Regulatory Filings • Sep 9, 2020
Regulatory Filings
Open in ViewerOpens in native device viewer
The following applies to the prospectus following this page and you are therefore advised to read this carefully before reading, accessing or making any other use of the prospectus. In accessing the prospectus, you agree to be bound by the following terms and conditions, including any modifications to them any time you receive any information from us as a result of such access.
THE FOLLOWING PROSPECTUS MAY NOT BE FORWARDED OR DISTRIBUTED OTHER THAN AS PROVIDED BELOW AND MAY NOT BE REPRODUCED IN ANY MANNER WHATSOEVER. THE ATTACHED PROSPECTUS MAY ONLY BE DISTRIBUTED OUTSIDE THE UNITED STATES TO PERSONS THAT ARE NOT U.S. PERSONS AS DEFINED IN, AND IN RELIANCE ON, REGULATION S ("REGULATION S") UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR WITHIN THE UNITED STATES TO QIBs WHICH ARE QPs (EACH AS DEFINED BELOW) AND THAT CAN MAKE REPRESENTATIONS SET FORTH IN THE NEXT PARAGRAPH IN ACCORDANCE WITH RULE 144A UNDER THE SECURITIES ACT ("RULE 144A"). ANY FORWARDING, DISTRIBUTION OR REPRODUCTION OF THE ATTACHED DOCUMENT IN WHOLE OR IN PART IS PROHIBITED. FAILURE TO COMPLY WITH THIS DIRECTIVE MAY RESULT IN A VIOLATION OF THE SECURITIES ACT OR THE APPLICABLE LAWS OF OTHER JURISDICTIONS.
NOTHING IN THIS ELECTRONIC TRANSMISSION CONSTITUTES AN OFFER OF SECURITIES FOR SALE IN ANY JURISDICTION WHERE IT IS UNLAWFUL TO DO SO. THE SECURITIES HAVE NOT BEEN, AND WILL NOT BE, REGISTERED UNDER THE SECURITIES ACT OR THE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES OR OTHER JURISDICTION. THE SECURITIES MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT (1) IN ACCORDANCE WITH RULE 144A UNDER THE SECURITIES ACT TO PERSONS REASONABLY BELIEVED TO BE QUALIFIED INSTITUTIONAL BUYERS (EACH A "QIB") WITHIN THE MEANING OF RULE 144A AND QUALIFIED PURCHASERS (EACH A "QP") AS DEFINED IN SECTION 2(A)(51) OF THE U.S. INVESTMENT COMPANY ACT OF 1940, AS AMENDED, WHICH CAN REPRESENT THAT (A) THEY ARE QPs WHO ARE QIBs WITHIN THE MEANING OF RULE 144A, (B) THEY ARE NOT BROKER-DEALERS WHO OWN AND INVEST ON A DISCRETIONARY BASIS LESS THAN U.S.\$25 MILLION IN SECURITIES OF UNAFFILIATED ISSUERS, (C) THEY ARE NOT A PARTICIPANT DIRECTED EMPLOYEE PLAN, SUCH AS A 401(k) PLAN, (D) THEY ARE ACTING FOR THEIR OWN ACCOUNT, OR THE ACCOUNT OF ONE OR MORE QIBs, EACH OF WHICH IS ALSO A QP, (E) THEY ARE NOT FORMED FOR THE PURPOSE OF INVESTING IN THE ISSUER OR THE NOTES, (F) EACH ACCOUNT FOR WHICH THEY ARE PURCHASING WILL HOLD AND TRANSFER AT LEAST U.S.\$100,000 IN PRINCIPAL AMOUNT OF NOTES AT ANY TIME, (G) THEY UNDERSTAND THAT THE ISSUER MAY RECEIVE A LIST OF PARTICIPANTS HOLDING POSITIONS IN ITS SECURITIES FROM ONE OR MORE BOOK-ENTRY DEPOSITORIES AND (H) THEY WILL PROVIDE NOTICE OF THESE TRANSFER RESTRICTIONS TO ANY SUBSEQUENT TRANSFEREES OR (2) IN AN OFFSHORE TRANSACTION TO A PERSON THAT IS NOT A U.S. PERSON IN ACCORDANCE WITH RULE 903 OR RULE 904 OF REGULATION S.
Confirmation of your representation: In order to be eligible to view the attached prospectus or make an investment decision with respect to the securities, you must be (i) outside the United States (as defined in Regulation S) and a person other than a U.S. person (as defined in Regulation S) who is not acting for the account or benefit of a U.S. person or (ii) a QIB who is a QP which can make the representations set forth above. By accepting the e-mail and accessing the attached prospectus, you shall be deemed to have represented to us that you are outside the United States and not a U.S. person and not acting for the account or benefit of a U.S. person or that you are a QIB that is a QP and that you can make the representations set forth above and that you consent to delivery of such prospectus by electronic transmission.
This prospectus is only being distributed to and is only directed at (i) persons who are outside the United Kingdom, (ii) investment professionals falling within article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "Order"), (iii) persons who fall within article 49(2)(a) to (d) of the Order and (iv) any other persons to whom this prospectus may for the purposes of section 21 of the Financial Services and Markets Act 2000 be distributed (all such persons together being referred to as "Relevant Persons"). The notes are only available to, and any invitation, offer or agreement to subscribe, purchase or otherwise acquire such notes will be engaged in only with, Relevant Persons. Any person who is not a Relevant Person should not act or rely on this prospectus or any of its contents.
You are reminded that this prospectus has been delivered to you on the basis that you are a person into whose possession this prospectus may be lawfully delivered in accordance with the laws of the jurisdiction in which you are located and you may not, nor are you authorised to, deliver this prospectus to any other person.
The materials relating to the offering do not constitute, and may not be used in connection with, an offer or solicitation in any place where offers or solicitations are not permitted by law. If a jurisdiction requires that the offering be made by a licensed broker or dealer and the underwriter or any affiliate of the underwriters is a licensed broker or dealer in that jurisdiction, the offering shall be deemed to be made by the underwriters or such affiliate on behalf of the Issuer in such jurisdiction.
This prospectus has been sent to you in an electronic form. You are reminded that documents transmitted via this medium may be altered or changed during the process of electronic transmission and consequently none of Barclays Bank PLC, ING Bank N.V., London Branch or The Royal Bank of Scotland plc or any person who controls any one of them, nor any director, officer, employee or agent of either of them nor any affiliate of any such person accepts any liability or responsibility whatsoever in respect of any difference between the prospectus distributed to you in electronic format and the hard copy version available to you on request from Barclays Bank PLC, ING Bank N.V., London Branch or The Royal Bank of Scotland plc.
● We are one of the largest publicly traded oil companies in the world in terms of proved crude oil and gas reserves and we are the second largest producer of crude oil in Russia. We divide our business into four main segments: exploration and production; refining, marketing and distribution; petrochemicals; and power generation.
● Our indirect wholly owned subsidiary, LUKOIL International Finance B.V., a company organised under the laws of The Netherlands, will issue the notes. The notes will be issued in two tranches at the same time of U.S.\$800,000,000 aggregate principal amount (the Tranche 1 Notes) and U.S.\$200,000,000 aggregate principal amount (the Tranche 2 Notes). The Tranche 1 Notes and the Tranche 2 Notes will have the same terms and conditions in all respects other than their respective issue prices and will be consolidated and will form part of the same series from the Closing Date. References to the notes in this prospectus are references to the Tranche 1 notes and the Tranche 2 notes.
● If LUKOIL International Finance B.V. fails to make payments on the notes when they are due, OAO LUKOIL (LUKOIL) will be required to make them under the guarantee. LUKOIL is the only guarantor of the notes.
● The notes will mature on 9 November 2020.
LUKOIL International Finance B.V. may at any time prior to 9 November 2020 redeem the notes in whole or in part by paying a "make-whole" premium. See "Terms and Conditions of the Notes".
LUKOIL International Finance B.V. may redeem all of the notes at 100% of the principal amount thereof, plus accrued and unpaid interest, in the event of certain taxation changes. See "Terms and Conditions of the Notes".
INVESTING IN THE NOTES INVOLVES RISKS. YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS BEGINNING ON PAGE 19 BEFORE INVESTING IN THE NOTES.
The notes will be offered and sold outside the United States in offshore transactions in reliance on Regulation S under the U.S. Securities Act of 1933, as amended (the Securities Act), and in the United States to "qualified institutional buyers" (as defined in Rule 144A under the Securities Act) that are also "qualified purchasers" (as defined in Section 2(a)(51) of the U.S. Investment Company Act of 1940, as amended), which can make certain representations as described in "Transfer Restrictions" and "Subscription and Sale", in reliance on the exemption from registration provided by Rule 144A. For a description of these and further restrictions, see "Transfer Restrictions" and "Subscription and Sale".
The notes are expected to be delivered on or about 9 November 2010.
We have applied to the Financial Services Authority in its capacity as the competent authority under the Financial Services and Markets Act 2000 (the UK Listing Authority) for the notes to be admitted to the official list of the UK Listing Authority (the Official List) and to the London Stock Exchange plc (the London Stock Exchange) for the notes to be admitted to trading on the London Stock Exchange's Regulated Market (the Market). References in this prospectus to the notes being "listed" (and all related references) shall mean that the notes have been admitted to the Official List and have been admitted to trading on the Market. The Market is a regulated market for the purposes of Directive 2004/39/EC (Markets in Financial Instruments Directive) of the European Parliament and of the Council. There can be no assurance that a trading market for the notes will develop.
99.081% for the Tranche 1 notes 102.44% for the Tranche 2 notes
Barclays Capital ING The Royal Bank of Scotland
Dated 8 November 2010
This prospectus comprises a prospectus for the purposes of Directive 2003/71/EC (the Prospectus Directive) and for the purpose of giving information with regard to LUKOIL International Finance B.V. (the Issuer), LUKOIL and its subsidiaries and affiliates taken as a whole (the Group) and the notes, which, according to the particular nature of the Issuer, LUKOIL and the notes, is necessary to enable investors to make an informed assessment of the assets and liabilities, financial position, profits and losses and prospects of the Issuer and LUKOIL and the rights attaching to the notes and the guarantee. The Issuer and LUKOIL accept responsibility for the information contained in this prospectus. To the best of the knowledge of the Issuer and LUKOIL (each of which has taken all reasonable care to ensure that such is the case), the information contained in this prospectus is in accordance with the facts and does not omit anything likely to affect the import of such information.
Certain information in this prospectus contained under the headings "Risk Factors", "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Business" and "Regulation of the Oil Industry in the Russian Federation" has been based on information obtained from third party sources that we believe to be reliable. These sources, as identified herein, are Platts and InfoTEK in "Management's Discussion and Analysis of Financial Condition and Results of Operations", the Russian Ministry of Energy in "Business", and Platts and the International Monetary Fund in "Risk Factors", and also include government agencies such as the Central Bank of Russia (CBR) and the Federal Statistics Service of Russia, market research and other research reports, press releases, securities filings and industry publications (including by publishers such as Platts, annual reports published by our competitors and other publicly available information). We accept responsibility for accurately reproducing this information and, as far as we are aware and are able to ascertain from information published by such sources, no facts have been omitted which would render this reproduced information inaccurate or misleading. See "Risk Factors – Other Risks – We have not independently verified information we have sourced from third parties".
No person is authorised to give any information or to make any representation in connection with the offer or sale of the notes other than as contained in this prospectus and any information or representation not so contained must not be relied upon as having been authorised by the Issuer, LUKOIL or any Manager (as defined in "Subscription and Sale"). Neither the delivery of this prospectus nor any sale made in connection herewith shall, under any circumstances, create any implication that there has been no change in the affairs of the Issuer or LUKOIL since the date hereof or the date upon which this prospectus has been most recently amended or supplemented or that there has been no adverse change in the financial position of the Issuer or LUKOIL since the date hereof or the date upon which this prospectus has been most recently amended or supplemented or that the information contained in it or any other information supplied in connection with the notes is correct as of any time subsequent to the date on which it is supplied or, if different, the date indicated in the document containing the same. No representation or warranty, express or implied, is made by any Manager as to the accuracy or completeness of such information.
To the fullest extent permitted by law, the Managers accept no responsibility whatsoever for the contents of this prospectus or for any other statement, made or purported to be made by a Manager or on its behalf in connection with the Issuer, LUKOIL or the issue and offering of the notes.
This prospectus does not constitute an offer to sell, or a solicitation to subscribe for or purchase, by or on behalf of the Issuer, LUKOIL, the Managers or any other person, any of the notes in any jurisdiction where it is unlawful for such person to make such offer or solicitation. The distribution of this prospectus and the offer and sale of the notes in certain jurisdictions is restricted by law. Persons into whose possession this prospectus may come are required by the Issuer, LUKOIL and the Managers to inform themselves about and to observe such restrictions. This prospectus may not be used for, or in connection with, any offer to, or solicitation by, anyone in any jurisdiction or under any circumstances in which such offer or solicitation is not authorised or is unlawful. Further information with regard to restrictions on offers and sales of the notes and the distribution of this prospectus is set out under "Subscription and Sale".
Except as otherwise stated in "Subscription and Sale", no action is being taken to permit a public offering of the notes or the distribution of this prospectus (in any form) in any jurisdiction where action would be required for such purposes.
Applications have been made to the UK Listing Authority for the notes to be admitted to the Official List and to the London Stock Exchange for such notes to be admitted to trading on the Market. Admission to the Official List together with admission to trading on the Market constitutes official listing on a stock exchange.
THE NOTES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION IN THE UNITED STATES OR ANY OTHER REGULATORY AUTHORITY IN THE UNITED STATES NOR HAVE ANY OF THE FOREGOING AUTHORITIES PASSED UPON OR ENDORSED THE MERITS OF THE NOTES OR THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE IN THE UNITED STATES.
THE NOTES AND THE GUARANTEE HAVE NOT BEEN AND WILL NOT BE REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE SECURITIES ACT), AND SUBJECT TO CERTAIN EXCEPTIONS, MAY NOT BE OFFERED OR SOLD WITHIN THE UNITED STATES OR TO, OR FOR THE ACCOUNT OR BENEFIT OF, U.S. PERSONS (AS DEFINED IN REGULATION S UNDER THE SECURITIES ACT (REGULATION S)). THE NOTES ARE BEING OFFERED AND SOLD OUTSIDE THE UNITED STATES TO NON-U.S. PERSONS IN RELIANCE ON REGULATION S AND BY THE MANAGERS THROUGH THEIR RESPECTIVE REGISTERED BROKER-DEALER AFFILIATES INSIDE THE UNITED STATES TO "QUALIFIED INSTITUTIONAL BUYERS" (QIBS) (AS DEFINED IN RULE 144A(A)(1) UNDER THE SECURITIES ACT) THAT ARE ALSO "QUALIFIED PURCHASERS" (QPS) (AS DEFINED IN SECTION 2(A)(51) OF THE UNITED STATES INVESTMENT COMPANY ACT OF 1940, AS AMENDED (THE INVESTMENT COMPANY ACT)) WHICH CAN MAKE CERTAIN REPRESENTATIONS AS DESCRIBED IN "TRANSFER RESTRICTIONS" AND "SUBSCRIPTION AND SALE" IN RELIANCE ON THE EXEMPTION FROM REGISTRATION PROVIDED BY RULE 144A UNDER THE SECURITIES ACT (RULE 144A) (FOR A DESCRIPTION OF THESE AND FURTHER RESTRICTIONS SEE "TRANSFER RESTRICTIONS" AND "SUBSCRIPTION AND SALE"). PROSPECTIVE PURCHASERS ARE HEREBY NOTIFIED THAT SELLERS OF ANY NOTE MAY BE RELYING UPON THE EXEMPTION FROM THE PROVISIONS OF SECTION 5 OF THE SECURITIES ACT PROVIDED BY RULE 144A.
TO NEW HAMPSHIRE RESIDENTS: NEITHER THE FACT THAT A REGISTRATION STATEMENT OR AN APPLICATION FOR A LICENSE HAS BEEN FILED UNDER CHAPTER 421-B OF THE NEW HAMPSHIRE REVISED STATUTES (RSA 421-B) WITH THE STATE OF NEW HAMPSHIRE NOR THE FACT THAT A SECURITY IS EFFECTIVELY REGISTERED OR A PERSON IS LICENSED IN THE STATE OF NEW HAMPSHIRE CONSTITUTES A FINDING BY THE SECRETARY OF STATE OF NEW HAMPSHIRE THAT ANY DOCUMENT FILED UNDER RSA 421-B IS TRUE, COMPLETE AND NOT MISLEADING. NEITHER ANY SUCH FACT NOR THE FACT THAT AN EXEMPTION OR EXCEPTION IS AVAILABLE FOR A SECURITY OR A TRANSACTION MEANS THAT THE SECRETARY OF STATE HAS PASSED IN ANY WAY UPON THE MERITS OR QUALIFICATIONS OF, OR RECOMMENDED OR GIVEN APPROVAL TO, ANY PERSON, SECURITY OR TRANSACTION. IT IS UNLAWFUL TO MAKE, OR CAUSE TO BE MADE, TO ANY PROSPECTIVE PURCHASER, CUSTOMER OR CLIENT ANY REPRESENTATION INCONSISTENT WITH THE PROVISIONS OF THIS PARAGRAPH.
The notes offered and sold outside the United States to non-U.S. persons in reliance on Regulation S (the Regulation S Notes) and the notes offered and resold within the United States only to QIBs that are also QPs in reliance on Rule 144A (the Rule 144A Notes) will be represented initially by two global certificates in registered form (respectively, the Regulation S Global Note and the Rule 144A Global Note and, together, the Global Notes). The Regulation S Global Note will be registered in the name of Citivic Nominees Ltd. as nominee for Euroclear Bank SA/NV (Euroclear) and Clearstream Banking, société anonyme (Clearstream, Luxembourg), and the Rule 144A Global Note will be registered in the name of Cede & Co. as nominee for The Depository Trust Company (DTC). The Regulation S Global Note will be held by Citibank, N.A., London Branch as common depository for Euroclear and Clearstream, Luxembourg and the Rule 144A Global Note will be held by Citibank, N.A., London Branch as custodian for DTC. Interests of participants in Euroclear, Clearstream, Luxembourg and DTC in the notes will be represented by book entries on the records of Euroclear, Clearstream, Luxembourg or DTC, as the case may be. It is expected that delivery of the Global Note will be made on or about 9 November 2010 (the Closing Date).
Unless the context otherwise requires, "RUR", "RUB" or "rubles" shall mean Russian rubles and "U.S. dollars", "U.S.\$" or "\$" shall mean United States dollars. Except for financial data derived from our financial statements or as otherwise provided, translation of rubles into U.S. dollars herein has been carried out at the rate of RUR
31.1954 = \$1 for 30 June 2010, RUR 30.2442 = \$1 for 31 December 2009, RUR 31.2904 = \$1 for 30 June 2009, RUR 29.3804 = \$1 for 31 December 2008 and RUR 24.5462 = \$1 for 31 December 2007. The official exchange rate of the CBR on 30 September 2010 was RUR 30.403 = \$1, and on 31 October 2010 it was RUR 30.7821 = \$1. These translation rates should not be construed as representations that the ruble amounts have been, could have been or could be converted into U.S. dollars at that or any other rate.
In connection with the issue of the notes, The Royal Bank of Scotland plc (the Stabilising Manager) or any person acting on behalf of the Stabilising Manager may over-allot notes or effect transactions with a view to supporting the market price of the notes at a level higher than that which might otherwise prevail. However, there is no assurance that the Stabilising Manager (or any persons acting on behalf of the Stabilising Manager) will undertake stabilisation action. Any stabilisation action may begin on or after the date on which adequate public disclosure of the terms of the offer of the notes is made and, if begun, may be ended at any time, but it must end no later than the earlier of 30 days after the issue date of the notes and 60 days after the date of the allotment of the notes. Any stabilisation action or over-allotment shall be conducted in accordance with all applicable laws and rules. Any stabilisation action, if commenced, shall be effected outside the Russian Federation.
This prospectus describes matters related generally to LUKOIL and its consolidated subsidiaries and affiliated companies and also describes a series of specific transactions related to the notes. This series of transactions involves certain specific entities, including LUKOIL and LUKOIL International Finance B.V. Unless otherwise stated, all references to the "notes" are to the U.S.\$1,000,000,000 6.125% notes due 2020 issued by LUKOIL International Finance B.V. References to the "guarantee" are to LUKOIL's guarantee of the notes. References to "our charter" relate only to LUKOIL's charter. In this prospectus, unless otherwise stated or otherwise required by the context, the following terms apply with respect to these entities:
This prospectus contains information concerning crude oil and gas reserves estimated by LUKOIL that has been derived or extracted from the reports of Miller and Lents, Ltd. (Miller and Lents), our independent reservoir engineers, dated as at 31 December 2009 and 1 January in each of 2008 and 2009.
Miller and Lents audited LUKOIL's internal estimates of oil and gas reserves as at 31 December 2009 that were prepared in accordance with the definitions contained in the U.S. Securities and Exchange Commission (SEC) Rule 4-10(a) of Regulation S-X at that time (SEC standards) and as at 1 January 2008 and 2009 in accordance with standards of the Petroleum Resources Management System as prepared by the Oil and Gas Reserves Committee of the Society of Petroleum Engineers, Inc. (SPE-PRMS standards). In addition to estimating our reserves under SPE-PRMS standards, we have also calculated our estimated proved reserves as at 1 January 2009 under SEC standards assuming for our Russian fields that production licences would be renewed and the fields would be produced until the economic limit of production is reached (SEC-LOF basis). Miller and Lents have confirmed to us that the amounts of our estimated proved crude oil and gas reserves as at 1 January 2009 under the SEC-LOF basis are the same as under the SPE-PRMS standards. In making this determination, Miller and Lents accepted our representations that our projects meet the "commitment to develop" and "market availability" criteria under SEC standards.
Petroleum engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. These estimates necessarily depend upon a number of variable factors and assumptions, many of which are beyond our control. Due to the inherent uncertainties and the necessarily limited nature of reservoir data and the inherently imprecise nature of reserves estimates the reserves amounts disclosed in this prospectus may change as additional information becomes available. You should not place undue reliance on the ability of the reserves estimated by LUKOIL to predict actual reserves or on comparisons of similar reports concerning companies established in other economic systems.
In estimating our reserves as at 31 December 2009 under the SEC standards and as at 1 January 2008 and 2009 under the SPE-PRMS standards, we have included within proved reserves significant quantities of crude oil and gas that we expect to produce after the expiry dates of certain of our current production licences in the Russian Federation. We believe that our Russian licences will be extended to permit production subsequent to their current expiry dates because we have already renewed 46% of our licences as at 30 June 2010 and because of certain amendments to the Russian subsoil law in 2004. We intend to extend the licence periods for any property that is profitable; i.e., producing above the economic limit of the property. We are in the process of extending all of our production licences in the Russian Federation. To date there have been no unsuccessful licence renewal applications. See "Risk Factors – Risks Relating to Our Business – Our Russian subsoil use licences may be suspended, terminated or revoked prior to their expiration and we may be unable to obtain or maintain various permits or authorisations" and "Business – Exploration and Production – Domestic Exploration and Production – Licences" for more information on our licences in Russia.
Our estimated reserves totals included in this prospectus are presented in barrels (for crude oil) and cubic feet (for natural gas). However, like many other Russian and European oil companies, we use the metric tonne and the cubic metre as the standard unit of measurement for quantities of crude oil and natural gas, respectively, which we produce and sell. For convenience, amounts of crude oil have been translated from tonnes into barrels (or from barrels into tonnes in respect of reserve amounts) and amounts of natural gas have been translated from cubic metres into cubic feet (or from cubic feet into cubic metres in respect of reserve amounts). Translations of barrels to tonnes were made at the rate of 7.33 barrels per tonne (other than in respect of crude oil production amounts, where such translations were made using conversion rates characterising the density of oil from each of the relevant oil fields). Translations of cubic feet to cubic metres were made at the rate of 35.31 bcf per bcm. Translations of barrels of crude oil into boe were made at the rate of 1 barrel per boe and of mcf into boe at the rate of 6 bcf per 1 mmboe.
| NOTICE TO INVESTORS | 1 |
|---|---|
| AVAILABLE INFORMATION | 1 |
| ENFORCEABILITY OF JUDGMENTS | 1 |
| USE OF PROCEEDS | 3 |
| FORWARD-LOOKING STATEMENTS | 4 |
| OVERVIEW | 5 |
| OVERVIEW OF THE OFFERING | 13 |
| SUMMARY CONSOLIDATED FINANCIAL AND OTHER INFORMATION | 16 |
| RISK FACTORS | 19 |
| CAPITALISATION | 53 |
| SELECTED CONSOLIDATED FINANCIAL AND OTHER INFORMATION | 54 |
| MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
57 |
| BUSINESS | 109 |
| MANAGEMENT | 151 |
| THE ISSUER | 157 |
| ADDITIONAL INFORMATION REGARDING THE COMPANY | 158 |
| TERMS AND CONDITIONS OF THE NOTES | 163 |
| TRANSFER RESTRICTIONS | 177 |
| SUMMARY OF PROVISIONS RELATING TO THE NOTES IN GLOBAL FORM | 182 |
| SUBSCRIPTION AND SALE | 188 |
| TAXATION | 191 |
| GENERAL INFORMATION | 201 |
| REGULATION OF THE OIL INDUSTRY IN THE RUSSIAN FEDERATION | 203 |
| GLOSSARY OF TERMS | 213 |
| INDEX TO FINANCIAL INFORMATION | F--1 |
Due to the restrictions on transfer of the notes, purchasers of the notes are advised to consult legal counsel prior to making any purchases of the notes or reoffering, reselling, pledging or otherwise transferring any of the notes.
LUKOIL has received an exemption under Rule 12g3-2(b) under the U.S. Securities Exchange Act of 1934 (the Exchange Act) and, pursuant to such Rule, furnishes to the SEC or publishes on its website in English specified non-United States disclosure documents.
Each of the Issuer and LUKOIL have agreed that, for so long as any notes are "restricted securities" within the meaning of Rule 144(a)(3) under the Securities Act, it will, during any period in which it is neither subject to Section 13 or 15(d) of the Exchange Act nor exempt from reporting pursuant to Rule 12g3-2(b) thereunder, provide to any holder or beneficial owner of such restricted securities or prospective purchaser designated by such holder or beneficial owner or to the Trustee for delivery to such holder, beneficial owner or prospective purchaser, in each case upon the request of such holder, beneficial owner, prospective purchaser or the Trustee (as defined in "Terms and Conditions of the Notes"), the information required to be provided by Rule 144A(d)(4) under the Securities Act. This covenant is intended to be for the benefit of the holders and the prospective purchasers designated by such holders, from time to time of such restricted securities.
LUKOIL is an open joint stock company organised under the laws of the Russian Federation and most of its directors and executive officers reside in Russia. The Issuer is a company organised under the laws of the Netherlands and some of its directors and executive officers reside in Russia. Most of the assets of LUKOIL and of such persons are located outside of the United States and the United Kingdom. Each of the Issuer and LUKOIL has appointed an agent for service of process in England; however, it may not be possible for investors to effect service of process within the United States or the United Kingdom on the directors and executive officers of the LUKOIL or the Issuer or enforce judgments against such persons or LUKOIL or the Issuer. Judgments rendered by a court in any jurisdiction outside the Russian Federation will be recognised by courts in Russia only if an international treaty providing for the recognition and enforcement of judgments in civil cases exists between the Russian Federation and the country where the judgment is rendered. No such treaty exists between the United States or the United Kingdom and the Russian Federation for reciprocal enforcement of foreign court judgments. However, we are aware of at least one instance in which Russian courts have recognised and enforced an English court judgment. The basis for this was a combination of the principle of reciprocity and the existence of a number of bilateral and multilateral treaties to which both the United Kingdom and the Russian Federation are parties. The courts decided that such treaties constituted grounds for the recognition and enforcement of the relevant English court judgment in Russia. In the absence of established court practice, however, it is difficult to predict whether a Russian court will be inclined in any particular instance to recognise and enforce an English court judgment on these grounds. Consequently, it may be impossible to enforce judgments of U.S. courts or English courts against LUKOIL or the Issuer and their officers or directors in the courts of the Russian Federation, including judgments predicated upon the civil liability provisions of U.S. federal securities laws or any state or territory within the United States or English law, when they are brought in original actions or in actions to enforce judgments of U.S. courts or English courts, without re-examination of the issues in the Russian Federation. Moreover, a court of the Russian Federation may refuse or limit enforcement of a foreign judgment, inter alia, on public policy grounds (see "Risk Factors – Risks Relating to the Russian Federation").
The notes and the guarantee will be governed by English law and will provide the option for disputes, controversies and causes of action brought by parties thereto against us to be settled by arbitration in accordance with the LCIA Rules. The Russian Federation is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). Consequently, an arbitral award from an arbitral tribunal in the United Kingdom and United States would generally be recognised and enforced in the Russian Federation on the basis of the rules of the New York Convention. However, it may be difficult to enforce arbitral awards in the Russian Federation due to:
● the difficulties of existing mechanisms for enforcement of such awards in the Russian Federation.
In addition, any arbitral award may be limited, in particular, by mandatory provisions of Russian laws relating to the exclusive jurisdiction of Russian courts and the application of Russian laws with respect to bankruptcy, winding up or liquidation of Russian companies. The Arbitration Procedure Code of the Russian Federation also contains an exhaustive list of grounds for the refusal of recognition and enforcement of foreign arbitral awards by Russian courts, which grounds are substantially similar to those provided by the New York Convention. The Arbitration Procedure Code and other Russian procedural laws could change and other grounds for Russian courts to refuse recognition and enforcement of foreign arbitral awards could arise.
Under current Russian law, state duty may be payable upon the initiation of any action or proceeding (including any proceeding for enforcement) arising out of the notes or the guarantee in any court of the Russian Federation.
After deduction of commissions and expenses (including total expenses related to the listing and admission to trading of the notes), which are expected to be approximately \$2,150,000, we anticipate the net proceeds from the issue of the notes to be approximately \$996,528,000. We intend to use the net proceeds from the issue of the notes for general corporate purposes, including the repayment of existing indebtedness.
Certain statements in this prospectus are not historical facts and are forward-looking statements. This prospectus contains certain forward-looking statements in various locations, including, without limitation, under the headings "Overview", "Risk Factors", "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Business" and "Additional Information Regarding the Company". We may from time to time make written or oral forward-looking statements in reports to shareholders and in other communications. Examples of such forward-looking statements include, but are not limited to:
Forward-looking statements that we may make from time to time (but that are not included in this prospectus) may also include projections or expectations of revenues, income (or loss), earnings (or loss) per share, dividends, capital structure or other financial items or ratios.
Words such as "believes", "anticipates", "expects", "estimates", "intends" and "plans" and similar expressions, including the negative of these terms, are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, and risks exist that the predictions, forecasts, projections and other forward-looking statements will not be achieved. You should be aware that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. These factors include:
This list of important factors and the other factors described in this prospectus (including in "Risk Factors") are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our future results. When relying on forward-looking statements, you should carefully consider the foregoing factors and other uncertainties and events, especially in light of the political, economic, social and legal environment in which we operate. Such forward-looking statements speak only as at the date on which they were made, and we do not undertake any obligation to update or revise any of them, whether as a result of new information, future events or otherwise. We do not make any representation, warranty or prediction that the results anticipated by such forward-looking statements will be achieved and such forward-looking statements represent, in each case, only one of many possible scenarios and should not be viewed as the most likely or standard scenario.
The following overview should be read in conjunction with, and is qualified in its entirety by reference to, the more detailed information in this prospectus and our audited annual consolidated financial statements and the related notes and unaudited supplemental oil and gas disclosure and our reviewed interim consolidated financial statements included elsewhere in this prospectus. Investing in the notes involves risk. The information set out under "Risk Factors" should be carefully considered. Certain statements in this prospectus include forward-looking statements, which also involve risks and uncertainties, as described under "Forward-Looking Statements".
We are one of the largest publicly traded oil and gas companies in the world in terms of proved crude oil and gas reserves and we are the second largest producer of crude oil in Russia. As at 31 December 2009, our estimated proved crude oil reserves were approximately 13,696 mmbls (1,868 million tonnes) and our estimated proved gas reserves were 22,850 bcf (647 bcm), an aggregate of 17,504 mmboe. As at the same date, our estimated probable crude oil reserves were 7,293 mmbls (995 million tonnes) and our estimated probable gas reserves were 15,163 bcf (429 bcm), an aggregate of 9,820 mmboe. For more information, see "Presentation of Reserves and Resources".
Our total revenues were \$49,755 million in the first six months of 2010, compared to \$34,861 million in the first six months of 2009. Our net income in the first six months of 2010 was \$4,002 million, compared to \$3,229 million in the first six months of 2009. Our total revenues were \$81,083 million in 2009, compared to \$107,680 million in 2008. Our net income in 2009 was \$7,011 million, compared to \$9,144 million in 2008.
In the first six months of 2010, we produced 355.0 mmbls (48.1 million tonnes) of crude oil, including 331.1 mmbls (45.0 million tonnes) in Russia and 23.9 mmbls (3.1 million tonnes) from our international projects. In the first six months of 2010, we produced 326.3 bcf (9.2 bcm) of gas available for sale, including 238.8 bcf (6.7 bcm) in Russia and 87.5 bcf (2.5 bcm) obtained from various international projects. In the first six months of 2010, we refined 237.6 mmbls (32.4 million tonnes) of raw materials at our own and affiliated refineries, including 162.6 mmbls (22.2 million tonnes) at our Russian refineries and 75.0 mmbls (10.2 million tonnes) at our international refineries (including our shares in the ISAB and TRN refinery complexes). In the first six months of 2010, we sold 174.8 mmbls (23.9 million tonnes) of crude oil and 42.6 million tonnes of refined products and to customers outside of Russia, including sales to CIS countries and exports to international markets. Our sales of crude oil and refined products to customers outside of Russia accounted for 92.5% and 83.5% of our total sales of crude oil and refined products, respectively, in the first six months of 2010.
In 2009, we produced 719.6 mmbls (97.6 million tonnes) of crude oil, including 675.7 mmbls (91.9 million tonnes) in Russia and 43.9 mmbls (5.7 million tonnes) from our international projects. Our 2009 domestic crude oil production accounted for 18.6% of all Russian crude oil production based on the aggregate Russian crude oil production for 2009 published by the Russian Ministry of Energy. In 2009, we produced 526.1 bcf (14.9 bcm) of gas available for sale, including 376.5 bcf (10.7 bcm) in Russia and 149.6 bcf (4.2 bcm) obtained from various international projects. In 2009, we refined 459.6 mmbls (62.7 million tonnes) of raw materials at our own and affiliated refineries, including 325.9 mmbls (44.5 million tonnes) at our Russian refineries and 133.7 mmbls (18.2 million tonnes) at our international refineries (including our shares in the ISAB and TRN refinery complexes). We also refined 15.0 mmbls (2.0 million tonnes) of crude oil under contracts with domestic third party refineries, primarily at refineries in Ufa, and 12.7 mmbls (1.7 million tonnes) of crude oil under contracts with international third party refineries. In 2009, we sold 344.4 mmbls (47.0 million tonnes) of crude oil and 84.7 million tonnes of refined products to customers outside of Russia, including sales to CIS countries and exports to international markets. Our sales of crude oil and refined products to customers outside of Russia accounted for 94.0% and 84.1% of our total sales of crude oil and refined products, respectively, in 2009.
As at 31 December 2009, approximately 95% of our estimated proved crude oil reserves were located in Russia. Our proved crude oil reserves in Western Siberia, including the Bolshekhetskaya depression located in the Yamal-Nenets Autonomous District, were 7,492 mmbls (1,022 million tonnes) as at 31 December 2009, constituting approximately 55% of our total estimated proved crude oil reserves. We are developing new reserves in Russia, most notably in Western Siberia, the Timan-Pechora region and the Northern Caspian region. We believe that these new areas will provide us with a reserves portfolio which is more balanced geographically.
As at 31 December 2009, approximately 70% of our estimated proved natural gas reserves were in Russia. Our core domestic gas producing area is the Bolshekhetskaya depression in Western Siberia. In April 2005, we started producing natural gas from the Nakhodkinskoye field in the Bolshekhetskaya depression. Our production of gas available for sale from this field was 145.1 bcf (4.1 bcm) in the first six months of 2010 and 209.6 bcf (5.9 bcm) in 2009.
Our primary international areas of focus are currently the non-Russian Caspian region and Central Asia, in particular Kazakhstan and Uzbekistan. However, we also have increasingly important interests in international projects in Africa, the Middle East, South America and elsewhere in the CIS. As at 31 December 2009, our international assets accounted for approximately 5% of our estimated proved crude oil reserves and 30% of our estimated proved gas reserves.
We own and operate four crude oil refineries in Russia, located in Perm, Volgograd, Ukhta and Nizhny Novgorod. These refineries, along with our mini-refineries in Urai and Kogalym, have a combined refining capacity of 45.1 million tonnes per year and refined a total of 22.2 million tonnes of crude oil in the first six months of 2010 and a total of 44.5 million tonnes of crude oil in 2009. Outside of Russia, we own and operate refineries in Bulgaria, Romania and Ukraine, a 49% share in a refining complex in Italy and a 45% share in a refinery in The Netherlands, which have a combined refining capacity of 27.9 million tonnes per year and refined a total of 10.2 million tonnes of crude oil in the first six months of 2010 and a total of 18.2 million tonnes of crude oil in 2009.
We have invested, and expect to continue to invest, substantial amounts on modernisation of our refineries. Our refinery in Odessa, Ukraine was closed from August 2005 until April 2008 for a large-scale reconstruction programme, which was part of a larger effort to upgrade and modernise all of our refineries to improve utilisation rates as well as refining depth and to increase production of refined products which comply with the more stringent current environmental requirements applicable in some of our export markets, including the European Union. In 2009, we spent \$827 million on capital expenditures in connection with modernising and reconstructing our refineries. In March 2010, we signed a multi-year agreement with Emerson Process Management to modernise 13 refining and petrochemical facilities in Russia and Eastern Europe. Under the agreement, which extends through 2014, Emerson Process Management will provide equipment, software and services as part of our enterprise-wide strategy to modernise process automation at our oil and gas refineries, petrochemical plants and related facilities. The refineries and petrochemicals plants that will be upgraded under the agreement include Stavrolen and Saratovorgsintez in Russia, Neftochim Bourgas in Bulgaria and Karpatnaftochim Ltd. in Ukraine, as well as other facilities in Romania, Odessa, Perm, the Volgograd region and the Komi Republic. Once we complete the upgrades of all of our refineries, both domestically and internationally, we believe that a significant portion of the refined products produced at our refineries will be in compliance with existing and expected future European Union standards.
Our downstream gas assets include four gas processing facilities: the Lokosovsky gas processing plant in the Khanty-Mansiysk Autonomous District, the Korobkovsky gas processing plant in the Volgograd region, the Permneftegazpererabotka gas processing plant in the Perm region and the Usinsk gas processing plant in the Komi Republic. These gas processing plants have a combined processing capacity of 133.7 bcf (3.8 bcm). Our gas processing plants processed 49.4 bcf (1.4 bcm) of gas and 0.4 million tonnes of natural gas liquids in the first six months of 2010 and 104.6 bcf (3.0 bcm) of gas and 0.7 million tonnes of natural gas liquids in 2009. The Lokosovsky gas processing plant is currently our main gas processing facility in Russia and has a gas processing capacity of 81.2 bcf (2.3 bcm) per year.
We sell the crude oil which we do not refine into the domestic and international markets, which includes exports from Russia and sales outside of Russia of crude oil production from our international projects. We also undertake crude oil trading activity on international markets. In the first six months of 2010, we sold 14.3 mmbls (1.9 million tonnes) of crude oil within Russia, or 7.5% of our total crude oil sales, and 174.8 mmbls (23.9 million tonnes) of crude oil outside of Russia, or 92.5% of our total crude oil sales. In 2009, we sold 21.9 mmbls (3.0 million tonnes) of crude oil within Russia, or 6.0% of our total crude oil sales and 344.4 mmbls (47.0 million tonnes) of crude oil outside of Russia, or 94.0% of our total crude oil sales.
We sell a wide range of refined products, including gasoline, diesel fuel, fuel oil and lubricants. We sold a total of 51.0 million tonnes of refined products through wholesale and retail channels in the first six months of 2010 and 100.8 million tonnes in 2009. In the first six months of 2010, we sold 8.4 million tonnes of our refined products in the domestic market, or 16.5% of our total refined products sales, and 42.6 million tonnes internationally, or 83.5% of our total refined products sales. In 2009, we sold 16.0 million tonnes of our refined products in the domestic market, or 15.9% of our total refined products sales, and 84.8 million tonnes internationally, or 84.1% of our total refined products sales.
As at 30 June 2010, we owned or leased 5,097 retail filling stations (excluding stations that were temporarily idle or leased to third parties), including 1,899 in Russia, 1,041 in the United States and 2,157 in the CIS (excluding Russia) and Europe. In the first six months of 2010, we sold 3.3 million tonnes of refined products through our filling stations in Russia and 3.4 million tonnes through our filling stations outside Russia. In 2009, we sold 6.2 million tonnes of refined products through our filling stations in Russia and 7.9 million tonnes through our filling stations outside Russia. In November 2008, we completed the acquisition of 100% of Akpet, a Turkish company that operated 689 retail filling stations and owns eight oil product terminals, five LNG storage tanks, three jet fuel terminals and a lubricant production plant in Turkey. In the first quarter of 2009, we purchased retail filling station networks totalling 96 retail filling stations and plots of land from OOO Smolenskneftesnab, OOO IRT Investment Company, OOO PM-Invest and OOO Retaier House. In the fourth quarter of 2008, we purchased retail filling station networks totalling 181 retail filling stations from ZAO Association Grand and OOO Mega Oil M.
We continue to expand our petrochemicals business through our petrochemicals operations in Russia, Ukraine and Bulgaria. Currently, we own two petrochemicals plants in southern Russia and one in Ukraine. We also manufacture petrochemicals at our Bourgas refinery in Bulgaria. Together, those plants manufactured 0.4 million tonnes of petrochemicals in the first six months of 2010 and 0.9 million tonnes of petrochemicals in 2009. We intend to utilise our expanding natural gas production and processing operations as a source of feedstock for our petrochemicals operations, particularly at the Caspian gas-chemical complex that we plan to construct in the Caspian region.
In 2010, we continued to develop the new power generation sector of our business as part of our strategic development programme. We expect power generation to be an important factor in our long-term growth. This new sector will encompass all aspects of the power generation business, from generation to transmission and sale of heat and electrical power, thereby ensuring reliable supplies for our own needs as well as for external customers. Our power generation business sector now includes recently acquired OAO UGK TGK-8 (TGK-8), our own power generating facilities at our oil and gas fields and power generators in Bulgaria, Romania and Ukraine. Our total output of electrical energy was 14.7 billion kW-h in 2009 (of which over 90% was generated by TGK-8). Our total output of heat energy was approximately 16.9 million Gcal in 2009. TGK-8 is a power generation company which owns power plants in Russia in the Astrakhan, Volgograd and Rostov regions, the Krasnodar and Stavropol districts and the Republic of Dagestan, with total electric power generation facilities of 3.6 GW and total thermal power generation facilities of 13,542 Gcal/hour. The power generation segment investment programme includes the construction of power plants with a total capacity of approximately 890 MW. TGK-8's annual gas consumption is approximately 212.0 bcf (6.0 bcm) and we expect our interest in TGK-8 will create synergies through natural gas supplies from our gas fields in the Northern Caspian and Astrakhan regions.
We use the Transneft pipeline system, our own pipeline network, rail cars and tankers to transport the crude oil which we produce within Russia, for export outside of Russia and to our refineries. In December 2009, we acquired the 46% interest of BP plc in LUKARCO, increasing our ownership stake from 54% to 100%. LUKARCO has a 12.5% share in the Caspian Pipeline Consortium (CPC), a pipeline project in
the Caspian region which is used to transport crude oil produced in Kazakhstan to a marine terminal near the Russian city of Novorossiysk on the Black Sea for transport on to international markets. We also own export terminals at the port of Svetly in the Kaliningrad region (with a total annual capacity of 6 million tonnes), at Varandey on the Barents Sea (with a total annual capacity of 12 million tonnes) and at Vysotsk, Vyborg's outer harbour on the Baltic Sea (with a total annual capacity of 12 million tonnes). Most of our gas is sold at the wellhead and then transported through the UGSS, owned and operated by Gazprom, which is responsible for gathering, transporting, dispatching and delivering substantially all natural gas supplies in Russia. We transport our refined products primarily through a combination of Russia's state-owned refined products pipeline, Transnefteproduct, and by rail car, river-class tanker and truck.
The oil and gas industry is intensely competitive. We compete with other major Russian and international oil and gas companies. Many of our international competitors have substantially greater financial resources and have been operating in a market-based, competitive economic environment for much longer than we have. The key activities in which we face competition are:
See "Risk Factors – Risks Relating to Our Business – We encounter competition from other oil and gas companies in all areas of our operations, including the acquisition of licences, exploratory prospects and producing properties, and we may encounter competition from suppliers of alternative forms of energy sources" for more information about the risks related to our ability to compete effectively with Russian oil and gas and international oil companies. We expect competition to intensify. A number of other Russian oil companies, as well as foreign oil companies, are permitted to compete for licences and to offer services in Russia, increasing the competition which we face domestically. We also expect competition to increase domestically and internationally due to the limited quantities of unexploited and unallocated oil reserves.
Our strategic objectives are sustainable growth and value creation.
We aim to increase our profitability by maintaining our sustainable and efficient growth of crude oil, natural gas and refined products production, replacing our reserves at competitive cost and maintaining returns on capital at levels comparable to our international peers.
We aim to create shareholder value through rigorous management of capital and costs, by increasing our valuation and paying fair dividends. We believe that one of the competitive advantages which allows us to achieve this strategic objective is our ability to identify and develop attractive upstream and downstream opportunities in our core Russian and international markets.
In order to achieve our strategic objectives of sustainable growth and value creation, we are in the process of implementing the following short-term and long-term development programmes. On 19 November 2009, our Board of Directors approved a comprehensive strategic development programme for 2010 to 2019 to achieve our strategic objectives of sustainable growth and value creation. As part of our strategic development programme for 2010 to 2019, we have focused on steps designed to deliver near- and medium-term benefits to our profitability and returns on investment and a long-term programme designed to sustain our growth and profitability. In addition, the strategic development programme for 2010 to 2019 aims to create value by improving free cash flow and increasing dividends and production by optimising capital expenditures.
Our development programme for the next two years is designed to take advantage of opportunities to increase profitability. We believe that the following initiatives will, upon successful implementation, have a positive impact on our profitability:
Our longer-term initiatives include the following:
Expand our upstream business in Russia. We intend to increase the profitability of our exploration and production business by accelerating field development where appropriate, utilising improved recovery technology, developing satellite fields close to existing infrastructure to gain incremental reserves and production at a relatively low cost per barrel and continuing to shut in less productive wells. We are also focused on increasing our reserves and production of hydrocarbons in Timan-Pechora, the Bolshekhetskaya depression and the Northern Caspian region. We believe that fields in these areas will have higher flow rates than our more mature reserves elsewhere in Russia, resulting in a lower per-barrel production cost.
Increase our international reserves and production through further development of our existing upstream assets and acquisitions. We aim to increase our reserves and production from international operations to mitigate the risks of geographic concentration. Our primary international areas of focus are currently the non-Russian Caspian region and Central Asia. We believe that we can produce significant amounts of hydrocarbons from various projects in these regions in the medium term. We have also identified attractive opportunities in Africa, the Middle East, South America and elsewhere in the CIS.
Investing in the notes is speculative and involves a high degree of risk. You should carefully consider the risks and other information contained in this prospectus, although you should note that the risks described in this prospectus are not the only risks we face and there may be additional risks that we currently consider not to be material or of which we are not presently aware.
Risks relating to business operations in emerging markets, including that: (a) emerging markets, such as Russia, are subject to greater risks than more developed markets, including significant political, legal and economic risks; and (b) most of our international reserves, production and refining interests are located in politically, economically and legally unstable areas.
Risks relating to the Russian Federation, including that: (a) the Russian tax system imposes substantial burdens on us, is not fully developed and is subject to frequent change and significant uncertainty; (b) instability in the Russian economy could materially adversely affect our business; (c) political and governmental instability could materially adversely affect our business, financial condition, results of operations and prospects; and (d) domestic political conflicts could create an uncertain operating environment that would hinder our long-term planning ability and could materially affect the value of investments in Russia.
We are currently rated by three rating agencies: Moody's Investors Service Inc., Fitch Ratings Ltd and Standard & Poor's Ratings Services. Our ratings as of 20 October 2010 are as follows:
| Moody's | Fitch | S&P | ||
|---|---|---|---|---|
| Long term implied Baa2 | Long term BBB- | Long term BBB |
||
| Senior unsecured Baa2 | Short term F3 |
Senior unsecured BBB |
||
| Credit Watch |
||||
| Outlook Stable | Outlook Stable | Outlook Negative |
The notes have been assigned a rating of Baa2 by Moody's, BBB- by Fitch and BBB- by S&P.
A credit rating is not a recommendation to buy, sell or hold securities and may be subject to revision, suspension or withdrawal at any time by the assigning rating organisation. Similar ratings on different types of notes do not necessarily mean the same thing. The ratings do not address the likelihood that the principal on the notes will be prepaid, paid on an expected final payment date or paid on any particular date before the legal final maturity date of the notes. The ratings do not address the marketability of the notes or any market price. Any change in the credit ratings of the notes or our company could adversely affect the price that a subsequent purchaser will be willing to pay for the notes. We recommend that you analyse the significance of each rating independently from any other rating.
In July 2010, we won a tender for exploration and development of two blocks, Est Rapsodia and Trident, in the Romanian sector of the Black Sea together with Vanco International. The respective stakes of LUKOIL Overseas and Vanco International in the consortium are 80% and 20%. The Est Rapsodia and Trident blocks are located in the Black Sea at depths ranging from 90 to 1,000 metres. The distance to the coastline is 60-100 kilometres and the nearest town on the coast is Sulina. The total area of the two licence blocks is approximately 2,000 square kilometres. A 3D seismic study is required to assess the geological structure of the blocks. In accordance with the conditions of the tender, we are to sign a concession agreement with the National Agency for Mineral Resources of Romania within six months of the tender.
We began exploration drilling in a block offshore Ghana in October 2009 and in February 2010 we discovered a vertically-oriented structure rich in hydrocarbons, approximately 94 metres thick, containing a multi-layer oil and gas reservoir approximately 25 metres thick. At present we are appraising the reserves.
In December 2009, we acquired BP plc's 46% stake in LUKARCO for \$1.6 billion, increasing our ownership stake to 100%. LUKARCO is a holding company, which owns a 5% share in Tengizchevroil, a joint venture which develops the Tengiz and Korolevskoe fields in Kazakhstan, and a 12.5% share in CPC, a pipeline project
in the Caspian region which is used to transport crude oil produced in Kazakhstan to a marine terminal near the Russian city of Novorossiysk on the Black Sea for transport on to international markets. Accordingly, we increased our ownership stake in Tengizchevroil from 2.7% to 5% and our ownership stake in CPC from 6.75% to 12.5%. The \$1.6 billion purchase price is to be paid in three instalments. The first instalment of \$300 million was paid in December 2009. The second instalment of \$800 million and third instalment of \$500 million are due in December 2010 and December 2011, respectively.
In December 2009, we won a tender for the rights to develop the West Qurna-2 oil field in Iraq (West Qurna-2) as part of a consortium with Statoil. In January 2010, we entered into a development and production agreement with two of Iraq's state-owned companies (North Oil Company and South Oil Company) and Statoil, under which our share in this project is 56.25%. The agreement has a term of twenty years with the possibility of a five-year extension. Recoverable reserves are estimated to be 12,900 mmbls.
On 3 September 2010, we made a partial prepayment of \$500 million from internal funds generated during the first six months of 2010 on a \$1.2 billion syndicated term loan facility, arranged in August 2009 by ABN AMRO Bank N.V. / The Royal Bank of Scotland plc, The Bank of Tokyo-Mitsubishi UFJ, Barclays Capital, BNP Paribas S.A., Calyon, Citigroup Global Markets, Ltd., Deutsche Bank AG, Amsterdam Branch, ING Bank N.V., Natixis, JSB "Orgresbank", Société Genérale and WestLB AG.
In August 2010, we raised a \$1.5 billion loan facility through Lukoil Finance Ltd. This loan is guaranteed by OAO LUKOIL. The loan is an unsecured club facility with a one year maturity and it was arranged by The Bank of Tokyo-Mitsubishi UFJ, Ltd.; Citibank, N.A., London branch; ING Bank N.V., London branch; Natixis; The Royal Bank of Scotland N.V.; and WestLB AG, London branch. Citibank International PLC acted as the agent for the transaction. The proceeds under this loan will be used for general corporate purposes.
In June 2010, our Board of Directors approved, by absentee ballot, the issuance of documents for registration with the FSFM of a programme for non-convertible interest-bearing documentary ruble bonds with a total nominal value of 100 billion rubles, placed through public subscription. The placement timing for each of the registered issues under this programme will be determined based on market conditions and our debt financing needs. The programme covers placement of 10 bond issues, each with a 10-year maturity period. The bonds will be placed at the Moscow Interbank Currency Exchange (MICEX). ZAO Troika Dialog Investment Company and ZAO Raiffeisenbank act as the underwriters.
In December 2009, we issued MICEX-listed bonds in the amount of 10 billion rubles with a coupon rate of 9.20% per annum. The bonds will mature in three years. The offering was arranged by ZAO Troika Dialog Investment Company. The proceeds from the issuance were used to prepay the remaining part of our \$500 million loan from Sberbank, which we borrowed in February 2009.
In November 2009, we issued two tranches of non-convertible bonds totalling \$1.5 billion. The first tranche totalling \$900 million with a coupon rate of 6.375% per annum was placed with a maturity of 5 years at a price of 99.474% of the bond's face value. The resulting yield to maturity for the first tranche is 6.500%. The second tranche totalling \$600 million with a coupon rate of 7.250% per annum was placed with a maturity of 10 years at a price of 99.127% of the bond's face value. The resulting yield to maturity for the second tranche is 7.375%. These tranches have a half year coupon period.
The following overview contains basic information about the notes and the guarantee and is not intended to be complete. For a more complete understanding of the notes and the guarantee, please refer to the section of this prospectus entitled "Terms and Conditions of the Notes".
| Issuer | LUKOIL International Finance B.V. |
|---|---|
| Guarantor | OAO LUKOIL |
| Notes | U.S.\$1,000,000,000 aggregate principal amount of 6.125% notes due 2020. The notes will be issued in two tranches at the same time as U.S.\$800,000,000 aggregate principal amount of Tranche 1 Notes and U.S.\$200,000,000 aggregate principal amount of Tranche 2 Notes. The Tranche 1 Notes and the Tranche 2 Notes will have the same terms and conditions in all respects other than their respective issue prices and will on issue be consolidated and will form part of the same series. |
| Issue Price | 99.081% for the Tranche 1 notes 102.44% for the Tranche 2 notes |
| Closing Date | 9 November 2010 |
| Maturity Date | Unless previously redeemed, or purchased and cancelled, the notes will be redeemed at their principal amount on 9 November 2020. |
| Interest | The notes bear interest at the rate of 6.125% per annum payable in equal instalments semi-annually in arrear on 9 May and 9 November in each year, commencing on 9 May 2011. |
| Form | The notes will be in registered form, without interest coupons attached, in denominations of U.S.\$200,000 or multiples of U.S.\$1,000 in excess thereof. |
| The notes will be issued in the form of a Regulation S Global Note and a Rule 144A Global Note, each in registered form without interest coupons. The Regulation S Global Note will be deposited with, and registered in the name of, a nominee for the common depository for Euroclear and Clearstream, Luxembourg. The Rule 144A Global Note will be deposited with a custodian for, and registered in the name of, Cede & Co., as nominee of DTC. Ownership interests in the Regulation S Global Note and the Rule 144A Global Note will be shown on, and transfer thereof will be effected only through, records maintained by DTC, Euroclear, Clearstream, Luxembourg and their respective participants. Notes in definitive form will be issued only in limited circumstances. |
|
| Status of the Notes | The notes constitute unsubordinated and (subject to Condition 4 of the Terms and Conditions of the Notes) unsecured obligations of the Issuer which rank pari passu and without any preference among themselves. Subject to Condition 4 of the Terms and Conditions of the Notes, each of the Issuer and the Guarantor shall ensure that at all times the claims of the Noteholders against them under the notes and the guarantee, respectively, rank in right of payment at least pari passu with the claims of all their other unsecured and unsubordinated creditors, save those whose claims are preferred by any mandatory operation of law. |
| Guarantee | The payment, when due, of all sums expressed to be payable by the Issuer under the notes and the trust deed has the benefit of an unconditional and irrevocable guarantee of the Guarantor, as further described in Condition 2(a) of the Terms and Conditions of the Notes. |
| Cross Default | There will be a cross default in respect of certain Indebtedness (as defined in the Terms and Conditions of the Notes) of the Issuer, the Guarantor or any Principal Subsidiary (as defined in the Terms and Conditions) equal to or greater than either (i) an individual amount of U.S.\$50,000,000 or (ii) an aggregate amount of U.S.\$150,000,000 (or their equivalents in another currency), as described in Condition 10(c) of the Terms and Conditions of the Notes. |
| Negative Pledge | There will be a negative pledge in respect of certain Relevant Indebtedness (as defined in the Terms and Conditions of the Notes) of the Issuer, the Guarantor and its Subsidiaries, as described in Condition 4 of the Terms and Conditions of the Notes. |
|||
|---|---|---|---|---|
| The protection that the negative pledge affords to Noteholders is limited in the following key ways: |
||||
| (1) As the definition of Relevant Indebtedness is limited to present or future Indebtedness (as defined in the Terms and Conditions of the Notes) in the form of, or represented by, notes, debentures, bonds or other securities (but, for the avoidance of doubt, excluding term loans, credit facilities, credit agreements and other similar facilities and evidence of indebtedness under such loans, facilities or agreements) which either are by their terms payable, or confer a right to payment, in any currency, and are for the time being, or ordinarily are, quoted, listed or ordinarily dealt in or traded on any stock exchange, over-the- counter or other securities market, the Issuer, LUKOIL and their Subsidiaries will be permitted to secure a range of other forms of Indebtedness without any obligation to provide equal and ratable security in respect of the notes or the guarantee, as the case may be. |
||||
| (2) The Issuer, LUKOIL and their Subsidiaries will be further permitted to secure an aggregate amount of Relevant Indebtedness not exceeding 20% of the value of Consolidated Assets (as defined in the Terms and Conditions of the Notes), without any obligation to afford any equal and ratable security to Noteholders. As a result, the Issuer, LUKOIL and their Subsidiaries may create security in respect of a significant amount of their Relevant Indebtedness without, at the same time, being obliged to grant equal and ratable security in respect of the notes or the guarantee, as the case may be. |
||||
| We urge you to read the Terms and Conditions of the Notes in their entirety and, in particular, Condition 4, which relates to the negative pledge. |
||||
| Covenants | The Terms and Conditions of the Notes contain covenants in respect of mergers and the payment of taxes. For more information, see "Terms and Conditions of the Notes". |
|||
| Tax Redemption | The Issuer may redeem the notes, in whole but not in part, at their principal amount, plus accrued interest, in the event of certain changes in taxation in The Netherlands or Russia. |
|||
| Redemption and | ||||
| "Make-Whole" Premium | The Issuer may also choose to redeem the notes prior to the Maturity Date, in whole or in part, on not less than 30 nor more than 60 days' irrevocable notice, by paying a redemption price equal to the sum of: |
|||
| (1) 100% of the principal amount of the notes to be redeemed, plus |
||||
| (2) the Applicable Premium (as defined in the Terms and Conditions of the Notes), plus |
||||
| (3) accrued and unpaid interest thereon, if any, to the redemption date. |
||||
| Listing of Notes | An application has been made to list the notes on the Official List of the UK Listing Authority and for the notes to be admitted to trading on the Market. |
|||
| Ownership Restrictions | Neither Euroclear, Clearstream, Luxembourg nor DTC will monitor compliance with any transfer or ownership restrictions. |
|||
| Transfer Restrictions | The notes and the guarantee have not been and will not be registered under the Securities Act. You may offer to sell the notes only in transactions exempt from, or not subject to, the registration requirements of the Securities Act and in compliance with all applicable laws of any relevant jurisdiction. See "Transfer Restrictions". |
|||
| ERISA Considerations | The notes may be acquired by an "employee benefit plan" (as defined in Section 3(3) of the U.S. Employee Retirement Income Security Act of 1974, as amended, |
| "ERISA") that is subject to Title I of ERISA, a "plan" described in and subject to Section 4975 of the U.S. Internal Revenue Code of 1986, as amended, (the "Code"), any entity whose underlying assets includes or are deemed to include, "plan assets" by reason of such employee benefit plan's or plan's investment in the entity or any employee benefit plan which is subject to any federal, state or local law, or foreign law, that is substantially similar to the provisions of Section 406 of ERISA or Section 4975 of the Code ("Similar Law"), provided that such purchase and holding of the notes will not constitute or result in a non-exempt prohibited transaction under ERISA or the Code (or, in the case of a another employee benefit plan subject to Similar Law, a violation of any Similar Law). Each purchaser and/or holder of notes and each transferee thereof will be deemed to have made certain representations as to its status under ERISA and the Code. Potential purchasers should read the sections entitled "Taxation – ERISA" and "Transfer Restrictions". |
||||
|---|---|---|---|---|
| Trustee | Citicorp Trustee Company Limited. | |||
| Principal Paying Agent and Registrar |
Citigroup Global Markets Deutschland AG. | |||
| Governing Law and Arbitration |
London, England. | The notes and the trust deed (including the guarantee) will be governed by and construed in accordance with English law and contain provisions for arbitration in |
||
| Use of Proceeds | existing indebtedness. | After deduction of commissions and expenses (including total expenses related to the listing and admission to trading of the notes), which are expected to be approximately \$2,150,000, we anticipate the net proceeds of the issue of the notes to be approximately \$996,528,000. We intend to use the net proceeds from the issue of the notes for general corporate purposes, including the repayment of |
||
| Security Identification | ISIN | Common Code | CUSIP | |
| Rule 144A Notes | US549876AE0 | – | 549876 AE0 | |
| Regulation S Notes | XS055465967 | 055465967 | – |
The following table sets forth a summary of our audited annual consolidated financial information and our reviewed interim consolidated financial statements. You should read the following summary information together with "Selected Consolidated Financial and Other Information", "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and notes and unaudited supplementary oil and gas information thereto included elsewhere in this prospectus. The financial information contained herein has been extracted from (i) our annual consolidated financial statements and notes, which have been prepared in accordance with U.S. GAAP and audited by KPMG, and our unaudited supplementary oil and gas information thereto and (ii) our first six months financial statements and notes, which have been prepared in accordance with U.S. GAAP and reviewed by KPMG. Investors should read this prospectus as a whole and not rely solely on selected or summarised information.
| Six months | ||
|---|---|---|
| ended 30 June 2010 |
2009 | |
| (millions of U.S. dollars, | ||
| Consolidated Statement of Income Data: | except per share amounts) | |
| Revenues | ||
| Sales (including excise and export tariffs) | 49,755 | 34,861 |
| Costs and other deductions | ||
| Operating expenses | (3,802) | (3,108) |
| Cost of purchased crude oil, gas and products | (20,275) | (13,272) |
| Transportation expenses | (2,780) | (2,356) |
| Selling, general and administrative expenses | (1,655) | (1,520) |
| Depreciation, depletion and amortisation | (2,060) | (2,003) |
| Taxes other than income taxes | (4,349) | (2,593) |
| Excise and export tariffs | (9,340) | (5,407) |
| Exploration expense | (146) | (69) |
| Gain on disposals and impairments of assets | 10 | 12 |
| Income from operating activities | 5,358 | 4,545 |
| Interest expense | (373) | (334) |
| Interest and dividend income | 98 | 65 |
| Equity share in income of affiliates | 236 | 182 |
| Currency translation loss | (42) | (124) |
| Other non-operating (expense) income | (75) | 61 |
| Income before income taxes | 5,202 | 4,395 |
| Current income taxes | (1,140) | (837) |
| Deferred income taxes | 44 | (196) |
| Total income tax expense | (1,096) | (1,033) |
| Net income | 4,106 | 3,362 |
| Less: net income attributable to noncontrolling interests | (104) | (133) |
| Net income attributable to OAO LUKOIL | 4,002 | 3,229 |
| Basic and diluted earnings per share of common stock (U.S. dollars) attributable to OAO LUKOIL |
4.72 | 3.81 |
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars, | |||
| except per share amounts) | |||
| Consolidated Statement of Income Data: | |||
| Revenues | |||
| Sales (including excise and export tariffs) | 81,083 | 107,680 | 81,891 |
| Costs and other deductions | |||
| Operating expenses | (7,124) | (8,126) | (6,172) |
| Cost of purchased crude oil, gas and products | (31,977) | (37,851) | (27,982) |
| Transportation expenses | (4,830) | (5,460) | (4,457) |
| Selling, general and administrative expenses | (3,306) | (3,860) | (3,207) |
| Depreciation, depletion and amortisation | (3,937) | (2,958) | (2,172) |
| Taxes other than income taxes | (6,474) | (13,464) | (9,367) |
| Excise and export tariffs | (13,058) | (21,340) | (15,033) |
| Exploration expense | (218) | (487) | (307) |
| Loss on disposals and impairments of assets | (381) | (425) | (123) |
| Income from operating activities | 9,778 | 13,709 | 13,071 |
| Interest expense | (667) | (391) | (333) |
| Interest and dividend income | 134 | 163 | 135 |
| Equity share in income of affiliates | 351 | 375 | 347 |
| Currency translation (loss) gain | (520) | (918) | 35 |
| Other non-operating expenses | (13) | (244) | (240) |
| Income before income taxes | 9,063 | 12,694 | 13,015 |
| Current income taxes | (1,922) | (4,167) | (3,410) |
| Deferred income taxes | (72) | 700 | (39) |
| Total income tax expense | (1,994) | (3,467) | (3,449) |
| Net income | 7,069 | 9,227 | 9,566 |
| Less: net income attributable to non-controlling interests | (58) | (83) | (55) |
| Net income attributable to OAO LUKOIL | 7,011 | 9,144 | 9,511 |
| Basic and diluted earnings per share of common stock | |||
| (U.S. dollars) attributable to OAO LUKOIL | 8.28 | 10.88 | 11.48 |
| As at 30 June |
As at 31 December | ||
| 2010 | 2009 | 2008 | |
| (millions of U.S. dollars) | |||
| Balance Sheet Data: | |||
| Cash and cash equivalents | 3,748 | 2,274 | 2,239 |
|---|---|---|---|
| Working capital | 8,288 | 8,145 | 5,058 |
| Property, plant and equipment | 53,334 | 52,228 | 50,088 |
| Total assets | 82,390 | 79,019 | 71,461 |
| Long-term debt (including current portion) | 9,538 | 10,308 | 7,508 |
| Stockholders' equity | 58,630 | 55,991 | 50,340 |
The reserves and production information in this prospectus includes reserves and production that we do not beneficially own which are attributable to minority interests in our consolidated subsidiaries and our equity share of reserves and production of our affiliated companies. Unless otherwise specified, the reserves and production information in this prospectus does not include information relating to:
We have extracted the reserves information set out below without material adjustment from the reserves reports prepared by Miller and Lents. See "Presentation of Reserves and Resources". We have extracted the production information set out below without material adjustment from our management accounts and operating records. We use this reserves and production information in managing our business and we expect to continue to report on such reserves and production information in our annual reports.
| As at 31 | |||
|---|---|---|---|
| December | As at 1 January | ||
| 2009 | 2009 | 2008 | |
| Reserves | |||
| Crude oil (mmbls) | |||
| Proved | 13,695.5 | 14,458.2 | 15,715.2 |
| Probable | 7,293.2 | 8,083.1 | 8,678.9 |
| Gas (bcf) | |||
| Proved | 22,849.9 | 29,253.4 | 27,920.5 |
| Probable | 15,162.7 | 22,103.5 | 21,048.2 |
| Crude oil and gas (mmboe) | |||
| Proved | 17,503.8 | 19,333.7 | 20,368.9 |
| Probable | 9,820.3 | 11,767.0 | 12,186.9 |
| As at | ||||
|---|---|---|---|---|
| 30 June | Year ended 31 December | |||
| 2010 | 2009 | 2008 | 2007 | |
| Production | ||||
| Crude oil (mmbls) | 355.0 | 719.6 | 702.9 | 713.0 |
| Russia | 331.1 | 675.7 | 662.3 | 670.7 |
| International | 23.9 | 43.9 | 40.6 | 42.3 |
| Gas available for sale (bcf) | 326.3 | 526.1 | 601.0 | 492.8 |
Investing in the notes is speculative and involves a high degree of risk. You should carefully consider the risks, and the other information contained in this prospectus, before you decide to invest in the notes. The trading price of the notes could decline due to any of these risks and you could lose all or part of your investment. You should note that the risks described below are not the only risks we face. We have described only the risks that we consider to be material. However, there may be additional risks that we currently consider not to be material or of which we are not presently aware. If any of the following risks were to materialise, our business, financial condition, results of operations and prospects could be materially adversely affected and it could affect the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Our results of operations are significantly influenced by the general economic conditions in the countries in which we operate and those in which we currently make, or may in the future make, sales. The economic situation in these markets has in various ways been adversely affected by weakening economic conditions and the turmoil in the global financial markets. In particular, some or all of the countries in which we operate have experienced declining GDP, reduced industrial production, increasing rates of unemployment and decreasing asset values. Adverse economic developments of the kind described above have affected and may continue to affect our business in a number of ways, including, among others, the financial condition of our customers, which could have an adverse impact on their access to capital which, in turn, could lower demand for our products and services.
The economic slowdown has resulted in a reduction in demand for certain of our products and services. The global economic climate in 2009 resulted in lower demand and lower prices for oil and natural gas, which reduced our drilling and gas production activity. See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Main Factors Affecting Our Results of Operations" for more information. Furthermore, recent volatility in the credit markets and the potential impact on the liquidity of major financial institutions may have an adverse effect on our cost of funding.
The general economic conditions in the markets in which we operate, and volatility in the credit markets, could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Our business, financial condition and results of operations depend substantially upon the prevailing prices of crude oil, refined products, natural gas and petrochemical products. Historically, prices for crude oil, refined products, natural gas and petrochemical products have fluctuated widely in response to changes in many factors. We do not and will not have control over the factors affecting prices for crude oil, refined products, natural gas and petrochemical products. These factors include:
Russian and foreign governmental regulations and actions, including export restrictions and taxes;
global and regional economic conditions;
Crude oil prices have been volatile in recent years, rising dramatically through July 2008 and then falling sharply over the second half of 2008. Crude oil prices began to level in the first quarter of 2009 and by the end of 2009 had increased to nearly \$80 per barrel. Since the end of 2009, crude oil prices have stayed within the range of \$70-\$87 per barrel. According to Platts, the price of Brent crude, an international benchmark oil blend, as at 28 December 2007, 31 December 2008, 31 December 2009, 31 March 2010 and 30 June 2010 was \$96.02, \$36.55, \$77.67, \$80.30 and \$74.97 per barrel, respectively.
International gas, refined products and petrochemical products prices, which typically follow changes in international oil prices, have also fluctuated considerably in recent years. Our revenues, operating results and future rate of growth are highly dependent on the prices we receive for our crude oil, refined products, natural gas and petrochemical products. In addition, lower prices may reduce the amount of crude oil that we can produce economically (thereby decreasing the size of our reserves) or reduce the economic viability of projects planned or in development.
It is impossible to predict future crude oil, refined products, natural gas and petrochemical price movements with certainty. Moreover, we engage in limited hedging transactions and other derivatives trading only in respect of our marketing and trading activity outside of our physical crude oil and refined products businesses.
The recent fluctuation in crude oil prices has contributed to an increase of our revenues. The Platts average price of Brent crude oil for the first six months of 2010 was \$77.29 per barrel, an increase of approximately 50% from \$51.68 per barrel for the first six months of 2009, which contributed to the 45% increase in our total crude oil sales revenues for the first six months of 2010, as compared to the first six months of 2009. See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Main Factors Affecting Our Results of Operations – Change in Price of International Crude Oil and Refined Products" for more information on the impact of crude oil price volatility on our results of operations. A decline in crude oil, refined products, natural gas or petrochemical products prices for protracted periods could materially adversely affect our business, financial condition, results of operations, prospects and our ability to finance planned capital expenditures.
Over the past ten years, the ruble has fluctuated dramatically against the U.S. dollar. The recent global economic crisis and general economic conditions in Russia caused the ruble to depreciate against the U.S. dollar by approximately 16% in the fourth quarter of 2008 and by approximately 16% in the first quarter of 2009 according to the CBR. Between 31 March 2009 and 1 October 2010, the ruble appreciated against the U.S. dollar by approximately 10%. The Russian government has used significant amounts of its international currency reserves to support the ruble, but has expressed that it may be unwilling or unable to continue such support in the future. While most of our revenues are either denominated in U.S. dollars or are correlated to U.S. dollar oil prices, most of our costs (other than debt service costs and costs that are linked to U.S. dollar oil prices, such as mineral extraction taxes, export duties, pipeline tariffs on exports and crude oil and refined product purchases) are denominated in rubles. Our results of operations are, therefore, significantly affected by the relative movements of ruble inflation and exchange rates. In particular, our operating margin is generally adversely affected by the appreciation of the ruble against the U.S. dollar because this will generally cause our costs to increase in real terms relative to our revenues. Conversely, our operating margin is generally positively affected by a depreciation of the ruble against the U.S. dollar because this will generally cause our costs to decrease in real terms relative to our revenues. We currently do not comprehensively hedge our exposure to foreign currency rate changes, although we selectively hedge certain foreign exchange rate exposures. See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures about Market Risks – Foreign Currency Risk" for discussion of how recent foreign exchange movements have impacted our business and of our hedging policies.
Most of the crude oil that we produce is transported through the pipeline system of Transneft. Transneft is a state-owned oil pipeline monopoly. As with any such pipeline system, the Transneft pipeline system is subject to breakdowns and leakage. By using multiple pipelines, however, Transneft has generally avoided serious disruptions in the transport of crude oil and, to date, we have not suffered significant losses arising from a failure of the pipeline system. Despite ongoing efforts of Transneft to decommission and replace obsolete segments of the pipeline, parts of the pipeline system may require reconstruction and replacement due to their age. Much of the system is located in regions with harsh climates where construction, maintenance and refurbishment are difficult and costly. In addition, the Transneft pipeline system has limited capacity. As a result, the system may experience outages or capacity constraints during required maintenance periods and it is likely that maintenance work will increase in the future. Transneft prepares a maintenance programme on an annual basis and unscheduled maintenance work is rare. During maintenance periods, we may experience delays in or be prevented from transporting crude oil. These delays, outages or capacity constraints could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The Russian government regulates access to Transneft's pipeline network and is required to provide access on a non-discriminatory basis. Pipeline capacity, including export pipeline capacity, is allocated to oil producers on a quarterly basis, generally in proportion to the amount of crude oil produced and delivered to Transneft's pipeline network in the prior quarter. Generally, a Russian oil company is given an allocation for export that equals approximately 40% of its crude oil so produced and delivered.
We, along with all other Russian crude oil producers, must pay transportation fees to Transneft in order to transport crude oil through the Transneft network. The Federal Tariff Service (the FTS) is responsible for setting Transneft's fees, which have risen in recent years and may continue to rise. Failure to pay these fees could result in the termination or temporary suspension of our access to the Transneft network. Significant increases in Transneft's fees or the termination or suspension of our access to the Transneft network would materially adversely affect our business, financial conditions and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
In 2001, a Russian court ordered Transneft to stop accepting shipments of our crude oil in response to a lawsuit filed by one of our minority shareholders. This order was overturned quickly, without causing an adverse effect on our business. In 2002, on several occasions, Russian courts granted similar requests in lawsuits against other Russian companies, all of which were overturned quickly. However, we can give no assurance that similar lawsuits will not be filed against us in the future or that any such lawsuits will be resolved in our favour.
A major disruption in (or in our access to) the Transneft system could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
We face similar risks in some of the other countries where we operate. For example, in early October 2009, the Ukrainian state pipeline operator, OAO Ukrtransnafta (Ukrtransnafta), reversed the direction of the Odessa-Kremenchug crude oil pipeline, causing us to suspend operations at our Odessa refinery due to a lack of crude oil supplies. In late October 2009, we agreed with Transneft on a new route for transportation of crude oil from Russia to our Odessa refinery through the Druzhba pipeline and we restarted operations at the Odessa refinery on 1 November 2009. However, we can give no assurance that we will continue to be able to supply crude oil to our Odessa refinery via this route or that operations at our Odessa refinery will reach levels obtained before the suspension when it reopens following the current maintenance works. We also can give no assurance that other state-owned oil pipeline monopolies transporting our crude oil or refined products will not cause similar disruptions in the future or that such disruptions will not have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
We transport most of our refined products through Russia's rail network. We also depend on railway transportation for the distribution of our crude oil. OAO Russian Railways (Russian Railways) is a state-owned monopoly provider of railway transportation services. Use of the railways exposes us to risks such as potential delivery disruptions due to the deteriorating physical condition of Russia's railway infrastructure. Russian Railways prepares a maintenance programme on an annual basis. The incompatibility of Russia's wider railway gauge with the railway gauge of most other countries imposes additional costs and logistical constraints on our ability to export our products using the railways. Furthermore, although Russian Railways' fees are subject to antimonopoly control, the fees tend to be increased annually. Significant increases in Russian Railways' fees would increase our transportation costs and could materially adversely affect our business, financial condition, results of operations and prospects and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The pipeline system of OAO AK Transnefteproduct (Transnefteproduct) transports an average of approximately 10% of refined products produced in Russia. Transnefteproduct is a state-owned refined product pipeline monopoly. Transnefteproduct has generally avoided serious disruptions in the transport of refined products and, to date, we have not suffered significant losses arising from breakdowns or leakages in the pipeline system. Any significant disruption in the pipeline system could, however, materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
We, along with other Russian refined product producers, must pay transportation fees to Transnefteproduct in order to transport our refined products through the Transnefteproduct network. The FTS is responsible for setting Transnefteproduct's fees for the use of the network, which tend to increase periodically. Significant increases in Transneftproduct's fees would increase our costs and could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Any limitations on our access to the pipeline or railway network may negatively impact our ability to transport our crude oil and/or refined products within Russia and export our crude oil and/or refined products internationally and could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
As at 31 December 2009, our gas reserves in Russia comprised approximately 70% of our total proved gas reserves. All material aspects of the Russian natural gas industry are subject to or materially affected by government regulation. Through its share ownership, representation on the board of directors and role as regulator, the government has strong influence over Gazprom, the dominant participant in Russia's natural gas industry. Gazprom is the primary buyer of the natural gas we produce in Russia. The significant participation in the Russian natural gas industry of independent gas producers is a relatively recent development. If the government were to determine, through legislation, administrative action or otherwise, that independent gas producers should have a less significant role in the Russian natural gas industry, it could take actions (including through Gazprom) that would have a material adverse effect on our ability to develop our natural gas assets, which could in turn have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The Unified Gas Supply System (the UGSS) is responsible for gathering, transporting, dispatching and delivering substantially all natural gas supplies in Russia and is owned and operated by Gazprom. Federal Law No. 117-F2 "On Gas Export" came into force on 31 July 2006 (the Gas Export Law) and granted Gazprom exclusive gas export rights. Under the existing legislation, Gazprom must provide access to the UGSS to all independent suppliers on a non-discriminatory basis subject to spare capacity and other factors. In practice, however, Gazprom exercises considerable discretion over access to the UGSS because it is the sole owner of information relating to UGSS's capacity. See "Business – Transportation – Gas Transportation" for more information about our transportation of gas through the UGSS. We can give no assurance that the legislation requiring Gazprom to provide access on a non-discriminatory basis will remain in place or be enforced, or that Gazprom will continue to provide us with access to the UGSS, to the extent we require, or at all, or that the terms of access offered will be commercially reasonable. A change in the existing legislation, a failure by Gazprom to comply with the legislation or other action by Gazprom to decrease our access to transportation capacity may limit the effective use and value of our gas producing assets and adversely affect our ability to implement our strategy to develop our natural gas resources, which could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The UGSS includes an extensive network of pipelines and compressor installations that were developed during the Soviet era, with some parts having been developed more recently. Most of the pipelines in the UGSS are over ten years old with certain parts being over 30 years old. Large segments of the network are located in regions with harsh climates where construction, maintenance and refurbishment are difficult and costly. As a result, the UGSS may experience outages or capacity constraints during required maintenance periods and it is likely that maintenance work will increase in the future. During these maintenance periods, we may experience delays in or be prevented from supplying natural gas to our customers. A major disruption in the UGSS could impact our ability to implement our strategy to develop our gas producing assets, which could ultimately have a material
adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
In Russia, the FTS regulates natural gas transportation tariffs. Regulated natural gas transportation tariffs have risen in recent years and we expect them to continue to rise. If natural gas transportation tariffs continue to rise and we are unable to pass on these additional costs to our end customers, or the impact of increased transportation tariffs on our wholesale customers requires us to decrease the natural gas prices we charge on a non-delivered basis, our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee could be materially adversely affected.
Gazprom is the monopoly supplier of gas in Russia. The Russian government regulates the prices for the gas that Gazprom sells in Russia. Although the regulated price has been rising in Russia, and is expected to continue to rise to a level closer to parity with export netbacks, it is still significantly below levels that prevail in international markets. According to the official Social and Economic Development Forecast for 2010-2012 prepared by the Russian Ministry of Economic Development and approved by the Russian Government in September 2009, the regulated internal wholesale gas price is expected to rise by 15% per year from 2010 to 2012 for all categories of gas consumers. The regulated internal retail gas price for industrial consumers is expected to rise by 26.5% in 2010 and by 15% in 2011-2012, and for the general population by 20.8% in 2010- 2011 and by 15% in 2012. The regulated price has affected, and is likely to continue to affect, the pricing of the gas we sell to Gazprom or any other customer. The limitations on our pricing flexibility due to Gazprom's dominant position in Russia and the Russian government's price regulations could have a material adverse effect on our business, financial condition and results of operations, particularly if the regulated prices are decreased or if we experience a significant increase in our operating costs related to the development of our gas producing assets.
We conduct our operations in Russia under numerous subsoil licences. The licensing regime in Russia for the exploration, development and production of crude oil and natural gas is governed primarily by Law of the Russian Federation No. 2395-1, "On Subsoil", dated 21 February 1992, as amended (the Subsoil Law) and related regulations. Most of our licences may be suspended, terminated or revoked if we fail to comply with licence requirements (including the obligation to reach a certain level of production), do not make timely payments of levies and taxes for the use of the subsoil, systematically fail to provide information, go bankrupt or fail to fulfil any capital expenditure and/or production obligations.
We may not comply with certain licence requirements for some or all of our licence areas. If we fail to fulfil the specific terms of any of our licences or if we operate in our licence areas in a manner that violates Russian law, government regulators may impose fines on us or suspend or terminate our licences, any of which could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
For example, in January 2005, the Commission for Subsoil Use of the Ministry of Natural Resources investigated certain breaches of the terms of licensing agreements involving LUKOIL-Western Siberia, our principal production subsidiary, relating to six oil fields in the Khanty-Mansiysky Autonomous Region-Yugra. In addition, in October 2006, an official at the Russian Ministry of Natural Resources threatened to revoke 36 of our exploration licences in the Komi region of Timan-Pechora and in the Khanty-Mansiysky Autonomous Region-Yugra, alleging that we failed to explore or drill according to the timelines set out in the licences. We believe that we have addressed all of these alleged violations or we have agreed with the commission to amend the licensing agreements to enable our compliance with the terms of the licences. In June 2006, we acquired 100% of Khanty-Mansiysk Oil Corporation (KMOC) from Marathon Oil Corporation, which at the time owned approximately 95% of the share capital of OAO Khantymansiyskneftegazgeologia and 100% of the share capital of OAO Paitykh Oil and OAO Nazymgeodobycha (the KMOC companies), which operate oil and gas fields in Western Siberia. In September 2006, the Federal Agency for Subsoil Use issued notices of revocation of the licences of the KMOC companies unless the alleged violations were remedied by 29 December 2006. The Russian Ministry of Natural Resources conducted additional reviews of our activities conducted under these licences after 29 December 2006. As at the date of this prospectus, we are not aware of any additional acts or documents issued by the Federal Agency for Subsoil Use or the Russian Ministry of Natural Resources that may lead to the revocation of these licences. We can give no assurance that similar regulatory claims will not arise in the future with respect to these or other fields or that we will be able to settle such claims without licence revocation by revising licence agreements or otherwise. Any such revocations could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
In addition, because we did not own or control all of our subsidiaries when they obtained their initial subsoil licences, we cannot be certain that all of our subsidiaries' licences were issued, or the preceding and current licences were re-issued, in accordance with all applicable law and regulations at the time. If it is determined that any of these licences were issued and/or re-issued in violation of applicable laws, such licences would be subject to revocation. A loss of any such licence could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Our production licences have generally been valid for 20 years, while our combined exploration and production licences are generally valid for 25 years. Many of our original licences, especially those relating to our Western Siberia operations, expire between 2013 and 2014. Recent legislation, passed after the issuance of many of our licences, provides that licences are now granted for a time equal to the economic viability of the relevant field. However, we can give no assurance that our original licences will be extended. The failure to extend any of our licences, upon expiration, for the economic life of the relevant fields could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
To operate our business as currently contemplated, we must obtain permits and authorisations to conduct operations, such as land allotments, approvals of design and feasibility studies, pilot projects and development plans and for the construction of any facilities on site. We may not be able to obtain all required permits and authorisations. If we fail to receive any required permits and authorisations, we may have to delay our investment or development programmes, or both, which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The amendments to the Subsoil Law that came into force in May 2008 provide that certain subsoil areas shall be considered as having federal importance. These subsoil areas include areas which, in particular, are located in the territory of Russia and contain recoverable oil reserves of at least 70 million tonnes or natural gas reserves of at least 50 bcm, or areas located in internal sea waters, territorial sea or the continental shelf of Russia. These amendments also state that if, during a geological survey conducted, inter alia, under a combined licence, a subsoil user which is a legal entity with foreign investment discovers a mineral deposit which has the characteristics of a field of federal importance, the Government of the Russian Federation may take a decision to deny the granting of the right to use the subsoil area for exploration and extraction of minerals on the given subsoil area of federal importance to such person or, in the event of geological exploration of subsoil under a combined licence, a decision to terminate the right to use the subsoil area for exploration and extraction of minerals on the given subsoil area of federal importance, in either case if it considers that it poses a threat to the country's defence or state security.
Furthermore, pursuant to the Subsoil Law, rights to develop oil fields designated as having federal importance situated on the continental shelf, or on the territory of Russia but extending to the continental shelf, may be granted only to Russian entities having at least five years of experience in the development of the continental shelf of the Russian Federation, with state (federal) equity participation exceeding 50% or in relation to which the Russian Federation has a right to either directly or indirectly control over 50% of the voting shares. Accordingly, there is a risk that if we wish to acquire any such rights, we would be required to participate in a joint venture with state participation, over which we may not have control or the terms of which may not be favourable to us. See "Regulation of the Oil Industry in the Russian Federation – Subsoil Production Licences – Issuance of licences" for more information on the use and legal status of the subsoil areas of federal importance.
The abovementioned amendments to the Subsoil Law are open to varying interpretations. As these provisions of the Subsoil Law have not yet been tested in practice, it is unclear how these amendments may affect the activity of the Group.
We conduct our operations outside of Russia under numerous production sharing and concession agreements. See "– Risks Relating to Business Operations in Emerging Markets – Most of our international reserves, production and refining interests are located in politically, economically and legally unstable areas" for information on the relevant jurisdictions in which we operate. See "Business – Exploration and Production – International Exploration and Production" for information on our various production sharing and concession agreements. The licensing regime for the exploration, development and production of crude oil and natural gas is governed primarily by the relevant local laws. Such subsoil use rights may be suspended, terminated or revoked if we fail to comply with relevant agreements' requirements, do not make timely payments to foreign governments or state owned operators, go bankrupt or fail to fulfil any substantial production obligations. We may not comply with certain contractual obligations for some or all of our production areas abroad. If we fail to fulfil the specific terms which may lead to unilateral termination of a production sharing or concession agreement, this could have an adverse effect on our business, financial condition and results of operations.
Our development and exploration projects may be delayed or unsuccessful for many reasons, including cost overruns, lower oil and gas prices, equipment shortages, power shortages and mechanical difficulties. These projects will also often require the use of new and advanced technologies, which can be expensive to develop, purchase and implement, and may not function as expected. In addition, some of our development and exploration projects are or will be located in deep water or frozen or other hostile environments, or involve or will involve production from challenging reservoirs, which can exacerbate such problems. The climate and topography of some of the regions where our fields are located limit access to certain fields and facilities during certain times of the year. During the summer and early fall, some fields are partially flooded and operating capacity is limited. If warmer weather starts earlier or ends later in the year than usual, then our operating capacity is more limited than normal. In winter, extreme cold or snowstorms could limit access to certain wells, and extreme cold could cause the temporary suspension of operations of wells with a high watercut. Such weather conditions could also limit our exploration operations.
We conduct exploration activities in areas, including Western Siberia, the Timan-Pechora region and areas in and around the Caspian Sea, where environmental conditions are challenging and costs can be high. The cost of drilling, completing and operating wells is often uncertain. As a result, we may incur cost overruns or may be required to curtail, delay or cancel drilling operations because of a variety of factors, including unexpected drilling conditions, dry holes, pressure or irregularities in geological formations, equipment failures or accidents, adverse weather conditions, compliance with governmental requirements, including those relating to environmental protection, and shortages or delays in the availability of drilling rigs and the delivery of equipment. In addition, our overall drilling activity or drilling activity within a particular project area may be unsuccessful in that we may not find commercially productive reservoirs.
Cost overruns, lower oil and gas prices, equipment shortages, power shortages, mechanical difficulties and unusually warm or severe weather conditions could impede our development or exploration plans for our fields and facilities and otherwise materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Our ability to exploit economically any reserves discovered will be dependent upon, among other things, the availability of the necessary infrastructure to transport oil and gas to potential buyers at a competitive price. Oil is usually transported by pipelines, tankers and rail to refineries. Natural gas is usually transported by pipelines to processing plants and end users. We face a number of significant obstacles related to the transportation of crude oil and natural gas from our holdings in the north Caspian region and the CIS which could prevent sales to international markets. Other obstacles in those regions include capacity constraints, general political and economic instability and the necessity of obtaining approvals for pipelines from several governments that may not share a common development strategy.
If we fail to conduct successful exploration and development activities or acquire properties with proved reserves, or both, our proved reserves will decline as we extract oil and natural gas. In addition, the volume of production from crude oil and natural gas properties generally declines as reserves are depleted.
Western Siberia, our main oil producing region, is maturing. Our future production is highly dependent upon our success in finding or acquiring and developing additional reserves. If we are unsuccessful, we may not meet our production targets and our total proved reserves and production will decline, which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The oil and gas industry is intensely competitive. We compete with other major Russian and international oil and gas companies. Many of our international competitors have substantially greater resources and have been operating in a market-based, competitive economic environment for much longer than we have. See "Business – Competition". The key activities in which we face competition are:
Russia signed the Energy Charter Treaty, an international treaty for establishing and improving the legal framework for corporate international co-operation in energy matters. However, on 30 July 2009, the Government of the Russian Federation issued Resolution No. 1055-r in which Russia officially announced that it does not intend to become a contracting party to the Energy Charter Treaty and the Protocol on Energy Efficiency and Related Environmental Aspects. In accordance with Article 45(3(a)) of the Energy Charter Treaty, such notification results in the termination of Russia's provisional application of the Energy Charter Treaty and the Protocol on Energy Efficiency and Related Environmental Aspects. However, ratification of the Energy Charter Treaty in its current form or in a modified form could provide foreign investors and oil companies with greater access to the energy markets in Russia and provide third parties with greater access to oil and gas trunk pipelines, including for the transportation of oil and natural gas to international markets. Accordingly, the ratification of the Energy Charter Treaty could also lead to substantially increased competition.
Additionally, we may encounter competition from suppliers of alternative forms of energy sources, including environmentally friendly renewable energy sources such as solar power or wind generated power, as a result of continuing high hydrocarbon prices or potential depletion of hydrocarbon reserves in the future.
In addition, Russian antimonopoly legislation is sometimes vague and subject to varying interpretations. This may fail to protect us from unfair competitive practices, and adversely affect our ability to compete.
Our failure to compete effectively could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
On 24 March 2010, ConocoPhillips announced plans to dispose of half of its stake in LUKOIL, which at the time constituted approximately 20% of LUKOIL's authorised and issued shares, during 2010 and 2011. On 28 July 2010, LUKOIL Finance signed a stock purchase agreement with Springtime Holdings Ltd., an affiliate of ConocoPhillips (Springtime), under which LUKOIL Finance agreed to purchase 64,638,729 LUKOIL ordinary shares, which constituted approximately 7.599% of LUKOIL's authorised and issued shares, at \$53.25 per share for approximately \$3.44 billion. The transaction was completed on 16 August 2010.
On 26 September 2010, LUKOIL exercised its option to acquire additional shares from ConocoPhillips by sending a notice of exercise in respect of 42,500,000 LUKOIL ADRs and entered into a share purchase agreement with UniCredit Bank AG as the purchaser of those ADRs. This transaction was completed on 29 September 2010, when 42,500,000 LUKOIL ADRs were directly transferred by Springtime to UniCredit Bank AG, and UniCredit Bank AG paid the purchase price of \$2.38 billion to Springtime. Simultaneously, UniCredit Bank AG issued a series of equity-linked notes to LUKOIL Finance exchangeable for 17,500,000 LUKOIL ADRs on or before 29 September 2011 and an option to purchase from UniCredit Bank AG an additional 25,000,000 LUKOIL ADRs on or before 29 September 2011. These arrangements give LUKOIL Finance the
opportunity to increase significantly its holding of LUKOIL's authorized and issued shares before the end of September 2011.
ConocoPhillips may sell the rest of the LUKOIL shares it owns on the market at the price that is no less than \$53.25 per share if such shares are sold in 2010 and without pricing restrictions thereafter, subject, in each case, to LUKOIL Finance's right of first offer.
As at 30 September 2010, ConocoPhillips beneficially owned 5.91% of LUKOIL's shares. Pursuant to the Shareholder Agreement of 29 September 2004 between ConocoPhillips and LUKOIL, all of ConocoPhillips's corporate governance rights and LUKOIL's corresponding obligations under the Shareholder Agreement ceased to be effective upon ConocoPhillips's stake falling below 7.599% of LUKOIL's share capital. Therefore, currently ConocoPhillips is treated like any other LUKOIL shareholder and its shareholder rights are governed only by Russian legislation and LUKOIL's charter.
During such time as ConocoPhillips's nominee continues to occupy a position on our Board of Directors, ConocoPhillips may have the power to cause our business to be conducted for its own benefit rather than for the benefit of all of our shareholders. LUKOIL's Board of Directors is responsible for important decisions including the determination of the business priorities of LUKOIL, approval of internal documents of our company (except those requiring approval of the general shareholders meeting and executive bodies), approval of interested party transactions, formation of the Management Committee, early termination of the powers of the Management Committee members, establishing key terms of contracts with the President and the Management Committee members and approving certain significant transactions consummated by OAO LUKOIL and its subsidiaries, as provided in LUKOIL's charter. See "Business – History" and "Management". Therefore, there is a risk that ConocoPhillips's nominee to LUKOIL's Board of Directors could use his position to block certain Board decisions.
Depending on the size of ConocoPhillips's stake in our share capital, ConocoPhillips in certain situations may exert similar influence in decisions requiring a vote at a general shareholder meeting, including proposed amendments to LUKOIL's charter, reorganisation proposals, proposed sales of assets for an amount in excess of 50% of the book value of LUKOIL's assets (calculated according to Russian Accounting Standards) or other major corporate transactions in a manner that may not be in LUKOIL's best interests or the best interests of our shareholders or holders of our other securities, including the notes.
As at 30 September 2010, several members of LUKOIL's Board of Directors and Management Committee, together with their affiliates, collectively beneficially own approximately 31.5% of LUKOIL and thereby can exercise significant influence over LUKOIL's management and affairs, including:
The influence that they have may not always benefit LUKOIL or be in the best interests of other shareholders or holders of our other securities, including the notes.
Our business requires significant capital expenditures, including in exploration and development, production, transportation and refining, and to meet our obligations under environmental laws and regulations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations, Other Contingencies and Off Balance Arrangements – Capital Commitments and Contractual Obligations" for an analysis of our planned capital expenditures. We rely on our cash flows from our operating activities or on external sources, including bank borrowings and offerings of debt or equity securities in the international capital markets to finance our capital expenditures. Our cash flows generated from crude oil, refined product, natural gas and petrochemical product sales may decrease because of the recent decline in crude oil prices and the decreased demand in these products as a result of the global financial crisis. In addition, the global banking and capital markets have experienced a significant disruption since August 2008, which has been characterised by severe reductions in liquidity, greater volatility and general widening of credit spreads. As a result, many lenders have reduced or ceased providing funding to borrowers, particularly in emerging markets, and there has been a general increase in the cost of borrowing for private-sector borrowers. See "– Global economic developments and market conditions may adversely affect our business, financial condition and results of operations" and "– A substantial or extended decline in oil, refined products, natural gas or petrochemical products prices would have a material adverse effect on our business, financial condition and results of operations" for more information. If our cash flows decrease or we are unable to raise the necessary financing, we will have to reduce our planned capital expenditures. Any such reduction could materially adversely affect our ability to expand our business and, if the reductions are severe enough, could materially adversely affect our ability to maintain our operations at current levels. If any of these risks were to materialise, it could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
We will have substantial amounts of outstanding indebtedness upon the completion of the issuance, primarily under the notes, other previously issued notes and our obligations under existing credit arrangements. As a result of the issuance, our total long-term debt will increase to approximately \$10.5 billion from approximately \$9.5 billion as of 30 June 2010, and our principal and interest payment obligations will increase substantially. We may seek additional financing in the near future in an amount similar to the amount of the issuance through the placement of additional bank or capital markets financing. We may also obtain working capital lines of credit, additional long-term debt, vendor financing and capital lease arrangements. We may not be able to generate enough cash to pay the principal, interest and other amounts due under all of our indebtedness.
Our substantial leverage could have significant negative consequences, including:
There can be no assurance that we will be able to meet such obligations, including our obligations under the notes. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, we would be in default under the terms of our indebtedness, which would permit the holders of such indebtedness to accelerate the maturity of such indebtedness and could cause defaults under our various indebtedness, including the notes. Such defaults could delay or preclude payments of interest or principal on our indebtedness, including the notes.
We incur and expect to continue to incur substantial capital and operating costs to comply with increasingly complex laws and regulations covering the protection of the environment and human health and safety. These include costs to reduce certain types of air emissions and discharges to the land and sea and to remediate contamination at various owned and previously owned facilities and at third-party sites where our products or waste have been handled or disposed. There are additional costs associated with the handling, use, storage, transportation, disposal and clean up of hazardous materials and non-hazardous wastes and the dismantlement or abandonment of our properties at the end of their useful lives. Our shipping and other transportation operations are also subject to extensive environmental and other regulations.
In 2009, our management committee approved the LUKOIL Group Environmental Safety Programme for 2009- 2013, which expands on the former Environmental Safety Programme for 2004-2008 and is aimed at improving our environmental monitoring system and minimising any negative environmental impacts caused by our operations. The programme contemplates 483 measures to protect the environment and ensure higher safety standards, with an expected total cost of approximately \$1.8 billion. However, there can be no assurance that the programme or the measures taken under the programme will protect us from negative environmental impacts caused by our operations.
PETROTEL LUKOIL S.A., our refinery in Romania, LUKOIL Neftochim Bourgas AD, and our refinery in Bulgaria require the remediation of a substantial amount of environmental pollution that pre-dated our acquisition of these facilities. At the time of our acquisition of the Petrotel refinery, there was an understanding that the Romanian government would retain liability for existing environmental pollution at the site, which we estimate to be an immaterial amount. In connection with our acquisition of the Bourgas refinery, we understand that the Bulgarian government retains liability for remediation of existing environmental pollution at the site, estimated at approximately \$40 million. There can be no assurance that the Romanian and Bulgarian governments will comply with their obligations in connection with remediation of the environmental pollution at these facilities in the way we expect. Accordingly, we could be exposed to additional remediation costs at these sites in excess of our planned expenditures.
Managed nuclear explosions were carried out within the Osinskoye oil field in 1969. This field is currently operated by OOO LUKOIL-PERM (LUKOIL-PERM). Subsequent drilling allowed radioactively contaminated water to enter the oil reservoir, which eventually led to a ground-level radioactive contamination problem being identified in 1976. Between 1996 and 2001, we undertook a project at a cost of \$6 million to manage and contain associated radiological risks and we believe that no further material liability exists for LUKOIL-PERM. Management procedures are in place to maintain a buffer zone around the location of the nuclear explosions. However, we can give no assurance that further ground water contamination of the surface soil will not occur and will not have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
New laws and regulations, the imposition of tougher requirements in licences, increasingly strict enforcement or new interpretations of existing laws, regulations and licences or the discovery of previously unknown contamination may require us to modify our operations or require further expenditures. These expenditures may include expenditures to install pollution-control equipment, perform site clean-ups and pay fines or make other payments for discharges or other breaches of environmental standards. Our operations could also expose us to civil claims by third parties for alleged liability resulting from contamination of the environment or personal injuries caused by release of hazardous substances. The expenditures associated with environmental pollution can be substantial. For example, at the Varandey site, operated by OOO Narianmarneftegaz (NMNG), our joint venture with ConocoPhillips, we reinject well produced water into the water producing formation at the oil field. As a result of an attempt by the Federal Natural Utilisation Control Service (Rosprirodnadzor) to reinterpret existing laws, we may face the risk of this activity being qualified as contamination of the site with waste water, which may lead to increased environmental fees in the future. In addition, we may be required to modify, curtail or cease certain activities which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Increasingly strict environmental requirements, including those relating to gasoline sulphur levels, diesel quality and the aromatic content of gasoline (including certain requirements that became effective in 2005 in the European Union), affect product specifications and operational practices. Our refineries will not, without significant modification and capital expenditures, be able to produce significant quantities of refined products that meet certain strict refined product specifications in some of our export markets, particularly those currently in effect or expected to take effect in the future in the European Union or the United States. In addition, with the admission of Bulgaria and Romania to the European Union on 1 January 2007, our refineries in these countries have become subject to stricter regulations relating to the quality of refined product production environmental protection. As a result, we have had to make substantial investments to upgrade our refineries to comply with such regulations, including those that relate to asbestos, which was present at both such refineries. Although our plans call for significant expenditures to continue to upgrade our refineries, we can give no assurance that we will have adequate resources to fulfil these plans. Failure to meet certain international standards at our refineries could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
In 1994, the 1992 United Nations' Framework Convention on Climate Change came into force in Russia and three years later led to the Kyoto Protocol, which requires nations to reduce their emissions of carbon dioxide and other greenhouse gases. In late 2004, Russia ratified the Kyoto Protocol and the protocol entered into force in February 2005 for all countries that had ratified it. The Ministry of Economic Development has developed a plan of action for the Russian government to implement the provisions of the Kyoto Protocol. The Ministry of Economic Development has issued certain regulations relating to the implementation of the provisions of the Kyoto Protocol within Russia. These regulations, among other things, include a target reduction in the total amount of greenhouse gas emissions of 300 million tonnes of CO2 equivalent for the period from 2008 to 2012 (including 205 million tonnes allocated to the energy sector). Other countries in which we operate have also ratified the Kyoto Protocol. Any changes in environmental legislation under the Kyoto Protocol or otherwise may require, among other things, reductions in emissions to the air from our operations and could result in increased capital expenditures which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Although the costs of the measures taken to comply with environmental regulations have not had a material adverse effect on our business, financial condition or results of operations to date, in the future, the costs of such measures and liabilities related to environmental damage that we cause may increase. Any such increased costs, or any requirements to modify our operations, could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Exploration for, the production of, and the transportation of oil and natural gas is hazardous, and natural disasters, operator error or other occurrences can result in oil spills, gas leaks, loss of containment of hazardous materials, cratering, fires, equipment failure and loss of well control. Failure to manage these risks could result in injury or loss of life, damage or destruction of wells and production facilities pipelines and other property and damage to the environment. For example, in 2010, a major oil spill occurred offshore in the Gulf of Mexico at a site operated by BP.
All modes of transportation of hydrocarbons contain inherent risks. A loss of containment of hydrocarbons and other hazardous materials could occur during transportation by road, rail, sea or pipeline. Given the high volumes involved, this is a significant risk due to the potential impact of a release on the environment and people.
Offshore operations are subject to marine perils, including severe storms and other adverse weather conditions, vessel collisions, as well as interruptions or termination by governmental authorities based on environmental and other considerations. Losses and liabilities arising from such events could significantly reduce our revenues or increase our costs and have a material adverse effect on our operations or financial condition. Offshore operations may be subject to stringent governmental regulations, particularly in light of the recent offshore oil spill in the Gulf of Mexico.
We are exposed to risks regarding the safety and security of our operations. Inability to provide safe environments for our workforce and the public could lead to injuries or loss of life and could result in regulatory action, legal liability and damage to our reputation. Security threats require continuous oversight and control. A breach of security, such as an act of terrorism, against our plants and offices, pipelines, transportation or computer systems could severely disrupt businesses and operations and could cause harm to people.
Any such disasters, catastrophes or breaches could result in significant losses, which could materially adversely affect our business, financial condition, results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The information concerning the crude oil and gas reserves estimated by LUKOIL as of 31 December 2009 included in this prospectus has been prepared in accordance with the definitions contained in SEC Regulation S-X Rule 4-10(a) at that time and has been derived or extracted from the 31 December 2009 report of Miller and Lents. For further information on the standards used in preparing estimated crude oil and gas reserves, see "Presentation of Reserves and Resources".
Petroleum engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. Estimates of the value and quantity of economically recoverable oil and gas reserves, rates of production, future net revenues and the timing of development expenditures are based on existing economic and operating conditions using prices and costs as at the date the estimate is made. In addition, estimates necessarily depend upon a number of variable factors and assumptions, including the following:
Because all reserves estimates are subjective, each of the following items may differ materially from those assumed in estimating reserves:
Many of the factors, assumptions and variables involved in estimating reserves are beyond our control and may prove to be incorrect over time. This is especially true in relation to countries with political and economic uncertainty and instability, such as Russia and the other regions where we operate, including the CIS, the Middle East, West Africa and South America. Results of drilling, testing and production after the date of the estimates may require substantial upward or downward revisions in our reserves data. Furthermore, different reservoir engineers may make different estimates of reserves and cash flows based on the same available data. Actual production, revenues and expenditures with respect to reserves will vary from estimates and the variances may be material. Any downward adjustment could lead to lower future production and, thus, materially adversely affect our business, financial condition and results
of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The discounted and undiscounted pre-tax future net revenues included in this prospectus should not be considered as the market value of the reserves attributable to our properties. Our actual pre-tax future net revenues will be affected by factors such as:
Additionally, in estimating our proved oil and gas reserves we have assumed that the production licences for our Russian fields would be renewed and the fields would be produced until the economic limit of production is reached. If any production licences for our Russian fields are not renewed, our estimated oil and gas reserves may materially decrease.
We and our principal shareholders have engaged in transactions with affiliated parties and may continue to do so. For example, we have engaged in transactions with certain of our directors and executive officers and companies that they control, including equity purchases and sales, supply contracts, insurance services (prior to 2009) and loan and financing arrangements. We may have conflicts of interest in transactions between us and our affiliates that may result in the conclusion of transactions on terms not determined by market forces. See "Additional Information Regarding the Company – Certain Interested Party Transactions and Relationships" for more information about certain transactions between our directors or executive officers and us.
We have expanded our operations significantly through acquisitions since being privatised in 1993, both in Russia and internationally, and we expect to continue to do so in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Changes in the Group Structure, Acquisitions and Disposals of Assets" for a discussion of our recent acquisitions. The integration of these recently acquired businesses, and of businesses we may acquire in the future, requires significant time and effort of our senior management, who are also responsible for managing our existing operations. Integration of new businesses can be difficult, as our culture may differ from the cultures of the businesses we acquire, unpopular cost cutting measures may be required and control over cash flows and expenditures may be difficult to establish. While we have generally been satisfied with the progress we have made in integrating the businesses we have acquired thus far, we can give no assurance that ongoing or future integrations of acquired businesses will be successful.
In 1997, we signed a contract for a 68.5% interest in a production sharing agreement (PSA) relating to the development of the second stage of the West Qurna-2 oil field in Iraq (West Qurna-2). The PSA required the parties to make a total investment of at least \$6 billion on a pro rata basis. As a result of the political situation in Iraq, we delayed our performance of certain obligations under the agreement. In December 2002, the former government of Iraq purported to terminate the PSA. Following the military campaign in Iraq in 2003, the provisional Iraqi administration expressed a desire to honour its obligations under the PSA. However, statements to the media made by Iraqi officials in 2008 indicated that the current Iraqi administration viewed the PSA as having been terminated. In December 2009, we won the tender to develop the West Qurna-2 field as part of a consortium with Statoil. In January 2010, we entered into a development and production agreement with two of Iraq's state-owned companies (North Oil Company and South Oil Company) and Statoil, which was ratified by the Iraqi Cabinet of Ministers. The agreement has a term of twenty years with the possibility of extension for another 5 years. Although we were successful in our bid for rights to develop the West Qurna-2 field, we cannot be sure that government intervention or other factors will not keep us from successfully pursuing the development of the West Qurna-2 field.
Our growth and future success depend in significant part upon the continued contributions of a number of our key senior management and personnel, in particular our President and a member of our Board of Directors, Vagit Yusufovich Alekperov. We can give no assurance that his services or the services of other key persons will continue to be available to us, and the loss of any one of them could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
There is a growing global shortage of workers in the oil and gas industry which has caused foreign companies to look to the Russian labour market for employees. A shortage in the supply of labourers in Russia could cause an increase in salaries which could result in an increase in our labour costs. We may also be forced to modernise production in order to reduce our dependence on our labour force. These and other risks associated with labour shortages in the oil and gas industry could have a material adverse effect on our business, financial condition and results of operations and, therefore, would affect the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Russian antimonopoly legislation prohibits anti-competitive behaviour, including abuse of a dominant position. This legislation is sometimes vague and subject to varying interpretations. Developments in the Russian antimonopoly law are trending towards stronger state control over the market participants.
In July 2009, the Federal Law "On Protection of Competition" was amended to grant the FAS additional powers to regulate the commercial activities of market participants, simplify the procedure of proving a breach of the antimonopoly legislation, increase the penalties for anticompetitive activities and introduce new elements to the relevant offences. In particular, the FAS' powers were expanded with respect to the right to issue an order to sell a certain amount of products at the commodity exchange, the requirements to obtain prior approval by the FAS of the starting price for the products and the procedure for calculation of such price when the products are sold on the commodity exchange. These new powers may adversely affect the volume of supplies to our own refineries and impair our relationship with our customers. In particular, there is a possibility that while approving the starting prices, the relevant authorities will decrease the prices for our products. Administrative sanctions may be imposed on us if the FAS concludes that our business was conducted in contravention of antimonopoly legislation. Any use by the FAS of such powers on our Group could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the
notes and LUKOIL's ability to meet its obligations under the guarantee. See "Additional Information Regarding the Company – Litigation and Claims" for information about proceedings by the FAS against us.
Court practice relating to contesting decisions of the FAS, in particular in cases regarding abuse of dominant position by setting excessively high prices and taking concerted actions with other market participants, lacks consistency. Because of the absence of explicit criteria for valuation of entities' financial and commercial operations and the lack of consistency in court practice, it is difficult to predict the outcome of cases contesting decisions adopted by the FAS and the penalties it imposes.
In October 2009, an amendment to Article 178 of the Criminal Code of the Russian Federation entered into force which clarified and expanded the elements of offence for economic crimes, and increased sanctions for misconduct in the form of larger financial penalties, a prohibition on holding certain offices or conducting certain activities and imprisonment. The application of such penalties for breach of antimonopoly legislation could impair our officers and managers ability to manage our operations and, as a result, have a material adverse effect on our business, financial condition and results of operations.
In 2009, pursuant to a request of the Chairman of the Government of the Russian Federation and in accordance with the Decree of the Government of the Russian Federation establishing the Key Focus Areas for the Government of the Russian Federation to 2012, the programme entitled Competition Promotion Programme for the Russian Federation (the Programme) was developed. The first section of the Programme describes the key directions for promoting competition in the market for oil products. The Programme contains a list of steps to promote competition, one of which is to split up different types of operations within vertically integrated oil companies (VIOC) between different legal entities within one and the same VIOC to create, based on the competitive relations between the supplier and the buyer (including between VIOCs), additional turnover of oil products within the wholesale and retail markets. Based on the Programme, in May 2010, the Russian Ministry of Economic Development approved a plan for the promotion of competition in the oil products markets, pursuant to which it is proposed to split-up the wholesale and retail operations within a VIOC to ensure nondiscriminatory access to oil and oil products transportation and storage infrastructure.
We believe that orders to split up the operations within a VIOC may be used against companies which are found to have violated antimonopoly legislation and which have a dominant position. In such case, the courts would be authorised either to decide to split up the operations of such companies or spin-off one or several companies which may not be part of the same group of persons according to the law. Any application by the FAS of any such measures to our Group could materially adversely affect our acquisition strategy and, more generally, our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Our business has grown substantially through the acquisition of shares (equity interests) or assets or creation of companies, many of which required the prior consent or subsequent notification of the FAS or any of its predecessor agencies. Russian antimonopoly legislation restricts the acquisition or creation of companies by groups of companies or individuals acting in concert without this approval or notification. The legislation is sometimes vague and subject to varying interpretations. If the FAS was to conclude that our acquisition of shares or assets or creation of a new company contravened applicable legislation, they could impose administrative sanctions on us and they could file a claim seeking liquidation or reorganisation by spin-off or separation of any such subsidiary or invalidation of the transactions related to such shares (equity interests) or assets, materially adversely affecting our acquisition strategy and, more generally, our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
As is the case with all Russian oil companies, we sell a portion of our crude oil and refined products in the Russian market, where prices have historically been lower than in the international market. Our domestic crude oil sales are small compared to our international crude oil sales. In the past, domestic Russian crude oil prices were set by the Russian government at levels substantially below those of world market prices. The Russian government ceased to regulate domestic prices for crude oil in early 1995. Domestic prices have remained below world levels due in part to export duties and transportation costs, although developments in export channels of
the Transneft pipeline system and other export infrastructure have had the effect of exerting upward pressure on domestic prices, in part because they reduce the supply available to the Russian market. In recent years, the prices we achieved for our domestic crude oil sales were close to, or sometimes even higher than, our export netback prices, which are the prices we achieved for exports, minus export duties and transportation costs.
While prices in Russia for refined products are generally determined by the market, occasionally they may still be subject to government control. Furthermore, Russian oil companies may, from time to time, be subject to political pressure to reduce domestic refined product prices. Accordingly, we can give no assurance that governmental price controls will not be implemented or increased for political or other reasons. Any resulting increase in the disparity between Russian and international market prices for refined products could have a material adverse effect on our business, financial condition and results of operations.
The crude oil that we transport through the Transneft pipeline network is blended with crude oil of other producers that may differ in quality. Our sales of crude oil that we transport through the Transneft system are of the crude oil blend that results from the combination of different types and qualities of crude oil in the system, which is usually referred to as "Urals blend" crude oil. Therefore, the price we get for our oil may be lower than the price that we could get for oil of the same quality if we could transport our oil independently of Transneft. Any decrease in the quality of the crude oil blend transported through Transneft could reduce the marketability of the oil we produce and, thereby, materially adversely affect our business, financial conditions and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
We depend upon our management information systems, including our Industrial Safety Management System and our Environmental Safety Management System, to conduct our operations. We are also in the process of introducing new solutions to support our exploration and development activities and standardising and rationalising the accounting systems used at our subsidiaries. Implementation of any major new systems and enhancements to existing systems could cause disruptions in our operations. If the implementation of our new management information systems is delayed or the systems fail to perform as anticipated, we could experience difficulties in conducting our operations or generating necessary financial and accounting information. Any of these or other systems-related problems could, in turn, adversely affect our financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Notwithstanding the risk described above, in the event that we experience difficulties in generating financial and accounting information using our management information systems, we believe that we have alternative information technology and personnel capabilities to meet our obligations as a listed company. As a result, we believe that our financial systems are sufficient to ensure compliance with the requirements of the UK Listing Authority's Disclosure and Transparency Rules as a listed entity.
We are involved in a number of legal proceedings. Although we do not currently expect a material adverse effect on our financial condition and results of operations because of any proceedings currently known to us, we can give no assurance that we will not incur material losses in connection with any such legal proceedings. Such losses are difficult to predict because of: (i) uncertainty regarding the outcome of the various proceedings; (ii) the occurrence of new developments that we could not take into consideration when evaluating the likely outcome of each proceeding in order to accrue the risk provisions as at the date of the latest financial statements; (iii) the emergence of new evidence and information; and (iv) errors in the estimate of probable future losses. Losses associated with legal proceedings could materially adversely affect our business, financial condition and results of operations. For information about certain pending legal proceedings that may have, or have had in the recent past, a significant effect on our financial position or profitability, see "Additional Information Regarding the Company – Litigation and Claims".
As a result of general economic conditions in the countries in which we operate and those in which we currently make, or may in the future make, sales, and in particular as a result of the economic slowdown, the tax legislation in these countries may be changed in order to increase tax revenues. A material change in the tax legislation in any of the jurisdictions in which we operate or those in which we currently make, or may in the future make, sales could have a material adverse effect on our business, financial condition and results of operations.
Fuel produced at our refineries currently meets Russian domestic quality standards. Investment plans for our refineries anticipate progressive tightening of domestic fuel standards, ultimately bringing them in line with European standards. However, a risk remains that the Russian government may accelerate the introduction of standards for cleaner fuels or that the changes, when introduced, may vary from our current expectations. We intend to work closely with the relevant federal and local authorities to understand the timing for the changes in fuel quality standards. If these changes, when introduced, vary significantly from our current expectations, they could force us to incur further capital expenditures to upgrade our refineries and could limit our fuel supply to the domestic market until refinery technical upgrades are completed. See "Business – Refining, Marketing and Distribution – Refining".
We only have limited, and potentially an insufficient level of, insurance coverage for potential losses or liabilities that may arise in connection with our business, including property damage, work-related accidents and occupational disease, natural disasters and environmental contamination. Accordingly, losses or liabilities arising from such events could increase our costs, which could have a material adverse effect on our business, financial condition and results of operations.
Investors should exercise particular care in evaluating the risks involved and must decide for themselves whether, in light of those risks, their investment is appropriate. Generally, investment in emerging markets is only suitable for sophisticated investors who fully appreciate the significance of the risks involved, and investors are urged to consult with their own legal, financial and tax advisors before making an investment in the notes.
Investors in emerging markets, such as Russia, should be aware that these markets are subject to greater risk than more developed markets, including in some cases significant political, legal and economic risks. Emerging economies such as the Russian economy are subject to rapid change and the information set out in this prospectus may become outdated relatively quickly. Moreover, financial turmoil in any emerging market country tends to adversely affect prices in debt and equity markets of other emerging market countries, as investors move their money to more stable, developed markets. Financial problems or an increase in the perceived risks associated with investing in emerging economies could dampen foreign investment in Russia and adversely affect the Russian economy. In addition, during such times, companies that operate in emerging markets can face severe liquidity constraints as foreign funding sources are withdrawn. Adverse economic developments of the kind described above may affect our business in a number of ways. As a result, demand for our products may decline, which would materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
As at 31 December 2009, approximately 5% of our proved crude oil reserves were located outside Russia. Currently, our principal international upstream interests are in two countries bordering the Caspian Sea: Kazakhstan and Uzbekistan. We also have upstream interests in Azerbaijan, Colombia, Egypt, Saudi Arabia, Venezuela, Ghana and Cote d'lvoire. As at 31 December 2009, approximately 30% of our proved gas reserves were located outside of Russia, in Kazakhstan, Uzbekistan and Azerbaijan. In addition, we have refining operations in Ukraine, Bulgaria and Romania.
See "– Risks Relating to Our Business – We may not be able to realise opportunities in Iraq" and "Business – Exploration and Production – International Exploration and Production – Iraq – West Qurna- 2" for information on our rights in relation to the West Qurna-2 oil field.
We are exposed to significant political, economic and legal risks in some of these countries. There has been war and civil strife in and around the Middle East, the Caspian region and in Colombia and Cote d'lvoire for much of the past two decades. Moreover, since the dissolution of the Soviet Union, the international legal status of the Caspian Sea has remained uncertain and is currently the subject of international negotiations that could have a material adverse effect on our interests there. In addition, changes in subsoil use legislation, as well as in legislation affecting production sharing agreements in these regions, in particular in the event of its retroactive application, may affect the way we conduct our business in these areas.
The military conflict in August 2008 between Russia and Georgia, involving South Ossetia and Abkhazia, temporarily obstructed our ability to transport natural gas we produced in Azerbaijan through the Southern Caucasus Pipeline and resulted in criticism of Russia by a number of Western European countries and countries in North America, which were considering political and economic sanctions and other actions against Russia. Any additional tensions in the region could negatively affect the Russian economy, which could have a material adverse effect on our business and therefore, on the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The process of transition into the European Union by countries in which we operate carries significant risks associated with changes in legislation and changes in trade relations between Russia and these countries. There is a risk that our operating expenses will increase due to higher minimum wages, stricter environmental standards and other European Union requirements. If any of these risks were to materialise it could have a material adverse effect on our business, financial condition and results of operations and, therefore, on the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee. See "– Risks Relating to Our Business – We may incur material costs to comply with, or as a result of, health, safety and environmental laws and regulations" for more information on risks associated with legislation of the European Union.
We focus on the selection of reliable partners for our business in terms of their ability to pay in a timely manner for the products purchased from us and perform their obligations in strict compliance with our existing agreements. However, our business is exposed to the risk that the amounts owed by our customers for products sold or services rendered will not be paid when due, and that some of them may not be able to perform timely and fully their obligations. In such cases we seek to resolve any disputes and recover amounts owed to us in conformity with the laws of the jurisdictions where we operate and with established business practices. We note, however, that in the markets of developed countries it is less cumbersome to settle such disputes as compared to emerging markets, due to better developed laws and the financial services market. In developed markets corporate debts are a financial asset which may be used as security, pledged, sold and purchased; therefore, such debts have high liquidity. In emerging markets this practice is not as developed and the recovery of overdue debts is a lengthy process. As a result of longer periods which we may need to recover overdue debts from our customers in emerging markets we may need substantial financial resources to maintain the financial stability of a number of our subsidiaries, which may adversely affect our business, financial condition and results of operations.
We are a Russian company and substantially all of our fixed assets are located in, and a significant portion of our revenues are derived from, Russia. There are certain risks associated with an investment in Russia.
We are subject to a broad range of taxes imposed at the federal, regional and local levels, which include, among others, corporate income tax, mineral extraction tax, value added tax, excise duty, export duty, compulsory insurance payments and corporate assets tax, and we are one of the largest sources of tax revenue to the federal authorities and to the regional and local authorities in those regions and localities in which we operate.
The taxation system in Russia is subject to frequent changes and inconsistent enforcement at the federal, regional and local levels. Until the adoption of the Tax Code of the Russian Federation (the Tax Code) the system of tax collection in Russia was relatively ineffective, resulting in the continual imposition of new taxes in an attempt to raise state revenues. The existing Russian tax laws, such as the Tax Code, have been in force for a short period of time as compared to tax laws in more developed market economies, and the implementation of these tax laws is often unclear or inconsistent. In practice, Russian tax authorities generally interpret the tax laws in ways that do not favour taxpayers, who often have to resort to court proceedings to defend their position against the tax authorities. During the past several years, the tax authorities have shown a tendency to take more assertive positions in their interpretation of tax legislation, which has led to an increased number of material tax assessments issued by them as a result of tax audits of companies operating in various industries, including the oil industry. In some instances the Russian tax authorities have applied new interpretations of tax laws retroactively. In addition, the Russian Federation may introduce changes into tax legislation that may adversely affect our business, including certain changes aimed at maximising state budget income received from the raw materials sector of our industry.
Generally, tax declarations are subject to inspection by tax and/or customs authorities for three calendar years immediately preceding the year in which the decision to conduct an audit is taken. However, the fact that a particular year has been reviewed by tax authorities does not preclude that year from further review or audit during the eligible three-year period by a superior tax authority. The Tax Code provides for the possible extension of the three-year limitation period if the actions of the taxpayer created insurmountable obstacles for the tax audit. As the terms "obstructed", "hindered" and "insurmountable obstacles" are not specifically defined in Russian tax legislation, the tax authorities may attempt to interpret them broadly, effectively linking any difficulty experienced in the course of their tax audit with obstruction by the taxpayer, and use that as a basis to seek tax adjustments and penalties beyond the three-year period. The statute of limitation is not therefore entirely effective with respect to liability for tax in Russia. Such inspection, if it concluded that we had significant tax underpayments relating to such periods, may have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The Group implemented tax planning and management strategies based on existing legislation at the time of implementation.
We are subject to periodic tax audits that may result in tax assessments and additional amounts owed by us for prior tax periods. At times, tax authorities have attempted to impose additional significant taxes on the Group. In 2009, Group companies which were subject to tax inspections faced tax claims for an aggregate amount in excess of RUR4 billion, 99% of which were disputed and 98% of which were resolved in our favour through pre-judicial and judicial challenges. We do not believe that any further claims from Russian tax authorities resulting from investigations of our activities could materially adversely affect our business, financial condition or results of operations. However, we can give no assurance that such authorities will not bring any substantial claims as a result of their investigations.
On 12 October 2006, the Plenum of the Supreme Arbitration Court of the Russian Federation issued Ruling No. 53 formulating the concept of "unjustified tax benefit", which is described in the Ruling by reference to circumstances, such as absence of business purpose or transactions where the form does not match the substance, and which could lead to the disallowance of tax benefits resulting from the transaction or the re-characterisation of the status of the transactions for tax purposes. Although the intention of this Ruling was to combat abuse of tax law, in practice the tax authorities may seek broad application of the Supreme Arbitration Court's principles to contest the correctness of a taxpayer's tax assessment. Based on cases brought to courts to date relating to this ruling, the tax authorities have started applying the "unjustified tax benefit" concept in a broader sense than may have been intended by the Supreme Arbitration Court. To date, in the majority of cases where this concept has been applied, the courts have ruled in favour of taxpayers, but it is too early to determine whether the courts will follow these precedents in the future.
Russian transfer pricing legislation allows Russian tax authorities to make transfer pricing adjustments and impose additional tax liabilities in respect of all "controlled" transactions (except for those conducted at state regulated prices and tariffs), provided that the transaction price differs from the market price upwards or downwards by more than 20%. "Controlled" transactions include transactions with related parties, barter transactions, foreign trade transactions and transactions with unrelated parties with significant price fluctuations (i.e., if the price of such transactions differs from the prices of similar transactions by more than 20% within a short period of time). Special transfer pricing rules apply to securities transactions and derivatives.
It is not always possible to determine market prices for crude oil in Russia, mainly due to the significant intragroup turnover of the vertically integrated oil companies that dominate the market. Substantially all crude oil produced in Russia is produced by vertically integrated oil companies, such as ours. As a result, most transactions are conducted between affiliated entities within vertically integrated groups. Thus, there is no concept of a benchmark domestic market price for crude oil in Russia. The price of crude oil that is produced, but not refined or exported by one of the vertically integrated oil companies, is generally determined on a transaction-by-transaction basis against the background of world market prices, but with no direct reference or correlation. At any time, there may be significant price differences between regions for similar quality crude oil as a result of the competitive and economic conditions in those regions. Due to the uncertainties in the interpretation of transfer pricing legislation, the tax authorities may take a view as to what constitutes an appropriate market price that differs from LUKOIL's view. As a result, the tax authorities may challenge LUKOIL's prices in such transactions and propose adjustments. If such price adjustments are implemented, our business, financial condition or results of operations could be materially adversely affected. In addition, we could face significant losses associated with the assessed amount of prior underpaid tax and related interest and penalties, which could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
A new draft law radically amending the transfer pricing legislation was approved by the Russian parliament in the first reading on 19 February 2010 with the second and third readings scheduled for the autumn session of 2010 by the State Duma of the Russian Federation. At this point it cannot be predicted with absolute certainty when these amendments will be enacted, if at all, and what effect they may have on taxpayers, including the Group.
It should also be noted that Russian tax law does not provide for a possibility of group relief or fiscal unity. Consequently, tax losses of a Russian legal entity within the Group may not be surrendered to reduce the tax liability of any other Russian legal entity within the Group.
In May 2009, the Russian President included in his Budget Message regarding the Budget Policy for 2010-2012 the proposal for legislative changes to the anti-avoidance mechanism with respect to double tax treaty benefits in cases where the ultimate beneficiaries of income do not reside in the relevant tax treaty jurisdictions. As a result, a law envisaging the introduction of the concept of an "actual recipient of income" to the Tax Code has been drafted. Although the draft law neither uses the term "beneficial owner" nor defines the term "actual recipient of income" (which is used in Russian official versions of all double taxation treaties), it is likely that the intent of the proposed amendments is to introduce a concept of beneficial ownership in the domestic tax legislation, and to combat the abuse of double taxation treaties where the beneficiaries of income reside in jurisdictions that do not have double taxation treaties with Russia. The draft law, if enacted in its current form, would add to the existing uncertainty and instability in the application of double tax treaties in Russia. It is currently uncertain if and when the draft law may be introduced, if it is ever introduced, how it will be interpreted and applied by the tax authorities and/or courts in practice and what effect it may have on taxpayers, including the Group.
The Group operates in various jurisdictions and includes companies incorporated outside of Russia. Russian tax law does not provide for detailed rules on taxation of foreign companies in Russia. It is possible that with the evolution of these rules or changes in the approach of the Russian tax authorities to their interpretation and application, the Group might be subject to additional taxation in Russia.
All of the factors described above create tax risks in Russia that are more significant than those typically found in jurisdictions with more developed tax systems. It imposes additional burden and costs on our operations, including management resources, and complicates our tax planning and related business decisions, potentially exposing us to significant fines and penalties and enforcement measures despite our best efforts at compliance with tax legislation.
The occurrence of any of the events set out above could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The Russian government has made statements suggesting it may pursue policies aimed at leveling export duties for dark and light petroleum products, and there is a draft law to this effect being discussed in the Russian parliament. Government officials have indicated that such policies, if adopted, will seek to boost the modernization of the national oil refining sector and to increase the refining depth in Russia. The government
proposes to level the duties gradually and start the process in 2011. Up to now, no final decision has been made, and the initiative's chances for success are unclear. We have prioritized the modernisation of our refineries, and we have undertaken large-scale operations to raise the complexity and refinery depth at other refineries. However, even in light of the unclear perspective of this governmental action and the absence of tools to implement it, given the current product mix of our refineries, this proposed legislative initiative may, if approved, adversely affect our business, financial performance and results of operations.
Since the dissolution of the Soviet Union, the Russian economy has been subject to abrupt downturns and has experienced at various times:
The Russian economy has been adversely affected by the global financial turmoil, which began in the third quarter of 2008. The Russian economy has recently been characterised by extreme volatility in debt and equity markets, reductions in foreign investment and sharp decreases in GDP. In late 2008, the Russian government announced plans to make available more than \$200 billion in emergency financial assistance measures in order to ease taxes, refinance foreign debt and encourage lending.
In the year ended 31 December 2009, according to Rosstat, the Russian Federation's real GDP contracted by 7.9% as compared to growth of 5.6% and 8.1% in 2008 and 2007, respectively. According to the CBR, Russian Federation's foreign currency reserves fell from a peak of \$598.10 billion in August 2008 to \$383.7 billion in May 2009, although they recovered to \$475.3 billion by August 2010. Rosstat's figures for 2009 also show industrial production and exports declining by 9.3% and 35.7%, respectively, and unemployment increasing by 48.9%.
During the first quarter of 2010, according to Rosstat, industrial production grew by 5.8% as compared to the same period in 2009. According to Rosstat, exports in the first quarter of 2010 increased by 61.6%, compared to the same period in 2009. The Russian Ministry of Economic Development estimates that the Russian Federation's real GDP will grow by not less than 4% in 2010.
In February 2009, in large part due to the impact of the global financial and economic crisis on the Russian economy, Fitch downgraded its long term sovereign rating for the Russian Federation from "BBB+" to "BBB" and downgraded Russia's country ceiling rating to "BBB+" from "A". In January 2010, Fitch raised the Russian Federation's ratings outlook to "stable" from "negative". In September 2010, Fitch raised the Russian Federation's ratings outlook to "positive" from "stable". In December 2008, Standard & Poor's Rating Services, a division of McGraw Hill Companies Inc. (Standard & Poor's) downgraded its foreign currency sovereign credit rating on the Russian Federation from "BBB+/A 2" to "BBB/A 3", stating that the downgrade of the ratings of the Russian Federation reflects risks associated with the sharp reversal in external portfolio and other investment flows, which increased the cost and difficulty of meeting the country's external financing needs. Any further deterioration or the continuation of the current economic situation in Russia and the markets in which we operate could have a material adverse effect on our business, financial condition and results of operations and, therefore, our ability to meet our obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
As Russia produces and exports large quantities of crude oil and natural gas, the Russian economy is particularly vulnerable to fluctuations in the prices of crude oil and natural gas on the world market, which reached record high levels in the first six months of 2008 and significantly decreased during the last six months of 2008. Since then the prices have stabilised. During the global financial and economic crisis, there were periodic suspensions of trading on the Russian stock market, extreme volatility in the Russian securities markets and sharp fluctuations in the share prices of Russian financial institutions. As of October 2008, the RTS stock index had declined by over 70% from its highest levels reached in May 2008 and the IFX-Cbonds bond index had declined by approximately 13.8% from its highest levels reached in June 2008. However, by the end of July 2010, the RTS stock index and the IFX-Cbonds bond index had recovered by 200.4% and 47.0%, respectively, from their lowest levels. Deterioration of, or the continued instability in, the Russian economy could adversely affect our revenues derived in Russia and inhibit our ability to obtain financing and could materially adversely affect our business, financial condition and results of operations.
Since 1991, Russia has sought to transform itself from a one-party state with a centrally planned economy to a pluralist democracy with a market-oriented economy. The Russian political system remains vulnerable to popular dissatisfaction, including dissatisfaction with the results of privatisations in the 1990s, and to demands for autonomy from particular regional and ethnic groups. The course of political, economic and other reforms has in some respects been uneven, and the composition of the Russian government, including the prime minister and the other heads of federal ministries, has at times been unstable. For example, six different prime ministers headed governments between March 1998 and May 2000.
Vladimir Putin was elected President of Russia in March 2000. Since that time, Russia has generally experienced a higher degree of governmental stability. On 2 March 2008, Dmitry Medvedev was elected President of Russia and appointed Mr. Putin as Prime Minister shortly thereafter.
Future presidential elections, changes in government, the creation, abolishment or reform of government bodies regulating the oil and gas industry, major policy shifts or a lack of consensus between the president, the government, Russia's parliament and powerful economic groups could lead to political instability, which could have a material adverse effect on the value of investment in Russia generally and the notes in particular.
Russia is a federation comprising various sub-federal political units, some of which have the right to manage their internal affairs pursuant to agreements with the federal government and in accordance with applicable laws. In practice, the division of authority between federal and regional governmental authorities remains uncertain and contested. This uncertainty could hinder our long-term planning efforts and may create uncertainties in our operating environment, which may prevent us from effectively carrying out our business strategy.
In addition, ethnic, religious, historical and other divisions have, on occasion, given rise to tensions and, in certain cases, military conflict, such as the conflict in Chechnya. The military conflict in Chechnya has brought normal economic activity within Chechnya to a halt and disrupted the economies of neighbouring regions. Various armed groups in Chechnya have engaged in attacks in that area. Violence and attacks relating to this conflict have also spread to other parts of Russia, including terrorist attacks in Moscow, most recently in March 2010. The further intensification of violence, including terrorist attacks and suicide bombings, or its continued spread to other parts of Russia, could have significant political consequences, including the imposition of a state of emergency in some or all of Russia. Moreover, any terrorist attacks and the resulting heightened security measures may cause disruptions to domestic commerce and exports from Russia, and could materially adversely affect our business, financial condition, results of operations and the value of investments in Russia, such as the notes.
Russia's banking and other financial systems are less well developed or regulated compared to those in developed countries, and Russian legislation relating to banks and bank accounts is subject to varying interpretations and inconsistent applications. Many Russian banks do not meet international banking standards, and the transparency of the Russian banking sector still does not meet internationally accepted norms.
The CBR's supervisory/control mechanisms may be in certain cases insufficient to timely identify noncompliance with banking legislation.
The deficiencies in the Russian banking sector, combined with the deterioration of Russian banks' credit portfolios' condition, may result in the banking sector being more susceptible to the current worldwide macroeconomic situation. The credit crisis that began in the United States in the autumn of 2008 resulted in decreased liquidity in the Russian credit market and weakened the Russian financial system. Starting from the fourth quarter of 2008, a majority of the Russian banks experienced difficulties with funding on domestic and international markets and interest rates increased significantly. Credit ratings of several banks were lowered. The lack of liquidity and economic slowdown raised the possibility of Russian corporate defaults. Since then much of the liquidity has been restored to the Russian credit market. However, a prolonged or serious banking crisis or the bankruptcy of a number of banks, including banks in which we receive or hold our funds, could materially adversely affect our business and our ability to complete banking transactions in Russia.
The Russian economy has been characterised by high rates of inflation. Inflation in Russia was 9.0% in 2006, increased to 11.9% in 2007 and 13.3% in 2008, declined to 8.8% in 2009, and was 4.4% as of 30 June 2010. In the beginning of 2010, it was forecasted by the International Monetary Fund to be 9.9% by the end of 2010. The forecast was further adjusted in August 2010 to be 6.0% by the end of 2010. Certain of our costs, such as salaries, are sensitive to increases in the general price level in Russia. Most of our revenues are either denominated in U.S. dollars or are linked to the U.S. dollar and are affected primarily by the international price of oil. See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Main Factors Affecting Our Results of Operations – Changes in U.S. Dollar-Ruble Exchange Rate and Inflation" for more information regarding ruble inflation and movements in U.S. dollar/ruble exchange rates. Our operating margins could be materially adversely affected if the inflation of our ruble costs in Russia is not balanced by a corresponding devaluation of the ruble against the U.S. dollar or an increase in oil prices.
Because of the limited development of the foreign currency market in Russia, we may experience difficulty converting rubles into other currencies. Furthermore, the Russian government and the CBR may impose burdensome requirements governing currency operations, as it has done in the past. Additionally, any delay or other difficulty in converting rubles into a foreign currency to make a payment or any practical difficulty in the transfer of foreign currency could limit our ability to meet our payment and debt obligations, which could result in the acceleration of debt obligations and cross defaults. There are also only a limited number of available rubledenominated instruments in which we may invest our excess cash. Any balances maintained in rubles will give rise to losses if the ruble devalues against major foreign currencies. Moreover, these restrictions could prevent or delay any acquisition opportunities outside of Russia that we might wish to pursue.
In addition, restrictive currency regulations in foreign countries where we have assets could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Russia is still developing the legal framework required by a market economy. Several fundamental Russian laws have only recently become effective. The relatively recent nature of much of Russian legislation and the rapid evolution of the Russian legal system place the enforceability of laws in doubt and result in ambiguities and inconsistencies. In addition, Russian legislation often leaves substantial gaps in the regulatory infrastructure. Among the risks of the current Russian legal system are:
All of these weaknesses could affect our ability to enforce our rights under contracts, or to defend ourselves against claims by others. We can give no assurance that regulators, judicial authorities or third parties will not challenge our internal procedures and by-laws or our compliance with applicable laws, decrees and regulations.
Many Russian laws are structured in a way that provides for significant administrative discretion in application and enforcement. Reliable texts of laws and regulations at the regional and local levels may not be available and are subject to different and changing interpretations and administrative applications. Russian laws often provide general statements of principles rather than a specific guide to implementation and government officials may be delegated or exercise broad authority in determining matters of significance. Such authority may be exercised in an unpredictable way, and effective appeal processes may not be available. As a result of these factors, even the best efforts to comply with the laws may not always result in full compliance.
In addition, amendments to several Russian laws (including those relating to the tax regime, corporations and licensing) have only recently become effective. The recent nature of much of Russian legislation, the lack of consensus about the scope, content and pace of economic and political reform and the rapid evolution of the Russian legal system in ways that may not coincide with market developments may result in ambiguities, inconsistencies and anomalies, the enactment of laws and regulations without a clear constitutional or legislative basis and ultimately in investment risks that do not exist in countries with more developed legal systems. For example, although Russian bankruptcy laws establish a procedure for declaring an entity bankrupt and liquidating its assets, relatively few entities have been declared bankrupt in Russia, and many of the bankruptcy proceedings that have occurred have not been conducted in the best interests of creditors. All of these weaknesses could affect our ability to enforce our rights, or to defend ourselves against claims by others in respect of our Russian subsidiaries, and could affect enforcement of any rights of holders of the notes against the Issuer or LUKOIL. Furthermore, we can give no assurance that the development or implementation or application of legislation (including government resolutions or presidential decrees) will not adversely affect foreign investors (or private investors generally).
The independence of the judicial system and its immunity from economic, political and nationalistic influences in Russia remain largely untested. The court system is understaffed and underfunded. Judges and courts generally lack sufficient experience in the area of business and corporate law. Under Russian legislation, judicial precedents generally have no binding effect on subsequent decisions and are not recognised as a source of law. However, in practice, courts usually consider judicial precedents in their decisions. In addition, most court decisions are not readily available to the public. Enforcement of court judgments can in practice be very difficult in Russia. Additionally, court claims are often used in furtherance of political and commercial aims. We may be subject to such claims and may not be able to receive a fair hearing. Additionally, court judgments are not always enforced or followed by law enforcement agencies. All of these factors make judicial decisions in Russia difficult to predict and make effective redress uncertain.
These uncertainties also extend to property rights. During Russia's transformation from a centrally planned economy to a market economy, legislation was enacted to protect private property against expropriation and nationalisation. However, these protections may not be enforced in the event of an attempted expropriation or nationalisation. Expropriation or nationalisation of any of the members of the Group or their assets, potentially with little or no compensation, could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Russia is not a party to multilateral or bilateral treaties for the mutual enforcement of court judgments with most Western countries. Consequently, if a judgment is obtained from a court in any such jurisdiction, it is highly unlikely to be given direct effect in Russian courts. However, Russia (as a successor to the Soviet Union) is a party to the New York Convention. A foreign arbitral award obtained in a state which is a party to the New York Convention should be recognised and enforced by a Russian court (subject to the qualifications provided for in the New York Convention and in compliance with Russian civil and arbitration procedures and other procedures and requirements established by Russian legislation). The Arbitration Procedure Code of the Russian Federation is in conformity with the New York Convention and thus has not introduced any substantial changes relating to the grounds for refusing to recognise and enforce foreign arbitral awards and court judgments. In practice, reliance upon international treaties may meet with resistance or a lack of understanding on the part of Russian courts or other officials, thereby introducing delay and unpredictability into the process of enforcing any foreign judgment or any foreign arbitral award in Russia.
Governmental authorities in Russia have a high degree of discretion and at times exercise their discretion arbitrarily, without hearing or prior notice, and sometimes in a manner that is contrary to law or influenced by political or commercial considerations. Selective or arbitrary governmental actions have included unscheduled inspections by regulators, suspension or withdrawal of licences and permissions, unexpected tax audits, criminal prosecutions and civil actions. In addition, governmental authorities have also tried, in certain circumstances, by regulation or government act, to interfere with the performance of, nullify or terminate contracts. Furthermore, federal and local government entities have used common defects in matters surrounding the documentation of business activities as pretexts for court claims and other demands to invalidate such activities or to void transactions, often for political purposes.
In October 2006, an official at the Russian Ministry of Natural Resources threatened to revoke 36 of our licences for exploration in the Komi region of Timan-Pechora and in the Khanty-Mansiysky Autonomous Region-Yugra, alleging that we failed to explore or drill according to the timelines set out in the licences. We believe that we have addressed all of these alleged violations or we have agreed with the commission to amend the licensing agreements to enable our compliance with the terms of the licences. The same ministry official was responsible, in September 2006, for cancelling the ministry's 2003 environmental approval of Sakhalin-II, an LNG project in Russia's Far East run by a consortium including Royal Dutch Shell, Mitsui & Co. and Mitsubishi Corporation, due to alleged environmental breaches. See "Business – Health, Safety and Environment" for more information on the Sakhalin-II environmental breaches. In December 2006, each of the consortium members signed an agreement diluting their stakes in Sakhalin-II by 50% in order to accommodate a sale of a 50% plus one share controlling stake in the project to Gazprom for a purchase price of \$7.45 billion. Selective or arbitrary government action directed at us or preferential treatment by the Russian government of any of our competitors could have a material adverse effect on our business, financial condition and results of operations.
We could be materially adversely affected by the adoption of new laws or regulations restricting foreign participation in, or increasing state regulation of, the oil and gas industry in Russia. On 7 May 2008, a new law restricting the level of foreign investment in the form of acquisition of shares (interests) in the charter capital of entities having strategic importance for ensuring the defence and security of the state, and other transactions as a result of which foreign investors or a group of persons, of which a foreign investor is a member, gain control over such entities, came into force. Federal Law No. 57-FZ "On procedure for carrying out foreign investments into enterprises which have strategic importance for ensuring defence and security of the State", dated 29 April 2008 (the Law on Strategic Enterprises), places restrictions on foreign investors and/or groups of persons of which a foreign investor is a member, in connection with their participation in charter capitals of entities having strategic importance for ensuring defence and security of the state, and/or the transactions made by them resulting in the establishment of control over such entities. Such transactions may only be made having received prior approval in accordance with the Law on Strategic Enterprises. The activities having strategic importance for ensuring defence and security of the state, include, without limitation, geological exploration of subsoil and/or exploration and extraction of natural resources from subsoil areas of federal significance. Pursuant to the Law on Strategic Enterprises, any transaction involving acquisition by foreign investors of shares (interests) in an entity having strategic importance for ensuring defence and security of the state and operating at a subsoil area of federal significance, if such investors have the right to directly or indirectly dispose of ten or more percent of the total number of votes attaching to the voting shares (interests) in the charter capital of such entity, is subject to the prior approval of a governmental commission. The above-mentioned restriction on foreign investment may limit our ability to raise equity financing in foreign capital markets, consummate strategic transactions in the future and, therefore, may have a material adverse effect on our business, financial condition and results of operations and may affect the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Russia's physical infrastructure largely dates back to Soviet times and has not been adequately funded and maintained over the past two decades. Particularly affected are the road networks, power generation and transmission systems, communication systems and building stock. For example, in May 2005, a fire and explosion in one of the Moscow power substations built in 1963 caused a major outage in a large section of Moscow and some surrounding regions, which resulted in a suspension of half of the Moscow metro lines, leaving thousands of people blocked underground for a long time. The blackout also hit the ground electric transport, led to road traffic accidents and massive traffic congestion, disrupted electricity and water supply in office and residential buildings and affected mobile communications. The trading on exchanges and the operation of many banks, stores and markets were also halted.
In addition, road conditions throughout Russia are poor. The further deterioration of Russia's physical infrastructure could harm the national economy, disrupt the transportation of goods and supplies, add costs to doing business in Russia and may interrupt business operations. The government is actively considering plans to reorganise the nation's rail, electricity and telephone systems. Any such reorganisation may result in increased charges and tariffs. These factors could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Salaries in Russia have historically been significantly lower than salaries in the more economically developed countries of North America and Europe for similarly skilled employees, although they have increased significantly in recent years. If, after the Russian economy recovers, salaries in Russia begin to increase as rapidly as they were increasing in the years preceding the recent financial and economic crisis, our margins could be reduced. Unless we are able to continue to increase the efficiency and productivity of our employees in line with, or at a faster rate than, the rate of salary increases, salary increases could have a material adverse effect on our business, results of operations, financial condition and prospects.
The political and economic changes in Russia since the early 1990s have resulted in reduced policing of society and increased lawlessness. Organised criminal activity has increased significantly since the dissolution of the Soviet Union, particularly in large metropolitan centres. Property crime in large cities has also increased substantially. In addition, the Russian and international press have reported high levels of official corruption, including the bribing of officials for the purpose of initiating investigations by government agencies. There have been instances in which government officials have engaged in selective investigations and prosecutions to further interests of the government officials and certain individuals. The effects of organised or other crime, demands of corrupt officials or claims that we have been involved in corruption could result in negative publicity, could disrupt our ability to conduct our business effectively and could, thus, have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Increased unemployment resulting from weakening economic conditions in Russia, the failure of the government and many private enterprises to pay full salaries on a regular basis and the failure of salaries and benefits generally to keep pace with the rapidly increasing cost of living have led in the past, and could continue to lead in the future, to labour and social unrest. Labour and social unrest may have political, social and economic consequences, such as increased support for a renewal of centralised authority, increased nationalism (with restrictions on foreign involvement in the economy of Russia) and increased violence. Any of these consequences could restrict our operations and lead to the loss of revenue, materially adversely affecting our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Our business includes a number of privatised companies and our business strategy will likely involve the acquisition of additional privatised companies. Many privatisations are arguably deficient and, therefore, vulnerable to challenge because the relevant privatisation legislation is vague, inconsistent or in conflict with other legislation. In the event that the privatisation of any of our companies is successfully challenged, we could risk losing our ownership interest in that company or its assets, which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
In addition, under Russian law, transactions with shares may be invalidated on many grounds, including a sale of shares by a person without the right to dispose of such shares, breach of interested party or major transaction rules and failure to register the share transfer in the securities register. As a result, defects in earlier transactions with shares in our subsidiaries (where such shares were acquired from third parties) may raise questions as to the validity of our title to such shares.
The regulation and supervision of the securities market, financial intermediaries and issuers are considerably less developed in Russia than in the United States and Western Europe. Corporate and securities laws, including those relating to corporate governance, disclosure and reporting requirements, anti-fraud safeguards, insider trading restrictions and fiduciary duties are relatively new to Russia and are unfamiliar to most Russian companies and managers. In addition, the Russian securities market is regulated by several different authorities, which are often in competition with each other, including the Federal Service for the Financial Markets, the Ministry of Finance, the FAS, the CBR and various professional self-regulatory organisations. The regulations of these various authorities are not always co- ordinated and may be contradictory. In addition, Russian corporate and securities rules and regulations can change rapidly, which may adversely affect the Issuer's ability to conduct securities-related transactions. While some important areas are subject to virtually no oversight, the regulatory requirements imposed on Russian issuers in other areas result in delays in conducting securities offerings and in accessing the capital markets. It is often unclear whether, or how, regulations, decisions and letters issued by various regulatory authorities apply to us. As a result, we may be subject to fines or other enforcement measures, including delisting of our shares in Russia, despite our best efforts at compliance, which could cause our financial results to suffer and which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The Russian government has the authority to direct us to deliver crude oil or refined products to certain government-designated customers, which may take precedence over market sales. In addition, the Russian government has used, and may continue to use, various administrative and fiscal measures to ensure sufficient supplies of crude oil and refined products are made available to domestic customers. Government-directed deliveries may take several forms. We may be directed to make deliveries to government agencies, the military, railways, agricultural producers, remote regions, specific consumers or refineries or to domestic refineries in general. Requirements for the delivery of domestic crude oil and refined products, with or without a corresponding limitation or ban of export sales, could be used or extended if the domestic market starts experiencing a shortage of crude oil or refined products. In addition, some of our oil production licences require us to sell crude oil that we produce to local government agencies. We have in the past and may in the future be directed to make such deliveries. Our deliveries of refined products under government-directed programmes in 2007, 2008, 2009 and the first six months of 2010 were made at domestic market prices. However, no assurance can be given that the government will not require that we deliver our products to government-designated customers at below market prices. See "Business – Refining, Marketing and Distribution – Refined Products Sales – Domestic Refined Products Sales" for more information on government-directed deliveries.
Depending on the level of such required supplies, any government-directed deliveries may force us to curtail our export of crude oil or refined products, which have been generally made at higher prices than domestic sales. In addition, any government-directed deliveries may disrupt our relations with our customers and lead to delays in payments for crude oil and refined products. In addition, any failure to make government-directed deliveries may
affect our ability to export our crude oil. For example, the Russian government has previously threatened to limit the access of Russian oil companies to export pipelines for failing to provide domestic refineries with steady supplies of oil. An increase in the levels of government-directed deliveries, or a revocation of export rights, could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The general system of export quotas and licensing of exports was abolished in 1995. At present, quantitative restrictions on exports may be imposed only if required to comply with Russia's obligations under international treaties or for national security purposes. No such restrictions currently apply to the export of crude oil, natural gas or refined products, although for the first six months of 2002, the Russian government implemented limits on allowable export volumes in response to increasing pressure from OPEC to reduce the world's crude oil supply and maintain high commodity prices. However, the legislation may change, and quantitative restrictions on the existing or extended legal grounds may be reintroduced, if the current liberalisation policy of the Russian Government is reversed. Any such reintroduction of export quotas or an export licensing regime could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The Civil Code of the Russian Federation and the Federal Law No. 208-FZ "On Joint Stock Companies", dated 26 December 1995, as amended (the JSC Law) generally provide that shareholders in a Russian joint stock company are not liable for the obligations of the joint stock company and bear only the risk of operating loss to the extent of the value of their shareholding. This may not be the case, however, when one legal entity is capable of determining decisions made by another legal entity. The entity capable of determining such decisions is deemed a "parent". The person whose decisions are capable of being so determined is deemed a "subsidiary". Under the JSC Law, the parent bears joint and several responsibility for transactions concluded by the subsidiary in carrying out the parent's instructions if the right to issue binding instructions to the subsidiary is provided for in the charter of the subsidiary or in a contract with the subsidiary. In addition, a parent is secondarily liable for a subsidiary's debts if a subsidiary becomes insolvent or bankrupt due to the fault of a parent. This is the case no matter how the parent's ability to determine decisions of the subsidiary arises. For example, this liability could arise through ownership of voting securities or by contract. In these instances, other shareholders of the subsidiary may claim compensation by the parent of the loss caused to the subsidiary due to the fault of the parent, provided that the parent exercised its right and/or capability to cause the subsidiary to take action knowing that such action would result in losses to the subsidiary. Accordingly, we could be liable in some cases for the debts of our consolidated subsidiaries. This liability could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Russian law provides that shareholders that vote against or abstain from voting on certain matters have the right to require us to repurchase their shares at a price not less than the market value, as determined in accordance with Russian law. Decisions that trigger this put right include:
Our obligation to purchase shares in these circumstances, which is limited to 10% of our net assets calculated in accordance with Russian accounting standards at the time the matter at issue is voted upon, could have a material adverse effect on our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
We are required by Russian law and our charter to obtain the approval of disinterested directors or shareholders for certain transactions with "interested parties". Under Russian law, the definition of an "interested party" includes members of the board of directors and members of any management body of a company, the chief executive officer of the company, the managing company of the company (if any) and any shareholder that owns, together with that person's close relatives and affiliates, at least 20% of the company's voting shares or a person who has the right to give binding instructions to the company if any of the above listed persons, or a close relative or affiliate of such person, is:
Due to the technical requirements of Russian law, entities within our Group may be deemed to be "interested parties" with respect to certain transactions between them. The failure to obtain necessary approvals for transactions within our Group would prevent us from entering into such transactions, which could materially adversely affect our business, financial condition and results of operations.
In addition, the concept of "interested parties" is defined with reference to the concepts of "affiliated persons" and "group of persons" under Russian law, which are subject to many different interpretations. Moreover, the provisions of Russian law defining the transactions which must be approved as "interested party" transactions are subject to different interpretations. Although we have generally taken a reasonably conservative approach in applying these concepts, our application of these concepts may be subject to challenge. Any such challenge could result in the invalidation of transactions that are important to our business, which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Russian bankruptcy law differs considerably from comparable law in the United States and the United Kingdom and is subject to varying interpretations. The Federal Law No. 127-FZ "On Bankruptcy (insolvency)" came into effect in late 2002. There is little precedent to predict how claims of Noteholders against a Russian guarantor would be resolved in a bankruptcy of the guarantor. Weaknesses relating to the Russian legal system and Russian legislation create an uncertain environment for investment and business activity and thus could have a material adverse effect on an investment in the notes.
In addition, under Russian bankruptcy law, in case of LUKOIL's bankruptcy, its obligations as guarantor of the notes could be subordinated to the following obligations:
In the event of LUKOIL's bankruptcy, this legislation may materially adversely affect the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
Certain provisions of Russian law may allow a court to order liquidation of a Russian legal entity on the basis of its formal non-compliance with certain requirements during formation, reorganisation or during its operation. There have been cases in the past in which formal deficiencies in the establishment process of a Russian legal entity or non-compliance with provisions of Russian law have been used by Russian courts as a basis for liquidation of a legal entity. For example, in Russian corporate law, negative net assets calculated on the basis of Russian accounting standards as at the end of the second or any subsequent financial year of a company's operation, can serve as a basis for a court to order the liquidation of the company, upon a claim by governmental authorities (if no decision is taken to decrease the charter capital or liquidate the company). Many Russian companies have negative net assets due to very low historical asset values reflected on their Russian accounting standards balance sheets. However, their solvency (i.e., their ability to pay debts as they come due) is not otherwise adversely affected by such negative net assets.
Some of the companies in our Group currently have negative net assets. We are taking action to rectify this situation. In addition, although some of our subsidiaries may have failed from time to time to fully comply with all the applicable legal requirements, we believe that neither we, nor any of our subsidiaries, should be subject to liquidation on such grounds, and none of the possible violations has caused any damage to anyone or has had any other negative consequences. However, weaknesses in the Russian legal system create an uncertain legal environment, which makes the decisions of a Russian court or a governmental authority difficult, if not impossible, to predict. If involuntary liquidation were to occur, then we may be forced to reorganise the operations we currently conduct through the affected subsidiaries. Any such liquidation could lead to additional costs, which could materially adversely affect our business, financial condition and results of operations and, therefore, the Issuer's ability to meet its obligations under the notes and LUKOIL's ability to meet its obligations under the guarantee.
The notes have not been registered under the Securities Act or any U.S. state securities laws and, unless so registered, may not be offered or sold except in a transaction exempt from, or not subject to, the registration requirements of the Securities Act and applicable state securities laws. Although it is expected that the notes will be admitted to trading on the London Stock Exchange on or after the Closing Date, there may be little or no secondary market for the notes. Even if a secondary market for the notes develops, it may not provide significant liquidity and it is expected that transaction costs in any secondary market would be high. As a result, the difference between bid and ask prices for the notes in any secondary market could be substantial and the value of the notes could be affected.
The markets for emerging market debt have been subject to disruptions on account of the global financial crisis that have caused substantial volatility in the prices of securities similar to the notes. There can be no assurance that the market for the notes will not be subject to similar disruptions. Any such disruptions may have an adverse effect on holders of the notes.
Except in limited circumstances, the notes will be issued only in global form with interests therein held through the facilities of Euroclear, Clearstream, Luxembourg and/or DTC. Ownership of beneficial interests in the notes will be shown on, and the transfer of that ownership will be effected only through, records maintained by Euroclear, Clearstream, Luxembourg and/or DTC or their nominees and the records of their participants. The laws of some jurisdictions may require that certain purchasers of securities take physical delivery of such securities in definitive form. These laws may impair the ability to transfer beneficial interests in the notes. Because Euroclear, Clearstream, Luxembourg and/or DTC can only act on behalf of their participants, which in turn act on behalf of owners of beneficial interests held through such participants and certain banks, the ability of a person having a beneficial interest in a note to pledge or transfer such interest to persons or entities that do not participate in the Euroclear, Clearstream, Luxembourg and/or DTC systems may be impaired.
The notes are being offered and sold in the United States in reliance on Rule 144A (the Rule 144A Offering) to purchasers who are QIBs and also QPs. The notes also may be offered and sold outside the United States (the Regulation S Offering) in reliance on Regulation S. Each purchaser of notes pursuant to the Rule 144A Offering will be deemed to have represented to the Issuer that it is a QIB and a QP. Each purchaser of the notes pursuant to the Regulation S Offering will be deemed to have represented to the Issuer that it is not a U.S. person within
the meaning of Regulation S and is not acquiring notes for the account or benefit of any U.S. person. See "Transfer Restrictions".
The Issuer has the option to redeem the notes prior to their scheduled maturity dates in certain circumstances as described in Condition 7 of the Terms and Conditions of the Notes. Even if the Issuer does not exercise its option to redeem the notes, its ability to do so may adversely affect the value of the notes.
We have agreed in Condition 4 of the Terms and Conditions of the Notes not to, and to procure that no Subsidiary (as defined in the Terms and Conditions of the Notes) will, create or permit to subsist any Security Interest (as defined in the Terms and Conditions of the Notes) other than a Permitted Security Interest (as defined in the Terms and Conditions of the Notes) upon the whole or any part of its undertaking, property, assets or revenues, present or future, to secure for the benefit of the holders of any Relevant Indebtedness (as defined in the Terms and Conditions of the Notes) any payment in respect of or relating to any Relevant Indebtedness without procuring that the notes are secured equally and rateably with such Relevant Indebtedness to the satisfaction of the Trustee. The application of this negative pledge and the protection that it affords to holders of the notes, however, is limited. For example, the definition of Relevant Indebtedness is limited to our present or future Indebtedness in the form of, or represented by, notes, debentures, bonds or other securities (but, for the avoidance of doubt, excluding term loans, credit facilities, credit agreements and other similar facilities and evidence of indebtedness under such loans, facilities or agreements) which either are by their terms payable, or confer a right to payment, in any currency, and are for the time being, or ordinarily are, quoted, listed or ordinarily dealt in or traded on any stock exchange, over-the-counter or other securities market. In addition, pursuant to an exemption from the negative pledge, we will be permitted to secure an aggregate amount of Relevant Indebtedness not exceeding 20% of the value of Consolidated Assets (as defined in the Terms and Conditions of the Notes), without any obligation to afford any equal and ratable security to holders of the notes. As a result, we will be permitted to secure a range of other forms of Indebtedness (as defined in the Terms and Conditions of the Notes) and may also create security in respect of a significant amount of Relevant Indebtedness without, at the same time, being obliged to grant equal and ratable security in respect of the notes or the guarantee, as the case may be, which may adversely affect the value of your investment in the notes and/or cause you to rank in terms of priority behind such secured creditors.
The Issuer is an indirect wholly owned subsidiary of LUKOIL and will use the net proceeds from the issue of the notes for general corporate purposes, including the repayment of our indebtedness. For example, the Issuer has obligations under the \$500,000,000 6.356% notes due in 2017 and the \$500,000,000 6.656% notes due in 2022, which were both issued in June 2007, and the \$900,000,000 6.375% notes due in 2014 and the \$600,000,000 7.250% notes due in 2019, which were both issued in November 2009. The Issuer has insufficient net assets, other than amounts due to it from LUKOIL in respect of any inter-company loans, to meet its obligations to pay interest and other amounts payable in respect of the notes. The Issuer would, therefore, in the absence of other funding sources, have to rely on LUKOIL or another Group company putting it in funds to meet such obligations.
In general, payments under a guarantee made by a Russian entity to a Non-resident Noteholder-legal entity or organisation should not be subject to Russian withholding tax to the extent such payments do not represent Russian source income. Payments under the guarantee related to interest on the notes are likely to be characterised as Russian source income. Such payments should be subject to withholding tax in Russia at a rate of 20%, or such other rate as may be in force at the time of payment, in the event that a payment under the guarantee on the notes is made to a Non-resident Noteholder (as defined in "Taxation – The Russian Federation") that is a legal entity or organisation, in each case not organised under Russian laws and which holds the notes and receives payments under the guarantee otherwise than through a permanent establishment in Russia. There can be no assurance that such withholding tax would not be imposed on the full payment under the guarantee, including with respect to the principal amount of the notes. This tax may be reduced or eliminated pursuant to the terms of an applicable double tax treaty subject to compliance with the treaty clearance formalities. However, since the Noteholders are not the immediate recipients of payments under the guarantee, it could be difficult to apply tax treaty benefits in practice.
Payments under the guarantee to a Non-resident Noteholder that is an individual made by the guarantor may be subject to Russian tax as Russian-source income. In this case, depending on how these payments would be effected, either the full amount of payment, or a part of such payments covering the interest on the notes, would be subject to tax at a rate of 30%, or such other rate as may be in force at the time of payment, which may be withheld at the source or payable on a self-assessed basis. This tax may be subject to relief or reduced tax rate under the terms of an applicable double tax treaty. See "Taxation – The Russian Federation". However, given the uncertainties regarding the form and procedures for providing the documentary support, it is unlikely that Non-resident Noteholders that are individuals in practice would be able to obtain advance treaty relief, while obtaining a refund of the taxes withheld can be extremely difficult, if not impossible.
If any payment required under the guarantee is subject to withholding tax, we will be obliged to increase the amount payable under the guarantee by the amount of withholding tax (except in circumstances specified in Condition 7(b) of the Terms and Conditions of the Notes (Redemption for tax reasons). As a result, we could incur expenses well in excess of the amount due to the Noteholders. We cannot be certain that we would have sufficient funds to make any payment required under the guarantee or to pay the additional amounts associated with withholding tax. Further, we can give no assurance that our obligation to pay the additional amounts associated with withholding tax is enforceable under Russian law.
If a Non-resident Noteholder that is a legal entity or organisation, in each case not organised under Russian laws which holds and disposes the notes otherwise than through a permanent establishment in Russia, sells notes and receives proceeds from a source within Russia, there is a risk that the part of the payment, if any, representing accrued interest may be subject to 20%, or such other rate as may be in force at the time of payment, Russian withholding tax (even if a disposal is made at a loss) unless relief is available under an applicable double tax treaty subject to compliance with the treaty clearance formalities.
Where income resulting from sale, redemption or disposal of the notes is received from a source within Russia by an individual who is a Non-resident Noteholder, a personal income tax maybe charged at a rate of 30%, or such other rate as may be in force at the time of payment, on the gross proceeds from such disposal of the notes less any available cost deduction (including the original purchase price). Although this tax rate may be reduced or eliminated under an applicable double tax treaty subject to compliance with the treaty clearance formalities, in practice, individuals would not be able to obtain advance treaty relief in relation to proceeds received from a source within Russia, whilst obtaining a refund of taxes withheld can be extremely difficult, if not impossible.
Furthermore, even though the Tax Code is typically interpreted such as only a Russian professional asset manager or broker, or another person (including a foreign company with a permanent establishment or any registered presence in Russia or an individual entrepreneur located in Russia) acting in a similar capacity is required to withhold the tax from payments associated with disposition of securities made to a non-Russian individual, there is no guarantee that other Russian companies or foreign companies with a registered presence in Russia or an individual entrepreneur located in Russia would not seek to withhold the tax under these circumstances. The imposition or possibility of imposition of withholding tax could adversely affect the value of the notes. See "Taxation".
In addition, while some Noteholders might be eligible for an exemption from or a reduction in Russian withholding tax rate under applicable double tax treaties, there is no assurance that such exemption or reduction will be available in practice under these circumstances.
The imposition or possibility of imposition of this withholding tax could adversely affect the value of the notes. See "Taxation – The Russian Federation".
The terms of the notes do not contain provisions that would afford you protection in the event of a decline in our credit quality resulting from highly leveraged or other similar transactions in which we may engage. We are also not limited in the amount of other indebtedness or other liabilities that we may incur or securities that we may issue. You do not have the right to require us to repurchase or redeem the notes in the event of many types of highly leveraged transactions.
LUKOIL will guarantee the notes, but the notes will not be guaranteed by LUKOIL's subsidiaries. Our operations are, to a significant extent, conducted through our subsidiaries. Accordingly, LUKOIL is and will be dependent on its subsidiaries' operations to service its indebtedness, including its guarantee of the notes. The guarantee is effectively subordinated to the claims of all of the creditors, including trade creditors, of LUKOIL's subsidiaries. In the event of an insolvency, bankruptcy, liquidation, reorganisation, dissolution or winding up of the business of any subsidiary of LUKOIL, creditors of such subsidiary generally will have the right to be paid in full before any distribution will be made to LUKOIL or the holders of the notes.
LUKOIL and most of its subsidiaries are incorporated outside of the United States and the United Kingdom, primarily in Russia. Further, the enforceability of the guarantee issued in connection with the notes may be subject to numerous legal defences, some of which could be based upon the structure utilised in this offering. See "Enforceability of Judgments".
We have sourced certain information contained in this prospectus from third parties, including private companies and Russian government agencies, and we have relied on the accuracy of this information without independent verification. The official data published by Russian federal, regional and local governments may be substantially less complete or researched than those of Western countries. Official statistics may also be produced on different bases than those used in Western countries. Any discussion of matters relating to Russia in this prospectus must, therefore, be subject to uncertainty due to concerns about the completeness or reliability of available official and public information.
The following table sets forth our consolidated capitalisation and short-term debt as at 30 June 2010, extracted from our reviewed interim consolidated financial information as at 30 June 2010. The net proceeds of the offering will be used as described under "Use of Proceeds". There have been no material changes in our capitalisation since 30 June 2010, except as described in "Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources", "Business – History" and "Business – Recent Developments". For further information regarding our financial condition, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our reviewed interim consolidated financial statements and notes included elsewhere in this prospectus.
| As at | |
|---|---|
| 30 June 2010 | |
| (millions of U.S. | |
| dollars) | |
| Short-term debt | |
| Short-term borrowings | 225 |
| Current portion of long-term debt | 1,506 |
| Total short-term debt | 1,731 |
| Long-term debt | |
| Long-term loans and borrowings | 5,285 |
| 6.375% U.S. dollar bonds, maturing 2014 | 896 |
| 6.356% U.S. dollar bonds, maturing 2017 | 500 |
| 7.250% U.S. dollar bonds, maturing 2019 | 595 |
| 6.656% U.S. dollar bonds, maturing 2022 | 500 |
| 7.10% Russian ruble bonds, maturing 2011 | 256 |
| 13.35% Russian ruble bonds, maturing 2012 | 801 |
| 9.20% Russian ruble bonds, maturing 2012 | 321 |
| 7.40% Russian ruble bonds, maturing 2013 | 192 |
| Capital lease obligation | 192 |
| Total long-term debt | 9,538 |
| Current portion of long-term debt | (1,506) |
| Total non-current portion of long-term debt | 8,032 |
| Total debt | 9,763 |
| Stockholders' equity | |
| Share capital | 15 |
| Treasury stock | (208) |
| Additional paid-in capital | 4,683 |
| Retained earnings | 54,208 |
| Accumulated other comprehensive loss | (68) |
| Total stockholders' equity | 58,630 |
| Total capitalisation(1) | 68,168 |
| Share capital of LUKOIL | |
| Ordinary shares, authorised, issued and fully paid, nominal value | |
| RUR0.025 per share | 850,563,255 |
Note:
(1) Comprising total long-term debt and total stockholders' equity.
Of the total debt of the Group of \$9,763 million, as at 30 June 2010, \$4,033 million was unsecured and unguaranteed, \$167 million was both secured and guaranteed by LUKOIL, \$4,168 million was only guaranteed by LUKOIL and \$1,395 million was only secured.
The selected consolidated financial data set out below present a summary of our historical consolidated financial information at 30 June 2010 and 2009 and for the six months then ended and at 31 December 2009, 2008, 2007, 2006 and 2005 and for the years then ended and are derived from (i) our annual consolidated financial statements and notes, which have been prepared in accordance with U.S. GAAP and audited by KPMG, and our unaudited supplementary oil and gas information thereto and (ii) our first three months financial statements and notes, which have been prepared in accordance with U.S. GAAP and reviewed by KPMG. The selected financial data set forth below should be read in conjunction with our consolidated financial statements and notes and unaudited supplementary oil and gas information thereto included elsewhere in this prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars, | ||
| except per share amounts) | ||
| Consolidated Statement of Income Data: | ||
| Revenues | ||
| Sales (including excise and export tariffs) | 49,755 | 34,861 |
| Costs and other deductions | ||
| Operating expenses | (3,802) | (3,108) |
| Cost of purchased crude oil, gas and products | (20,275) | (13,272) |
| Transportation expenses | (2,780) | (2,356) |
| Selling, general and administrative expenses | (1,655) | (1,520) |
| Depreciation, depletion and amortisation | (2,060) | (2,003) |
| Taxes other than income taxes | (4,349) | (2,593) |
| Excise and export tariffs | (9,340) | (5,407) |
| Exploration expense | (146) | (69) |
| Gain on disposals and impairments of assets | 10 | 12 |
| Income from operating activities | 5,358 | 4,545 |
| Interest expense | (373) | (334) |
| Interest and dividend income | 98 | 65 |
| Equity share in income of affiliates | 236 | 182 |
| Currency translation loss | (42) | (124) |
| Other non-operating (expense) income | (75) | 61 |
| Income before income taxes | 5,202 | 4,395 |
| Current income taxes | (1,140) | (837) |
| Deferred income taxes | 44 | (196) |
| Total income tax expense | (1,096) | (1,033) |
| Net income | 4,106 | 3,362 |
| Less: net income attributable to noncontrolling interests | (104) | (133) |
| Net income attributable to OAO LUKOIL | 4,002 | 3,229 |
| Basic and diluted earnings per share of common stock (U.S. dollars) attributable to OAO LUKOIL |
4.72 | 3.81 |
| Year ended 31 December | |||||
|---|---|---|---|---|---|
| 2009 | 2008 | 2007 | 2006 | 2005 | |
| (millions of U.S. dollars, except per share amounts) | |||||
| Consolidated Statement of Income | |||||
| Data: | |||||
| Revenues | |||||
| Sales (including excise and | |||||
| export tariffs) | 81,083 | 107,680 | 81,891 | 67,684 | 55,774 |
| Costs and other deductions | |||||
| Operating expenses | (7,124) | (8,126) | (6,172) | (4,652) | (3,443) |
| Cost of purchased crude oil, gas | (31,977) | (37,851) | (27,982) | (22,642) | (19,590) |
| 2010 | 2009 | 2008 2007 |
2006 | 2005 | |
|---|---|---|---|---|---|
| As at 30 June |
As at 31 December | ||||
| Diluted earnings per share of common stock (U.S. dollars) attributable to OAO LUKOIL |
8.28 | 10.88 | 11.48 | 9.04 | 7.79 |
| Basic earnings per share of common stock (U.S. dollars) attributable to OAO LUKOIL |
8.28 | 10.88 | 11.48 | 9.06 | 7.91 |
| LUKOIL | 7,011 | 9,144 | 9,511 | 7,484 | 6,443 |
| Net income attributable to OAO | |||||
| Less: net income attributable to non-controlling interests |
(58) | (83) | (55) | (80) | (121) |
| Total income tax expense Net income |
(1,994) 7,069 |
(3,467) 9,227 |
(3,449) 9,566 |
(2,773) 7,564 |
(2,467) 6,564 |
| Current income taxes Deferred income taxes |
(1,922) (72) |
(4,167) 700 |
(3,410) (39) |
(2,906) 133 |
(2,301) (166) |
| Income before income taxes | 9,063 | 12,694 | 13,015 | 10,337 | 9,031 |
| Other non-operating expense | (13) | (244) | (240) | (118) | (44) |
| Currency translation (loss) gain | (520) | (918) | 35 | 169 | (134) |
| Equity share in income of affiliates |
351 | 375 | 347 | 425 | 441 |
| Interest and dividend income | 134 | 163 | 135 | 111 | 96 |
| Interest expense | (667) | (391) | (333) | (302) | (275) |
| Income from operating activities | 9,778 | 13,709 | 13,071 | 10,052 | 8,947 |
| (Loss) gain on disposals and impairments of assets |
(381) | (425) | (123) | (148) | 52 |
| Exploration expense | (218) | (487) | (307) | (209) | (317) |
| Excise and export tariffs | (13,058) | (21,340) | (15,033) | (13,570) | (9,931) |
| amortisation Taxes other than income taxes |
(3,937) (6,474) |
(2,958) (13,464) |
(2,172) (9,367) |
(1,851) (8,075) |
(1,315) (6,334) |
| administrative expenses Depreciation, depletion and |
(3,306) | (3,860) | (3,207) | (2,885) | (2,578) |
| Transportation expenses Selling, general and |
(4,830) | (5,460) | (4,457) | (3,600) | (3,371) |
| and products |
| (millions of U.S. dollars) | ||||||
|---|---|---|---|---|---|---|
| Balance Sheet Data: | ||||||
| Cash and cash equivalents | 3,748 | 2,274 | 2,239 | 841 | 752 | 1,650 |
| Working capital | 8,288 | 8,145 | 5,058 | 8,041 | 6,641 | 6,661 |
| Property, plant and | ||||||
| equipment | 53,334 | 52,228 | 50,088 | 38,056 | 31,316 | 25,464 |
| Total assets | 82,390 | 79,019 | 71,461 | 59,632 | 48,237 | 40,345 |
| Long-term debt (including | ||||||
| current portion) | 9,538 | 10,308 | 7,508 | 6,105 | 5,183 | 4,674 |
| Stockholders' equity | 58,630 | 55,991 | 50,340 | 41,213 | 32,900 | 26,804 |
The following discussion and analysis should be read in conjunction with our U.S. GAAP audited annual consolidated financial statements as at 31 December 2009 and 2008 and for each of the years in the three- year period ended 31 December 2009 and the related notes and supplemental oil and gas disclosure and our reviewed interim consolidated financial statements as of and for the six-month periods ended 30 June 2010 and 2009 and the related notes included elsewhere in this prospectus. This discussion contains forward looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward looking statements as a result of numerous factors, including the risks discussed in the section entitled "Risk Factors" and elsewhere in this prospectus.
References to "LUKOIL", "the Company", "the Group", "we" or "us" are references to OAO LUKOIL and its subsidiaries and equity affiliates. All dollar amounts are in millions of U.S. dollars, unless otherwise indicated.
| Six months ended 30 June | Year ended 31 December | |||||||
|---|---|---|---|---|---|---|---|---|
| % | % | % | ||||||
| 2010 | Change | 2009 | 2009 | Change | 2008 | Change | 2007 | |
| Sales (including excise and export | ||||||||
| tariffs) (millions of U.S. dollars) 49,755 | 42.7 | 34,861 | 81,083 | (24.7) | 107,680 | 31.5 | 81,891 | |
| Net income attributable to OAO | ||||||||
| LUKOIL (millions of U.S. dollars) | 4,002 | 23.9 | 3,229 | 7,011 | (23.3) | 9,144 | (3.9) | 9,511 |
| EBITDA (millions of U.S. dollars) | 7,433 | 13.8 | 6,534 | 13,475 | (14.7) | 15,797 | 3.0 | 15,330 |
| Taxes other than income taxes, excise | ||||||||
| and export tariffs (millions of U.S. dollars)(13,689) | 71.1 | (8,000) | (19,532) | (43.9) | (34,804) | 42.6 | (24,400) | |
| Basic and diluted earnings per | ||||||||
| share of common stock attributable to OAO | ||||||||
| LUKOIL | ||||||||
| (U.S. dollars) | 4.72 | 23.9 | 3.81 | 8.28 | (23.9) | 10.88 | (5.2) | 11.48 |
| Hydrocarbon production by the | ||||||||
| Group including our share in equity affiliates (mboe) 409,373 | 1.9 401,730 | 807,301 | 0.5 | 803,109 | 1.0 | 795,099 | ||
| Crude oil production by the Group | ||||||||
| including our share in equity | ||||||||
| affiliates (thousand tonnes) 48,140 | (1.0) | 48,633 | 97,615 | 2.5 | 95,240 | (1.5) | 96,645 | |
| Gas available for sale produced by | ||||||||
| the Group including our share in equity affiliates | ||||||||
| (mmcm) | 9,242 | 25.6 | 7,356 | 14,898 | (12.5) | 17,020 | 22.0 | 13,955 |
| Refined products produced by the | ||||||||
| Group including our share in affiliates | ||||||||
| (thousand tonnes) 31,097 | 8.1 | 28,768 | 59,879 | 12.9 | 53,033 | 8.6 | 48,819 | |
| The Group's hydrocarbon proved | ||||||||
| reserves including our share in equity affiliates | ||||||||
| (mmboe) | – | – | – | 17,504 | (9.5) | 19,334 | (5.1) | 20,369 |
During the first six months of 2010, our net income was \$4,002 million, an increase of \$773 million, or 23.9%, from the same period in 2009. The main factor that led to the increase was an increase in hydrocarbon prices in the first half of 2010.
For the year ended 31 December 2009, our net income was \$7,011 million, a decrease of \$2,133 million, or 23.3%, compared to 2008. The decrease was mainly the result of a sharp decrease in average prices for hydrocarbons in 2009, compared to 2008, and a general reduction in demand globally as a result of the economic slowdown. These and other factors impacting our results of operations are discussed in detail below.
See "Business – Recent Developments" for more information on our activities since 30 June 2010.
Our operations are divided into four main business segments:
● Power generation – which includes generation, transportation and sales of electricity, heat and related services.
Each of our four main 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, our Refining, Marketing and Distribution segment purchases crude oil from our Exploration and Production segment. As a result of certain factors considered in "- Main Factors Affecting Our Results of Operations – Domestic Crude Oil and Refined Products Prices" below, benchmarking 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 refining crude oil and other factors. Accordingly, an analysis of any of these segments on a stand-alone basis could give a misleading impression of those segments' underlying financial position and results of operations. For this reason, we do not analyse any of our main segments separately in the discussion that follows. For a presentation of separate financial data for each of our main segments (except for Power Generation, which we began reporting as a separate segment in 2010) see Note 22 "Segment information" to our consolidated financial statements for the year ended 31 December 2009 (Note 19 to our interim consolidated financial statements for the six months ended 30 June 2010) included elsewhere in this prospectus. We also have a segment for other businesses, which include banking, finance and other activities.
In January 2010, the Company signed an agreement to develop the West Qurna-2 field located in the south of Iraq. The parties to the agreement are: the Iraqi state-owned South Oil Company and the contracting consortium consisting of the Iraqi state-owned North Oil Company, the Company and Norway's Statoil ASA. The Company's share in the project is 56.25%. Under this agreement, as of 30 June 2010, the Company has a commitment in the amount of approximately \$263 million. The West Qurna-2 field has recoverable reserves of about 12.9 billion barrels.
In December 2009, we acquired BP plc's 46.0% stake in our equity affiliate LUKARCO for \$1.6 billion, increasing our ownership stake to 100%. LUKARCO is a holding company, which owns a 5% share in Tengizchevroil, a joint venture which develops the Tengiz and Korolevskoe fields in Kazakhstan, and a 12.5% share in CPC, a pipeline project in the Caspian region which is used to transport crude oil produced in Kazakhstan to a marine terminal near the Russian city of Novorossiysk on the Black Sea for transport on to international markets. Accordingly, we increased our ownership stake in Tengizchevroil from 2.7% to 5% and our ownership stake in CPC from 6.75% to 12.5%. The \$1.6 billion purchase price is to be paid in three instalments. The first instalment of \$300 million was paid in December 2009. The second instalment of \$800 million is due no later than December 2010, and the remaining amount is due no later than December 2011.
During 2009, we also increased our ownership stake in the share capital of OAO RITEK ("RITEK") to 100% by acquiring the remaining 25.2% of RITEK's share capital for approximately \$235 million. RITEK is a crude oil producing company operating in European Russia and Western Siberia.
In June 2009, we entered into an agreement with Total S.A. to acquire a 45% interest in the TRN refinery in The Netherlands for approximately \$700 million. We completed the acquisition in September 2009. This acquisition is in accordance with our plans to develop our refining capacity in Europe.
In the first quarter of 2009, we acquired 100% interests in OOO Smolenskneftesnab, OOO IRT Investment, OOO PM Invest and OOO Retaier House for an aggregate price of \$238 million. These companies together own 96 retail filling stations and plots of land in Moscow, the Moscow region and other regions of central European Russia. These acquisitions were made in order to expand our presence in what we believe to be the most attractive retail markets in the Russian Federation.
In the fourth quarter of 2008, we acquired 100% interests in ZAO Association Grand and OOO Mega Oil M for \$493 million. ZAO Association Grand and OOO Mega Oil M are holding companies that together own 181 retail filling stations in Moscow, the Moscow region and other regions of central European Russia. These acquisitions were made in order to expand the Group's presence in what we believe to be among the most attractive retail markets in the Russian Federation.
In July 2008, we entered into an agreement to acquire a 100% interest in the Akpet group for \$555 million. The transaction was completed in November 2008. The Akpet group operated 689 retail filling stations on the basis of dealer agreements and owns eight refined product terminals, five LNG storage tanks, three jet fuel terminals and a lubricant production plant in Turkey.
In June 2008, we signed an agreement with ERG S.p.A. (ERG) to establish a joint venture to operate the ISAB refinery complex in Priolo, Italy. In December 2008, we completed the acquisition of a 49% stake in the joint venture for €1.45 billion (approximately \$1.83 billion) and paid an initial €600 million (approximately \$762 million). The remaining amount was paid in February 2009. The seller has a put option, the effect of which would be to increase the Group's stake in the company operating the ISAB refinery complex up to 100%. The agreement states that each partner is responsible for procuring crude oil and marketing refined products in line with its equity stake in the joint venture. The ISAB refinery complex has the flexibility to process Urals blend crude oil, includes three jetties and storage tanks totalling 3,700 mcm and has an annual refining capacity of 16 million tonnes.
In March 2008, we entered into an agreement to acquire 75 retail filling stations and storage facilities in Bulgaria for approximately \$367 million. The transaction was completed in the second quarter of 2008.
In March 2008, we acquired 100% of the share capital of SNG Holdings Ltd. for an initial consideration of \$578 million. The purchase agreement provided for two tranches of additional contingent purchase consideration of \$100 million each, which were paid in 2008. SNG Holdings and its subsidiaries hold a 100% interest in a production sharing agreement in oil and gas condensate fields located in the South- Western Gissar and Ustyurt regions of Uzbekistan. The purpose of the acquisition was to increase our presence in the Uzbekistan oil and gas sector.
In March 2008, we entered into an agreement with a related party, whose management and directors include members of the Group's management and LUKOIL's Board of Directors, to acquire a 64.31% interest in TGK-8 for approximately \$2.12 billion. The purchase consideration partly consisted of 23.55 million shares of common stock of LUKOIL (at a market value of approximately \$1.62 billion), with a portion of the consideration paid in cash. The transaction was completed in May 2008. From May 2008 to June 2009, we acquired the remaining interests in TGK-8 for a total of \$1.2 billion. TGK-8 is one of the major gas consumers in the Southern Federal District of the Russian Federation with an annual consumption of 6.0 bcm per year. Its power plants are located in Astrakhan, Volgograd and Rostov regions, Krasnodar and Stavropol Districts, and the Republic of Dagestan of the Russian Federation with total productive capacity of 3.6 GW. By purchasing TGK-8, we expect significant synergies through natural gas supplies from our gas fields located in the northern Caspian and in the Astrakhan region. This acquisition is made in accordance with our plans to develop our electric power business.
During the first half of 2008, LUKOIL acquired the remaining 3.09% of the share capital of OAO LUKOIL-Nizhegorodnefteorgsintez from minority shareholders for \$64 million, increasing LUKOIL's ownership in LUKOIL-Nizhegorodnefteorgsintez to 100%. LUKOIL-Nizhegorodnefteorgsintez is a refinery plant located in European Russia.
The table below summarises the net oil-equivalent proved reserves of consolidated subsidiaries and our share in equity affiliates as at 31 December 2009 compared to 1 January 2009. See "Presentation of Reserves and Resources" for more information on our reserves estimates. See also "Business – Exploration and Production".
| Changes in 2009 | |||||
|---|---|---|---|---|---|
| Extensions, | |||||
| As at | discoveries and | Revision of | As at | ||
| 31 December | changes in | previous | 1 January | ||
| 2009 | Production(1) | structure | estimates | 2009 | |
| (mmboe) | |||||
| Western Siberia | 9,751 | (450) | 332 | (625) | 10,494 |
| Timan-Pechora | 2,735 | (163) | 38 | (157) | 3,017 |
| Ural region | 2,124 | (94) | 30 | 23 | 2,165 |
| Volga region | 895 | (26) | 142 | (891) | 1,670 |
| Other in Russia | 231 | (16) | 12 | 1 | 234 |
| Outside Russia | 1,768 | (75) | 210 | (121) | 1,754 |
| Proved oil and gas reserves | 17,504 | (824) | 764 | (1,770) | 19,334 |
| Probable oil and gas reserves | 9,820 | 11,767 | |||
| Possible oil and gas reserves | 5,054 | 5,282 |
(1) Gas production shown before Group consumption.
Our proved reserves as of 31 December 2009 amounted to 17,504 mmboe, consisting of 13,696 mmboe of crude oil and 3,808 mmboe of gas, as compared to proved reserves of 19,334 mmboe, consisting of 14,458 mmboe of crude oil and 4,875 mmboe of gas, as of 1 January 2009.
The increase in proved reserves as a result of geological exploration and production drilling amounted to 617 mmboe in 2009. Acquisitions increased our proved reserves by 124 mmboe, mainly due to the increase of our share in Tengizchevroil to 5% as a result of increasing our share in LUKARCO to 100%. In addition, changes in our licence portfolio led to a net increase of our reserves by 23 mmboe.
Under the SEC standards, undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer period of time. As a result of changes to our development plans in certain locations which pushed their scheduled drilling dates beyond five years, we transferred 1.8 billion boe from proved reserves to lower reserve categories and to resources. However, we expect to transfer these reserves back to the proved category as the scheduled drilling dates near or new technology becomes available.
Our results of operations and the period-to-period changes in our results of operations have been, and will continue to be, affected by various factors, the most important of which are discussed below.
The prices at which we sell crude oil and refined products, which are the primary drivers of our revenues, are subject to significant fluctuations. During the first six months of 2010, the Brent crude oil price fluctuated between \$67 and \$87 per barrel and reached its peak near \$86.80 in late April of 2010, which contributed to the 44.7% increase in our total crude oil sales revenues, as compared to the first six months of 2009.
During 2009, the Brent crude oil price fluctuated between \$39 and \$78 per barrel and reached its peak of \$78.86 in mid-November of 2009, which contributed to the 16.1% decrease in our total crude oil sales revenues, as compared to 2008.
In 2008, crude oil prices were the highest ever in real terms. Crude oil prices began to decline in July 2008 and by the end of the year crude oil price had dropped by more than \$100 per barrel to \$37 per barrel, driven mainly by the global economic downturn.
Substantially all of the crude oil that we export is Urals blend. The following table shows the average crude oil and refined product prices according to Platts for the six months ended 30 June 2010 and 2009 and the years ended 31 December 2009, 2008 and 2007, respectively.
| Six months ended 30 June | Year ended 31 December | |||||||
|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | 2009 | % Change | 2008 | % Change | 2007 | |
| (U.S. dollars per bbl, except %) | ||||||||
| Brent crude | 77.29 | 49.6 | 51.68 | 61.67 | (36.6) | 97.26 | 34.4 | 72.39 |
| Urals crude (CIF Mediterranean)(1) | 76.12 | 49.3 | 50.99 | 61.22 | (35.4) | 94.76 | 36.6 | 69.38 |
| Urals crude (CIF Rotterdam)(1) | 76.10 | 49.4 | 50.94 | 61.15 | (35.5) | 94.83 | 37.1 | 69.16 |
| (U.S. dollars per tonne, except %) | ||||||||
| Fuel oil 3.5% (FOB Rotterdam) | 402.84 | 46.7 | 274.63 | 345.72 | (24.8) | 459.74 | 35.6 | 339.00 |
| Diesel fuel (FOB Rotterdam) | 691.46 | 46.7 | 471.25 | 534.84 | (40.7) | 901.53 | 42.2 | 634.09 |
| High-octane gasoline (FOB | ||||||||
| Rotterdam) | 671.64 | 35.2 | 496.84 | 579.01 | (30.8) | 836.79 | 20.2 | 695.97 |
(1) We sell crude oil on foreign markets on various delivery terms. Thus, our average realised sale price of oil on international markets differs from the average prices of Urals blend on Mediterranean and Northern Europe markets.
Substantially all crude oil produced in Russia is produced by vertically integrated oil companies such as ours. As a result, most transactions are between affiliated entities within vertically integrated groups. Thus, there is no concept of a benchmark domestic market price for crude oil. The price of crude oil that is produced but not refined or exported by one of the vertically integrated oil companies is generally determined on a transaction-bytransaction basis against a background of world market prices, but with no direct reference or correlation. At any time there may exist significant price differences between regions for similar quality crude oil as a result of the competition and economic conditions in those regions.
Domestic prices for refined products are determined to some extent by world market prices, but they are also directly affected by local demand and competition.
The table below represents average domestic wholesale prices of refined products according to InfoTEK (with figures exclusive of VAT) for the six months ended 30 June 2010 and 2009 and the years ended 31 December 2009, 2008 and 2007, respectively.
| Six months ended 30 June | Year ended 31 December | |||||||
|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | 2009 | % Change | 2008 | % Change | 2007 | |
| (U.S. dollars per tonne, except %) | ||||||||
| Fuel oil | 223.60 | 70.2 | 131.34 | 162.12 | (32.1) | 238.87 | 42.2 | 167.93 |
| Diesel fuel | 546.91 | 27.0 | 430.65 | 462.65 | (37.8) | 744.07 | 39.0 | 535.32 |
| High-octane gasoline (Regular) | 692.65 | 50.7 | 459.59 | 584.87 | (22.2) | 751.95 | 19.9 | 626.95 |
| High-octane gasoline (Premium) | 710.26 | 38.5 | 512.77 | 636.24 | (26.0) | 860.07 | 20.3 | 714.72 |
A substantial part of our revenue is either denominated in U.S. dollars or is correlated to some extent with U.S. dollar crude oil prices, while most of our costs in the Russian Federation are settled in Russian rubles. Therefore, ruble inflation and movements in ruble-U.S. dollar exchange rates can significantly affect the results of our operations. In particular, the real devaluation of the ruble against the U.S. dollar generally causes our costs to decrease in U.S. dollar terms, and vice versa. The devaluation of the purchasing power of the U.S. dollar in the Russian Federation, calculated on the basis of the ruble-U.S. dollar exchange rates and the level of inflation in Russia, was 17.2% in the first six months of 2010, compared to the same period of 2009. The ruble-U.S. dollar exchange rate as at 30 June 2010 was 3.2% higher than the rate as at 1 January 2010. The 2009 year-end ruble-U.S. dollar exchange rate exceeded the year-opening rate by 2.9%. Ruble-U.S. dollar and other exchange rate movements during the year resulted in a \$520 million currency translation loss in 2009.
The following table sets out data on inflation in Russia and the change in the ruble-U.S. dollar exchange rate.
| Six months ended 30 June | Year ended 31 December | |||||
|---|---|---|---|---|---|---|
| 2010 | 2009 | 2009 | 2008 | 2007 | ||
| Ruble inflation (CPI), % | 4.4 | 7.5 | 8.9 | 13.3 | 11.9 | |
| Change of the ruble-U.S. dollar exchange rate, % |
(3.2) | (6.5) | (2.9) | (19.7) | 6.8 | |
| Average exchange rate for the period (rubles/U.S. dollar) |
30.07 | 33.07 | 31.72 | 24.86 | 25.58 | |
| Exchange rate at the end of the | ||||||
| period (rubles/U.S. dollar) | 31.20 | 31.29 | 30.24 | 29.38 | 24.55 |
We are subject to a broad range of taxes imposed at the federal, regional and local levels, and the taxes to which we are subject have had a significant effect on our results of operations. Given the relative size of our operations in Russia compared to our international operations, our tax profile is largely determined by the taxes payable in Russia. See "Regulation of the Oil Industry in the Russian Federation – Current System of Oil and Gas-Related Taxes and Duties" for more information on the tax regime for the production and sale of crude oil, gas and refined products in Russia.
The following tables represent average enacted rates for taxes specific to the oil industry in Russia for the six months ended 30 June 2010 and 2009 and the years ended 31 December 2009, 2008 and 2007, respectively.
| Six months ended 30 June | Year ended 31 December | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| % | % | % | |||||||
| 2010(1) | Change | 2009(1) | 2009(1) | Change | 2008(1) | Change | 2007(1) | ||
| Export tariffs on crude oil (\$/tonne) Export tariffs on refined products Light distillates (gasoline), middle |
272.66 | 121.9 | 122.90 | 179.93 | (49.3) | 355.08 | 71.8 | 206.70 | |
| distillates (jet fuel), diesel fuel and gas oils (\$/tonne) |
196.03 | 106.1 | 95.11 | 133.54 | (46.9) | 251.53 | 65.9 | 151.59 | |
| Liquid fuels (fuel oil) (\$/tonne) Excise tax on refined products |
105.60 | 106.1 | 51.23 | 71.93 | (46.9) | 135.51 | 66.0 | 81.64 | |
| Straight-run gasoline (RUR/tonne) | 4,290.00 | 10.0 | 3,900.00 | 3,900.00 | 46.8 | 2,657.00 | – | 2,657.00 | |
| High-octane gasoline (RUR/tonne) | 3,992.00 | 10.0 | 3,629.00 | 3,629.00 | – | 3,629.00 | – | 3,629.00 | |
| Low-octane gasoline (RUR/tonne) | 2,923.00 | 10.0 | 2,657.00 | 2,657.00 | – | 2,657.00 | – | 2,657.00 | |
| Diesel fuel (RUR/tonne) | 1,188.00 | 10.0 | 1,080.00 | 1,080.00 | – | 1,080.00 | – | 1,080.00 | |
| Motor oils (RUR/tonne) | 3,246.10 | 10.0 | 2,951.00 | 2,951.00 | – | 2,951.00 | – | 2,951.00 | |
| Mineral extraction tax | |||||||||
| Crude oil (RUR/tonne) | 2,928.87 | 56.3 | 1,873.57 | 2,302.85 | (30.8) | 3,328.35 | 34.6 | 2,472.67 | |
| Natural gas (RUR/mcm) | 147.00 | – | 147.00 | 147.00 | – | 147.00 | – | 147.00 |
(1) Average values.
Average tax rates for the ruble-denominated tariffs in the table above and translated into U.S. dollars at the average exchange rates for the six months ended 30 June 2010 and 2009 and the years ended 31 December 2009, 2008 and 2007, respectively, are as follows:
| Six months ended 30 June | Year ended 31 December | |||||||
|---|---|---|---|---|---|---|---|---|
| % | % | |||||||
| 2010(1) | % Change | 2009(1) | 2009(1) | Change | 2008(1) | Change | 2007(1) | |
| Excise on refined products | ||||||||
| Straight-run gasoline (\$/tonne) | 142.68 | 21.0 | 117.94 | 122.94 | 15.0 | 106.90 | 2.9 | 103.88 |
| High-octane gasoline (\$/tonne) | 132.77 | 21.0 | 109.74 | 114.40 | (21.7) | 146.01 | 2.9 | 141.89 |
| Low-octane gasoline (\$/tonne) | 97.21 | 21.0 | 80.35 | 83.76 | (21.7) | 106.90 | 2.9 | 103.88 |
| Diesel fuel (\$/tonne) | 39.51 | 21.0 | 32.66 | 34.04 | (21.7) | 43.45 | 2.9 | 42.23 |
| Motor oils (\$/tonne) | 107.96 | 21.0 | 89.24 | 93.02 | (21.7) | 118.73 | 2.9 | 115.38 |
| Mineral extraction tax | ||||||||
| Crude oil (\$/tonne) | 97.41 | 71.9 | 56.66 | 72.59 | (45.8) | 133.91 | 38.5 | 96.68 |
| Natural gas (\$/mcm) | 4.89 | 9.8 | 4.45 | 4.63 | (21.7) | 5.91 | 2.9 | 5.75 |
(1) Average values.
The rates of taxes specific to the oil industry in Russia are linked to international crude oil prices and are changed in line with them. The methods to determine the rates for such taxes are presented below.
Crude oil extraction tax rate. The base rate of crude oil extraction tax is 419 rubles per tonne extracted, and it is adjusted depending on the international market price of Urals blend and the ruble-U.S. dollar exchange rate.
During the period from 2005 through 2008, the crude oil extraction tax rate was zero when the average Urals blend international market price for a tax period was less than or equal to \$9.00 per barrel. Each \$1.00 per barrel increase in the international Urals blend price over the threshold (\$9.00 per barrel) resulted in an increase of the tax rate by \$1.61 per tonne extracted (or \$0.22 per barrel extracted using a tonne to barrel conversion factor of 7.33).
Effective from 1 January 2009, the threshold crude oil price up to which the tax rate is zero was raised from \$9.00 to \$15.00 per barrel (while the base rate remained at 419 rubles per tonne extracted). This has led to a \$1.30 per barrel decrease in the crude oil extraction tax rate in Russia. Also, the list of regions where, depending on the period and volume of production, the zero crude oil extraction tax rate applies was expanded. In particular, it now includes the Caspian offshore region and the Nenetsky Autonomous District, two areas where we explore for and produce hydrocarbons.
Effective from 1 January 2007, the crude oil extraction tax rate also varies depending on the development and depletion of a particular oil field. The tax rate is zero for extra-heavy crude oil and for crude oil produced in certain regions of Eastern Siberia, depending on the period and volume of production. For crude oil produced in other regions the tax rate calculation described above is also multiplied by a coefficient characterising the depletion of a particular oil field. The coefficient is equal to 1.0 for oil fields with depletion below 80%. Each 1% increase of depletion of a particular oil field above 80% results in a decrease of the coefficient by 0.035. The minimum value of the coefficient is 0.3. The depletion level assessment is based on crude oil production and reserves information reported to the Russian government.
Natural gas extraction tax rate. The mineral extraction tax on natural gas production, which has been in effect since 1 January 2006, is calculated using a flat rate of 147 rubles per mcm of natural gas extracted.
Crude oil export duty rate. The crude oil export duty rate is calculated on a progressive scale. The rate is zero when the average Urals blend international market price is less than or equal to approximately \$15.00 per barrel (\$109.50 per tonne). If the Urals blend price is between \$15.00 and \$20.00 per barrel (\$146.00 per tonne), each \$1.00 per barrel increase in the Urals blend price over \$15.00 results in an increase of the crude oil export duty rate by \$0.35 per barrel exported. If the Urals blend price is between \$20.00 and \$25.00 per barrel (\$182.50 per tonne), each \$1.00 per barrel increase in the Urals blend price over \$20.00 results in an increase of the crude oil export duty rate by \$0.45 per barrel exported. Each \$1.00 per barrel increase in the Urals blend price over \$25.00 per barrel results in an increase of the crude oil export duty rate by \$0.65 per barrel exported.
Prior to 1 October 2008, the Russian government set export tariff rates for two-month periods. The rates in a specific two-month period were based on Urals blend international market prices in the preceding two months. Thus, the calculation method that the Russian government employed to determine export tariff rates resulted in a two-month gap between movements in crude oil prices and the revision of the export duty rate based on those crude oil prices.
This method of calculation was amended in September 2008. The Russian government set the specific crude oil export duty rate for October, November and December 2008 at \$372.20, \$287.30 and \$192.10 per tonne, respectively, in order to offset the negative effect of sharply decreased crude oil prices. Effective from December 2008, the crude oil export duty rate is revised monthly on the basis of the immediately preceding one-month period of crude oil price monitoring.
Export duty rates on refined products. Export duty rates on refined products are set by the Russian government. The rate of export duty depends on internal demand for refined products and international crude oil market conditions.
Crude oil and refined products exported to CIS countries, other than Ukraine and Belarus, are not subject to export duties. Crude oil exported from Russia to Belarus was subject to export duties calculated in 2009 with the application of a coefficient of 0.356 (0.335 in 2008) to the regular export duty rate set by the Russian government.
In 2010, under the agreement between the Russian Federation and Belarus, crude oil exported from Russia to Belarus up to a total amount of 6.3 million tonnes will not be subject to export duty. Volumes of crude oil above this limit will be taxed at the regular export duty rate. Crude oil exported from Russia to Ukraine is subject to export duty at the regular rate.
Excise on refined products. The responsibility to pay excises on refined products (except for straight-run gasoline) in Russia is imposed on refined product producers. In other countries where we operate, excise taxes are paid either by producers or retailers depending on the local legislation.
Income tax. Before 2009, operations in the Russian Federation were subject to an income tax rate of up to 24%. The Federal income tax rate was 6.5% and the regional income tax rate varied from 13.5% to 17.5% at the discretion of the regional authorities. Starting on 1 January 2009, the Federal income tax rate was decreased to 2.0% and the regional income tax rate varies between 13.5% and 18.0%. Our foreign operations are subject to taxes at the tax rates applicable to the jurisdictions in which they operate.
The main Russian crude oil production regions are remote from the main crude oil and refined products markets. Therefore, access of crude oil production companies to the markets is dependent on the extent of diversification of transport infrastructure and access to it. As a result, transportation costs are an important factor affecting our net income. Increases in transportation costs have affected, and possible future increases could further affect, our results of operations. See "Risk Factors – Risks Relating to Our Business – We depend on monopoly suppliers of crude oil and refined product transportation services and we have no control over the infrastructure they maintain or the fees they charge" for more information on providers of certain crude oil and refined products transportation services in Russia.
Transportation of crude oil produced in Russia to refineries and export destinations is performed primarily through the trunk oil pipeline system of state-owned Transneft. Access to the Transneft crude oil export pipeline network is allocated quarterly, based on recent volumes produced and delivered through the pipeline and proposed export destinations. The crude oil transported by Transneft is Urals blend – a mix of crude oils of various qualities. Therefore Russian companies that produce crude oil of a higher quality, cannot benefit from selling their higher quality oil using Transneft's pipeline. Alternative access to international markets bypassing Transneft export routes can be obtained through railroad transport, by tankers, and by oil producing companies' own export infrastructure. Our own export infrastructure includes the Vysotsk terminal in the Leningrad region, the Varandey terminal in the Nenetsky Autonomous District and the Svetly terminal in the Kaliningrad region. We use our offshore ice-resistant terminal in Varandey with annual capacity of 12.0 million tonnes to export crude oil produced by our joint venture with ConocoPhillips located in Northern Timan-Pechora. The Svetly terminal exports crude oil primarily produced by OOO LUKOIL-Kaliningradmorneft, our subsidiary operating in the Kaliningrad region, and refined products. Its capacity is 6.0 million tonnes per year. We use the Vysotsk terminal to export refined products. In the future we expect to use the terminal to export both crude oil and refined products, depending on market conditions. Currently, the terminal has a capacity of 12.0 million tonnes per year, which can be expanded to up to 15.0 million tonnes per year.
Transportation of refined products in Russia is performed by railway transport and the pipeline system of Transnefteproduct. The Russian railway infrastructure is owned and operated by Russian Railways. Both of these companies are state-owned. Besides transportation of refined products, Russian Railways provides oil companies with crude oil transportation services. We transport the major part of our refined products by railway transport.
As the activities of the above mentioned companies fall under the scope of natural monopolies, the fundamentals of their tariff policies are defined by the state authorities to ensure the balance of interests of the state and all participants in the transportation process are considered. Transportation tariffs of natural monopolies are set by the FTS. The tariffs are dependent on transport destination, delivery volume, distance of transportation, and several other factors. Changes in the tariff rates depend on inflation forecasts by the Ministry of Economic Development of the Russian Federation, the investment needs of owners of transport infrastructure, other macroeconomic factors, and compensation of economically reasonable expenses incurred by the transport natural monopolies. Tariff rates are revised by the FTS at least annually.
The following table sets forth our production volumes, sales and expenses for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| Daily production of hydrocarbons, including the Company's share in | ||
| equity affiliates (mboe/day) | 2,262 | 2,220 |
| crude oil (mbls/day) | 1,962 | 1,981 |
| natural and petroleum gas(1) (mboe/day) | 300 | 239 |
| Hydrocarbon extraction expenses (\$/boe) | 4.02 | 3.25 |
| (millions of U.S. dollars) | ||
| Sales of gas and crude oil | 13,548 | 9,418 |
| Hydrocarbon extraction expenses | 1,584 | 1,267 |
| – in Russia | 1,491 | 1,179 |
| – outside Russia | 93 | 88 |
| Exploration expenses | 146 | 69 |
| – in Russia | 50 | 34 |
| – outside Russia | 96 | 35 |
| Mineral extraction tax | 3,757 | 2,070 |
| – in Russia | 3,723 | 2,047 |
| – outside Russia | 34 | 23 |
Note:
(1) Gas available for sale (excluding gas produced for our own consumption).
Crude Oil Production. In the first six months of 2010, we decreased our total daily crude oil production by 1.0%, compared to the same period in 2009. We produced (including our share in equity affiliates) 355.0 mmbls (48.1 million tonnes) of crude oil in the first six months of 2010.
The following table sets forth our production in the six months ended 30 June 2010 and 2009, respectively, by major regions.
| Six months | Six months | ||||
|---|---|---|---|---|---|
| ended | % | Structural | Organic | ended | |
| 30 June 2010 | Change | Change(1) | Change | 30 June 2009 | |
| Western Siberia | 25,434 | (4.5) | – | (1,205) | 26,639 |
| Timan-Pechora | 10,871 | 2.4 | – | 255 | 10,616 |
| Ural region | 6,106 | 3.8 | – | 226 | 5,880 |
| Volga region | 1,432 | (1.0) | – | (14) | 1,446 |
| Other in Russia | 1,021 | (3.0) | – | (32) | 1,053 |
| Crude oil produced in Russia | 44,864 | (1.7) | – | (770) | 45,634 |
| Crude oil produced internationally | 1,749 | (1.4) | – | (25) | 1,774 |
| Total crude oil produced by |
|||||
| consolidated subsidiaries | 46,613 | (1.7) | – | (795) | 47,408 |
| Our share in crude oil production of equity affiliates: |
|||||
| in Russia | 164 | 9.3 | – | 14 | 150 |
| outside Russia | 1,363 | 26.8 | 287 | 1 | 1,075 |
| Total crude oil produced | 48,140 | (1.0) | 287 | (780) | 48,633 |
Note:
(1) Change due to acquisitions or disposals.
Our main oil-producing region is Western Siberia, where we produced 54.6% of our crude oil in Russia in the first six months of 2010 (56.2% in the first six months of 2009).
A significant impact on our production in Western Siberia was caused by natural decline rates as well as a decrease in the drilling of new wells.
In December 2009, we started production drilling on the Yu. Korchagin field in the Caspian Sea. In April 2010, we started commercial production at the field. We plan to produce approximately 340 thousand tonnes from this field in 2010, and the maximum annual production from this field is expected to be 2.5 million tonnes of oil and gas condensate and 1.0 bcm of gas.
In addition to our crude oil production, we purchase crude oil in Russia and in the international markets. In Russia, we primarily purchase crude oil from affiliated producing companies and other producers, including vertically integrated oil companies that lack refining capacity or are unable to export their crude oil. We either refine or export purchased crude oil. Crude oil purchased on international markets is used for trading activities, for supplying our overseas refineries or for processing at third party refineries.
The following table sets forth our crude oil purchases in the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||||||
|---|---|---|---|---|---|---|
| 2010 | 2009 | |||||
| (thousand | (thousand | |||||
| (mbls) | tonnes) | (mbls) | tonnes) | |||
| Crude oil purchases in Russia | 381 | 52 | 491 | 67 | ||
| Crude oil purchases internationally | 77,610 | 10,588 | 76,958 | 10,499 | ||
| Total crude oil purchased | 77,991 | 10,640 | 77,449 | 10,566 |
Volumes of crude oil purchased internationally did not change significantly. In the first six months of 2010, we purchased 5,385 thousand tonnes in order to process at our and at third party refineries (including 2,109 thousand tonnes at the ISAB refinery complex and 1,103 thousand tonnes at the TRN refinery), compared to 5,152 thousand tonnes in the first six months of 2009. Production at our Russian refineries increased by 1.7%.
Gas production. In the first six months of 2010, we produced 9,242 mmcm of gas available for sale (including our share in equity affiliates), an increase of 25.6% compared to the same period of 2009, which resulted from increased production in Russia due to increased purchases of our gas by Gazprom.
Our major gas production field is the Nakhodkinskoe gas field, where we produced 4,110 mmcm of natural gas in the first six months of 2010, compared to 2,951 mmcm in the first six months of 2009. The 39.3% increase in gas production from this field resulted from the increase of purchases of our gas by Gazprom starting from the second half of 2009.
As at 30 June 2010, we owned and operated four refineries located in European Russia and three refineries located outside of Russia – in Bulgaria, Ukraine and Romania. We also have ownership interests in two affiliated refineries, which include a 49% interest in the ISAB refinery complex in Priolo, Italy, which we acquired in December 2008, and a 45% interest in the TRN refinery in The Netherlands, which we acquired in September 2009. The ISAB refinery has an annual refining capacity of 16.0 million tonnes (of which our share is 7.8 million tonnes). The TRN refinery has an annual refining capacity of 11.3 million tonnes (of which our share is 5.1 million tonnes).
In August 2005, we closed the Odessa refinery in Ukraine to commence a wide-scale upgrade. In April 2008, we put it back into operation after the completion of the upgrade. Due to conditions on the Ukrainian market in October 2010, we decided to move scheduled maintenance at the Odessa refinery from the first quarter of 2011 to the fourth quarter of 2010 and to temporarily shut down operations there. The annual capacity of the Odessa refinery amounts to 2.8 million tonnes.
Compared to the first six months of 2009, in the first six months of 2010 production at our consolidated and affiliated refineries increased by 8.1%. In the first six months of 2010, the production of our international refineries, including our share of production at the ISAB refinery complex and the TRN refinery, increased by 24.8% as compared to the first six months of 2009. This increase was mainly due to the acquisition of TRN in September 2009. Production at our Russian refineries increased by 1.7%.
During the first six months of 2010, our share of refined products produced at the ISAB refinery complex amounted to 3.0 million tonnes, and our share of refined products produced at the TRN refinery complex amounted to 2.4 million tonnes.
We are continuously seeking to improve the refined products mix at our refineries in order to produce more profitable products of higher quality. At our Russian refineries we produced 4,304 and 3,364 thousand tonnes of Euro 4 and Euro 5 diesel fuel in the first six months of 2010 and 2009, respectively. In the first six months of 2010 and 2009, our production of Euro 3 gasoline amounted to 2,716 and 2,213 thousand tonnes, respectively.
Along with our own production of refined products, until the end of 2009 we refined crude oil at third party refineries. In Russia we refined crude oil at third party refineries primarily to supply our network in the Ural region and for export sales. To supply our retail networks in Eastern Europe we refined crude oil in Belarus and Serbia. Refined products processed in Belarus were used for supplying our local retail network and for wholesale export.
The following table summarises refining expenses, volumes of refinery throughput and volumes of refined products produced for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Own refining expenses | 515 | 435 |
| Refining expenses at third party and affiliated refineries | 351 | 328 |
| Capital expenditures | 336 | 411 |
| (thousand bpd) | ||
| Refinery throughput at the Group's and affiliated(1)(2) refineries | 1,307 | 1,222 |
| Refinery throughput at third party refineries | – | 90 |
| Total refinery throughput | 1,307 | 1,312 |
| (thousand tonnes) | ||
| Refined products produced at the Group's refineries in Russia(3) | 21,194 | 20,830 |
| Refined products produced at the Group's and affiliated(1) refineries outside Russia | 9,903 | 7,938 |
| Total refined products produced at the Group's and affiliated refineries | 31,097 | 28,768 |
| Refined products produced at third party refineries in Russia | – | 1,243 |
| Refined products produced at third party refineries outside Russia | 4 | 729 |
| Total refined products produced at third party refineries | 4 | 1,972 |
Notes:
(1) Group's share.
(2) Including refined products processed.
(3) Excluding mini refineries.
The table below summarises our marketing and trading activities for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Retail sales | 6,963 | 5,745 |
| Wholesale sales | 26,424 | 17,553 |
| Total refined product sales | 33,387 | 23,298 |
| (thousand tonnes) | ||
| Refined products purchased in Russia | 855 | 217 |
| Refined products purchased internationally | 23,015 | 20,383 |
| Total refined products purchased | 23,870 | 20,600 |
| Average daily sales through owned and leased stations in Russia, tonnes per day |
9.6 | 8.3 |
| Average daily sales through owned and leased stations outside of Russia, | ||
| tonnes per day | 5.3 | 5.8 |
| Total average daily sales through owned and leased stations, tonnes per day | 6.9 | 6.7 |
As at 30 June 2010 and 2009, we owned or leased 1,899 and 1,856 retail filling stations in Russia and 3,198 and 3,568 retail filling stations abroad, respectively (excluding stations that were temporarily idle or leased to third parties).
In the first six months of 2010, our export of crude oil from Russia was 6.5% less than in the first six months of 2009, and we exported 45.5% of our total domestic crude oil production (47.8% in the first six months of 2009). This decrease resulted from decreased crude oil production and termination of processing operations in Belarus and resulting decrease of export to the CIS.
The volumes of crude oil exported from Russia by our subsidiaries are summarised as follows:
| Six months ended 30 June | ||||
|---|---|---|---|---|
| 2010 | 2009 | |||
| (thousand | (thousand | |||
| (mbls) | tonnes) | (mbls) | tonnes) | |
| Exports of crude oil using Transneft export routes | 116,650 | 15,914 | 128,781 | 17,569 |
| Exports of crude oil bypassing Transneft | 32,919 | 4,491 | 31,262 | 4,265 |
| Total crude oil exports | 149,569 | 20,405 | 160,043 | 21,834 |
In the first six months of 2010, the crude oil exported through our own export infrastructure was 4,491 thousand tonnes, or 5.9% more than in the first six months of 2009. This was due to increased export of crude oil produced from the Yuzhnaya Khylchuya oil field through our export terminal in Varandey.
In the first six months of 2010, we exported from Russia 12.9 million tonnes of refined products, a decrease of 8.2% compared to the same period of 2009, due to a decrease in export sales to the CIS. We export from Russia primarily diesel fuel, fuel oil and gas oil. These products account for approximately 91.5% of our refined products export volumes.
The following table sets forth our production volumes, sales and expenses for the years ended 31 December 2009 and 2008, respectively.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| Daily production of hydrocarbons, including Company's share in | |||
| equity affiliates (mboe/day) | 2,212 | 2,194 | 2,178 |
| crude oil (mbls/day) | 1,972 | 1,921 | 1,953 |
| natural and petroleum gas(1) (mboe/day) | 240 | 273 | 225 |
| Hydrocarbon extraction expenses (\$/boe) | 3.56 | 4.12 | 3.58 |
| (millions of U.S. dollars) | |||
| Hydrocarbon extraction expenses | 2,787 | 3,208 | 2,757 |
| – in Russia | 2,592 | 3,006 | 2,616 |
| – outside Russia | 195 | 202 | 141 |
| Exploration expenses | 218 | 487 | 307 |
| – in Russia | 71 | 131 | 149 |
| – outside Russia | 147 | 356 | 158 |
| Mineral extraction tax | 5,452 | 12,267 | 8,482 |
| – in Russia | 5,399 | 12,267 | 8,482 |
| – outside Russia | 53 | – | – |
Note:
(1) Gas available for sale (excluding gas produced for our own consumption).
Crude Oil Production. In 2009, we increased our total daily crude oil production by 2.7%, compared to 2008. We produced (including our share in equity affiliates) 719.6 mmbls (97.6 million tonnes) of crude oil.
The following table sets forth our production of crude oil in the years ended 31 December 2009 and 2008, respectively, by major regions.
| Change from 2008 | |||||
|---|---|---|---|---|---|
| Year ended 31 | Year ended 31 | ||||
| December | % | Structural | Organic | December | |
| 2009 | Change | Change(1) | Change | 2008 | |
| (thousand tonnes) | |||||
| Western Siberia | 52,962 | (5.7) | – | (3,225) | 56,187 |
| Timan-Pechora | 21,662 | 29.8 | – | 4,977 | 16,685 |
| Ural region | 11,958 | 3.6 | – | 410 | 11,548 |
| Volga region | 2,848 | (6.3) | – | (193) | 3,041 |
| Other in Russia | 2,130 | (2.5) | – | (55) | 2,185 |
| Crude oil production in Russia | 91,560 | 2.1 | – | 1,914 | 89,646 |
| Crude oil produced internationally | 3,515 | 9.8 | – | 315 | 3,200 |
| Total crude oil produced by |
|||||
| consolidated subsidiaries | 95,075 | 2.4 | – | 2,229 | 92,846 |
| Our share in crude oil production of equity affiliates: |
|||||
| in Russia | 308 | 3.0 | – | 9 | 299 |
| outside Russia | 2,232 | 6.5 | 26 | 111 | 2,095 |
| Total crude oil production | 97,615 | 2.5 | 26 | 2,349 | 95,240 |
Note:
(1) Change due to acquisitions or disposals.
In 2009, we produced 55.7% of our crude oil in Western Siberia (compared to 60.5% in 2008 and 63.6% in 2007). In 2009, the Western Siberian producing assets continued to mature resulting in a production decline and water cut increase. A significant impact on our production in Western Siberia was caused by natural decline rates as well as a decrease in the drilling of new wells.
In line with our strategy, we are developing new oil fields in the Northern Timan-Pechora and Caspian regions in order to compensate for the decrease in crude oil production in the traditional regions. In August 2008, we began commercial production on the Yuzhnaya Khylchuya oil field, which is located in the Timan-Pechora region. We produced 7.0 million tonnes from this field in 2009. This oil field is being developed by NMNG.
The structural growth of our share in equity affiliates' production outside of Russia is mainly the result of our increased ownership in Tengizchevroil, a joint venture which develops the Tengiz and Korolevskoe fields in Kazakhstan. We increased our ownership in Tengizchevroil by acquiring the remaining 46% of LUKARCO, which owns 5% of Tengizchevroil.
| Year ended 31 December | ||||||
|---|---|---|---|---|---|---|
| 2009 | 2008 | 2007 | ||||
| (thousand | (thousand | (thousand | ||||
| (mbls) | tonnes) | (mbls) | tonnes) | (mbls) | tonnes) | |
| Crude oil purchases in Russia | 4,442 | 606 | 1,730 | 236 | 345 | 47 |
| Crude oil purchases | ||||||
| internationally | 150,258 | 20,499 | 76,078 | 10,379 | 32,802 | 4,475 |
| Total crude oil purchased | 154,700 | 21,105 | 77,808 | 10,615 | 33,147 | 4,522 |
In 2009, the volume of crude oil purchased internationally increased substantially as a result of increased refining and trading volumes. In 2009, we purchased 11,313 thousand tonnes of crude oil to process at our, and at third party, refineries (including 5,116 thousand tonnes at the ISAB refinery complex and 698 thousand tonnes at the TRN refinery complex), compared to 5,029 thousand tonnes in 2008.
Gas Production. In 2009, we produced 14,898 mmcm of gas available for sale (including our share in equity affiliates), a decrease of 12.5%, compared to 2008. Our major gas production field is the Nakhodkinskoe gas field, where we produced 5,936 mmcm of natural gas in 2009, compared to 8,313 mmcm in 2008. The 28.6% decrease in gas production from this field resulted from the decrease in purchases of our gas by Gazprom due to lower demand for gas in 2009, compared to 2008. In 2009, our share in production from the Shakh-Deniz field in Azerbaijan was 518 mmcm, compared to 552 mmcm in 2008. Our production from the Khauzak gas field in Uzbekistan was 2,227 mmcm of natural gas, compared to 2,340 mmcm in 2008.
Compared to 2008, production at our consolidated and affiliated refineries increased in 2009 by 12.9%. Our Russian refineries increased their production by 0.8%. Production of our international refineries, including our share of production at ISAB and TRN, increased by 59.3%. This increase was due to our acquisitions of interests in ISAB and TRN in December 2008 and September 2009, respectively, and occurred notwithstanding the fact that the production at our Romanian refinery was 7.4% lower due to an overhaul performed at the refinery in January-February 2009 and decreased production at our Bulgarian refinery, which was 7.1% lower than in 2008 as a result of a revision to the 2009 production plan due to low refining margins.
In 2009, our share of refined products produced at the ISAB refinery complex amounted to 6,153 thousand tonnes (578 thousand tonnes in 2008), and our share in production at the TRN refinery complex amounted to 1,528 thousand tonnes.
We are continuously seeking to improve the refined products mix at our refineries in order to produce higher quality and more profitable products. At our Russian refineries we produced 7,266, 7,224 and 7,218 thousand tonnes of Euro 4 and Euro 5 diesel fuel in 2009, 2008 and 2007, respectively. In 2009, 2008 and 2007 our production of Euro 3 gasoline amounted to 4,746, 4,191 and 852 thousand tonnes, respectively.
In Russia we refined crude oil at third party refineries primarily to supply our network in the Ural region and for export sales. To supply our retail networks in Eastern Europe, we refined crude oil at third party refineries in Belarus and Serbia. In early 2007, we decreased processing of our crude oil at Belarussian refineries due to a reduction in profitability of these operations resulting from changes in tax legislation. However, the growth in refining margins at the end of 2007 and beginning of 2008 resulted in increased volumes of refining in Belarus. Refined products processed in Belarus are used for supplying our local retail network and for wholesale export.
The following table represents refining expenses, volumes of refinery throughput and volumes of refined products produced and purchased for the years ended 31 December 2009, 2008 and 2007.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| Own refining expenses | 923 | 1,115 | 880 |
| – in Russia | 671 | 780 | 651 |
| – outside Russia | 252 | 335 | 229 |
| Refining expenses at ISAB and TRN | 543 | 39 | – |
| Refining expenses at third party refineries | 170 | 400 | 242 |
| – in Russia | 126 | 341 | 214 |
| – outside Russia | 44 | 59 | 28 |
| Capital expenditures | 828 | 1,023 | 830 |
| – in Russia | 520 | 688 | 606 |
| – outside Russia | 308 | 335 | 224 |
| (thousand bpd) | |||
| Refinery throughput at the Group refineries in Russia(1) | 889 | 881 | 851 |
| Refinery throughput at the Group refineries outside Russia | 210 | 231 | 193 |
| Refinery throughput at the Group refineries | 1,099 | 1,112 | 1,044 |
| Refinery throughput at ISAB and TRN(2) | 123 | 11 | – |
| Refinery throughput at the Group and affiliated refineries | 1,222 | 1,123 | 1,044 |
| Refinery throughput at third party refineries in Russia | 41 | 64 | 72 |
| Refinery throughput at third party refineries outside Russia | 36 | 46 | 21 |
| Refinery throughput at third party refineries | 77 | 110 | 93 |
| Total refinery throughput | 1,299 | 1,233 | 1,137 |
| (thousand tonnes) | |||
| Refined products produced at the Group refineries in Russia(1) | 42,408 | 42,067 | 40,381 |
| Refined products produced at the Group refineries outside Russia | 9,790 | 10,388 | 8,438 |
| Total refined products produced at the Group refineries | 52,198 | 52,455 | 48,819 |
| The Group's share of the production of ISAB and TRN | 7,681 | 578 | – |
| Total refined products produced at the Group and affiliated | |||
| refineries | 59,879 | 53,033 | 48,819 |
| Refined products produced at third party refineries in Russia | 1,873 | 2,881 | 3,270 |
| Refined products produced at third party refineries outside Russia | 1,612 | 2,123 | 945 |
Total refined products produced at third party refineries................... 3,485 5,004 4,215
(1) Excluding mini refineries.
(2) The Group's share.
Marketing and trading. Our marketing and trading activities mainly include wholesale and bunkering operations in Western Europe, South-East Asia, Central America and retail operations in the USA, Central and Eastern Europe, the Baltic States and other regions. In Russia, we purchase refined products on occasion, primarily to manage supply chain bottlenecks.
We retail refined products in 26 countries through over 6,000 retail filling stations. Most of the stations operate under the LUKOIL brand.
The table below summarises our marketing and trading activities for the years ended 31 December 2009, 2008 and 2007.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| Retail sales | 13,146 | 17,812 | 12,904 |
| Wholesale sales | 41,843 | 58,602 | 43,833 |
| Total refined products sales | 54,989 | 76,414 | 56,737 |
| (thousand tonnes) | |||
| Refined products purchased in Russia | 625 | 1,635 | 1,543 |
| Refined products purchased internationally | 41,445 | 38,743 | 38,745 |
| Total refined products purchased | 42,070 | 40,378 | 40,288 |
In 2009, our export of crude oil from Russia was 6.9% higher than in 2008, and we exported 45.9% of our total domestic crude oil production (43.8% in 2008 and 46.5% in 2007). This increase resulted from the commencement of production on the Yuzhnaya Khylchuya oil field by our joint venture with ConocoPhillips, crude oil from which we export from Russia.
The volumes of crude oil exported from Russia by our subsidiaries in the years ended 31 December 2009, 2008 and 2007 are summarised as follows:
| Year ended 31 December | ||||||
|---|---|---|---|---|---|---|
| 2009 | 2008 | 2007 | ||||
| (thousand | (thousand | (thousand | ||||
| (mbls) | tonnes) | (mbls) | tonnes) | (mbls) | tonnes) | |
| Exports of crude oil using | ||||||
| Transneft export routes | 241,890 | 33,000 | 264,393 | 36,070 | 293,163 | 39,995 |
| Exports of crude oil bypassing | ||||||
| Transneft | 66,109 | 9,019 | 23,639 | 3,225 | 15,818 | 2,158 |
| Total crude oil exports | 307,999 | 42,019 | 288,032 | 39,295 | 308,981 | 42,153 |
In 2009, the crude oil exported through our own export infrastructure was 8,712 thousand tonnes, which is over than three times more than in 2008. This was due to the export of crude oil produced from the Yuzhnaya Khylchuya oil field (7.0 million tonnes in 2009) through our export terminal in Varandey.
In 2009, we exported from Russia 27.8 million tonnes of refined products, an increase of 7.7% compared to 2008. We export from Russia primarily diesel fuel, fuel oil and gasoil. These products accounted for approximately 89.4% of our refined products export volumes in 2009.
In 2009, our revenue from export from Russia both to the Group companies and third parties amounted to \$17,485 million for crude oil and \$11,414 million for refined products.
The table below represents our consolidated statements of income for the periods indicated.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Revenues | ||
| Sales (including excise and export tariffs) | 49,755 | 34,861 |
| Costs and other deductions | ||
| Operating expenses | (3,802) | (3,108) |
| Cost of purchased crude oil, gas and products | (20,275) | (13,272) |
| Transportation expenses | (2,780) | (2,356) |
| Selling, general and administrative expenses | (1,655) | (1,520) |
| Depreciation, depletion and amortisation | (2,060) | (2,003) |
| Taxes other than income taxes | (4,349) | (2,593) |
| Excise and export tariffs | (9,340) | (5,407) |
| Exploration expense | (146) | (69) |
| Gain on disposals and impairments of assets | 10 | 12 |
| Income from operating activities | 5,358 | 4,545 |
| Interest expense | (373) | (334) |
| Interest and dividend income | 98 | 65 |
| Equity share in income of affiliates | 236 | 182 |
| Currency translation loss | (42) | (124) |
| Other non-operating (expense) income | (75) | 61 |
| Income before income taxes | 5,202 | 4,395 |
| Current income taxes | (1,140) | (837) |
| Deferred income taxes | 44 | (196) |
| Total income tax expense | (1,096) | (1,033) |
| Net income | 4,106 | 3,362 |
| Less: net income attributable to noncontrolling interests | (104) | (133) |
| Net income attributable to OAO LUKOIL | 4,002 | 3,229 |
| Basic and diluted earnings per share of common stock attributable to OAO LUKOIL | ||
| (in U.S. dollars) | 4.72 | 3.81 |
The analysis of the principal financial indicators from the financial statements is provided below.
The following table sets forth our sales revenues by type of product for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Crude oil | ||
| Export and sales on international markets other than CIS | 12,175 | 8,275 |
| Export and sales to CIS | 513 | 781 |
| Domestic sales | 481 | 43 |
| 13,169 | 9,099 | |
| Refined products | ||
| Export and sales on international markets | ||
| Wholesale | 23,950 | 15,908 |
| Retail | 4,464 | 3,990 |
| Domestic sales | ||
| Wholesale | 2,474 | 1,645 |
| Retail | 2,499 | 1,755 |
| 33,387 | 23,298 | |
| Petrochemicals | ||
| Export and sales on international markets | 270 | 274 |
| Domestic sales | 350 | 174 |
| 620 | 450 | |
| Gas and gas products | ||
| Export and sales on international markets | 645 | 494 |
| Domestic sales | 386 | 219 |
| 1,031 | 713 | |
| Domestic sales of energy and related services | 730 | 535 |
| Other | ||
| Export and sales on international markets | 483 | 510 |
| Domestic sales | 335 | 266 |
| 818 | 776 | |
| Total sales | 49,755 | 34,861 |
The following table sets forth our sales volumes by type of product for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| Crude oil | (mbls) | |
| Export and sales on international markets other than CIS | 162,792 | 164,221 |
| Export and sales to CIS | 12,073 | 20,165 |
| Domestic sales | 14,279 | 1,231 |
| 189,144 | 185,617 | |
| Crude oil | (thousand tonnes) | |
| Export and sales on international markets other than CIS | 22,209 | 22,404 |
| Export and sales to CIS | 1,647 | 2,751 |
| Domestic sales | 1,948 | 168 |
| 25,804 | 25,323 | |
| Refined products | (thousand tonnes) | |
| Export and sales on international markets | ||
| Wholesale | 39,195 | 37,888 |
| Retail | 3,420 | 3,924 |
| Domestic sales | ||
| Wholesale | 5,129 | 4,860 |
| Retail | 3,265 | 2,804 |
| 51,009 | 49,476 | |
| Total sales volume of crude oil and refined products | 76,813 | 74,799 |
The following table sets forth our average realised sales prices for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||||
|---|---|---|---|---|
| 2010 | 2009 | |||
| (\$/bbl) | (\$/tonne) | (\$/bbl) | (\$/tonne) | |
| Average realised price international | ||||
| Crude oil (excluding CIS) | 74.79 | 548.22 | 50.39 | 369.34 |
| Crude oil (CIS) | 42.47 | 311.28 | 38.74 | 283.93 |
| Refined products | ||||
| Wholesale | 611.03 | 419.87 | ||
| Retail | 1,305.13 | 1,016.64 | ||
| Average realised price within Russia | ||||
| Crude oil | 33.69 | 246.95 | 34.84 | 255.41 |
| Refined products | ||||
| Wholesale | 482.54 | 338.46 | ||
| Retail | 765.05 | 625.79 |
During the first six months of 2010, our revenues increased by \$14,894 million, or by 42.7%, compared to the same period of 2009. Our revenues from crude oil sales increased by \$4,070 million, or by 44.7%, and revenues from sales of refined products increased by \$10,089 million, or by 43.3%. The increase in sales was due to an increase in hydrocarbon prices in the first half of 2010, compared to the first half of 2009, and the appreciation of the ruble against the U.S. dollar, which increased the U.S. dollar value of our ruble-denominated sales revenue.
Sales of crude oil and refined products on international markets, including the CIS, accounted for 86.5% of the total sales volume in the first six months of 2010, compared to 89.5% in the first six months of 2009.
The 44.7% increase in our total crude oil sales revenues was attributable primarily to growth of crude oil prices and increased sales volumes. The increase in our revenues from domestic crude oil sales was primarily due to an increase of sales volumes as a result of the termination of processing operations in Russia and Belarus, which compensated for a slight decline in domestic crude oil production. The decrease in our revenues from crude oil sales to the CIS was primarily due to the increase in crude oil prices.
In the first six months of 2010, our revenue from the wholesale of refined products outside Russia increased by \$8,042 million, or by 50.6%, compared to the same period of 2009, as a result of a 45.5% increase in the average realised price.
In the first six months of 2010, our revenue from international retail sales increased by \$474 million, or by 11.9%, compared to the same period of 2009, mainly as a result of a 28.4% increase in average retail prices.
In the first six months of 2010, our revenue from the wholesale of refined products on the domestic market increased by \$829 million, or by 50.4%, compared to the same period of the previous year, due to a 42.6% increase in the average realised price. Sales volumes increased by 269 thousand tonnes, or by 5.5%.
In the first six months of 2010, our revenue from retail sales in Russia increased by \$744 million, or by 42.4%, compared to the same period of 2009, as a result of an increase in prices and volumes.
In the first six months of 2010, our revenue from sales of petrochemical products increased by \$170 million, or by 37.8%, compared to the same period of 2009. This resulted from increased realised prices outside of Russia and increased sales volumes and realised prices, as well as the real ruble appreciation against the U.S. dollar, within Russia.
In the first six months of 2010, sales of gas and gas products amounted to \$1,031 million, an increase of 44.6% from the first six months of 2009. Gas products sales revenue increased by \$258 million, or by 65.5%, compared to the same period of 2009. Both increases were as a result of an increase in sales prices and volumes.
Natural gas sales revenue amounted to \$354 million, an increase of 14.9% compared to the same period of 2009. Our domestic natural gas sales revenue increased due to increased purchases of our gas by Gazprom, while at the same time our natural gas sales revenue outside of Russia decreased as a result of a decrease in realised selling prices.
In the first six months of 2010, our revenue from sales of electricity, heat and related services increased by \$205 million, or by 39.0%, compared to the same period of 2009. This was due to the development of our energy business since the acquisition of TGK-8 in 2008 as well as to the ruble's appreciation.
Other sales include non-petroleum sales through our retail network, other services provided and goods not related to our primary activities (such as transportation) sold by our production and marketing companies.
In the first six months of 2010, our other sales increased by \$42 million, or by 5.4%, compared to the same period of 2009. The main reason for the increase in other sales was higher non-petroleum retail revenue.
During the first six months of 2010, sales of goods and other products from our retail stations amounted to \$297 million, an increase of \$37 million from the level of the first six months of 2009. This was mainly due to an increase in such sales in Russia and Eastern Europe.
The following table provides a breakdown of our operating expenses for the periods indicated below.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Hydrocarbon extraction expenses | 1,584 | 1,267 |
| Own refining expenses | 515 | 435 |
| Refining expenses at third party and affiliated refineries | 351 | 328 |
| Expenses for crude oil transportation to refineries | 541 | 465 |
| Power generation and distribution expenses | 293 | 200 |
| Petrochemical expenses | 80 | 54 |
| Other operating expenses | 670 | 651 |
| 4,034 | 3,400 | |
| Change in operating expenses in crude oil and refined products inventory | ||
| originating within the Group(1) | (232) | (292) |
| Total operating expenses | 3,802 | 3,108 |
Note:
Compared to the first six months of 2009, operating expenses increased by \$694 million, or by 22.3%, in the first six months of 2010, which was mainly due to a general increase in operating expenses in Russia due to the real ruble appreciation against the U.S. dollar, an increase in hydrocarbon extraction expenses, expenses for crude oil transportation to refineries, refining expenses and power generation and distribution expenses.
Our extraction expenses include expenditures related to repairs of extraction equipment, labour costs, expenses on artificial stimulation of reservoirs, fuel and electricity costs, property insurance for extraction equipment and other similar costs.
In the first six months of 2010, our extraction expenses increased by \$317 million, or by 25.0%, compared to the same period of 2009. The increase was mainly a result of the real ruble appreciation against the U.S. dollar, increased expenses for power supply, artificial stimulation of reservoirs and labour costs, and an increase in other expenses. During the first six months of 2010, our average hydrocarbon extraction cost increased from \$3.25 to \$4.02 per boe, or by 23.7%, compared to the same period of 2009.
In the first six months of 2010, our refining expenses increased by \$80 million, or by 18.4%, compared to the same period of 2009.
Refining expenses at our domestic refineries increased by 23.3%, or by \$72 million, mainly as a result of the real ruble appreciation against the U.S. dollar, an increase in power supply costs and higher consumption of additives.
Refining expenses at our international refineries increased by 6.3%, or by \$8 million. This resulted from increased power supply costs.
Along with our own production of refined products, we have the ability to refine crude oil at third party and affiliated refineries both in Russia and overseas.
We did not process crude oil at third party refineries in the first six months of 2010. Nevertheless, in the first six months of 2010, refining expenses at third party and affiliated refineries increased by 7.0% compared to the same period of 2009, mainly as a result of our commencement of crude oil refining at the TRN refinery.
(1) The change in operating expenses in crude oil and refined products inventory originating within the Group includes extraction and refining expenses related to crude oil and refined products produced by the Group during the reporting period but not sold to third parties.
In the first six months of 2010, operating expenses of our petrochemical plants increased by \$26 million, or by 48.1%, compared to the same period of 2009, as a result of increased production in Russia and ruble appreciation against the U.S. dollar.
Expenses associated with crude oil transportation to refineries increased in the first six months of 2010 by \$76 million, or by 16.3%, compared to the same period of 2009, as a result of an increase in the transportation tariff rates and as a result of the real ruble appreciation in Russia.
Power generation and distribution expenses in the first six months of 2010 increased by \$93 million, or by 46.5%, compared to the same period of 2009, reflecting the expansion of our power generating business and as a result of the real ruble appreciation in Russia.
Other operating expenses include expenses of the Group's upstream and downstream enterprises that do not relate to their core activities, namely sales of transportation services and other goods, operating expenses of our gas processing plants, the costs of other services provided and goods sold by our marketing companies and operating expenses of non-core businesses of the Group.
In the first six months of 2010, our other operating expenses increased by \$19 million, or by 2.9%, compared to the same period of 2009.
Cost of purchased crude oil, gas and products increased by \$7,003 million, or by 52.8%, in the first six months of 2010, compared to the same period of 2009, as a result of an increase in international crude oil and refined products prices and an increase in volume of refined products purchases.
Cost of purchased crude oil, gas and products includes the result of hedging of international crude oil and refined products sales. In the first six months of 2010, we recognised a \$247 million gain from hedging, compared to a loss of \$542 million in the first six months of 2009.
Cost of purchased crude oil, gas and products includes purchases of natural gas and fuel oil to supply our power generation segment entities.
In the first six months of 2010, our transportation expenses increased by \$424 million, or by 18.0%, compared to the same period of 2009. This was primarily as a result of an increase in ruble denominated pipeline and railway transportation tariffs in Russia, the effect of which was magnified by the ruble appreciation against the U.S. dollar.
Our actual transportation expenses related to crude oil and refined products deliveries to various export destinations, weighted by volumes transported, changed in the first six months of 2010, compared to the same period of the previous year, as follows: crude oil pipeline tariffs increased by 26.8%, railway tariffs for refined products transportation increased by 31.0%, crude oil freight tariffs decreased by 18.1% and refined products freight tariffs increased by 7.0%.
Selling, general and administrative expenses include general business expenses, payroll costs (excluding extraction entities' and refineries' production staff costs), insurance costs (except for property insurance related to extraction and refinery equipment), costs of maintenance of social infrastructure, movement in bad debt provision and other expenses.
In the first six months of 2010, our selling, general and administrative expenses increased by \$135 million, or by 8.9%, compared to the same period of 2009. The increase was primarily as a result of the effect of ruble appreciation on selling, general and administrative expenses in Russia and an increase in our selling expenses due to an incrase in our retail sales in Russia.
Depreciation, depletion and amortisation expenses include depletion of assets fundamental to production and depreciation of other productive and non-productive assets and certain intangible assets.
Our depreciation, depletion and amortisation expenses increased by \$57 million, or by 2.8%, compared to the same period of 2009.
During the first six months of 2010, exploration expenses increased by \$77 million, or by 111.6%, compared to the same period of 2009, mainly as a result of the increase in dry hole costs. Dry hole costs increased by \$71 million to \$94 million, \$66 million of which reflected the cost of an exploratory well in Cote d'Ivoire. Dry hole costs in Russia amounted to \$28 million.
In the first six months of 2010, we recognised a net gain on disposal of assets in the amount of \$10 million, while in the first six months of 2009, gain on disposal amounted to \$12 million.
In the first six months of 2010, interest expense amounted to \$373 million, which is 11.7% more than in the same period of 2009. This was mainly a result of the discounting of the VAT recoverable by our refinery in Ukraine as a result of the restructuring of this receivable.
We have investments in equity method affiliates and corporate joint ventures. These companies are primarily engaged in crude oil exploration, production, marketing and distribution operations in the Russian Federation, crude oil production and marketing in Kazakhstan and refining operations in Europe.
Compared to the first six months of 2009, our share in income of affiliates increased by \$54 million, or by 29.7%, primarily as a result of the share in income of our exploration and production affiliates.
The following table sets forth our taxes other than income taxes paid in Russia and internationally for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| In Russia | ||
| Mineral extraction taxes | 3,723 | 2,047 |
| Social security taxes and contributions | 203 | 201 |
| Property taxes | 238 | 197 |
| Other taxes | 58 | 38 |
| Total in Russia | 4,222 | 2,483 |
| International | ||
| Mineral extraction taxes | 34 | 23 |
| Social security taxes and contributions | 48 | 31 |
| Property taxes | 18 | 15 |
| Other taxes | 27 | 41 |
| Total internationally | 127 | 110 |
| Total | 4,349 | 2,593 |
In the first six months of 2010, taxes other than income taxes increased by 67.7%, or by \$1,756 million, compared to the same period of 2009, mainly as a result of an increase in mineral extraction taxes in Russia. The increase in the Russian mineral extraction tax rate resulted from the increase in international crude oil prices. The application of a zero tax rate for crude oil produced in Timan-Pechora, and the decreased tax rate for depleted oilfields, led to a reduction in tax expense of approximately \$679 million in the first six months of 2010 and approximately \$600 million in the first six months of 2009.
We incur expenses relating to excise and export tariffs which include taxes on sales of refined products and export tariffs on the export of crude oil and refined products.
The following table sets forth our expenses incurred related to excise and export tariffs in Russia and internationally for the six months ended 30 June 2010 and 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| In Russia | ||
| Excise tax and sales taxes on refined products | 435 | 352 |
| Crude oil export tariffs | 5,363 | 2,370 |
| Refined products export tariffs | ||
| 1,752 | 927 | |
| Total in Russia | 7,550 | 3,649 |
| International | ||
| Excise tax and sales taxes on refined products | 1,732 | 1,680 |
| Crude oil export tariffs | 54 | 40 |
| Refined products export tariffs | 4 | 38 |
| Total internationally | 1,790 | 1,758 |
| Total | 9,340 | 5,407 |
Export tariffs increased by \$3,798 million, or by 112.5%, compared to the same period of 2009, primarily as a result of an increase in tariff rates in Russia as a result of the growth in international crude oil prices.
In the first six months of 2010, our total income tax expense increased by \$63 million, or by 6.1%, compared to the same period of 2009, as a result of the increase in income before income tax by \$807 million, or by 18.4%.
In the first six months of 2010, our effective income tax rate was 21.1%, compared to 23.5% in the first six months of 2009, which is higher than the maximum statutory rate for the Russian Federation (20% in the first six months of 2010 and 2009). Our effective income tax rate for the periods presented differs from the statutory income tax rate primarily due to the fact that Group companies operate in various jurisdictions, domestic and foreign currency rate differences and the incurrence of costs that are either not tax- deductible or are only deductible to a certain extent.
| Six months ended 30 June | |||
|---|---|---|---|
| 2010 | 2009 | ||
| (millions of U.S. dollars) | |||
| Net income attributable to OAO LUKOIL | 4,002 | 3,229 | |
| Add back: | |||
| Income tax expense | 1,096 | 1,033 | |
| Depreciation, depletion and amortisation | 2,060 | 2,003 | |
| Interest expense | 373 | 334 | |
| Interest and dividend income | (98) | (65) | |
| EBITDA | 7,433 | 6,534 |
EBITDA is a non-U.S. GAAP financial measure. EBITDA is defined as net income before interest, income taxes and depreciation, depletion and amortisation. We believe that EBITDA provides useful information to investors because it is an indicator of the strength and performance of our business operations, including our ability to finance capital expenditures, acquisitions and other investments and our ability to incur and service debt. While depreciation, depletion and amortisation are considered as operating costs under U.S. GAAP, these expenses primarily represent the non-cash current period allocation of costs associated with long-lived assets acquired or constructed in prior periods. EBITDA calculation is commonly used as a basis for some investors, analysts and credit rating agencies to evaluate and compare the periodic and future operating performance and value of companies within the oil and gas industry. EBITDA should not be considered in isolation as an alternative to net income, operating income or any other measure of performance under U.S. GAAP. EBITDA does not include our need to replace our capital equipment over time.
The table below represents our consolidated statements of income for the periods indicated.
| Year ended 31 December | ||||
|---|---|---|---|---|
| 2009 | 2008 | 2007 | ||
| (millions of U.S. dollars) | ||||
| Revenues | ||||
| Sales (including excise and export tariffs) | 81,083 | 107,680 | 81,891 | |
| Costs and other deductions | ||||
| Operating expenses | (7,124) | (8,126) | (6,172) | |
| Cost of purchased crude oil, gas and products | (31,977) | (37,851) | (27,982) | |
| Transportation expenses | (4,830) | (5,460) | (4,457) | |
| Selling, general and administrative expenses | (3,306) | (3,860) | (3,207) | |
| Depreciation, depletion and amortisation | (3,937) | (2,958) | (2,172) | |
| Taxes other than income taxes | (6,474) | (13,464) | (9,367) | |
| Excise and export tariffs | (13,058) | (21,340) | (15,033) | |
| Exploration expense | (218) | (487) | (307) | |
| Loss on disposals and impairments of assets | (381) | (425) | (123) | |
| Income from operating activities | 9,778 | 13,709 | 13,071 | |
| Interest expense | (667) | (391) | (333) | |
| Interest and dividend income | 134 | 163 | 135 | |
| Equity share in income of affiliates | 351 | 375 | 347 | |
| Currency translation (loss) gain | (520) | (918) | 35 | |
| Other non-operating expense | (13) | (244) | (240) | |
| Income before income taxes | 9,063 | 12,694 | 13,015 | |
| Current income taxes | (1,922) | (4,167) | (3,410) | |
| Deferred income taxes | (72) | 700 | (39) | |
| Total income tax expense | (1,994) | (3,467) | (3,449) | |
| Net income | 7,069 | 9,227 | 9,566 | |
| Less: net income attributable to non-controlling interests | (58) | (83) | (55) | |
| Net income attributable to OAO LUKOIL | 7,011 | 9,144 | 9,511 | |
| Basic and diluted earnings per share of common stock (in U.S. | ||||
| dollars) attributable to OAO LUKOIL | 8.28 | 10.88 | 11.48 |
The analysis of the principal financial indicators from the financial statements is provided below.
The following table sets forth our sales revenues by type of product for the periods indicated.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| Sales breakdown | |||
| Crude oil | |||
| Export and sales on international markets other than CIS | 18,276 | 22,382 | 18,346 |
| Export and sales to CIS | 1,638 | 1,625 | 912 |
| Domestic sales | 735 | 600 | 440 |
| 20,649 | 24,607 | 19,698 | |
| Refined products | |||
| Export and sales on international markets | |||
| Wholesale | 38,023 | 50,553 | 37,971 |
| Retail | 8,865 | 11,989 | 9,183 |
| Domestic sales | |||
| Wholesale | 3,820 | 8,049 | 5,862 |
| Retail | 4,281 | 5,823 | 3,721 |
| 54,989 | 76,414 | 56,737 | |
| Petrochemicals | |||
| Export and sales on international markets | 574 | 1,232 | 1,569 |
| Domestic sales | 514 | 880 | 733 |
| 1,088 | 2,112 | 2,302 | |
| Gas and gas products | |||
| Export and sales on international markets | 1,091 | 926 | 562 |
| Domestic sales | 548 | 985 | 831 |
| 1,639 | 1,911 | 1,393 | |
| Other products and services | 2,718 | 2,636 | 1,761 |
| Total sales | 81,083 | 107,680 | 81,891 |
The following table sets forth our sales volumes by type of product and market for the periods indicated.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (mbls) | |||
| Crude oil | |||
| Export and sales on international markets other than CIS | 305,273 | 242,784 | 268,974 |
| Export and sales to CIS | 39,106 | 31,629 | 19,879 |
| Domestic sales | 21,909 | 15,408 | 11,757 |
| 366,288 | 289,821 | 300,610 | |
| Crude oil | (thousand tonnes) | ||
| Export and sales on international markets other than CIS | 41,647 | 33,122 | 36,695 |
| Export and sales to CIS | 5,335 | 4,315 | 2,712 |
| Domestic sales | 2,989 | 2,102 | 1,604 |
| 49,971 | 39,539 | 41,011 | |
| Refined products | (thousand tonnes) | ||
| Export and sales on international markets | |||
| Wholesale | 76,885 | 67,669 | 64,394 |
| Retail | 7,863 | 8,200 | 7,910 |
| Domestic sales | |||
| Wholesale | 9,796 | 13,314 | 13,704 |
| Retail | 6,216 | 5,964 | 4,853 |
| 100,760 | 95,147 | 90,861 | |
| Total sales volume of crude oil and refined products | 150,731 | 134,686 | 131,872 |
The following table sets forth our average realised sales prices for the periods indicated.
| Year ended 31 December | ||||||
|---|---|---|---|---|---|---|
| 2009 | 2008 | 2007 | ||||
| (\$/bbl) | (\$/tonne) | (\$/bbl) | (\$/tonne) | (\$/bbl) | (\$/tonne) | |
| Average realised price | ||||||
| international | ||||||
| Crude oil (excluding CIS) | 59.87 | 438.84 | 92.19 | 675.76 | 68.21 | 499.96 |
| Crude oil (CIS) | 41.89 | 307.05 | 51.38 | 376.58 | 45.86 | 336.15 |
| Refined products | ||||||
| Wholesale | 494.55 | 747.06 | 589.66 | |||
| Retail | 1,127.44 | 1,462.14 | 1,160.90 | |||
| Average realised price | ||||||
| within Russia | ||||||
| Crude oil | 33.56 | 245.97 | 38.97 | 285.66 | 37.43 | 274.37 |
| Refined products | ||||||
| Wholesale | 389.92 | 604.55 | 427.74 | |||
| Retail | 688.74 | 976.40 | 766.67 | |||
During 2009, our revenues decreased by \$26,597 million, or by 24.7%, compared to 2008 (in 2008 revenues increased by \$25,789 million, or by 31.5%, compared to 2007). Our revenues from crude oil sales decreased by \$3,958 million, or by 16.1% (in 2008 revenues from crude oil sales increased by \$4,909 million, or by 24.9%, compared to 2007). Our revenues from sales of refined products decreased by \$21,425 million, or by 28.0% (in 2008 revenues from sales of refined products increased by \$19,677 million, or by 34.7%, compared to 2007). In 2009, the decrease in sales revenue was due to a sharp decrease in hydrocarbon prices compared to 2008. Moreover, the devaluation of the ruble against the U.S. dollar also negatively impacted our average realised prices in Russia.
In 2009, we increased crude oil production and trading, which raised the volume of our crude oil sales by 26.4% as compared to 2008. The increase in crude oil production was a result of commencement of production on the Yuzhnaya Khylchuya oil field in August 2008, from which we produced about 7.0 million tonnes in 2009, compared to 1.5 million tonnes in 2008.
In 2009, we also increased our refined product sales outside of Russia in terms of volumes by 11.7%, mainly due to commencement of processing at the ISAB refinery complex and the TRN refinery complex. In 2009, our share of production at these refineries amounted to 6.2 million tonnes and 1.5 million tonnes, respectively. In 2008, we produced 0.6 million tonnes at the ISAB refinery complex.
Sales of crude oil and refined products on international markets, including the CIS, accounted for 87.4% of the total sales volume in 2009 (compared to 84.1% in 2008 and 84.7% in 2007).
The 16.1% decrease in our total crude oil sales from 2008 to 2009 was attributable primarily to a decrease in international sales revenue. International sales revenue, which accounted for approximately 88.5% of our total crude oil sales revenue in 2009 and 91.0% in 2008, decreased by 18.3% from 2008 to 2009 as a result of a 35.1% decrease in sales prices. At the same time, the volume of international crude oil sales increased by 25.7% from 2008 to 2009 as a result of an increased crude oil trading and export from Russia. In 2009, we increased the volume of domestic sales to benefit from current market conditions.
The 24.9% increase in our total crude oil sales from 2007 to 2008 was attributable primarily to an increase in our international crude oil sales revenues (excluding CIS). This sales revenue, which accounted for approximately 91.0% of our total crude oil sales revenue in 2008 and 93.1% in 2007, increased by 22.0% primarily as a result of an increase in sales prices by 35.2%. At the same time, the volume of international crude oil sales decreased by 9.7% compared to 2007 as a result of decreased crude oil production and increased crude oil refining in Russia.
In 2009, our revenue from the wholesale of refined products outside of Russia decreased by \$12,530 million, or by 24.8%, compared to 2008, due to a 33.8% decrease in the average realised price. At the same time, the commencement of crude oil refining at the ISAB refinery complex and the TRN refinery complex and expansion of trading activities contributed to a 13.6% increase in volumes sold.
In 2009, our revenue from international retail sales decreased by \$3,124 million, or by 26.1%, compared to 2008, mainly due to a 22.9% decrease in average retail prices. Sales volumes also decreased as a result of a general negative economic situation globally.
In 2009, our revenue from the wholesale of refined products on the domestic market decreased by \$4,229 million, or by 52.5%, compared to the previous year, due to a decrease in the average realised price by 35.5%, and a decrease in volumes sold by 3,518 thousand tonnes, or by 26.4%. The decrease in volumes sold was a result of decreased domestic purchases and increased refined product exports from Russia by 7.7%.
In 2009, our revenue from retail sales in Russia decreased by \$1,542 million, or by 26.5%, compared to the 2008, due to a decrease in the average realised price. In 2009, our retail sales revenue was 52.8% of total refined products sales in Russia, compared to 42.0% in 2008.
In 2009, our revenue from export of refined products from Russia both to Group companies and third parties amounted to \$11,414 million, compared to \$16,956 million in 2008.
In 2008, our revenue from the wholesale of refined products outside Russia increased by \$12,582 million, or by 33.1%, compared to 2007, mainly as a result of an increase in the average realised price.
In 2008, our revenue from international retail sales increased by \$2,806 million, or by 30.6%, compared to 2007, mainly as a result of an increase in average retail prices by 25.9%. The increase of retail sales volumes outside Russia amounted to 290 thousand tonnes, or 3.7%. This increase was attributable to the expansion of our retail network as a result of our acquisition of retail filling stations in Turkey, retail filling stations and storage facilities in Bulgaria in 2008 and retail filling stations in seven European countries in the second quarter of 2007.
Our international retail sales include supplies of refined products to third party retail networks under long-term contracts with pricing similar to retail pricing.
In 2008, our revenue from the wholesale of refined products on the domestic market increased by \$2,187 million, or by 37.3%, compared to the previous year, as a result of an increase in the average realised price by 41.3%.
In 2008, our revenue from retail sales in Russia increased by \$2,102 million, or by 56.5%, compared to 2007, as a result of an increase both in sales volumes and prices. Revenue from retail sales was 42.0% of total refined products sales in Russia in 2008 (in 2007 – 38.8%).
In 2009, our revenue from sales of petrochemical products decreased by \$1,024 million, or by 48.5%, compared to 2008. This resulted from a decrease in prices by 35.8% and a decrease in sales volumes by 19.7%. The decrease in volumes resulted from general overhauls at our Russian plants and a temporary shutdown of our petrochemical plant Karpatnaftochim Ltd. in Ukraine, which was stopped for modernisation and construction of a chlorine and caustic production line in May 2008 and resumed operations in September 2010.
In 2008, our revenue from sales of petrochemical products decreased by \$190 million, or by 8.3%, compared to 2007. This resulted from a decrease in sales volumes by 15.5%, and occurred despite the 8.6% increase in prices. The decrease in volumes resulted from a temporary shutdown of our petrochemical plant Karpatnaftochim Ltd., Ukraine, as in May 2008, this plant was shut down for modernisation and construction of a chlorine and caustic production line. Moreover, the overall negative situation on the world petrochemical market led to a decrease of sales volumes.
In 2009, sales of gas and gas refined products decreased by \$272 million, or by 14.2%, compared to 2008. Gas products sales revenue decreased by \$158 million, or by 13.2%, primarily as a result of a decrease in prices. Natural gas sales revenue amounted to \$571 million, representing a decrease of 17.2%, compared to 2008. Decreases in domestic sales volumes and selling prices were partly compensated by an increase in realised selling price in Uzbekistan.
Our major purchaser of natural gas produced in the Russian Federation is Gazprom. In 2009, we sold 5,936 million cubic metres of natural gas to Gazprom (7,856 million cubic metres in 2008). The average realised price decreased by 21.6% to \$33.4 per 1,000 cubic metres as a result of the ruble devaluation.
In 2008, sales of gas and gas products amounted to \$1,911 million, which is an increase of 37.2% compared to 2007. This was as a result of an increase in gas products and natural gas sales revenues. Gas products sales revenue increased by \$215 million, or by 21.9%, compared to 2007, mainly as a result of an increase in prices for gas products both in Russia and abroad. Natural gas sales revenue amounted to \$690 million (an increase of 77.4% compared to 2007). This increase was a result of the commencement of natural gas production in Uzbekistan and Azerbaijan, and an increase in average realised prices in Russia.
Our major purchaser of natural gas produced in Russia is Gazprom. In 2008, we sold 7,856 mmcm of natural gas to Gazprom (7.2 bcm in 2007), and the average realised price increased by 2.9% to \$42.6 per mcm.
In 2009, our other sales increased by \$82 million, or by 3.1%. The increase was a result of scaling up our power generating and distribution sector, which resulted from the acquisition of TGK-8 in May 2008. The increase was partially offset by a decrease in other sales outside of Russia, primarily through retail stations and transportation services, and by the effect of devaluation of the ruble in Russia. During 2009, sales of goods and other products from our retail stations amounted to \$568 million, representing a decrease of \$45 million from the level of 2008.
This was mainly attributable to the overall decrease of such sales outside of Russia as a result of the adverse macroeconomic environment.
During 2008, sales of goods and other products from our retail outlets amounted to \$613 million, an increase of \$188 million above the level of 2007. This was mainly attributable to the expansion of our retail network.
We continued to develop our electric power business. Related sales increased by \$528 million, compared to 2007, mainly as a result of the acquisition of TGK-8.
As a result, in 2008, other sales increased by \$875 million, or 49.7%.
The following table provides a breakdown of our operating expenses for the periods indicated below.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| Hydrocarbon extraction expenses | 2,787 | 3,208 | 2,757 |
| Own refining expenses | 923 | 1,115 | 880 |
| Refining expenses at third party refineries | 713 | 439 | 242 |
| Excise included in processing fee paid to third party refineries(1) | 54 | 116 | 158 |
| Petrochemical expenses | 127 | 235 | 272 |
| Expenses for crude oil transportation to refineries | 955 | 1,072 | 848 |
| Other operating expenses | 1,781 | 1,691 | 1,271 |
| 7,340 | 7,876 | 6,428 | |
| Change in operating expenses in crude oil and refined products | |||
| inventory originated within the Group(2) | (216) | 250 | (256) |
| Total operating expenses | 7,124 | 8,126 | 6,172 |
Notes:
(2) The change in operating expenses in crude oil and refined products inventory originating within the Group includes extraction and refining expenses related to crude oil and refined products produced by the Group during the reporting period but not sold to third parties.
Compared to 2008, operating expenses decreased by \$1,002 million, or by 12.3%, in 2009, which is mainly explained by a general decrease in operating expenses in Russia due to the ruble devaluation. At the same time, refining expenses at third party and affiliated refineries increased significantly due to the commencement of refining crude oil at the ISAB refinery complex at the end of 2008 and at the TRN refinery in September 2009.
In 2009, our extraction expenses decreased by \$421 million, or by 13.1%, compared to 2008, despite increased crude oil production by 2.5% and an increase in expenses for power supply. The decrease was mainly attributable to the real ruble devaluation against the U.S. dollar. Our average hydrocarbon extraction cost decreased from \$4.12 to \$3.56 per boe, or by 13.6%, compared to 2008.
In 2008, our extraction expenses increased by \$451 million, or by 16.4%, compared to 2007. The increase resulted from the effect of the real ruble appreciation against the U.S. dollar, increased expenses for power supply, materials, artificial stimulation of reservoirs and labour. Our average hydrocarbon extraction cost per boe increased from \$3.58 to \$4.12, or by 15.1%, compared to 2007.
(1) As a result of amendments to Russian tax legislation effective from 1 January 2007, the responsibility to pay excises on refined products (other than straight-run gasoline) was transferred from traders and retailers to refineries. Therefore, excises are included in processing fees.
In 2009, our refining expenses decreased by \$192 million, or by 17.2%, compared to 2008.
Refining expenses at our domestic refineries decreased by 14.2%, or by \$111 million, mainly as a result of the devaluation of the ruble against the U.S. dollar and the implementation of our cost cutting program beginning in the fourth quarter of 2008. The decrease in refining expense was offset in part by an increase in power supply and overhaul costs.
Refining expenses at our international refineries decreased by 24.3%, or by \$81 million, compared to 2008. This resulted mainly from a decrease in the cost of power supply at our refinery in Bulgaria. In 2009, we produced energy from our own resources, while, in 2008, we purchased gas for this purpose from third parties. In addition, the decrease in production and changes in the exchange rates of the local currencies in jurisdictions in which we operate to the U.S. dollar contributed to the decrease in our refining expenses abroad.
In 2008, refining expenses increased by \$235 million, or by 26.7%, compared to 2007.
Refining expenses at our domestic refineries increased by 19.8%, or by \$129 million, mainly as a result of increased expenses for power supply, real ruble appreciation against the U.S. dollar and increased production volumes.
Refining expenses at our international refineries increased by 46.5%, or by \$106 million. This resulted mainly from increased expenses for power supply, the effect of appreciation of the exchange rates of the Romanian and Bulgarian currencies against the U.S. dollar, and an increase in production volumes mainly as a result of commencement of operations at the Odessa refinery after a wide-scale upgrade.
We doubled our processing volumes from 2008 to 2009 as a result of the commencement of crude oil refining at the ISAB refinery complex and the TRN refinery. However, this was partially offset by a decrease in processing costs and a decrease in volumes in Russia and Belarus. As a result, in 2009 refining expenses at third party and affiliated refineries increased by 62.4% compared to 2008.
In 2008, refining expenses at third party and affiliated refineries increased by 81.4% compared to 2007, as a result of increased refining costs in Russia that are linked to crude oil prices. Increased refining volumes in Belarus and commencement of crude oil refining at the ISAB refinery complex in December 2008 also contributed to this increase in refining expenses.
In 2009, operating expenses of our petrochemical companies decreased by \$108 million, or by 46.0%, compared to 2008, due to a general decrease of production volumes attributable to the suspension of operations at our Ukrainian petrochemical plant Karpatnaftochim Ltd. for modernisation and the construction of a chlorine and caustic production line.
In 2008, operating expenses of our petrochemical companies decreased by \$37 million, or by 13.6%, compared to 2007, due to a decrease in production volumes. The decrease resulted from a temporary shutdown of our Karpatnaftochim petrochemical plant in Ukraine. In May 2008, this plant was shut down for modernisation and construction of a chlorine and caustic production line.
In 2009, expenses for crude oil transportation to refineries decreased by \$117 million, or by 10.9%, compared to 2008, due to a decrease in transportation tariffs as a result of a real ruble devaluation in Russia and an increase in the proportion of crude oil we purchased from third parties. The price of purchased crude oil typically includes transportation costs, and crude oil is generally purchased from a source geographically closer to the destination refinery than crude oil from our own production.
Crude oil transportation to refineries increased in 2008 by \$224 million, or by 26.4%, compared to 2007, due to an increase in transportation tariffs and volumes transported.
In 2009, our other operating expenses increased by \$90 million, or by 5.3%, compared to 2008. The increase was a result of scaling up our power generating and distribution sector, which resulted from our acquisition of TGK-8 in May 2008. However, this was partially offset by the ruble devaluation, the decrease in expenses related to other sales through petrol stations and transportation services outside of Russia.
In 2008, our other operating expenses increased by \$420 million, or by 33.0%, compared to 2007. This was a result of a general increase in other sales including growth of transportation and other services provided by the Group internationally. Approximately half of the increase in other operating expenses was attributable to changes in the Group structure, mainly to the acquisition of TGK-8 in May 2008.
Cost of purchased crude oil, gas and products decreased by \$5,874 million in 2009, or by 15.5%, compared to 2008, due to a decrease in international crude oil and refined products prices. The effect of decreased prices was partly offset by an increase in purchase volumes due to scaling up trading operations outside of Russia, especially in the fourth quarter of 2009.
Cost of purchased crude oil, gas and products includes the result of hedging of international crude oil and refined products sales. In 2009, we recognised a \$781 million loss from hedging, compared to a \$902 million gain in 2008.
Cost of purchased crude oil, gas and products increased by \$9,869 million in 2008, or by 35.3%, compared to 2007, due to increases in international crude oil and refined products prices and an increase in volumes of crude oil purchases.
Cost of purchased crude oil, gas and products includes the result of hedging of international crude oil and refined products sales. In 2008, we recognised a \$902 million gain from hedging, compared to a loss of \$575 million in 2007.
Cost of purchased crude oil, gas and products in 2009 and 2008 included purchases of natural gas and fuel oil to supply our power generation segment entities.
In 2009, our transportation expenses decreased by \$630 million, or by 11.5%, compared to 2008. This was primarily due to a decrease in freight rates and railway transportation tariffs in Russia. Ruble denominated transportation tariffs in Russia increased in 2009, but this increase was offset by the ruble devaluation.
Our actual transportation expenses related to crude oil and refined products deliveries to various export destinations, weighted by volumes transported, changed in 2009, compared to the previous year, as follows: crude oil pipeline tariffs increased by 8.9%, railway tariffs for refined products transportation decreased by 10.9%, crude oil and refined products freight rates decreased by 42.3% and 50.1%, respectively.
In 2008, our transportation expenses increased by \$1,003 million, or by 22.5%, compared to 2007. This was due to an increase in transportation tariffs and an overall increase in refined products sales volumes in Russia and internationally.
Our actual transportation expenses related to crude oil and refined products deliveries to various export destinations, weighted by volumes transported, changed in 2008, compared to the previous year, as follows: crude oil and refined products freight rates increased by 15.7% and 20.4%, respectively; crude oil pipeline tariffs increased by 15.9%; railway tariffs for refined products transportation increased by 13.6%.
In 2009, our selling, general and administrative expenses decreased by \$554 million, or by 14.4%, compared to 2008. The decrease was primarily due to the devaluation of the ruble, partially offset by the increase of expenses for bad debt provisioning and the effect of changes in the Group's structure.
In 2008, our selling, general and administrative expenses increased by \$653 million, or by 20.4%, compared to 2007. The growth was mainly a result of real ruble appreciation, expansion of our activities both in Russia and internationally, and a corresponding increase in selling expenses.
Our depreciation, depletion and amortisation expenses increased by \$979 million, or by 33.1%, compared to 2008. The increase was a result of our capital expenditures and the corresponding increase in depreciable assets, in particular due to commencing production at the Yuzhnaya Khylchuya oil field.
Our depreciation, depletion and amortisation expenses increased by \$786 million, or by 36.2%, compared to 2007. The increase was a result of the Company's capital expenditures and the corresponding increase in depreciable assets, in particular due to putting the Yuzhnaya Khylchuya oil field into production. Besides, the decrease of our proved reserves resulted in an increase in depletion of our oil and gas producing assets.
During 2009, exploration expenses decreased by \$269 million, or by 55.2%, compared to 2008, primarily due to the decrease in dry hole costs by \$200 million to \$117 million. In 2009, we charged to expense the cost of a dry well in Saudi Arabia totalling \$56 million. Also, we expensed dry hole costs related to our project in Azerbaijan in the amount of \$9 million. In 2009, we charged to expense \$30 million as idle costs related to first phase of drilling an exploratory well in Ghana. Dry hole costs in Russia amounted to \$22 million, primarily relating to Western Siberia.
During 2008, exploration expense increased by \$180 million, or by 58.6%, compared to 2007, primarily due to the increase in dry hole costs by \$174 million to \$317 million.
In 2008, we charged to expense the costs of three dry wells in Saudi Arabia totalling \$122 million. The amount of \$93 million was charged to expense in the fourth quarter of 2008 in regard of our project Yalama in Azerbaijan. Also, we expensed dry hole costs related to our projects in Kazakhstan and Colombia in amounts of \$20 million and \$45 million, respectively.
In 2009, loss on disposals and impairments of assets amounted to \$381 million, compared to \$425 million in 2008. As a result of an impairment test of exploration and production assets performed in December 2009, we recognised an impairment loss of \$238 million for certain properties in the Timan-Pechora and Central European regions of Russia. We also recognised an impairment loss in the amount of \$63 million related to our project in Iran due to our inability to undertake further works because of the threat of economic sanctions of the U.S. Government. In addition, we charged to expense \$33 million related to the realisation of the Atashsky project in Kazakhstan.
In 2008, loss on disposals and impairments of assets amounted to \$425 million, compared to \$123 million in 2007.
In 2008, the loss included \$156 million related to impairment of certain oil and gas assets located in the Timan-Pechora region. The impairment resulted from a decrease in crude oil reserves due to revisions to the geological models. The loss also included \$171 million related to impairment of goodwill and certain retail assets in the United States and Serbia due to the change in the economic environment.
The losses included the financial result from disposals of a number of non-core assets and individually insignificant impairments of non-performing business units.
2009 vs. 2008
In 2009, interest expense amounted to \$667 million, which is a 70.6% increase from the previous year. This was a result of the termination of interest capitalisation related to assets in Timan-Pechora after completion of their construction and a general increase in our indebtedness and cost of borrowings due to the unfavorable situation on capital markets.
In 2008, interest expense amounted to \$391 million, which is \$58 million, or 17.4%, more than in the previous year. In 2008, interest expense was affected by termination of interest capitalisation related to certain assets in Timan-Pechora due to completion of their construction and a general increase in our indebtedness.
2009 vs. 2008
Compared to 2008, our share in income of affiliates decreased by \$24 million, or by 6.4%.
2008 vs. 2007
Compared to 2007, our share in income of affiliates in 2008 increased by \$28 million, or by 8.1%.
2009 vs. 2008
In 2009, currency translation loss amounted to \$520 million, of which \$437 million is attributable to the Russian segment of the Group, and \$83 million to the international segment.
In 2008, currency translation loss amounted to \$918 million, of which \$631 million relates to the Russian segment of the Group, and \$287 million to the international segment. Those losses mostly relate to the fourth quarter results.
The main reasons for the losses in 2009 and 2008 were a decrease in the U.S. dollar value of ruble-denominated accounts receivable, advances, VAT recoverable, other taxes prepaid (less value of ruble-denominated liabilities), and fluctuations in the euro-U.S. dollar exchange rate, which affected results of some operations performed by the Group outside of Russia.
The following table sets forth our taxes other than income taxes paid in Russia and internationally for the periods indicated.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| In Russia | |||
| Mineral extraction taxes | 5,399 | 12,267 | 8,482 |
| Social security taxes and contributions | 330 | 435 | 385 |
| Property tax | 438 | 374 | 284 |
| Other taxes | 92 | 180 | 105 |
| Total in Russia | 6,259 | 13,256 | 9,256 |
| International | |||
| Mineral extraction taxes | 53 | – | – |
| Social security taxes and contributions | 69 | 77 | 57 |
| Property tax | 32 | 31 | 29 |
| Other taxes | 61 | 100 | 25 |
| Total international | 215 | 208 | 111 |
| Total | 6,474 | 13,464 | 9,367 |
In 2009, taxes other than income taxes decreased by 51.9%, or by \$6,990 million, compared to 2008, mainly due to a decrease in mineral extraction taxes in Russia, as a result of a decrease in the tax rate resulting from the low level of crude oil prices. Moreover, the change in the tax rate calculation effective from 1 January 2009 led to an approximately \$754 million decrease in the extraction taxes. The effect of the application of the zero tax rate for crude oil produced mainly in Timan-Pechora and Western Siberia and the decreased rate for depleted oilfields led to an approximately \$961 million tax reduction.
In 2008, taxes other than income taxes increased by 43.7%, or by \$4,097 million, compared to 2007, mainly as a result of an increase in mineral extraction tax resulting from an increase in the crude oil extraction tax rate by 38.5%.
The following table sets forth our expenses incurred related to excise and export tariffs in Russia and internationally for the periods indicated.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| In Russia | |||
| Excise tax and sales taxes on refined products | 763 | 956 | 734 |
| Export tariffs | 6,251 | 11,911 | 8,160 |
| Refined products export tariffs | 2,306 | 4,119 | 2,654 |
| Total in Russia | 9,320 | 16,986 | 11,548 |
| International | |||
| Excise tax and sales taxes on refined products | 3,524 | 3,984 | 3,468 |
| Export tariffs | 107 | 143 | – |
| Refined products export tariffs | 107 | 227 | 17 |
| Total international | 3,738 | 4,354 | 3,485 |
| Total | 13,058 | 21,340 | 15,033 |
Despite the increase in crude oil and refined products export volumes, export tariffs decreased by \$7,629 million, or by 46.5%, in 2009 compared to 2008, due to the decrease in tariff rates in Russia because of the decline in crude oil prices. The decrease in excises in Russia was due to the ruble devaluation. Despite the fact that the changes in the Group structure contributed \$101 million to the excise increase, our international excises decreased by \$460 million, or by 11.5%, compared to 2008. The decrease was a result of the decrease in sales volumes of refined products subject to excise taxes and decrease in excise rates, caused mainly by the changes of the exchange rates of local currencies to the U.S. dollar.
Despite a decrease in crude oil export volumes, export tariffs increased by \$5,569 million, or by 51.4%, compared to 2007, as a result of an increase in tariff rates.
The growth in international excise expenses was mainly a result of the increase in volumes sold due to the expansion of our retail network in Europe and the appreciation of the Euro against the U.S. dollar, as the excise rates in most European countries we operate in are either denominated in Euro or tied to it.
In 2009, our total income tax expense decreased by \$1,473 million, or by 42.5%, compared to 2008, due to the decrease in income before income tax by \$3,631 million, or by 28.6%.
In 2009, our effective income tax rate was 22.0%, compared to 27.3% in 2008, which is higher than the maximum statutory rate for the Russian Federation (20% in 2009 and 24% in 2008). This was principally due to the fact that Group companies operate in various jurisdictions and that some costs incurred during the period are not tax-deductible or are only deductible to a certain extent.
In 2008, our total income tax expense increased by \$18 million, or by 0.5%, compared to 2007, due to a decrease in income before income tax by \$652 million, or 5.0%, and recalculation of deferred taxes in Russia and Kazakhstan.
Starting from 1 January 2009, the income tax rate in the Russian Federation was decreased from 24.0% to 20.0%. Moreover, starting from 2009, the tax burden is reduced in Kazakhstan. As a result of this amendment we recalculated the deferred tax assets and liabilities as at 31 December 2008 at a reduced income tax rate, which resulted in \$299 million of income tax benefit in 2008 that we recognised in the fourth quarter.
In 2008, our effective income tax rate was 27.3%, compared to 26.5% in 2007, which is higher than the maximum statutory rate for the Russian Federation (24.0%). This was principally due to the fact that Group companies operate in various jurisdictions and that some costs incurred during the period are not tax-deductible or are only deductible to a certain extent.
| Year ended 31 December | ||||
|---|---|---|---|---|
| 2009 | 2008 | 2007 | ||
| (millions of U.S. dollars) | ||||
| Net income | 7,011 | 9,144 | 9,511 | |
| Add back: | ||||
| Income tax expense | 1,994 | 3,467 | 3,449 | |
| Depreciation, depletion and amortisation | 3,937 | 2,958 | 2,172 | |
| Interest expense | 667 | 391 | 333 | |
| Interest and dividend income | (134) | (163) | (135) | |
| EBITDA | 13,475 | 15,797 | 15,330 |
Changes in Net Cash Flow – Six Months Ended 30 June 2010 Compared to Six Months Ended 30 June 2009
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Net cash provided by operating activities | 6,259 | 3,140 |
| Net cash used in investing activities | (3,333) | (4,909) |
| Net cash (used in) provided by financing activities | (1,379) | 1,114 |
Our primary source of cash flow is funds generated from our operations. During the first six months of 2010, cash generated by operating activities was \$6,259 million, or a 99.3% increase compared to the same period of 2009, mainly due to an increase in sales revenues.
We believe that our working capital will be sufficient for our present requirements.
In the first six months of 2010, our capital expenditures increased by \$150 million, or by 4.9%, compared to the same period of 2009 (for a detailed analysis of capital expenditures see "– Analysis of Capital Expenditures for Six Months Ended 30 June 2010 Compared to Six Months Ended 30 June 2009").
In the first six months of 2010, cash used in investing activities decreased by \$1,576 million, or by 32.1%, compared to the same period of 2009 due to a decrease in payments for acquisitions.
In the first six months of 2010, we made an advance payment of \$235 million for potential acquisitions of downstream assets in Russia.
In the first six months of 2010, net movements of short-term and long-term debt generated an outflow of \$1,362 million, compared to an inflow of \$1,138 million in the first six months of 2009.
See "Business – Recent Developments" for more information regarding our financing activities since 30 June 2010.
We may seek additional financing in the near future in an amount similar to the amount of the issuance through the placement of additional bank or capital markets financing.
The following table sets forth our capital expenditures for the six months ended 30 June 2010 and 30 June 2009, respectively.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Capital expenditures(1) | ||
| Exploration and production | ||
| Russia | 1,838 | 1,899 |
| International | 552 | 342 |
| Total exploration and production | 2,390 | 2,241 |
| Refining, marketing and distribution | ||
| Russia | 379 | 343 |
| International | 153 | 264 |
| Total refining, marketing and distribution | 532 | 607 |
| Chemicals | ||
| Russia | 12 | 6 |
| International | 31 | 55 |
| Total chemicals | 43 | 61 |
| Power generation and distribution | 200 | 111 |
| Other | 25 | 20 |
| Total capital expenditures | 3,190 | 3,040 |
| Acquisitions of subsidiaries and minority shareholding interest(2) | ||
| Exploration and production | ||
| Russia | 3 | 197 |
| International | – | – |
| Total exploration and production | 3 | 197 |
| Refining, marketing and distribution | ||
| Russia | 235 | 206 |
| International | – | 1,565 |
| Total refining, marketing and distribution | 235 | 1,771 |
| Power generation and distribution | 1 | 137 |
| Less cash acquired | – | (9) |
| Total acquisitions | 239 | 2,096 |
Notes:
(1) Including non-cash transactions and prepayments.
(2) Including prepayments related to acquisitions of subsidiaries and minority shareholding interests and non-cash transactions.
During the first six months of 2010, our capital expenditures, including non-cash transactions, amounted to \$3,190 million, an increase of 4.9% from the first six months of 2009. Capital expenditures in our exploration and production segment increased by \$149 million, or by 6.6%, compared to the same period of 2009. The exploration and production capital expenditures in new regions decreased by \$138 million due to the completion of several projects, particularly in Timan-Pechora and the Caspian region.
The table below shows our exploration and production capital expenditures in new production regions in the six months ended 30 June 2010 and 2009.
| Six months ended 30 June | ||
|---|---|---|
| 2010 | 2009 | |
| (millions of U.S. dollars) | ||
| Northern Timan-Pechora | 129 | 233 |
| Yamal | 91 | 82 |
| Caspian region(1) | 165 | 208 |
| Total | 385 | 523 |
Note:
(1) Russian and international projects.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| Net cash provided by operating activities | 8,883 | 14,312 | 10,881 |
| Net cash used in investing activities | (8,923) | (13,559) | (9,715) |
| Net cash provided by (used in) financing activities | 87 | 763 | (1,098) |
Our primary source of cash flow is funds generated from our operations. During 2009, cash generated by operating activities was \$8,883 million, or 37.9% less than in 2008, mainly due to the decrease in sales revenues. In 2009, our operating cash inflows were affected by an increase of working capital by \$2,483 million, compared to 1 January 2009. This was mainly caused by:
At the same time, the negative effect from the above mentioned factors was partly offset by a \$274 million net decrease in other assets and liabilities.
During 2008, cash generated by operating activities was \$14,312 million, an increase of 31.5% compared to 2007. In 2008, our operating cash inflows were supported by a decrease of working capital by \$2,699 million, compared to 1 January 2008. This was mainly caused by:
The positive effect of the above mentioned factors was partly offset by the net increase of other assets and liabilities of \$237 million.
In 2009, the decrease in cash used in investing activities compared to 2008 mainly resulted from a decrease in cash spent on capital expenditures. In 2009, our capital expenditures decreased by \$4,042 million, or by 38.4%, compared to 2008.
In 2009, we paid the remaining amount of \$1,066 million for the acquisition of a 49% stake in ISAB and \$127 million for the remaining interests in TGK-8. We also made a payment of approximately \$600 million as part of the acquisition of a 45% interest in TRN, settled a \$305 million liability within the acquisition of Akpet group and paid \$235 million for increasing our share in RITEK. We also paid \$300 million as a first instalment of the acquisition of the remaining 46% interest in LUKARCO. Other payments for acquisitions refer to advances for downstream assets in Russia.
In 2008, the increase in cash used in investing activities mainly resulted from an increase in cash paid for acquisitions of subsidiaries and cash spent on capital expenditures.
In 2008, we made a final payment of \$157 million and two contingent payments totalling \$200 million for the acquisition of upstream assets in Uzbekistan (SNG Holdings Ltd.). During 2008, we paid \$64 million for the increase in our share of the share capital of our refinery in Nizhny Novgorod and \$1,222 million as the cash part of the consideration for the TGK-8 acquisition. As first instalments for the acquisitions of the 49% stake in the ISAB refinery complex and the 100% stake in the Akpet retail filling stations in Turkey we paid \$762 million and \$250 million, respectively. We also paid \$343 million and \$221 million for acquisitions of retail filling stations in Bulgaria and retail filling station networks in Russia, respectively. The other payments were primarily advances related to acquisitions of marketing assets in Russia and abroad.
In 2007, cash flows from investing activities included \$1,155 million of cash received from the sale of our 50% interest in Caspian Investments Resources Limited (Caspian Investments Resources).
In 2008, capital expenditures increased by \$1,454 million, or by 16.0%, compared to 2007.
During 2007, the Company paid \$255 million for the acquisition of licences for crude oil exploration and production on two oil fields in the Komi Republic. Payments for acquisition of licences in 2008 were \$12 million.
2009 vs. 2008
In 2009, net movements of short-term and long-term debt generated an inflow of \$1,489 million, compared to an inflow of \$2,311 million in 2008.
In December 2009, we issued stock exchange bonds worth 10 billion rubles. The bonds will mature after 1,092 days and have a coupon period of 182 days. The coupon rate is set at 9.20% per annum.
In November 2009, the Issuer issued two-tranche non-convertible bonds totalling \$1.5 billion. The first tranche totalling \$900 million with a coupon yield of 6.375% per annum was placed with a maturity of 5 years at a price of 99.474% of the bond's face value. The resulting yield to maturity for the first tranche is 6.500%. The second tranche totalling \$600 million with a coupon yield of 7.250% per annum was placed with a maturity of 10 years at a price of 99.127% of the bond's face value. The resulting yield to maturity for the second tranche is 7.375%. These tranches have a half year coupon period.
In August 2009, we entered into a \$1.2 billion syndicated term loan facility. This three-year loan facility bears interest at LIBOR plus 4% per annum and is secured by proceeds from our oil export contracts. The proceeds from this loan facility were used to repay a €1,000 million loan from Gazprombank, which we borrowed in February 2009.
In August 2009, we issued stock exchange bonds in the amount of 25 billion rubles with a coupon rate of 13.35% per annum. The bonds will mature in three years. The proceeds from the issuance were used to repay the majority of our \$500 million and 17 billion ruble loans from Sberbank, which we borrowed in February 2009.
In June 2009, we completed offering of three series of issued stock exchange bonds, altogether worth 15 billion rubles. Coupon rate for each of the issues was set at 13.5%. The bonds will mature in 364 days.
In February 2009, we received short-term loans of \$500 million and 17 billion rubles from Sberbank to finance our working capital. Also, in the first quarter of 2009, we received a long-term loan of €1,000 million from Gazprombank. We have since repaid these loans.
In 2008, net movements of short-term and long-term debt generated an inflow of \$2,311 million, compared to an inflow of \$616 million in 2007.
Net inflows in 2008 included long-term loans of \$889 million received from ConocoPhillips as its part of financing of our joint venture in the Timan-Pechora region. In 2007, we received \$672 million from ConocoPhillips as its part of financing the joint venture.
Cash inflows in 2008 included \$235 million related to the sale of 7,449 LPG and oil tank-wagons, which were leased back by the Group under a capital lease agreement.
During 2007, as a result of the settlement of a stock-based compensation plan, employees purchased 8.8 million shares held by the Group as treasury stock at the grant price for \$129 million and resold approximately 1.5 million shares back to the Group for \$134 million.
The following table sets forth our capital expenditures for the periods indicated.
| Year ended 31 December | |||
|---|---|---|---|
| 2009 | 2008 | 2007 | |
| (millions of U.S. dollars) | |||
| Capital expenditures(1) | |||
| Exploration and production | |||
| Russia | 3,916 | 6,813 | 6,391 |
| International | 771 | 1,076 | 871 |
| Total exploration and production | 4,687 | 7,889 | 7,262 |
| Refining, marketing and distribution | |||
| Russia | 832 | 1,377 | 1,177 |
| International | 559 | 773 | 645 |
| Total refining, marketing and distribution | 1,391 | 2,150 | 1,822 |
| Chemicals | |||
| Russia | 13 | 23 | 73 |
| International | 100 | 98 | 98 |
| Total chemicals | 113 | 121 | 171 |
| Other | 343 | 429 | 117 |
| Total capital expenditures | 6,534 | 10,589 | 9,372 |
| Acquisitions of subsidiaries and minority shareholding interest(2) | |||
| Exploration and production | |||
| Russia | 244 | 4 | 77 |
| International | 300 | 357 | 357 |
| Total exploration and production | 544 | 361 | 434 |
| Refining, marketing and distribution | |||
| Russia | 213 | 636 | 685 |
| International | 2,069(3) | 1,397 | 511 |
| Total refining, marketing and distribution | 2,282 | 2,033 | 1,196 |
| Other | 138 | 3,194(4) | 38 |
| Less cash acquired | (19) | (190) | (102) |
| Total acquisitions | 2,945 | 5,398 | 1,566 |
Notes:
(1) Including non-cash transactions and prepayments.
(2) Including prepayments related to acquisitions of subsidiaries and minority shareholding interest and non-cash transactions.
(3) Including \$100 million of non-cash part of consideration for acquisition of TRN.
(4) Including \$1,969 million of non-cash part of consideration for acquisition of TGK-8.
During 2009, our capital expenditures, including non-cash transactions, amounted to \$6,534 million, which is 38.3% less than in 2008. The decrease was in compliance with our plan to reduce capital expenditures in 2009 because of the economic downturn. Capital expenditures in our exploration and production segment decreased by \$3,202 million, or by 40.6%, compared to 2008. The exploration and production capital expenditures in new regions decreased by \$1,411 million mainly due to commencement of commercial production on the Yuzhnaya Khylchuya oil field. In the traditional exploration and production regions of Western Siberia and European Russia capital expenditures decreased by \$1,004 million and \$555 million, or by 33.6% and 32.2%, respectively. The decrease in the capital expenditures in our international exploration projects (excluding the Caspian region) amounted to \$232 million, or 24.2%, and was primarily related to our projects in Kazakhstan and Saudi Arabia.
During 2008, our capital expenditures, including non-cash transactions, amounted to \$10,589 million, which is 13.0% more than in 2007. The growth mainly resulted from expenditures in our exploration and production segment, which increased by \$627 million, or by 8.6%, compared to 2007. Our exploration and production capital expenditures in new regions decreased by \$414 million, or by 14.4%. The capital expenditures in the traditional exploration and production region of Western Siberia increased by \$570 million, or by 26.2% mainly as a result of an increase in production drilling. The capital expenditures in European Russia increased by \$292 million, or 20.4%, as a result of an increase in exploratory drilling and investments in pipelines and machinery. An increase in the capital expenditures in our overseas exploration projects (excluding the Caspian region) amounted to \$179 million, or 22.9%, and was primarily related to our projects in Kazakhstan and Saudi Arabia. The increase in the other segment was due to expenditures of TGK-8.
The table below shows our exploration and production capital expenditures in new oil production regions.
| Year ended 31 December | ||||||
|---|---|---|---|---|---|---|
| 2009 | 2008 | 2007 | ||||
| (millions of U.S. dollars) | ||||||
| Northern Timan-Pechora | 385 | 1,878 | 2,357 | |||
| Yamal | 131 | 161 | 75 | |||
| Caspian region(1) | 532 | 420 | 441 | |||
| Total | 1,048 | 2,459 | 2,873 |
Note:
(1) Russian and international projects.
We own and operate refineries in Bulgaria (LUKOIL Neftochim Bourgas AD) and Romania (PETROTEL-LUKOIL S.A.). As a result of Bulgaria and Romania joining the European Union in 2007, LUKOIL Neftochim Bourgas AD and PETROTEL-LUKOIL S.A. are required to upgrade their refineries to comply with the requirements of European Union legislation in relation to the quality of produced petroleum products and environmental protection. These requirements are stricter than those that previously existed under Bulgarian and Romanian legislation. We estimate the amounts of future capital commitment required to upgrade LUKOIL Neftochim Bourgas AD and PETROTEL-LUKOIL S.A. to be approximately \$25 million and \$33 million, respectively.
Under the terms of existing exploration and production licence agreements in Russia, we are required to fulfill certain operations on the fields covered by those licences, including oil and gas exploration, well drilling and field development, and we also have commitments to reach a certain level of production on those fields. Management believes that our approved annual capital expenditure budgets fully cover all the requirements of these licence obligations.
We signed a three-year agreement for the years 2010-2012 for drilling services with OOO Eurasia Drilling Company. The volume of these services is based on our capital construction programme, which is re-evaluated on an annual basis. We estimate the amount of capital commitment under this agreement for the second half of 2010 to be approximately \$344 million.
We have signed a strategic agreement for the ongoing provision of construction, engineering and technical services with ZAO Globalstroy-Engineering. The volume of these services is based on our capital construction programme, which is re-evaluated on an annual basis. We estimate the amount of capital commitment under this agreement for the second half of 2010 to be approximately \$142 million.
We have commitments for capital expenditure contributions in the amount of \$506 million related to various production sharing agreements over the next 28 years.
We have a commitment to purchase equipment for modernisation of our petrochemical refinery Karpatnaftochim Ltd., located in Ukraine, until the end of 2011 in the amount of \$21 million.
We have a commitment to execute a capital construction programme to develop our power generation segment. Under the terms of this programme, power plants with total capacity of 890 MW should be constructed. We are in the process of approving certain amendments to the capital construction programme, which include its extension until the end of 2013. As at 30 June 2010, we estimate the amount of this commitment to be approximately \$784 million.
In January 2010, the Company signed an agreement to develop the West Qurna-2 field located in the south of Iraq. The parties to the agreement are the Iraqi state-owned South Oil Company and the contracting consortium formed by the Iraqi state-owned North Oil Company, the Company and Norway's Statoil ASA. The Company's share in the project is 56.25%. Under this agreement as at 30 June 2010 the Company has a commitment in the amount of approximately \$263 million. The West Qurna-2 field has recoverable reserves of about 12.9 billion barrels. For more information on the uncertainties surrounding our interests in Iraq, see "Risk Factors – Risks Relating to Our Business – We may not be able to realise opportunities in Iraq."
In March 2010, an ethanol purchase agreement signed by a Group company came into force. The initial term of the agreement is five years. As of 30 June 2010, the estimated value of the contract is approximately \$1.0 billion.
The following table displays our total contractual obligations and other commitments as at 30 June 2010:
| Last six | |||||||
|---|---|---|---|---|---|---|---|
| months of | |||||||
| Total | 2010 | 2011 | 2012 | 2013 | 2014 | After | |
| (millions of U.S. dollars) | |||||||
| On balance sheet | |||||||
| Short term debt | 225 | 184 | 41 | – | – | – | – |
| Long-term loans and borrowings from third parties | 3,543 | 515 | 1,501 | 868 | 282 | 140 | 237 |
| Long-term loans and borrowings from related parties | 1,742 | 22 | 51 | 41 | 31 | 23 | 1,574 |
| 6.375% Non-convertible U.S. dollar bonds, maturing | |||||||
| 2014 | 896 | – | – | – | – | 896 | – |
| 6.356% Non-convertible U.S. dollar bonds, maturing | |||||||
| 2017 | 500 | – | – | – | – | – | 500 |
| 7.250% Non-convertible U.S. dollar bonds, maturing | |||||||
| 2019 | 595 | – | – | – | – | – | 595 |
| 6.656% Non-convertible U.S. dollar bonds, maturing | |||||||
| 2022 | 500 | – | – | – | – | – | 500 |
| 7.10% Russian ruble bonds, maturing 2011 | 256 | – | 256 | – | – | – | – |
| 13.35% Russian ruble bonds, maturing 2012 | 801 | – | – | 801 | – | – | – |
| 9.20% Russian ruble bonds, maturing 2012 | 321 | – | – | 321 | – | – | – |
| 7.40% Russian ruble bonds, maturing 2013 | 192 | – | – | – | 192 | – | – |
| Capital lease obligations | 192 | 44 | 61 | 54 | 33 | – | – |
| TOTAL | 9,763 | 765 | 1,910 | 2,085 | 538 | 1,059 | 3,406 |
| Off balance sheet | |||||||
| Operating lease obligations | 968 | 129 | 213 | 168 | 126 | 111 | 221 |
| Capital commitment in LUKOIL-Neftochim Bourgas | |||||||
| AD | 25 | 25 | – | – | – | – | – |
| Capital commitment in LUKOIL-Petrotel | 33 | 3 | 6 | 2 | 11 | 11 | – |
| Commitment for modernisation of the petrochemical | |||||||
| refinery in Ukraine | 21 | 18 | 3 | – | – | – | – |
| Capital commitments in PSAs | 506 | 352 | 92 | 24 | 2 | 2 | 34 |
| Capital commitments in power generation segment | 784 | 91 | 405 | 178 | 110 | – | – |
| Obligation under contract with Eurasia Drilling | |||||||
| Company | 344 | 344 | – | – | – | – | – |
| Obligation under contract with ZAO Globalstroy | |||||||
| Engineering | 142 | 142 | – | – | – | – | – |
We are exposed to changes in interest rates, primarily associated with our variable rate short-term and long-term borrowings. We do not utilise any interest rate swaps or other derivatives to hedge against the risk of changes in interest rates on our variable rate debt. As at 30 June 2010, our long-term borrowings that are sensitive to changes in interest rates totaled \$3,350 million (for details on long-term borrowings please refer to Note 10 "Long-term debt" of the consolidated financial statements for the six months ended 30 June 2010). Utilising the actual interest rates in effect and the balance of our variable rate debt as at 30 June 2010, and assuming a 10% change in interest rates and no change in the balance of debt outstanding, the potential effect on our annual interest expense would not be material to our results of operations.
The countries in which our principal operations are located have been subject to hyperinflation, and during the last 10 years, the local currencies have been subject to large devaluations. As a result, we are subject to the risk that the local currencies may suffer future devaluation that may subject us to losses, depending on our net monetary position. Because we have operations in a number of countries, we are required to conduct business in a variety of foreign currencies and, as a result, we are subject to foreign exchange rate risk on cash flows related to sales, expenses, financing and investment transactions. The impacts of fluctuations in foreign currency exchange rates on our geographically diverse operations are varied. We recognised a net foreign currency translation loss of \$42 million in the first six months of 2010, a loss of \$520 million in 2009, a loss of \$918 million in 2008 and a gain of \$35 million in 2007.
We currently do not comprehensively hedge our exposure to foreign currency rate changes, although we selectively hedge certain foreign currency exchange rate exposures, such as firm commitments for capital projects or local currency tax payments and dividends. Our foreign currency risk is mitigated in part because a substantial part of our revenue is denominated in U.S. dollars or, to some extent, linked to oil prices quoted in U.S. dollars. Additionally, we keep part of our cash and cash equivalents in U.S. dollars in order to manage against the risk of ruble devaluation.
Appreciation of the ruble against the U.S. dollar in 2006 through 2008 had a negative impact on our operating profit and cash flows, because it led to an increase of our ruble costs in U.S.-dollar terms and a decrease in the amount of our export cash revenue in ruble terms. As mentioned above, a substantial part of our revenue is denominated in U.S. dollars or, to some extent, linked to oil prices quoted in U.S. dollars, while a significant part of our costs is ruble denominated. Should the ruble appreciate/ devaluate against the U.S. dollar during the second half of 2010 by 10%, our net cash provided by operating and investing activities will decrease/increase by approximately \$0.2 billion (assuming all other factors remain constant).
We participate in certain petroleum products marketing and trading activity outside of our physical crude oil and petroleum products businesses. Our derivative activity is limited to these marketing and trading activities and hedging of commodity price risks. Currently this activity involves the use of futures and swap contracts together with purchase and sale contracts that qualify as derivative instruments. We maintain a system of controls over these marketing and trading activities that includes policies covering the authorisation, reporting and monitoring of derivative activity. We recognised income of \$247 million and expense of \$542 million during the six months ended 30 June 2010 and 2009, respectively, and expense of \$781 million in 2009, income of \$902 million in 2008 and expense of \$575 million in 2007 from the use of derivative instruments. The fair value of derivative contracts outstanding and recorded on the consolidated balance sheets was a net asset of \$39 million as at 30 June 2010, a net liability of \$45 million, a net asset of \$340 million and a net liability of \$50 million as at 31 December 2009, 2008 and 2007, respectively.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to select appropriate accounting policies and to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. See Note 2 "Summary of significant accounting policies" to our consolidated financial statements included elsewhere in this prospectus for descriptions of the Company's major accounting policies. Certain of these accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts would have been reported under different conditions, or if different assumptions had been used.
Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities of the acquired business. For most assets and liabilities, purchase price allocation is accomplished by recording the asset or liability at its estimated fair value. The most difficult estimations of individual fair values are those involving property, plant and equipment and identifiable intangible assets. We use all available information to make these fair value determinations and, for major business acquisitions, typically engage an outside appraisal firm to assist in the fair value determination of the acquired long-lived assets. We have, if necessary, up to one year after the acquisition closing date to finish these fair value determinations and finalise the purchase price allocation.
Our consolidated financial statements include the financial position and results of the Company, controlled subsidiaries of which the Company directly or indirectly owns more than 50% of the voting interest, unless minority interest shareholders have substantive participating rights, and variable interest entities where the Group is determined to be the primary beneficiary. Other significant investments in companies of which the Company directly or indirectly owns between 20% and 50% of the voting interest and over which it exercises
significant influence but not control, are accounted for using the equity method of accounting. Investments in companies of which the Company directly or indirectly owns more than 50% of the voting interest but where minority interest shareholders have substantive participating rights are accounted for using the equity method of accounting. Undivided interests in oil and gas joint ventures are accounted for using the proportionate consolidation method. Investments in other companies are recorded at cost.
Revenues from the production and sale of crude oil and petroleum products are recognised when title passes to customers at which point the risks and rewards of ownership are assumed by the customer and the price is fixed or determinable. Revenues include excise on petroleum products sales and duties on export sales of crude oil and petroleum products.
Revenues from non-cash sales are recognised at the fair market value of the crude oil and petroleum products sold.
Accounting for oil and gas activities is subject to special accounting rules that are unique to the oil and gas industry. Property acquisitions, successful exploratory wells, all development costs and support equipment and facilities are capitalised. Artificial stimulation and well work-over costs are included in operating expenses as incurred.
For individually significant undeveloped properties, management periodically performs impairment tests based on exploration and drilling efforts to date. For undeveloped properties that individually are relatively small, management exercises judgment and determines a periodic property impairment charge as required that is reported in loss on disposals and impairments of assets.
For exploratory wells, drilling costs are temporarily capitalised, or "suspended", on the balance sheet, pending a judgmental determination of whether potentially economic oil and gas reserves have been discovered by the drilling effort. If a judgment is made that the well did not encounter potentially economic oil and gas quantities, the well costs are expensed as a dry hole and are reported in exploration expense. Exploratory wells that are judged to have discovered potentially economic quantities of oil and gas and that are in areas where a major capital expenditure would be required before production could begin, remain capitalised on the balance sheet as long as additional exploratory appraisal work is under way or firmly planned. There is no periodic impairment assessment of suspended exploratory well costs. Management continuously monitors the results of the additional appraisal drilling and seismic work and expenses the suspended well costs as dry holes when it judges that the potential field does not warrant further exploratory efforts in the near term.
Other exploratory expenditures, including geological and geophysical costs are expensed as incurred.
Due to the inherent uncertainties and the necessarily limited nature of reservoir data, estimates of reserves are inherently imprecise, require the application of judgment and are subject to change as additional information becomes available. The estimates are made using all available geological and reservoir data as well as historical production data. Estimates are reviewed and revised as appropriate. Revisions occur as a result of changes in prices, costs, fiscal regimes, reservoir performance or a change in the Company's plans.
Proved oil and gas reserves are the estimated quantities of crude oil, natural gas liquids including condensate and natural gas that geological and engineering data demonstrate with reasonable certainty can be recovered in future years from known reservoirs under existing economic and operating conditions (i.e., prices and costs as at the date the estimate is made). Reserves are considered proved if they can be produced economically as demonstrated by either actual production or conclusive formation tests. Proved reserves do not include additional quantities of oil and gas reserves that may result from applying secondary or tertiary recovery techniques not yet tested and determined to be economic. The proved reserves include volumes which are recoverable up to and after licence expiry dates. Proved developed reserves are the quantities of proved reserves expected to be recovered through existing wells with existing equipment and operating methods.
Management has included within proved reserves significant quantities which the Group expects to produce after the expiry dates of certain of its current production licences in the Russian Federation. The Subsoil Law of the Russian Federation states that, upon expiration, a licence is subject to renewal at the initiative of the licence holder provided that further exploration, appraisal, production or remediation activities are necessary and provided that the license holder has not violated the terms of the licence. Since the law applies both to newly issued and old licences and the Group has currently renewed nearly 50% of its licences, management believes that licences will be renewed upon their expiration for the remainder of the economic life of each respective field.
Long lived assets, such as oil and gas properties, other property, plant, and equipment, and purchased intangibles subject to amortisation, are assessed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by that group. If the carrying amount of an asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognised by writing down the carrying amount to the estimated fair value of the asset group, generally determined as discounted future net cash flows. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.
Deferred income tax assets and liabilities are recognised in respect of future tax consequences attributable to temporary differences between the carrying amounts of existing assets and liabilities for the purposes of the consolidated financial statements and their respective tax bases and in respect of operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse and the assets be recovered and liabilities settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognised in the consolidated statement of income in the reporting period which includes the enactment date.
The ultimate realisation of deferred income tax assets is dependent upon the generation of future taxable income in the reporting periods in which the originating expenditure becomes deductible. In assessing the realisability of deferred income tax assets, management considers whether it is more likely than not that the deferred income tax assets will be realised. In making this assessment, management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies.
Under various laws, contracts, permits and regulations, we have legal obligations to remove tangible equipment and restore the land or seabed at the end of operations at production sites. Our largest asset retirement obligations relate to wells and oil and gas production facilities and pipelines. We record the fair value of liabilities related to our legal obligations to abandon, dismantle or otherwise retire tangible long-lived assets in the period in which the liability is incurred. A corresponding increase in the carrying amount of the related long-lived asset is also recorded. Subsequently, the liability is accreted for the passage of time and the related asset is depreciated using the unit-of-production method. Estimating the future asset retirement obligations costs necessary for this accounting calculation involves significant estimates and judgments by management. Most of these obligations are many years in the future and the contracts and regulations often have vague descriptions of what removal practices and criteria will have to be met when the removal event actually occurs. Asset removal technologies and costs are constantly changing, as well as political, environmental, safety and public relations considerations.
Certain conditions may exist as at balance sheet dates that may result in losses, but the impact of which will only be resolved when one or more future events occur or fail to occur. We are required to both determine whether a loss is probable based on judgment and interpretation of laws and regulations and determine whether the loss can be reasonably estimated. If our assessment of a contingency indicates that it is probable that a material loss will arise, and the amount of the liability can be estimated, then the estimated liability is accrued and charged to the consolidated statement of income. If our assessment indicates that a potentially material loss is not probable, but is only reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability is disclosed in the notes to our consolidated financial statements. Loss contingencies considered remote are
generally not disclosed unless they involve guarantees, in which case the nature of the guarantee is disclosed. Our management continually monitor known and potential contingent matters and make appropriate charges to the consolidated statement of income when warranted by circumstance.
Our derivative activity is limited to certain petroleum products marketing and trading outside of our physical crude oil and petroleum products businesses and hedging of commodity price risks. Currently this activity involves the use of futures and swaps contracts together with purchase and sale contracts that qualify as derivative instruments. We account for these activities under the mark-to-market methodology in which the derivatives are revalued each accounting period. Resulting realised and unrealised gains or losses are presented in the consolidated statement of income on a net basis. Unrealised gains and losses are carried as assets or liabilities on the consolidated balance sheet.
In February 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-09, "Subsequent events", which amends Accounting Standards Codification (ASC) No. 855 (former SFAS No. 165, "Subsequent events"), issued in May 2009. We adopted ASC No. 855 starting from the second quarter of 2009. These standards address accounting and disclosure requirements related to subsequent events and require management of an entity which is an SEC filer or is a conduit bond obligator for conduit securities that are traded in a public market to evaluate subsequent event through the date that the financial statements are issued. Entities that do not meet these criteria should evaluate subsequent events through the date the financial statements are available to be issued and are required to disclose the date through which subsequent events have been evaluated. We determined that we should evaluate subsequent events through the date the financial statements are available to be issued and applied the requirements of ASU No. 2010-09 starting from the financial statements for 2009.
In January 2010, the FASB issued ASU No. 2010-06, "Improving Disclosures about Fair Value Measurements", which requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information about purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. This ASU also clarifies existing fair-value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques. ASU No. 2010-06 is effective for interim and annual reporting periods beginning after 15 December 2009, except for the detailed Level 3 roll forward disclosures (which are effective for the annual reporting periods starting after 15 December 2010 and for interim periods within those annual reporting periods). We adopted the requirements of ASU No. 2010-06 (except for the detailed Level 3 roll forward disclosures) starting from the first quarter of 2010. This adoption did not have a material impact on our results of operations, financial position or cash flows.
In January 2010, the FASB issued ASU No. 2010-03, "Extractive activities – Oil and Gas (Topic 932): Oil and Gas Reserve Estimation and Disclosures". The main provisions of ASU No. 2010-03 are the following: (1) expanding the definition of oil- and gas-producing activities to include the extraction of saleable hydrocarbons, in solid, liquid, or gaseous state, from oil sands, shale, coalbeds, or other nonrenewable resources that are intended to be upgraded into synthetic oil or gas, and activities undertaken with a view to such extraction; (2) entities should use first-day-of-the-month price during the 12-month period (the 12-months average price) in calculating proved oil and gas reserves and estimating related standardised measure of discounted net cash flows; (3) requiring entities to disclose separately information about reserves quantities and financial statement amounts for geographic areas that represent 15 percent or more of proved reserves; (4) separate disclosure for consolidated entities and equity method investments. ASU No. 2010-03 is effective for annual reporting periods ending on or after 31 December 2009. We adopted ASU No. 2010-03 starting from the 2009 annual financial statements. This adoption did not have a material impact on our reported reserves evaluation, results of operations, financial position or cash flows.
In January 2010, the FASB issued ASU No. 2010-02, "Accounting and Reporting for Decreases in Ownership of a Subsidiary – A Scope Clarification" to clarify the scope of ASC Subtopic No. 810-10, "Consolidation – Overall". This ASU specifies that the guidance in ASC Subtopic No. 810-10 on accounting for decreases in ownership of a subsidiary applies to: (1) a subsidiary or group of assets that constitutes a business or nonprofit activity; (2) a subsidiary that is a business or a nonprofit activity that is transferred to an equity method investee or a joint venture; and (3) an exchange of a group of assets that constitute a business or nonprofit activity for a noncontrolling interest in an entity. If a company's ownership interest in a subsidiary that is not a business or nonprofit activity decreases, then other accounting guidance generally would be applied based on the nature of the transaction. The new pronouncement also clarifies that the recent guidance on accounting for decreases in ownership of a subsidiary does not apply if the transaction is a sale of in-substance real estate or a conveyance of oil and gas properties. This ASU is effective for interim and annual periods ending after 15 December 2009 and the guidance should be applied on a retrospective basis to the first period in which the company adopted ASC No. 810. We adopted ASU No. 2010-02 for the 2009 annual financial statements. This adoption did not have a material impact on our results of operations, financial position or cash flows.
In January 2010, the FASB issued ASU No. 2010-01, "Accounting for Distributions to Shareholders with Components of Stock and Cash", which addresses how an entity should account for the stock portion of a dividend in certain arrangements when a shareholder makes an election to receive cash or stock, subject to limitations on the amount of the dividend to be issued in cash. The stock portion of the dividend should be accounted for as a stock issuance upon distribution, resulting in basic earnings per share being adjusted prospectively. Prior to distribution, the entity's obligation to issue shares would be reflected in diluted earningsper-share based on the guidance in ASC No. 260, which addresses contracts that may be settled in shares. This ASU is effective for interim and annual periods ending after 15 December 2009. We adopted ASU No. 2010-01 for the 2009 annual financial statements. This adoption did not have a material impact on our results of operations, financial position or cash flows.
In December 2009, the FASB issued ASU No. 2009-17, "Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities", which amends the guidance on variable interest entities ("VIE") in ASC No. 810. This ASU changes the approach to determining VIE primary beneficiary from a quantitative assessment to a qualitative assessment designed to identify a controlling financial interest, and increases the frequency of required reassessments to determine whether an entity is the primary beneficiary of a VIE. ASU No. 2009-17 also clarifies, but does not significantly change, the characteristics that identify a VIE. ASU No. 2009-17 is effective as of the beginning of a company's first fiscal year that begins after 15 November 2009, and for subsequent interim and annual reporting periods. We adopted the requirements of ASU No. 2009-17 starting from the first quarter of 2010. This adoption did not have a material impact on our results of operations, financial position or cash flows.
In August 2009, the FASB issued ASU No. 2009-05, "Measuring Liabilities at Fair Value", which amends Subtopic No. 820-10, "Fair Value Measurements and Disclosures–Overall" for the fair value measurements of liabilities. ASU No. 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: valuation based on the quoted price of the identical liability when traded as an asset; valuation based on quoted prices for similar liabilities or similar liabilities when traded as an asset, or another valuation technique that is consistent with the principles of Topic 820 (such as present value technique or price for the identical liability). This ASU also clarifies that an entity is not required to include a separate input relating to the existence of a restriction that prevents the transfer of the liability. ASU No. 2009-05 is effective for the first interim or annual reporting periods after its publication. We adopted the requirements of ASU No. 2009-05 starting from the financial statements for 2009. This adoption did not have a material impact on our results of operations, financial position or cash flows.
In March 2008, the FASB issued ASC No. 815 (former SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities"). This ASC improves financial reporting about derivative instruments and hedging activities by enhanced disclosures of their effects on an entity's financial position, financial performance and cash flows. We adopted the provisions of ASC No. 815 starting from the first quarter of 2009. This adoption did not have any impact on our results of operations, financial position or cash flows.
In December 2007, the FASB issued ASC No. 810 (former SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51"). This ASC applies to all entities that prepare consolidated financial statements (except not-for-profit organisations) and affects those which have an outstanding noncontrolling interest (or minority interest) in their subsidiaries or which have to deconsolidate a subsidiary. This ASC changes the classification of a non-controlling interest; establishing a single method of accounting for changes in the parent company's ownership interest that does not result in deconsolidation and requires a parent company to recognise a gain or loss when a subsidiary is deconsolidated. We prospectively adopted the provisions of ASC No. 810 in the first quarter of 2009, except for the presentation and disclosure requirements which were applied retrospectively. This adoption did not have any impact on our results of operations, financial position or cash flows.
We are one of the largest publicly traded oil and gas companies in the world in terms of proved crude oil and gas reserves and we are the second largest producer of crude oil in Russia. As at 31 December 2009, as audited by Miller and Lents, our estimated proved crude oil reserves were approximately 13,696 mmbls (1,868 million tonnes) and our estimated proved gas reserves were 22,850 bcf (647 bcm), an aggregate of 17,504 mmboe. As at the same date, our estimated probable crude oil reserves were 7,293 mmbls (995 million tonnes) and our estimated probable gas reserves were 15,163 bcf (429 bcm), an aggregate of 9,820 mmboe. For more information, see "Presentation of Reserves and Resources".
Our total revenues were \$49,755 million in the first six months of 2010, compared to \$34,861 million in the first six months of 2009. Our net income in the first six months of 2010 was \$4,002 million, compared to \$3,229 million in the first six months of 2009. Our total revenues were \$81,083 million in 2009, compared to \$107,680 million in 2008. Our net income in 2009 was \$7,011 million, compared to \$9,144 million in 2008.
In the first six months of 2010, we produced 355.0 mmbls (48.1 million tonnes) of crude oil, including 331.1 mmbls (45.0 million tonnes) in Russia and 23.9 mmbls (3.1 million tonnes) from our international projects. In the first six months of 2010, we produced 326.3 bcf (9.2 bcm) of gas available for sale, including 238.8 bcf (6.7 bcm) in Russia and 87.5 bcf (2.5 bcm) obtained from various international projects. In the first six months of 2010, we refined 237.6 mmbls (32.4 million tonnes) of raw materials at our own and affiliated refineries, including 162.6 mmbls (22.2 million tonnes) at our Russian refineries and 75.0 mmbls (10.2 million tonnes) at our international refineries (including our shares in the ISAB and TRN refinery complexes). In the first six months of 2010, we sold 174.8 mmbls (23.9 million tonnes) of crude oil and 42.6 million tonnes of refined products to customers outside of Russia, including sales to CIS countries and exports to international markets. Our sales of crude oil and refined products to customers outside of Russia accounted for 92.5% and 83.5% of our total sales of crude oil and refined products, respectively, in the first six months of 2010.
In 2009, we produced 719.6 mmbls (97.6 million tonnes) of crude oil, including 675.7 mmbls (91.9 million tonnes) in Russia and 43.9 mmbls (5.7 million tonnes) from our international projects. Our 2009 domestic crude oil production accounted for 18.6% of all Russian crude oil production based on the aggregate Russian crude oil production for 2009 published by the Russian Ministry of Energy. In 2009, we produced 526.1 bcf (14.9 bcm) of gas available for sale, including 376.5 bcf (10.7 bcm) in Russia and 149.6 bcf (4.2 bcm) obtained from various international projects. In 2009, we refined 459.6 mmbls (62.7 million tonnes) of raw materials at our own and affiliated refineries, including 325.9 mmbls (44.5 million tonnes) at our Russian refineries and 133.7 mmbls (18.2 million tonnes) at our international refineries (including our shares in the ISAB and TRN refinery complexes). We also refined 15.0 mmbls (2.0 million tonnes) of crude oil under contracts with domestic third party refineries, primarily at refineries in Ufa, and 12.7 mmbls (1.7 million tonnes) of crude oil under contracts with international third party refineries. In 2009, we sold 344.4 mmbls (47.0 million tonnes) of crude oil and 84.7 million tonnes of refined products to customers outside of Russia, including sales to CIS countries and exports to international markets. Our sales of crude oil and refined products to customers outside of Russia accounted for 94.0% and 84.1% of our total sales of crude oil and refined products, respectively, in 2009.
As at 31 December 2009, approximately 95% of our estimated proved crude oil reserves were located in Russia. Our proved crude oil reserves in Western Siberia, including the Bolshekhetskaya depression located in the Yamal-Nenets Autonomous District, were 7,492 mmbls (1,022 million tonnes) as at 31 December 2009, constituting approximately 55% of our total estimated proved crude oil reserves. We are developing new reserves in Russia, most notably in Western Siberia, the Timan-Pechora region and the Northern Caspian region. We believe that these new areas will provide us with a reserves portfolio which is more balanced geographically. In August 2008, we commenced the first stage of production at the Yuzhnaya Khylchuya field in the Timan-Pechora region. This field is being developed by NMNG, our joint venture with ConocoPhillips. Crude oil output from the Yuzhnaya Khylchuya field reached approximately 27.1 mmbls (3.7 million tonnes) in the first six months of 2010 and approximately 50.7 mmbls (7.0 million tonnes) in 2009.
As at 31 December 2009, approximately 70% of our estimated proved natural gas reserves were in Russia. Our core domestic gas producing area is the Bolshekhetskaya depression in Western Siberia. In April 2005, we started producing natural gas from the Nakhodkinskoye field in the Bolshekhetskaya depression. Our production of gas available for sale from this field was 145.1 bcf (4.1 bcm) in the first six months of 2010 and 209.6 bcf (5.9 bcm) in 2009.
Our primary international areas of focus are currently the non-Russian Caspian region and Central Asia, in particular Kazakhstan and Uzbekistan. However, we also have increasingly important interests in international projects in Africa, the Middle East, South America and elsewhere in the CIS. As at 31 December 2009, our international assets accounted for approximately 5% of our estimated proved crude oil reserves and 30% of our estimated proved gas reserves.
In July 2010, we won a tender for exploration and development of two blocks, Est Rapsodia and Trident, in the Romanian sector of the Black Sea together with Vanco International. The respective stakes of LUKOIL Overseas and Vanco International in the consortium are 80% and 20%. The Est Rapsodia and Trident blocks are located in the Black Sea at depths ranging from 90 to 1,000 metres. The distance to the coastline is 60-100 kilometres, the nearest town on the coast is Sulina. The total area of the two licence blocks is approximately 2,000 square kilometres. A 3D seismic study is required to assess the geological structure of the blocks. In accordance with the tender conditions, LUKOIL Overseas is to sign a concession agreement with the National Agency for Mineral Resources of Romania within six months of the tender.
In December 2009, we won a tender for the rights to develop the West Qurna-2 oil field as part of a consortium with Statoil. In January 2010, we entered into a development and production agreement with two of Iraq's stateowned companies (North Oil Company and South Oil Company) and Statoil, under which our share in this project is 56.25%. The agreement has a term of twenty years with the possibility of a five-year extension. Recoverable reserves are estimated to be 12,900 mmbls.
In mid-2007, we commenced production from the Shakh-Deniz gas field in Azerbaijan, where our share in commodity gas production totaled 10.2 bcf (0.3 bcm) for the first six months of 2010. At the end of 2007, we commenced production from the Khauzak gas field in Uzbekistan, where we produced 46.1 bcf (1.3 bcm) of commodity gas in the first six months of 2010 and 78.6 bcf (2.2 bcm) in 2009.
In April 2007, we signed agreements with Vanco Energy, which included a joint offshore exploration project in the deep-water zone of Ghana. We began exploration drilling in a block offshore Ghana in October 2009 and, in February 2010, we discovered a vertically-oriented structure rich in hydrocarbons, approximately 94 metres thick, containing a multi-layer oil and gas reservoir approximately 25 metres thick. We are currently appraising the reserves.
We own and operate four crude oil refineries in Russia, located in Perm, Volgograd, Ukhta and Nizhny Novgorod. These refineries, along with our mini-refineries in Urai and Kogalym, have a combined refining capacity of 45.1 million tonnes per year and refined a total of 22.2 million tonnes of crude oil in the first six months of 2010 and a total of 44.5 million tonnes of crude oil in 2009. Outside of Russia, we own and operate refineries in Bulgaria, Romania and Ukraine, a 49% share in a refining complex in Italy and a 45% share in a refinery in The Netherlands, which have a combined refining capacity of 27.9 million tonnes per year and refined a total of 10.2 million tonnes of crude oil in the first six months of 2010 and a total of 18.2 million tonnes of crude oil in 2009.
We have invested, and expect to continue to invest, substantial amounts on modernisation of our refineries. Our refinery in Odessa, Ukraine was closed from August 2005 until April 2008 for a large-scale reconstruction programme, which was part of a larger effort to upgrade and modernise all of our refineries to improve utilisation rates as well as refining depth (the difference between crude input and marketable output) and to increase production of refined products which comply with the more stringent current environmental requirements applicable in some of our export markets, including the European Union. In 2009, we spent \$827 million on capital expenditures in connection with modernising and reconstructing our refineries. In March 2010, we signed a multi-year agreement with Emerson Process Management to modernise 13 refining and petrochemical facilities in Russia and Eastern Europe. Under the agreement, which extends through 2014, Emerson Process Management will provide equipment, software and services as part of our enterprise-wide strategy to modernise process automation at our oil and gas refineries, petrochemical plants and related facilities. The refineries and petrochemicals plants that will be upgraded under the agreement include Stavrolen and Saratovorgsintez in Russia, Neftochim Bourgas in Bulgaria and Karpatnaftochim Ltd. in Ukraine, as well as other facilities in Romania, Odessa, Perm, the Volgograd region and the Komi Republic. Once we complete the upgrades of all of our refineries, both domestically and internationally, we believe that a significant portion of the refined products produced at our refineries will be in compliance with existing and expected future European Union standards.
Our downstream gas assets include four gas processing facilities: the Lokosovsky gas processing plant in the Khanty-Mansiysk Autonomous District, the Korobkovsky gas processing plant in the Volgograd region, the Permneftegazpererabotka gas processing plant in the Perm region and the Usinsk gas processing plant in the Komi Republic. These gas processing plants have a combined processing capacity of 133.7 bcf (3.8 bcm). Our gas processing plants processed 49.4 bcf (1.4 bcm) of gas and 0.4 million tonnes of natural gas liquids in the first six months of 2010 and 104.6 bcf (3.0 bcm) of gas and 0.7 million tonnes of natural gas liquids in 2009. The Lokosovsky gas processing plant is currently our main gas processing facility in Russia and has a gas processing capacity of 81.2 bcf (2.3 bcm) per year.
We sell the crude oil which we do not refine into the domestic and international markets, which includes exports from Russia and sales outside of Russia of crude oil production from our international projects. We also undertake crude oil trading activity on international markets. In the first six months of 2010, we sold 14.3 mmbls (1.9 million tonnes) of crude oil within Russia, or 7.5% of our total crude oil sales, and 174.8 mmbls (23.9 million tonnes) of crude oil outside of Russia, or 92.5% of our total crude oil sales. In 2009, we sold 21.9 mmbls (3.0 million tonnes) of crude oil within Russia, or 6.0% of our total crude oil sales and 344.4 mmbls (47.0 million tonnes) of crude oil outside of Russia, or 94.0% of our total crude oil sales.
We sell a wide range of refined products, including gasoline, diesel fuel, fuel oil and lubricants. We sold a total of 51.0 million tonnes of refined products through wholesale and retail channels in the first six months of 2010 and 100.8 million tonnes in 2009. In the first six months of 2010, we sold 8.4 million tonnes of our refined products in the domestic market, or 16.5% of our total refined products sales, and 42.6 million tonnes internationally, or 83.5% of our total refined products sales. In 2009, we sold 16.0 million tonnes of our refined products in the domestic market, or 15.9% of our total refined products sales, and 84.8 million tonnes internationally, or 84.1% of our total refined products sales.
As at 30 June 2010, we owned or leased 5,097 retail filling stations (excluding stations that were temporarily idle or leased to third parties), including 1,899 in Russia, 1,041 in the United States and 2,157 in the CIS (excluding Russia) and Europe. In the first six months of 2010, we sold 3.3 million tonnes of refined products through our filling stations in Russia and 3.4 million tonnes through our filling stations outside Russia. In 2009, we sold 6.2 million tonnes of refined products through our filling stations in Russia and 7.9 million tonnes through our filling stations outside Russia. In November 2008, we completed the acquisition of 100% of Akpet, a Turkish company that operated 689 retail filling stations and owns eight oil product terminals, five LNG storage tanks, three jet fuel terminals and a lubricant production plant in Turkey. In the first quarter of 2009, we purchased retail filling station networks totalling 96 retail filling stations and plots of land from OOO Smolenskneftesnab, OOO IRT Investment Company, OOO PM-Invest and OOO Retaier House. In the fourth quarter of 2008, we purchased retail filling station networks totalling 181 retail filling stations from ZAO Association Grand and OOO Mega Oil M.
We continue to expand our petrochemicals business through our petrochemicals operations in Russia, Ukraine and Bulgaria. Currently, we own two petrochemicals plants in southern Russia and one in Ukraine. We also manufacture petrochemicals at our Bourgas refinery in Bulgaria. Together, those plants manufactured 0.4 million tonnes of petrochemicals in the first six months of 2010 and 0.9 million tonnes of petrochemicals in 2009. We intend to utilise our expanding natural gas production and processing operations as a source of feedstock for our petrochemicals operations, particularly at the Caspian gas-chemical complex that we plan to construct in the Caspian region.
In 2010, we continued to develop the new power generation sector of our business as part of our strategic development programme. We expect power generation to be an important factor in our long-term growth. This new sector will encompass all aspects of the power generation business, from generation to transmission and sale of heat and electrical power, thereby ensuring reliable supplies for our own needs as well as for external customers. Our power generation business sector now includes TGK-8, our own power generating facilities at our oil and gas fields and power generators in Bulgaria, Romania and Ukraine. Our total output of electrical energy was 14.7 billion kW-h in 2009 (of which over 90% was generated by TGK-8). Our total output of heat
energy was approximately 16.9 million Gcal in 2009. TGK-8 is a power generation company which owns power plants in Russia in the Astrakhan, Volgograd and Rostov regions, the Krasnodar and Stavropol districts and the Republic of Dagestan, with total electric power generation facilities of 3.6 GW and total thermal power generation facilities of 13,542 Gcal/hour. The power generation segment investment programme includes the construction of power plants with a total capacity of approximately 890 MW. We are in the process of approving certain amendments to the capital construction programme, which include its extension until the end of 2013. TGK-8's annual gas consumption is approximately 212.0 bcf (6.0 bcm) and we expect our interest in TGK-8 will create synergies through natural gas supplies from our gas fields in the Northern Caspian and Astrakhan regions.
We use the Transneft pipeline system, our own pipeline network, rail cars and tankers to transport the crude oil which we produce within Russia, for export outside of Russia and to our refineries. In December 2009, we acquired the 46% interest of BP plc in LUKARCO, increasing our ownership stake from 54% to 100%. LUKARCO has a 12.5% share in the Caspian Pipeline Consortium (CPC), a pipeline project in the Caspian region which is used to transport crude oil produced in Kazakhstan to a marine terminal near the Russian city of Novorossiysk on the Black Sea for transport on to international markets. We also own export terminals at the port of Svetly in the Kaliningrad region (with a total annual capacity of 6.0 million tonnes), at Varandey on the Barents Sea (with a total annual capacity of 12.0 million tonnes) and at Vysotsk, Vyborg's outer harbour on the Baltic Sea (with a total annual capacity of 12.0 million tonnes). Most of our gas is sold at the wellhead and then transported through the UGSS, owned and operated by Gazprom, which is responsible for gathering, transporting, dispatching and delivering substantially all natural gas supplies in Russia. We transport our refined products primarily through a combination of Russia's state-owned refined products pipeline, Transnefteproduct, and by rail car, river-class tanker and truck.
The oil and gas industry is intensely competitive. We compete with other major Russian oil and gas companies and major international oil and gas companies. Many of our international competitors have substantially greater financial resources and have been operating in a market-based, competitive economic environment for much longer than we have. The key activities in which we face competition are:
See "Risk Factors – Risks Relating to Our Business – We encounter competition from other oil and gas companies in all areas of our operations, including the acquisition of licences, exploratory prospects and producing properties, and we may encounter competition from suppliers of alternative forms of energy sources" for more information about the risks related to our ability to compete effectively with Russian and international oil and gas companies. We expect competition to intensify. A number of other Russian oil companies, as well as foreign oil companies, are permitted to compete for licences and to offer services in Russia, increasing the competition which we face domestically. We also expect competition to increase domestically and internationally due to the limited quantities of unexploited and unallocated oil reserves.
Our strategic objectives are sustainable growth and value creation.
We aim to increase our profitability by maintaining our sustainable and efficient growth of crude oil, natural gas and refined products production, replacing our reserves at competitive cost and maintaining returns on capital at levels comparable to our international peers.
We aim to create shareholder value through rigorous management of capital and costs, by increasing our valuation and paying fair dividends. We believe that one of the competitive advantages which allows us to achieve this strategic objective is our ability to identify and develop attractive upstream and downstream opportunities in our core Russian and international markets.
In order to achieve our strategic objectives of sustainable growth and value creation, we are in the process of implementing the following short-term and long-term development programmes. On 19 November 2009, our Board of Directors approved a comprehensive strategic development programme for 2010 to 2019 to achieve our strategic objectives of sustainable growth and value creation. As part of our strategic development programme for 2010 to 2019, we have focused on steps designed to deliver short- and medium-term benefits to our profitability and returns on investment and a long-term programme designed to sustain our growth and profitability. In addition, the strategic development programme for 2010 to 2019 aims to create value by improving free cash flow and increasing dividends and production by optimising capital expenditures.
Our development programme for the next two years is designed to take advantage of opportunities to increase profitability. We believe that the following initiatives will, upon successful implementation, have a positive impact on our profitability:
Divest non-core businesses and reduce head count. We continue to review our non-core activities, which include activities outside the exploration for and production of hydrocarbons and their refining, marketing and distribution, and will consider divesting non-core businesses as appropriate. For example, in 2004, we disposed of our drilling operations and most of our banking and finance operations. We disposed of our construction operations in 2005. In 2009, with a view to optimising the organisational structure of LUKOIL-Western Siberia, we divested 10 service companies as part of the Group's non-core assets divestment efforts, thus reducing the cost and headcount. We intend to continue reducing the head count where possible through divestment of non-core businesses and natural attrition and retirements. Our average head count was approximately 143,400 employees in 2009 and 133,930 employees for the six months ended 30 June 2010.
Strengthen performance-related pay. We intend to continue a trend of increasing the use of performance-related compensation across all levels of our Group to ensure a strong link between our financial results and the rewards for managers and employees. In December 2009, we introduced a compensation plan for certain members of our management and key employees for the period from 2010 to 2012, which is based on assigned phantom shares.
Our longer-term initiatives include the following:
agreements with Vanco Energy in relation to, inter alia, an offshore exploration project in the deep-water zone of Ghana. In October 2009, pursuant to our agreements with Vanco Energy, we began exploration drilling in a block offshore Ghana and, in February 2010, we discovered a vertically-oriented structure rich in hydrocarbons. In December 2009, we became the 100% owner of LUKARCO, which owns a 5% share in Tengizchevroil and a 12.5% share in CPC. In December 2009, we won a tender for the rights to develop the West Qurna-2 oil field in Iraq as part of a consortium with Statoil. See "– Recent Developments – Exploration and Production".
Bourgas refinery in Bulgaria. Together, those plants manufactured 0.4 million tonnes of petrochemicals in the first six months of 2010 and 0.9 million tonnes of petrochemicals in 2009. We believe that demand in the Russian and international markets for petrochemicals products will grow in the coming years and we intend to expand our petrochemicals production capacity to meet this demand.
● Develop our power generation business. We treat the power generation business as a new and promising segment of our overall business, which helps further diversify our product line and better take advantage of available business opportunities. In keeping with our recent acquisition of TGK-8, we intend to develop this new segment with the aims of benefiting from rising energy prices and realising synergies through natural gas supplies from our gas fields located in the Northern Caspian and in the Astrakhan region.
In July 2010, we won a tender for exploration and development of two blocks, Est Rapsodia and Trident, in the Romanian sector of the Black Sea together with Vanco International. The respective stakes of LUKOIL Overseas and Vanco International in the consortium are 80% and 20%. The Est Rapsodia and Trident blocks are located in the Black Sea at depths ranging from 90 to 1,000 metres. The distance to the coastline is 60-100 kilometres and the nearest town on the coast is Sulina. The total area of the two licence blocks is approximately 2,000 square kilometres. A 3D seismic study is required to assess the geological structure of the blocks. In accordance with the conditions of the tender, LUKOIL Overseas is to sign a concession agreement with the National Agency for Mineral Resources of Romania within six months of the tender.
We began exploration drilling in a block offshore Ghana in October 2009 and in February 2010 we discovered a vertically-oriented structure rich in hydrocarbons, approximately 94 metres thick, containing a multi-layer oil and gas reservoir approximately 25 metres thick. At present we are appraising the reserves.
In December 2009, we acquired BP plc's 46% stake in LUKARCO for \$1.6 billion, increasing our ownership stake to 100%. LUKARCO is a holding company, which owns a 5% share in Tengizchevroil, a joint venture which develops the Tengiz and Korolevskoe fields in Kazakhstan, and a 12.5% share in CPC, a pipeline project in the Caspian region which is used to transport crude oil produced in Kazakhstan to a marine terminal near the Russian city of Novorossiysk on the Black Sea for transport on to international markets. Accordingly, we increased our ownership stake in Tengizchevroil from 2.7% to 5% and our ownership stake in CPC from 6.75% to 12.5%. The \$1.6 billion purchase price is to be paid in three instalments. The first instalment of \$300 million was paid in December 2009. The second instalment of \$800 million and third instalment of \$500 million are due in December 2010 and December 2011, respectively.
In December 2009, we won a tender for the rights to develop the West Qurna-2 oil field in Iraq as part of a consortium with Statoil. In January 2010, we entered into a development and production agreement with two of Iraq's state-owned companies (North Oil Company and South Oil Company) and Statoil, under which our share in this project is 56.25%. The agreement has a term of twenty years with the possibility of a five-year extension. Recoverable reserves are estimated to be 12,900 mmbls.
On 3 September 2010, we made a partial prepayment of \$500 million from internal funds generated during the first six months of 2010 on a \$1.2 billion syndicated term loan facility, arranged in August 2009 by ABN AMRO Bank N.V. / The Royal Bank of Scotland plc, The Bank of Tokyo-Mitsubishi UFJ, Barclays Capital, BNP Paribas S.A., Calyon, Citigroup Global Markets, Ltd., Deutsche Bank AG, Amsterdam Branch, ING Bank N.V., Natixis, JSB "Orgresbank", Société Genérale and WestLB AG.
In August 2010, we raised a \$1.5 billion loan facility through Lukoil Finance Ltd. This loan is guaranteed by OAO LUKOIL. The loan is an unsecured club facility with a one year maturity and it was arranged by The Bank of Tokyo-Mitsubishi UFJ, Ltd., Citibank, N.A., London branch, ING Bank N.V., London branch, Natixis, The Royal Bank of Scotland N.V., and WestLB AG, London branch. Citibank International PLC acted as the agent for the transaction. The proceeds under this loan will be used for general corporate purposes.
In June 2010, our Board of Directors approved, by absentee ballot, the issuance of documents for registration with the FSFM of a programme for non-convertible interest-bearing documentary ruble bonds with a total nominal value of 100 billion rubles, placed through public subscription. The placement timing for each of the registered issues under this programme will be determined based on market conditions and our debt financing needs. The programme covers placement of 10 bond issues, each with a 10-year maturity period. The bonds will be placed on the MICEX. ZAO Troika Dialog Investment Company and ZAO Raiffeisenbank act as the underwriters.
In December 2009, we issued MICEX-listed bonds in the amount of 10 billion rubles with a coupon rate of 9.20% per annum. The bonds will mature in three years. The offering was arranged by ZAO Troika Dialog Investment Company. The proceeds from the issuance were used to prepay the remaining part of our \$500 million loan from Sberbank, which we borrowed in February 2009.
In November 2009, we issued two tranches of non-convertible bonds totalling \$1.5 billion. The first tranche totalling \$900 million with a coupon rate of 6.375% per annum was placed with a maturity of 5 years at a price of 99.474% of the bond's face value. The resulting yield to maturity for the first tranche is 6.500%. The second tranche totalling \$600 million with a coupon rate of 7.250% per annum was placed with a maturity of 10 years at a price of 99.127% of the bond's face value. The resulting yield to maturity for the second tranche is 7.375%. These tranches have a half year coupon period.
We were initially established in November 1991 as a state-owned oil concern, LangepasUraiKogalymneft (from which we derive the acronym LUK). In line with the Russian government's privatisation plans, we were converted into a joint stock company in 1993, and the Russian government transferred to us 51% of the voting shares of 15 enterprises. The Russian government transferred an additional nine enterprises to us in 1995. In 1994, the Russian government disposed of 51% of our share capital through an exchange of shares for vouchers tendered by private investors in Russia, sales to private investors in Russia for cash and the distribution of shares to employees. The Russian government subsequently disposed of all our shares. The Russian government sold its remaining 7.6% of our share capital to ConocoPhillips for \$1.988 billion, or \$30.76 per share, in a transaction which was completed in October 2004.
At the time of the Russian government's sale of our shares to ConocoPhillips, we entered into a series of agreements with ConocoPhillips to form a broad-based strategic alliance. Under our shareholder agreement with ConocoPhillips dated 29 September 2004, when ConocoPhillips's ownership interest in LUKOIL exceeded 12.5%, ConocoPhillips had the right to nominate two representatives to our Board of Directors and when its ownership interest in LUKOIL was between 7.6% and 12.5% ConocoPhillips had the right to nominate one representative to the Board of Directors. Following its initial acquisition of our shares, ConocoPhillips increased its stake in LUKOIL through open market purchases on the London Stock Exchange.
On 24 March 2010, ConocoPhillips announced plans to dispose of half of its stake in LUKOIL, which at the time constituted approximately 20% of LUKOIL's authorised and issued shares, during 2010 and 2011. On 28 July 2010, LUKOIL Finance signed a stock purchase agreement with Springtime to purchase 64,638,729 LUKOIL ordinary shares, which constituted approximately 7.599% of LUKOIL's authorised and issued shares, at \$53.25 per share for approximately \$3.44 billion. The transaction was completed on 16 August 2010.
On 26 September 2010, LUKOIL exercised its option to acquire additional shares from ConocoPhillips by sending a notice of exercise in respect of 42,500,000 LUKOIL ADRs and entered into a share purchase agreement with UniCredit Bank AG as the purchaser of those ADRs. This transaction was completed on 29 September 2010, when 42,500,000 LUKOIL ADRs were directly transferred by Springtime to UniCredit Bank AG, and UniCredit Bank AG paid the purchase price of \$2.38 billion to Springtime. Simultaneously, UniCredit Bank AG issued a series of equity-linked notes to LUKOIL Finance exchangeable for 17,500,000 LUKOIL ADRs on or before 29 September 2011 and an option to purchase from UniCredit Bank AG an additional 25,000,000 LUKOIL ADRs on or before 29 September 2011. These arrangements give LUKOIL Finance the opportunity to increase significantly its holding of LUKOIL's authorized and issued shares before the end of September 2011.
Our domestic operations are conducted primarily through:
● seven wholly-owned regional marketing and distribution subsidiaries.
Our international operations are conducted through two principal subsidiaries: LUKOIL Overseas Holding Ltd. (LUKOIL Overseas) and LUKOIL INTERNATIONAL GmbH (LUKOIL INTERNATIONAL). LUKOIL Overseas is responsible for our international exploration and production activities. LUKOIL INTERNATIONAL, which includes LITASCO SA (LITASCO), our wholly-owned trading subsidiary, is primarily responsible for our international refining, trading, distribution and retail marketing operations.
We divide our operations into four principal segments: an exploration and production segment; a refining, marketing and distribution segment; a petrochemicals segment; and a power generation segment, each of which we discuss below. A fifth segment, which includes our other businesses such as banking, finance and other activities, is not currently material to our results of operations. In a series of transactions from May 2008 through June 2009, we acquired 100% of TGK-8, a power generating company. Starting from 2010, we include its operations in a separate segment. Prior to 2010, TGK-8 was included in the other businesses segment.
We are one of the largest publicly traded oil and gas companies in the world in terms of proved crude oil and gas reserves and we are the second largest producer of crude oil in Russia. Our three core producing areas in Russia are Western Siberia, European Russia and the Timan-Pechora region where, as at 31 December 2009, we had an aggregate of 15.1 bboe of proved and 8.9 bboe of probable hydrocarbon reserves. In addition, as at the same date, we had 0.6 bboe of proved and 0.7 bboe of probable oil and gas reserves in the Northern Caspian region. Our main exploration and production subsidiaries in Western Siberia are LUKOIL-Western Siberia, RITEK and LUKOIL-AIK. Our main exploration and production subsidiaries in European Russia are LUKOIL-PERM, LUKOIL-Volgogradneftegas and LUKOIL- Kaliningradmorneft. Our main exploration and production subsidiary in the Northern Caspian region is LUKOIL-Nizhnevolzhskneft. In Timan-Pechora, our main exploration and production companies are LUKOIL-Komi and NMNG. As part of our efforts to develop our reserves in Timan-Pechora, we entered into a joint venture agreement with ConocoPhillips in September 2004, pursuant to which, in 2005, we sold a 30% interest in NMNG to ConocoPhillips.
We must obtain licences from governmental authorities to explore for and produce oil and natural gas from our fields. As at 30 June 2010, we held 420 licences, of which 402 are either production or combined exploration and production licences and 18 are exploration licences. Exploration licences give the licence holder the nonexclusive right to explore for oil and natural gas in fields in a defined area and are generally valid for a period of five years. These licences do not give us the right to extract any oil which we find. However, if our exploration efforts are successful and we find oil, natural gas or both, our exploration licences generally provide that we can obtain a production licence without auction or tender. Production licences have generally been valid for 20 years and give us the exclusive right to extract oil and natural gas from fields in a defined area. Combined exploration and production licences permit both exploration and production and are generally valid for 25 years. Approximately 25% of our original licences, especially those relating to our Western Siberia operations, expire between 2013 and 2018. Recent legislation, passed after the issuance of many of our licences, provides that licences are now granted for a time equal to the economic viability of the relevant field. As long as we meet certain conditions, such as compliance with approved development programmes, we believe that each of our licences issued prior to this legislation can be extended, upon expiration, for the economic life of the relevant fields. As at 30 June 2010, 192 licences have been extended in accordance with recent legislation. See "Risk Factors – Risks Relating to Our Business – Our Russian subsoil use licences may be suspended, terminated or revoked prior to their expiration and we may be unable to obtain or maintain various permits or authorisations" for more information on the risks relating to our licences. To date there have been no unsuccessful licence renewal applications. Our licences generally impose obligations on the licence holder to pay certain local and federal taxes and meet certain environmental requirements. Licences generally require the licence holder to make various commitments, including extracting an agreed target amount of reserves annually, conducting agreed minimum drilling levels and other exploratory and development activities, protecting the environment in the licence area from damage, providing certain progress reports and geological data to the relevant authorities and paying royalties and other amounts when due. Licences may be suspended or revoked if the licence holder fails to comply with their terms or to heed warnings from regulatory authorities. See "Regulation of the Oil Industry in the Russian Federation – Subsoil Production Licences".
At our request, Miller and Lents, our independent reservoir engineers, has carried out an independent audit of our reserve estimates as at 31 December 2009. Unless otherwise specified, any information in this prospectus relating to our estimated crude oil and gas reserves is extracted or derived from the reserves reports prepared by Miller and Lents as at 31 December 2009 and 1 January in each of 2008 and 2009. The information concerning our estimated crude oil and gas reserves as at 31 December 2009 included in this prospectus has been prepared in accordance with the definitions contained in SEC Regulation S-X Rule 4.10(a) at that time and has been derived or extracted from the 31 December 2009 report of Miller and Lents. For further information on the SEC standards and a discussion of the standards used in preparing estimated crude oil and gas reserves for dates prior to 31 December 2009, see "Presentation of Reserves and Resources".
The process of estimating oil reserves is complex and inherently uncertain. We must project production rates and timing of development and analyse available geological, geophysical, production, engineering and economic data for each reservoir. The extent, quality and reliability of this data can vary. The accuracy of reserves data is also a function of the quality and quantity of other available data, engineering and geological interpretation and judgment. See "Summary Consolidated Financial and Other Information – Summary Reserves and Production Information". See also "Risk Factors – Risks Relating to Our Business – The crude oil and natural gas reserves data in this prospectus are only estimates and our actual production, revenues and expenditures with respect to our reserves may differ materially from these estimates".
The following table sets out our total crude oil and natural gas reserves as at 31 December 2009.
| As at 31 December 2009 | ||||||
|---|---|---|---|---|---|---|
| Net reserves(1) | ||||||
| Oil (mmbls) | Gas (bcf) | Total (mmboe) | ||||
| Reserve Category | ||||||
| PROVED | ||||||
| Developed: | ||||||
| Russia | 8,462 | 5,642 | 9,402 | |||
| Eurasia (excluding Russia) | 356 | 2,153 | 715 | |||
| Africa | 9.7 | – | 9.7 | |||
| South America | – | – | – | |||
| Undeveloped: | ||||||
| Russia | 4,618 | 10,296 | 6,334 | |||
| Eurasia (excluding Russia) | 250 | 4,759 | 1,043 | |||
| Africa | 0.2 | – | 0.2 | |||
| South America | – | – | – | |||
| Total Proved | 13,696 | 22,850 | 17,504 | |||
| PROBABLE | ||||||
| Russia | 7,265 | 14,153 | 9,624 | |||
| Eurasia (excluding Russia) | 28 | 1,010 | 196 | |||
| Africa | – | – | – | |||
| South America | – | – | – | |||
| Total Probable | 7,293 | 15,163 | 9,820 | |||
| POSSIBLE | ||||||
| Russia | 3,669 | 8,125 | 5,023 | |||
| Eurasia (excluding Russia) | 14 | 101 | 31 | |||
| Africa | – | – | – | |||
| South America | – | – | – | |||
| Total Possible | 3,683 | 8,226 | 5,054 |
Notes:
For further information on our estimated oil and gas reserves for the 2009 fiscal year, see "Management's Discussion and Analysis of Financial Condition and Results of Operations – Resource Base".
The following tables set out our Russian crude oil and gas reserves by our main production areas as at 31 December 2009 and 1 January in each of 2009 and 2008.
(1) Net oil and gas reserves include reserves that we do not beneficially own which are attributable to minority interests in our consolidated subsidiaries and our equity share of reserves of our affiliated companies. For disclosure that excludes reserves attributable to minority interests in our consolidated subsidiaries, see Table IV of "Supplementary Information on Oil and Gas Exploration and Production Activities (Unaudited)", supplemented to our consolidated financial statements and notes thereto included elsewhere in this prospectus and presented in accordance with ASC No.932 (former SFAS No. 69), "Disclosures About Oil and Gas Producing Activities".
| Net Oil Reserves | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 31 December 2009 | 1 January 2009 | 1 January 2008 | ||||||||
| Proved | Proved | Proved | ||||||||
| plus | plus | plus | ||||||||
| Proved | Probable | Probable | Proved | Probable | Probable | Proved | Probable | Probable | ||
| Region | ||||||||||
| Western Siberia | 7,491.9 | 4,776.3 | 12,268.3 | 8,016.9 | 5,468.9 | 13,485.7 | 8,818.9 | 5,812.6 | 14,631.5 | |
| European Russia | 2,488.7 | 1,063.7 | 3,552.4 | 2,561.3 | 1,061.2 | 3,622.5 | 2,648.0 | 968.5 | 3,616.5 | |
| Timan-Pechora | 2,649.1 | 1,034.4 | 3,683.4 | 2,912.0 | 825.9 | 3,738.0 | 3,346.4 | 1,092.5 | 4,438.9 | |
| Northern Caspian | 449.8 | 391.2 | 841.0 | 376.1 | 659.1 | 1,035.1 | 406.9 | 679.9 | 1,087.0 | |
| Total for Russia | 13,079.5 | 7,265.7 | 20,345.2 | 13,866.3 | 8,015.0 | 21,881.3 | 15,220.3 | 8,553.6 | 23,774.0 |
| Net Gas Reserves (bcf)(1) | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 31 December 2009 | 1 January 2009 | 1 January 2008 | |||||||||
| Proved | Proved | Proved | |||||||||
| plus | plus | plus | |||||||||
| Proved | Probable | Probable | Proved | Probable | Probable | Proved | Probable | Probable | |||
| Region | |||||||||||
| Western Siberia | 13,556.0 | 7,906.2 | 21,462.3 | 14,864.3 | 7,916.0 | 22,780.3 | 15,405.9 | 7,642.4 | 23,048.3 | ||
| European Russia | 676.1 | 3,978.0 | 4,654.1 | 725.9 | 4,173.9 | 4,899.7 | 680.8 | 3,931.8 | 4,612.6 | ||
| Timan-Pechora | 515.3 | 136.9 | 652.2 | 630.8 | 115.8 | 746.7 | 709.3 | 160.9 | 870.2 | ||
| Northern Caspian | 1,191.3 | 2,131.4 | 3,322.7 | 6,060.3 | 8,659.1 | 14,719.4 | 6,057.2 | 8,703.7 | 14,760.9 | ||
| Total for Russia | 15,938.8 | 14,152.5 | 30,091.3 | 22,281.3 | 20,864.8 | 43,146.1 | 22,853.2 | 20,438.8 | 43,292.0 |
(1) Totals may not equal sums due to rounding.
The majority of our current production comes from our three core producing areas of Western Siberia, European Russia and Timan-Pechora. Our total Russian crude oil production was 333.1 mmbls (45.0 million tonnes) in the first six months of 2010 and 675.7 mmbls (91.9 million tonnes) in 2009, representing 18.6% of Russia's total crude oil production in 2009, based on the aggregate Russian crude oil production published by the Russian Ministry of Energy. Our total production of gas available for sale was 238.8 bcf (6.7 bcm) in the first six months of 2010, of which approximately 86.6 bcf (2.4 bcm) was petroleum gas and 152.2 bcf (4.3 bcm) was natural gas. In 2009, our total Russian production of gas available for sale was 376.5 bcf (10.7 bcm), of which approximately 152.6 bcf (4.3 bcm) was petroleum gas and 223.9 bcf (6.4 bcm) was natural gas.
As part of our strategy of cutting costs and maximising profitability, we intend to utilise more advanced reserves management techniques to increase production at our wells while shutting in low producing wells. We believe that this will allow us to increase production efficiency in Western Siberia and European Russia. In addition, we believe that further production increases will come from Timan- Pechora and the Northern Caspian region, where relatively young reserves should provide higher flow rates. See "– Strategy".
The following table sets out our daily crude oil production data in our main crude oil production areas in Russia for the first six months ended 30 June 2010 and each of the years ended 31 December 2009, 2008 and 2007.
| Analysis of Daily Crude Oil Production | ||||||
|---|---|---|---|---|---|---|
| Six months ended | For the year ended 31 December | |||||
| 30 June 2010 | 2009 | 2008 | 2007 | |||
| (mbls/day) | ||||||
| Western Siberia | 1,042 | 1,076 | 1,138 | 1,216 | ||
| European Russia | 353 | 346 | 342 | 334 | ||
| Timan-Pechora | 435 | 429 | 330 | 288 | ||
| Totals for Russia | 1,830 | 1,851 | 1,810 | 1,838 |
Our exploration drilling in Russia totalled approximately 64,500 metres in the first six months of 2010 and 62,900 metres in 2009. One new oil field was discovered in 2009 (the Timerovskoye field in Tatarstan). We also discovered 17 new deposits at previously discovered fields. The Group as a whole carried out 1,341 kilometres (833.3 miles) of 2D seismic exploration and 3,489 square kilometres (1,347 square miles) of 3D seismic exploration in the first six months of 2010, and 2,446 kilometres (1,520 miles) of 2D seismic exploration and 4,548 square kilometres (1,756 square miles) of 3D seismic exploration in 2009. In Russia, we carried out 2,325 kilometres (1,445 miles) of 2D seismic exploration and 2,375 square kilometres (917 square miles) of 3D seismic exploration in 2009. Our exploration costs in Russia totalled \$91 million in the first six months of 2010 and \$162 million in 2009. Our development costs in Russia totalled \$1,746 million in the first six months of 2010 and \$3,726 million in 2009. Exploration and production expenditures target the most promising exploratory prospects in the Caspian region, major development projects in the Timan-Pechora region and the maintenance and/or increase of production from existing fields in Western Siberia and other regions. We may revise these allocations to reflect the results of our exploration activities.
The Western Siberia basin is located approximately 1,900 kilometres (1,181 miles) east of Moscow and extends over an area of approximately 3.1 million square kilometres (1.2 million square miles). The basin is bordered on the west by the Ural Mountains, on the south by the Kazakhstan plate and on the east by the Siberian plate, is open to the north and extends under the Kara Sea. Our Western Siberia crude oil production operations accounted for approximately 55% of our domestic crude oil production in the first six months of 2010 and approximately 58% of our domestic crude oil production in 2009. Our core gas producing area in Russia is the Bolshekhetskaya depression in the Yamal-Nenets Autonomous District in Western Siberia.
Our Western Siberia production operations are conducted principally through LUKOIL-Western Siberia, a wholly owned consolidated subsidiary which has several crude oil production units and one natural gas production unit.
As at 31 December 2009, LUKOIL-Western Siberia had estimated proved crude oil reserves of 6,971 mmbls (951 million tonnes) and estimated probable crude oil reserves of 4,514 mmbls (615.8 million tonnes). As at the same date, LUKOIL-Western Siberia had estimated proved natural gas reserves of 13,440 bcf (380.6 bcm) and estimated probable natural gas reserves of 7,864 bcf (222.7 bcm). LUKOIL- Western Siberia produced 170.3 mmbls (23.0 million tonnes) of crude oil in the first six months of 2010 and 354.9 mmbls (48.0 million tonnes) of crude oil in 2009.
We sell gas that we produce in Russia to Gazprom or directly to Russian consumers. We cannot export gas that we produce in Russia because Gazprom has a monopoly on gas exports and owns the gas transportation system. In April 2005, through LUKOIL-Western Siberia's natural gas production unit, we started producing natural gas from the Nakhodkinskoye field in the Bolshekhetskaya depression. Our production of gas available for sale from this field was 145.1 bcf (4.1 bcm) in the first six months of 2010 and 209.6 bcf (5.9 bcm) in 2009. Since 2005, we have sold a portion of our production from the Nakhodkinskoye field in Western Siberia to Gazprom. In addition, we signed a gas supply agreement with Gazprom in 2007 under which Gazprom committed to purchase at least 282.5 bcf (8.0 bcm) from the Nakhodkinskoye field. In 2009, procurements by Gazprom declined due to reduced international gas demand. In March 2005, we signed a general agreement on strategic partnership with Gazprom for the period from 2005 to 2014. Under this agreement, among other things, we agreed to jointly pursue oil and gas exploration and development projects in the Yamal-Nenets Autonomous District and the Nenets Autonomous District in Western Siberia, as well as the Russian sector of the Caspian Sea, the Republic of Uzbekistan and certain other regions. In addition, in May 2007, we set up Gas-Oil Trading, a 50/50 joint venture with Gazprom, to supply natural, associated and dry stripped gas produced by our company and other companies. We expect the joint venture will help us to ensure a long-term, more stable market for our gas, to ensure access to the Gazprom gas transport system and to sell gas to customers in Russian regions at better prices.
We effectively own 73.05% of LUKOIL-AIK, which produces crude oil from three fields in Kogalym in Western Siberia. As at 31 December 2009, our share of LUKOIL-AIK's estimated proved crude oil reserves was 277.7 mmbls (37.8 million tonnes) and of LUKOIL-AIK's estimated probable crude oil reserves was 114.7 mmbls (15.6 million tonnes). LUKOIL-AIK's production was 9.9 mmbls (1.3 million tonnes) of crude oil in the first six months of 2010 and 20.7 mmbls (2.7 million tonnes) in 2009.
We also currently own 100% of RITEK, which has operations in both Western Siberia and European Russia. As at 31 December 2009, RITEK had estimated proved crude oil reserves in Western Siberia of 238.3 mmbls (32.5 million tonnes) and estimated probable crude oil reserves in Western Siberia of 146.7 mmbls (20 million tonnes). RITEK produced 7.8 mmbls (1.0 million tonnes) of crude oil in Western Siberia in the first six months of 2010 and 16.0 mmbls (2.1 million tonnes) in 2009.
In June 2006, we acquired Khanty-Mansiysk Oil Corporation (KMOC) from Marathon Oil Corporation for \$847 million. KMOC and its subsidiaries held exploration and production interests in the Khanty- Mansiysk Autonomous District of Western Siberia. Since the time of the acquisition, KMOC and its subsidiaries have been merged into our Group.
Our production of crude oil in European Russia, mainly based in the Volga-Ural basin, accounted for approximately 19% of our domestic production in the first six months of 2010 and in 2009. The Volga-Ural basin is located approximately 800 kilometres (500 miles) southeast of Moscow and covers an area of approximately 700,000 square kilometres (270,000 square miles) which includes the Russian cities of Volgograd, Astrakhan, Perm and Samara. The basin is a regional uplift of the east-central part of Russia and is bounded on the east by the Ural Mountains, on the south by the Pre-Caspian basin, and on the west by the Baltic basin.
We have three principal wholly owned production subsidiaries in the European Russia region: LUKOIL-PERM, LUKOIL-Volgogradneftegas (in the Volga-Ural basin) and LUKOIL- Kaliningradmorneft (in the Baltic basin). As at 31 December 2009, these three companies and their subsidiaries and affiliates had estimated proved crude oil reserves 2,312 mmbls (315.4 million tonnes) and estimated probable crude oil reserves of 575 mmbls (78.4 million tonnes). These three companies and their subsidiaries and affiliates produced 61.1 mmbls (8.3 million tonnes) of crude oil in the first six months of 2010 and 120.7 mmbls (16.4 million tonnes) in 2009.
RITEK's European Russia production is included under "European Russia" in the table above setting out our daily crude oil production in Russia. As at 31 December 2009, RITEK had estimated proved crude oil reserves in European Russia of 165.2 mmbls (22.5 million tonnes) and estimated probable crude oil reserves in European Russia of 35.8 mmbls (4.8 million tonnes). RITEK produced 2.7 mmbls (0.4 million tonnes) of crude oil in European Russia in the first six months of 2010 and 5.6 mmbls (0.8 million tonnes) in 2009.
Primorieneftegaz, our wholly owned subsidiary, has subsoil licences in the Poimenny block, located between the Volga and Akhtuba rivers in European Russia. The Tsentralno-Astrahanskoye field was discovered on this block in 2004. We conducted 2D and 3D seismic exploration work at this field in 2006 and 2007. In 2009, we completed drilling of an exploration well and identified a gas deposit. As at 31 December 2009, Primorieneftegaz had estimated probable gas condensate reserves of 445.9 mmbls (60.8 million tonnes). Primorieneftegaz has not yet started producing natural gas or gas condensate.
Our production of crude oil in Timan-Pechora accounted for approximately 24% of our domestic production in the first six months of 2010 and 23% in 2009. Our Timan-Pechora oil production operations include properties located in northern Russia in the Timan-Pechora basin, which is Russia's third largest region in terms of crude oil reserves. The Timan-Pechora basin is located approximately 1,100 kilometres (684 miles) northeast of Moscow in north-western Russia. The region covers approximately 777,000 square kilometres (300,000 square miles) and is a triangular-shaped basin bounded on the east by the Ural Mountains and on the southwest by the Timan ridge and extending beneath the Barents Sea to the north.
Currently, our key assets in Timan-Pechora are held through LUKOIL-Komi and NMNG. LUKOIL-Komi holds most of our exploration and development licences in the Komi Republic, which relate to fields generally located in the southern part of Timan-Pechora. As at 31 December 2009, LUKOIL-Komi and its subsidiaries had estimated proved crude oil reserves of 2,096 mmbls (285.9 million tonnes) and estimated probable crude oil reserves of 846 mmbls (115.4 million tonnes). LUKOIL-Komi and its subsidiaries produced 49.3 mmbls (6.8 million tonnes) of crude oil in the first six months of 2010 and 101.4 mmbls (14.1 million tonnes) in 2009.
In December 2001, we established NMNG as a wholly owned subsidiary to hold our subsoil licences in the northern part of Timan-Pechora and in the Arkhangelsk region. As part of our efforts to develop our reserves in Timan-Pechora, we entered into a joint venture agreement with ConocoPhillips in September 2004, pursuant to which it acquired a 30% interest in NMNG in 2005. Under the terms of the joint venture agreement, ConocoPhillips paid us an acquisition price of \$529 million for a 30% interest in the joint venture's oil and gas resources, which included payment for its 30% share of working capital and for its 30% share of our capital investments in the joint venture's fields from 1 January 2004. The joint venture is governed jointly by ConocoPhillips and us on a 50/50 basis. As at 31 December 2009, NMNG had estimated proved crude oil reserves of 553 mmbls (75.4 million tonnes) and estimated probable crude oil reserves of 189 mmbls (25.8 million tonnes). NMNG produced 29.2 mmbls (4.0 million tonnes) of crude oil in the first six months of 2010 and 55.2 mmbls (7.6 million tonnes) in 2009.
In August 2008, we commenced production at the Yuzhnaya Khylchuya field, which is being developed in the Timan-Pechora region by NMNG. The first stage of construction included the drilling of 32 development wells and building of an oil treatment unit and other infrastructure, and the second stage, which involved the drilling of an additional 32 wells and increasing the capacity of the oil treatment unit, was completed in December 2008. Crude oil production from the Yuzhnaya Khylchuya field totalled approximately 27.1 mmbls (3.7 million tonnes) in the first six months of 2010.
We have licences to explore and develop certain areas of the Russian sector of the Caspian Sea. The licensed area comprises approximately 8,000 square kilometres (3,089 square miles). The majority of our Northern Caspian hydrocarbon reserves relate to gas production. As at 30 June 2010, we had drilled a number of exploratory wells on several of our Northern Caspian fields and discovered hydrocarbon deposits in each of these fields. As at 31 December 2009, we had 1,191.3 bcf (33.7 bcm) of proved and 2,131.4 bcf (60.4 bcm) of probable gas reserves in the Northern Caspian region. We intend to continue drilling exploratory wells and to begin developing our new reserves in the near term. In the second quarter of 2010, we commenced production at Yu. Korchagin field in the Northern Caspian region.
In July 2003, we established a joint venture with Gazprom to develop the Tsentralnaya geological structure in the Russian sector of the Caspian Sea jointly with KazMunaiGaz, Kazakhstan's national oil company, as authorised by the Russian government pursuant to a treaty between Russia and Kazakhstan. Our application for a licence is being considered. In May 2008, the joint venture drilled the first exploration well and discovered a major oil and gas condensate field at the Tsentralnaya structure. In addition, in March 2005, we signed an equal participation joint venture agreement with KazMunaiGaz forming Caspian Oil & Gas Company for the joint development of the Khvalynskoye field located in the northern part of the Caspian Sea. Each party has a 50% interest in the joint venture. Caspian Oil & Gas Company has prepared a feasibility study for a production sharing agreement in relation to the project, which is now pending review by the Russian authorities. We also own a 49.89% interest in the Caspian Oil Company (another 49.89% is owned by OAO Rosneft and the remaining 0.22% is owned by Gazprom), which discovered a new field at the Zapadno-Rakushechnaya structure in the Northern Caspian region in 2008.
In November 2005, we discovered a new field in the Northern Caspian region with potentially significant crude oil reserves. The field, named the Vladimir Filanovsky field after a prominent Russian oilman, is a multilayer oil and gas condensate field in the Severny licence area in the northern part of the Caspian Sea and is the first predominantly oil field within our Northern Caspian licensed areas. Through an exploration well drilled in 2006, we confirmed crude oil deposits in a previously discovered stratum as well as in an additional stratum at this field. We continued preparations for development of the Vladimir Filanovsky field in 2007 and 2008. The other five fields which we have discovered in the Northern Caspian region contain primarily gas reserves. As at 31 December 2009, our estimated proved crude oil reserves in the Northern Caspian region were 449.8 mmbls (61.4 million tonnes), and our estimated probable crude oil reserves were 391.2 mmbls (53.4 million tonnes). As at 31 December 2009, the Vladimir Filanovsky field had estimated proved crude oil reserves of 354.8 mmbls (48.4 million tonnes) and estimated proved gas reserves of 206.5 bcf (5.8 bcm). As at the same date, the Vladimir
Filanovsky field had estimated probable crude oil reserves of 219.0 mmbls (29.8 million tonnes) and estimated probable gas reserves of 128.7 bcf (3.6 bcm).
As part of our long-term corporate development programme, we aim to increase our reserves and production from international operations to mitigate the risks of geographic and transportation concentration and to diversify our cost base. Our primary international areas of focus are currently Kazakhstan and Uzbekistan. For a discussion of recent developments involving our exploration project offshore of Ghana and our West Qurna-2 field in Iraq, see "–Recent Developments – Exploration and Production".
Exploration drilling at our international projects totalled 8,740 metres (28,674.5 feet) in the first six months of 2010 and 17,000 metres (55,774.3 feet) in 2009. Our share of 2D seismic exploration in our international projects in 2009 was 121 kilometres (75.2 miles) and of 3D seismic exploration was 2,173 square kilometres (839 square miles). Our exploration costs in our international projects totalled \$115 million in the first six months of 2010 and \$221 million in 2009. Our development costs in our international projects totalled \$437 million in the first six months of 2010 and \$549 million in 2009.
The following tables set out our share of the crude oil and gas reserves as at 31 December 2009 and 1 January 2009 and 2008 at each of our international projects with proved and/or probable reserves.
| 31 December 2009 |
Our Share of Oil Reserves (mmbls) | ||||||
|---|---|---|---|---|---|---|---|
| 31 December 2009 | 1 January 2009 | 1 January 2008 | |||||
| Area | Proved | Probable | Proved | Probable | Proved | Probable | |
| Azerbaijan | |||||||
| Shakh-Deniz(1) | 10.0% | 15.7 | – | 17.7 | 11.3 | 11.5 | 11.2 |
| Colombia | |||||||
| Condor | 70.0% | – | – | 1.3 | 12.3 | 6.1 | 11.8 |
| Kazakhstan | |||||||
| Caspian | |||||||
| Investments | |||||||
| Resources(1) | 50.0% | 99.9 | 10.3 | 101.3 | 23.4 | 111.8 | 46.3 |
| Karachaganak(1) | 15.0% | 167.0 | 0.3 | 245.9 | 4.5 | 156.5 | 2.5 |
| Kumkol(2) | 50.0% | 69.3 | 2.5 | 68.4 | 3.3 | 77.9 | 10.2 |
| Tengiz and | |||||||
| Korolevskoye(2) | 5.0% | ||||||
| (2.7% before | |||||||
| December 2009) | 217.2 | 10.1 | 119.8 | 9.4 | 116.9 | 42.0 | |
| Uzbekistan | |||||||
| Kandym-Khauzak | |||||||
| Shady | 90.0% | 6.3 | 3.0 | 9.7 | 2.6 | 6.4 | 1.0 |
| Southwest Gissar | 100.0% | 30.6 | 1.4 | 17.2 | 1.4 | – | – |
| Egypt(3) | |||||||
| Meleiha(1) | 24.0% | 5.0 | – | 3.9 | – | 3.0 | 0.3 |
| WEEM | 100.0% | 4.9 | – | 6.7 | – | 4.8 | – |
| Total International(4) | 616.0 | 27.5 | 591.9 | 68.0 | 494.9 | 125.3 |
Notes:
(2) Accounted for using the equity method.
Our Equity Interest as at
(3) We are responsible for 24% of the costs of the Meleiha project and 100% of the costs of the WEEM project. See "– Egypt" for more information.
(4) Totals may not equal sums due to rounding.
(1) Consolidated on a proportionate basis.
| Our Equity |
|---|
| Interest as at |
| 31 December |
| 2009 | Our Share of Oil Reserves (bcf) | |||||||
|---|---|---|---|---|---|---|---|---|
| 31 December 2009 | 1 January 2009 | 1 January 2008 | ||||||
| Area | Proved | Probable | Proved | Probable | Proved | Probable | ||
| Azerbaijan | ||||||||
| Shakh-Deniz(1) | 10.0% | 522.9 | – | 531.5 | 265.0 | 475.7 | 100.0 | |
| Colombia | ||||||||
| Condor | 70.0% | – | – | – | – | – | – | |
| Kazakhstan | ||||||||
| Caspian | ||||||||
| Investments | ||||||||
| Resources(1) | 50.0% | 41.6 | 1.3 | – | – | – | – | |
| Karachaganak(1) | 15.0% | 1,332.2 | 0.2 | 1,861.1 | 63.1 | 1,136.5 | 29.8 | |
| Kumkol(2) | 50.0% | 13.4 | 0.5 | 13.2 | 0.6 | 14.2 | 1.9 | |
| Tengiz and | ||||||||
| Korolevskoye(2) | 5.0% | |||||||
| (2.7% before | ||||||||
| December 2009) | 266.6 | – | 152.3 | 2.5 | 150.9 | – | ||
| Uzbekistan | ||||||||
| Kandym-Khauzak | ||||||||
| Shady | 90.0% | 3,118.6 | 930.8 | 3,018.6 | 813.1 | 3,290.2 | 477.9 | |
| Southwest Gissar | 100.0% | 1,615.9 | 77.5 | 1,395.3 | 94.4 | – | – | |
| Egypt(3) | ||||||||
| Meleiha(1) | 24.0% | – | – | – | – | – | – | |
| WEEM | 100.0% | – | – | – | – | – | – | |
| Total International(4) | 6,911.0 | 1,010.2 | 6,972.0 | 1,238.7 | 5,067.5 | 609.5 |
Notes:
(1) Consolidated on a proportionate basis.
(2) Accounted for using the equity method.
(4) Totals may not equal sums due to rounding.
In the first six months of 2010, our international crude oil production accounted for approximately 6% of our total crude oil production and our international production of gas available for sale accounted for approximately 27% of our total production of gas available for sale. In 2009, our international crude oil production accounted for approximately 6% of our total crude oil production and our international production of gas available for sale accounted for approximately 28% of our total production of gas available for sale. The following tables set out our share of the average daily crude oil production and natural gas production available for sale in the first six months of 2010 and each of the years ended 31 December 2009, 2008 and 2007 at each of our international projects currently in production.
(3) We are responsible for 24% of the costs of the Meleiha project and 100% of the costs of the WEEM project. See `– Egypt" for more information.
| Our Share of Oil Production (mbls per day)(1) | |||||||
|---|---|---|---|---|---|---|---|
| Our Equity Interest as at 30 June 2010 |
Six Months ended 30 June |
Year ended 31 December | |||||
| Area | 2010 | 2009 | 2008 | 2007 | |||
| Azerbaijan | |||||||
| Shakh-Deniz(2) | 10.0% | 3.4 | 3.0 | 3.1 | 1.9 | ||
| Kazakhstan | |||||||
| Caspian Investments Resources(2) | 50.0% | 29.7 | 29.3 | 25.7 | 30.4 | ||
| Karachaganak(2) | 15.0% | 33.7 | 35.1 | 33.6 | 34.5 | ||
| Kumkol(3) | 50.0% | 31.1 | 33.1 | 34.1 | 36.9 | ||
| Tengiz and Korolevskoye(3) | 5.0% (2.7% before December 2009) |
27.5 | 14.0 | 10.2 | 8.2 | ||
| Uzbekistan | |||||||
| Kandym-Khauzak-Shady | 90.0% | 0.2 | 0.2 | 0.2 | 0.04 | ||
| Southwest Gissar | 100.0% | 1.7 | 0.8 | 0.1 | – | ||
| Egypt(4) | |||||||
| Meleiha(2) | 24.0% | 1.3 | 1.7 | 1.0 | 1.0 | ||
| WEEM | 100.0% | 3.3 | 3.2 | 2.8 | 3.0 | ||
| Total International | 131.9 | 120.4 | 110.8 | 115.9 |
Notes:
(1) Production figures include imputed volumes based on our share of revenues attributable to cost and profit of oil volumes and the weighted average commodity prices at the point of sale.
(2) Consolidated on a proportionate basis.
(3) Accounted for using the equity method.
(4) We are responsible for 24% of the costs of the Meleiha project and 100% of the costs of the WEEM project. See "– Egypt" for more information.
| Our Share of Gas Production Available for Sale (mmcf per day)(1) | |||||||
|---|---|---|---|---|---|---|---|
| Our Equity Interest as at 30 June 2010 |
Six Months ended 30 June |
Year ended 31 December | |||||
| Area | 2010 | 2009 | 2008 | 2007 | |||
| Azerbaijan | |||||||
| Shakh-Deniz(2) | 10.0% | 56.5 | 50.1 | 53.2 | 29.9 | ||
| Kazakhstan | |||||||
| Caspian Investments Resources(2) | 50.0% | 6.0 | 4.5 | – | – | ||
| Karachaganak(2) | 15.0% | 108.4 | 109.6 | 103.1 | 101.2 | ||
| Kumkol(3) | 50.0% | 4.9 | 4.1 | 4.0 | 4.2 | ||
| Tengiz and Korolevskoye(3) | 5.0% | ||||||
| (2.7% before | |||||||
| December 2009) | 53.1 | 26.0 | 18.3 | 14.2 | |||
| Uzbekistan | |||||||
| Kandym-Khauzak-Shady | 90.0% | 254.6 | 215.4 | 225.8 | 13.2 | ||
| Southwest Gissar | 100.0% | – | – | – | – | ||
| Egypt(4) | |||||||
| Meleiha(2) | 24.0% | – | – | – | – | ||
| WEEM | 100.0% | – | – | – | – | ||
| Total International | 483.5 | 409.7 | 404.4 | 162.7 |
Note:
(2) Consolidated on a proportionate basis.
(3) Accounted for using the equity method.
(1) Production figures include imputed volumes based on our share of revenues attributable to cost and profit of gas volumes and the weighted average commodity prices at the point of sale.
(4) We are responsible for 24% of the costs of the Meleiha project and 100% of the costs of the WEEM project. See "– Egypt" for more information.
Shakh-Deniz. We have a 10% interest in a PSA to develop the Shakh-Deniz area of Azerbaijan. BP is the operator of the project and has a 25.5% interest in the PSA. The other companies with interests in the PSA are Statoil (25.5%), Total (10%), National Iranian Oil Company (10%), Turkish Petroleum (9%) and SOCAR (10%). Gas and condensate were encountered in the first exploratory well drilled in 1999. Further successful gas condensate wells were announced in early 2000, and commercial reserves were discovered in March 2001. In 2003, the operator commenced a stage-by-stage field development plan including a pre-drilling programme. In December 2006, the PSA consortium began commercial production of hydrocarbons from the first production well in the Shakh-Deniz field. In 2007, volumes of oil and gas condensate production in the field rapidly increased due to the launch of three production wells. We drilled one production well in 2008 and another in 2009. In 2009, we commissioned a further well. Currently there are four wells in production and one well has been suspended. In 2010, a decision was taken to execute the project of LUKOIL's Standalone Offtake Facility to provide an alternative condensate transportation route from the Sangachal terminal to the Azertrans terminal. Gas from the project is supplied to the domestic market in Azerbaijan and is also shipped through the Baku-Tbilisi- Erzurum Pipeline (also known as the South Caucasus Pipeline) through Georgia to Turkey, while condensate is shipped through the Baku-Tbilisi-Ceyhan Pipeline. In August 2008, the South Caucasus Pipeline was temporarily shut down for safety reasons due to the conflict between Russia and Georgia. See "Risk Factors – Risks Relating to Business Operations in Emerging Markets – Most of our international reserves, production and refining interests are located in politically, economically and legally unstable areas".
D-222 (Yalama). Prior to mid-2009, we had a 65% interest in the D-222 Yalama project, in the Caspian Sea offshore of Azerbaijan, where we acted as operator and were also responsible for 81.25% of the costs. No promising oil and gas presence was discovered, and effective from June 2009, we no longer participate in this project.
Structure of Ownership. We own one of our exploration and production projects in Kazakhstan through LUKARCO, which became our wholly owned subsidiary in December 2009. We participate in four of our projects in Kazakhstan through Caspian Investments Resources, in which we have a 50% interest. We participate in the Karachaganak consortium through our subsidiary, LUKOIL Overseas Karachaganak B.V. We participate in our remaining international projects through other subsidiaries.
LUKARCO. Until December 2009, LUKARCO was a joint venture between us and BP. The purpose of the LUKARCO joint venture was to enable us to cooperate with Atlantic Richfield Company, which was subsequently acquired by BP, in various exploration and development projects and in the development of related infrastructure in certain areas of Russia (including the Northern Caspian region) and in other states of the former Soviet Union. In December 2009, we acquired a 46% interest of BP plc in LUKARCO, increasing our ownership stake from 54% to 100%. LUKARCO is a holding company which owns a 5% share in Tengizchevroil, a joint venture which develops the Tengiz and Korolevskoe fields in Kazakhstan, and a 12.5% share in CPC, a pipeline project in the Caspian region which is used to transport crude oil produced in Kazakhstan to a marine terminal near the Russian city of Novorossiysk on the Black Sea for transport on to international markets. Accordingly, we increased our ownership stake in Tengizchevroil from 2.7% to 5% and our ownership stake in CPC from 6.75% to 12.5%. See "– Crude Oil Transportation – Pipelines" for more information about our participation in the CPC.
Caspian Investments Resources. In 2005, we acquired 100% of Nelson Resources Limited (which we have since renamed Caspian Investments Resources), with substantial operations in Kazakhstan, for approximately \$1,951 million. We currently hold a 50% interest in Caspian Investments Resources, following the sale of a 50% interest to Mittal Investments S.a.r.L (Mittal Investments) in April 2007, which Mittal Investments sold to Tiptop Energy (BVI) Corporation, an affiliate of Sinopec International Petroleum and Production Corporation, on 31 August 2010. Through Caspian Investments Resources, we have an effective 25% interest in three of our projects in Kazakhstan (Arman, Buzachi Operating and Kazakhoil-Aktobe), an effective 50% interest in the KarakudukMunai project in Kazakhstan and an effective 12.5% interest in Zhambai Company (which has interests in the South Zhambai and South Zaburunye blocks in the Kazakh sector of the Caspian Sea).
Arman. Caspian Investments Resources has a 50% interest in the PSA related to the development of the Arman field, giving us an effective 25% interest. Shell holds the remaining 50% interest in the PSA, which has a term of 30 years. The Arman field is located approximately 200 kilometres north of the Caspian Sea port of Aktau in Kazakhstan. There were 16 oil production wells at the field as at 31 December 2009.
Atashsky Area. In January 2004, we signed an agreement with KazMunaiGaz and KazMunaiTeniz to conduct a geological survey of the Atashsky area, which covers 9,744 square kilometres (3,762 square miles) in Kazakhstan's sector of the Caspian Sea shelf, on a parity basis. The first exploration well was drilled in 2008 but failed to find commercial hydrocarbon reserves. We extended the agreement in 2006 and again in 2008 until the end of 2010. Based on the results of geological evaluation of the contract area we have made a decision to stop our participation in this project.
Buzachi Operating. Caspian Investments Resources has a 50% interest in the PSA related to the Buzachi Operating project to develop the North Buzachi field, giving us an effective 25% interest. CNPC International holds the remaining 50% interest in the PSA, which has a term of 25 years. The North Buzachi field is located approximately 180 kilometres north of Aktau in Kazakhstan. In 2009, the North Buzachi project commissioned 130 new production wells. We commenced drilling of horizontal wells, developed and approved the technological scheme of development and implemented a gas utilisation programme. Also, in the first quarter of 2010, we completed the programme of expanding the oil pre- treatment and pumping facility capacity to 40,000 barrels per day. There were 544 operating oil wells at the field on 31 December 2009.
Karachaganak. The Karachaganak field was discovered in 1979 and has been operated under a PSA by the Karachaganak Petroleum Operating (KPO) joint venture since 1997. The term of the PSA is 40 years. We have a 15% interest in the joint venture. Our partners are BG Group (32.5%), ENI (32.5%) and Chevron (20%). BG Group and ENI jointly manage the operations for KPO. In 2006, a new, more efficient oil export route was developed, carrying oil from Karachaganak to Samara, from where it can be delivered to the Transneft pipeline either to the Black Sea and Baltic Sea ports or directly to Central Europe via the Druzhba pipeline. The Karachaganak consortium carried out preparatory work for an expansion of its production capabilities in 2007. One multi-bore horizontal well was launched and construction of another multi-bore well was completed. Work was carried out in 2007 for the third stage of the project, which involved substantial capacity increases, including four multi-bore wells commissioned in 2008, with another three drilled in the same year. In 2009, we drilled and connected 10 production wells to the oil field collection system, including 8 wells with horizontal end segment, and continued the expansion of the Karachaganak processing complex. There were 45 operating oil wells and 59 operating gas wells at Karachaganak as of 31 December 2009. KPO is currently constructing a fourth liquid stabilisation line which is planned to become operational in the first quarter of 2011.
KarakudukMunai. Caspian Investments Resources has a 100% interest in the KarakudukMunai project to develop the Karakuduk field, giving us an effective 50% interest. At the time of our acquisition of Caspian Investments Resources, it had an effective 76% interest in the project, including through its 60% ownership of Chaparral Resources. In September 2006, Caspian Investments Resources acquired the remaining 40% of Chaparral Resources, giving it a 100% interest in the project. The Karakuduk field is located approximately 365 kilometres northeast of Aktau in Kazakhstan. There were 155 operating oil wells at the field at the end of December 2009. Work has also begun on the design and construction of a complex gas processing unit to utilise and market associated gas, which will be delivered to Russia. A railway loading rack and terminal were commissioned in 2007 to enable transportation of crude oil to the port of Aktau without co-mingling with lesser quality oils. In 2008, a gas utilisation programme was implemented and a gas treatment unit was commissioned. In 2009, we commissioned a central oil preparation facility, 33 new production wells and completed field tests of large scale hydraulic fracturing of reservoirs.
Kazakhoil-Aktobe. Caspian Investments Resources has a 50% interest in the joint venture related to the Kazakhoil-Aktobe project to develop the Alibekmola and Kozhasai fields, giving us an effective 25% interest in this project. KazMunaiGaz holds the remaining 50% interest in the joint venture, which has a term of 25 years. The Alibekmola and Kozhasai fields are located approximately 260 and 320 kilometres, respectively, south of Aktobe in Kazakhstan. There were 75 operating oil wells at the fields as at 31 December 2009.
Kumkol. The Kumkol field was discovered in 1984 and commenced production in May 1990. The northern part of the field, known as Kumkol North, is defined by a separate licence issued in 1995 for a 25-year term. We have a 50% interest in Turgai Petroleum, which owns a 100% interest in and is the operator of Kumkol North. Our partner is CNPC, which owns the other 50% interest. The agreement relating to this project was entered into in April 1996 for a term expiring on 20 December 2020. Production at Kumkol North commenced in September 1995. In order to reduce oil transportation costs, a separate consortium formed by Turgai Petroleum and PetroKazakhstan constructed the 176.1-kilometre (109.4-mile) long Kumkol-Dzhusaly oil pipeline system connecting the field to the Dzhusaly oil loading terminal, where crude oil is delivered by rail to the CPC pipeline for export. Crude oil from this field is also supplied to the Shymkent refinery for subsequent sale of petroleum products in Kazakhstan and other CIS countries. A total of 66 production wells and additional sidetracks at the 11 existing wells were drilled in 2009. We developed and approved a further field development plan. In 2009, we implemented phase one of a scheme to utilise associated gas and built and commissioned a comprehensive gas preparation unit with a capacity of 150 million cubic metres per year. We anticipate that the gas processing programme will reach its final stage in 2011, based on the minutes of a 21 July 2010 meeting of the interagency task force at the Oil and Gas Ministry of Kazakhstan. There were 362 operating oil wells at the field as at 31 December 2009.
Tengiz and Korolevskoye. The Tengiz field was discovered in 1979 and has been operated under a project agreement by the Tengizchevroil joint venture since 1993. The joint venture also operates the Korolevskoye field. LUKARCO, now our wholly owned subsidiary, has a 5% interest in the project. The project agreement has a term of 40 years. Our partners in this project include Chevron (50%), Exxon Mobil (25%) and KazMunaiGaz (20%). There were 98 oil production wells at this field as at 31 December 2009. Crude oil and other products (dry gas, propane, butane and sulfur) are transported to world markets via pipeline, railway and tankers.
Tyub-Karagan Area. In January 2004, we signed an agreement with KazMunaiGaz and KazMunaiTeniz under which we acquired a 50% interest in the PSA for the Tyub-Karagan area. The PSA for the Tyub-Karagan project has a term of 40 years. The Tyub-Karagan area is located in the central part of the Kazakhstani sector of the Caspian Sea and covers more than 1,350 square kilometres (521 square miles). 2D seismic surveys in the area were started in 2004, and we began drilling the first exploration well in May 2005. Exploration conducted at this well did not result in any oil and gas discoveries and the well was abandoned in August 2005. We conducted large scale explorations in 2007-2009. We processed and interpreted extensively the 2D seismic data in light of the exploration wells drilling results, held additional geochemical and other tests and analysis, performed a comprehensive reservoir modeling and refined the structural and tectonic model of the block. These activities helped to determine the subsequent perspective areas of geological exploration at Tyub-Karagan area primarily associated with Southern Tyub-Karagan structure. In 2009, the 2D seismic data was reprocessed and reinterpreted. As a result, the geological structure, structural and tectonic model of the block were detailed, an isochron map was built and a certificate for the South Tyub-Karagan structure was prepared and approved. We are currently carrying out a site survey programme focused on well location and plan to drill an exploration well within the next year.
Zhambai. In November 2006, Caspian Investments Resources entered into an agreement with KazMunaiGaz pursuant to which it acquired 25% of Zhambai Company, which gives us an effective 12.5% interest in the company. The other owners of Zhambai Company are KazMunaiGaz (50%) and Repsol YPF (25%). The company has interests in the South Zhambai and South Zaburunye blocks, two geological exploration blocks in the Kazakh sector of the Caspian Sea. The total area of these blocks is approximately 2,090 square kilometres (807 square miles). The results of 2D seismic work indicate the presence of three structures we believe may contain deposits of hydrocarbons. The exploration period of the blocks was extended to the end of 2011. In 2009, design work was carried out for construction of the first exploration well with a planned depth of 1,850 metres. All necessary authorisations for this well have been granted by the relevant authorities. We are currently involved in ongoing negotiations with a potential drilling contractor to drill the well next year. In 2011, we are going to drill the first exploration well on the North Edil structure.
Est Rapsodia and Trident. In July 2010, we won a tender for exploration and development of two blocks, Est Rapsodia and Trident, in the Romanian sector of the Black Sea together with Vanco International. The respective stakes of LUKOIL Overseas and Vanco International in the consortium are 80% and 20%. The Est Rapsodia and Trident blocks are located in the Black Sea at depths ranging from 90 to 1,000 metres. The distance to the coastline is 60-100 kilometres, and the nearest town on the coast is Sulina. The total area of the two license blocks is approximately 2,000 square kilometres. A 3D seismic
study is required to assess the geological structure of the blocks. In accordance with the conditions of the bidding, we are to sign a concession agreement with the National Agency for Mineral Resources of Romania within six months of the tender.
Aral Sea. In September 2005, we entered into an agreement with a consortium including Uzbekneftegaz (the Uzbek national oil company), Petronas Carigali Overseas (Indonesia), CNPC (China) and Korea National Oil Corporation. Pursuant to the agreement, the consortium signed a 35-year PSA in August 2006 with the government of Uzbekistan on the exploration and development of oil and gas fields in the Uzbek sector of the Aral Sea. The contract area covers approximately 18,300 square kilometres (7,066 square miles). All members of the consortium have equal 20% shares in the PSA. The consortium began 2D seismic exploration work at this project in autumn 2007, which continued through 2008 and 2009. In 2009, we completed processing and interpretating all 2D seismic data obtained since 2007. Based on the results, we prepared four properties for drilling, namely Western Aral, Umid, Ak-Tepe (Northern Umid) and Shagala structures. We are currently commencing drilling on a new exploration well on the Shagala structure.
Kandym-Khauzak-Shady. In June 2004, we signed a PSA with Uzbekneftegaz on the Kandym-Khauzak- Shady project for the production of natural gas in the Bukharo-Khivinsky Region in south-western Uzbekistan, including the Khauzak – Shady, Kandym and Kungradskiy licence areas. We have a 100% interest in the PSA, however, under the PSA, Uzbekneftegaz is entitled to a royalty of 10% of crude oil production from the project. The term of the PSA is 35 years and estimated capital expenditures are \$2 billion. The project provides for the creation of a modern gas-chemical complex with a capacity of 282.5 bcf (8.0 bcm) per year. We completed construction of a gas treatment unit at the Khauzak area in 2007, and the first commercial production of natural gas and gas condensate commenced in the Khauzak area in November 2007. We launched 12 production wells in this area in 2008 and a further 5 production wells in 2009, bringing the total number of production wells to 27 by the end of 2009. In 2009, we completed the processing and interpretation of 2008 seismic data and the environmental monitoring of the site. Infrastructure development and construction of facilities was commenced on the Kandym natural gas field in September 2009 pursuant to the project's development programme and began with drilling gas producing wells. In 2010, seven gas producing wells were drilled.
Southwest Gissar and Ustyurt. In March 2008, we purchased 100% of SNG Holdings, Ltd., whose wholly owned subsidiary has a 100% interest in a PSA for fields in Southwest Gissar and the Ustyurtsky region in Uzbekistan. The total purchase price was approximately \$578 million, with two additional payments of contingent purchase consideration totalling \$200 million, which were paid in 2008 after certain reserves and production targets were met. The 36-year PSA covers seven fields in Southwest Gissar, two of which are already producing oil and gas condensate. The PSA also includes a five-year licence for exploration in central Ustyurt and additional exploration in the Southwest Gissar contract territory. The other party to the PSA is Uzbekneftegaz, acting as the authorised agent for the Uzbek government. There were 12 production wells operating in the framework of the project as at 31 December 2009. LUKOIL will make a decision about its future exploration strategy after the completion of seismic processing and interpretation of the Ustyurt block. The Southeast Kyzykbairak appraisal well was drilled and tested in July 2010 on the South Kyzylbairak field. The maximum gas flow rate of the well was 600 cubic metres per day. The well was temporarily abandoned. We are currently drilling a new appraisal well at the Shamoltegmas structure. Also, we are continuing a seismic acquisition programme at the Southwest Gissar Block. The planned total volume of the seismic is 1,300 km. There are ongoing development works at the Dzharkuduk-Yangi Kizilcha, Gumbulak and Adamtash gascondensate fields and at the South- East Kyzylbairak oil-condensate field.
In July 2006, we acquired a 63% interest in an exploration, development and production project in the deepwater block CI-205 offshore Cote d'lvoire in the Gulf of Guinea from Oranto Petroleum International Ltd., a Nigerian company. Oranto International retained a 27% interest in the project. The National Petroleum Company of Cote d'lvoire, PETROCI Holding, holds the remaining 10% of the project. The size of the block is 2,600 square kilometres (1,004 square miles) and its distance to shore is approximately 100 kilometres (62 miles). The PSA for this block was signed in July 2001. The exploration period is split into three phases. At present, the project is in the second exploration phase, in which the consortium is required to drill an exploration well. In the Eastern part of CI-205 block we have mapped three potential properties following 2D seismic tests. Upon a discovery of hydrocarbons, the block's development period will be 25 years with a possible extension for an additional ten years. The first exploration well, Orca 1x, was drilled on block CI-401. A full geological survey programme was completed, and oil samples were collected during drilling. The processing and interpretation of 3D seismic data collected in 2009 is continuing in 2010. We finished interpreting 3D seismic data collected in 2009 on block CI-101 and mapping structures for drilling in 2011. We have also begun preparations for drilling an exploration well in 2011.
In May 2010, we received an extension of the current exploration period for block CI-205 from the government until July 2011. We are finalizing 3D seismic interpretation and mapping the Buffalo prospect and have begun drilling preparation activity.
In April 2007, we signed agreements with Vanco Energy to acquire a 56.66% stake in three offshore exploration projects totalling approximately 15,000 square kilometres (5,792 square miles) in the deep- water zone of the Gulf of Guinea, offshore of Cote d'lvoire and Ghana. The transaction for two of the projects was completed in 2007, and completion for the third project occurred in 2008. The other parties to the project agreement in Ghana are state oil company Ghana National Petroleum (15%) and Vanco Energy (28.34%). Geological exploration in Cote d'lvoire is continuing. The other parties to the project agreement in Cote d'lvoire are state oil company PETROCI Holding (15%) and Vanco Energy (28.34%). We are preparing the Dzata appraisal plan, to be provided to the government. In 2010, a major oil and gas field was discovered at the Dzata structure at a depth of about 4,500 metres. In addition, we started preparation for drilling appraisal wells in the Dzata field in 2011. In March 2010, we finished 3D seismic acquisition. The total volume was 1,842 square kilometres (711 square miles). Data processing is currently ongoing.
Meleiha. The Meleiha block consists of four main oil fields located in the western desert of Egypt. We are responsible for 24% of the costs of the project. To cover our costs, we receive a share in the "profit oil" from the
project. Our share in the "profit oil" from the project was 6.8% in the first six months of 2010 and 8.6% in 2009. Our partners in the project are IEOC (56%) and MITSUI (20%). Eni is the operator of the project. 18 new production wells were put into operation in 2009, and there were a total of 179 oil production wells at the field by the end of December 2009. Oil is delivered to export via a 167-kilometre (104-mile) pipeline to the Al-Khamra oil terminal. There were 179 oil production wells as at 31 December 2009.
WEEM Block. The West Eshet-Malahha (WEEM) is an oil and gas development concession in Egypt. We are responsible for 100% of the costs of the project. To cover our costs, we receive a share in the "profit oil" from the project. Our share in the "profit oil" from the project was 30.6% in the first six months of 2010 and 33.9% in 2009. The other party to the concession agreement is EGPC. We commissioned one new production well in 2009. Further, we drilled a side hole at one of the wells. There were 32 oil production wells at the WEEM block as at 31 December 2009.
WEEM Extension. In September 2009, we signed an agreement with Tharwa Petroleum for 50% of its share in the exploration and production of the WEEM Extension block, which adjoins the WEEM block. The concession agreement for this block was initially signed in August 2009 between the Government of Egypt, Ganoub El-Wadi Holding Petroleum Company and Tharwa Petroleum. We started exploration works on this block, and in 2010 we continued the exploration stage at this site, which includes drilling two exploration wells, seismic works and detailing the structure.
West Qurna-2. In 1997, we signed a contract for a 68.5% interest in a PSA relating to the development of the second stage of the West Qurna-2 oil field in Iraq. The PSA required the parties to make a total investment of at least \$6 billion on a pro rata basis. As a result of the political situation in Iraq, we delayed our performance of certain obligations under the agreement. In December 2002, the former government of Iraq purported to terminate the PSA. In 2009, the Iraqi government held a tender process for the rights to develop the West Qurna-2 field in which we participated. In December 2009, we won tender for the West Qurna-2 field as part of a consortium with Statoil. In January 2010, we entered into a development and production agreement with two of Iraq's state-owned companies (North Oil Company and South Oil Company) and Statoil, which was ratified by the Iraqi Cabinet of Ministers. Recoverable reserves are estimated to be 12,900 mmbls. Our share in this project is 56.25%. The agreement has a term of twenty years with the possibility of a five-year extension. Drilling operations are expected to start at the West Qurna-2 field in 2011, with production commencing by the end of 2012. During the first stage, which is anticipated to last until 2013, the maximum expected oil production is approximately 20 million tonnes per year. The target production level of over 90 million tonnes of oil per year is expected to be reached in 2017. The development plan of the West Qurna-2 field requires additional seismic work and the drilling of more than five hundred wells. See "-Risk Factors – Risks relating to Our Business – We may not be able to realise opportunities in Iraq" for a description of risks associated with West Qurna-2 project. In 2010, construction tenders were initiated for the project's early oil phase, and we started work aimed at deactivating mines and unexploded ordinance.
Block A. In March 2004, we signed an upstream agreement with a term of 40 years for the exploration, development and production of non-petroleum gas and condensate in Block A, an area in central Saudi Arabia near the Ghawar field, the world's largest oil field. We hold an 80% interest in the agreement. Saudi Aramco, the Saudi Arabian state oil company, holds the remaining 20% interest. We have drilled a total of nine exploration wells. In 2009, we drilled two prospecting wells at the block – Abu-Nasr-1 and Faidah-2, and commenced drilling of an appraisal well at Tuhman-4. We expect that gas produced from Block A will be supplied to Saudi Arabia's domestic market. The Tuhman-4 appraisal well was drilled and tested in May 2010 on the Tuhman field. The well was temporarily abandoned. We decided to suspend the active phase of the appraisal works and to defer carrying out additional geological and technical surveying until we are able to determine the possibility of getting a commercial gas flow rate from the formation on the Faidah and Mushaib fields.
Condor Block. In June 2002, we signed a joint exploration agreement with Ecopetrol, Colombia's state- owned oil company, for the exploration and development of the Condor block in Eastern Colombia. We have a 70% interest in the project. The total area of the block measures 3,089 square kilometres (1,193 square miles), and it is situated in the foothills of the Andes in the western part of the Llanos oil and gas basin. Based on the results of our exploration activities to date, we believe that the Condor block has potentially recoverable hydrocarbon deposits located in up to seven separate structures. In February 2007, we announced the discovery of potentially commercially recoverable crude oil reserves in the Medina structure of the Condor block, and preparations were made for commercial production at the field. In 2009, we completed the geological exploration phase. Our research and development activities led to the creation of a new tectonic model of Condor Block based on 2D
and 3D seismic data interpretation. In 2010, we completed 3D seismic interpretation and prepared the Amarillo structure for drilling. In addition, we started a long-term testing operation for the Condor 1 well on the Medina field in July 2010.
In July 2008, we signed a two-year agreement with the National Oil & Gas Company of Venezuela (PDVSA) to jointly evaluate production, refining and export of oil from the Junin-3 block, with expenses shared equally between the parties. We expect to extend this agreement. The total block area is 678 square kilometres (261.8 square miles). Seven stratigraphic wells have been drilled at the block, with another three planned.
In April 2010, Russia and Venezuela signed a deal to jointly develop the Junin-6 oil field in Latin America. Venezuela's state-run PDVSA and a consortium of Russian firms with LUKOIL (stake of LUKOIL Group in this project is 8%) agreed in February to set up a venture to tap the Junin-6 field in the oil belt.
The refining, marketing and distribution segment of our business comprises refining, gas processing, sales and other deliveries of crude oil, sales of refined products and retail marketing of refined oil products.
We refined a total of 32.4 million tonnes of raw materials at our own refineries (including our share in the ISAB and TRN refining complexes) in the first six months of 2010 and a total of 62.7 million tonnes in 2009. In 2009, we also refined 2.0 million tonnes of crude oil under contracts with domestic third party refineries, primarily at refineries in Ufa, and 1.7 million tonnes under contract with international third party refineries. We currently produce more crude oil than we can refine at our own facilities.
We own four oil refineries in Russia, located in Perm, Volgograd, Ukhta and Nizhny Novgorod. These refineries, along with our mini-refineries in Urai and Kogalym, have a combined refining capacity of approximately 45.1 million tonnes per year and refined a total of 22.2 million tonnes of crude oil in the first six months of 2010 and 44.5 million tonnes in 2009. Outside of Russia, we own refineries in Ukraine, Bulgaria, Romania, a 49% share in a refining complex in Italy and a 45% share in a refinery complex in The Netherlands, which have a combined refining capacity of 27.9 million tonnes per year and refined a total of 10.2 million tonnes of crude oil in the first six months of 2010 and 18.2 million tonnes in 2009.
In June 2009, we signed an agreement with Total to purchase a 45% stake in TRN, which operates a refinery near Vlissingen, The Netherlands that has a total refining capacity of approximately 7.9 million tonnes per year and a hydro-cracking unit that has a capacity of approximately 3.4 million tonnes per year. Under the agreement, we acquired a 45% stake in the refinery for approximately \$700 million (including inventory and subject to postcompletion adjustments). The transaction was completed in September 2009.
As part of our strategy to participate in more stages of the hydrocarbon production chain, we intend to upgrade our refineries to produce higher volumes of higher-value light products such as gasoline, jet fuel and diesel fuel, and expand into petrochemicals. We intend to continue to invest in our refineries to expand their capacities and to upgrade the quality of refined products and the proportion of higher value light products to improve the profitability of these facilities and improve returns from our downstream business.
We have invested, and expect to continue to invest, substantial amounts in the modernisation of our refineries. As a result of such modernisation, all our European refineries comply with the current European Union standards in terms of the products produced. Fuels exported from Russian refineries also meet the European Union specifications which gives us an additional competitive advantage. Our Odessa refinery in Ukraine was closed from August 2005 until April 2008 for a large-scale reconstruction programme. This reconstruction programme has been part of a larger effort to upgrade and modernise all of our refineries to improve utilisation rates and depth of refining and to increase production of refined products which comply with the more stringent current environmental requirements. In 2009, we spent \$827 million on capital expenditures in connection with modernising and reconstructing our refineries. In March 2010, we signed a multi-year agreement with Emerson Process Management to modernise 13 refining and petrochemical facilities in Russia and Eastern Europe. Under the agreement, which extends through 2014, Emerson Process Management will provide equipment, software, and services as part of our enterprise-wide strategy to modernise process automation at our oil and gas refineries, petrochemical plants and related facilities. The refineries and petrochemicals plants that shall be upgraded under the agreement include Stavrolen and Saratovorgsintez in Russia, Neftochim Bourgas in Bulgaria, and Karpatnaftochim Ltd. in Ukraine, as well as other facilities in Romania, Odessa, Perm, the Volgograd region, and the Komi Republic.
The following table provides our share of current refining capacity and historical throughput at each of our refineries for the first six months of 2010 and each of the years ended 31 December 2009, 2008 and 2007.
| Throughput | ||||||||
|---|---|---|---|---|---|---|---|---|
| Year ended 31 December | ||||||||
| Annual | Six months | |||||||
| Refining | ended 30 | |||||||
| Capacity | June 2010 | 2009 | 2008 | 2007 | ||||
| (million tonnes of crude oil) | ||||||||
| Refinery | ||||||||
| Russia | ||||||||
| Perm | 13.0 | 6.5 | 12.7 | 12.5 | 11.9 | |||
| Volgograd | 11.0 | 5.3 | 11.3 | 10.7 | 9.6 | |||
| Ukhta | 3.7 | 1.9 | 4.2 | 3.8 | 4.1 | |||
| Nizhny Novgorod | 17.0 | 8.4 | 16.1 | 17.0 | 16.7 | |||
| Mini refineries | 0.4 | 0.1 | 0.2 | 0.2 | 0.2 | |||
| International | ||||||||
| Odessa(1) | 2.8 | 0.8 | 2.1 | 2.0 | – | |||
| Bourgas(2) | 9.8 | 2.7 | 6.3 | 7.1 | 7.1 | |||
| Petrotel(3) | 2.4 | 1.2 | 2.2 | 2.4 | 2.5 | |||
| ISAB(4) | 7.8 | 3.0 | 6.2 | 0.5 | – | |||
| TRN(5) | 5.1 | 2.5 | 1.5 | – | – | |||
| Total(6) | 73.0 | 32.4 | 62.7 | 56.3 | 52.2 |
Notes:
(1) We currently own 99.58% of the Odessa refinery.
(2) We currently own 99.45% of the Bourgas refinery.
(3) We currently own 94.65% of the Petrotel refinery.
(4) We currently own 49% of the ISAB refinery complex, which we acquired in December 2008. Capacity shown represents LUKOIL's 49% share.
(5) We currently own 45% of the TRN refinery, which we acquired in September 2009. Capacity shown represents LUKOIL's 45% share.
(6) Totals may not equal sums due to rounding.
The following table sets out our production of certain refined products in the first six months of 2010 and for the year ended 31 December 2009 expressed as a percentage of our total refined products production volume (excluding production from our mini-refineries).
| Six months | ||
|---|---|---|
| ended 30 June | Year ended 31 | |
| 2010 | December 2009 | |
| Product | ||
| Diesel fuel | 30.3% | 30.8% |
| Fuel oil | 23.8% | 24.1% |
| Motor gasoline | 15.6% | 15.4% |
| Vacuum gas oil | 12.1% | 12.2% |
| Jet fuel | 4.6% | 4.7% |
| Process gasoline | 2.2% | 3.1% |
| Other refined products | 4.0% | 2.3% |
| Ship fuel | 2.0% | 2.2% |
| Lubricants | 2.3% | 2.0% |
| Bitumen | 1.5% | 1.4% |
| Coke | 1.3% | 1.2% |
| Heating fuel | 0.3% | 0.6% |
| Total | 100% | 100% |
Perm. We own 100% of the Perm refinery, which we acquired in 1991. The refinery was built in 1958 and currently has a refining capacity of 13.0 million tonnes per year. The refinery processes a blend of crude oils from the northern part of the Perm region and from Western Siberia. It produces a range of products, including gasoline, jet fuel, diesel fuel, lubricants, fuel oil, fuel grade petroleum cokes and bitumen. The refinery's facilities include catalytic cracking, catalytic reforming, delayed coking, lubricants production and hydrotreating units. We commissioned an isomerisation unit with a hydrotreatment block in October 2007, enabling it to increase production of high-octane gasoline and produce gasoline that meets Euro 3 and eventually Euro 4 standards. The refinery also produces Euro 4 and Euro 5 diesel fuel. We invested \$47.9 million in 2009, \$119.8 million in 2008 and \$210.3 million in 2007 in our Perm refinery in connection with our efforts to upgrade and modernise all of our refineries. We have commenced a large-scale modernisation programme at the Perm refinery to increase refining depth and to increase the refinery's production of higher quality refined products. We expect to complete the programme, which includes construction of a catalytic cracking complex, by 2019. We supply crude oil to the Perm refinery from our fields in Western Siberia and from the Perm region through the Transneft pipeline network and local intra-field pipelines which feed into an on-site crude oil reservoir park. We transport products from the Perm refinery through the Perm-Andreevka-Ufa oil product pipeline and by rail, river-class tanker and truck.
Volgograd. We own 100% of the Volgograd refinery, which we acquired in 1991. The refinery was originally built in 1957 and currently has a refining capacity of 11.0 million tonnes per year. The refinery processes a light blend of West-Siberian and Lower-Volga crude oils. It produces a range of products, including gasoline, diesel fuel, fuel oil, electrode coke, lubricants and bitumen. The refinery's facilities include catalytic reforming, coke calcination, delayed coking, bitumen production and hydrotreating units. The refinery also has gas refining facilities with an annual capacity of 240,000 tonnes of natural gas liquids. We invested \$93.5 million in 2009, \$111.5 million in 2008 and \$124.1 million in 2007 in our Volgograd refinery in connection with our efforts to upgrade and modernise all of our refineries. In August 2005, we installed a coke calcination facility at the Volgograd refinery with an annual capacity of 100,000 tonnes of calcinated coke. In 2006, we completed the installation of the refinery's catalytic reforming unit, which enables the refinery to produce a higher portion of higher-octane gasoline. In 2007, we commissioned an isomerisation unit, which will allow us to upgrade the quality of gasoline produced at the refinery to Euro 3 and Euro 4 standards. We plan to construct a delayed coking unit and a unit for hydrotreatment of diesel fuel by 2012. We supply crude oil to our Volgograd refinery from our fields in Western Siberia and the lower Volga region in European Russia through the Transneft pipeline system. The Volgograd refinery transports its refined products by rail, river-class tanker or truck.
Ukhta. We own 100% of the Ukhta refinery, which we acquired in 1999. The refinery was originally built in 1934 and currently has a refining capacity of 3.7 million tonnes per year. The refinery processes a blend of crude oils from Komi fields and Yareg heavy oil. It produces a range of products including gasoline, diesel, fuel oil and bitumen. The refinery's facilities include primary petroleum processing, catalytic reforming, bitumen production and diesel fuel hydrodeparafinisation units. The refinery also has a tank car loading rack for light refined products. We invested \$24.3 million in 2009, \$40.6 million in 2008 and \$34.9 million in 2007 in our Ukhta refinery in connection with our efforts to upgrade and modernise all of our refineries. In 2007, we commissioned a vacuum residue vis-breaking unit at the refinery, with an annual capacity of 800,000 tonnes. In 2008, work continued to upgrade the catalytic reforming unit. In 2009, we completed construction of the isomerisation unit at the Ukhta refinery. The unit is designed to produce high-octane components of gasoline free of any sulfur compounds, benzene and aromatics. The upgrade has enabled the Ukhta refinery to commence production of automotive gasolines meeting Euro-3 and Euro-4 requirements. The unit has a capacity of 120,000 tonnes of feedstock per year. The investment in the construction of the unit was approximately \$40.0 million. The Ukhta refinery receives crude oil by pipeline and rail. Its refined products are stored prior to shipment in an on-site reservoir park and are shipped by rail.
Nizhny Novgorod. We own 100% of the Nizhny Novgorod refinery, which we acquired in October 2001. The refinery began operation in 1958 and currently has a refining capacity of 17.0 million tonnes per year. The refinery processes a blend of West Siberian and Tatarstan crude oils. The refinery's production includes gasoline (to Euro 3 standards), diesel fuel (to Euro 5 standards), fuel oil, vacuum gas oil, jet fuel, bitumen and lubricants. The refinery's facilities include isomerisation, catalytic reforming, hydrotreating, bitumen production and lubricants production units. We invested \$353.7 million in 2009, \$415.9 million in 2008 and \$236.3 million in 2007 at our Nizhny Novgorod refinery in connection with our efforts to upgrade and modernise all of our refineries. We began a complex reconstruction and modernisation programme in July 2005, a process which involves construction of a deep-refining complex (including catalytic cracking, alkylation and vacuum gas oil hydrotreatment units) is scheduled for completion in 2011. As part of this programme, we completed the construction of a gasoline isomerisation unit and upgraded the refinery's atmospheric and vacuum distillation and hydrotreatment units in 2006. In September 2008, we commissioned a vacuum residue vis-breaking unit with an annual capacity of 2.4 million tonnes at the refinery. A dedicated pipeline connects the refinery directly to the Transnefteproduct system, the state-owned refined products pipeline, which makes transportation costs comparatively less expensive than rail transport.
Odessa. We own 99.58% of the Odessa refinery in Ukraine (ZAO LUKOIL-Odessky NPZ), which we acquired in May 2000. The refinery was built in 1937 and currently has a refining capacity of 2.8 million tonnes per year. Prior to our acquisition of the refinery in May 2000, it had stopped production due to a lack of supply of crude oil. Immediately upon acquisition, we began supplying crude oil to the facility and production of refined products. The refinery processes Urals blend crude oil. The refinery's production includes gasoline (to Euro 3 standards), diesel fuel (to Euro 4 standards), jet fuel, fuel oil, liquefied gas and bitumen. The refinery's facilities include isomerisation, catalytic reforming, hydrotreating and bitumen production. We invested \$13.2 million in 2009, \$28.9 million in 2008 and \$57.9 million in 2007 in our Odessa refinery in connection with our efforts to upgrade and modernise all of our refineries. Our Odessa refinery in Ukraine was closed from August 2005 until April 2008 for a large-scale reconstruction programme. This reconstruction programme has been part of a larger effort to upgrade and modernise all of our refineries to improve utilisation rates and depth of refining and to increase production of refined products which comply with the more stringent current environmental requirements. Following the completion of the reconstruction programme, the refinery's annual crude refining capacity remained at 2.8 million tonnes, but refining depth was increased to 72% from 56% and production of fuel oil will be reduced in favour of high-value products such as vacuum gas oil and high-octane gasoline. Crude oil is delivered to the refinery by pipeline and its refined products are delivered by truck, rail or pipeline to the port of Odessa. In early October 2009, we suspended operations at the Odessa refinery due to a lack of crude oil supplies resulting from the decision by Ukrtransnafta, the Ukrainian state pipeline operator, to reverse the direction of the Odessa-Kremenchug pipeline. Alternative routes for delivery of crude oil that had been presented to us by Ukrtransnafta would have increased transportation costs and made operation of the Odessa refinery uncommercial. In late October 2009, we agreed with Transneft on a new route for transportation of crude oil from Russia to our Odessa refinery through the Druzhba pipeline and we restarted operations at the refinery on 1 November 2009. The refinery refined 5.9 mmbls in the first six months of 2010, 31% less than the first six months of 2009 due to scheduled maintenance at the facility in 2010 and unfavourable economic conditions. Due to unfavourable conditions on the Ukrainian market in October 2010, we decided to move scheduled maintenance at the refinery from the first quarter of 2011 to the fourth quarter of 2010 and to temporarily shut down operations there. Management is continuing to evaluate options for improving the economic efficiency of crude oil supply to the Odessa refinery.
Bourgas. We own 99.45% of the Bourgas refinery in Bulgaria (LUKOIL Neftochim Bourgas AD). In October 1999 we acquired, together with a local partner, a 58% interest in the Bourgas refinery from the government of Bulgaria. In July 2000, we purchased our local partner's interest. Since 2002, we have been increasing our ownership interest in the Bourgas refinery by buying stock from minority shareholders in an ongoing buy-back programme. The Bourgas refinery was built in 1964 and has a refining capacity of 9.8 million tonnes per year. The Bourgas refinery processes Urals blend crude oil and fuel oil from the Odessa refinery. It produces a range of products, including gasoline (to Euro 4 standards), jet fuel, diesel fuel (to Euro 4 standards) and fuel oil. The refinery's facilities include primary refining, fluid catalytic cracker, catalytic reforming, thermocracking, hydrotreating and sulphuric acid alkylation units. The refinery's complex also includes a petrochemicals plant and a polymerisation plant which produce petrochemical products. See "- Refined Products Sales – Petrochemicals" for more information about the Bourgas refinery's involvement in our petrochemicals operations.
We are currently in the process of implementing an investment programme for the Bourgas refinery. We invested \$245.9 million in 2009, \$225.1 million in 2008 and \$123.6 million in 2007 in our Bourgas refinery in connection with our efforts to upgrade and modernise all of our refineries. In 2007, we completed construction of a unit for isomerisation of n-butane, which raises production potential by 60,000 tonnes per year and enables greater flexibility in the production of high-octane gasolines. In 2008, we completed modernisation of a diesel fuel hydrotreatment unit. In 2009, we commissioned a new sulphur acid alkylation unit (SAA) with a capacity of 300,000 tonnes per year. Investments in this new production facility exceeded \$90 million. The design of the unit includes state-of-the-art technology which is expected to enable us to significantly increase the octane number of alkylate, improve the quality of the gasolines we produce, and reduce the level of air pollution and consumption of energy, materials and chemicals involved in the production process. We also completed the modernisation of the diesel fuel hydrotreating unit with a view to producing Euro-5 compliant fuel. In 2010, we successfully completed planned maintenance and began a gradual restart of the shut units and the Bourgas refinery became fully operational. The Bourgas refinery is located 30 kilometres (19 miles) from a port terminal on the Black Sea. This location allows the refinery to receive crude oil shipments by sea, and also to deliver its products by sea in addition to truck, rail and product pipelines. Approximately 40% of the Bourgas refinery's output is distributed into the Bulgarian market and 60% is exported, primarily to Turkey.
Petrotel. We own 94.65% of the Petrotel refinery in Romania (PETROTEL-LUKOIL S.A.), which we acquired in a series of transactions from 1998 through 2002. The refinery was built in 1927 and has a refining capacity of approximately 2.4 million tonnes. When we purchased our initial interest in Petrotel in 1998, it was operating on a profitable basis. However, a recession commenced in 1999, which caused demand for refined products in Romania to decline significantly so that demand was substantially lower than the country's total refinery capacity. As a result, the leading domestic producer of crude oil reacted by reducing the crude oil transfer price to its own refineries. The resulting decrease in refined product prices effectively forced Petrotel out of the domestic wholesale market and its market share fell from 38% in 1999 to 6% in 2001. In August 2001, we shut down the refinery. We engaged Purvin & Gertz, international energy consultants, to perform a review of the Romanian downstream oil industry and Petrotel's competitive position. As a result of this study we undertook a comprehensive reconstruction plan to improve the quality of gasoline produced and bring it up to European Union standards.
In October 2004, we put the refinery back into operation after an upgrade and modernisation programme at an estimated cost of \$120.7 million. We invested \$48.9 million in 2009, \$79.8 million in 2008 and \$42.0 million in 2007 in our Petrotel refinery in connection with our efforts to upgrade and modernise all of our refineries. The refinery processes Urals blend crude oil, which is supplied via pipeline from the port of Constanta. In 2008, we upgraded the FCC gasoline hydrotreatment and diesel fuel hydrotreatment units. In 2009, we completed the reconstruction of a diesel fuel hydrotreatment unit, a catalytic cracking unit for hydrotreatment of gasoline and production of MTBE/TAME and the vacuum block of ADU-1 unit. In addition, in 2009, we completed construction of a hydrogen production unit. The Petrotel refinery produces a range of products, including diesel fuel and gasoline (both to Euro 5 standards), and adjusts its product mix to match demand on the market. Most of the gasoline and diesel fuel produced by the refinery is marketed through LUKOIL's retail network in Romania; the excess is exported to supply LUKOIL's retail outlets in neighboring countries.
ISAB. We own a 49% stake in a joint venture that manages the ISAB refinery complex in Priolo, Italy. We acquired our interest in ISAB in December 2008, pursuant to an agreement we signed with ERG in June 2008. We also entered into a put option with ERG, under which, for six years from the transaction closing date, ERG can require us to purchase additional stakes in the ISAB joint venture at a market value to be determined by an independent appraiser. We manage the refinery with ERG on a 50/50 basis. The refinery was built in 1975 and has a total refining capacity of 16.0 million tonnes per year (of which our share is 7.8 million tonnes per year). The refinery complex consists of two oil refineries joined by a system of pipelines and integrated into a single operating complex, and also includes three jetties, storage tanks with a total capacity of 3.7 mcm and a 99 MW power station. The ISAB refinery mainly processes sour crudes, similar to the Urals blend, but has historically been supplied by the Black Sea, North and West Africa and Persian Gulf countries. Its production includes diesel fuel and gasoline (to Euro 5 standards) and fuel oil. The refinery is located at the centre of the Mediterranean petroleum products trade, and most of its products are exported, with most gasoline going to the United States and most of the diesel fuel produced going to European Union markets.
TRN. We own a 45% stake in the TRN refinery near Vlissingen, The Netherlands. We acquired our interest in TRN in September 2009 for approximately \$700 million (including inventory and subject to post-completion adjustments) pursuant to an agreement we signed with Total in June 2009. Total owns the remaining 55% stake in TRN, and we manage the refinery with Total on a 50/50 basis. Construction of the TRN refinery was completed in 1973. It has a total refining capacity of approximately 7.9 million tonnes per year (of which our share is 3.6 million tonnes per year) and a hydro-cracking unit that has a capacity of approximately 3.4 million tonnes per year (of which our share is 1.5 million tonnes per year). TRN has the capability to process a variety of crude oil qualities, although it mainly processes heavy, sulphurous crude oils, and we have historically supplied crude oil to TRN from our production in Timan- Pechora. The refinery also has the capacity to import and process hydrocracker feedstocks such as straight run fuel oil and vacuum gas oil. The hydrocracker configuration at TRN is focused on producing premium quality middle distillates, including jet fuel, diesel fuel, solvents and lube base oil. The refinery's location allows it to receive crude oil from sea tankers and to ship refined products by inland waterways. TRN owns certain other assets, including a marine terminal, a barge jetty and a minority interest in the Maasvlakte Oil Terminal in Rotterdam.
We have two Russian mini-refineries in Urai and Kogalym with a combined annual capacity of 450,000 tonnes. Prior to 2010, we refined oil at other refineries. These refineries included refineries in Ufa, Russia, the Naftan and the Mozyr refineries in Belarus and the Panchevo refinery in Serbia. In 2009, we refined 2.0 million tonnes of crude oil under contracts with domestic third party refineries. In 2009, we entered into contracts with a number of Ufa refineries and, as a result, in 2010, we supply oil produced by the Group to these refineries. We
also refined 1.7 million tonnes of crude oil under contracts with international third party refineries in 2009. Processing at third party international refineries declined in late 2009 and stopped in the first quarter of 2010 because oil was rerouted to be processed at ISAB and TRN complexes.
We currently process our gas production at four domestic facilities: the Korobkovsky gas processing plant (in the Volgograd region), the Permneftegazpererabotka plant (in the Perm region), the Usinsk gas processing plant (in the Komi Republic) and the Lokosovsky gas processing plant (in the Tyumen region). These gas processing plants have a combined capacity of 134 bcf (3.8 bcm) of gas feedstock per year and 1,161,000 tonnes of natural gas liquids per year. We own 100% of each of these processing plants. Our gas processing plants processed 49.4 bcf (1.4 bcm) of gas feedstock and 0.4 million tonnes of natural gas liquids in the first six months of 2010, and 104.6 bcf (3.0 bcm) of gas feedstock and 0.7 million tonnes of natural gas liquids and 81.2 bcf (2.3 bcm) of stripped gas, 785,000 tonnes of LPG and 625,000 tonnes of liquid hydrocarbons in 2009. The Lokosovsky gas processing plant is currently our main gas processing facility in Russia. We completed reconstruction work at this plant in 2006 to increase its gas processing capacity to 81.2 bcf (2.3 bcm) per year, which enables us to process petroleum gas from our Western Siberia fields.
We sell the crude oil which we do not refine into the domestic market and international market, which includes exports from Russia and sales outside of Russia of crude oil production from our international projects. We also undertake crude oil trading activity on international markets.
The table below sets out our domestic and international crude oil sales for the six months ended 30 June 2010 and each of the years ended 31 December 2009, 2008 and 2007.
| Six months ended | Years ended 31 December | |||||||
|---|---|---|---|---|---|---|---|---|
| 30 June 2010 | 2009 | 2008 | 2007 | |||||
| (mmbls) | (\$ million) | (mmbls) | (\$ million) | (mmbls) | (\$ million) | (mmbls) | (\$ million) | |
| Russia | 14.3 | 481 | 21.9 | 735 | 15.4 | 600 | 11.8 | 440 |
| International | 174.8 | 12,688 | 344.4 | 19,914 | 274.4 | 24,007 | 288.8 | 19,258 |
| Total | 189.1 | 13,169 | 366.3 | 20,649 | 289.8 | 24,607 | 300.6 | 19,698 |
We sold 14.3 mmbls (1.9 million tonnes) of crude oil within Russia in the first six months of 2010 and 21.9 mmbls (3.0 million tonnes) in 2009.
We sold 174.8 mmbls (23.9 million tonnes) of crude oil outside of Russia in the first six months of 2010 and 344.4 mmbls (47.0 million tonnes) in 2009. Our international sales are primarily to purchasers in Europe. In the first six months of 2010, 85% of our international crude oil sales were through our subsidiary LITASCO (and its wholly owned subsidiaries). In 2009, 81% of our international crude oil sales were through LITASCO.
LITASCO, a wholly owned subsidiary of LUKOIL INTERNATIONAL, is our primary marketing vehicle for international sales of crude oil and refined products. LITASCO's key functions include both marketing the Group's crude oil and products and trading with third parties. Third party trading activity represented approximately 46% of LITASCO's total activity in 2009, approximately 37% in 2008 and approximately 32% in 2007 by volume. Trading with third parties allows LITASCO to increase the efficiency of LUKOIL system barrel sales and enables the Group to further expand its international operations. For this reason, the Group expects to increase the scale of LITASCO's third party trading activity over the next several years.
LITASCO (and its wholly owned subsidiaries) made sales to third parties of 149 mmbls (20 million tonnes) of crude oil and 34 million tonnes of refined products in the first six months of 2010, and 278 mmbls (38 million tonnes) of crude oil and 65 million tonnes of refined products in 2009. In addition, as part of its crude oil trading activities, LITASCO purchased from third parties 76 mmbls (10 million tonnes) of crude oil and 20 million tonnes of refined products in the first six months of 2010 and 148 mmbls (20 million tonnes) of crude oil and 32
million tonnes of refined products in 2009. LITASCO's total sales were \$35,579 million in the first six months of 2010 and \$52,496 million in 2009.
The Group uses derivative instruments in international petroleum products marketing and trading operations. The types of derivative instruments used include futures and swap contracts, used for hedging purposes, and purchase and sale contracts that qualify as derivative instruments. The Group maintains a system of controls over these activities that includes policies covering the authorisation, reporting and monitoring of derivative activities.
Through LITASCO (and its wholly owned subsidiaries and branch offices) we:
LITASCO's international trading network includes offices located in nine countries.
We sold a total of 51.0 million tonnes of refined products in the first six months of 2010 and 100.8 million tonnes in 2009 through both retail and wholesale channels. We sell a wide range of refined products, including gasoline, diesel fuel, fuel oil and lubricants. In the first six months of 2010, we sold 8.4 million tonnes, or 16.5% of our refined products in the domestic market and 42.6 million tonnes, or 83.5%, internationally, and in 2009 we sold 16.0 million tonnes, or 15.9%, of our refined products in the domestic market and 84.7 million tonnes, or 84.1%, internationally. The table below provides information on our refined products sales for the six months ended 30 June 2010 and each of the years ended 31 December 2009, 2008 and 2007.
| Years ended 31 December | ||||||||
|---|---|---|---|---|---|---|---|---|
| Six months ended 30 June 2010 |
2009 2008 |
2007 | ||||||
| (millions of | (millions of | (millions of | (millions of | |||||
| tonnes) | (\$ million) | tonnes) | (\$ million) | tonnes) | (\$ million) | tonnes) | (\$ million) | |
| Russia | 8.4 | 4,973 | 16.0 | 8,101 | 19.3 | 13,872 | 18.6 | 9,583 |
| International | 42.6 | 28,414 | 84.7 | 46,888 | 75.9 | 62,542 | 72.3 | 47,154 |
| Total(1) | 51.0 | 33,387 | 100.8 | 54,989 | 95.1 | 76,414 | 90.9 | 56,737 |
Note:
(1) Totals may not equal sums due to rounding.
We transport our refined products through Transnefteproduct's refined product pipeline, via ship, rail and truck. In the first six months of 2010, we transported 10.3 million tonnes of refined products via rail, 1.2 million tonnes through the Transnefteproduct system and 1.0 million tonnes via ship, truck and other means. In 2009, we transported 21.8 million tonnes of refined products via rail, 2.4 million tonnes through the Transnefteproduct system and 2.8 million tonnes via ship, truck and other means.
Our retail distribution system is divided into a central office and regional distribution centres. Sales and distribution are managed centrally from our Moscow headquarters. Using data from internal sources on refined product production and projected demand from individual regions, the central sales and distribution office directs refineries to send refined products to regional distribution centres. The refinery then ships the product via the designated transport route to the regional distribution centre for onward distribution. The regional distribution centres receive instructions from the central selling and distribution centre on the destination of products. This centralised system helps us improve distribution efficiency by determining distribution according to regional demand and enables us to consider a greater number of markets for receipt of our products.
Domestically, we sell refined products through wholesale and retail channels. We sold a total of 8.4 million tonnes of refined products domestically, including government-related sales, in the first six months of 2010, and a total of 16.0 million tonnes in 2009. These sales included 3.3 million tonnes through our retail filling stations within Russia and 5.1 million tonnes through wholesale channels in the first six months of 2010 and 6.2 million tonnes through our retail filling stations within Russia and 9.8 million tonnes through wholesale channels in 2009. See "– Refining, Marketing and Distribution – Retail Marketing" for more information about our domestic retail filling station network.
The Russian government has the authority to direct us to deliver crude oil or refined products to certain government-designated customers, which may take precedence over market sales. Government-directed deliveries may take several forms. We may be directed to make deliveries to government agencies, the military, railways, agricultural producers, remote regions, specific consumers or refineries or to domestic refineries in general. Additionally, some of our oil production licences require us to sell crude oil which we produce to local government agencies. See "Risk Factors – Risks Relating to the Russian Federation – The Russian government can mandate deliveries of crude oil and refined products, including at less than market prices, which could materially adversely affect our relationships with other customers and, more generally, our business, financial condition and results of operations."
Internationally, we sell refined products to third parties through wholesale and retail channels. In the first six months of 2010, we sold a total of 42.6 million tonnes of refined products in the international market, 12.9 million tonnes of which were exported from Russia. Over that period, 3.4 million tonnes of refined products were sold through our retail filling stations outside Russia and 39.2 million tonnes were sold through wholesale channels. In 2009, we sold a total of 84.7 million tonnes of refined products in the international market, 27.8 million tonnes of which were exported from Russia. Over that period 7.8 million tonnes of refined products were sold through our retail filling stations outside Russia and 76.9 million tonnes were sold through wholesale channels. See "– Refining, Marketing and Distribution – Retail Marketing" for more information about our international retail filling station network.
As at 30 June 2010, we owned or leased 5,097 retail filling stations (excluding stations that were temporarily idle or leased to third parties) in Russia, other countries of the CIS, Europe and the United States. We have one of the largest retail networks in Russia, where we own or lease 1,899 filling stations. We also have a network of 932 franchised stations in Russia and internationally which sell our products exclusively. Our franchise programme includes rigid quality control requirements including those relating to LUKOIL corporate specifications and designs. Our retail network also includes 195 tank farm facilities with a total capacity of 3.1 mmcm.
In 2006, we began selling gasoline and diesel in Russia under our new EKTO brand, which is an acronym from the Russian words for "ecological fuel". These gasoline and diesel fuels have improved performance and environmental characteristics which meet Euro 3 and Euro 4 standards and exceed Russian legal standards for gasoline. We also expanded the sales of these fuels to more filling stations in 12 Russian regions in 2007. We continued expanding sales of EKTO fuels to additional filling stations and Russian regions in 2008 and in 2009. In addition to automotive fuels, many of our retail filling stations provide car accessories and basic vehicle service, and increasingly offer goods such as fast food, convenience products and groceries.
The following table provides selected data on our retail filling station as at 30 June 2010.
| CIS and | United | |||
|---|---|---|---|---|
| Russia | Europe | States | Total | |
| Number of Stations which are | ||||
| LUKOIL owned or leased(1) | 1,899 | 2,157 | 1,041 | 5,097 |
| Franchised(2) | 120 | 812 | – | 932 |
| Total | 2,019 | 2,969 | 1,041 | 6,029 |
Notes:
(1) Excluding stations that were temporarily idle or leased to third parties.
(2) Stations owned by third-party dealers and subject to long-term contracts with pricing similar to retail pricing.
Outside Russia, we have retail operations in Azerbaijan, Belarus, Georgia, Moldova, Ukraine, Bulgaria, Hungary, Finland, Estonia, Latvia, Lithuania, Poland, Serbia, Montenegro, Romania, Macedonia, Cyprus, Turkey, Belgium, Luxembourg, Czech Republic, Slovakia and Croatia, Bosnia and Herzegovina, as well as in the United States.
Our efforts at optimisation in our retail network are focused on withdrawal of stations and tank farms with low efficiency levels. In 2009, we withdrew from the Group seven gas filling stations in Europe and 10 filling stations and five petroleum depots in Russia and sold 16 filling stations and eight petroleum terminals depots worldwide. In the United States, we have reduced the retail network by almost 200 low- margin filling stations. We continue to build and acquire new, more efficient filling stations and upgrade existing ones. In Europe, we built 35 and reconstructed 38 filling stations in 2009. In Russia, we built 40 and reconstructed 39 filling stations in 2009. Capital investments in the retail sector in 2009 were \$157 million in Russia and \$156 million internationally.
In March 2005, we acquired a 100% interest in the Finnish companies Oy Teboil Ab and Suomen Petrooli Oy for \$160 million. Since the time of the acquisitions, Suomen Petrooli has been merged into Teboil. Teboil is primarily engaged in the wholesale and retail sale of refined products and the production and sale of lubricants. As at 30 June 2010, Teboil operated 449 retail filling stations in Finland.
In December 2006, we signed an agreement with ConocoPhillips to purchase 376 of ConocoPhillips's retail filling stations in Europe, including 156 in Belgium and Luxembourg, 49 in Finland, 44 in the Czech Republic, 30 in Hungary, 83 in Poland and 14 in Slovakia. On 30 April 2007, we completed the acquisition of the filling stations located in Finland, which we rebranded as Teboil stations in 2007. We completed the acquisition of the remaining stations on 1 June 2007, which we rebranded as LUKOIL stations.
In the second quarter of 2008, we acquired 75 retail filling stations and one tank farm in Bulgaria from Bulgarian company Petrol for approximately \$367 million. In November 2008, we completed the acquisition of 100% of Akpet, a Turkish company that operated 689 retail filling stations and owns eight petroleum product terminals, five LNG storage tanks, three jet fuel terminals and a lubricant production plant in Turkey, for \$555 million. In addition, in the fourth quarter of 2008, we acquired ZAO Association Grand and OOO Mega Oil M, whose assets include 181 retail filling stations in Moscow and other regions of Russia, for \$493 million. In the first quarter of 2009, we purchased retail filling station networks totalling 96 filling stations and plots of land from OOO Smolenskneftesnab, OOO IRT Investment Company, OOO PM-Invest and OOO Retaier House.
In 2007, we designed a programme to develop our marketing and sales network for liquefied and compressed gas, with the goal of increasing sales of these products in Russia. We also have a significant share of the retail lubricant market in Russia and we are engaged in an advertising campaign in Russia to promote the sale of LUKOIL-branded packaged lubricants through our chain of retail filling stations.
We view our petrochemicals operations as an important part of our business strategy and believe that they provide us with strategic benefits, including more diversified revenues and an additional source of petrochemicals products necessary for our operations. We intend to develop our petrochemicals business
primarily by upgrading our existing petrochemical facilities and constructing new facilities, and also by using petrochemical feedstock supplies available in Russia. We believe that demand in the Russian and international markets for petrochemicals products will grow in the coming years and we intend to expand our petrochemicals production capacity to meet this demand.
Our petrochemicals operations are conducted through our three petrochemicals plants in Russia and Ukraine and our Bourgas refinery. In Russia, we own the OOO Stavrolen and OOO Saratovorgsintez petrochemicals plants. The Stavrolen plant produces polyethylene, liquid pyrolysis fractions, polypropylene, benzene and other products, and the Saratovorgsintez plant produces acrylonitrile and other organic synthesis products. In March 2007, we commissioned a polypropylene production unit with an annual capacity of 120,000 tonnes at the Stavrolen petrochemical plant, which we continued modernising in 2008. We completed installation of a new polyethylene compounding line with an annual capacity of 120,000 tonnes in 2009.
We also have an effective 84.7% interest in Karpatnaftochim Ltd., a petrochemicals plant in Ukraine, which produces polyethylene, vinyl chloride and other products. Karpatnaftochim was established in 2000 as a joint venture with the Ukrainian company Oriana. In May 2008, we suspended production at the Karpatnaftochim plant to begin work on a large-scale upgrade, which includes commissioning a chlorine and caustic soda production unit using membrane electrolysis technology and construction of a unit to produce polyvinylchloride. In 2009, we completed construction and assembly operations at the electromembrane process unit relating to chlorine and sodium hydroxide production. The plant resumed operations in September 2010. Construction of a PVC production unit with a capacity of 300,000 tonnes per year is continuing.
In addition, our Bourgas refinery has petrochemicals manufacturing capabilities. Products of the Bourgas refinery include ethylene glycol, polyethylene, polypropylene, toluene, acrylonitrile, benzene.
We have been steadily increasing production of high value-added chemicals (polymers, monomers and organic synthesis products) at our petrochemicals plants over the last five years, in line with our strategy to develop our petrochemical business. At the same time, production of low value-added chemicals (such as pyrolysis products and fuel fractions) has been reduced. Total combined output of marketable chemicals from our petrochemicals facilities was 0.4 million tonnes in the first six months of 2010 and 0.9 million tonnes in 2009, and our products were sold in Russia and exported to more than 50 countries. Capital expenditures in the petrochemicals sector were \$43 million in the first six months of 2010 and \$113 million in 2009.
In 2010, we continued to develop the new power generation sector of our business as part of our strategic development programme. We expect power generation to be an important factor in our company's long-term growth. This new sector will encompass all aspects of the power generation business, from generation to transmission and sale of heat and electrical power, thereby ensuring reliable supplies for our own needs as well as for external customers. Our power generation business sector now includes TGK-8, our own power generating facilities at our oil and gas fields and power generators in Bulgaria, Romania and Ukraine. Our total output of electrical energy was 14.7 billion kW-h in 2009 (of which over 90% was generated by TGK-8). Our total output of heat energy was approximately 16.9 million Gcal in 2009.
In March 2008, we entered into an agreement to purchase a 64.31% interest in TGK-8 for approximately \$2.12 billion. The purchase consideration consisted partly of 23.55 million shares of LUKOIL (at a market value of approximately \$1.62 billion), with a portion of the consideration paid in cash. We completed this transaction in May 2008. From May 2008 to June 2009, we acquired the remaining interest in TGK-8 for a total of \$1.2 billion. On 3 September 2009, TGK-8 was reorganised into a limited liability company. TGK-8's directors include members of our management. TGK-8 is a power generation company which owns power plants in Russia in the Astrakhan, Volgograd and Rostov regions, the Krasnodar and Stavropol districts and the Republic of Dagestan, with total electric power generation facilities of 3.6 GW and total thermal power generation facilities of 13,542 Gcal/hour. The power generation segment investment programme includes the construction of power plants with a total capacity of approximately 890 MW. TGK-8's annual gas consumption is approximately 212.0 bcf (6.0 bcm), and we expect our interest in TGK-8 will create synergies through natural gas supplies from our gas fields in the Northern Caspian and Astrakhan regions.
We use the Transneft pipeline system, our own pipeline network, interests in other pipelines, rail cars and tankers to transport the crude oil which we produce within Russia, for export outside of Russia and to our refineries. We transport most of our crude oil production in Western Siberia through the Transneft pipeline system. LUKOIL-Western Siberia's Uraineftegas production unit transports its high quality light low-sulphur crude oil directly from its production facilities via a dedicated Transneft pipeline network to the Black Sea port of Tuapse, thus avoiding the blending which would otherwise occur. Substantially all of our European Russia crude oil production is transported via Transneft or is exported by tanker. In Timan-Pechora, production from LUKOIL-Komi is transported through the Transneft pipeline. We transport oil from other fields in Timan-Pechora, primarily from the Yuzhnaya Khylchuya field, via pipeline to our terminal at Varandey on the Barents Sea and then shipped via tanker to international markets. The following discussion sets out further details about the crude oil transportation infrastructure that we use.
Transneft. Most of our crude oil production is transported through the Transneft pipeline system. In 2009, we exported 241.9 mmbls (33.0 million tonnes) of crude oil, or 79% of our total crude oil exports in 2009, via Transneft. Transneft is a state-owned pipeline monopoly. The Russian government regulates access to Transneft's pipeline network and is required to provide access on a non-discriminatory basis. Pipeline capacity, including export pipeline capacity, is allocated to oil producers on a quarterly basis, generally in proportion to the amount of crude oil produced and delivered to Transneft's pipeline network in the prior quarter. Generally, a Russian oil company is given an allocation for export that equals approximately 40% of its crude oil so produced and delivered. Some Russian companies are able to obtain excess export quota through extra allocation from Transneft or by purchasing quota from other oil companies.
The FTS is responsible for setting Transneft's fees, which have risen in recent years and may continue to rise. The fees tend to increase annually. The overall cost of transporting crude oil through the Transneft pipeline system depends on the location of the fields in relation to the ultimate destination (including the length of the transport route and whether deliveries are for export or for domestic consumption). See "Regulation of the Oil Industry in the Russian Federation – Crude Oil and Refined Product Transportation Regime" for more information on crude oil transportation.
The crude oil that we transport through the Transneft pipeline network is blended with crude oil of other producers that may differ in quality. Our sales of crude oil that we transport through the Transneft system are of the crude oil blend that results from the combination of different types and qualities of crude oil in the system, which is usually referred to as "Urals blend" crude oil. Therefore, the price we get for our oil may be lower than the price that we could get for oil of the same quality if we could transport our oil independently of Transneft. See "Risk Factors – Risks Relating to Our Business – We depend on monopoly suppliers of crude oil and refined product transportation services and we have no control over the infrastructure they maintain or the fees they charge" for more information about the risks related to our transportation of crude oil through the Transneft pipeline system.
Domestic crude oil pipelines. To avoid the blending which occurs in the main Transneft system, we use alternative pipelines to the extent possible. For example, we transport the crude oil produced at LUKOIL-Western Siberia's Uraineftegas production unit, which is a high quality light low-sulphur crude oil, directly from its production facilities to the Black Sea port of Tuapse via a dedicated Transneft pipeline network. We transport crude oil which we produce at our LUKOIL-Komi subsidiary to the Transneft system through our Kharyaga-Usa pipeline, which has an annual capacity of 88.0 mmbls (12.0 million tonnes). The opening of additional capacity via the Transneft-controlled Baltic Pipeline System to the port of Primorsk in April 2005 enabled us to transport more crude oil for export.
Caspian Pipeline Consortium. LUKARCO has a 12.5% interest in the CPC pipeline, which is a 1,510-kilometre (932-mile) oil pipeline connecting oil fields in Western Kazakhstan to the CPC's marine export terminal at the Black Sea port of Novorossiysk in Russia. Other parties involved in the CPC are the government of Russia (24%), the government of Kazakhstan (19%), Chevron (15%), Rosneft-Shell Caspian Ventures (7.5%), Exxon Mobil (7.5%), CPC Company (Russia) (7%), ENI (2%), BG Group (2%), Kazakhstan Pipeline Ventures (1.75%) and Oryx (1.75%). The pipeline has a capacity of approximately 650,000 bpd (28.2 million tonnes per year). The CPC plans to expand the pipeline's capacity to 1,345 mbpd (67.0 million tonnes per year). Crude oil produced from several of our projects, including our Karachaganak, Kumkol and Tengiz projects, is transported to the CPC terminal at Novorossiysk through the CPC pipeline. For more information on our ownership interest in CPC through LUKARCO, see "–Exploration and Production – International Exploration and Production – Kazakhstan – LUKARCO".
The CPC operates a "quality bank" system, under which exporters who supply high-quality hydrocarbons receive a price premium, and those who supply lower-quality hydrocarbons receive a price discount, to the average blend transported through the CPC pipeline. The blend of oil transported through the CPC pipeline is referred to as "CPC blend", the price for which is quoted separately with a premium over Urals blend.
International Pipelines. The Caspian Sea is land-locked. The export of oil from this region is therefore dependent on onshore pipelines. Currently, hydrocarbons are exported from the Caspian Sea via a northern route through Azerbaijan and Russia to the Russian Black Sea port at Novorossiysk and via a western route through Azerbaijan and Georgia to the Black Sea port at Supsa. As production volumes increase as a result of development of fields in Azerbaijan, the export capacity of the current infrastructure will be insufficient.
In 2003, the construction of the 176.1-kilometre (109.4-mile) long Kumkol-Djusali oil pipeline system and an oil-loading terminal at Djusali were completed in order to reduce oil transportation costs from the Kumkol project in Kazakhstan and the permit to operate the pipeline was issued by the Kazakhstan Ministry of Energy and Mineral Resources.
Construction of a permanent sea terminal at Varandey on the Barents Sea was completed in 2008, and the sea terminal has the capacity to receive and reload up to 240,000 bpd (12.0 million tonnes per year). The project includes a stationary, ice-resistant loading terminal at sea, an underwater pipeline, a system of onshore reservoirs and an offshore transshipment base. We currently transport crude oil (mainly from the Yuzhnaya Khylchuya field in Timan-Pechora) inbound to the terminal by pipeline and outbound from this terminal with ice-breaking shuttle tankers through the Barents Sea to a floating reservoir in the ice-free waters off Murmansk. The crude oil is then loaded onto long distance tankers, which transport it to markets in Western Europe and the United States. The expanded Varandey terminal is a key part of our strategy to increase our ability to transport oil to markets in Europe, the United States and southeast Asia. As part of our efforts to develop our reserves in Timan-Pechora, we entered into a joint venture agreement with ConocoPhillips in September 2004, pursuant to which we sold a 30% interest in NMNG to ConocoPhillips. Under the terms of our agreements, ConocoPhillips also participated in the design and financing of the Varandey terminal.
In 2002, we commenced the construction of a terminal located in Vysotsk, Vyborg's outer harbour on the Baltic Sea. Construction of the third stage of the Vysotsk terminal was completed in September 2006. The current capacity of the terminal is 12.0 million tonnes per year, and it can handle crude oil, fuel oil, vacuum gas oil and diesel. In April 2007, we signed a supplemental agreement to our June 2006 agreement with Russian Railways developing railway transportation infrastructure to increase the supply capacity of refined products to our Vysotsk terminal.
We also own an export terminal at the port of Svetly in the Kaliningrad region (with a total capacity of approximately 120,000 bpd (6.0 million tonnes per year)). The Svetly terminal primarily exports crude oil produced by OOO LUKOIL-Kaliningradmorneft, our subsidiary operating in the Kaliningrad region, as well as refined products.
We shipped approximately 2.2 mmbls (0.3 million tonnes) of crude oil exports, or 1% of our total crude oil exports, by rail car (primarily via the Russian Railways rail network) in the first six months of 2010 and 8.0 mmbls (1.1 million tonnes) of crude oil exports, or 3% of our total crude oil exports, in 2009. For information about rail transportation of refined products via rail, see "– Refining, Marketing and Distribution – Refined Products Sales".
We transport most of our gas through the UGSS, which is responsible for gathering, transporting, dispatching and delivering substantially all natural gas supplies in Russia and is owned and operated by Gazprom. The UGSS transports natural gas from fields in Western Siberia and the Volga region towards the more heavily populated regions of European Russia, and onward to other CIS countries and Europe. Under Russian law, Gazprom is obliged to provide third-party access to the UGSS as long as there is spare transport capacity at the relevant time and place requested, the proposed gas shipments meet established quality and technical standards, input and output connections and quality control stations are available and customer demand exists at the relevant time. Historically, Gazprom has been able to deny third-party gas producers access to the UGSS, citing a lack of spare capacity.
Gazprom's management board has approved a proposal to expand and upgrade facilities as necessary to better accommodate access requests from third-party gas producers. The costs of these expansions and upgrades would be borne by the third-party gas producers, either through increased transportation tariffs or loans to Gazprom which would be repaid through reduced transportation tariffs. In either case, Gazprom will retain ownership and operation of the UGSS and may still be able to influence access to the UGSS by application of access criteria other than capacity constraints. See "Risk Factors – Risks Relating to Our Business – We face several risks in connection with the implementation of our strategy to develop our natural gas operations."
The oil and gas industry is intensely competitive. We compete with other major Russian oil and gas companies and major international oil and gas companies. Many of our international competitors have substantially greater financial resources and have been operating in a market-based, competitive economic environment for much longer than we have. The key activities in which we face competition are:
purchase of capital equipment which may be scarce;
recruitment of qualified and experienced personnel;
See "Risk Factors – Risks Relating to Our Business – We encounter competition from other oil and gas companies in all areas of our operations, including the acquisition of licences, exploratory prospects and producing properties, and we may encounter competition from suppliers of alternative forms of energy sources" for more information about the risks related to our ability to compete effectively with Russian oil and gas and international oil companies.
The integrated oil and gas industry is currently subject to several important influences which impact the industry's competitive landscape. In recent years, the oil and gas industry has experienced consolidation, as well as increased deregulation and integration in strategic markets. In addition, our ability to remain competitive will require, among other things, management's continued focus on reducing unit costs and improving efficiency, maintaining long-term growth in our reserves and production through continued technological innovation and our ability to capture international opportunities.
In addition to intense competition, oil and gas companies are also facing increasing demands to conduct their operations in a manner consistent with environmental and social goals. Investors, customers and governments are more actively following the oil industry's performance on environmental responsibility and human rights, including performance with respect to the development of alternative and renewable fuel resources.
As a result of these influences and other factors, we expect competition to intensify. A number of other Russian oil and gas companies, as well as foreign oil and gas companies, are permitted to compete for licences and to offer services in Russia, increasing the competition which we face domestically. We also expect competition to increase domestically and internationally due to the limited quantities of unexploited and unallocated oil and gas reserves.
We are currently rated by three rating agencies: Moody's Investors Service Inc., Fitch Ratings Ltd and Standard & Poor's Ratings Services. Our ratings as of 20 October 2010 are as follows:
| Moody's | Fitch | S&P | |||
|---|---|---|---|---|---|
| Long term implied | Baa2 | Long term | BBB- | Long term | BBB |
| Senior unsecured | Baa2 | Short term | F3 | Senior unsecured | BBB |
| Credit | |||||
| Watch | |||||
| Outlook | Stable | Outlook | Stable | Outlook | Negative |
The notes have been assigned a rating of Baa2 by Moody's, BBB- by Fitch and BBB- by S&P.
A credit rating is not a recommendation to buy, sell or hold securities and may be subject to revision, suspension or withdrawal at any time by the assigning rating organisation. Similar ratings on different types of notes do not necessarily mean the same thing. The ratings do not address the likelihood that the principal on the notes will be prepaid, paid on an expected final payment date or paid on any particular date before the legal final maturity date of the notes. The ratings do not address the marketability of the notes or any market price. Any change in the credit ratings of the notes or our company could adversely affect the price that a subsequent purchaser will be willing to pay for the notes. We recommend that you analyse the significance of each rating independently from any other rating.
Our operations are subject to a number of environmental laws and regulations in Russia and each of the other areas in which we operate. These laws govern, among other things, air emissions, wastewater discharges and discharges to the sea, the use, handling and disposal of hazardous substances and wastes, soil and groundwater contamination and employee health and safety. As with our competitors, environmental liability risks are inherent in our operations. We have environmental liabilities due to past activities which have caused pollution of land, disturbance to land and generation of waste oils, sludge and drill cuttings. Additionally, we also have long-term obligations concerning the decommissioning of operational facilities and the remediation of soil or groundwater at certain of our facilities and liability for waste disposal or contamination on properties owned by others.
The following table provides data on environmental and decommissioning liabilities of our exploration and production subsidiaries as at 30 June 2010.
| LUKOIL | ||||
|---|---|---|---|---|
| Western | LUKOIL | Other | ||
| Siberia | Komi | E&P(1) | Total | |
| (millions of U.S. dollars) | ||||
| Polluted land | 13 | 7 | 6 | 26 |
| Asset retirement obligations | 540 | 179 | 654 | 1,373 |
| Total | 553 | 186 | 660 | 1,399 |
(1) This includes liabilities of NMNG of \$194 million and LUKOIL-PERM of \$151 million.
We have undertaken significant efforts and have made significant expenditures to comply with environmental regulations. However, additional financial reserves or compliance expenditures could be required in the future due to changes in law, new information on environmental conditions or other unforeseen events, and those expenditures could have a material adverse effect on our business, financial condition or results of operations.
In addition, with the admission of Bulgaria and Romania to the European Union on 1 January 2007, our refineries in these countries have become subject to stricter regulations relating to the quality of refined product production and environmental protection. As a result, we have had to make substantial investments to upgrade our refineries to comply with such regulations, including those that relate to asbestos, which was present at both such refineries. We estimate that the amount of future capital expenditures required to upgrade our Bourgas and Petrotel refineries is approximately \$25 million and \$33 million, respectively.
Russian legislation provides a basis for requiring those violating environmental regulations to remediate any environmental damage such violations have caused. However, to date there have been few attempts to enforce these requirements. Instead, environmental authorities have imposed relatively low fines for breaches of environmental and sanitation standards in what is effectively a "pay-to-pollute" scheme. Compensation also may be payable for any damage caused. Notwithstanding the relatively limited environmental enforcement in place in Russia and some other countries in which we operate, and the moderate level of any fines and fees imposed, we are committed to a long-term proactive policy to address environmental concerns and actively pursue policies which are designed to reduce pollution and its effects.
In addition, there may be indications that the Russian government's lenient approach towards environmental enforcement may be changing. In September 2006, the Russian Natural Resources Ministry cancelled its 2003 environmental approval of Sakhalin-II, an LNG project in Russia's Far East run by a consortium including Royal Dutch Shell, Mitsui & Co. and Mitsubishi Corporation, due to alleged environmental breaches. Further investigations by Rosprirodnadzor found multiple violations of environmental protection measures. In December 2006, 12 licences for water use held by a Sakhalin-II contractor were suspended for two months for violations of the Russian water code. This revocation would have made construction of Sakhalin-II infrastructure virtually impossible. In addition, the Russian government commenced criminal proceedings for unauthorised felling of timber on the Sakhalin-II licence area. Faced with this mounting regulatory pressure, the members of the Sakhalin-II consortium ceded control of a majority interest in the project to state-owned Gazprom in December 2006.
We allocate operating and cash expenditures in the amounts necessary to minimise risks of environmental loss and to comply with all pertinent environmental regulations. Although our operating and capital expenditures on the prevention, control, abatement or elimination of air, water and solid waste pollution are often not incurred as separately identifiable transactions, they often form a part of larger transactions, such as normal maintenance expenditures. We also create provisions for future environmental remediation. We believe our provisions are sufficient, based upon known requirements, and we do not believe that our costs will differ significantly from those of other companies engaged in similar industries, or that our competitive position will be adversely affected as a result.
In connection with our acquisition of KomiTEK in 1999, we inherited significant environmental problems. We agreed to remediate the consequences of approximately 350 oil spills which took place in the Usinsk Region of the Komi Republic. The recovery programme, including the reclamation of more than 745 hectares of damaged and contaminated land, was completed in November 2005 at a total cost of approximately \$155.5 million.
Our Petrotel refinery in Romania and our Bourgas refinery in Bulgaria require the remediation of a substantial amount of environmental pollution which pre-dated our acquisition of these facilities. At the time of our acquisition of the Petrotel refinery in 1998 and 1999, there was an understanding that the Romanian government would retain liability for existing environmental pollution at the site, which we estimate to be an immaterial amount. In connection with our acquisition of the Bourgas refinery, we understand that the Bulgarian government retains liability for remediation of existing environmental pollution at the site, estimated at approximately \$40 million. There can be no assurance that the Romanian and Bulgarian governments will remediate the environmental pollution at these facilities in the way we expect. Accordingly, we could be exposed to additional remediation costs at these sites in excess of our planned expenditures.
Managed nuclear explosions were carried out within the Osinskoye oil field in 1969. This field is currently operated by LUKOIL-PERM. Subsequent drilling allowed radioactively contaminated water to enter the oil reservoir, which eventually led to a ground-level radioactive contamination problem being identified in 1976. Between 1996 and 2001, we undertook a project at a cost of \$6 million to manage and contain associated radiological risks, and we believe that no further material liability exists. Management procedures are in place to maintain a buffer zone around the location of the nuclear explosions. However, we cannot assure you that further ground water contamination of the surface soil will not occur.
In 2008, we adopted a revised version of our XXI Century Health, Safety and Environment Policy, which establishes our strategic goal of ensuring sustainable development by balancing economic, social and environmental objectives. The objectives of the new policy include raising our consumption of associated gas, limiting polluting discharge when developing underwater oil fields, increasing our production of fuels compliant with European Union standards, implementing Kyoto Protocol regulations on reducing greenhouse gas emissions and recycling our waste.
In 2009, our management committee approved the Environmental Safety Programme for 2009-2013, which expands on the former Environmental Safety Programme for 2004-2008 and is aimed at improving our environmental monitoring system and minimising any negative environmental impacts caused by our operations. The current programme contemplates 483 measures to protect the environment and ensure higher safety standards, with an expected total cost of approximately \$1.9 billion. The planned measures are structured in eight sub-programmes: clean air, clean water, waste, reclamation, accident suppression and avoidance, research and experimental activities, ecological management, and ecological monitoring. Our priority targets include reducing air emissions, reducing water consumption, reducing wastewater discharge, improving waste management and rehabilitating contaminated lands.
We believe that our approach to prevention of pollution by means of adopting low-waste, environment- friendly technologies is the best way to achieve further improvement of the environmental impact of our activities. This requires implementation of a clean production strategy, and such strategy is now the basis of our environmental policy.
We had an average of approximately 133,930 employees in the first six months of 2010 and averages of approximately 143,400, 152,500 and 151,400 employees in 2009, 2008 and 2007, respectively. We believe that our relations with our employees are satisfactory.
The insurance industry in the Russian Federation and certain other areas where we have operations is in the course of development. Our management believes that we have adequate property damage coverage for our main production assets. In respect of third party liability for property and environmental damage arising from accidents on our property or relating to our operations, we have insurance coverage that is generally higher than insurance limits set by local legal requirements. Our management believes that we have adequate insurance coverage of the risks which could have a material effect on our business, financial condition or results of operations. However, there is a risk that we may not have adequate insurance coverage. See "Risk Factors – Risks Relating to Our Business – We do not carry insurance against all potential risks and losses and our insurance might be inadequate to cover all of our losses or liabilities".
The current members of our Board of Directors are as follows:
| Name | Position at LUKOIL | Date of birth |
|---|---|---|
| ALEKPEROV, Vagit Yusufovich Director, President and Chairman of the Management | 1 September 1950 | |
| Committee | ||
| BELIKOV, Igor Vyacheslavovich Non-Executive Director | 1 October 1956 | |
| BLAZHEEV, Victor Vladimirovich Non-Executive Director | 10 January 1961 | |
| GRAYFER, Valery Isaakovich Chairman of the Board of Directors | 20 November 1929 | |
| GREF, Herman Oskarovich Non-Executive Director | 8 February 1964 | |
| IVANOV, Igor Sergeevich Non-Executive Director | 23 September 1945 | |
| MAGANOV, Ravil Ulfatovich Director, First Executive Vice President and member of | 25 September 1954 | |
| the Management Committee | ||
| MIKHAILOV, Sergei Anatolyevich Non-Executive Director | 15 February 1957 | |
| MOBIUS, Mark Non-Executive Director | 17 August 1936 | |
| SHOKHIN, Alexander Nikolaevich Non-Executive Director | 25 December 1951 | |
| WALLETTE, Donald Evert Jr. Non-Executive Director | 22 November 1958 |
The current members of our Management Committee who are not members of our Board of Directors are as follows:
| Name | Position at LUKOIL | Date of birth |
|---|---|---|
| BARKOV, Anatoly Alexandrovich Vice President and Head of the Main Division of | General Affairs, Corporate Security and | 19 May 1948 |
| Communications | ||
| FEDOTOV, Gennady Stanislavovich Vice President and Head of the Main Division of | Economics and Planning | 7 October 1970 |
| FEDUN, Leonid Arnoldovich Vice President and Head of the Main Division of | Strategic Development and Investment Analysis | 5 April 1956 |
| KHAVKIN, Evgueni Leonidovich Secretary of the Board of Directors and Head of the | Office of the Board of Directors | 1 January 1964 |
| KHOBA, Lyubov Nikolaevna Chief Accountant (on maternity leave) | 19 January 1957 | |
| KUKURA, Sergei Petrovich First Vice President for Economics and Finance | 31 October 1953 | |
| MASLIAEV, Ivan Alexeyevich Head of the Main Division of Legal Support | 21 May 1958 | |
| MATYTSYN, Alexander Kuzmich Vice President and Head of the Main Division of | Treasury and Corporate Financing | 7 August 1961 |
| MOSKALENKO, Anatoly Alekseyevich Head of the Main Division of Human Resources | 31 May 1959 | |
| MULYAK, Vladimir Vitalyevich Vice President and Head of the Main Division of Oil | and Gas Production and Infrastructure | 13 August 1955 |
| NEKRASOV, Vladimir Ivanovich First Vice President for Refining and Marketing | 31 March 1957 | |
| SUBBOTIN, Valery Sergeevich Vice President and Head of the Main Division of | Supplies and Sales | 28 March 1974 |
| VOROBYOV, Vadim Nikolaevich Vice President and Head of the Main Division of | Coordination of Petroleum Product Marketing and Distribution |
16 April 1961 |
The business address of our Directors and members of our Management Committee is 11 Sretensky Bulvar, 101000, Moscow, Russian Federation, which is our registered address.
Under our shareholder agreement with ConocoPhillips dated 29 September 2004, ConocoPhillips had the right to nominate one candidate for election to our Board of Directors as long as its ownership interest in LUKOIL was between 7.6% and 12.5% on a fully diluted basis. ConocoPhillips's current representative on our Board of Directors is Donald Evert Wallette, Jr., who was elected to our Board in June 2007 and was re-elected to our Board in June 2008, in June 2009 and in June 2010.
Mr. Alekperov has served as our President since 1993 and as the Chairman of our Management Committee since 1993. He also serves as a member of our Board of Directors and as the Chairman of the Supervisory Board of LUKOIL INTERNATIONAL. From 1992 to 1993, Mr. Alekperov served as the President of the oil company Langepasuraikogalymneft. From 1993 to 2000, he also served as the Chairman of our Board of Directors. From 1990 to 1991, he served as Deputy Minister and then First Deputy Minister of the Ministry of Oil and Gas of the Soviet Union. In 1974, Mr. Alekperov earned a degree in Economics and Engineering from the Azizbekov Institute of Oil and Chemistry in Azerbaijan. He also holds a doctorate degree in economics and is a fellow of the Russian Academy of Natural Science.
Mr. Belikov has served as a member of our Board of Directors since 2010. He also serves as a member of our Human Resources and Compensation Committee of the Board of Directors. He also served as a member of our Board of Directors from 2008 to 2009. Since 2001 Mr. Belikov has served as Director (CEO) of the Russian Institute of Directors. From 2002 to 2004 Mr. Belikov was a member of the Expert Council of the Federal Commission for the Security Market, from 2003 to 2004 he served as Executive Secretary of the National Council for Corporate Governance, and since 2004 as member of the Expert Council for Corporate Governance of the Federal Financial Markets Service. From 2003 to 2006 Mr. Belikov served as an expert in the UNCTAD Intergovernmental Expert Group for International Standards of Accounting and Reporting, Geneva. Mr. Belikov is also Deputy Chairman of the Board of Professional Community Corporate Directors, member of the National Register of Corporate Directors and of ICGN. He graduated from Voronezh State University in 1980. In 1986 Mr. Belikov completed a post-graduate course at the Institute of African Studies, USSR Academy of Sciences. He also completed post-doctoral fellowship at the University of London, and earned a Diploma in banking and insurance from the RF Government Finance Academy. Mr. Belikov has a Certificate in general audit from the RF Government Finance Academy, and a Certificate in Corporate Governance from Shulich School of Business, University of York, Toronto, Canada.
Mr. Blazheev has served as a member of our Board of Directors since 2009. He also serves as a member of the Audit Committee of the Board of Directors. In addition he has acted as Rector of the Kutafin Moscow State Academy of Law since 2007. Since 1994 he has been a lecturer and administrator occupying various positions at Moscow State Academy of Law. Mr Blazheev graduated from the evening department of the All-Union Extra-Mural Law Institute (AELI) in 1987 and completed a post-graduate program at AELI/Moscow Law Institute in the department of civil litigation in 1990.
Mr. Grayfer has served as the Chairman of our Board of Directors since 2000 and has been a member of our Board of Directors since 1996. In addition, Mr. Grayfer served as the General Director of OAO RITEK from 1992 to 2009 and has served as the Chairman of the Board of Directors of RITEK since 2010. He has also served as a member of the Board of Directors of CJSC Ritek-Vnedreniye from 1997 to 2007. He served as the General Director of OAO Nazymgeodobycha from 2006 to 2007. From 1985 to 1990, he served as Deputy Minister of the Ministry of Oil and Gas of the Soviet Union in charge of the Chief Tyumen Production Division for the oil and gas industry. Mr. Grayfer graduated from the I.M. Gubkin Moscow Oil institute in 1952, where he earned a Ph.D. degree in Science. He is a professor of the I.M. Gubkin Russsian State University of Oil and Gas.
Mr. Gref has served as a member of our Board of Directors since 2009. He also serves as Chairman of the Audit Committee of the Board of Directors. Mr. Gref has acted as President and Chairman of the Executive Board of the Savings Bank of the Russian Federation (SBERBANK) since 2007. From 1998 to 2000, Mr. Gref acted as First Deputy Minister of the Ministry of Property Relations of the Russian Federation. Mr. Gref also served as Minister of Economic Development and Trade of the Russian Federation from 2000 to 2007. Mr. Gref graduated from Omsk State University in 1990 and completed a post-graduate program at St. Petersburg State University in 1993.
Mr. Ivanov has served as a member of our Board of Directors since 2009. He also serves as Chairman of our Strategy and Investment Committee of the Board of Directors. Since 2007, Mr. Ivanov has served as a Professor of the Moscow State Institute of International Relations. From March 2004 to July 2007, Mr. Ivanov acted as Secretary of the Security Council of the Russian Federation. From 1993 to 1998, Mr. Ivanov acted as First Deputy Minister of Foreign Affairs of the Russian Federation and from 1998 to 2004 as Minister of Foreign Affairs of the Russian Federation. Mr. Ivanov graduated from the Maurice Thorez Moscow State Institute of Foreign Languages in 1969. He also holds a doctorate degree in history.
Mr. Maganov has served as a member of our Board of Directors and Management Committee since 1993 and as a First Executive Vice President since 2006. He also serves as a member of our Strategy and Investment Committee of the Board of Directors and the Supervisory Board of LUKOIL INTERNATIONAL. Mr. Maganov served as our First Vice President from 1994 to 2006 and as our Vice President from 1993 to 1994. He also served as the General Director of AOOT LUKOIL-Langepasneftegas, one of our subsidiaries, from May to November of 1993. Mr. Maganov worked in several capacities for Production association Langepasneftegas from 1988 to 1993, including as General Director from 1991 to 1993. In 1977, he earned a degree in Engineering from the I.M. Gubkin Moscow Institute of the Oil and Gas Industry.
Mr. Mikhailov has served as a member of our Board of Directors since 2003. He serves as a member of our Audit Committee of the Board of Directors and is a member of our Human Resources and Compensation Committee of the Board of Directors. He has also served as the General Director of OOO Management Consulting since 2001 and as the General Director of ZAO Gruppa Consulting since 2002. Mr. Mikhailov has also served as the Chairman of the Board of Directors of ZAO Russkaya Mediagruppa, OOO Kapital Investment Funds Management Company and the National League of Managers and a member of the Boards of Directors of OAO ASVT, OAO Spartak-Moskva Football Club, OAO Bank Petrokommerts, ZAO IFD Kapital, OAO Editorial Board of Izvestia, OOO Kapital Management Company and other companies. Since 2008 he has served as the Chairman of the Board of Directors of ZAO Kapital Investment Group. He is a member of the Collegium of the Professional Association of Corporate Directors. He served in the Russian military from 1974 to 1992. From 1992 to 1996, he served as Deputy Minister of the Russian Federal Property Fund. From 1996 to 1997, Mr. Mikhailov was Head of the Restructuring and Investment Department of the Russian Ministry of Industry. Mr. Mikhailov graduated from the F.E. Dzerzhinsky Military Academy in 1979 and from the Plekhanov Russian Economics Academy in 1998. He holds a Ph.D. degree in science and a doctorate in economics and he is also a professor.
Mr. Mobius was appointed as a member of our Board of Directors in 2010. He also served as a member of our Board of Directors from 2002 to 2004. He holds the position of Executive President of Templeton Asset Management Ltd. Mr. Mobius joined Franklin Templeton Investments in 1987. Mr. Mobius graduated from the Massachusetts Institute of Technology in 1964. He earned a Ph.D. in economics and political science from the Massachusetts Institute of Technology, as well as Bachelor's and Master's degrees from Boston University.
Mr. Shokhin has served as a member of our Board of Directors since 2005. He serves as Chairman of our Human Resources and Compensation Committee of the Board of Directors. From 1991 to 1994, he served as a Deputy Chairman of the Government of the Russian Federation, Minister of the Economy and Minister for Labour and Employment. From 1994 to 2002, he served as deputy of three different State Dumas of the Russian Federation. From 1996 to 1997, he served as the First Deputy Chairman of the State Duma of the Russian Federation and from 1997 to 1998 as the Chairman of the "Our Home is Russia" Duma faction. He served as the Deputy Chairman of the Government of the Russian Federation in 1998. Mr. Shokhin served as Chairman of the Supervisory Board of Renaissance Capital from 2002 to 2006 and has served as President of the State University School of Economics since 1995. He has been the President of the Russian Union of Industrialists and Entrepreneurs since 2005. In 1974, he graduated from the Lomonosov Moscow State University. He holds a doctorate in economics and is also a professor. Mr. Shokhin is a member of the Russian President's Council for National Priority Projects and Demographic Policy, the Chairman of the Russian Government's Council for Competitiveness and Entrepreneurship, a member of the Russian Government's Commissions for administrative reform, legislative activities and investment projects of federal importance.
Mr. Wallette has been a member of our Board of Directors since 2007. He is also a member of our Strategy and Investment Committee of the Board of Directors. Since 2006, Mr. Wallette has as served President of ConocoPhillips for the Russia/Caspian region. From 2005 to 2006, he served as Vice President of the Shtokman Project for ConocoPhillips in the Russia/Caspian region. From 2002 to 2005, Mr. Wallette acted as Manager for production assurance and optimisation of ConocoPhillips. Mr. Wallette earned a degree in Chemical Engineering from the University of Southern California in 1981.
There are no potential conflicts of interest between any duties of the Members of the Board of Directors or the Management Committee of the Guarantor towards either the Guarantor or the Issuer and their private interests and/or other duties.
The beneficial ownership interests of each director (including interests held through his connected persons and trusts, funds and other investment vehicles) in our share capital, the existence of which is known to such director, including through the exercise of reasonable diligence, whether or not such interests are held through another party, as at 30 September 2010, which is the most recent practicable date prior to the date of this prospectus, were as follows:
| Name of Director | Percentage of Ordinary Shares Held |
|---|---|
| Vagit Yu. Alekperov | 20.599% |
| Igor V. Belikov | – |
| Victor V. Blazheev | – |
| Valery I. Grayfer | 0.007% |
| Herman O. Gref | – |
| Igor S. Ivanov | – |
| Ravil U. Maganov | 0.486% |
| Sergei A. Mikhailov | 0.044% |
| Mark Mobius | – |
| Alexander N. Shokhin | – |
| Donald Evert Wallette, Jr | – |
As at 30 September 2010, which is the most recent practicable date prior to the date of this prospectus, Mr. Leonid Fedun, a Vice President and member of our Management Committee, beneficially owned (including interests held through his connected persons and through trusts, funds and other investment vehicles) 9.27% of our share capital. Each of the other members of our Management Committee who are not members of our Board owns less than 1% of our share capital.
Our shareholders determine the compensation of our directors at each annual shareholders meeting. In addition to a basic sum, Board members receive extra remuneration for assuming the responsibilities of the chairman of our Board of Directors or a committee of our Board of Directors, for attending meetings in person, for longdistance flights to attend Board or Committee meetings and for participation in conferences and other events at the written request of the Chairman of the Board for newly elected members of the Board of Directors. Remuneration and reimbursements payable to our Board members and members of the Audit Commission are determined by a decision taken at our general shareholders meeting. Remuneration of the Management Committee members consists of the following components:
Total remuneration paid to all members of the Board of Directors and Management Committee for 2009 was approximately \$31 million.
In December 2006, the Board of Directors approved a long-term compensation plan for LUKOIL and its subsidiaries' management and key employees for the period from 2007 to 2009. To continuously and consistently motivate employees of LUKOIL and its subsidiaries, ensure their interest in LUKOIL's share value growth and capitalisation in the following three-year period (2010-2012), the program was resumed subject to new start-up conditions. The long-term compensation plan for LUKOIL and its subsidiaries for 2010-2012 was approved by the Board of Directors on 14 December 2009. The plan is based on assigned phantom shares and provides compensation consisting of two parts. The first part represents annual bonuses that are based on the number of assigned phantom shares and the amount of dividend per share. The second part is a bonus which is calculated upon completion of the plan, and its size depends on the number of assigned phantom shares and the difference between the price of a share at the beginning and at the end of the program. This part of the bonus will be allocated to acquisistion of shares for the plan participants. The number of assigned phantom shares is approximately 17.2 million shares.
Members of our Board of Directors are elected by a majority vote of shareholders at shareholders' meetings by cumulative voting. Directors serve until the next annual general shareholders meeting and may be re-elected an unlimited number of times. Our Board of Directors has the authority to make overall management decisions for us, except those matters reserved to our general shareholders meeting. The current term of office for each of our directors expires at our next annual general shareholders meeting, which will take place in June 2011.
We also maintain an Audit Committee of the Board of Directors. The Audit Committee analyses annual independent external audits of LUKOIL's financial statements and prepares recommendations to the Board of Directors for decisions on these issues. Its responsibilities also include making recommendations for selection of the company's auditor, evaluating the auditor's report and determining whether the auditor meets the auditor independence requirements. The Audit Committee is elected from among the non-executive members of the Board of Directors (who are members of our Board of Directors who are not also members of our Management Committee) and consists of at least three persons. At least one member of the committee must be an independent director if our Board of Directors has an independent director. The Audit Committee members are elected at the meeting of the new membership of the Board of Directors for a period lasting until the election of the next Board of Directors at our general shareholders meeting. The current chairman of the committee is Herman Gref and the other committee members are Sergei Mikhailov and Victor Blazheev.
Our Human Resources and Compensation Committee of the Board of Directors determines criteria for selecting, and preliminarily evaluates candidates for, member of the Board of Directors, member of the Management Committee and position of the President of the company and makes a preliminary evaluation of the candidates to the Management Committee and to the position of the President. The committee also considers and prepares recommendations for the Board of Directors to be used for making decisions on matters related to human resources and compensation of members of the company's management bodies and the Audit Commission. The Human Resources and Compensation Committee is elected from among the non-executive members of the Board of Directors (who are members of our Board of Directors who are not also members of our Management Committee) and consists of at least three persons. At least one member of the committee must be an independent director if our Board of Directors has an independent director. The members of the committee are elected at the meeting of the new membership of the Board of Directors for a period lasting until the election of the next Board of Directors at our general shareholders meeting. The current chairman of the committee is Alexander Shokhin and the other committee members are Igor Belikov and Sergei Mikhailov.
Our Strategy and Investment Committee of the Board of Directors prepares proposals for the Board of Directors for establishing priority in our activities and in the development of our long-term development strategy. Its responsibilities also include making recommendations to the Board of Directors on the amounts of dividends and procedure for their payment. The Strategy and Investment Committee is elected from among the members of our Board of Directors and consists of at least three persons. At least one member of the committee must be an independent director if our Board of Directors has an independent director. The members of the committee are elected at the meeting of the new membership of the Board of Directors for a period lasting until the election of the next Board of Directors at our general shareholders meeting. The current chairman of the committee is Igor Ivanov and the other committee members are Ravil Maganov, Mark Mobius and Donald Evert Wallette, Jr.
Our shareholders appoint our President, who is also the Chairman of our Management Committee, for a term of five years. Our Board of Directors determines the principal terms and conditions of the President's employment. The President is responsible for the day-to-day management of our activities. Our Management Committee is determined annually by our Board of Directors and currently consists of 15 members. The President proposes the size of the Management Committee and candidates for membership of the Management Committee to our Board of Directors for approval. Members of our
Management Committee serve until our Board of Directors confirms the new members of our Management Committee. The Management Committee is our collective executive body and, under the direction of its Chairman, is responsible for our day-to-day management.
Our Audit Commission verifies the accuracy of our financial reporting under Russian law and generally supervises our financial activity. The members of our Audit Commission are elected annually at each annual general shareholders meeting and serve until the following annual shareholders meeting and consists of three members. Members of our Audit Commission may be shareholders, but may not be members of our Board of Directors or Management Committee or President of our company. Remuneration payable to the members of our Audit Commission is approved at our general shareholders meeting. The Audit Commission has the right to call an extraordinary shareholders' general meeting and may conduct an audit of our financial and business records at any time. In addition it must conduct an audit if resolved at the general meeting of the shareholders or at the request of the Board of Directors or any shareholder or group of shareholders owning at least 10% of our voting shares. Currently the members of our Audit Commission are Vladimir Nikitenko, Pavel Kondratyev and Lyubov Ivanova.
We have entered into contracts with the following directors:
We have a contract, dated 28 June 2006, as amended on 5 February 2007, 21 January 2008, 29 September 2009 and 31 March 2010, with Mr. Alekperov governing his service as President of LUKOIL. His contract expires on the date of the annual general shareholders' meeting held in 2011. The contract can be terminated early with one month's notice. If we terminate Mr. Alekperov's contract prior to its expiration in 2011, we must pay him a severance amount equal to 24 months of his base salary.
We have a contract with Mr. Maganov dated 19 July 2005 governing his service as First Vice President of LUKOIL. The contract was amended on 1 April 2006, 1 August 2006, 31 October 2006, 21 January 2008, 17 November 2009 and 29 March 2010. Pursuant to the amendment dated 31 October 2006, Mr. Maganov's position was changed from First Vice President to First Executive Vice President of LUKOIL. His contract has an indefinite term and may be terminated according to the Labour Code of the Russian Federation. In the event that we wish to terminate his contract early, he would be entitled to a severance payment of an amount equal to 12 months of his base salary. There is also an agreement with Mr. Maganov which governs his membership on the Management Committee.
Except as disclosed above, there are no contracts existing or proposed between our directors and us.
The Issuer is a Netherlands company whose statutory seat is in Amsterdam and which was incorporated as a private company with limited liability (besloten vennootschap) under the laws of The Netherlands on 16 August 2006. Its number at the trade register is 34254022.
The authorised share capital of the Issuer at incorporation was €90,000 divided into 90,000 shares of par value €1 each. As at 30 September 2010, 18,000 shares have been issued and are fully paid at par value. The issued shares are owned by LUKOIL INTERNATIONAL, a wholly owned subsidiary of LUKOIL.
The Issuer has three managing directors, Mr. Stanislav Nikitin, Mr. R.G.A. de Schutter and Equity Trust Co. N.V., a limited liability company incorporated in The Netherlands. Mr. Nikitin is also deputy Head of the Main Division of Treasury and Corporate Financing at LUKOIL. Mr. De Schutter is a member of several management and supervisory boards in The Netherlands. Mr. E.G.F. Baron van Tuyll van Serooskerken is. the sole member of Equity Trust's Supervisory Board. Messrs. F. van der Rhee and J.C.W. van Burg are the members of Equity Trust's Management Board. The members of Equity Trust's Supervisory Board and Management Board perform no principal activities outside of Equity Trust which are significant with respect to Equity Trust or the Issuer. None of the Issuer's directors has or had any interest in any transaction effected by the Issuer during the current or immediately preceding financial year (or during an earlier financial year and remain in any respect outstanding or unperformed), which is or was unusual in its nature or conditions or significant to the Issuer's business. There are no potential conflicts of interest between any duties of the directors of the Issuer (and the directors of Equity Trust) towards either the Issuer or Equity Trust and their private interests and/or other duties.
The Issuer has no employees or property and no subsidiaries. The principal activity of the Issuer is to raise funds for LUKOIL.
The registered office of the Issuer is Atrium, Strawinskylaan 3105, 1077 ZX Amsterdam, The Netherlands, and its phone number is +31 20 406 44 44. The business address of Stanislav Nikitin is 11 Sretensky Bulvar, 101000, Moscow, Russian Federation, the business address of Mr. De Schutter is Dorpsstraat 50, 4152 ER Rhenoy, The Netherlands and the business address of Equity Trust and the members of Equity Trust's Supervisory Board and Management Board is Atrium, Strawinskylaan 3105, 1077 ZX Amsterdam, The Netherlands. Administrative services are provided to the Issuer by Equity Trust Co. N.V. and by LUKOIL Accounting and Finance Limited of Rotunda Point, 11 Hartfield Crescent, London SW19 3RL, United Kingdom.
KPMG Accountants N.V., having its registered office at Laan van Langerhuize 1 1186 DS Amstelveen, The Netherlands, was appointed to act as auditor of the Issuer for the years ended 31 December 2009 and 2008. KPMG Accountants N.V. is a member of the Koninklijk Nederlands Instituut van Registeraccountants (Royal Netherlands Institute of Registered Accountants).
The Issuer's fiscal year ends on 31 December of each year. The Issuer's audited financial statements as of and for the years ended 31 December 2009 and 31 December 2008 were prepared in accordance with Dutch GAAP and Book 2, Part 9 of the Dutch Civil Code and are included elsewhere in this prospectus.
The following table sets out details, in so far as is known to LUKOIL, as at 30 September 2010 (being the latest practicable date prior to the date of this prospectus), unless otherwise indicated, of all shareholders (other than directors and members of the Management Committee of LUKOIL but including nominee shareholders) that hold 5% or more of the share capital of LUKOIL.
| Name of Shareholder(1)(2) | Percent of issued ordinary share capital |
|---|---|
| ZAO ING Bank Eurasia (nominee) | 68.34% |
| ZAO Depositary and Clearing Company (nominee) | 8.15% |
| LUKOIL Finance Limited | 7.60% |
| ZAO National Depositary Centre (nominee) | 6.14% |
Notes:
(1) As of 30 September 2010 ConocoPhillips owned approximately 5.91% of our approximately 851 million authorised and issued shares, which is equivalent to approximately 6.43% based on estimated shares outstanding (excluding treasury shares and shares held by Company subsidiaries) as at 30 September 2010. As of 29 October 2010 ConocoPhillips owned approximately 4.92% of our authorised and issued shares. ConocoPhillips's shareholding in LUKOIL is held through ZAO ING Bank Eurasia (nominee).
(2) For information on the beneficial ownership interests of our directors in the Company, please see "Management – Additional Information About Our Directors – Interests of the Directors in Our Share Capital".
None of our directors has or had any interest in any transaction effected by us during the current or immediately preceding three financial years (or during an earlier financial year and remain in any respect outstanding or unperformed), which is or was unusual in its nature or conditions or significant to our business except as disclosed in the following paragraphs. There are no potential conflicts of interest between any duties of the members of our Board of Directors or the Management Committee towards LUKOIL and their private interests and/or other duties.
In March 2008, we entered into an agreement to purchase a 64.31% interest in TGK-8 for approximately \$2.12 billion. The purchase consideration consisted partly of 23.55 million shares of common stock of LUKOIL (at a market value of approximately \$1.6 billion), with a portion of the consideration paid in cash. We completed this transaction in May 2008. From May 2008 to June 2009, we acquired the remaining interest in TGK-8 for a total of \$1.2 billion. On 3 September 2009, TGK-8 was reorganised as a limited liability company. TGK-8's directors include the Vice-President and Head of our Main Energy Department, A.S. Smirnov. TGK-8 is a power generation company which owns power plants located in the Astrakhan, Volgograd and Rostov regions; the Krasnodar and Stavropol districts; and the Republic of Dagestan in the Russian Federation.
LUKOIL Garant is a private pension fund that operates a benefit plan covering the majority of our employees. It also provides pension benefits and services to employees of other companies that are not related to us. Mr. Matytsyn, a member of LUKOIL's Management Committee, is a member of the Council of the Fund, which is the governing board of LUKOIL Garant. As a result, LUKOIL may be considered to have influence over LUKOIL Garant through its management bodies even though the company does not have direct legal control. See Note 13 "Pension benefits" to our consolidated financial statements for the year ended 31 December 2009 included elsewhere in this prospectus for more information on the pension benefits we provide through LUKOIL Garant.
In April 2009, LUKOIL-Western Siberia made a voluntary offer to the minority shareholders of RITEK, one of LUKOIL's key Western Siberia subsidiaries, to purchase their shares. As a result of the voluntary offer, the Group acquired 23.58% of the charter capital of RITEK. In August 2009, LUKOIL-Western Siberia, pursuant to Russian law, made a mandatory offer to the minority shareholders of RITEK to purchase the remaining shares of RITEK. As a result of the mandatory offer, LUKOIL, together with its affiliates, acquired the remaining shares
held by minority shareholders and became the 100% owner of RITEK. See "Business – Exploration and Production – Domestic Exploration and Production". Mr. Mulyak, a member of LUKOIL's Management Committee, is a member of the Board of Directors of RITEK. Mr. Grayfer, the Chairman of LUKOIL's Board of Directors, is the Chairman of the Board of Directors of RITEK.
Financial Corporation URALSIB is comprised of a number of Russian financial services companies, including an investment bank, management company, brokerage, insurance company and registrar, including OAO Registrar NIKoil and OAO URALSIB. OAO Registrar NIKoil is our registrar. As at 30 September 2010, URALSIB Depository company held 1.42% of our shares as a nominee. In addition, Mr. Alekperov is a beneficial owner of Financial Corporation URALSIB.
In August 2004, the company entered into an agreement to sell its 99% interest in OAO Bank Petrocommerce (Bank Petrocommerce) to Financial Group IFD Kapital, a related party whose beneficial owners, management and directors include certain members of the company's Management Committee and Board of Directors. The company sold 78% of Bank Petrocommerce to IFD Kapital for \$169 million in September 2004 and the company sold the remaining 21% interest for \$33 million in May 2006. The company purchased insurance services from IFD Kapital for approximately \$133 million in 2006, \$143 million in 2007 and \$93 million in 2008. IFD Kapital disposed of its insurance business to a third party in 2008.
On 24 March 2010, ConocoPhillips announced plans to dispose of half its stake in LUKOIL, which at the time constituted approximately 20% of LUKOIL's authorised and issued shares, during 2010 and 2011. On 28 July 2010, LUKOIL Finance signed a stock purchase agreement with Springtime, an affiliate of ConocoPhillips, under which LUKOIL Finance agreed to purchase 64,638,729 LUKOIL ordinary shares, which constituted approximately 7.599% of LUKOIL's authorised and issued shares, at \$53.25 per share for approximately \$3.44 billion. The transaction was completed on 16 August 2010.
On 26 September 2010, LUKOIL exercised its option to acquire additional shares from ConocoPhillips by sending a notice of exercise in respect of 42,500,000 LUKOIL ADRs and entered into a share purchase agreement with UniCredit Bank AG as the purchaser of those ADRs. This transaction was completed on 29 September 2010, when 42,500,000 LUKOIL ADRs were directly transferred by Springtime to UniCredit Bank AG, and UniCredit Bank AG paid the purchase price of \$2.38 billion to Springtime. Simultaneously, UniCredit Bank AG issued a series of equity-linked notes to LUKOIL Finance exchangeable for 17,500,000 LUKOIL ADRs on or before 29 September 2011 and an option to purchase from UniCredit Bank AG an additional 25,000,000 LUKOIL ADRs on or before 29 September 2011. These arrangements give LUKOIL Finance the opportunity to increase significantly its holding of LUKOIL's authorized and issued shares before the end of September 2011.
Mr. Wallette, a member of LUKOIL's Board of Directors, became president of Russia/Caspian for ConocoPhillips in 2006 and is ConocoPhillips's representative on LUKOIL's Board of Directors. See "Management – Members of the Board of Directors and the Management Committee" and "Business – History" for more information on the corporate governance relationship between the company and ConocoPhillips. As part of our efforts to develop our reserves in Timan-Pechora, by virtue of the joint venture agreement entered into with LUKOIL in September 2004, ConocoPhillips acquired a 30% interest in NMNG in 2005. NMNG and the company that operates our Varandey terminal have a number of loan agreements with ConocoPhillips, under which \$1,495 million and \$247 million, respectively, was outstanding as at 30 June 2010. In addition, in June 2007, we completed our acquisition from ConocoPhillips of a 100% interest in companies owning 376 petrol stations in Europe for \$444 million. See also "Risk Factors – Risks Relating to Our Business – As at 30 September 2010, ConocoPhillips beneficially owned 5.91% of LUKOIL's shares, and ConocoPhillips's nominee continues to hold a seat on our Board of Directors, which may afford it some influence over LUKOIL and over Board and shareholder decisions".
We engage in transactions with equity affiliates, ConocoPhillips and other related parties in the ordinary course of business that include the sale and purchase of crude oil and refined products and the purchase of construction and processing services. See Note 20 "Related party transactions" to our consolidated financial statements for the year ended 31 December 2009 and Note 17 "Related party transactions" to our interim consolidated financial statements for the six months ended 30 June 2010 for more information on these transactions.
In addition, we make loans to our equity affiliates in the ordinary course of business. As at 30 June 2010 and 31 December 2009, the aggregate amount outstanding under our loans and advances to equity affiliates was \$385 million and \$279 million, respectively.
There are no and have been no governmental, legal or arbitration proceedings against LUKOIL, the Issuer or any member of the Group (including any such proceedings which are pending or threatened of which we are aware) during the 12 months preceding the date of this prospectus, which may have, or have had in the recent past, significant effects on our, our Group's or the Issuer's financial position or profitability, except as described below.
On 27 November 2001, Archangel Diamond Corporation (ADC), a Canadian diamond development company, filed a lawsuit in the District Court of Denver, Colorado against OAO Arkhangelskgeoldobycha (AGD), a company in our Group, and LUKOIL (together the Defendants). ADC alleged that the Defendants interfered with the transfer of a diamond exploration licence to Almazny Bereg, a joint venture between ADC and AGD. ADC claimed total damages of approximately \$4.8 billion, including compensatory damages of \$1.2 billion and punitive damages of \$3.6 billion. On 15 October 2002, the District Court dismissed the lawsuit for lack of personal jurisdiction. The Colorado Court of Appeals upheld this ruling on 25 March 2004. On 21 November 2005, the Colorado Supreme Court affirmed the lower courts' ruling that no specific jurisdiction exists over the Defendants. By virtue of this finding, AGD (the holder of the diamond exploration licence) was dismissed from the lawsuit. The Colorado Supreme Court found, however, that the trial court made a procedural error by not holding an evidentiary hearing before making its ruling concerning general jurisdiction regarding LUKOIL, which is whether LUKOIL had systematic and continuous contacts in the State of Colorado at the time the lawsuit was filed. In a modified opinion dated 19 December 2005, the Colorado Supreme Court remanded the case to the Colorado Court of Appeals (instead of the District Court) to consider whether the lawsuit should have been dismissed on alternative grounds (i.e., forum non conveniens). On 29 June 2006, the Colorado Court of Appeals declined to dismiss the case based on forum non conveniens. We filed a petition for certiorari on 28 August 2006 asking the Colorado Supreme Court to review this decision. This petition was denied. On 5 March 2007, the Colorado Supreme Court remanded the case to the District Court. On 11 June 2007, the District Court ruled that it would conduct an evidentiary hearing on the issue of whether LUKOIL is subject to general jurisdiction in Colorado. Discovery regarding jurisdiction was commenced. On 26 June 2009, three creditors of ADC filed an Involuntary Bankruptcy Petition putting ADC into bankruptcy. On 25 November 2009, after adding a claim based on the Racketeer Influence and Corrupt Organization Act (RICO), ADC removed the case from the Colorado state court to the United States Bankruptcy Court. On 22 December 2009, LUKOIL filed a motion seeking to have the case remanded to the Colorado state court. On 31 December 2009, before there was a ruling on the motion seeking remand, ADC filed a motion seeking withdrawal of the reference to the Bankruptcy Court and requesting the case be heard by United States District Court. On 3 February 2010, the United States Bankruptcy Court ordered the Motion For Withdrawal Of The Reference be transferred to the United States District Court for further action. All pending motions as well as discovery were stayed pending further order of the Court. On 7 July 2010, the District Court denied ADC's Motion for Withdrawal of reference and returned the case to the Bankruptcy Court for the determination of LUKOIL's Motion for Remand and Abstention seeking return of the case to Colorado state court. On 20 September 2010, the Bankruptcy Court heard LUKOIL's Motion for Remand and Abstention and took the matter under advisement. A written opinion is expected before the end of the calendar year 2010. Management intends to contest jurisdiction and denies all material allegations against LUKOIL. Management does not believe that the ultimate resolution of this matter will have a material adverse effect on LUKOIL's financial condition.
On 20 February 2004, the Stockholm District Court overturned the decision of the Arbitral Tribunal of the Arbitration Institute of the Stockholm Chamber of Commerce (the Arbitration Tribunal) made on 25 June 2001 dismissing ADC's action against AGD based on lack of jurisdiction. ADC's lawsuit against AGD was initially filed with the Arbitration Tribunal claiming alleged non-performance under an agreement between the parties and its obligation to transfer the diamond exploration licence to Almazny Bereg. This lawsuit claimed compensation of damages amounting to \$492 million. In March 2004, AGD filed an appeal against the Stockholm District Court decision with the Swedish Court of Appeals. On 15 November 2005, the Swedish Court of Appeals denied AGD's appeal and affirmed the Stockholm District Court decision. On 13 December 2005, AGD filed an appeal against the Swedish Court of Appeals decision with the Swedish Supreme Court. On 13 April 2006, the Swedish Supreme Court denied the application of AGD for appeal against the Swedish Court of Appeal's decision dated 15 November 2005. On 6 May 2006, a Notice of Arbitration was received on behalf of ADC. On 20 December 2006, the first session of the Arbitration Tribunal with participation of both parties took place in order to define procedural issues related to the tribunal. As a result of the hearing, the Arbitration Tribunal issued a detailed procedural order setting out the rules and timetable for the conduct of the arbitration. In May 2007, ADC filed a statement of claim requesting that the Arbitration Tribunal require AGD to transfer the diamond exploration licence to Almazny Bereg. On 22 October 2007, AGD submitted a statement of defense. On 5 February 2009, the Arbitration Tribunal issued a procedural order setting out the rules and timetable for the conduct of the arbitration in 2009. On 16 June 2009, ADC filed a statement on case withdrawal due to complete inability to fund the litigation. On 21 September 2009, the parties presented their positions on the termination of arbitration. Pursuant to a decision of the Arbitration Tribunal dated 20 October 2009, these arbitration proceedings were terminated.
In 2008 and 2009, FAS issued two decisions recognising the major Russian oil companies, including LUKOIL and the refineries forming part of the Group, to be in breach of the antimonopoly laws due to abuse of a dominant position in the Russian refined products wholesale market.
The first decision of FAS, issued on 27 October 2008, was challenged by the refineries in the Arbitration Court of the City of Moscow. The aggregate amount of claims is approximately \$47.5 million (at the exchange rate of 30 September 2010). On 1 June 2010, the Arbitration Court of the City of Moscow issued a decision which was upheld by the Ninth Arbitration Court of Appeals on 27 September 2010, dismissing the claims of the refineries and affirming the position of FAS, holding that LUKOIL and the refineries forming part of the Group were in breach of the antimonopoly laws due to abuse of a dominant position in the Russian refined products wholesale market.
The second decision of FAS, issued on 10 September 2009, was challenged by the refineries in their local courts. The aggregate amount of fines claimed by FAS and challenged in these proceedings is approximately \$215.3 million (at the exchange rate of 30 September 2010). On 8 February 2010 the Arbitration Court of the Nizhny Novgorod Region granted the claim of OOO LUKOIL- Nizhegorodnefteorgsintez seeking invalidation of this FAS decision and the decree regarding imposition of a fine in the amount of approximately \$79.2 million (at the exchange rate of 30 September 2010). FAS challenged this decision in the appellate court. The hearing in the appellate instance will take place on 11 November 2010. Court cases initiated by the other refineries have been suspended until the court resolution on the claim of OOO LUKOIL-Nizhegorodnefteorgsintez comes into force.
During the second half of 2009 and the first six months of 2010, over 100 cases were initiated against certain Group companies, including in Ukraine and Cyprus, on the grounds of alleged breach of antimonopoly laws. The alleged offences by the Group companies mainly relate to abuse of a dominant position and consorted actions in retail markets. The acts of the antimonopoly authorities with regard to the Group companies are being judicially contested. The total penalties accrued to date under all cases involving the Group amount to approximately \$285.6 million (at the exchange rate of 30 September 2010).
Our management believe that our Group companies have complied with all legal requirements and, consequently, the ultimate outcome of the antimonopoly disputes will be cancelled or the amount of penalties will be reduced and that these will not have a material adverse impact on the Group's operating results or financial condition.
The Group is involved in a cost recovery dispute with the Republic of Kazakhstan in which the latter has alleged that participants in the Karachaganak project recovered excessive costs. The Group's share of the initial claim is approximately \$244 million. Management is of the view that substantially all of the amounts subject to dispute were in fact recoverable under the Final Production Sharing Agreement. Management believes that the ultimate resolution of the claim will not have a material adverse impact on the Group's operating results or financial condition.
We are involved in various other claims and legal proceedings arising in the normal course of business. While these claims may seek substantial damages against us and are subject to uncertainty inherent in any litigation, we do not believe that the ultimate resolution of such matters will have a material adverse impact on our operating results or financial condition.
There are no and have been no governmental, legal or arbitration proceedings against the Issuer (including any such proceedings which are pending or threatened of which the Issuer is aware) during the 12 months preceding the date of this prospectus, which may have, or have had in the recent past, significant effects on the Issuer's financial position or profitability.
LUKOIL's initial charter was registered with the Moscow Registration Chamber on 22 April 1993 with a registration number of 24020, and the current version of the charter (version No. 4) was registered with the Inspectorate of the Ministry of Taxes and Excise of the Russian Federation No. 8 for the Central Administrative District of Moscow on 25 July 2002 under state registration number 2027708000494. Version No. 4 of the Charter has been amended several times since it was registered. On 17 July 2002, LUKOIL was entered into the Unified State Registrar of Legal Entities under registration number 1027700035769. LUKOIL's registered address is Sretensky Bulvar 11, Moscow 101000, Russian Federation, and our telephone number is +7 (495) 627 4444.
The following is the text of the terms and conditions of the notes which, subject to amendment, will be endorsed on each Definitive Note (as defined below) and will be attached and (subject to the provisions thereof) apply to the Global Notes.
The U.S.\$1,000,000,000 6.125 per cent. Notes due 2020 (the "Notes", which expression includes any further Notes issued pursuant to Condition 16 and forming a single series therewith) of LUKOIL International Finance B.V. (the "Issuer") were authorised by a written resolution of the board of directors of the Issuer dated 21 October 2010.
The Notes are constituted by a trust deed dated 9 November 2010 (the "Trust Deed") between the Issuer, OAO LUKOIL (the "Guarantor") and Citicorp Trustee Company Limited (the "Trustee", which expression shall include all persons for the time being who are the trustee or trustees under the Trust Deed) as trustee for the holders of the Notes. These terms and conditions include summaries of, and are subject to, the detailed provisions of the Trust Deed. The Issuer and the Guarantor have entered into an agency agreement dated 9 November 2010 (the "Agency Agreement") with the Trustee and Citibank, N.A., London Branch, as principal paying agent (the "Principal Paying Agent" and, together with any other paying agents appointed under the Agency Agreement, the "Paying Agents") and as transfer agent (the "Transfer Agent") and Citigroup Global Markets Deutschland AG as registrar (the "Registrar"). The Registrar, Paying Agents and Transfer Agent are together referred to herein as the "Agents". Copies of the Trust Deed and the Agency Agreement are available for inspection during normal business hours at the specified office of the Trustee, being at the date hereof Citigroup Centre, Canada Square, Canary Wharf, London E14 5LB, United Kingdom, and at the specified offices of the Agents. The Noteholders (as defined below) are entitled to the benefit of, are bound by, and are deemed to have notice of, all the provisions of the Trust Deed and are deemed to have notice of those provisions of the Agency Agreement applicable to them. Capitalised terms used but not defined in these Terms and Conditions shall have the respective meanings given to them in the Trust Deed.
The Notes are issued in fully registered form, without interest coupons attached, in denominations of U.S.\$200,000 or integral multiples of U.S.\$1,000 in excess thereof ("authorised denominations") and, provided that the Notes may be transferred only in amounts not less than an authorised denomination. Title to the Notes shall pass by registration in the register (the "Register") which the Issuer shall procure to be kept by the Registrar. The Notes are initially issued in global, fully registered form, and will only be exchangeable for Notes in definitive, fully registered form ("Definitive Notes") in the limited circumstances set forth in the Agency Agreement.
The Guarantor has in the Trust Deed unconditionally and irrevocably guaranteed the payment when due of all sums expressed to be payable by the Issuer under the Trust Deed and the Notes (the "Guarantee"). The Guarantor's obligations in respect of the Guarantee are contained in the Trust Deed.
The Guarantor has undertaken in the Trust Deed that so long as any of the Notes remains outstanding (as defined in the Trust Deed) it will not take any action for the liquidation or winding-up of the Issuer.
The Notes constitute unsubordinated and (subject to Condition 4) unsecured obligations of the Issuer and shall at all times rank pari passu and without any preference among themselves. Subject to Condition 4, each of the Issuer and the Guarantor shall ensure that at all times the claims of the Noteholders against them under the Notes and the Guarantee, respectively, rank in right of payment at least pari passu with the claims of all their other unsecured and unsubordinated creditors save those whose claims are preferred by any mandatory operation of law.
The Registrar shall maintain the Register in respect of the Notes in accordance with the provisions of the Agency Agreement. The Register shall be kept at the specified office for the time being of the Registrar and shall record the names and addresses of the holders of the Notes, particulars of the Notes and all transfers thereof. In these Conditions, the "holder" of a Note means the person in whose name such Note is for the time being registered in the Register (or, in the case of a joint holding, the first named thereof) and "Noteholder" shall be construed accordingly.
Title to the Notes will pass by and upon registration in the Register. The holder of each Note shall (except as otherwise required by a court of competent jurisdiction or applicable law) be treated as the absolute owner of such Note for all purposes (whether or not it is overdue and regardless of any notice of ownership, trust or any other interest therein, any writing on the Definitive Note relating thereto (other than the endorsed form of transfer) or any notice of any previous loss or theft of such Definitive Note) and no person shall be liable for so treating such holder.
Subject to Conditions 3(f) and 3(g) below, a Note may be transferred in whole or in part in an authorised denomination upon surrender of the relevant Definitive Note representing that Note, together with the form of transfer (including any certification as to compliance with restrictions on transfer included in such form of transfer endorsed thereon) (the "Transfer Form"), duly completed and executed, at the specified office of the Transfer Agent or of the Registrar, together with such evidence as such Agent or the Registrar may reasonably require to prove the title of the transferor and the authority of the persons who have executed the Transfer Form. Where not all the Notes represented by the surrendered Definitive Note are the subject of the transfer, a new Definitive Note in respect of the balance not transferred will be delivered by the Registrar to the transferor in accordance with Condition 3(d). Neither the part transferred nor the balance not transferred may be less than the applicable authorised denomination.
Within five business days of the surrender of a Definitive Note in accordance with Condition 3(c) above, the Registrar shall register the transfer in question and deliver a new Definitive Note to each relevant holder at the specified office of the Registrar or (at the request of the relevant Noteholder) at the specified office of the Transfer Agent or (at the request and risk of such relevant holder) send it by uninsured first class mail (airmail if overseas) to the address specified for the purpose by such relevant holder.
The registration of the transfer of a Note shall be effected without charge to the holder or transferee thereof, but against such indemnity from the holder or transferee thereof as the Registrar may require in respect of any tax or other duty of whatsoever nature which may be levied or imposed in connection with such transfer.
Noteholders may not require the transfer of a Note to be registered during the period of 15 days ending on the due date for any payment of principal or interest in respect of such Note.
All transfers of Notes and entries on the Register are subject to the detailed regulations concerning the transfer and registration of Notes set out in the First Schedule to the Agency Agreement. The regulations may be changed by the Issuer and the Guarantor with the prior written approval of the Trustee, the Transfer Agent and the Registrar. A copy of the current regulations will be sent by the Registrar free of charge to any person who so requests and will be available at the specified office of the Registrar in London.
So long as any of the Notes remains outstanding (as defined in the Trust Deed):
(a) neither the Issuer nor the Guarantor will, and each of the Issuer and the Guarantor will procure that no Subsidiary (as defined below) will, create or permit to subsist any mortgage, charge, pledge, lien or other form of encumbrance or security interest (each a "Security Interest") other than a Permitted Security Interest (as defined below) upon the whole or any part of its undertaking, property, assets or revenues, present or future, to secure for the benefit of the holders of any Relevant Indebtedness (as defined below):
without in any such case at the same time or prior thereto procuring that the Notes or, as the case may be, the Guarantor's obligations under the Guarantee (x) are secured equally and rateably with such Relevant Indebtedness for so long as such Relevant Indebtedness is so secured or (y) have the benefit of such other guarantee, indemnity or other like obligations or such other security (in each case) as the Trustee in its absolute discretion shall deem to be not materially less beneficial to the Noteholders or (z) as shall be approved by an Extraordinary Resolution (as defined in the Trust Deed) of the Noteholders.
The Guarantor shall not enter into or become subject to, and shall not permit the Issuer or any Principal Subsidiary to enter into or become subject to, any reorganisation (including, without limitation, any amalgamation, demerger, merger or corporate reconstruction) or to change its corporate structure if such a reorganisation or change would have a Material Adverse Effect.
So long as any amount remains outstanding hereunder, the Guarantor shall, and shall ensure that its Subsidiaries shall, pay or discharge or cause to be paid or discharged, before the same shall become overdue, all taxes, assessments and governmental charges levied or imposed upon, or upon the income, profits or assets of the Guarantor or any Subsidiary, provided, however, that none of the Guarantor nor any of its Subsidiaries shall be required to pay or discharge or cause to be paid or discharged any such tax, assessment, charge or claim (x) whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which adequate reserves in accordance with U.S. GAAP or other appropriate provision has been made or (y) if such failure to pay or discharge shall not have a Material Adverse Effect.
The Notes bear interest from the Issue Date (as defined below) at the rate of 6.125 per cent. per annum, payable in equal instalments semi-annually in arrear on 9 May and 9 November in each year, commencing on 9 May 2011.
The Notes will cease to bear interest from the due date for redemption unless, upon due presentation, payment of principal is improperly withheld or refused. In such event the Notes shall continue to bear interest at such rate (both before and after judgment) until whichever is the earlier of (a) the day on which all sums due in respect of the Notes up to that day are received by or on behalf of the relevant holder, and (b) the day seven days after the Trustee or the Principal Paying Agent has notified Noteholders of receipt of all sums due in respect of all the Notes up to that seventh day (except to the extent that there is failure in the subsequent payment to the relevant holders under these Conditions). If interest is required to be calculated for a period other than a semi-annual interest period ending on 9 May and 9 November in each year, it will be calculated on the basis of a 360-day year consisting of 12 months of 30 days each and, in the case of an incomplete month, the number of days elapsed.
Unless previously redeemed, or purchased and cancelled, the Notes will be redeemed at their principal amount on 9 November 2020.
The Notes may be redeemed at the option of the Issuer in whole, but not in part, at any time, on giving not less than 30 nor more than 60 days' notice to the Noteholders (which notice shall be irrevocable) at the principal amount thereof, together with interest accrued to the date fixed for redemption, if (i) the Issuer satisfies the Trustee immediately prior to the giving of such notice that it (or, if the Guarantee was called, the Guarantor) has or will become obliged to pay additional amounts as provided or referred to in Condition 9 as a result of any change in, or amendment to, the laws or regulations of The Netherlands or the Russian Federation or any political or governmental subdivision or any authority thereof or therein having power to tax, or any change in the application or official interpretation of such laws or regulations, which change or amendment becomes effective on or after 9 November 2010 and (ii) such obligation cannot be avoided by the Issuer (or the Guarantor, as the case may be) taking reasonable measures available to it; provided that no such notice of redemption shall be given earlier than 60 days prior to the earliest date on which the Issuer (or the Guarantor, as the case may be) would be obliged to pay such additional amounts were a payment in respect of the Notes (or the Guarantee, as the case may be) then due. Prior to the publication of any notice of redemption pursuant to this paragraph, the Issuer shall deliver to the Trustee (x) a certificate signed by two directors of the Issuer (or the Guarantor, as the case may be) stating that the obligation referred to in (i) above cannot be avoided by the Issuer (or the Guarantor, as the case may be) taking reasonable measures available to it and the Trustee shall be entitled to accept such certificate as sufficient evidence of the satisfaction of the conditions precedent set out in (ii) above, in which event it shall be conclusive and binding on the Noteholders and (y) an opinion of independent legal advisers of recognised standing to the effect that the Issuer (or the Guarantor, as the case may be) has or will become obliged to pay such additional amounts as a result of such change or amendment. All Notes in respect of which any such notice of redemption is given under and in accordance with this Condition shall be redeemed on the date specified in such notice in accordance with this Condition.
The Issuer may compel any beneficial owner of Notes sold pursuant to Rule 144A under the Securities Act to sell its interest in such Notes, or may sell such interest on behalf of such holder, if such holder is a U.S. person that is not a qualified institutional buyer (as defined in Rule 144A under the Securities Act) and a qualified purchaser (as defined in Section 2(a)(51) of the Investment Company Act). Any sale by the Issuer on behalf of a beneficial owner shall be at a price equal to the least of (x) the purchase price therefor paid by the beneficial owner, (y) 100 per cent. of the principal amount thereof or (z) the fair market value thereof.
The Issuer may also choose to redeem the Notes prior to 9 November 2020, in whole or in part, on not less than 30 nor more than 60 days' irrevocable notice to the Noteholders, by paying a redemption price equal to the sum of:
plus accrued and unpaid interest thereon, if any, to the redemption date.
The Issuer shall not be entitled to redeem the Notes otherwise than as provided in paragraphs (a) and (b) above and this paragraph (d). All Notes in respect of which any such notice of redemption is given under this Condition 7 shall be redeemed on the date specified in such notice in accordance with this Condition 7.
The Issuer, the Guarantor and any of their respective Subsidiaries may at any time purchase Notes in the open market or otherwise at any price.
All Notes redeemed or purchased pursuant to this Condition 7 shall be cancelled forthwith and may not be held or resold. Any Notes so cancelled may not be reissued.
Payments of principal (whenever due) and interest due on redemption shall be made by the Paying Agents by U.S. Dollar cheque drawn on a bank in New York City, or by transfer to a U.S. Dollar account maintained by the payee with a bank in New York City and shall only be made upon surrender (or, in the case of part payment only, endorsement) of the relevant Definitive Notes at the specified office of any Paying Agent.
Payments of interest (other than interest due on redemption) shall be made by the Paying Agents by U.S. Dollar cheque drawn on a bank in New York City, or by transfer to a U.S. Dollar account maintained by the payee with a bank in New York City not later than the due date for such payment.
All payments in respect of the Notes are subject in all cases to any applicable fiscal or other laws and regulations, but without prejudice to the provisions of Condition 9. No commissions or expenses shall be charged to the Noteholders in respect of such payments.
If the due date for any payment of principal or interest under this Condition 8 is not a business day, the holder of a Note shall not be entitled to payment of the amount due until the next following business day and shall not be entitled to any further interest or other payment in respect of any such delay. In this Condition, "business day" means any day on which banks are open for business in the place of the specified office of the relevant Paying Agent and, in the case of payment by transfer to a U.S. Dollar account as referred to above, on which dealings in foreign currencies may be carried on both in New York City and in such other place.
Each payment in respect of a Note will be made to the person shown as the holder in the Register at the opening of business (in the place of the Registrar's specified office) on the fifteenth day before the due date for such payment. Any cheque will be mailed to the holder of the relevant Note at his address appearing in the Register.
The initial Agents and their initial specified offices are listed below. The Issuer and the Guarantor, acting together, reserve the right, with the written approval of the Trustee, to vary or terminate the appointment of all or any of the Agents at any time and appoint additional or other payment or transfer agents, provided that they will maintain (i) a Principal Paying Agent, (ii) Paying Agents and a Transfer Agent having specified offices in at least one major European city approved by the Trustee, being London so long as the Notes are admitted to the Official List of the Financial Services Authority in its capacity as competent authority under the Financial Services and Markets Act 2000 and admitted to trading on the London Stock Exchange's EEA Regulated Market and (iii) a Paying Agent with a specified office in a European Union member state that will not be obliged to withhold or deduct tax pursuant to any law implementing European Council Directive 2003/48/EC or any other European Union Directive implementing the conclusions of the ECOFIN Council meeting of 26-27 November 2000 on the taxation of savings income. Notice of any such change will be provided as described in Condition 17 below.
In this Condition, "EEA Regulated Market" means a "regulated market" as defined by Article 4(1)(14) of Directive 2004/39/EC of the European Parliament and of the Council on markets in financial instruments.
All payments of principal and interest in respect of the Notes by or on behalf of the Issuer or under the Guarantee by the Guarantor shall be made free and clear of, and without withholding or deduction for, any taxes, duties, assessments or governmental charges of whatsoever nature imposed, levied, collected, withheld or assessed by or within The Netherlands or the Russian Federation or any political subdivision
or any authority thereof or therein having power to tax, unless such withholding or deduction is required by law. In that event, the Issuer or (as the case may be) the Guarantor shall increase the relevant payment so as to result in the receipt by the Noteholders of such amounts as would have been received by them if no such withholding or deduction had been required, except that no such additional amounts shall be payable in respect of any Note:
In these Conditions, "Relevant Date" means whichever is the later of (a) the date on which the payment in question first becomes due and (b) if the full amount payable has not been received in New York City by or for the account of the Principal Paying Agent or the Trustee on or prior to such due date, the date on which (the full amount having been so received) notice to that effect has been given to the Noteholders.
Any reference in these Conditions to principal or interest shall be deemed to include any additional amounts or premium in respect of principal or interest (as the case may be) which may be payable under this Condition.
If the Issuer or the Guarantor becomes subject at any time to any taxing jurisdiction other than (or in addition to) The Netherlands or the Russian Federation, respectively, references in these Conditions to The Netherlands or the Russian Federation shall be construed as references to The Netherlands or (as the case may be) the Russian Federation and/or such other jurisdiction.
The Trustee at its discretion may, and if so requested in writing by the holders of not less than one-quarter of the principal amount of the Notes then outstanding or if so directed by an Extraordinary Resolution shall (subject to its rights under the Trust Deed to be indemnified and/or secured and/or prefunded to its satisfaction), give notice to the Issuer that the Notes are immediately due and repayable if any of the following events occurs and is continuing (each an "Event of Default"):
paragraph (c) has occurred and is continuing equals or exceeds U.S.\$50,000,000 or (ii) the aggregate amount of the relevant Indebtedness, guarantees and indemnities in respect of which one or more of the events mentioned above in this paragraph (c) have occurred and is continuing equals or exceeds U.S.\$150,000,000 or, in the case of an amount specified in (i) or (ii) above, its equivalent (as reasonably determined by the Trustee) (on the basis of the middle spot rate for the relevant currency against the U.S. Dollar as quoted by any leading bank on the day on which such calculation is made); or
(k) a moratorium is agreed or declared in respect of any Indebtedness of the Issuer, the Guarantor or any Principal Subsidiary or any governmental authority or agency condemns, seizes, compulsorily purchases, transfers or expropriates all or (in the opinion of the Trustee) a material part of the assets, licences or shares of the Issuer, the Guarantor or any Principal Subsidiary; or
(l) the Guarantee is not (or is claimed by the Guarantor not to be) in full force and effect to at least the same extent as at the date of issue of the Notes; or
and, except in the case of (a) above, the Trustee shall have certified in writing to the Issuer that the event is, in its opinion, materially prejudicial to the interests of the Noteholders.
Upon any such notice being given to the Issuer, the Notes will immediately become due and repayable at their principal amount together with interest incurred to such date.
Claims for the payment of principal and interest in respect of any Definitive Note shall be prescribed unless made within 10 years (for claims for the payment of principal) or five years (for claims for the payment of interest) of the appropriate Relevant Date.
If any Definitive Note is lost, stolen, mutilated, defaced or destroyed, it may be replaced at the specified office of the Registrar, subject to all applicable laws and stock exchange requirements, upon payment by the claimant of the expenses incurred in connection with such replacement and on such terms as to evidence, security, indemnity and otherwise as the Issuer and the Guarantor may reasonably require. Mutilated or defaced Definitive Notes must be surrendered before replacements will be issued.
The Trust Deed contains provisions for convening meetings of Noteholders to consider matters affecting their interests, including the sanctioning by Extraordinary Resolution of a modification of any of these Conditions or any provisions of the Trust Deed. Such meetings shall be held in accordance with the provisions set out in the Trust Deed. Such a meeting may be convened by Noteholders holding not less than 10 per cent. in principal amount of the Notes for the time being outstanding. The quorum at any meeting convened to vote on an Extraordinary Resolution will be two or more persons holding or representing a clear majority in principal amount of the Notes for the time being outstanding, and to vote on a resolution other than an Extraordinary Resolution will be two or more persons holding or representing not less than 10 per cent. in principal amount of the notes for the time being outstanding, or at any adjourned meeting two or more persons being or representing Noteholders whatever the principal amount of the Notes held or represented, unless the business of such meeting includes consideration of proposals, inter alia, (i) to modify the maturity of the Notes or the dates on which interest is payable in respect of the Notes, (ii) to reduce or cancel the principal amount of, or interest on, the Notes, (iii) to alter the method of calculating the amount of any payment in respect of the Notes, (iv) to change the currency of payment of the Notes, (v) to modify the provisions concerning the quorum required at any meeting of Noteholders or the majority required to pass an Extraordinary Resolution, or (vi) to modify or cancel the Guarantee, in which case the necessary quorum will be two or more persons holding or representing not less than 75 per cent., or at any adjourned meeting not less than 25 per cent., in principal amount of the Notes for the time being outstanding. Any Extraordinary Resolution duly passed shall be binding on Noteholders (whether or not they were present at the meeting at which such resolution was passed). A written resolution signed by or on behalf of the holders of not less than 90 per cent. of the aggregate principal amount of Notes outstanding shall be as valid and effective as a duly passed Extraordinary Resolution.
The Trustee may agree with the Issuer and the Guarantor, without the consent of the Noteholders, to (i) any modification of any of the provisions of the Trust Deed or the Notes which is, in the opinion of the Trustee, of a formal, minor or technical nature or is made to correct a manifest error, and (ii) any other modification (except as mentioned in the Trust Deed), and any waiver or authorisation of any breach or proposed breach of any of the provisions of the Notes or the Trust Deed which is in the opinion of the Trustee not materially prejudicial to the interests of the Noteholders. Any such modification, authorisation or waiver shall be binding on the Noteholders and, if the Trustee so requires, shall be notified to the Noteholders as soon as practicable.
The Trust Deed contains provisions permitting the Trustee to agree with the Issuer and the Guarantor, subject to such amendment of the Trust Deed and such other conditions as the Trustee may require, but without the consent of the Noteholders, to the substitution of certain other entities in place of the Issuer, or of any previous substituted company, as principal debtor under the Trust Deed and the Notes. In the case of such substitution, the Trustee may agree with the Issuer and the Guarantor, without the consent of the Noteholders, to a change of law governing the Notes and/or the Trust Deed, provided that such change would not in the opinion of the Trustee be materially prejudicial to the interests of Noteholders. Notice of any such substitution will be provided as described in Condition 17 below.
In connection with the exercise of its functions (including but not limited to those referred to in this Condition) the Trustee shall have regard to the interests of the Noteholders as a class and shall not have regard to the consequences of such exercise for individual Noteholders and the Trustee shall not be entitled to require, nor shall any Noteholder be entitled to claim, from the Issuer, the Guarantor, the Trustee or any other Person, any indemnification or payment in respect of any tax consequences of any such exercise upon individual Noteholders.
At any time after the Notes become due and payable, the Trustee may, at its discretion and without further notice, institute such proceedings against the Issuer and/or the Guarantor as it may think fit to enforce the terms of the Trust Deed and the Notes (whether by arbitration pursuant to the Trust Deed or by litigation), but it need not take any such proceedings unless (a) it shall have been so directed by an Extraordinary Resolution or so requested in writing by Noteholders holding at least one-quarter in principal amount of the Notes outstanding and (b) it shall have been indemnified and/or secured and/or prefunded to its satisfaction. No Noteholder may proceed directly against the Issuer or the Guarantor unless the Trustee, having become bound so to proceed, fails to do so within a reasonable time and such failure is continuing.
The Trust Deed contains provisions for the indemnification of the Trustee and for its relief from responsibility. The Trustee is entitled to enter into business transactions with the Issuer, the Guarantor and any entity related to the Issuer or the Guarantor without accounting for any profit. The Trustee may rely without liability to Noteholders on any report, confirmation or certificate or any advice of the Auditors, the Chief Accountant of the Guarantor, or any expert considered by the Trustee to be of good repute, whether or not addressed to the Trustee and whether or not liability in relation thereto is limited by reference to a monetary cap, methodology or otherwise.
The Issuer may from time to time, without the consent of the Noteholders, create and issue further securities having the same terms and conditions as the Notes in all respects (or in all respects except for the first payment of interest) and so that such further issue shall be consolidated and form a single series with the outstanding Notes. References in these Conditions to the Notes include (unless the context requires otherwise) any other securities issued pursuant to this Condition. Any such other securities shall be constituted by a deed supplemental to the Trust Deed. The Trust Deed contains provisions for convening a single meeting of the Noteholders for the holders of securities of other series where the Trustee so decides.
Notices to the Noteholders shall be valid if sent to them by first class mail (airmail if overseas) at their respective addresses on the Register. Any such notice shall be deemed to have been given on the fourth day after the date of mailing. In addition, notices will be published in a leading newspaper having general circulation in London (which is expected to be the Financial Times) or, if in the opinion of the Trustee such publication shall not be practicable, in any English language newspaper of general circulation in Europe. Any such notice shall be deemed to have been given on the date of such publication or, if published more than once or on different dates, on the first date on which publication is made.
If any sum due from the Issuer in respect of the Notes or any order or judgment given or made in relation thereto has to be converted from the currency (the "first currency") in which the same is payable under these Conditions or such order or judgment into another currency (the "second currency") for the purpose of (a) making or filing a claim or proof against the Issuer, (b) obtaining an order or judgment in any court or other tribunal or (c) enforcing any order or judgment given or made in relation to the Notes, the Issuer, failing whom the Guarantor, shall indemnify each Noteholder, on the written demand of such Noteholder addressed to the Issuer and the Guarantor and delivered to the Issuer and the Guarantor or to the specified office of the Registrar, against any loss suffered as a result of any discrepancy between (i) the rate of exchange used for such purpose to convert the sum in question from the first currency into the second currency and (ii) the rate or rates of exchange at which such Noteholder may in the ordinary course of business purchase the first currency with the second currency upon receipt of a sum paid to it in satisfaction, in whole or in part, of any such order, judgment, claim or proof.
This indemnity constitutes a separate and independent obligation of the Issuer or, as the case may be, the Guarantor and shall give rise to a separate and independent cause of action, will apply irrespective of any indulgence granted by the Trustee and will continue in full force and effect despite any judgment, order, claim or proof for a liquidated amount in respect of any sum due under the Trust Deed and/or the Notes or any other judgment or order.
No person shall have any right to enforce any term or condition of the Notes under the Contracts (Rights of Third Parties) Act 1999.
The Notes (including for the avoidance of doubt Condition 20), the Trust Deed and any non-contractual obligations arising out of or in connection with any one of them are governed by, and shall be construed in accordance with, English law.
Subject to Condition 20, the courts of England are to have jurisdiction to settle any disputes which may arise out of or in connection with the Notes or the Trust Deed and accordingly any legal action or proceedings arising out of or in connection with the Notes or the Trust Deed (Proceedings) may be brought
in such courts and any final and conclusive judgment in any Proceedings brought in the courts of England shall be conclusive and binding and may be enforced in the courts of any other jurisdiction. Each of the Issuer and the Guarantor has in the Trust Deed irrevocably submitted to the jurisdiction of such courts and waives any objection to Proceedings in such courts whether on the ground of venue or on the ground that the Proceedings have been brought in an inconvenient forum. These submissions are made for the benefit of each of the Noteholders and shall not limit the right of any of them to take Proceedings in any other court of competent jurisdiction nor shall the taking of Proceedings in one or more jurisdictions preclude the taking of Proceedings in any other jurisdiction (whether concurrently or not).
Each of the Issuer and the Guarantor has appointed LUKOIL Accounting & Finance Limited at its registered office (being, at the date hereof, Rotunda Point, 11 Hartfield Crescent, London SW19 3RL, England) as its agent in England to receive service of process in any Proceedings in England in connection with the Notes or the Trust Deed.
The Issuer and the Guarantor consent generally in respect of any Proceedings or Disputes to the giving of any relief or the issue of any process in connection with such Proceedings or Disputes including (without limitation) the making, enforcement or execution against any property whatsoever (irrespective of its use or intended use) of any judgment or award which may be made or given in such Proceedings or Disputes.
To the extent that either the Issuer or the Guarantor may in any jurisdiction claim for itself or its assets or revenues immunity from suit, execution, attachment (whether in aid of execution, before the making of a judgment or an award or otherwise) or other legal process including in relation to the enforcement of an arbitration award and to the extent that such immunity (whether or not claimed) may be attributed in any such jurisdiction to the Issuer, the Guarantor or their respective assets or revenues, the Issuer and the Guarantor agree not to claim and irrevocably waive such immunity to the full extent permitted by the laws of such jurisdiction.
In these Conditions, the following terms shall have the following meanings:
"Affiliate" has the meaning ascribed to it under Rule 405 of the Securities Act;
"Applicable Premium" means, with respect to a Note at any time, the excess of (a) the present value at such redemption date of such Note, plus any required interest payments that would otherwise be due to be paid on such Note from such redemption date through 9 November 2020, together with any accrued and unpaid interest as of such redemption date, if any, calculated using a discount rate equal to the Treasury Rate at such redemption date plus 50 basis points, over (b) the principal amount of such Note, provided that if the value of Applicable Premium at any time would otherwise be less than zero, then in such circumstances for the purposes of these Conditions the value of Applicable Premium will be equal to zero.
"Auditors" means the auditors of the Group's U.S. GAAP consolidated financial statements for the time being or, if they are unable or unwilling to carry out any action requested of them under terms of the Notes, such other internationally recognised firm of accountants as may be approved in writing by the Trustee for this purpose;
"business day" means (except where expressly defined otherwise) a day on which commercial banks are open for business (including dealings in foreign currencies) in the city where the Registrar has its specified office;
"Consolidated Assets" means the total amount of assets appearing on the consolidated balance sheet of the Guarantor, prepared in accordance with U.S. GAAP, as of the date of the most recently prepared consolidated financial statements;
"Closing Date" means 9 November 2010;
"Domestic Relevant Indebtedness" means any Relevant Indebtedness which is denominated and payable in roubles, is not quoted, listed or ordinarily dealt in or traded on any stock exchange, over the counter or other recognised securities market outside the Russian Federation and which on issue was placed only with investors within the Russian Federation;
"European Union" means the European Union, including the countries of Austria, Belgium, Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom but not including any country which becomes a member of the European Union after the Issue Date;
"Event of Default" has the meaning assigned to such term in Condition 10;
"Group" means the companies which are consolidated in the most recent accounts of the Guarantor prepared in accordance with U.S. GAAP;
"Indebtedness" means, in respect of any Person, any indebtedness for, or in respect of, moneys borrowed; any amount raised by acceptance under any credit facility; any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument; any amount raised pursuant to any issue of shares which are expressed to be redeemable; any amount of money raised under any other transaction (including any forward sale or purchase agreement) having the commercial effect of a borrowing; the amount of any liability in respect of a capital lease that would at that time be required to be capitalised on a balance sheet in accordance with U.S. GAAP and (without double counting) the amount of any liability in respect of any guarantee or indemnity (whether on or off balance sheet) for any of the items referred to above; provided that, for the avoidance of doubt, Indebtedness shall not include moneys raised by way of the issue of share capital (whether or not for cash consideration and excluding shares which are expressed to be redeemable) and any premium on such share capital; and provided further that Indebtedness shall not include Indebtedness among the Issuer, Guarantor and Subsidiaries; and provided further that Indebtedness shall not include any trade credit extended to such Person in connection with the acquisition of goods and/or services on arm's length terms and in the ordinary course of trading of that Person;
"Issue Date" means 9 November 2010;
"Material Adverse Effect" means a material adverse effect on (a) the financial condition or operations of the Guarantor or the Group, or (b) the Issuer's or the Guarantor's ability to perform its obligations under the Notes and the Guarantee, respectively or (c) the validity, legality or enforceability of the Notes or the Guarantee or the rights or remedies of the Noteholders under the Notes or the Guarantee.
(ii) whose net income equals or exceeds 10 per cent. of the net income of the Group; or
(iii) whose net assets equal or exceed 10 per cent. of the net assets of the Group,
The Trustee shall be entitled to rely on a certificate of an Authorised Officer as to whether a Subsidiary constitutes a Principal Subsidiary and will not be responsible to any Person for any loss occasioned by relying on such a certificate;
"Relevant Indebtedness" means any present or future Indebtedness in the form of, or represented by notes, debentures, bonds or other securities (but for the avoidance of doubt, excluding term loans, credit facilities, credit agreements and other similar facilities and evidence of indebtedness under such loans, facilities or credit agreements) which either are by their terms payable, or confer a right to receive payment, in any currency, and are for the time being, or ordinarily are, quoted, listed or ordinarily dealt in or traded on any stock exchange, over-the-counter or other securities market;
"Subsidiary" means any corporation or other business entity of which the Issuer or the Guarantor owns or controls (either directly or through one or more Subsidiaries) 50 per cent. or more of the issued share capital or other ownership interest having ordinary voting power to elect a majority of the directors, managers or trustees of such corporation or other business entity;
"Treasury Rate" means the yield to maturity at the time of computation of United States Treasury securities with a constant maturity most nearly equal to the period from the redemption date to 9 November 2020. The Issuer will obtain such yield to maturity from information compiled and published in the most recent Federal Reserve Statistical Release H.15 (519) which has become publicly available at least two business days (but not more than five business days) prior to the redemption date (or, if such Statistical Release is not so published or available, any publicly available source of similar market data selected by the Issuer in good faith)); provided, however, that if the period from the redemption date to 9 November 2020 is not equal to the constant maturity of a United States Treasury security for which a weekly average yield is given, the Treasury Rate shall be obtained by linear interpolation (calculated to the nearest one-twelfth of a year) from the weekly average yields of United States Treasury securities for which such yields are given, except that if the period from the redemption date to 9 November 2020 is less than one year, the weekly average yield on actually traded United States Treasury securities adjusted to a constant maturity of one year shall be used; and
"U.S. Dollars", "U.S.\$" or the sign "\$" means such coin or currency of the United States of America as at the time of payment shall be legal tender for the payment of public and private debts.
There will appear at the foot of the Conditions endorsed on each Definitive Note the name and specified office of the Agents as set out at the end of this prospectus.
In connection with its purchase of Rule 144A Notes, the purchaser hereof (the Investor), by virtue of its acceptance of this prospectus, will be deemed to represent, acknowledge and agree as follows:
THE NOTES REPRESENTED HEREBY AND THE GUARANTEE THEREOF HAVE NOT BEEN AND WILL NOT BE REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933 (THE SECURITIES ACT) OR WITH ANY SECURITIES REGULATORY AUTHORITY OF ANY STATE OR OTHER JURISDICTION OF THE UNITED STATES AND THE NOTES REPRESENTED HEREBY MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT (1) IN ACCORDANCE WITH RULE 144A UNDER THE SECURITIES ACT (RULE 144A) TO A PERSON THAT THE HOLDER AND ANY PERSON ACTING ON ITS BEHALF REASONABLY BELIEVE IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A (A QIB) THAT IS ALSO A QUALIFIED PURCHASER (A QP) WITHIN THE MEANING OF SECTION 2(a)(51) OF THE UNITED STATES INVESTMENT COMPANY ACT OF 1940 (THE INVESTMENT COMPANY ACT) PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF ONE OR MORE QIBS EACH OF WHICH IS A QP WHOM THE HOLDER HAS INFORMED, IN EACH CASE, THAT SUCH OFFER, SALE, PLEDGE OR OTHER TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, AND IN AN AMOUNT FOR EACH ACCOUNT OF NOT LESS THAN U.S.\$100,000 PRINCIPAL AMOUNT OF NOTES OR (2) TO A PERSON WHO IS NOT A U.S. PERSON (AS DEFINED IN REGULATION S) IN AN OFFSHORE TRANSACTION IN ACCORDANCE WITH RULE 903 OR RULE 904 OF REGULATION S UNDER THE SECURITIES ACT (REGULATION S), AND IN EACH CASE IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF ANY STATE OR OTHER JURISDICTION OF THE UNITED STATES, AND THE HOLDER OF THE NOTES REPRESENTED HEREBY WILL, AND EACH SUBSEQUENT HOLDER OF THE NOTES REPRESENTED HEREBY IS REQUIRED TO, NOTIFY ANY PURCHASER FROM IT OF THE NOTES REPRESENTED HEREBY OF THE RESALE RESTRICTIONS REFERRED TO ABOVE. TRANSFERS IN VIOLATION OF THE FOREGOING WILL BE OF NO FORCE OR EFFECT, WILL BE VOID AB INITIO, AND WILL NOT OPERATE TO TRANSFER ANY RIGHTS TO THE TRANSFEREE, NOTWITHSTANDING ANY INSTRUCTIONS TO THE CONTRARY TO THE ISSUER OF THE NOTES REPRESENTED HEREBY, THE TRUSTEE OR ANY INTERMEDIARY. NO REPRESENTATION CAN BE MADE AS TO THE AVAILABILITY OF ANY EXEMPTION UNDER THE SECURITIES ACT FOR RESALES OF THE NOTES REPRESENTED HEREBY.
IF THE BENEFICIAL OWNER OF THE NOTES REPRESENTED HEREBY IS A U.S. PERSON WITHIN THE MEANING OF REGULATION S, SUCH BENEFICIAL OWNER REPRESENTS THAT (1) IT IS A QIB THAT IS ALSO A QP; (2) IT IS NOT A BROKER- DEALER WHICH OWNS AND INVESTS ON A DISCRETIONARY BASIS LESS THAN U.S.\$25,000,000 IN SECURITIES OF UNAFFILIATED ISSUERS; (3) IT IS NOT A PARTICIPANT-DIRECTED EMPLOYEE PLAN, SUCH AS A 401(k) PLAN; (4) IT IS HOLDING THE NOTES REPRESENTED HEREBY FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF ONE OR MORE QIBS, EACH OF WHICH IS A QP; (5) IT WAS NOT FORMED FOR THE PURPOSE OF INVESTING IN THE ISSUER OR THE NOTES REPRESENTED HEREBY; (6) IT, AND EACH ACCOUNT FOR WHICH IT HOLDS NOTES, WILL HOLD AND TRANSFER AT LEAST U.S.\$100,000 IN PRINCIPAL AMOUNT OF NOTES; (7) IT UNDERSTANDS THAT THE ISSUER MAY RECEIVE A LIST OF PARTICIPANTS HOLDING POSITIONS IN ITS SECURITIES FROM ONE OR MORE BOOK-ENTRY DEPOSITARIES AND (8) IT WILL PROVIDE NOTICE OF THE FOREGOING TRANSFER RESTRICTIONS TO ITS SUBSEQUENT TRANSFEREES. THE BENEFICIAL OWNER OF THE NOTES REPRESENTED HEREBY ACKNOWLEDGES THAT IF AT ANY TIME WHILE IT HOLDS AN INTEREST IN THE NOTES REPRESENTED HEREBY IT IS A U.S. PERSON WITHIN THE MEANING OF REGULATION S WHO IS NOT A QIB THAT IS ALSO A QP, THE ISSUER MAY (A) COMPEL IT TO SELL ITS INTEREST IN THE NOTES REPRESENTED HEREBY TO A PERSON WHICH IS (I) A U.S. PERSON WHICH IS A QIB AND A QP AND WHO IS OTHERWISE QUALIFIED TO PURCHASE THIS NOTE IN A TRANSACTION EXEMPT FROM REGISTRATION UNDER THE SECURITIES ACT OR (II) NOT A U.S. PERSON WITHIN THE MEANING OF REGULATION S OR (B) COMPEL THE BENEFICIAL OWNER TO SELL ITS INTEREST IN THE NOTES REPRESENTED HEREBY TO THE ISSUER OR AN AFFILIATE OF THE ISSUER OR TRANSFER ITS INTEREST IN THE NOTES REPRESENTED HEREBY TO A PERSON DESIGNATED BY OR ACCEPTABLE TO THE ISSUER AT A PRICE EQUAL TO THE LEAST OF (X) THE PURCHASE PRICE THEREFOR PAID BY THE BENEFICIAL OWNER, (Y) 100% OF THE PRINCIPAL AMOUNT THEREOF OR (Z) THE FAIR MARKET VALUE THEREOF. THE ISSUER HAS THE RIGHT TO REFUSE TO HONOUR A TRANSFER OF AN INTEREST IN THE NOTES REPRESENTED HEREBY TO A U.S. PERSON WHICH IS NOT A QIB AND A QP AND WHICH CANNOT MAKE THE REPRESENTATIONS SET FORTH IN THE FIRST SENTENCE OF THE SECOND PARAGRAPH OF THIS LEGEND. THE ISSUER HAS NOT BEEN AND WILL NOT BE REGISTERED UNDER THE INVESTMENT COMPANY ACT.
BY ITS PURCHASE AND HOLDING OF THE NOTES REPRESENTED HEREBY (OR ANY INTEREST THEREIN), THE PURCHASER AND ANY TRANSFEREE THEREOF WILL BE DEEMED TO HAVE REPRESENTED AND AGREED EITHER THAT: (I) IT IS NOT AND FOR SO LONG AS IT HOLDS THE NOTES REPRESENTED HEREBY (OR ANY INTEREST THEREIN) WILL NOT BE (AND IS NOT ACQUIRING ANY NOTE REPRESENTED HEREBY DIRECTLY OR INDIRECTLY WITH THE ASSETS OF A PERSON WHO IS OR WHILE THE NOTES ARE HELD WILL BE) (A) AN "EMPLOYEE BENEFIT PLAN" (AS DEFINED IN SECTION 3(3) OF THE U.S. EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974, AS AMENDED (ERISA)); THAT IS SUBJECT TO TITLE I OF ERISA, (B) A "PLAN" DESCRIBED IN AND SUBJECT TO SECTION 4975 OF THE U.S. INTERNAL REVENUE CODE OF 1986, AS AMENDED (THE "CODE"), (C) ANY ENTITY WHOSE UNDERLYING ASSETS INCLUDE, OR ARE DEEMED TO INCLUDE, "PLAN ASSETS" BY REASON OF SUCH EMPLOYEE BENEFIT PLAN'S OR PLAN'S INVESTMENT IN THE ENTITY OR (D) ANY EMPLOYEE BENEFIT PLAN WHICH IS SUBJECT TO ANY FEDERAL, STATE OR LOCAL LAW, OR FOREIGN LAW, THAT IS SUBSTANTIALLY SIMILAR TO THE PROVISIONS OF SECTION 406 OF ERISA OR SECTION 4975 OF THE CODE ("SIMILAR LAW"); OR (II) ITS PURCHASE AND HOLDING OF THE NOTES REPRESENTED HEREBY WILL NOT CONSTITUTE OR RESULT IN A NON-EXEMPT PROHIBITED TRANSACTION UNDER SECTION 406 OF ERISA OR SECTION 4975 OF THE CODE (OR, IN THE CASE OF ANOTHER EMPLOYEE BENEFIT PLAN SUBJECT TO SIMILAR LAW, IS NOT IN VIOLATION OF ANY SIMILAR LAW).
THE ISSUER MAY COMPEL THE HOLDER OF THE NOTES REPRESENTED HEREBY TO CERTIFY PERIODICALLY THAT SUCH HOLDER IS A QIB (DURING SUCH TIME THAT THE NOTES REPRESENTED HEREBY ARE "RESTRICTED SECURITIES" WITHIN THE MEANING OF RULE 144(a)(3) UNDER THE SECURITIES ACT) AND A QP.
In connection with its purchase of the Regulation S Notes, the Investor and each subsequent purchaser of Regulation S Notes in resales prior to the expiration of the distribution compliance period, by virtue of its acceptance of this prospectus hereof, will be deemed to represent, acknowledge and agree as follows:
Each purchaser of notes, and each subsequent transferee of any notes by virtue of the transfer of such notes to such transferee, by accepting delivery of this Prospectus and the notes, will be deemed to have represented, agreed and acknowledged that either:
Each series of notes will be evidenced on issue by (i) in the case of Regulation S Notes, a Regulation S Global Note deposited with, and registered in the name of a nominee for, a common depositary for Euroclear and Clearstream, Luxembourg and (ii) in the case of Rule 144A Notes, a Rule 144A Global Note deposited with a custodian for, and registered in the name of Cede & Co. as nominee of, DTC.
Beneficial interests in the Regulation S Global Note may be held only through Euroclear or Clearstream, Luxembourg at any time. See "– Book-Entry Procedures for the Global Notes". By acquisition of a beneficial interest in the Regulation S Global Note, the purchaser thereof will be deemed to represent, among other things, that it is not a U.S. Person, and that, if it determines to transfer such beneficial interest prior to the expiration of the 40-day distribution compliance period, it will transfer such interest only to a person whom the seller reasonably believes (a) to be a non-U.S. person in an offshore transaction in accordance with Rule 903 or Rule 904 of Regulation S or (b) to be a person who takes delivery in the form of an interest in the Rule 144A Global Note (if applicable). See "Transfer Restrictions". Beneficial interests in the Rule 144A Global Note may only be held through DTC at any time. See "– Book-Entry Procedures for the Global Notes". By acquisition of a beneficial interest in the Rule 144A Global Note, the purchaser thereof will be deemed to represent, among other things, that it is a QIB that is also a QP which can make the representations set forth in paragraphs 4 and 5 of "Transfer Restrictions —Rule 144A Notes" and that, if in the future it determines to transfer such beneficial interest, it will transfer such interest in accordance with the procedures and restrictions contained in the agency agreement. See "Transfer Restrictions".
Beneficial interests in each Global Note will be subject to certain restrictions on transfer set forth therein and in the agency agreement, and with respect to the Rule 144A Global Note, as set forth in Rule 144A, and the notes will bear the legends set forth thereon regarding such restrictions set forth under "Transfer Restrictions". A beneficial interest in the Regulation S Global Note may be transferred to a person who takes delivery in the form of an interest in the Rule 144A Global Note only upon receipt by the Registrar of a written certification (in the form provided in the agency agreement) to the effect that the transferor
reasonably believes that the transferee is a QIB that is also a QP which can make the representations set forth in paragraphs 4 and 5 of "Transfer Restrictions —Rule 144A Notes" and that such transaction is in accordance with any applicable securities laws of any state or other jurisdiction of the United States. Beneficial interests in the Rule 144A Global Note may be transferred to a person who takes delivery in the form of an interest in the Regulation S Global Note only upon receipt by the Registrar of a written certification (in the form provided in the agency agreement) from the transferor to the effect that the transfer is being made in accordance with Regulation S.
Any beneficial interest in the Regulation S Global Note that is transferred to a person who takes delivery in the form of an interest in the Rule 144A Global Note will, upon transfer, cease to be an interest in the Regulation S Global Note and become an interest in the Rule 144A Global Note and, accordingly, will thereafter be subject to all transfer restrictions and other procedures applicable to beneficial interests in the Rule 144A Global Note and become an interest in the Regulation S Global Note and, accordingly, will thereafter be subject to all transfer restrictions and other procedures applicable to beneficial interests in the Regulation S Global Note for so long as it remains such an interest. No service charge will be made for any registration of transfer or exchange of notes, but the Registrar may require payment of a sum sufficient to cover any tax or other governmental charge payable in connection therewith. Except in the limited circumstances described below, owners of beneficial interests in Global Notes will not be entitled to receive physical delivery of certificated notes in definitive form (the Definitive Notes). The notes are not issuable in bearer form.
Each Global Note contains provisions that apply to the notes that they represent, some of which modify the effect of the above Terms and Conditions of the Notes. The following is a summary of those provisions:
Payments of principal and interest in respect of notes evidenced by a Global Note will be made to the person who appears at the relevant time on the register of Noteholders against presentation for endorsement by the Principal Paying Agent and, if no further payment falls to be made in respect of the relevant notes, surrender of such Global Note to or to the order of the Principal Paying Agent or such other Paying Agent as shall have been
notified to the relevant Noteholders for such purpose. A record of each payment so made will be endorsed in the appropriate schedule to the relevant Global Note, which endorsement will be prima facie evidence that such payment has been made in respect of the relevant notes.
So long as any notes are evidenced by a Global Note and such Global Note is held by or on behalf of a clearing system, the definition of "business day" in Condition 8(d) (Payments on business days) will be modified by the terms of the Global Note to mean any day which is a day on which dealings in foreign currencies may be carried on in New York City.
Notwithstanding the provisions of Condition 8(e) (Record Date), for so long as any notes are evidenced by a Global Note and such Global Note is held by or on behalf of a clearing system, payments in respect of the notes will be made to each accountholder in whose account with a clearing system the notes are held at the opening of business on the Clearing System Business Day before the due date for such payment, where "Clearing System Business Day" means a day on which each clearing system for which the Global Note is being held is open for business.
So long as any notes are evidenced by a Global Note and such Global Note is held by or on behalf of a clearing system, notices to Noteholders may be given by delivery of the relevant notice to that clearing system for communication by it to entitled account holders in substitution for delivery thereof as required by the Terms and Conditions of such notes.
The holder of each Global Note will be treated as being two persons for the purposes of any quorum requirements of, or the right to demand a poll at, a meeting of Noteholders and in any such meeting as having one vote in respect of each of the notes for which the relevant Global Note may be exchangeable.
In considering the interests of Noteholders while the relevant Global Note is held on behalf of a clearing system, the Trustee, to the extent it considers it appropriate to do so in the circumstances, may have regard to any information provided to it by such clearing system or its operator as to the identity (either individually or by category) of its accountholders with entitlements to such Global Note and may consider such interests as if such accountholders were the holders of such Global Note.
Each Global Note will be exchangeable, free of charge to the holder, in whole but not in part, for notes in definitive, registered form if: (i) a Global Note is held by or on behalf of (A) DTC, and DTC notifies the Issuer that it is no longer willing or able to discharge properly its responsibilities as depositary with respect to the Global Note or ceases to be a "clearing agency" registered under the Exchange Act or if at any time it is no longer eligible to act as such, and the Issuer is unable to locate a qualified successor within 90 days of receiving notice or becoming aware of such ineligibility on the part of DTC or (B) Euroclear or Clearstream, Luxembourg, and Euroclear or Clearstream, Luxembourg, as the case may be, is closed for business for a continuous period of 14 days (other than by reason of holidays, statutory or otherwise) or announces an intention permanently to cease business or does in fact do so, by the holder giving notice to the Registrar or any Transfer Agent or (ii) principal in respect of any notes is not paid when due and payable.
The Registrar will not register the transfer of, or exchange of interests in, a Global Note for definitive notes for a period of 15 calendar days ending on the date for any payment of principal or interest or on the date of optional redemption in respect of the notes.
"Exchange Date" means a day falling not later than 90 days after that on which the notice requiring exchange is given and on which banks are open for business in the city in which the specified office of the Registrar or the Transfer Agent is located.
In such circumstances, the relevant Global Note shall be exchanged in full for definitive notes and the Issuer will, at the cost of the Issuer (but against such indemnity as the Registrar or any relevant Transfer Agent may require in respect of any tax or other duty of whatever nature which may be levied or imposed in connection with such exchange), cause sufficient Definitive Notes to be executed and delivered to the Registrar for completion, authentication and dispatch to the relevant Noteholders. A person having an interest in a Global Note must provide the Registrar with (a) a written order containing instructions and such other information as the Issuer and the Registrar may require to complete, execute and deliver such notes and (b) in the case of the Rule 144A Global Note only, a fully completed, signed certification substantially to the effect that the exchanging holder is not transferring its interest at the time of such exchange or, in the case of simultaneous sale pursuant to Rule l44A, a certification that the transfer is being made in compliance with the provisions of Rule 144A to a QIB that is also a QP which can make the representations set forth in paragraphs 4 and 5 of "Transfer Restrictions —Rule 144A Notes". Definitive Notes issued in exchange for a beneficial interest in the Rule 144A Global Note shall bear the legend applicable to transfers pursuant to Rule 144A, as set out under "Transfer Restrictions".
The holder of a Definitive Note may transfer the notes evidenced thereby in whole or in part in the applicable minimum denomination by surrendering it at the specified office of the Registrar or any Transfer Agent, together with the completed form of transfer thereon. Upon the transfer, exchange or replacement of a Rule 144A Definitive Note bearing the legend referred to under "Transfer Restrictions", or upon specific request for removal of the legend on a Rule 144A Definitive Note, the Issuer will deliver only Rule 144A Definitive Notes that bear such legend, or will refuse to remove such legend, as the case may be, unless there is delivered to the Issuer and the Registrar such satisfactory evidence, which may include an opinion of counsel, as may reasonably be required by the Issuer that neither the legend nor the restrictions on transfer set forth therein are required to ensure compliance with the provisions of the Securities Act and the Investment Company Act.
For each series of notes evidenced by both a Regulation S Global Note and a Rule 144A Global Note, custodial and depository links are to be established between DTC, Euroclear and Clearstream, Luxembourg to facilitate the initial issue of the notes and cross-market transfers of the notes associated with secondary market trading. See "– Book-Entry Ownership – Settlement and Transfer of Notes".
Euroclear and Clearstream, Luxembourg each hold securities for their customers and facilitate the clearance and settlement of securities transactions through electronic book-entry transfer between their respective accountholders. Indirect access to Euroclear and Clearstream, Luxembourg is available to other institutions which clear through or maintain a custodial relationship with an accountholder of either system. Euroclear and Clearstream, Luxembourg provide various services including safekeeping, administration, clearance and settlement of internationally-traded securities and securities lending and borrowing. Euroclear and Clearstream, Luxembourg also deal with domestic securities markets in several countries through established depository and custodial relationships. Euroclear and Clearstream, Luxembourg have established an electronic bridge between their two systems across which their respective customers may settle trades with each other. Their customers are worldwide financial institutions including underwriters, securities brokers and dealers, banks, trust companies and clearing corporations. Investors may hold their interests in such Global Notes directly through Euroclear or Clearstream, Luxembourg if they are accountholders (Direct Participants) or indirectly (Indirect Participants and together with Direct Participants, Participants) through organisations which are accountholders therein.
DTC has advised the Issuer as follows: DTC is a limited purpose trust company organised under the laws of the State of New York, a "banking organization" under the laws of the State of New York, a member of the U.S. Federal Reserve System, a "clearing corporation" within the meaning of the New York Uniform Commercial code and a "clearing agency" registered pursuant to the provisions of Section 17A of the Exchange Act. DTC was created to hold securities for its Participants and facilitate the clearance and settlement of securities transactions between Participants through electronic computerised book- entry changes in accounts of its Participants, thereby eliminating the need for physical movement of certificates. Participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other organisations. Indirect access to DTC is available to others, such as banks, securities brokers, dealers and trust companies, which clear through or maintain a custodial relationship with a DTC Direct Participant, either directly or indirectly. More information about DTC may be found at www.dtcc.com.
Investors may hold their interests in the Rule 144A Global Note directly through DTC if they are Direct Participants in the DTC system, or as Indirect Participants through organisations which are Direct Participants in such system.
DTC has advised the Issuer that it will take any action permitted to be taken by a holder of notes only at the direction of one or more Direct Participants and only in respect of such portion of the aggregate principal amount of the Rule 144A Global Note as to which such Participant or Participants has or have given such direction. However, in the circumstances described under "Exchange for Definitive Notes", DTC will surrender the Rule 144A Global Note for exchange for individual Rule 144A Definitive Notes (which will bear the legend applicable to transfers pursuant to Rule 144A).
The Regulation S Global Note representing the Regulation S Notes will have an ISIN and a Common Code and will be registered in the name of a nominee for, and deposited with a common depositary on behalf of, Euroclear and Clearstream, Luxembourg.
The Rule 144A Global Note representing the Rule 144A Notes will have a CUSIP number and will be deposited with a custodian for, and registered in the name of Cede & Co. as nominee of, DTC. The Custodian and DTC will electronically record the principal amount of the notes held within the DTC System.
Each of the persons shown in the records of Euroclear, Clearstream, Luxembourg or DTC as the holder of a note evidenced by a Global Note must look solely to Euroclear, Clearstream, Luxembourg or DTC (as the case may be) for his share of each payment made by the Issuer to the holder of such Global Note and in relation to all other rights arising under the Global Note, subject to and in accordance with the respective rules and procedures of Euroclear, Clearstream, Luxembourg or DTC (as the case may be). The Issuer expects that, upon receipt of any payment in respect of notes evidenced by a Global Note, the common depositary by whom such note is held, or nominee in whose name it is registered, will immediately credit the relevant participants' or accountholders' accounts in the relevant clearing system with payments in amounts proportionate to their respective beneficial interests in the principal amount of the relevant Global Note as shown on the records of the relevant clearing system or its nominee. The Issuer also expects that payments by Direct Participants in any clearing system to owners of beneficial interests in any Global Note held through such Direct Participants in any clearing system will be governed by standing instructions and customary practices. Save as aforesaid, such persons shall have no claim directly against the Issuer in respect of payments due on the notes for so long as the notes are evidenced by such Global Note and the obligations of the Issuer will be discharged by payment to the registered holder, as the case may be, of such Global Note in respect of each amount so paid. None of the Issuer, the Trustee or any Agent will have any responsibility or liability for any aspect of the records relating to or payments made on account of ownership interests in any Global Note or for maintaining, supervising or reviewing any records relating to such ownership interests.
Subject to the rules and procedures of each applicable clearing system, purchases of notes held within a clearing system must be made by or through Direct Participants, which will receive a credit for such notes on the clearing system's records. The ownership interest of each actual purchaser of each such note (the Beneficial Owner) will in turn be recorded on the Direct and Indirect Participants' records. Beneficial Owners will not receive written confirmation from any clearing system of their purchase, but Beneficial Owners are expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which such Beneficial Owner entered into the transaction.
Transfers of ownership interests in notes held within the clearing system will be affected by entries made on the books of Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in such notes, unless and until interests in any Global Note held within a clearing system are exchanged for Definitive Notes.
No clearing system has knowledge of the actual Beneficial Owners of the notes held within such clearing system and their records will reflect only the identity of the Direct Participants to whose accounts such notes are credited, which may or may not be the Beneficial Owners. The Participants will remain responsible for keeping account of their holdings on behalf of their customers. Conveyance of notices and other communications by the clearing systems to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time.
The laws of some jurisdictions may require that certain persons take physical delivery in definitive form of securities. Consequently, the ability to transfer interests in a Global Note to such persons may be limited. Because DTC can only act on behalf of Direct Participants, who in turn act on behalf of Indirect Participants, the ability of a person having an interest in the Rule 144A Global Note to pledge such interest to persons or entities that do not participate in DTC, or otherwise take actions in respect of such interest, may be affected by a lack of physical certificate in respect of such interest.
Secondary market sales of book-entry interests in the notes held through Euroclear or Clearstream, Luxembourg to purchasers of book-entry interests in the notes held through Euroclear or Clearstream, Luxembourg will be conducted in accordance with the normal rules and operating procedures of Euroclear and Clearstream, Luxembourg and will be settled using the procedures applicable to conventional Eurobonds.
Secondary market sales of book-entry interests in the notes between DTC participants will occur in the ordinary way in accordance with DTC rules and will be settled using the procedures applicable to United States corporate debt obligations in DTC's Same-Day Funds Settlement (SDFS) system in same-day funds, if payment is effected in U.S. dollars, or free of payment, if payment is not effected in U.S. dollars. Where payment is not effected in U.S. dollars, separate payment arrangements outside DTC are required to be made between the DTC participants.
When book-entry interests in notes are to be transferred from the account of a DTC participant holding a beneficial interest in the Rule 144A Global Note to the account of a Euroclear or Clearstream, Luxembourg accountholder wishing to purchase a beneficial interest in the Regulation S Global Note (subject to the certification procedures provided in the agency agreement), the DTC participant will deliver instructions for delivery to the relevant Euroclear or Clearstream, Luxembourg accountholder to DTC by 12 noon, New York time, on the settlement date. Separate payment arrangements are required to be made between the DTC participant and the relevant Euroclear or Clearstream, Luxembourg participant. On the settlement date, the custodian of the Rule 144A Global Note will instruct the Registrar to (i) decrease the amount of notes registered in the name of Cede & Co. and evidenced by such Rule 144A Global Note of the relevant class and (ii) increase the amount of notes registered in the name of the nominee of the common depositary for Euroclear and Clearstream, Luxembourg and evidenced by the Regulation S Global Note. Book-entry interests will be delivered free of payment to Euroclear or Clearstream, Luxembourg, as the case may be, for credit to the relevant accountholder on the first business day following the settlement date.
When book-entry interests in the notes are to be transferred from the account of a Euroclear or Clearstream, Luxembourg accountholder to the account of a DTC participant wishing to purchase a beneficial interest in the Rule 144A Global Note (subject to the certification procedures provided in the agency agreement), the Euroclear or Clearstream, Luxembourg participant must send to Euroclear or Clearstream, Luxembourg delivery free of payment instructions by 7:45 p.m., Brussels or Luxembourg time, one business day prior to the settlement date. Euroclear or Clearstream, Luxembourg, as the case may be, will in turn transmit appropriate instructions to the common depositary for Euroclear and Clearstream, Luxembourg and the Registrar to arrange delivery to the DTC participant on the settlement date. Separate payment arrangements are required to be made between the DTC participant and the relevant Euroclear or Clearstream, Luxembourg accountholder, as the case may be. On the settlement date, the common depositary for Euroclear and Clearstream, Luxembourg will (a) transmit appropriate instructions to the custodian of the Rule 144A Global Note who will in turn deliver such book-entry interests in the notes free of payment to the relevant account of the DTC participant and (b) instruct the Registrar to (i) decrease the amount of notes registered in the name of the nominee of the common depositary for Euroclear and Clearstream, Luxembourg and evidenced by the Regulation S Global Note; and (ii) increase the amount of notes registered in the name of Cede & Co. and evidenced by the Rule 144A Global Note.
Although Euroclear, Clearstream, Luxembourg and DTC have agreed to the foregoing procedures in order to facilitate transfers of beneficial interest in Global Notes among participants and accountholders of Euroclear, Clearstream, Luxembourg and DTC, they are under no obligation to perform or continue to perform such procedure, and such procedures may be discontinued at any time. None of the Issuer, the Trustee or any Agent will have the responsibility for the performance by Euroclear, Clearstream, Luxembourg or DTC or their respective Direct or Indirect Participants of their respective obligations under the rules and procedures governing their operations.
It is expected that delivery of notes will be made against payment therefor on the Closing Date thereof, which could be more than three business days following the date of pricing. Under Rule 15c6-1 under the Exchange Act, trades in the United States secondary market generally are required to settle within three business days (T+3), unless the parties to any such trade expressly agree otherwise. Accordingly, purchasers who wish to trade notes in the United States on the date of pricing or the next succeeding business days until three days prior to the relevant Closing Date will be required, by virtue of the fact the notes initially will settle beyond T+3, to specify an alternate settlement cycle at the time of any such trade to prevent a failed settlement. Settlement procedures in other countries will vary. Purchasers of notes may be affected by such local settlement practices, and purchasers of notes between the relevant date of pricing and the relevant Closing Date should consult their own advisors.
Barclays Bank PLC, ING Bank N.V., London Branch and The Royal Bank of Scotland plc (together, the Managers) have, pursuant to a Subscription Agreement dated 8 November 2010, jointly and severally agreed with the Issuer and LUKOIL, subject to the satisfaction of certain conditions, to subscribe for the notes at 99.081% of the principal amount of the Tranche 1 notes and 102.44% of the principal amount of the Tranche 2 notes, less concessions and commissions plus accrued interest, if any. In addition, the Issuer has agreed, under certain circumstances, to reimburse the Managers for certain of their expenses in connection with the issue of the notes. The Subscription Agreement entitles the Managers to terminate it in certain circumstances prior to payment being made to the Issuer.
Neither the Issuer nor LUKOIL nor any Manager has made any representation that any action will be taken in any jurisdiction by the Managers or the Issuer or LUKOIL that would permit a public offering of the notes, or possession or distribution of any offering material (in preliminary, proof or final form) in relation thereto in any country or jurisdiction where action for that purpose is required. Each Manager has agreed that it will, to the best of its knowledge having made due enquiries, comply with all applicable laws and regulations in each country or jurisdiction in which it purchases, offers, sells or delivers notes or has in its possession or distributes this prospectus, in all cases at its own expense.
The notes have not been and will not be registered under the Securities Act or the securities laws of any state or other jurisdiction of the United States and may not be offered or sold within the United States except in certain transactions exempt from the registration requirements of the Securities Act. Each Manager has represented, warranted and agreed that it will not offer or sell the notes (i) as part of their distribution at any time or (ii) otherwise until 40 days after the later of the commencement of the offering and the Closing Date, within the United States or to, or for the account or benefit of U.S. persons, and it will have sent to each dealer to which it sells notes during the distribution compliance period a confirmation or other notice setting forth the restrictions on offers and sales of the notes within the United State or to, or for the account or benefit of, U.S. persons. Terms used in this paragraph have the meanings given to them by Regulation S.
In addition, until 40 days after commencement of the offer, an offering or sale of notes within the United States by a dealer which is not participating in the offering may violate the registration requirements of the Securities Act if such offer or sale is made otherwise than in accordance with Rule 144A under the Securities Act.
Notes offered and sold outside the United States may be sold in reliance on Regulation S. The Subscription Agreement provides that the Managers may directly or through their respective U.S. broker-dealer affiliates arrange for the offer and resale of notes within the United States only to persons whom they reasonably believe are QIBs and QPs who can represent that (a) they are QPs who are QIBs within the meaning of Rule 144A; (b) they are not broker-dealers who own and invest on a discretionary basis less than U.S.\$25 million in securities of unaffiliated issuers; (c) they are not a participant-directed employee plan, such as 401(k) plan; (d) they are acting for their own account, or the account of one or more QIBs each of which is a QP; (e) they are not formed for the purpose of investing in the Issuer or the notes; (f) each account for which they are purchasing will hold and transfer at least U.S.\$100,000 in principal amount of notes at any time; (g) they understand that the Issuer may receive a list of participants holding positions in its securities from one or more book-entry depositaries; and (h) they will provide notice of the transfer restrictions set forth in this prospectus to any subsequent transferees.
The Issuer and the Managers reserve the right to reject any offer to purchase the notes, in whole or in part, for any reason. This prospectus does not constitute an offer to any person in the United States or to any U.S. person other than any QIB that is also a QP which can make the representations set out in the previous paragraph and to whom an offer has been made directly by one of the Managers or its U.S. broker-dealer affiliate. Distribution of this prospectus by any non-U.S. person outside the United States or by any QIB that is also a QP within the United States to any U.S. person or to any other person within the United States, other than any QIB that is also a QP which can make the representations set out in the previous paragraph and those persons, if any, retained to advise such non-U.S. person or QIB that is also a QP which can make the representations set out in the previous paragraph with respect thereto, is unauthorised and any disclosure without the prior written consent of the Issuer of any of its contents to any such U.S. person or person within the United States, other than any QIB that is also a QP which can make the representations set out in the previous paragraph and those persons, if any, retained to advise such non-U.S. person or QIB that is also a QP which can make the representations set out in the previous paragraph, is prohibited.
Each Manager has represented, warranted and undertaken that:
Each Manager represents, warrants and agrees that the notes have not been and will not be offered, transferred or sold as part of their initial distribution or at any time thereafter to or for the benefit of any persons (including legal entities) resident, incorporated, established or having their usual residence in the Russian Federation or to any person located within the territory of the Russian Federation, unless and to the extent otherwise permitted under Russian law.
Each Manager has acknowledged that this prospectus has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, each Manager has represented and agreed that it has not offered or sold any notes or caused such notes to be made the subject of an invitation for subscription or purchase and will not offer or sell such notes or cause such notes to be made the subject of an invitation for subscription or purchase, and has not circulated or distributed, nor will it circulate or distribute, this prospectus or any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of such notes, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 274 of the Securities and Futures Act, Chapter 289 of Singapore (the SFA), (ii) to a relevant person pursuant to Section 275(1), or any person pursuant to Section 275(1A), and in accordance with the conditions specified in Section 275 of the SFA or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.
Where the notes are subscribed or purchased under Section 275 of the SFA by a relevant person which is:
shares, debentures and units of shares and debentures of that corporation or the beneficiaries' rights and interest (howsoever described) in that trust shall not be transferred within six months after that corporation or that trust has acquired the notes pursuant to an offer made under Section 275 of the SFA, except:
Each Manager has represented and agreed that:
The notes have not been and will not be registered with the Securities Exchange Commission of the Philippines and hence cannot be sold or offered for sale or distribution in the Philippines. Each Manager has represented, warranted and agreed that it has not and will not sell or offer for sale or distribution any notes in the Philippines except in an exempt transaction as defined in the Philippine Securities Regulation Code.
The offering of the notes has not been registered pursuant to Italian securities legislation and, accordingly, each Manager has acknowledged that no notes may be offered, sold or delivered, nor may copies of this prospectus or of any other document relating to the notes be distributed in the Republic of Italy (Italy), except:
Moreover, and subject to the foregoing, each of the Managers has represented and agreed that any offer, transfer or sale of the notes or distribution of copies of this prospectus or any other document relating to the notes in Italy under (a) or (b) above must, and will, be made in accordance with all Italian securities, tax, exchange control and other applicable laws and regulations, and in particular will be:
Any investor purchasing the notes in the offering is solely responsible for ensuring that any offer or resale of the notes it purchases in the offering of the notes occurs in compliance with applicable Italian laws and regulations.
The following is a general description of certain tax laws relating to the notes. It does not purport to be a complete analysis of all tax considerations relating to the notes, whether in those countries referred to or elsewhere. However, prospective investors should consult their own advisers regarding the tax consequences of an investment in the notes.
The following is a summary of certain material Dutch tax consequences of purchasing, owning and disposing of the notes. It does not purport to be a complete analysis of all possible tax situations that may be relevant to a decision to purchase, own or dispose of the notes. In particular, this discussion does not consider any specific facts or circumstances that may apply to a particular purchaser. This summary does not allow any conclusions to be drawn with respect to issues not specifically addressed. This summary is based on the laws of The Netherlands currently in force and as applied on the date of this prospectus, which are subject to change, possibly with retroactive of retrospective effect.
It is assumed that the notes and income received or capital gains derived therefrom, are not attributable to employment activities of the holder of the notes and that a holder of notes will not hold directly or indirectly a substantial interest (aanmerkelijk belang) in the Issuer.
All payments made by the Issuer under the notes may be made free of withholding or deduction of, for or on account of any taxes of whatever nature imposed, levied, withheld or assessed by The Netherlands or any political subdivision or taxing authority thereof or therein.
A holder of notes who is an individual will not be subject to any Dutch taxes on income or capital gains in respect of any benefit derived or deemed to be derived from notes, including any payment under notes and any gain realised on the disposal of notes, except if:
Furthermore, a holder of notes who is an individual and who does not come under exception (a) nor under exception (b) above will not be subject to Dutch taxes on income or on capital gains in respect of any payment under the notes or any gain realised on the disposal or deemed disposal of the notes, provided that such holder does not carry out any activities in The Netherlands with respect to the notes that exceed ordinary active asset management (normaal vermogensbeheer) and such holder of notes does not derive, or is deemed to derive, benefits from the notes that are (otherwise) taxable as benefits from other activities in The Netherlands (resultaat uit overige werkzaamheden).
A holder of notes other than an individual will not be subject to any Dutch taxes on income or capital gains in respect of any benefit derived or deemed to be derived from notes, including any payment under notes and any gain realised on the disposal of notes, except if:
A holder of notes will not become subject to Dutch taxation on income or capital gains by reason only of the issue of the notes or the performance by the Issuer of its obligations thereunder.
Gift and inheritance tax will arise in The Netherlands with respect to a transfer of the notes by way of a gift by, or on the death of, a holder of notes who is resident or deemed to be resident in The Netherlands at the time of the gift or his/her death.
For purposes of Dutch gift and inheritance taxes, amongst others, a person that holds the Netherlands nationality will be deemed to be resident in The Netherlands if such person has been resident in The Netherlands at any time during the 10 years preceding the date of the gift or the death of this person. Additionally, for purposes of Dutch gift tax, a person not holding the Dutch nationality will be deemed to be resident in The Netherlands if such person has been resident in The Netherlands at any time during the 12 months preceding the date of the gift. Applicable tax treaties may override deemed residency.
No Dutch gift or inheritance taxes will arise on the transfer of the notes by way of a gift by, or on the death of, a holder of notes who is neither resident nor deemed to be resident in The Netherlands, unless in the case of a gift of the notes by an individual who at the date of the gift was neither resident nor deemed to be resident in The Netherlands, such individual dies within 180 days after the date of the gift, while being resident or deemed to be resident in The Netherlands.
There is no Dutch registration tax, transfer tax, capital tax, stamp duty or any other similar tax or duty, other than court fees and contributions for the registration with the Trade Register of the Chamber of Commerce, payable in The Netherlands in respect of or in connection with the execution, delivery and enforcement by legal proceedings (including any foreign judgment in the courts of The Netherlands) of the notes or the performance of the Issuer's obligations under the notes.
There is no Dutch value added tax payable in respect of payments in consideration for the issue of the notes or in respect of the payment of interest or principal under the notes or the transfer of the notes, other than the value added tax which may be due with respect to advisory fees incurred in relation to such payments.
The following is a summary of certain Russian tax considerations relevant to the purchase, ownership and disposal of the notes, as well as taxation of payments under the guarantee. The summary is based on the laws of Russia in effect on the date of this prospectus and is subject to any change in law that may take effect after such date. The information and analysis contained in this section are limited to taxation issues and prospective investors should not apply any information or analysis set out below to other areas, including (but not limited to) the legality of transactions involving the notes. This summary does not seek to address the applicability of, and procedures in relation to, taxes levied by the regions, municipalities or other non-federal authorities of the Russian Federation. Nor does this summary seek to address the availability of double tax treaty relief in respect of the notes, or practical difficulties involved in claiming and obtaining such double tax treaty relief.
Prospective investors should consult their own advisers in relation to the tax consequences of investing in the notes in their particular circumstances. No representations with respect to the Russian tax consequences pertinent to any particular noteholder are made herein.
The provisions of the Russian Tax Code applicable to Noteholders and transactions with the notes are uncertain and lack interpretive guidance. Both the substantive provisions of the Russian Tax Code applicable to securities and financial instruments and the interpretation and application of those provisions by the Russian tax authorities may be subject to more rapid and unpredictable change and inconsistency as compared to jurisdictions with more developed capital markets and tax systems.
In practice, interpretation by different tax inspectorates in Russia may be inconsistent or contradictory, and may result in the imposition of conditions, requirements or restrictions not stated by the law. Similarly, in the absence of binding precedent, court rulings on tax or other related matters by different courts relating to the same or similar circumstances may also be inconsistent or contradictory.
For the purposes of this summary, a "Non-resident Noteholder" means:
A "Resident Noteholder" means any noteholder (including any individual and any legal entity or organisation) who does not qualify as a Non-resident Noteholder.
For the purposes of this summary, the definitions of "Resident Noteholder" and "Non-resident Noteholder" in respect of individuals are taken at face value based on the wording of the tax law as currently written. In practice however the application of the above formal residency definition may differ based on the position of the tax authorities. The law is currently worded in a way that implies the potential for a split year residency for individuals. However, both the Ministry of Finance of the Russian Federation and the tax authorities have expressed the view that an individual should be either resident or non-resident in Russia for the full year and consequently even where the travel pattern dictates differing residency status for a part of the tax year, the application of the residency tax rate may in practice be disallowed. This situation may be altered by amendments to articles of the Tax Code dealing with taxation of individuals, a change in the position of the authorities or by outcomes of tax controversy through the courts.
A Non-resident Noteholder that is a legal entity or organisation should not be subject to any Russian taxes in respect of payments of interest and repayment of principal received from the Issuer in respect of the notes.
A Non-resident Noteholder that is a legal entity or organisation also generally should not be subject to any Russian taxes in respect of gains or other income realised on redemption, sale or other disposal of the notes outside of Russia, provided that the proceeds of such sale, redemption, or disposal are not received from a source within Russia.
In the event that proceeds from sale, redemption or disposal of the notes are received from Russian sources, a Non-resident Noteholder that is a legal entity or organisation should not be subject to Russian withholding tax in respect of such proceeds, although there is some residual uncertainty regarding the treatment of the portion of proceeds, if any, that is attributable to accrued interest on the notes. Proceeds attributable to accrued interest, if received from a source within Russia may be subject to Russian withholding tax at 20%, or such other rate as may be in force at the time of payment, even in a situation of a capital loss on the disposal of notes. Withholding tax relating to interest may potentially be reduced or eliminated under the terms of an applicable double tax treaty depending on the tax residence of the Non-resident Noteholder.
Non-resident Noteholders that are legal entities or organisations should consult their own tax advisors with respect to taxation of the notes in Russia or elsewhere.
Acquisition of the notes by Non-resident Noteholders that are individuals may constitute a taxable event pursuant to the provisions of the Russian Tax Code concerning material benefit (deemed income) received as a result of the acquisition of securities. If the notes are acquired for a price that is below the "market price" decreased by the amount of the maximum permissible fluctuation rate, the difference may be subject to Russian tax. Although the Tax Code does not contain any provisions in relation to how the material benefit should be attributed to Russian or non-Russian sources, it may be inferred that such income should be considered as Russian source income if the notes are purchased "in Russia". In the absence of any additional guidance as to what should be considered as a purchase "in Russia", the Russian tax authorities may use various criteria to determine the source of any such material benefit, including looking at the place of performance, the location of the Issuer, or other similar criteria. Legislation stipulates a specific procedure for the calculation of the market price of securities and its maximum permissible fluctuation rate for tax purposes. In addition, it is expected that starting from January 1, 2011 a new piece of legislation will enter into force, potentially altering the method of determination of the market price of securities and the maximum permissible fluctuation rate.
A Non-resident Noteholder that is individual should not be subject to any Russian taxes in respect of payments of interest and repayment of principal received from the Issuer in respect of the notes.
A Non-resident Noteholder that is individual should not be subject to any Russian taxes in respect of gains or other income realised on a redemption, sale or other disposal of the notes outside of Russia, provided that the proceeds of such sale, redemption, or disposal are not received from a source within Russia.
Russian tax law gives no clear indication as to how the income from operations with securities conducted by individuals should be sourced, other than that income from the sale of securities "in Russia" should be considered as Russian-source income. As there is no further definition of what should be considered as a sale "in Russia", the Russian tax authorities have a certain amount of freedom to conclude what transactions take place in or outside Russia, including looking at the place of the transaction, the place of the issuer of the notes, or other similar criteria.
If the proceeds from a disposal of the notes by a Non-resident Noteholder that is individual are classified as income from a source within Russia for personal income tax purposes the corresponding income will be subject to Russian personal income tax at a rate of 30 per cent on the gross proceeds received less any available cost deduction (including the original purchase price of the notes), unless such tax is reduced or eliminated under an applicable double tax treaty. There is a risk that, if the documentation supporting the cost deductions is deemed insufficient by the tax authorities, the deduction will be disallowed. There is uncertainty regarding the treatment of the portion of the proceeds, if any, from a disposal of the notes that is attributable to interest income on the notes. Proceeds attributable to interest income, if received from a Russian source by a Non-resident Noteholder that is an individual, may be subject to withholding tax at a rate of 30%, or such other rate as may be in force at the time of payment, even if the disposal results in a capital loss. If the disposal proceeds are paid by a licensed Russian broker, asset manager, management company, which performs asset management of a unit investment fund property, or another person acting in a similar capacity, the payer may be required to withhold the tax at source. The amount of tax withheld would be calculated after taking into account documented deductions for the purchase value and related expenses to the extent such deductions and expenses can be determined by the entity making the payment of income. When a sale is made to other companies or individuals, generally no
withholding of tax needs to be made. The Non-resident Noteholder that is individual would be liable to file a tax return, report his or her income realised and apply for a deduction of acquisition expenses, based on the provision of supporting documentation. The applicable tax would then have to be paid by the individual on the basis of the tax return.
Under certain circumstances gains received and losses incurred by a Non-resident Noteholder that is individual as a result of disposal of the notes and other securities occurring within the same year may be aggregated which would affect the tax on income realised from the disposal of the notes.
There is also a risk that any gain derived from a disposal of the notes may be affected by changes in the exchange rate between the currency of acquisition of the notes, the currency of disposal of the notes and rubles.
Non-resident Noteholders that are individuals should consult their own tax advisors with respect to the taxation of the notes in Russia.
Where proceeds from the disposal of the notes are received from a Russian source, withholding tax on interest or on capital gains (if applicable under Russian domestic tax law) may be reduced or eliminated in accordance with the provisions of an applicable double tax treaty. Advance treaty relief should be available for the eligible Nonresident Noteholders, subject to the requirements of the laws of the Russian Federation. In order for the Nonresident Noteholder, whether an individual, legal entity or organisation, to enjoy the benefits of an applicable double tax treaty, the Noteholder must comply with the certification, information, and reporting requirements in force in Russia. Currently, a Non-resident Noteholder which is a legal entity or an organisation would need to provide the payer of income with a certificate of tax residence issued by the competent tax authority of the relevant treaty country; however, the payer of income in practice may request additional documents confirming the eligibility of the Non-resident Noteholder that is a legal entity for the benefit of the double tax treaty. This certificate should generally be apostilled or legalised by a relevant competent authority. A notarised Russian translation of the certificate would be required. The tax residency confirmation needs to be renewed on an annual basis, and provided to the payer of income before the first payment of income in each calendar year. A Nonresident Noteholder who is an individual must provide to the tax authorities, together with the tax residency certificate issued by the competent authority of his or her country of residence for tax purposes, a confirmation from the foreign tax authorities of income received and the tax paid outside Russia in relation to income with
respect to which treaty benefits are claimed. Technically, such requirements may mean that a Non-resident Noteholder who is an individual cannot rely on the double tax treaty until he or she pays the tax in the jurisdiction of his or her tax residency. Because of uncertainties regarding the form and procedures for providing such documentary proof, individuals in practice may not be able to obtain treaty benefits on receipt of proceeds from a source within Russia and obtaining a refund can be extremely difficult. In addition, the fact that the Noteholders would not be the immediate recipients of payments under the guarantee would further complicate the application of tax treaty benefits/refund in practice. Non-resident Noteholders should consult their own tax advisors regarding possible tax treaty relief and procedures for obtaining such relief with respect to any Russian taxes imposed in respect of proceeds received on a disposal of notes.
For a Non-resident Noteholder that is a legal entity or organisation, for which double taxation treaty relief is available, if the Russian withholding tax on income was withheld at source, a claim for a refund of such tax can be filed within three years from the end of the tax period during which the tax was withheld.
For a Non-resident Noteholder that is an individual, for whom double taxation treaty relief is available, if Russian tax on income was withheld at source, a claim for refund of such tax can be filed within one year after the end of the year in which the tax was withheld.
Russian tax authorities may, in practice, require a wide range of documentation confirming a Noteholder's right to obtain relief under a double taxation treaty. Such documentation may not be explicitly required by the Russian Tax Code. Obtaining a refund of the Russian tax withheld at source may be a time-consuming process, and no assurance can be given that such a refund will be granted in practice.
A Resident Noteholder will be subject to all applicable Russian taxes in respect of gains from disposal of the notes and interest received on the notes.
Resident Noteholders should consult their own tax advisers with respect to the effect that acquisition, holding and disposal of the notes may have on their tax position.
In general, payments under a guarantee by a Russian entity to a Non-resident Noteholder that is a legal entity or organisation should not be subject to Russian withholding tax to the extent such payments do not represent Russian source income. Payments under the guarantee related to interest on the notes are likely to be characterised as Russian source income. Accordingly such payments should be subject to withholding tax in Russia at a rate of 20%, or such other rate as may be in force at the time of payment, in the event that a payment under the guarantee is made to a Non-resident Noteholder that is a legal entity or organisation, in each case not organised under Russian laws and which holds and disposes of the notes otherwise than through a permanent establishment in Russia. There is some residual uncertainty regarding the treatment of the payment under the guarantee related to the principal amounts due under the notes. There is a potential risk, albeit small, that such payments may be charactarised as Russian source income taxed at a rate of 20%, or such other rate as may be in force at the time of payment. Russian withholding tax may be reduced or eliminated under the terms of the applicable double tax treaty. However, there can be no assurance that such relief will be available. The treaty relief and refund procedures should generally be similar to the tax relief and refund procedures described above with respect to proceeds from disposal of the notes.
Payments under the guarantee to a Non-resident Noteholder that is an individual performed by the guarantor may be subject to Russian tax as Russian-source income. In this case, depending on how these payments would be effected, either the full amount of payments, or a part of such payments covering the interest on the notes, would be subject to tax at a rate of 30%, or such other rate as may be in force at the time of payment, which may be withheld at the source or payable on a self-assessed basis. This tax may be subject to relief under the terms of an applicable double tax treaty. However, because of uncertainties regarding the form and procedures for providing such documentary proof, Non-resident Noteholder that is an individual in practice would be unlikely to be able to obtain advance treaty relief, while obtaining a refund of the taxes withheld can be extremely difficult, if not impossible. The treaty relief and refund procedures should generally be similar to the tax relief and refund procedures described above with respect to proceeds from disposal of the notes.
When payments under the guarantee that relate to interest and principal on the notes are paid to the Trustee pursuant to the Trust Deed, it is not expected that the Trustee would be able to benefit from a double tax treaty
between Russia and the country of residence of the Trustee. In such cases, there can be no assurance that Nonresident Noteholders will be able to obtain reduction of or relief from withholding tax under double taxation treaties entered into between their countries of residence and Russia, where such treaties exist and to the extent they are applicable.
If payments under the guarantee become subject to the Russian withholding tax (as a result of which the guarantor would have to reduce payments made under the notes by the amount of tax withheld), LUKOIL will be obliged (subject to certain conditions) to increase payments under the guarantee as may be necessary so that the net payments received by the Non-resident Noteholders will be equal to the amounts they would have received in the absence of such withholding.
It is currently unclear whether the provisions obliging LUKOIL to gross up interest payments under the guarantee will be enforceable under the Russian law. There is a risk that gross up for withholding tax will not take place and that the payments made by LUKOIL under the guarantee will be reduced by the amount of the Russian income tax withheld by LUKOIL at the rate of 20%, or such other rate as may be in force at the time of payment.
Payments under the guarantee should not be subject to Russian VAT.
The tax discussion contained in this document is not given in the form of a covered opinion within the meaning of Circular 230 issued by the U.S. Secretary of the Treasury. Thus, we are required to inform you that you cannot rely upon any advice contained in this document for the purpose of avoiding U.S. federal tax penalties. The tax discussion contained in this document was written to support the promotion or marketing of the transactions or matters described in this document. Each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.
The following is a summary of the material U.S. federal income tax consequences of the acquisition, ownership and disposition of the notes by U.S. Holders (as defined below), but does not purport to be a complete analysis of all the potential tax considerations. This summary is based upon the Internal Revenue Code of 1986, as amended (the Code), the Treasury Regulations promulgated or proposed thereunder (the Regulations) and administrative and judicial interpretations thereof, all as of the date hereof and all of which are subject to change at any time, possibly on a retroactive basis. No assurance can be given that the treatment of the notes described herein will be respected by the Internal Revenue Service (the IRS) or, if challenged, by a court. This summary is limited to the tax consequences to those persons who are initial purchasers of the notes and who hold the notes as capital assets within the meaning of Section 1221 of the Code. This summary does not purport to deal with all aspects of U.S. federal income taxation that might be relevant to particular U.S. Holders in light of their particular investment circumstances or status, nor does it address specific tax consequences that may be relevant to particular persons (including, for example, financial institutions, broker-dealers, insurance companies, partnerships or other passthrough entities, expatriates, banks, real estate investment trusts, regulated investment companies, tax-exempt organisations, U.S. Holders that have a functional currency other than the U.S. dollar or persons in special situations, such as those who have elected to mark securities to market or those who hold the notes as part of a straddle, hedge, conversion transaction or other integrated investment). In addition, this summary does not address tax considerations applicable to U.S. Holders that own (directly or by attribution) 10% or more of the voting stock of LUKOIL. This summary does not address U.S. federal alternative minimum, estate and gift tax consequences or consequences under the tax laws of any state, local or foreign jurisdiction. We have not sought any ruling from the IRS with respect to the statements made and the conclusions reached in this summary, and we cannot assure you that the IRS will agree with such statements and conclusions.
This summary is for general information only. U.S. Holders are urged to consult their tax advisors concerning the U.S. federal income taxation and other tax consequences to them of acquiring, owning and disposing of the notes, as well as the application of state, local and foreign income and other tax laws.
For purposes of this summary, a "U.S. Holder" means a beneficial owner of a note that is for U.S. federal income tax purposes: (1) an individual who is a citizen or resident of the United States, (2) a corporation created or organised under the laws of the United States, any state thereof, or the District of Columbia, (3) an estate the income of which is subject to U.S. federal income tax regardless of its source, or (4) a trust if (a) a court within the United States is able to exercise primary supervision over the administration of the trust, and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (b) a valid election to be treated as a U.S. person is in effect with respect to such trust.
For purposes of this summary, an entity treated as a partnership for U.S. federal tax purposes will not be treated as a U.S. Holder. A partnership for U.S. federal income tax purposes is not subject to U.S. federal income tax on income derived from holding a note. The U.S. taxation of a partner in a partnership will depend on the nature of the partnership's activities. If you are a partner in a partnership which holds the notes, you should consult your tax advisor about the U.S. tax consequences of acquiring, owning and disposing of the notes.
There are no regulations, published rulings or judicial decisions addressing the characterisation for U.S. federal income tax purposes of securities issued under the same circumstances and with substantially the same terms as the notes. The company believes and intends to take the position that the notes constitute debt for U.S. federal income tax purposes. However, no ruling will be obtained from the IRS with respect to the characterisation of the notes as debt, and there can be no assurance that the IRS or the courts would agree with this characterisation of the notes. If, due to the capital structure of the company or otherwise, the notes were treated as equity interests in the company, U.S. Holders likely would be treated as owning interests in a "passive foreign investment company" (a PFIC). Prospective investors should consult their tax advisers regarding the characterisation of the notes and the consequences of owning an equity interest in a PFIC. The discussion below assumes that the notes will be treated as debt for U.S. federal income tax purposes.
Payments of interest on a note will be taxable to a U.S. Holder as ordinary income at the time it is received or accrued in accordance with such U.S. Holder's regular method of accounting for U.S. federal tax purposes. Payments of interest on the notes will constitute income from sources outside the United States and generally will be treated as "passive income" for foreign tax credit limitation purposes.
As discussed in "Taxation – The Russian Federation", under current law payments made by LUKOIL under the guarantee to holders of the notes who are not Russian residents may be subject to Russian withholding taxes. In this circumstance, LUKOIL may become liable for the payment of additional amounts to U.S. Holders (see "Terms and Conditions of the Notes – Taxation") so that U.S. Holders receive the same amounts they would have received had no Russian withholding taxes been imposed. For U.S. federal income tax purposes, U.S. Holders would be treated as having received the amount of Russian taxes withheld by the Issuer with respect to a note, and as then having paid over the withheld taxes to the Russian taxing authorities. As a result of this rule, the amount of interest income included in gross income for U.S. federal income tax purposes by a U.S. Holder with respect to a payment of interest may be greater than the amount of cash actually received (or receivable) by the U.S. Holder from the Issuer with respect to the payment.
Subject to certain limitations, a U.S. Holder generally will be entitled to a credit against its U.S. federal income tax liability, or a deduction in computing its U.S. federal taxable income, for Russian income taxes withheld and paid by the company. For purposes of the foreign tax credit limitation, foreign source income is classified in one of two "baskets", and the credit for foreign taxes on income in either basket is limited to U.S. federal income tax allocable to income in such basket. Interest on the notes generally will constitute foreign source income in the passive basket. A. U.S. Holder will not be entitled to a credit against its U.S. federal income tax liability for Russian taxes withheld in excess of the applicable tax rate under the United States-Russia Tax Treaty if such amounts are treated as recoverable by the U.S. Holder for U.S. federal income tax purposes, regardless of whether the U.S. Holder successfully claims a refund for such taxes. In addition, in certain circumstances, a U.S. Holder may be unable to claim foreign tax credits (and may instead be allowed only deductions) for foreign taxes imposed on interest if the notes are held under arrangements in which the U.S. Holder's expected profit is insubstantial. Prospective purchasers should consult their tax advisers concerning the foreign tax credit implications of the payment of these Russian taxes.
If a U.S. Holder purchases a note for an amount greater than its principal amount, the U.S. Holder generally may elect to amortise this premium over the term of the note. If a U.S. Holder makes this election, the amount of interest income in each payment period will be reduced by the amount of premium allocated to that period. The U.S. Holder's basis will also be reduced by the amortised amount. Generally, an election to amortise premium for one note requires a U.S. Holder to amortise premium for all debt instruments it acquired or acquires at a premium. U.S. Holders should consult their own advisors about whether the election would be advisable in their particular circumstances and about how to calculate the amount of premium allocated to each payment period.
A U.S. Holder generally will recognise gain or loss on the sale, exchange or retirement of a note equal to the difference between the amount realised on the sale or retirement (excluding any amount attributable to accrued by unpaid interest, which will be treated as a payment of interest as described above) and the U.S. Holder's tax basis in the note, decreased (but not below zero) by any amortized premium (as described above). A U.S. Holder's tax basis in a note generally will be the cost of the note to such holder. Any gain or loss recognised by a U.S. Holder on the sale, exchange or retirement of a note will be capital gain or loss and will be long-term capital gain or loss if the note was held by the U.S. Holder for more than one year. Long-term capital gains recognised by non-corporate are eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations. Gain or loss realised by a U.S. Holder on the sale, exchange or retirement of a note generally will be U.S. source gain or loss.
Payments of principal and interest on, and the proceeds of the sale or other disposition of notes by, a U.S. paying agent or other U.S. connected intermediary will be reported to the IRS along with certain information, including the beneficial owner's name, address and taxpayer identification number, the aggregate amount of interest or other amounts paid to that beneficial owner during the calendar year and the amount of tax withheld, if any. This obligation, however, does not apply with respect to payments to certain U.S. Holders, including tax-exempt organisations, provided that they establish entitlement to an exemption.
In the event that a U.S. Holder subject to the reporting requirements described above fails to supply its correct taxpayer identification number in the manner required by applicable law, or underreports its tax liability, backup withholding may apply to each payment of interest and principal on the notes and on proceeds from a sale or other disposition of the notes. Backup withholding is not an additional tax and may be refunded or credited against the U.S. Holder's U.S. federal income tax liability, provided that the required information is furnished to the IRS.
U.S. Holders should consult their own tax advisors regarding their qualifications for an exemption from backup withholding and the procedure for obtaining such exemption, if applicable.
Subject to specified exceptions and future guidance, recently enacted U.S. tax legislation generally requires a U.S. Holder that is an individual (or, to the extent provided in future guidance, a domestic entity) to report to the IRS certain interests of such U.S. Holder in stock or securities issued by a non- U.S. person (such as the Issuer) for taxable years beginning after 18 March 2010. This reporting requirement should not apply to an interest held through a U.S financial institution. Failure to report information required under this legislation could result in substantial penalties. U.S. Holders are urged to consult their own tax advisors regarding the information reporting obligations that may arise from their ownership of the Issuer's notes.
Under EC Council Directive 2003/48/EC on the taxation of savings income, each Member State is required to provide to the tax authorities of another Member State details of payments of interest or other similar income paid by a person within its jurisdiction to, or collected by such a person for, an individual resident or certain limited types of entity established in that other Member State; however, for a transitional period, Austria and Luxembourg may instead apply a withholding system in relation to such payments, deducting tax at rates rising over time to 35%. This transitional provision formerly applied also to Belgium, but on 1 January 2010 Belgium ceased to apply the transitional regime. The transitional period is to terminate at the end of the first full fiscal year following agreement by certain non-EU countries to the exchange of information relating to such payments.
A number of non-EU countries, and certain dependent or associated territories of certain Member States, have adopted similar measures (either provision of information or transitional withholding) in relation to payments made by a person within its jurisdiction to, or collected by such a person for, an individual resident or certain limited types of entity established in a Member State. In addition, the Member States have entered into provision of information or transitional withholding arrangements with certain of those dependent or associated territories in relation to payments made by a person in a Member State to, or collected by such a person for, an individual resident or certain limited types of entity established in one of those territories.
On 13 November 2008 the European Commission published a proposal for amendments to the Directive, which included a number of suggested changes which, if implemented, would broaden the scope of the requirements described above. Discussion of the proposed amendments is ongoing within the European Council. Investors who are in any doubt as to their position should consult their professional advisers.
The tax discussion contained in this document is not given in the form of a covered opinion within the meaning of Circular 230 issued by the U.S. Secretary of the Treasury. Thus, we are required to inform you that you cannot rely upon any advice contained in this document for the purpose of avoiding U.S. federal tax penalties. The tax discussion contained in this document was written to support the promotion or marketing of the transactions or matters described in this document. Each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.
The U.S. Employee Retirement Income Security Act of 1974, as amended (ERISA), imposes certain requirements on "employee benefit plans" (as defined in Section 3(3) of ERISA) subject to Title I of ERISA, including entities such as collective investment funds and separate accounts whose underlying assets include the assets of such plans (collectively, ERISA Plans) and on those persons who are fiduciaries with respect to ERISA Plans. Investments by ERISA Plans are subject to ERISA's general fiduciary requirements, including the requirement of investment prudence and diversification and the requirement that an ERISA Plan's investments be made in accordance with the documents governing the ERISA Plan.
Section 406 of ERISA and Section 4975 of the U.S. Internal Revenue Code of 1986, as amended (the Code) prohibit certain transactions involving the assets of an ERISA Plan (as well as those plans that are not subject to ERISA but which are subject to Section 4975 of the Code, such as individual retirement accounts (together with ERISA Plans, Plans)) and certain persons (referred to as parties in interest or disqualified persons) having certain relationships to such Plans, unless a statutory or administrative exception or exemption is applicable to the transaction.
Governmental plans and certain church and various other plans, while not subject to the fiduciary responsibility provisions of ERISA or the provisions of Section 4975 of the Code, may nevertheless be subject to state or other federal or foreign laws that are substantially similar to ERISA and the Code ("Similar Law"). Fiduciaries of any such plans should consult with their counsel before purchasing any notes.
Prohibited transactions within the meaning of Section 406 of ERISA or Section 4975 of the Code may arise if any notes are acquired by a Plan with respect to which the Managers or any of their affiliates are a party in interest or a disqualified person. Certain exemptions from the prohibited transaction provisions of Section 406 of ERISA and Section 4975 of the Code may be applicable, however, depending in part on the type of Plan fiduciary making the decision to acquire notes and the circumstances under which such decision is made. There can be no assurance that any exemption will be available with respect to any particular transaction involving the notes, or that, if an exemption is available, it will cover all aspects of any particular transaction. Accordingly, by its purchase and holding of any notes (or any interest therein), each purchaser thereof and each transferee will be deemed to have represented and agreed either that: (i) it is not and for so long as it holds notes (or any interest therein) will not be (and is not acquiring the notes directly or indirectly with the assets of a person who is or while the notes are held will be) an ERISA Plan or other Plan, an entity whose underlying assets include, or are deemed to include, "plan assets" by reason of such ERISA Plan's or other Plan's investment in the entity, or any employee benefit plan which is subject to any Similar Law, or (ii) its purchase and holding of the notes will not constitute or result in a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Code (or, in the case of another employee benefit plan subject to Similar Law, a violation of any Similar Law.
The foregoing discussion is general in nature and not intended to be all inclusive. Any Plan fiduciary who proposes to cause a Plan to purchase any notes should consult with its counsel regarding the applicability of the fiduciary responsibility and prohibited transaction provisions of ERISA and Section 4975 of the Code to such an investment, and to confirm that such investment will not constitute or result in a prohibited transaction or any other violation of an applicable requirement of ERISA.
The sale of notes to a Plan is in no respect a representation by the Managers that such an investment meets all relevant requirements with respect to investments by Plans generally or any particular Plan, or that such an investment is appropriate for Plans generally or any particular Plan.
| ISIN | Common Code | |
|---|---|---|
| Regulation S Global Note | XS0554659671 | 055465967 |
The address of Euroclear is 1 Boulevard du Roi Albert II, B-1210 Brussels, Belgium and the address of Clearstream, Luxembourg is 42 Avenue JF Kennedy L-1855, Luxembourg.
| ISIN | CUSIP | |
|---|---|---|
| Rule 144A Global Note | US549876AE01 | 549876 AE0 |
The address of DTC is 55 Water Street, New York, New York 10041-0099, United States of America.
(iii) the reserves reports prepared by Miller and Lents referred to in this prospectus;
(iv) the audited annual consolidated accounts of the Group prepared in accordance with U.S. GAAP for the years ended 31 December 2007, 2008 and 2009;
The following information relating to the regulation of the oil industry in the Russian Federation is for background purposes only. This information has been extracted from publicly available sources. LUKOIL has not independently verified the following information. Although LUKOIL accepts responsibility for extracting and reproducing such information accurately, none of LUKOIL or any of the Joint Lead Managers accepts responsibility for the accuracy of such information.
Set forth below are certain key provisions of the Russian legislation relating to the oil industry applicable to the Group. This description is not comprehensive and is qualified in its entirety by reference to applicable Russian law.
The regulation of the oil industry in the Russian Federation is primarily based on the following laws:
At the federal level, regulatory authority over the oil industry is divided primarily between the Ministry of Energy of the Russian Federation, which replaced the Ministry of Industry and Energy of the Russian Federation pursuant to Presidential Decree No. 724 dated 12 May 2008 (Decree No. 724), and the Ministry of Natural Resources and Ecology of the Russian Federation, which replaced the Ministry of Natural Resources of the Russian Federation pursuant to Decree No. 724. The Ministry of Energy of the Russian Federation sets governmental policy for the industry, drafts legislation regulating the energy sector and has the enforcement authority and the functions of providing state services and property management.
The Ministry of Natural Resources and Ecology of the Russian Federation is involved in the licensing of subsoil resources and also regulates exploration and geological prospecting for the oil and gas industries. On the basis of Presidential Decree No. 314 dated 9 March 2004 (Decree No. 314), the control and surveillance functions related to use of natural resources and ecology are fulfilled by the Federal Service for the Supervision of the Use of Natural Resources of the Russian Federation, and the law enforcement functions related to subsoil use are fulfilled by the Federal Agency for Subsoil Use of the Russian Federation. Prior to enactment of Decree No. 314, the functions of these two federal authorities were performed by the Ministry of Natural Resources of the Russian Federation. The Federal Service for the Supervision of the Use of Natural Resources of the Russian Federation and the Federal Agency for Subsoil Use of the Russian Federation are subordinate to the Ministry of Natural Resources and Ecology of the Russian Federation.
Among other things, the Federal Agency for Subsoil Use of the Russian Federation is responsible for organising tenders and auctions for the award of subsoil licences, issuing and terminating subsoil licences and supervising the compliance by licence holders with the terms of such licences.
The Federal Service for Environmental, Technological and Nuclear Surveillance of the Russian Federation is a federal authority which is also subordinate to the Ministry of Natural Resources and Ecology of the Russian Federation and which, among other things, issues or authorises other organisations to issue industrial safety certificates.
The FTS, which replaced the Federal Energy Commission following Decree No. 314, and the Ministry of Energy of the Russian Federation coordinate activities of various federal executive agencies to address issues in the oil industry, including, among others, issues related to access to Transneft's pipeline and tariffs for services rendered by Transneft.
Generally, regional authorities with jurisdiction over the specific area in which an oil and gas project, pipeline, refinery or other enterprise is located have substantial authority. Regional and local authorities usually control regional and local (respectively) land-use allocations.
Under the Regulation on Licensing of Subsoil Use No. 3314-1 dated 15 July 1992, as amended (the Regulation), and the Subsoil Law, subsoil plots are provided for the purposes of production of mineral resources for the term of operation of the field, calculated on the basis of a feasibility study for the development of natural resource deposits providing for the rational use and protection of the subsoil. Since December 2007, geological exploration licences may have a maximum term of five years, except for licences for geological exploration of subsoil resources of internal sea waters, territorial seas and the continental shelf of the Russian Federation, which may have a maximum term of up to 10 years.
A licence holder has the right to develop and sell oil extracted from the area indicated in the licence. The Russian Federation, however, retains ownership of all subsoil resources at all times, and the licence holder only has rights to the crude oil or other relevant types of mineral resources when extracted.
Generally, a licence cannot be held by more than one legal entity. A subsoil exploration and production licence gives its holder exclusive subsoil use rights with respect to an identified licence area (including subsurface zones) for the term of the licence.
Most of the currently existing subsoil licences owned by companies derive from (i) pre-existing rights granted during the Soviet era and up to the enactment of the Subsoil Law to state-owned enterprises that were subsequently reorganised in the course of post-Soviet privatisations, or (ii) tender or auction procedures held in the post-Soviet period.
At present, subsoil licences are generally issued by the Federal Agency for Subsoil Use of the Russian Federation. The Civil Code, the Subsoil Law and the Regulation contain the major requirements relating to tenders and auctions for granting subsoil licences. The Subsoil Law allows for exploration and production licences to be issued without a tender or auction procedure only in a limited number of circumstances, such as when a mineral deposit is discovered by the licence holder who performed geological exploration of the discovered mineral deposit at its own expense.
In May 2008, the Subsoil Law was amended to provide criteria for determining subsoil plots of federal importance and define grounds for establishment and termination of rights to use subsoil plots of federal importance. The law provides that subsoil plots of federal importance must be awarded primarily through auctions or tenders. In an auction, the most important criterion for determining the winner is the bid price for the licence. In a tender, however, factors such as the scientific and technical levels of proposed exploration and production programmes, extraction rates, contributions to the social and economic progress of a territory, timing
of implementation of the programmes, environmental efficiency and safety and national security considerations are taken into account first.
The subsoil in the subsoil areas of federal importance in the continental shelf of the Russian Federation, and in the subsoil areas of federal importance located in the territory of the Russian Federation and partially located in its continental shelf, may be used by legal entities, which are organised under the laws of the Russian Federation, have at least five years experience in the development of subsoil areas located in the continental shelf of the Russian Federation and in which the Russian Federation holds an equity or voting interest of more than 50%.
Licences cannot be sold or transferred to another entity except in certain limited circumstance specified by the Subsoil Law, such as to an affiliated company in the event of the reorganisation of a company, to a licensee's subsidiary if the licensee holds a 50% or greater interest in the subsidiary, to a licensee's parent company or to a company that was newly formed for the purpose of holding a transferred licence, together with the transfer of the property necessary to operate the licence.
The Subsoil Law prohibits the transfer of a subsoil area of federal importance to any entity in which a foreign investor has the ability to (i) directly or indirectly control 10% or more of its voting shares, (ii) control its management by contract or otherwise, or (iii) appoint its chief executive officer or more than 10% of its executive officers or members of its board of directors or other management committee. Such transfer is only permitted in limited circumstances pursuant to a decision of the Russian Government.
A licence granted under the Subsoil Law is generally accompanied by a licensing agreement. There are typically three parties to any subsoil licensing agreement: the regional authority of the region where the licence area is located, the federal authorities and the licensee. The licensing agreement sets out the terms and conditions for the use of the subsoil licence.
Under a licensing agreement, the licensee makes certain environmental, safety and production commitments. For example, the licensee makes a production commitment to bring the field into production by a certain date and to extract an agreed upon volume of natural resources each year. The licence agreement may also contain commitments with respect to the region's social and economic development.
Governmental authorities may undertake periodic reviews for ensuring compliance by subsoil licence users with the terms of their licences and applicable legislation.
The license may be terminated, suspended or limited by the licensing authorities upon notice in the following events:
The licensee is also fined in case of a material breach of the license terms. Government authorities, such as the Federal Service for the Supervision of the Use of Natural Resources and the Federal Service for Environmental, Technological and Nuclear Supervision, undertake periodic reviews for ensuring compliance by subsoil license users with the terms of their licences and applicable legislation. Although the Subsoil Law, as well as administrative law regulations do not specify which terms are material, failure to pay subsoil taxes and failure to commence operations in a timely manner have been common grounds for limitation, suspension or termination of the rights of a subsoil user. Consistent overproduction or underproduction and failure to meet obligations to finance a project (as opposed to the levels set up in the licensing agreement) would also be likely to constitute violations of material license terms.
When a licence expires, the licensee must return the land to a condition which is adequate for future use. Although most of the conditions set out in a licence are based on mandatory rules contained in Russian law, certain provisions in a licensing agreement are left to the discretion of the licensing authorities and are often negotiated between the parties. However, commitments relating to safety and the environment are generally not negotiated.
The fulfilment of a licence conditions is a major factor in the good standing of the licence. If the subsoil licensee fails to fulfil the licence conditions, upon notice, the licence may be terminated by the licensing authorities. However, if a subsoil licensee cannot meet certain deadlines or achieve certain volumes of exploration work or production output as set forth in a licence, it may apply to amend the relevant licence conditions, although such amendments may be denied.
If the licensee disagrees with a decision of the licensing authorities, including a decision relating to a licence termination or the refusal to re-issue an existing licence, the licensee may appeal the decision through administrative or judicial proceedings. In certain cases of termination, the licensee has the right to attempt to cure the violation within three months of its receipt of notice of the violation. If the issue has been resolved within such a three-month period, no termination or other action may be taken.
The Subsoil Law provides that, upon expiration of a licence, it is subject to renewal and extension for the economic life of the relevant field at the initiative of the licence holder as long as the licence holder did not violate the terms of its licence and as long as completion of the exploration, appraisal, production or remediation activities is necessary.
In addition to a subsoil production licence, Russian oil companies are required to obtain rights to use surface land within the specified licensed area. Under the Land Code, Russian legal entities generally have one of the following rights with regard to land in the Russian Federation: (i) ownership, (ii) lease or (iii) right of free use for a fixed term.
Most land plots in the Russian Federation are owned by federal, regional or municipal authorities who, through public auctions or tenders, can sell, lease or grant other use rights to the land to third parties.
Companies may have also been granted a right of perpetual use of land that was acquired prior to the enactment of the Land Code; however, Federal Law No. 137-FZ On Introduction of the Land Code dated 25 October 2001, as amended, with certain exceptions, requires companies using land pursuant to rights of perpetual use either to purchase the land from, or to enter into a lease agreement relating to, the land with the relevant federal, regional or municipal authority owner of the land by 1 January 2012. The violation of the requirement thereof will be penalised under administrative law regulations that are supposed to be enacted as from 1 January 2013.
The Subsoil Law provides for the basic framework of payments applicable to licence holders, including: (i) one time payments in cases specified in the licence, (ii) regular payments for the subsoil use (i.e., rentals paid for the right to conduct prospecting and exploration works), (iii) payments for geological subsoil information, (iv) fees for the right to participate in auctions or tenders and (v) fees for the issuance of licences.
Operations of Russian oil companies are subject to extensive federal and regional environmental laws and regulations. These laws and regulations set standards for health and environmental quality, provide for penalties and other liabilities for the violation of such standards and establish, in certain circumstances, obligations to compensate for environmental damage and restore environmental conditions.
The Environment Protection Law establishes what is effectively a "pay-to-pollute" regime administered by the Federal Service for Environmental, Technological and Nuclear Surveillance of the Russian Federation, which issues pollution discharge limits. In accordance with Decree No. 314, control over environmental quality and subsoil use is exercised by the Federal Service for the Supervision of the Use of Natural Resources of the Russian Federation.
Fees are assessed both for pollution within the limits agreed on emissions and effluents and for pollution in excess of these limits. There are additional fines for certain other breaches of environmental regulations. The environmental protection legislation contains an obligation to make compensation payments to the budget for all environmental losses caused by pollution. In the event of a dispute concerning losses caused by breaches of environmental laws and regulations, the prosecutor's office or other authorised governmental bodies may bring an action, and although there is no private right of action for monetary relief, courts may impose clean-up obligations subject to the agreement of the parties in lieu of or in addition to imposing fines.
Subsoil licences generally require certain environmental commitments. Although the commitments may be stringent in a particular licence, the penalties for failing to comply with such commitments are generally low and clean-up requirements are generally insignificant.
Natural resource development matters are subject to periodic environmental evaluation. While in the past these evaluations generally have not resulted in substantial limitations on natural resource exploration and development activities, they are expected to become increasingly strict in the future.
The Subsoil Law and the Regulation also provide that a subsoil licence must include a provision establishing the procedure for the restoration of the site and recultivation of the land plot upon termination of the subsoil licence. This procedure generally requires the licensee to submit, for the approval of regional authorities, a proposed plan detailing the timeframe and actions the licensee will undertake to restore the site and recultivate the land plot. Additional requirements in respect of restoration of the environment, recultivation of land and compensation of damage to the environment are prescribed by the Environment Protection Law.
Russian oil producers, including the Group, flare a portion of the gas produced in their fields. Consequently, such oil producers are subject to insignificant state-imposed charges for excess gas flared. These charges are levied in accordance with regulations of the Ministry of Natural Resources and Ecology of the Russian Federation and applicable regulations of the Russian Government. Limitations on gas flaring may be established in the licences. Under Resolution No. 7 of the Russian Government dated 8 January 2009, starting from 2012, no more than 5% of the amount of associated gas produced may be flared. Any associated gas flared in excess of this limit will result in increased emission charges.
From 1995, as part of a scheme to deregulate prices and liberalise export controls, the Russian Government established equal pipeline and sea terminal access procedures for all oil companies in proportion to the actual production volume of each company. This system allowed Russian oil companies to export, on average, 35% of the oil they produced.
In August 2001, the Russian Government began implementing reforms relating to the allocation of pipeline and sea terminal access rights, and since September 2001, pipeline and sea terminal access rights have been distributed among oil producers and their parent companies in proportion to the volumes of oil they produce and actually deliver to the Transneft pipeline system (and not solely in proportion to the volumes of oil they produce).
The allocation of pipeline and sea terminal access rights is currently overseen by the Ministry of Energy of the Russian Federation. The Ministry of Energy of the Russian Federation approves on a quarterly basis schedules that, inter alia, detail the precise volumes of oil that each oil producer can pump through the Transneft pipeline system. Once access rights are allocated, oil producers generally cannot increase their allotted capacity in the export pipeline system, although they do have limited flexibility in altering delivery routes. Oil producers are generally allowed to assign their access rights to third parties.
Transneft has a very limited ability to transport individual batches of crude oil, with the result that crude oil of differing qualities, delivered in the pipeline system, is blended. Transneft does not currently operate a "quality bank" system whereby companies shipping heavy and sour crude oil would compensate the shippers of higherquality crude oil for the deterioration in the crude quality arising from blending. Although the introduction of such a compensatory system is currently under discussion between Transneft and the Russian Government, these proposals cause aggressive resistance from regions with lower-grade quality reserves. Therefore, the Group's sales of crude oil that it transports through the Transneft pipeline system are priced as the crude oil blend that results from the combination of different types and qualities of crude oil in the pipeline system, which is usually referred to as "Urals blend" crude oil. As a result, the price the Group gets for its oil may be lower than the price that it could get for oil of the same quality if the Group could transport oil independently of Transneft.
In accordance with Decree No. 314, the tariffs for using Transneft's pipelines are set by the FTS.
The PSA Law sets forth general principles for investment in the exploration and production of minerals on a "production sharing" basis.
A production sharing agreement is a contract between the Russian Government and an investor in which the investor agrees to bear the costs and risks of exploration and production of a mineral resource and the parties agree predetermined shares of the output.
The PSA Law governs petroleum operations carried out pursuant to PSAs. It established the principal legal framework for state regulation of PSAs relating to oil and gas field development and production. Under the PSA Law, the Russian Federation as a state is represented (in its relations with investors under PSAs) by the Russian Government or the state bodies authorised by it. The PSA Law contains stabilisation rules purporting to protect investors against adverse changes in federal and regional laws and regulations, including certain uncertainties in tax laws and regulations. The PSA Law provides that operations conducted under a PSA pursuant to the PSA Law will be governed by the PSA itself and will not be affected by contrary provisions of any other laws, including the Subsoil Law.
Since the PSA Law was enacted, the legislature has approved a number of oil fields as eligible for production sharing agreements. Currently, few of these fields are subject to effective production sharing agreements. As at the date of this Prospectus, the Group does not participate in any PSA in Russia.
Effective from 1 January 2007, the tax rate related to crude oil extraction amounts to RUR419 per tonne of oil extracted, adjusted for: (i) the monthly average world market price of Urals blend crude oil (in US\$ per barrel), (ii) the monthly average US\$/RUR exchange rate and (iii) the depletion factor, which represents the depletion of an oil field. The formula for calculation of the crude oil extraction tax rate also provides for a cut-off price of Urals blend crude oil at or below which the tax rate amounts to zero. Since 1 January 2009, the cut-off price has been \$15.00 per barrel, while previously it amounted to \$9.00 per barrel.
The depletion factor depends on the ratio of accumulated volume of oil produced to the total volume of the oil field reserves (Depletion), based on reserves and production information reported to the Russian Government, and will equal:
Assuming the average monthly US\$/RUR exchange rate is constant and the depletion factor equals 1.0, each increase in the average world market price of Urals blend oil by \$1.00 per barrel above the cut-off price (currently set at \$15.00 per barrel) will result in an increase of the tax rate by approximately \$1.61 per tonne of oil extracted (or \$0.22 per barrel of oil extracted using a conversion factor of 7.33 barrels/tonne).
Depending on certain conditions (such as the production period in a subsoil licence, accumulated volume of production and depletion of an oil field), a zero tax rate may apply to extra-heavy crude oil as well as to crude oil produced in certain regions of Eastern Siberia, in oil fields north of the Arctic Circle fully or partially located within the boundaries of inland sea waters and the territorial waters, in the continental shelf of the Russian Federation or in the Azov and the Caspian seas.
Since 1 January 2006, the production of natural gas in Russia has been subject to taxation at a flat tax rate of RUB147 per mem of natural gas extracted, while production of gas condensate and associated gas are subject to taxation at tax rates of 17.5% and 0% of the value of extracted hydrocarbons, respectively.
Since 1 December 2008, the export duty rate on crude oil is established by the Russian Government on a monthly basis based on the average world market price of Urals blend crude oil over the preceding month. In
practice, this procedure of export duty rate determination results in a one-month gap between actual fluctuation of the average crude oil prices and the export duty rate based on those prices.
The effective Russian legislation provides for the maximum rates of crude oil export duties that may be established by the Russian Government based on the actual average world market price of Urals blend oil:
The crude oil export duty rate effective from 1 September 2010 amounts to \$37.48 per barrel (\$273.50 per tonne).
Export duty rates on oil products are established by the Russian government monthly mainly based on the international crude oil market conditions.
Exports of crude oil to Kazakhstan are not subject to export duties. From 2009 to January 2010, the applicable export duty rate on crude oil exports from Russia to Belarus was equal to the export duty rate set by the Russian government multiplied by a special coefficient of 0.356. From February 2010 oil exported to Belarus is subject to general export duties rate except for a statutory established limit of 6.3 mln. tonnes which is exportable without any export duties being applied.
Exports of oil products to Kazakhstan and Belarus are exempt from export duties.
The excise tax rates applicable for transactions in oil products in 2009, 2010 and 2011, respectively, are as follows:
| Oil Product | Rate, RUB per tonne | |||
|---|---|---|---|---|
| 2009 | 2010 | 2011 | ||
| Gasoline: | ||||
| – Under and including 80 octane (for 2009 and 2010) | 2,657.0 | 2,923.0 | ||
| – Over 80 octane (for 2009 and 2010) | 3,629.0 | 3,992.0 | ||
| – Inconsistent with Class 3, 4 or 5 (for 2011) | 4,624.6 | |||
| – Class 3 (for 2011) | 4,302.2 | |||
| – Class 4 and 5 (for 2011) | 3,773.0 | |||
| Diesel fuel: | ||||
| – Diesel fuel (for 2009 and 2010) | 1,080.0 | 1,188.0 | ||
| – Inconsistent with Class 3, 4 or 5 (for 2011) | 1,573.0 | |||
| – Class 3 (for 2011) | 1,304.4 | |||
| – Class 4 and 5 (for 2011) | 1,067.2 | |||
| Motor oil | 2,951.0 | 3,246.1 | 3,570.7 | |
| Straight-run gasoline | 3,900.0 | 4,290.0 | 4,719.0 |
Regular subsoil use payments depend on the size of the licence area (subsoil plot) provided to the subsoil user (the licensee), the kind of natural resources and location of subsoil plot (offshore or onshore plot). The current annual minimum and maximum rates of regular payments are set as follows: (1) the rate for the right to prospect and evaluate oil fields ranges from RUB120 to RUB360 per square kilometre (from RUB50 to RUB150 per square kilometre for offshore subsoil plots (Russian continental shelf and areas outside the territory of Russia but under its jurisdiction)); and (2) the rate for the right to explore oil fields ranges from RUB5,000 to RUB20,000 per square kilometre (from RUB4,000 to RUB16,000 per square kilometre for offshore subsoil plots (Russian continental shelf and areas outside the territory of Russia but under its jurisdiction)).
Currently the Russian Government is considering certain amendments to the tax legislation regarding the oil and gas industry. The parameters of such potential changes have not been publicised; however, public statements by government officials have suggested that these planned amendments may be focused on decreasing export duty on crude oil, as well as on introducing differential tax treatment for new oil fields.
Federal Law No 135-FZ "On Protection of Competition", dated 26 July 2006, as amended (the Antimonopoly Law), sets forth the framework for regulation. The Group must conduct its operations in compliance with the Antimonopoly Law, which provides for certain restrictions, such as an obligation to notify, or obtain the consent of, the antimonopoly authorities for actions/transactions that meet certain criteria. The Antimonopoly Law also prohibits certain actions by companies, holding a dominant market position (for example, setting monopolistically high or low prices for goods, works or services), engaging in unfair competition and entering into agreements that impede competition or concerted actions. The federal and regional antimonopoly authorities have the right to conduct investigations with regard to compliance with the requirements of the Antimonopoly Law, and a failure to comply with certain requirements may result in administrative fines or criminal liability or courts' invalidating transactions that violate the Antimonopoly Law at the claim of antimonopoly authorities.
The Group's business operations and most of its activities are conducted at industrial sites by large numbers of workers, and workplace safety issues are of significant importance to the operation of these sites. The principal law regulating the safety of employees at industrial workplaces is the Federal Law No. 116-FZ "On Industrial Safety of Hazardous Industrial Activities" dated 21 July 1997, as amended (the Safety Law). We are also subject to the Rules of Safety in the Oil and Gas Industry PB 08-624-03 dated 5 June 2003 No. 56.
Oil companies that operate hazardous facilities have a wide range of obligations under the Safety Law and the Labour Code. In particular, they must limit access to such sites to qualified specialists, maintain industrial safety controls and carry insurance for third-party liability for injuries caused in the course of operating industrial sites. Any construction, liquidation or other activities in relation to regulated industrial sites is subject to a state industrial safety review which is conducted by the Federal Service for Ecological, Technological and Atomic Inspection (Rostekhnadzor), which has broad authority in the field of industrial safety. In case of an accident, a special commission led by a representative of Rostekhnadzor conducts a technical investigation of the cause. The company operating the hazardous facility where the accident took place bears all costs of this investigation. The officials of Rostekhnadzor have the right to access industrial sites and may inspect documents to ensure a company's compliance with safety rules. The officers of Rostekhnadzor may bring persons to administrative liability for violation of requirements of industrial safety in accordance with the procedure established by Russian legislation as well as send to the law enforcement agencies information and materials to hold such persons criminally liable.
Any company or individual violating industrial safety rules may incur administrative and/or civil liability, and individuals may also incur criminal liability. A company that violates safety rules in a way that negatively impacts the health of an individual may also be obligated to compensate the individual for lost earnings, as well as health-related damages.
Labour matters in Russia are primarily governed by the Labour Code, various federal laws, such as the Russian Law No. 1032-1 "On Employment in the Russian Federation" dated 19 April 1991, as amended, and other regulations adopted in accordance with these laws.
Generally, the employment contracts for an indefinite term are concluded with all employees. Russian labour legislation expressly limits the possibility of entering into fixed-term employment contracts. However, an employment contract may be entered into for a fixed term of up to five years in certain cases where labour relations may not be established for an indefinite term due to the nature of the duties or the conditions of the performance of such duties, as well as in other cases expressly identified by federal law. An employer may terminate an employment contract only on the basis of the specific grounds set out in the Labour Code.
Any termination of an employment contract by an employer that is inconsistent with the Labour Code requirements may be challenged by a court, and the employee may be reinstated. Lawsuits resulting in the reinstatement of illegally dismissed employees and the payment of damages for wrongful dismissal are increasingly frequent, and Russian courts tend to support employees' rights in most cases. Where an employee is reinstated by a court, the employer must compensate the employee for unpaid salary for the period between the wrongful termination and reinstatement, as well as for mental distress.
The Labour Code generally sets the regular working week at 40 hours. Any time worked beyond 40 hours per week, as well as work on public holidays and weekends, must be compensated at a higher rate. Annual paid leave under the law is 28 calendar days. Employees who work in hazardous, strenuous or severe conditions may be entitled to an additional paid vacation ranging from six to 36 working days. Similarly, additional benefits, such as additional pay leaves and monetary compensations, must be provided to employees working in Russia's far north and certain other Russian regions, including those where we operate.
The activities of trade unions are generally governed by the Federal Law No. 10-FZ "On Trade Unions, Their Rights and Guarantees of Their Activity" dated 12 January 1996 (as amended) (the Trade Union Law). The Trade Union Law defines a trade union as a voluntary union of individuals with common industrial, professional interests that is incorporated for the purposes of representing and protecting the rights and interests of its members. As part of their activities, trade unions represent interests of employees in collective negotiations, execution and amending ofcollective contracts and agreements, monitor compliance with labour laws, collective contracts and other agreements, represent their members and other employees in individual and collective labour disputes with management and monitor redundancy of employees and seek action by municipal authorities to delay or suspend mass layoffs.
The trade union may apply to state authorities and labour inspectors and prosecutors to ensure that an employer does not violate Russian labour laws. Trade unions may participate in resolving collective labour disputes and have the right to organise and conduct strikes and other collective actions. Russian laws require that companies cooperate with trade unions and do not interfere with their activities.
The Labour Code defines a strike as the temporary and voluntary refusal of workers to fulfill their work duties with the intention of settling a collective labour dispute. Russian legislation contains several requirements for strikes to be considered legal. Participation in a legal strike may not be considered by an employer as grounds for terminating an employment contract.
The expressions below shall have the following meanings throughout this prospectus unless the context requires otherwise:
References to:
"alkylation" is a refining process that combines low molecular weight olefins (primarily a mixture of propylene and butylene) with isobutene in the presence of a catalyst (either sulphuric acid or hydrofluoric acid) to produce alkylate, which is composed of a mixture of high-octane branched-chain paraffinic hydrocarbons.
"catalytic cracking" means a refining process whereby crude oil is broken down into simpler hydrocarbon compounds at the molecular level by means of extreme heat and exposure to a chemical catalyst.
"catalytic reforming" means a refining process to convert low octane naphtha into high octane blending components by rearranging (rather than cracking) molecules.
"coke" means a solid material similar to coal produced from processing crude oil.
"completion" means the installation of permanent equipment for the production of oil or gas.
"condensate" is a term used to describe light liquid hydrocarbons separated from crude oil after production and sold separately.
"development well" means a well drilled within the known area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.
"distillation" means the first stage in the refining process in which crude oil is heated and unfinished refined products are initially separated at their various boiling points.
"downstream" is a term used to refer to all petroleum activities from the refining of crude oil into refined products to the distribution, marketing and shipping of the products. The opposite of downstream is upstream.
"enhanced oil recovery" is a generic term for any process, such as water flooding, whereby oil is produced other than by natural reservoir pressure.
"exploratory well" means a well drilled to find and produce oil or gas in an unproven area, to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir.
"field" means an area consisting of a single or multiple reservoirs all grouped in or related to the same individual geological structure or stratigraphic condition.
"fraction" means that part of petroleum separated from other parts at a particular boiling range.
"gas available for sale" means the amount of gas produced excluding gas used for internal consumption.
"hydrocarbons" means compounds formed from the elements hydrogen (H) and carbon (C) and may be in solid, liquid or gaseous forms.
"hydrotreating" is a refining process for treating petroleum fractions from atmospheric or vacuum distillation units and other petroleum in the presence of catalysts and substantial quantities of hydrogen to remove impurities.
"isomerisation" means a refining process that uses a catalyst to change the chemical or physical properties of a compound without adding or removing anything from the original material.
"naphtha" is a generic term used for refined, partly refined or unrefined petroleum products and liquid products of natural gas that boil between 347 and 464 degrees Fahrenheit.
"natural gas" means petroleum that consists principally of light hydrocarbons. It can be divided into lean gas, primarily methane but often containing some ethane and smaller quantities of heavier hydrocarbons (also called sales gas) and wet gas, primarily ethane, propane and butane as well as smaller amounts of heavier hydrocarbons; partially liquid under atmospheric pressure.
"operator" means a company appointed by venture stake holders to take primary responsibility for day-to-day operations of exploration and production activities.
"petrochemicals" means chemicals such as ethylene, propylene and benzene that are derived from petroleum.
"petroleum" is a collective term for hydrocarbons, whether solid, liquid or gaseous. The proportion of different compounds in a petroleum find varies from discovery to discovery. If a reservoir primarily contains light hydrocarbons, it is described as a gas field. If heavier hydrocarbons predominate, it is called an oil field. An oil field may feature free gas above the oil and contain a quantity of light hydrocarbons, also called associated gas.
"petroleum gas" means gas occurring in combination with crude oil, as distinct from gas occurring separately or manufactured from crude oil.
"profit oil" means the amount of production, after deducting "cost oil" production allocated to costs and expenses, that is divided between the participating parties and the host government under a production sharing contract.
"pyrolysis" means the transformation of a compound into one or more other substances by heat alone.
"reservoir" means a porous and permeable underground rock formation where crude oil or gas has naturally accumulated.
"royalty" as employed in the Reserves Report is a tax on production that is equal to the royalty percentage multiplied by the gross revenue to the interest of the Company.
"seismic" is the use of shock waves generated by controlled explosions to ascertain the nature and contour of geological structures.
"2D seismic" means seismic data that is acquired and processed to yield a two-dimensional picture of the subsurface.
"3D seismic" means seismic data that is acquired and processed to yield a three-dimensional picture of the subsurface.
"thermocracking" means the use of heat to reduce the size of the hydrocarbon molecular structure and convert heavy oils into lighter, value-added products.
"upstream" is a term that includes exploring for oil, developing oil fields and producing oil from the oil fields. The opposite of upstream is downstream.
"vacuum distillation" means distillation under less than atmospheric pressure, which lowers the boiling temperature of the liquid being distilled. This technique is used to prevent cracking or decomposition (a change in the chemical makeup of a hydrocarbon.
"vis-breaking" means thermal cracking used to reduce the viscosity of long or short residues.
LUKOIL International Finance B.V. Atrium Strawinskylaan 3105 1077 ZX Amsterdam The Netherlands
11 Sretensky Boulevard Moscow 101000 Russia
ZAO KPMG 10 Presnenskaya Naberezhnaya Block C Moscow 123317 Russia
To the Company To the Issuer KPMG Accountants N.V. Laan van Langerhuize 1 1186 DS Amstelveen The Netherlands
Citigroup Centre Canada Square, Canary Wharf London E14 5LB United Kingdom
PRINCIPAL PAYING AGENT REGISTRAR Citibank, N.A., London Branch Citigroup Centre Canada Square, Canary Wharf London E14 5LB United Kingdom
Citigroup Global Markets Deutschland AG Frankfurter Welle, Reuterweg 16 60323 Frankfurt am Main Germany
LAWYERS
To the Company as to English, Russian and United States law
Eighth Floor, Ten Bishops Square London E1 6EG United Kingdom
Ducat Place II 7 Gasheka Street, P.B. 20 Moscow 123056 Russia
To the Issuer as to Netherlands law
Van Doorne N.V. Jachthavenweg 121 P.O. Box 75265 1070 AG Amsterdam The Netherlands
To the Managers as to Russian, English and United States law To the Trustee as to English law
Clifford Chance LLP 10 Upper Bank Street
Clifford Chance CIS Limited Ul. Gasheka 6
Clifford Chance LLP 10 Upper Bank Street
London E14 5JJ United Kingdom Moscow 125047 Russia
London E14 5JJ United Kingdom
Ernst & Young 77/1 Sadovnicheskaya Nab. 115035 Moscow Russia
Building tools?
Free accounts include 100 API calls/year for testing.
Have a question? We'll get back to you promptly.