Interview: Kirill Kravchenko, NIS CEO

December 29, 2011

„We invested € 1.5 bln in NIS development, in the next three years we intend to invest as much“

The year of 2010 was a turning point for Naftna industrija Srbije (Petroleum Industry of Serbia, or NIS), as from a loss-making company it emerged as the most profitable system in Serbia, posting a RSD 17 bln net profit. Despite the crisis NIS score in 2011 will be even better, with the expected doubled last year’s profit, says for the Ekonom: east magazine Kirill Kravchenko, NIS CEO, pointing out the most important among the achievements of his company its becoming effectively the largest long-term investor in Serbia. „Here, I mean all our investments, starting with direct ones into business operations, through share acquisition at stock exchange and investment in people and socially responsible corporate actions up to the streamlining of three companies and funds for the repayment of loans to banks. In a nutshell, our overall investments so far amount to one and a half billion Euros, and we intend to invest at least as much in the next three years”, announces Kravchenko.

E: which are the crucial factors that brought about this outcome?

Kirill Kravchenko: Our most important results may be achieved by different tools. 2011 was a watershed for NIS. Back in 2010 we also posted profit, but that result was the initial one, hence less reliable. Achievement of positive results for the second year in a row is no fluke, but a logical development. To get there, however, we had to get the better of a loser complex and find a way to emerge victorious. 2011 for NIS was a year of learning all sorts of things – to maintain the positive financial results trend, to boost the performance efficiency by implementing new technologies in production and refining process, to roll with the competition punches. We managed to put together a strong international team – at this point our company employs citizens of 22 different countries, and it is exactly thanks to this patchwork of cultures, languages and ethnicities that we achieved exquisite results in 2011 and it will be our keystone for the future.

E: Is there already an assessment of a possible distribution of an anticipated RSD 34 bln worth doubled profit?

K. Kravchenko: This is rather Shareholders’ Assembly domain then mine. We have been gradually and steadily increasing our profit and intend first to cover the previous years’ losses and there should be legal tools enabling us to do so.

E: Profit posted in 2010 and 2011 is expected to exceed the price paid Gazprom Neft for the majority stake in NIS, in other words, the purchase price will be paid up in a matter of two years, which does not occur that often. Analysts call it a “good bargain” for the Russian side.

K. Kravchenko: Assertions that NIS is paid up based on 2010-2011operation results is wrong. As soon as we took over the company in 2009 we understood that it is not going to be party time all year round. Let me remind you that back then NIS was on the verge of bankruptcy. In the package with the company we also acquired RSD 33 billion-worth loss and as much as approximately $ 1 billion of debts. As much as RSD 7 billion was paid out in severance packages, in 2011 Gazprom Neft paid approximately € 40 million for 5.15 per cent of shares bought out from minority shareholders, and on top of that there is a modernisation programme, which would cost at least €500 million. This being said, NIS’ investment programme, Gazprom Neft funding not included, has been on the increase year on year (in 2010 the growth was 87% as compared with 2009, in 2011 – 300% on 2010) and it comprises the retail network overhaul, implementation of novel hydrocarbons production technologies, environment programmes implementation. In 2009-2011, RSD 53.85 bln was spent for this purpose; approximately $ 500 million worth in bank loans was repaid, while the overall volume of committed funds amounted to €1.5 billion, not including the investment into projects of social significance, where NIS is one of Serbia’s leaders. Real economy-wise, NIS may claim the title of biggest. In addition to that Board of Directors has already adopted a new investment plan, its package for the next three years to be worth another €1.5 billion. If we add up all the figures, it is apparent to the naked eye that it will be long before NIS becomes «worthwhile» in the sense of cost-effectiveness. We have to bear in mind that that funds earned by the company in Serbia are not being carted off by sack loads to Moscow by anyone – whatever we earn we invest into NIS, thus laying the foundations for making NIS a regional energy corporation, capable to bring about energy stability to Serbia and emerge as regional energy leader.

E: Recently, Serbia passed a law increasing the mining rent, however NIS is exempted from this increase up until the investments return, something seen by others as a privilege.

K. Kravchenko: We should bear in mind that interstate agreements, as this particular one stipulating the petroleum and gas partnership between Russia and Serbia, invariably supersede local principles, this being international practice. Serbia is responsible European country acting in compliance with the hierarchy. Being a large investor seeking to plan an unimpeded increase in investments we need to maintain a positive investment climate in conformance to the international agreements. Our take on this is that the existing taxation conditions being applied to NIS have to be in place up until the return on investment to enable us to commit more funds for the development of both the company and Serbia.

E: How long will it take for the return of all investments?

K. Kravchenko: Pursuant to the Purchase Agreement the deadline for the repayment of Gazprom Neft-granted loan is 2023. Following the completion of modernisation stage in the Pančevo Refinery, as stipulated by above Agreement, we shall commence the next stage already under preparation. Other than that, we are looking into possibilities to revamp the Refinery in Novi Sad in order to transform it into a base oils producing plant. We have similar plans for our refuelling stations next year. This year, we have fully or in part reconstructed as many as 50 stations, and for the next year we anticipate another 100 to be reconstructed, in addition to putting on stream new petrol stations throughout Serbia and expansion of retail network in the region.

E: Is modernisation work in NIS on schedule and can the completion be expected by next year’s end, especially against the background of an anticipated fresh bout of crisis in 2012?

K. Kravchenko: We faced certain problems earlier this year, but, at this junction we are on schedule as stipulated in contract. You should know that economic crisis in Serbia does not affect the modernisation project of the Pančevo Refinery, as it is not dependant on the results of operative business operations of NIS. Modernisation will be completed by the end of next year. Moreover, the investment in the environment to the tune of €80 million (€60 million out of them in accordance with the Purchase Agreement) is also being fully realised in compliance with the previously determined schedule.

E: Does the crude production growth continue, and to what extent is that strategically beneficial for Serbia, having in mind an opinion that resources should be spared?

K. Kravchenko: The production was increased in 2011 by 20 per cent on average. In 2012, we expect less growth, around 10 per cent, but we will maintain a positive production trend. However, it is much more important that, along with crude extraction, we accumulate reserves. Over the recent three years the growth of reserves exceeded the crude and gas production, which is the first occurrence in NIS in the recent 15 years. Next year, we allocate more than € 50 million for the explorations on the territory of Serbia. All this will definitely result in an increase of strategic reserves of oil and gas in Serbia. Other than that, we have initiated a project for prospecting the reserves in unconventional sources and if the outcome is significant, the reserves will be additionally increased.

E: Are there any areas in Serbia that were not known for their crude reserves, but could potentially be new oilfields?

K. Kravchenko: Apart from the Pannonian Basin, which is a recognised oilfield, relatively new potential locations are in the south of Serbia. Our seismic surveys will be significantly expanded next year and we will get a more precise picture concerning the places where crude can be found and where it should not be expected. Naturally, we would like to come across it more often, but only our surveys shall show its real presence.

E: Have you succeeded in entering all NIS assets into the books, in other words, to change their status from state into company’s ownership?

K. Kravchenko: Assets-wise, there is a certain progress. Our shareholders have good relationship, so we have full support from the government on this issue. In 2011, we expect to legally enter into books as much as 55 per cent of NIS property, along with another 29 per cent of cases where the company has the right of use. Next year we are going to complete that matter in full.

E: Consumers in Serbia have been paying the most expensive fuel in the region. Is the problem in too big dues to government or in some other reasons?

K. Kravcenko: Fuel in Greece is more expensive, but our prices are indeed close to the highest prices in the region. There are a number of reasons for this, one of them is related to logistics, because unlike Croatia or Hungary we are geographically separated from direct supplies by oil pipelines and sea ports. Secondly, it is undoubtedly the matter of responsibility of participants in the market, including the Government of Serbia which sets the parameters. Excises on oil products are rather high and that is one of key factors that impact the prices. We need to deal with this matter together with the state, and as far as we know they have addressed this issue as well. We are planning to take additional steps already in the beginning of 2012 in order to reduce retail prices. When we speak about margins our position is that the market is the best regulator. The practice which has been established in the market is highly positive because now, regardless of high excises we manage our margins and we can take various marketing actions in order to reduce fuel prices. It is psychologically important to have competition because in an open market it is the key price regulation mechanism. In addition to it, excise policy must be flexible. I’ll give you an example – many neighboring counties have the practice of VAT return for fuel purchase in transit. This practice has been applied for a long time now, which proves its effectiveness. Serbia is a transit country as well and such an example could be useful for it in view of the increase of fuel sales at petrol stations on trans-European highways.

E: Is there any possibility of oil refining cost reduction, which could contribute to lower prices in the market?

K. Kravcenko: Yes, there is such possibility, and it will happen when we put into operation a revamped production unit. We are working on the issue of cost reduction and it will enable us to offer much better terms to buyers in 2013 and 2014.

E: It is a well-known assessment that there is a surplus of about 40 per cent of refining capacities in the region. Do you expect any rearrangements in the region and different co-relation of forces in the refining sector, and also in the retail sphere?

K. Kravcenko: It is true that there is surplus refining capacity. Some plants were closed earlier, and some of the existing refineries in the region do not work at full capacity. The possibility of rearrangement in this market exists, some companies are already changing their priorities. NIS considers various possibilities; we develop not only oil and gas production but also the retail network abroad. We should have the full picture of retail network in the surrounding countries by 2013, which will enable our product placement through premium channels. We are planning also to develop the bunkering business, as well as LPG and jet fuel business. We are currently operating in Belgrade, NIS and Timisoara, and we are exploring the possibility of operations at other airports. We are certainly going to develop our network in the area of petrochemical industry.

E: What is a strategic aim of NIS Gaspromneft in the region?

K. Kravcenko: The situation in the regional market is complex. A number of companies, such as Turkoil and OMV, decided to leave the markets of several countries of former Yugoslavia. NIS, on the contrary, intends to expand its presence in the region. Currently, Romania, Bulgaria, BH are our priorities, and Croatia is also part of our plans for the future. In the situation when there is a crisis in Eurozone it will not be all that easy, but surely together with state authorities in Serbia and countries where we are going to operate, we will reach success. I would like to emphasize the fact that in this region we are not doing our business only in the interest of NIS but also in the interest of Serbia. Reaching the strategic aim of the company – gaining a status of a regional leader, will inevitably lead to a greater significance of Serbia in the countries where NIS has its operations. A well-known Serbian saying is suitable to mention here – „Serbia is eternal as long as her children are faithful“.

E: According to the latest agreement with the Serbian Government NIS share in Petrohemija has increased by 33,6 per cent. Are you interested in NIS having majority ownership in that company and under what conditions?

K. Kravcenko: We are not planning to increase our equity stake in Petrohemija. We are satisfied with the level of cooperation and current shareholders. This arrangement is quite significant for us because the Pancevo refinery and Petrohemija share a common infrastructure. After the completion of reconstruction we will be producing more straight-run naphtha which be sold to Petrohemija and we will be their main source of high quality feed material. We have made an investment program for Petrohemija which includes putting into operation the current facilities and construction of new facilities for polypropylene.

E: In what spheres should the state help the economy, and NIS, in order to help overcome the crises?

K. Kravcenko: Serbia is still attractive to foreign investors –1,2 billion Euro was invested in Serbia in the first 8 months in 2011, while only 164 million dollars were invested in Croatia, and about 70 million Euro in Bosnia. Serbia has a plus side – income tax of only 10%. But, of course, there are possibilities for improvements – wider implementation of European administration practice, a greater transparency of state authorities, campaigns against corruption and unemployment. Inflation in 21011 was rather high – about 8 per cent, but, on the other hand, monetary policy is important for establishing a balance between currency stability and export. We also consider it important to have a foreseeable tax policy whose parameters we can include in our calculations without being afraid that they might change unexpectedly.

E: Do you plan to further reduce the number of employees in response to the crisis?

K. Kravcenko: NIS performed the staff rationalization in the last three years and that rate is much slower now. As for the social programs, we are among the leading companies in the region because we pay out about 25.000 Euro of severance pay per employee on the average. At the same time we open new vacancies – about 1.600 people have been employed in the reconstruction of the Pancevo refinery alone. A long term character of the investment program will contribute to the increase of this number, which is important in the situation when more than 20 per cent of working population is unemployed. Another priority is providing jobs for young people, who are actually the force which will make NIS one of the regional leaders by 2020. In this field, the „First chance“ program of the government is welcome – dozens of young specialists have got a job in NIS through this program.

E: Belgrade Exchange operates largely owing to NIS shares. Are minority ownership packages already grouped and do you expect that bigger groups of minority shareholders will be formed?

K. Kravcenko: We already have serious institutional investors from Europe, large investment funds. I personally do not expect any significant leaps in the future because apart from Telekom I do not see any major players in Belgrade Exchange, but with joint forces, together with the state, we will develop Belgrade Exchange. The Exchange has recognized us – for two years on end we have won their award for the best relations with clients.

E: Have you considered the possibility of being listed in some stock exchange abroad?

K. Kravcenko: It is up to shareholders to decide. As a manager, I am responsible for current business activities. We are technically ready for it because we have an international reporting format, a high quality system of work with clients, but it is up to shareholders to decide.

E: NIS in 2012 the way you see it? Do you expect a drop in fuel consumption because of the crisis?

K. Kravcenko: We do not let ourselves be carried away by success. We are cautious about our expectations for 2012 – politicians and economists say that this year will be rather difficult for the economy of Serbia. NIS as one of the pillars of its economy will not be able to avoid the crisis. Its consequences may include the fuel market reduction – individuals and companies will be forced to save money, also on power fluids, and this trend is already apparent in the whole region. If certain incentive measures are implemented there is a possibility to increase consumption or maintain the level we had in 2011. If the policy does not change and the crises gets more serious then there will be a reduction. We have been moderately optimistic in our business plan for 2012 and we have foreseen a 0% growth. We will be able to live through the crisis and go on only if we work efficiently, as a company, and together with the state. Even so, our task is not to just survive, but to develop ourselves. In 2012 NIS intends to put into operation the biggest industrial project in Serbia in recent period – a revamped refinery in Pancevo, increase the resources, increase oil and gas production, develop new business areas. Our aim is for NIS to have the same place in the world of business as Nikola Tesla in the world of science, or Novak Djoković in tennis, so that Serbia would be proud of NIS as a serious European player.