Energy Leader in the Balkans. Kirill Kravchenko Interview to Gazprom magazine

December 4, 2015

Let us talk about results, Mr Kravchenko, what kind of results have NIS generated in recent years? - Firstly, what is important to us is EBITDA. Based on it, we measure the value, determine the financial status and key economic indicators. If we look at the dynamics in recent years, starting from 2009, we have been quite actively developing. Last year alone, we achieved an operating profit of about USD 550 million. In fact, we have a relatively small volume of production and processing of hydrocarbons, but due to our efficiency, geographical location and a number of other factors, it is comparable with indicators of any company possessing large production and refining capacities. Say, like the petroleum "Moscow Refinery" or the "Noyabrsk-Naftagas" refinery. Another important component is the investments. In recent years, we have invested totally EURO 2.5 billion. At the same time, it is important that we keep pace - every year we reinvest at least EURO 350-400 million, which is more than the profit. Another important parameter is the way we keep balancing between economic and social spheres. Because, from the social point of view, our participation in filling the budget of Serbia, is very important. Over the last five years, from the seven per cent we have arrived at 15 percent. In other words, up to 15 percent of the state budget is being filled directly and indirectly from the NIS business operations. Although Serbia has remained to be the key country for us, let me note that we do business also in other countries of the Balkan region, where the importance of our company is also gradually increasing.

In recent years, we have invested totally EURO 2.5 billion. At the same time, it is important that we keep pace - every year we reinvest at least EURO 350-400 million, which is more than the profit
NIS production indicators are more or less stable. Today, the big challenge for us are low petroleum prices, and as a result the low gas prices, which for nine months now, have had a tendency to decrease along with petroleum prices. We are trying to influence the situation, improving internal efficiency, and therefore we have prepared quite an extensive program to enhance internal efficiency and reduce costs. We are working on changing and improving certain internal business-processes. We saw that in this way, we could save about USD 100 million and for the nine months 2015, we have already saved 70 percent of these funds, because we were concentrated on productive efficiency. When it comes to the preliminary results for the current year, they will certainly be lower than the indicators for the previous year. Because petroleum prices are twice lower. Among other things, we will be much more stable than in 2009, when we first came to the Balkans. According to the then status quo, the Company was simply threatened by bankruptcy. Today, we maintain a solid level of profitability. Operating income will be slightly lower than last year, but still stable and quite high. According to this indicator, we will preserve the regional leader position. It is understood that we are going to continue to invest, which is very significant, and thirdly, irrespective of the fact that because of the reduction in petroleum and gas prices we have revised the NIS development strategy to some extent, rationalizing it slightly, we will continue to grow actively. Our goal is to be and remain a vertically integrated energy company in the Balkans; including not only the geological exploration, production, refining, sales and distribution of hydrocarbons and their products, but also the electrical energy. Likewise, to be the major player not only in the market of Serbia, but in the entire Balkans - Bulgaria, Romania, Hungary, Bosnia and Herzegovina ... For this reason we do not alter the objectives but we reserve investments and strive for stable profitability. Throughout this process, the participation of our employees, who responded to the call to improve internal efficiency in times of crisis, has been of critical importance, as well as the support of main shareholders. We have many shareholders, but two are especially significant for us - those are Gazprom Neft and the Republic of Serbia. It is their support that keeps us on the right track towards efficiency improvement and further development of the Company.  Revising What is assumed as revising of the NIS development strategy? Does that mean ranking of the projects by priority, where their status for implementation is simply changed depending on the market situation? - Essentially, the strategy and mission have not changed. First of all - we need to be the most effective in our region, secondly - we are trying to achieve the maximum balance in relation to the different segments. We have the experience for half of those, as we call them “the segments”. Four of them are critical, they are: hydrocarbon production, their processing, sales and distribution of gas and petroleum products, as well as electricity generation, and two extra ones, which is why we call them "five and a half." The first of those two are the Oilfield Services, which we cannot abandon due to the narrowing market. The second relate to our minority stake in the Serbian petrochemical structure. For each of these segments we have our own priority projects. In production, the most important is to maintain the production level, since the exhaustion of the sites is in the fourth stage, as well as the resupplying. Today, the resupplying is at the level of one to ten. For the last five years, we have increased that by 50 percent, although in the previous 20 years, prior to our arrival there had been a tendency of gradual stagnation. Currently, a lot of significant attention is drawn to geological research, in order to achieve long-term business prospects.
First of all - we need to be the most effective in our region, secondly - we are trying to achieve the maximum balance in relation to the different segments
With a view to refining - that includes construction of the new modern facility. We fully switched to the "Euro 5" Standard in 2012. Today, our task is to cut off the dark fuel completely. That is, to build a plant for deep processing of petroleum based on coking. Construction of this facility will be completed in early 2019. We have already started working in this direction, made project designs, have been investing money, and the process is underway. In the field of sales and distribution - it is the modernization and development of the retail network. However, not specifically and only in Serbia. On this day, for about 20 percent of the retail business of NIS is located outside the borders of Serbia. This year we are actively developing in terms of the average volume of the fuel issuance and the retail sale scope through our retail network. We work additionally in three countries - Romania, Bulgaria and Bosnia. Our task is to balance the sales and distribution in relation to the processing volume. In the field of energy - it is the realization of projects, primarily the gas generation. The reason is that we produce gas and want to monetize it - which is more favourable from the sale of raw gas. Secondly, it is the "green" energy, because to a certain extent, we inherited that together with NIS. Those are geothermal sources, which are also partly the European Union requirement. We understood what the wind energy is, what the emissions of carbon dioxide (CO₂) are, and we realized that it was cheaper for us to produce "green energy" than to pay fines. And thirdly – there is the energy based on solid fuels, which is for us a relatively new road, atypical for us, as well as for the big Gazprom. But we are developing, because we are located here, and our strategy is to be the leader in the Balkans, within the given framework. Therefore, we are working on several projects in the field of energy from solid fuels. That is something that falls under the basic segments. If we talk about the extra segments, then Oilfield Services are a cutting edge support, which is sufficient for our production projects, which are being realized, not only in Serbia but also in Romania, Hungary and Bosnia. These include first of all, the drilling and detailed overhaul of wells as well as the seismic. If we take a look at petrochemicals - it is the maximum aid to Serbia in this field, keeping the local petrochemical industry not only alive, in these difficult conditions, when the Arab world is pressuring with cheap petrochemicals, but also modernizing it and developing. It should be noted that the Republic of Serbia is the majority shareholder of HIP-Petrohemija a.d. Pancevo, while NIS is a minority shareholder. In petrochemicals, we singled out three main objectives for us. The first is to have in Pancevo the polypropylene produced in addition to propylene due to the investments, yet not from our side, but from the side of our the strategic partner. Through our business management, we have already made a business efficiency plan. And now we are in a promotional stage of negotiations, searching for a strategic partner. Several companies aspire to this position. We are convinced that, given the integration of our major refinery in Pancevo and petrochemical complex (because we supply them with raw materials, and purchase part of the products from them), we can successfully complete this project. Second – there is the construction and expansion of the energy complex in Pancevo that will satisfy the energy needs, not only of the city but also of the petrochemical complex, along with the production of nitrogen fertilizers, in whose share capital we do not have any stakes, as opposed to Petrohemija. In addition, the third direction is - acetic acid and methanol, which are being produced in Kikinda, where we are the minority shareholders. We are willing to help and in terms of business efficiency, and we already after four-year of delays commissioned a factory in September this year. Of course, we have reduced costs through additional electrical and thermal power generation. For this purpose, we are currently reviewing the new project of construction of a large thermal power plant in Kikinda, which will supply this chemical complex with heat and electricity. Consequently, in each of these five and a half routes we have strategic projects where we invest. In addition, in terms of low prices of energy fluids, our program is certainly more modest than it was originally anticipated. However, we agreed to invest in the next three years an additional one billion dollars in the development of our basic business trends. Does the solid fuel energy refer to coal? - The point is that there are two tracks where we have a particular interest, not as the majority shareholder, but rather as a company, that develops electric generation. First is coal, second are oil shale, which are produced from the open pit mines, like, for example, in Estonia. Oil shale is not associated with petroleum and gas shale. Is the project for the production of base oils and special oils on the existing sites in Serbia, which was mentioned by NIS some years ago, still active nowadays? - The project is still active, but for the time being, we have to postpone it. The main reason is the drop in petroleum and gas prices, which changed the ratio between the prices of various petroleum and gas products. In addition, it significantly deteriorated the project economic indicators and construction capacities for the production of base oils. There are also several additional reasons. When we started this project, we had already invested in it some funds, and discovered that deep below the production site there were more than 1.3 thousand lethal weapons, which could include unexploded bombs from the NATO bombing. And that meant not just a significant extra spending of the funds, but also the time. For us the market conjucture and prepared ground are important. And second - when we started to analyze the market, we found that it was quite changed. That is not just in terms of price assumptions, but also in terms of significant reduction in demand for base oils in the crisis circumstances. That is why we decided to postpone the project, but not suspend it. It remains in our portfolio, but not among the top priority projects. Sale How successful is the development of the sales and distribution in NIS, considering not only the retail, but also the wholesale? - Speaking about the sales and distribution, fuels are our priority. We have additional products, such as heavy oil or bitumen. We try to cover local needs, and in doing so we concentrate on high-tech products. So, in the last two years we have placed a number of unique products in the local Balkan market. These are high-octane gasoline and ultramodern diesel fuel. In this domain, for example, we cooperate with the German concern BASF - use their additives to improve fuel quality. If we talk about the share, there is a steady growth. Not only concerning the quantities, but also in the market share. There is a regular increase not only in Serbia, where NIS has a dominant position – of over 75 per cent as a whole in motor fuels, but also in the neighbouring countries, where we have both the wholesale and retail.
There is a regular increase not only in Serbia, where NIS has a dominant position – of over 75 per cent as a whole in motor fuels, but also in the neighbouring countries, where we have both the wholesale and retail
Within wholesale, we supply all neighbouring countries, including, in addition to Bosnia, also Romania, Bulgaria, Macedonia, Croatia and partly Hungary. In addition, in the retail trade, there are three countries where we have our own gas stations; those are Bosnia, Bulgaria and Romania. In Bosnia, we are already leaders in the average volume of sales at FS gas stations. In Romania and Bulgaria, we have been constantly increasing efficiency and this year we have achieved a good level of profit. For us this is very important, because in times of crisis and a shortfall in prices in "upstream" it is necessary to partly balance that regarding the "downstream". Now we have switched fully to the two brands, while we used to have eight different brands only in Serbia. We have won the whole Balkan region, where in the premium segment, we operate under the GAZPROM brand, and in the mass segment under the NIS Petrol brand. In both segments, we have already reached a leading position not only in Serbia, but also in neighbouring countries where we develop retail. The issue of the gasoline with an octane rating of 100 produced by NIS, was actively discussed in Serbia, not so long ago. What is this product like? - We have started the production of high-quality gasoline and diesel. The structure of consumption of motor fuel in Europe is somewhat different from the situation in Russia. Here, more than 60 percent of consumption makes diesel, while in Russia it is gasoline. Then the remaining two segments in Serbia are divided between gasoline and gas, whereas the share of gasoline has been steadily decreasing. From the aspect of high-tech products, we have improved the diesel to super-diesel, and concerning the gasoline we switched to the 100 octane, because the share of the above-mentioned products keeps constantly growing here. We have already entered this market, and we work actively on increasing our share. What are the main export-petroleum products for NIS, if we neglect the motor fuel retail to neighbouring Balkan countries? - We have defined our circle of logistic availability for each petroleum product. Each of them, in addition to Serbia, has its local markets. For example, liquefied petroleum gas, and propane-butane, we supply not only in Serbia, including Kosovo and Metohija, but also in Bosnia. Moreover, now we have introduced CNG. We supply gasoline in Bosnia, Bulgaria, Romania and Croatia. Depending on the conjuncture, we can deliver diesel in various countries in the region. If we focus on non-motor fuels, such as bitumen, we try to provide delivery to all parts - sell them in Bulgaria, Romania, Macedonia, Montenegro, etc. Regarding  the jet fuel, we have two target markets - Serbia and Romania. Different types of heavy oil have a few basic routes of delivery. Apart from Serbia, a big consumer of our heavy oil is also Constanta in Romania, where we supply one of the Gazprom Neft daughter companies, which specializes in marine ships bunkering. That is how each product has its own niche, and we are present in the entire region. Elements of diversification What is expected from the diversification of the NIS business segments? - Among our strategy objectives, which we formalized in the course of 2009-2010, the diversification was not the only issue, but also the balancing of the business segments. What had the situation been like before that? Production had been falling for twenty years, decreasing the stock, with an excessive volume of refining and slowed down retail. The situation had been very vibrant and diverse. We are now of the view that each segment should be maximally coordinated with other segments, in order to obtain a synergistic effect. We have started to increase supplies and production, we have optimized the volume of refining, actively expanding the retail network. This is the first strategic direction. For us it is an element of diversification. Therefore, we do not swim downstream, but rather, we try to balance the different segments. The second element is a step out into an absolutely new sphere. It is electricity generation. We started with gas from geothermal and wind energy. Now we are thinking that about 20-25 percent of our operating profit should be achieved from the projects of electricity generation by 2020. We have a portfolio of relevant projects, which now cannot discuss now, because the negotiations are still ongoing. However, we have opted for our strategic goal, and this segment is an important aspect of our company as a whole. Not only the balance between the different segments, but also the introduction of new, important components. At the same time, in each of the segments we cooperate with the parent company. For instance, in the field of gas that is Gazprom Export, and in the field of generation of electricity that is - Gazprom Energy Holding. Of course, there is also our main company - Gazprom Neft, which controls our entire business operations. Furthermore, coordination of all the links in the chain provides a synergistic effect. NIS buys raw materials from abroad, for example from Russia? - We have tender procedure. Gazprom Neft is one of the players in the market, and during the last six years, it has always been the biggest supplier of raw materials from Russia for NIS. Moreover, we contribute to the development of related areas such as petrochemical complex in Serbia, of which I have already spoken. We dedicate a lot of time negotiating, for example, with Gazprom Energy Holding on the subject of gas supplies. Because, while different types of oil can be procured from different markets, gas is supplied through pipelines and its composition cannot be changed. That is why we have a productive cooperation with Gazprom Energy Holding. We are not the principal subcontractor, but rather that is the JP Srbijagas. We simply help them, because we are interested in the preservation and development of the petrochemical complex in Serbia. Social and Economic Responsibility What has NIS undertaken in the area of ​​social support and cultural cooperation in the Balkans? - Regarding social issues, we understand our role in the economy and the life of the Balkan region. NIS is the largest and most profitable company, so we cannot act otherwise but to assume additional social responsibility. As for ourselves, we have defined four strategic roadmaps of investments in this sphere - from youth and education to culture and sports. For example, in the past year we have received in our company, more than 700 young people, thus reducing the average staff age 49 to 37 years. We pursue a balanced policy of supporting various sports clubs in different sports. In doing so, we do everything fully transparently, adhering to the two criteria. First - we respect the standards of corporate social responsibility, and according to the international practices, we constantly increase our open-mindedness.
Since 2009, NIS and Gazprom Neft have allocated for social projects in Serbia a total of about EURO 45 million
Second - a significant part of our social investments, primarily for local communities in the regions, is allocated to the open calls, where the citizens themselves decide what projects should be funded. That is just something that we brought to the region with the arrival of NIS and have fairly well systematized it. Since 2009, NIS and Gazprom Neft have allocated for social projects in Serbia a total of about EURO 45 million. That is a portion of our social responsibility. Why, despite all this, the taxes for NIS in Serbia keep growing?
We have increased our share in the filling of the Serbian budget from seven to 15 percent, while keeping the base rates at the same level
- Talking about taxes, it is also a part of social and economic responsibility. We are maximally transparent and pay whatever is required. We assist the country in fighting the "grey" or "black" economy, investing our own funds in order to increase not only our competitiveness in relation to the unfair market players, but also to facilitate the collection of taxes from the other competitors. As for the tax dynamics - yes, it has really been growing. Excise grows, so does the profit tax, and certain exemptions have been stopped. Nonetheless, we initially agreed some fundamental things  under the Shares Purchase Agreement. For example, the royalty rate, which has remained the same. That is something worth respect, because it is not only the mutual appreciation between the parties, and the fulfilment of the agreement reached, which the presidents of Russia and Serbia signed, and furthermore it is the European practice. Similar agreements have been signed when MOL entered in Croatia and OMV in Romania. There too, contractual terms of taxation were agreed, for a period, of not less than 10 years. Therefore, overall taxes do increase – let me remind you that we have increased our share in the filling of the Serbian budget from seven to 15 percent, while keeping the base rates at the same level. The interview was published in the 11th issue of the Gazprom corporate magazine.

 Interview by: Denis Kirilov