Kirill Kravchenko interview to Izvestia

September 21, 2015

Acquisition By Gazprom Neft in 2008 of the controlling stake in Serbia's largest oil company, Naftna Industrija Srbije, became Russia's biggest single investment in the Balkans. Considering the condition that NIS was back then, that money could have been spent more efficiently by investing in oil production in Russia. What was special about this asset for Gazprom Neft? — Gazprom Neft adopted a strategy back then to expand its business operations abroad, meaning that at least 10% of its upstream and 30% of its downstream business should be outside Russia. We eyed various assets then, and we found NIS interesting as it consisted of various components each having a big growth potential. NIS had been managed by government for a long time, though, which had created problems for the company. What were the most serious problems? — According to our deal with the government, in additional to paying for the controlling stake we had two major commitments. The first was to invest $500 mln in modernizing the oil refineries and the second to start production of Euro-5 fuel as quickly as possible. We had to deal with the debts that had accumulated before we stepped in and with substantial amount of operating loss, which was why our main task at that point was to make the company break even. As things were getting better, a new strategy was adopted for NIS, which implied developing the company as a vertically integrated oil enterprise capable of performing a full cycle of operations from crude oil production to finished products sale, and turning NIS into a regional leader in the Balkans region. As of now, a total of € 2.5 bln has been invested in NIS. And this amount does not include the money spent on the acquisition per se, right? Initial rumours had it that the purchase of the 51% stake cost € 400 mln, but then Gazprom Neft bought 6,15% of shares more. How many shares did you buy eventually? — After we'd bought the controlling stake, we spent around € 40 to 50 mln more to buy additional shares in the market. All in all, the deal cost us around €450 mln. A part of the shares was distributed among Serbian citizens, which was a unique case for Europe. Minority shareholders numbered more than 2.5 mln, and we had to offer them good terms to buy out the shares. Did you launch a buy-out campaign? — We did. We made a offer to the general public via newspapers, suggesting specific channels for the public to sell their shares; for example, we bought 5% of shares via post offices, but the remaining 15% stayed in possession of the citizens, which left the total minority shareholders count at 2.3 mln. Shares were being bought by investment funds from the U.S. and Europe too, but they have less than 1% now. Since 2011, when we increased our share, the price of shares has risen by more than 50%.It is a measure of progress we have achieved in managing this company. What did you use the funds invested in the company for? — Most of the funds were invested in oil production and increasing the reserves which had been dwindling before we came. The reserves have been rising six years in a row now; since the acquisition the reserves have increased by 50%, and oil production nearly doubled (in 2014 crude oil production was 1.596 t.o.e. — Izvestia). But in addition to the upstream and refining business, the company also owns power generation capacities which is quite unusual for companies in this sector both in Europe and in Russia. — Yes, we started it around 2011 as a way to diversify our business, which was when we launched co-generation projects (use of natural gas to produce heat and electricity — Izvestia) on some of our smaller oil fields. In addition to that, we are also doing what is known as green generation which means harnessing geothermal and wind energy. It goes in line with the major European energy trends. Why would an oil company take an interest in green energy? — There are two reasons for this: the first reason is purely historical — NIS had been operating geothermal power plants even before we came. The second reason is legal: European laws impose tough penalties on companies with a big GHG footprint; another option for such companies is to switch to environmentally friendly ways of power generation. Our study showed that it was more cost-effective for us to create one big windfarm. Thankfully, the natural conditions in Serbia are conducive to it.This is why today it would be wrong to call us just an upstream company; we are no longer just an oil company but a full-fledged energy company instead. The current problem is the oil price crisis; we believe that the prices will not rebound any time soon, which is why our main focus now is on enhancing our internal production efficiency. What is your oil price forecast? — The price is known to be highly volatile. We have reduced out medium-term projection for the next three years to $46 per barrel. But you are not going to discontinue your power generation projects? In June, an agreement was signed on creating a company to build a CHP plant in the Serbian town of Pancevo. Why do you need this project? — In addition to oil we also produce natural gas in Serbia. It is more cost-effective to monetize it through the sale of electricity rather than fuel. It marks a transition from small-scale power generation to a large power generation capacity, the more so since our main customer, in addition to our Pancevo Oil Refinery, will be the petrochemical complex (NIS is a minority shareholder in a chemicals company, Petrohemija — Izvestia) also located in Pancevo. It is business logic; it also adds to the stability of our business as oil prices change all the time. However, we are not financing this project on our own, only with partners. We have newer projects too, but we are still in negotiations there. In the Pancevo CHP project, for example, we are contributing only 10% of the total € 140 mln but getting a 49% stake in the final enterprise at that. How badly have the oil prices affected the company? — Not badly. Our most important financial indicator, which operating profit or EBITDA, in the past six months amounted to € 200 million; it is slightly less than before but above our business plan expectations. We have invested more than € 100 mln since the beginning of the year; by the end of the year we plan to reach a crisis scenario level of € 350 million. Last year NIS net profit was $260 mln. Do you have any longer term plans, maybe any specific financial targets, in spite of the rapidly changing oil prices? — Speaking about our plans and strategy by 2030, we will be investing a total of around € 400 mln of our own funds every year in the various business segments, of which 60% will go into upstream (crude oil production — Izvestia) and 40% into downstream (refining and sale — Izvestia). And small cogeneration units, do you produce them on your own? — They are singularly ours, our investment and our assets. What is the current share of your energy in the total market of the country? — So far it is insignificant, around 5%, our target is to achieve a share of 20-25%. For the time being, we are the second producer, the market is currently dominated by a major public power company “EPS”, with a share of 90%. However, they mainly specialize in coal, whereas we work on gas. And yet effective EU requirements are aimed at decreasing coal generation throughout member states, and Serbia is among the pre-accession countries. — It is, and at this point the share of coal generation amounts to 70% in the country, this segment is under a lot of pressure and it is bound to shrink. Do you think it will affect the growth of your market share? — We intend to build up our generation capacities regardless of this factor. What we see as a key factor is that Serbian power market is well linked with other countries, which translates into a constant demand for new generation. For instance, we are currently selling electricity to Bulgaria and Romania. Serbian government is the second largest shareholder of the company accounting for 29.8% shares.  If past experience is any guide, governmental officials and public servants on the boards often act from political rather than economic motives when taking important decisions. As a consequence, company's performance and business indicators are affected. How do you shape relationship with the authorities represented on your Board of Directors? From the very outset, the presence of “Gazprom Neft” in Serbia was viewed with a dose of ambiguity. — We certainly have our controversies but we always strike a compromise. In the past 6 years we have never had to re-vote at shareholder meetings. We have developed a framework enabling to find optimum solutions for all parties, and we try to accommodate Serbian national interests to the greatest possible extent. And yet last summer Serbian authorities initiated an inquiry of NIS privatization, to be explained later on as discontent with company's contributions to the state budget. — No matter how well a partially government-owned company works, authorities will always be aimed at receiving maximum taxes. This is how it works in life irrespective of the country. Our tax liabilities are based on a royalty rate fixed in an intergovernmental agreement, it is a common practice. When the Prime Minister said it would be great to receive more, we tried to improve our operational efficiency but this is as far as we can go. At the moment, we account for 15% of the Serbian budget, in 2009 when we concluded controlling interest purchase agreement our share in the budget was 7%. It should be borne in mind that we have invested in this company much more than we have received from it so far. We believe that all questions call for well-reasoned answers, any problem can be solved if parties have economic interests at heart and are willing to hear each other. We have conciliated our differences now and we do not see any pressing issues in our present collaboration. Don't you think that decreasing oil prices can give rise to new claims towards the end of the year? — We have three delegates of Serbian government on the Board representing different parties. They are fully aware of all details and parameters of our development under these less than perfect economic conditions, they obtain all the information required to take reasonable decisions. How do you shape your business relationship with the Minister for Energy of Serbia Aleksandar Antic? — We have developed a most effective format of cooperation, we meet on a weekly basis. We also hold regular meetings with both the Prime Minister, and the President of Serbia. What is the general attitude of country leaders towards the partnership with Russia? One might get the impression that it is ambivalent: on the one hand, Serbian authorities cannot help noticing the overwhelmingly positive attitude of Serbian society towards Russia, on the other hand, Serbia is a EU accession country, which forces those in the halls of power to offer up the relationship with Russia as a sacrifice to this process. And the decision to close the "Turkish stream" project only added fuel to the flames. — Despite the EU accession process, Serbia never imposed sanctions against Russia. Our countries have been walking hand in hand for centuries, it is a crucial factor. Clearly, relationship with Russia has been going from strength to strength; nonetheless, Serbia is augmenting its potential of cooperation with other Asian and Near East countries. In my opinion, our relationship will benefit from Serbia's forthcoming European integration. Harmonization of relationship with both Russia and the EU, steering a middle course and defending strategic Serbian interests will be the best decision in this process. On the whole, do you feel you are a Russian company or a Serbian one? — It is difficult to say since we mainly speak two languages - English and Serbian, we also try to introduce Russian at top management level. We put a lot of effort into promotion of the Russian language, and it is getting increasingly popular of late. What languages do you speak at the Company? — Serbian is the main language of our communication but we speak English a lot due to major business of the company in adjacent countries. And certainly Russian which is also spoken by many Serbian employees. In addition, we have foreigners aboard, there are 25 expatriates in management, and 150 from the total of 11 thousand employees, around two-thirds of them are Russian specialists. We apply stringent requirements to our expatriate personnel, 90% of them have broad international experience, and all of them learn Serbian culture and language during the first year here. English is mandatory. The differences in culture and mindset, do they affect your operations? — In my view, we have a lot in common with the Serbs, we are result-oriented, we work towards a specific shared result. It is not characteristic of Western countries since, say, Americans and Germans are more focused on individual success. Serbs are hard-workers but they also know how to relax. It brings us together. Do you spend much time in Serbia? — I do, over 70% of my time, my family lives here. I spend up to 20% in the countries where we are developing our business and the remaining time in Russia. How much do you invest in charity and social projects?  — We have a total of four strategic directions of our social investments. We invest in Serbian young people actively hiring them; as a result, average age of the company has gone from 49 to 37. The second and third programs are sports ones, we support different kinds of sports. We have been a sponsor of basketball club "Partisan" and football club "Crvena Zverzda" for seven years now, besides we have sponsored European mountain racing champion Dusan Borkovic and Serbian tennis alliance for five years. We also invest in local culture and communities committing financial resources to 600 projects; last year we allocated 1 million USD to 164 projects. Does Gazpromneft implement social projects in Serbia? — Like I said, for many years now Gazpromneft has been the general sponsor of the Crvena Zvezda football club. Furthermore, we support Russian language courses for Serbians. In the recent years we have teamed up with Emir Kusturica to organize an amazing Russian-Serbian festival of classical music - the Bolshoi festival in the town of Mokra Gora that gathers both celebrated artists and aspiring musicians from our countries. An important example is also the initiative of Gazpromneft employees, who made personal donations to help the victims of the flood of 2014. An important step for preserving the Russian and Serbian historical heritage was the Gazpromneft-sponsored restoration of the Russian Necropolis, a cemetery for Russians who were forced to leave the country after 1917 and remained in Serbia. The memorial complex also includes Iberian chapel and a monument to Russian soldiers killed in the First World War. It is symbolic that the Russian monument stands right next to the memorial to Serbian soldiers killed in World War II. You are managing one of Europe's largest networks of petrol stations under the Gazprom brand in Serbia and the neighbouring countries. How do see the development of the network? Are you planning to buy out stations of competitors to extend the coverage? — Our brand is present in four countries - Serbia, Bosnia and Herzegovina, Romania, and Bulgaria. In the first two countries we have the biggest through put per station in the market. All in all we have 410 petrol stations with 80% on Serbia and 20% abroad. Of course we will keep strengthening our presence in these four markets, will consider entering other markets and, if necessary, buying out competitors. Target markets for us are, in fact, those where we have logistical advantages supplying from our refinery in the Serbian town of Pancevo. Besides Gazprom you company also works under the NIS Petrol brand. How do you choose what brand will be used for a new petrol station? — When we started working here NIS used as much as eight petrol station brands. We position NIS Petrol as a mass brand, whereas Gazprom represents the premium segment. This is a common practice for companies like us in Europe. There is a market segment where people are willing to pay more for additional services and better quality, and this is where the Gazprom brand is positioned. It accounts for around 30% of our petrol stations. Fuel prices in Europe are now falling and might soon reach the Russian price level. How does it influence your sales? — Due to the tax policy of the EU countries the fuel prices there will hardly ever come close to those in Russia. This year there has been an increase: we see a 20-25% growth in Bosnia and Bulgaria and up to 6% in Serbia. Despite the drop in prices we are still in the green and are actually seeing positive market trends. Right now refineries in Russia are being upgraded to reach compliance with Euro-5, the new environmental standard, though the government is considering putting off the implementation of the standard as not all refineries might have time to prepare. If the standard is implemented and causes a shortage in the Russian market, will you supply there? — Definitely not - we are just too far and it would be impossible from a logistics standpoint. How is business going in the neighbouring countries? Are you facing any problems with the authorities? — We are trying to find common ground with everyone. All three of our businesses (production, petrol stations and wholesale) are present in the regions. Wholesale is present in all the countries, whereas our retail network covers so far only Serbia, Romania, and Bulgaria. Exploration and production projects are being implemented in Bosnia, Romania, and Hungary. So far you are producing only on-shore. Are you planning to try off-shore? No, such projects are outside of our area of expertise and require large investments. Due to the oil price reduction the Russian Lukoil has had to pull out of several projects in Africa. You also have shares in projects there, in Angola. — We have inherited this asset and have minority shares in all three segments of the business, but all is well there, and we are planning to stay. We also own a stake in an oilfield service company in Turkmenistan, but are planning to pull out due to the business climate there and growing demand in our local markets. Does it have to do with the oil prices? — There is a number of factors, and a rapid price reduction that caused a drop in demand is one of them. We are now being much more active in Eastern Europe with a lot of drilling projects. So now we are deciding whether to bring the drilling crews here or to deploy them in other regions that would require their services. What will happen to your non-core assets, that are quite unusual for an oil company - the Ozone network of hotels and restaurants, and Jazak water? — We did not buy these businesses; we got them as part of the NIS package. We used to own more hotels, restaurants, and residential buildings. We have to maintain some of these assets as part of our social responsibility under the contract with trade unions, but we are not interested in them and are looking for co-investors to share a part of these assets, especially now during the crisis. If the relationship between Russia and the EU keeps deteriorating is there a possibility the company will be sold? — I do not see any reasons why our relationship with the government would deteriorate, so no. This interview has been published in Izvestia newspaper 12th of September 2015.