In Russia, an increase of 3.3 percent was mainly due to a higher utilization rate of the Nizhny Novgorod refinery. Outside of Russia, the growth of 2.0 percent was explained by the maintenance at the refinery in Bulgaria in the first quarter of 2018.

In the reporting periods, Lukoil processed its crude oil at third party refineries in Belarus, Kazakhstan, and Canada. In 2016, a Lukoil group company entered into a tolling agreement originally valid through 2019 and subsequently prolonged until August 31, 2022 with a Canadian refinery. In the third quarter and the first nine months of 2019, refined products output amounted to 1.6 million tons and 4.6 million tons (1.5 million tons in the second quarter of 2019 and 4.7 million tons in the first nine months of 2018).

Marketing & trading

In addition to Lukoil’s production, Lukoil purchases crude oil in Russia and on international markets. In Russia, Lukoil primarily purchases crude oil from affiliated producing companies and other producers. Then Lukoil either refines or exports the purchased crude oil. The crude oil purchased on international markets is used for trading activities, for supplying Lukoil’s international refineries, or for processing at third party refineries.

In Russia, Lukoil purchases refined products on occasion, primarily to manage supply chain bottlenecks. Refined products purchases outside of Russia are either traded or supplied to Lukoil’s international refineries.

Lukoil undertakes trading operations on international markets through Lukoil’s 100-percent subsidiary LITASCO. Lukoil uses traditional physical volumes hedging techniques to hedge trading operations to secure trading margins.

As of September 30, 2019, the volume of Lukoil’s crude oil exports from Russia decreased by 2.5 percent compared to the second quarter of 2019, even as it increased by 1.4 percent compared to the first nine months of 2018. In the third quarter and the first nine months of 2019, Lukoil exported 44.8 percent and 45.3 percent of its domestic crude oil production (46.5 percent in the second quarter of 2019 and 44.9 percent in the first nine months of 2018) and 43 thousand tons and 117 thousand tons of crude oil purchased from Lukoil’s affiliates and third parties (73 thousand tons in the second quarter of 2019 and 142 thousand tons in the first nine months of 2018), respectively.

The volume of Lukoil’s refined products exports increased by 14.1 percent compared to the second quarter of 2019 as a result of an increase in production volumes against the background of planned maintenance at Lukoil’s Perm refinery, while increasing by 15.4 percent compared to the first nine months of 2018 against the backdrop of relatively low volumes of exports in the first nine months of 2018 due to a high domestic demand for Lukoil’s products.

Lukoil predominantly uses the Transneft infrastructure to export its crude oil. Nevertheless, a sizeable amount of crude oil is exported through Lukoil’s own infrastructure, which allows the company to preserve the premium quality of the crude oil and thus enables it to achieve higher netbacks. The entire volume of the crude oil exported that bypassed Transneft was routed beyond the Customs Union.

Besides Lukoil’s own infrastructure, Lukoil also exports light crude oil through the Caspian Pipeline Consortium and the Eastern Siberia to Pacific Ocean pipeline that also allows the company to preserve the premium quality of crude oil and to achieve higher netbacks compared to traditional export routes.

Priority sales channels

Lukoil develops its priority sales channels, aiming at increasing its margin on the sale of refined products produced by the Lukoil group.

In the third quarter and the first nine months of 2019, Lukoil sold 2.7 million tons and 7.5 million tons of motor fuels via Lukoil’s domestic retail network, which was 8.3 percent more compared to the second quarter of 2019 due to the seasonality factor, and 7.9 percent less compared to the first nine months of 2018 due to a high demand for Lukoil’s products in the previous year. Outside of Russia, retail sales increased by 4.9 percent compared to the second quarter of 2019 due to seasonality factors, even as sales increased by 0.3 percent compared to the first nine months of 2018.

Lukoil also supplies jet fuel to airports and bunker fuel to sea and river ports in and outside of Russia. In the first nine months of 2019, Lukoil’s deliveries of jet fuel into-plane were 1.9 million tons (including sales of Lukoil’s joint ventures), and bunkering volumes were 3.2 million tons.

Power generation

Lukoil established a vertically integrated chain from generation to transportation and sale of power and heat for third party customers (commercial generation) and for its own consumption. Lukoil owns commercial generation facilities in the Southern regions of the European part of Russia, Romania, and Italy. Lukoil also owns renewable energy capacity in Russia and abroad. In the third quarter and the first nine months of 2019, Lukoil’s total output of commercial electrical energy was 4.2 billion kWh and 13.4 billion kWh (3.6 billion kWh in the second quarter of 2019 and 14.8 billion kWh in the first nine months of 2018), and Lukoil’s total output of commercial heat energy was approximately 0.8 million Gcal (gigacalories) and 6.7 million Gcal (1.3 million Gcal in the second quarter of 2019 and 7.4 million Gcal in the first nine months of 2018), respectively.

Financial results

Compared to the second quarter of 2019, Lukoil’s revenues decreased by 8.1 percent, driven mainly by a decrease in hydrocarbon prices and crude oil and refined products trading volumes.

Compared to the first nine months of 2018, Lukoil’s revenues decreased by 1.1 percent, largely as a result of a decrease in hydrocarbon prices and refined products trading volumes, which was partially offset by the effect of the ruble’s devaluation on Lukoil’s revenues denominated in the U.S. dollars, as well as higher crude oil trading volumes.

Crude oil sales

Compared to the second quarter of 2019, Lukoil’s international crude oil sales revenue decreased by 13.1 percent, mainly due to a decrease in international hydrocarbon prices and Lukoil’s trading volumes (beyond the Customs Union). In the third quarter of 2019, Lukoil’s sales volumes in Russia more than halved and Lukoil’s domestic sales revenue decreased consequently.

In the first nine months of 2019, Lukoil’s international crude oil sales revenue didn’t change compared to the first nine months of 2018. A decrease in crude oil prices was offset by an increase in trading volumes. At the same time, Lukoil’s domestic sales volumes more than halved, and Lukoil’s sales revenue decreased consequently.

Q3 2019 versus Q2 2019

Lukoil’s revenue from the wholesale of refined products outside of Russia decreased by 10.5 percent due to a decrease in trading volumes and the prices realized.

International retail revenue increased by 2.4 percent due to a seasonal increase in sales volumes.

Revenue from the wholesale and retail sale of refined products on the domestic market increased by 5.5 and 9.7 percent, respectively, due to a seasonal increase in sales volumes.

9M 2019 versus 9M 2018

Lukoil’s revenue from the wholesale of refined products outside of Russia decreased by 3.9 percent, mainly due to a decrease in prices in dollar terms that was partially offset by the effect of the ruble’s devaluation.

Lukoil’s international retail revenue increased by 1.9 percent, mainly as a result of the effect of the ruble’s devaluation on Lukoil’s realized prices.

Lukoil’s revenue from the wholesale of refined products on the domestic market increased by 4.4 percent as a result of increases in Lukoil’s realized prices.

Lukoil’s revenue from refined products retail sales in Russia decreased by 1.4 percent, as a result of a decrease in sales volumes against a background of high demand for Lukoil’s products in the first nine months of 2018.

Sales of petrochemical products

Compared to the second quarter of 2019, Lukoil’s revenue from sales of petrochemical products decreased by 13.3 percent, as a result of a decrease in trading volumes and the average realized sales prices outside of Russia, as well as a decrease in production at Lukoil’s refineries in Russia due to maintenance works.

Compared to the first nine months of 2018, Lukoil’s revenue from sales of petrochemical products increased by 36.4 percent, as a result of rising trading volumes outside of Russia and the effect of the ruble’s devaluation.

Sales of gas

Compared to the second quarter of 2019, Lukoil’s revenue from gas sales increased by 3.4 percent as a result of an increase in gas sales volumes outside of Russia after the completion of maintenance works at the Kandym gas processing complex.

Lukoil’s sales of gas increased by 17.2 percent compared to the first nine months of 2018. This increase related mostly to Lukoil’s operations outside of Russia and was a result of natural gas production growth in Uzbekistan. Higher gas prices also contributed to an increase in Lukoil’s gas sales revenue.

Sales of energy & related services

Compared to the second quarter of 2019, Lukoil’s revenue from sales of energy and related services increased by 9.9 percent due to a seasonal factor outside of Russia. Compared to the first nine months of 2018, Lukoil’s revenue from sales of energy and related services didn’t change significantly.

Other sales

Other sales include non-petroleum sales through Lukoil’s retail network, transportation services, rental revenue, crude oil extraction services, and other revenue of Lukoil’s production and marketing companies from sales of goods and services not related to Lukoil’s primary activities.

In the third quarter of 2019, revenue from other sales increased by 26.3 percent compared to the second quarter of 2019, largely as a result of a seasonal increase in non-petrol revenue of Lukoil’s retail network, as well as an increase in the sales of transportation services abroad.

Compared to the first nine months of 2018, revenue from other sales decreased by 3.1 percent. This was largely a result of discontinuing of a non-core car sales business. Moreover, other sales revenue for the third quarter and the first nine months of 2019 included 2.2 billion rubles (approximately 30 million euros) of profit compensation in relation to energy supplies in Sicily, Italy in 2016.

Hydrocarbon extraction expenses

Lukoil’s extraction expenses include expenditures related to repairs of extraction equipment, labor costs, expenses for the artificial stimulation of reservoirs, fuel and electricity costs, cost of extraction of natural gas liquids, property insurance for extraction equipment, and other similar costs.

Compared to the second quarter of 2019, per-BOE hydrocarbon extraction expenses and Lukoil’s total extraction expenses in Russia didn’t change significantly.

Lukoil’s extraction expenses outside of Russia increased by 20.5 percent compared to the second quarter of 2019 due to higher expenses for repairs and maintenance costs in Kazakhstan and an adjustment related to IFRS 16 adoption related to Lukoil’s project in Azerbaijan. At the same time, per-BOE hydrocarbon extraction expenses increased by 18.8 percent.

In Russia, in the first nine months of 2019, a decrease in workover operations and reservoir stimulation was partially offset by higher electricity costs. A decrease of Lukoil’s extraction expenses was also driven by the adoption of IFRS 16. Lukoil’s domestic per-BOE hydrocarbon extraction expenses decreased by 2.6 percent compared to the first nine months of 2018.

Outside of Russia, Lukoil’s hydrocarbon extraction expenses increased by 13.5 percent as a result of an increase in expenses on gas production due to substantial gas production growth in Uzbekistan, maintenance work in Kazakhstan, as well as the ruble’s devaluation. Lukoil’s per-BOE hydrocarbon extraction expenses outside of Russia only increased by 3.6 percent owing to an increase in the gas share in Lukoil’s production structure.

Compared to the second quarter of 2019, refining expenses at Lukoil’s domestic refineries increased by 4.6 percent, mainly due to higher throughput volumes. Outside of Russia, Lukoil’s expenses increased by 7.7 percent, largely as a result of an increase in refinery throughput in Italy.

Compared to the first nine months of 2018, expenses at Lukoil’s domestic refineries decreased by 5.0 percent, mainly due to a decrease in the consumption of the additives purchased, despite an increase in electricity and maintenance costs, as well as an increase in throughput volumes. Outside of Russia, Lukoil’s expenses decreased by 5.6 percent due to a decline in fuel, electricity, and maintenance costs, despite higher throughput volumes.

Third-party refining expenses 

Along with Lukoil’s own production of refined products Lukoil processes crude oil at third-party refineries.

At the end of 2016, as part of Lukoil’s trading business development, a Lukoil group company entered into a three-year tolling agreement with a Canadian refinery. Related refining expenses represent a variable toll that is mostly the difference between the price of feedstocks supplied, including various related costs, and the selling price of the refined products taken. When the refined products are sold, this toll is naturally offset by the respective refined products sales revenue. The Lukoil group company then receives the agreed compensation.

In the third quarter of 2019, this tolling fee increased to 4.4 billion rubles compared to 1.1 billion rubles in the previous quarter as a result of a higher refining margin.

In the first nine months of 2019, tolling fees amounted to 8.2 billion rubles compared to 8.3 billion rubles in the first nine months of 2018.

Expenses for crude oil and refined products transportation to refineries include pipeline, railway, freight, and other costs related to the delivery of crude oil and refined products to refineries for further processing. Compared to the second quarter of 2019, Lukoil’s expenses for crude oil transportation to refineries decreased by 4.9 percent due to changes in volumes of the company’s own crude oil supplies to its refineries in Europe. Compared to the first nine months of 2018, Lukoil’s expenses for crude oil transportation to refineries increased by 4.6 percent, mainly due to an increase in volumes and tariffs.

Petrochemical expenses

Lukoil’s petrochemical expenses decreased by 9.1 percent quarter-on-quarter as a result of a significant decrease in production volumes due to maintenance works at Lukoil’s plants in Russia. Lukoil’s petrochemical expenses increased by 5.2 percent year-on-year as a result of an increase in production volumes during the first nine months of 2019 against the background of production stoppage at Lukoil’s Bulgarian refinery in 2018.

Cost of purchased crude oil, gas & products

The cost of purchased crude oil, gas, and products includes the cost of crude oil and refined products purchased for trading or refining, gas, and fuel oil to supply Lukoil’s power generation entities and the result of hedging crude oil and refined products sales. Compared to the second quarter of 2019, the cost of the crude oil, gas, and products purchased decreased, largely as a result of a decrease in hydrocarbon prices and in volumes of crude oil and refined products trading. Compared to the first nine months of 2018, the cost of the crude oil, gas, and other products purchased decreased as a result of lower hydrocarbon prices.

Compared to the second quarter of 2019, Lukoil’s expenses for the transportation of refined products didn’t change significantly. Lukoil’s expenses for the transportation of crude oil increased by 9.7 percent, which was mainly due to an increase in volumes sold on Incoterms with the transportation component outside of Russia, partly offset by expenses decrease in Russia due to lower sales and export volumes and an inventory effect.

Compared to the first nine months of 2018, the impact of tariff indexation, higher freight expenses, and the ruble’s devaluation on crude oil and refined products transportation expenses was largely offset by the positive impact of IFRS 16 adoption, which amounted to 15.4 billion rubles.

Selling, general & administrative expenses

Selling, general, and administrative expenses include payroll costs (excluding production staff costs of extraction entities, refineries, and power generation entities), insurance costs (except for property insurance), costs of social infrastructure maintenance, movement in allowance for expected credit loss, and other expenses. Lukoil’s selling, general, and administrative expenses are roughly equally split between domestic and international operations.

In late December 2017, the company announced a new compensation plan based on approximately 40 million shares available to certain members of management and key employees for the period from 2018 to 2022, which was implemented in July 2018 and recognized as an equity-settled share-based compensation plan.

The decrease in selling, general, and administrative expenses in the third quarter of 2019 was largely a result of a change in expenses on allowance for expected credit losses, as well as bonus payments in the second quarter of 2019.

An increase in labor costs compared to the first nine months of 2018 was a result of indexation and bonus payments. In the first nine months of 2019, Lukoil’s selling, general, and administrative expenses were also positively impacted by the effect of IFRS 16 adoption to the tune of 6.6 billion rubles.

Operating activities

Lukoil’s primary source of cash flow consists of funds generated from Lukoil’s operations. Compared to the second quarter of 2019 and the first nine months of 2018, Lukoil’s cash generated from operations increased by 17.8 percent and 22.0 percent, respectively. An increase to the second quarter of 2019 was mainly a result of a decrease in the working capital compared to an increase in the previous quarter. An increase in the cash provided by operating activities compared to the first nine months of 2018 was a result of higher profitability of Lukoil’s core operations and changes in the working capital. The positive impact of IFRS 16 adoption on Lukoil’s cash provided by operating activities in the first nine months of 2019 amounted to 26.5 billion rubles.

Investing activities

Lukoil’s cash used in investing activities increased compared to the previous quarter and to the first nine months of 2018, largely due to the acquisition of a 25-percent interest in the Marine XII license in the Republic of Congo for approximately 51 billion rubles.

Lukoil’s capital expenditures increased by two billion rubles, or by 1.4 percent, compared to the second quarter of 2019, and decreased by 24 billion rubles, or by 7.2 percent, compared to the first nine months of 2018.The positive impact of IFRS 16 adoption on Lukoil’s cash used in investing activities in the first nine months of 2019 amounted to 8.4 billion rubles and resulted in decreased capital expenditures.

In Russia, an increase in Lukoil’s upstream capital expenditures in the third quarter of 2019 was mainly due to an increase in capital expenditures in the Volga region, where Lukoil continues to develop the Yu. Korchagin and V. Filanovsky fields and prepares to develop the V. Grayfer (Rakushechnoye) field.

An increase in capital expenditures in the refining segment in Russia compared to the previous quarter was primarily due to the construction of new facilities at Lukoil’s refineries.

Compared to the first nine months of 2018, Lukoil’s domestic capital expenditures in the exploration and production segment decreased, due to a decrease in expenses in the Timan-Pechora region as a result of an uneven payments schedule, as well as the completion of the next stages of development works at the Yu. Korchagin and the V. Filanovsky fields in the Caspian Sea. Higher capital expenditures in West Siberia were a result of an increase in production drilling footage.

The decrease in Lukoil’s international capital expenditures year-on-year was due to lower expenditures in Uzbekistan that was partially offset by the ruble’s devaluation.

A decrease in capital expenditures in the refining segment in Russia year-on-year was due to prepayments in the previous year related to the construction of a delayed coker complex at the Nizhny Novgorod refinery. 

Financing activities

In the third quarter of 2019, net movements of short-term and long-term debt generated an outflow of 13 billion rubles, compared to an outflow of 14 billion rubles in the second quarter of 2019. In the first nine months of 2019, net movements of short-term and long-term debt generated an outflow of 48 billion rubles, including 28.6 billion rubles related to the newly adopted IFRS 16, compared to an outflow of 148 billion rubles in the first nine months of 2018.

In the first nine months of 2019, Lukoil also recognized additional 6.4 rubles billion of interest payments under IFRS 16.

In August 2018, Lukoil announced the start of an open market buyback program to reduce the capital of the company. As part of this program and a tender offer that took place in July and August 2019, a Lukoil group company spent 110,086 million rubles and 243,691 million rubles in the third quarter and the first nine months of 2019, respectively. On August 20, 2019, the company announced the completion of the buyback program. Taking into account the tender offer, 56.7 million ordinary shares and depositary receipts of the company were purchased in the aggregate.