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Executives

Andrey Gaidamaka – Deputy Vice President-Strategic Development

Analysts

Andrey Gromadin – JPMorgan

Tatiana M. Boroditskaya – UBS Ltd.

Ivan Khromushin – Gazprombank

Alexander Kirevnin – VTB Capital

Zoltan Palfi – Credit Suisse

LUKOIL (OTCPK:LUKOY) Q3 2012 Earnings Call November 27, 2012 9:00 AM ET

Unidentified Company Representative

Ladies and gentlemen, thank you for coming. And I want to introduce Deputy Vice President, Strategic Development, Mr. Gaidamaka who will inform you about the financial presentations and financial results of the third quarter.

Andrey Gaidamaka

Good morning, dear ladies and gentlemen. Thanks for coming and giving us this opportunity to tell you a little bit about the results of our company. I would like to start with the most exciting part, and this is something that lawyers do have – tell us we have to show.

And I also would like to talk a little bit about the company itself first. And of course, most of you here know the company very, very well, but it never stays the same. It changes. Today, LUKOIL is a global energy company in scale; today, we operate in 38 countries; and it’s important to note that an increasing portion of our upstream and downstream operations is coming from international operations.

And as you can see here, we have very sizeable upstream operations today on top of Russian Federation. We have very large operations in Uzbekistan where we’re number one from private operators. We’re about number three or four operator in Kazakhstan. We have a large operations and presence in Azerbaijan. Of course, we are significantly increasing our presence in Iraq as we speak.

And today, we produce over 10% of our total hydrocarbon output outside of Russia, and that has been growing at about 15% CAGR compared to way slower growth of our Russian operations. It’s one thing.

Second, it’s important to note that LUKOIL is not just an upstream company. We generate over $5 billion of EBITDA from our downstream operations, most of which are Russia and CIS located. It’s very important to know that our downstream net income or downstream EBITDA went from about $0.5 billion about 10 years ago to between $5 billion and $6 billion depending on the year currently or just in the last decade also.

Just a few matrixes of how the company compares to the rest of our peers. And as you can see, it’s one of the largest liquid hydrocarbon holders, reserve holders, but at the same time, we have very large reserves of natural gas.

And it’s important to note that the reserves of natural gas that we are developing today and most of the production growth that we are experiencing in natural gas are coming not from Russia, but they are coming from Uzbekistan and Central Asian countries. Hence, that gas per barrel of production is significantly more profitable than some of the Russian liquids.

The two – just wanted to also show the company is working on higher production growth and higher investments currently. And you will see in the presentation that our capital expenditures have grown about 50% year-on-year. But as you can see, in 2012-2021, our CapEx per boe of production is going to grow, but it’s not going to grow that significantly compared to 2007-2011 matrixes.

And even our forecast growth of capital expenditures in the right upper graph, you will see that it’s significantly lower than the historical results that have been achieved by most of our competition, which means that, and also, the lifting costs, as we can see here, lifting costs are significantly below the averages of our international competition, which means that even in the situation of fairly harsh tax environment in Russia, the company is able to generate very competitive rate of return on invested capital of ROACE, as you can see here.

It’s also important to know that the company continues to generate world-class free cash flows. Right now, as you can see from our competition, in terms of our free cash flow generation, we are somewhere between Chevron and Total in nine months of 2012.

Just a couple of recaps of what the company looks like in sort of longer-term future. This is part of our strategy presentation. As you can see, we’re going to continue to grow both on liquids and on natural gas side. And it’s important to note again that natural gas side growth is going to come mostly from non-Russian sources, which is going to be significantly more profitable than Russian natural gas. As you can see, nat gas is going to grow from 16% to 27%. And the company is going to continue to fairly significantly increase its hydrocarbons output into the future.

How do we achieve that? In Russia, it’s coming on the back of stabilization of Western Siberia as you can see here. It’s coming on the back of continuous growth of our Urals and Lower Volga region. We had a significant decline in production in Timan-Pechora due to YK project that many of you have heard of, but that has stabilized – is stabilizing as well and we expect a resumption of growth in Timan-Pechora in 2014 as well.

Here, we are showing that despite the fact that there is a significant increase of capital expenditures in the program of 2012-2021, it’s also important to note that about $30 billion out of that increase, which is a significant portion, is going to come from self-funding project such as West Qurna and other production sharing agreement contracts, which means this is capital that is going to be very quickly expanded and recovered pretty much in the same year.

The company has grown its EBITDA level about five times in the last 10 years. And according to our growth strategy, it’s going to increase by about another 50% to 60% going forward in the situation of stable and significantly lower crude price that we have today.

Now, a couple of words about dividend. We just announced an interim dividend. And today, we have shareholders’ meeting that is in the process. And some of you should have been getting the ballots for the shareholders’ meeting. The shareholders’ meeting is going to conclude on December 16. And it is about first ever payment of the interim dividend in the history of the company that has been announced at 40 rubles per share.

In 2011, we announced 75 rubles per share dividend, which was a very significant increase of about 27% increase year-on-year. And 2012, we are guiding our investor base that we will have at least 15% increase year-on-year, which means that today LUKOIL stock is trading at dividend yield of somewhere around 5%, which makes it a very comparable even to fixed income investment in kind of the same – in securities of Russian oil and gas companies.

Now with all this, to the financial results that we have been able to achieve. As you can see, net income went to about $8.3 billion and free cash flows in nine months of 2012 went to $4.8 billion, on the back of EBITDA of $14.2 billion and net debt, which went to just above $4 billion. Obviously, with such a ratio of EBITDA to net debt, that makes LUKOIL one of the most underleveraged companies in the investment universe and we continue to decrease our leverage.

Now, in terms of hydrocarbon production in nine months of 2012, we are the second in Russia to Rosneft. And at the same time, it’s important to know that in terms of net income, we are actually higher than any of our competition in Russia. And that is, again, due to the fact that we have two segments that are less developed in other Russian competition. And that is international upstream and downstream segment.

International upstream is more profitable per barrel of production than Russian. And what is even more important is very developed and more sophisticated and more modernized Russian downstream segment that is quite profitable that makes us – that gives us that edge.

So, that includes refining, marketing and petrochemical operations, but also a number of smaller operations such as bunkering, such as retail, air fuel and so forth. Lubricants which is also a significant contributor to our operations, we have one of the largest trading companies inside of LUKOIL, Litasco and so forth. This slide basically shows the same thing and that is EBITDA per barrel and I think our per barrel is the highest in the Russian universe amongst all of the companies.

Couple of words about the changes of macro environment. As you can see, we have sort of positive and the negative factors at the same time. We have fairly substantial increases, nine months to nine months of pricing. And the refining margins actually and the downstream margins in Europe, we had 3% to 5% increases in diesel and gasoline in Europe that did improve the refining margins.

At the same time, we had a fairly substantial devaluation average, devaluation of ruble in Russia, which temporarily has put some pressure on Russian refining margins. And as you can see, gasoline in Russia went down by about 8%. The ruble appreciated in real terms, but it was very volatile during that time. It’s also important to know that MET, mineral extraction tax, also went up nine months to nine months, at the same time, crude oil export tariff went down.

And in terms of physical parameters, this is – I’m glad to report that the company is glad to report that we stabilized production. As you can see nine months on nine months, our hydrocarbon production is 0.3% growth. That comes from the back of a very significant increase of almost 11% of natural gas production, all of it is coming from non-Russian sources and some decrease in liquids production.

But also it’s important that the company has significantly increased high-octane gasoline production after commissioning one of the largest and most sophisticated cat crackers at North Sea refinery. We’re continuing to increase, as you can see, domestic sales of refined products, which is by far the most profitable part of LUKOIL operations.

Three quarters – third quarter on the second quarter 2012 shows even better picture. As you can see, hydrocarbon production is up 2% quarter-on-quarter, third on the second quarter. And that comes on the back of 2% increase in liquids production and about 3% of gas production increase and continuous increase of high-octane gasoline production.

I won’t go through all of the parameters of our income statement. I just would like to highlight couple of things here. As we promised, the very significant reduction of our average net income in the second quarter, which was just over $1 billion, was temporary due to offsetting effect of how export tax on crude oil works in Russia. There is some delayed effect after crude prices decrease. It does hurt for a quarter. As you can see, net income did recover to about $3.5 billion, which is more sort of normalized running rates of the Company. EBITDA has also increased from $3.5 billion in the previous quarter to $5.4 billion.

This is something that I’ve been always sort of asking our investors and analysts to concentrate on kind of longer term trends in the Company i.e. nine months to 12 months financials and pay less attention to quarterly financial fluctuations.

Very important slide, as you can see here the western refining margin has been extremely volatile during the nine months of 2012. And this is something that you will see the – what has happened in Europe and U.S. it’s very easy to track. It is less easy to track what is happening with the Russian refining. So I wanted to concentrate on that for a second.

As you can see, the Russian refining went to over $20 a barrel of refining margin in between April and July and then it went down to below both European and U.S. averages in sort of July, August and that was on the back of devaluation of rubles, because the Russian retail prices were not adjusting fast enough for volatility of ruble exchange rate. And but as you can see when ruble stabilized and actually it started to appreciate back again.

We had sort of normalization of refining margins at levels about $20 a barrel, which is more a longer-term, I would say $15 to $20 a barrel is more kind of longer-term Russian refining margin. That also went on the back of as I said very significant increase of close to 9% increase of high-octane gasoline production in the lower right graph that we are showing here. And that was due to as I mentioned the fact that we are putting into full commercial operation, the cat cracker in Nizhegorod right now.

In terms of operating expenses we actually have very stable operating environment with a very small, with very stable hydrocarbon extraction expenses, which is good. We are sort of overcoming the inflationary pressure. In terms of refining expenses, they were somewhat influenced by the fact that we did increase the share of our ownership at ISAB refinery, so that’s organically we did not have a significant growth in refining expenses.

It’s important to note that listing costs during this time actually went down. As you can see they went down from close to $5 a barrel to about $4.92 and this is something that shows that the company is able to overcome inflationary pressures both through rigorous cost controls and also through changes in combination of its hydrocarbon output. That applies uniformly also to transportation and SG&A expenses. As you can see, SG&A sort of went down year-on-year and both quarter-on-quarter and transportation expenses remained fairly flat.

The company did generate somewhat smaller, somewhat lower net income in nine months of 2012 compared to nine months of 2011. But in reality, we have some accounting reconciliation that did allow us to improve net income in 2011 through additional tax offsets, which were not available in nine months of 2012.

So in terms of overall profitability of the business, the profitability did not decrease, we stayed at fairly constant level.

In terms of cash flows, it’s important to know that the company in the third quarter of 2012 generated a record free cash flows of about $3.1 billion and that did allow us to substantially continue to reduce debt and also to continue buyback some of the shares of the market.

Well, since like if that red line in debt to capital ratio continues its trend then we are going to be one of the lowest gearing ratio our companies definitely in this sector. And as you can see here with net debt of $4.1 billion and EBITDA sort of mid-cycle EBITDA of about $20 billion that makes LUKOIL one of the least leverage companies.

In nine months 2012 the company managed to reduce net debt by about $2.3 billion despite the fact that we were increasing buyback of the stocks.

In terms of capital expenditures it's very important to know that the company did significantly increase E&P expenditures, as you can see nine months to nine months of 2012 and 2011, the CapEx in E&P sector went by over 40% in Russia and just under 40% internationally.

Refining marketing is also increasing both on the back of Russian increases and international as well. This is something that we were showing you from the very beginning this year that the company is going to go through significant CapEx increase, but at the same time, we are conservative enough to stay with a very low gearing ratio.

Now, where that investment is going to, it's important to know that the company has started full-blown investment into West Qurna-2 project and I’m glad to report that through certain optimization work, we have somewhat reduced from the beginning of the year, net free capital that the company is going to be deploying into the project before it comes into self-financing stage, and the commercial production is still set to start in the end of 2013.

So after which, it will grow very significantly to, as you can see here, to about 60 million barrels in 2014 at which point West Qurna-2 project is going to be one of the most significant contributors for three or four years to production growth of the company and also into the cash flows of the company as well.

It’s important to note that unlike some of the views that I have seen expressed by the analysts, West Qurna-2 is a combination of production sharing agreement and the service contract. Production sharing agreement is to about 2016, when we recover all of our initial investments in the project or most of it annually, after which, yet that’s which to a significant lower cash flow project, but that’s after we got back all of our money and all of your money of initial investments out of that project.

After that the huge project becomes self-financeable and all that RevPAR, which is about $29 billion, is our capital expenditures that are going to be spammed and recovered within the same year or within the couple of years in the project.

It’s also important to know that the LUKOIL overseas management, which is the operator of this project, is very firmly convinced that the company will be able to achieve its target return rate of about 15% in this project.

Couple more significant developments that have happened in the past nine months, we continue to consolidate position in the Caspian, which is by far the largest growth area for LUKOIL in Russian upstream. And as you can see here, we have – we continue to negotiate the consortium participants with the Russian and Kazakh government for two very large projects and that is (inaudible) field.

The [Korchagin] field is close to 700 million barrels of liquids and about 250 million barrels of gas; and Filanovsky field is another 0.5 billion barrel property in terms of hydrocarbon, where LUKOIL has respectively in (inaudible) field we have 25% share and 50% in Filanovsky field. The development of these fields has not started. And this is – it’s still something that – it’s part of the forecast and future capital expenditures of the company.

I’m also glad to report that the company has fairly substantially increased the reserves at Karchagin field which is producing property and some of you have visited that property this summer when we organized a field trip and flew helicopters to the production platform. This is the property that is to be in operation, one of the most profitable operations that we have in our portfolio because it is enjoying very good tax treatment. It is enjoying about 50% reduction in export tax and it’s enjoying zero mineral extraction tax at the moment.

This is the platform that I’m talking about. And as you can see that the production in the Caspian has been increasing already in nine months of 2012 to basically it’s more than doubled 2012 from 2011. And it’s going to continue to increase till 2015 and onwards, till 2014 it will be increasing on the back of Karachaganak field; 2015, 2016 is when our second way larger, close to $1 billion barrel Filanovsky field comes into production at which point we will continue to increase production on the back of that field.

Right now, again, we are increasing production only from Karachaganak field, but we are investing quite heavily into platform construction that will be deployed – the platform will be deployed next year onto the site, and to start production at a way larger property at Filanovsky field.

Now, it’s important to know that as we say here that the effective growth of EBITDA due to increased production from the tax-exempt properties in the Caspian will likely to amount to above 1.7 billion into three years from 2013, including about 300 million in 2013 alone.

One more value driver that I would like to highlight is the company has connected its South Timan Pechora operations with its YK field, which does allow us to use the downstream infrastructure and transport infrastructure that was created for YK field that obviously is in decline today to increase throughput of crude going from the continent and being reloaded at Varandey terminal.

That development itself we estimate that initially it will improve EBITDA by about $200 million, so the payback of that project is basically one year. We have expanded about $0.25 billion in construction of that pipeline and due to improvement in crude quality compared to the euros bank we are expecting to double that level going forward.

Also important to know that the company continues to increase production of high viscosity crude at Yaregskoye field and we received very good tax treatment of high viscosity field on the so-called 10-10-10 PEG (inaudible) program, which will generate about $0.25 billion in 2013 additionally and about $1 billion in the next three years on this production forecast.

Very important development that we continue to talk about and surprisingly to me it continues to surprise some of the investors.

This is our Uzbekistan properties. Many people have heard about [little] beauty country called China and many people even know that they need hydrocarbon. Well believe at LUKOIL that the most sensible and the most logical way of filling in the growing demand for energy in China is pipeline gas, and Chinese natural gas demand is increasing.

And as you can see, there is a pipeline that has been built about already almost 12 months ago that connects Uzbekistan through Kazakhstan as you can see in that map on the upper right part. That goes to China and China has created with this pipeline that is a very significant development for China, its about 25 bcm line. Now we understand from our Chinese partners that their way into the process of increasing capacity of their pipeline to about $60 billion and that is ongoing project as we speak.

The pipelines are not being built by LUKOIL. LUKOIL does not participate in construction of those pipelines. They are being built by Chinese National Petroleum Company by CNPC, but it happens to pass through as you can see through some of our most significant gas producing properties.

We are not selling gas to China, we are selling to Uzbek government, Uzbekneftegaz and whatever they do with it, it’s up to them. We are combo PSA operator, but we are just showing that the full effect, the demand effect for natural gas out of the region is continuously increasing, and that’s what allows us to significantly continue to increase our production volumes of that gas. And that is going to continue.

It’s very important to know that the nat gas out of Central Asia is substantially more profitable on EBITDA per barrel of oil equivalent in its level than regular taxation Russian, Western Siberian liquids. So some people have been telling me what you guys are increasing gas production, it’s actually less profitable than oil production, that is actually opposite. The PSA regulated natural gas production out of Central Asia is actually more profitable than regular taxation with Siberian liquids.

Also we would like to note that the company will continue to improve its position in Russian refining. We have a number of projects that will become on stream. I don’t want to be going through all of them. But basically the total effect on EBITDA for new units launched in 2013 to 2015 is expected to be about $1.3 billion.

It’s also very important to note and please take some time to look at our MD&A about it that the Russian government has finally put its regulation were its mouth has been for a long time in terms of decreasing excises on high quality Euro V compliant fuels and increasing excises on low quality Euro III and lower grade fuels in Russia.

That alone in 2013 and 2015 that those excise savings likely to give us about $1.9 billion in the next three years. And it is very important for us, because we have been very active modernizers of the Russian refineries. We are very happy about the financial results we have been able to achieve up to date, and this is something that we are going to continue to improve going forward.

The facts that I was just talking about likely to come to an increase of our mid-level, EBITDA level of about 20% in the next three years or so with about 6% increase in 2013 alone.

With this, I would like to conclude this presentation, and say once again that LUKOIL is the company which is stabilizing production right now, which has a number of very large Greenfield project, very diversified project, which come both from the Russian Caspian, from the Central Asian gas, from Iraqi liquids it's very diversified Russian international portfolio with more emphasis on non-Russian liquids, and natural gas hydrocarbon growth.

At the same time, we will continue to significant to improve the profitability of our Russian downstream sector, which by far is the most profitable part of LUKOIL operations up to date. And it's also important to understand that the company has been very conservative in terms of its dividend policy. We are increasing dividend payout to the shareholders, and as I have mentioned in my previous presentation, the company has never decreased its dividend throughout the Q3. We’ve been always growing our dividend even in the most difficult years in such years as ‘98 or 2008. the company has been always increasing the dividend payment that is important part of our philosophy and we will continue to do so.

Despite the fact that we’ll continue to maintain say kind of low financial gearing, and we have enough capacity to fund older project that I was just talking about. It is possible that in 2013-2014, the company can be cash negative depending on the market situation, but the company has very strong balance sheet to tackle any investment projects that we have in front of us.

With this, I’ll conclude my presentation and I’ll open floor to the questions.

Unidentified Company Representative

Thank you. I think I’ll just sit down to remind.

Question-and-Answer Session

Operator

(Operator Instructions) (Inaudible) We had continuous increase of the sort of high-spec drilling at LUKOIL. As I have shown, we had about 40% increase in total CapEx most of it did come on the back of higher investments in the, it won’t just horizontal drilling, it’s a number of techniques such as multizone hydrofracturing, which has been very significant factor for improvement for our operations in Western Siberia such as Cyprus and so forth.

In terms of the exact numbers, we’ll get back with you on this, I would appreciate if you could email that question to irlukoil.com. And also I’d appreciate if when someone else has any question, you can state your company.

Unidentified Analyst

Yes, actually just follow-on question on that, and this is [Maria Agustin] from UBS. Could you tell us also what was the average initial flow rate at the new wells in West Siberia in that same period nine months 2012?

Andrey Gaidamaka

Well, the average total rate has been fluctuating between sort of 11, 12 tons per day per well, which is about 80 barrels to 90 barrels per day per well. But that’s not an initial rate, that’s an average rate. In terms of average initial rate, we don’t track that path, so it depends on sort of what kind of wells you’re talking about. Generally, the company does not make an investment decision into well in Western Siberia at levels of about below 150 barrels per day per well for initial flow rates.

Unidentified Analyst

Hi, [Susan Gim from Caxton.] I had a follow-up question on the Corona project. obviously, getting some Chinese partners involved to decrease the CapEx is the potential options, any color in terms even getting CNBC or Sinopec as potential partners in the Iraq project? Just to lightening some of the CapEx obligations, any color you have on that opportunity?

Andrey Gaidamaka

Well, we see Iraqi project as quite an attractive opportunity in itself. so I just want to make sure that we will understand here that LUKOIL is going to continue and pursue that project regardless of what partnership situation is going to look like, but we do have very significant solid interest in entering that project from qualified bidders. So I do believe that we will have a share that CapEx responsibility with the partner absolutely. This is an ongoing sort of project, but it has some issues associated with that, but we are actively working on this. So answering your question, yes, we will have a partner in that project and it will further lighten up the CapEx obligations as well, but of course, we will have to share the upside of the project as well.

Just a couple of things I want to mention on the previous question. We had which is called the stats here, we had in terms of wells, we had a very substantial increase in horizontal drilling, which went up by about 60% on 2012 to 2011, so that continues to be fairly substantial part of our increasing investment in drilling.

Unidentified Analyst

You wouldn’t have that number in meter, would you?

Andrey Gaidamaka

In terms of meter, so I would have to get back with you on this. I think in meters it’s going to be way smaller. In terms of meters, I probably would say, it’s going to be more like 10%, 15%, because we are going to have shorter wells in general.

Unidentified Analyst

Thanks.

Unidentified Analyst

[Peter McMillan from Kingdom Capital]. On West Qurna-2 if Iraq dials down there targets, they are under review for production, do you remember taking to account a lower target production by 2017 already or is that still subject to revision?

Andrey Gaidamaka

You see it’s a production sharing agreement, so I think any obligation that Iraq takes upon themselves to the country are going to reflect on or can’t reflect on a number of projects in that country. I don’t expect that we will be exempt from it, but again I won’t describe the fact that it’s a production sharing agreement. So usually the operator does not suffer that much from reducing selling on upstream output, which means the return on capital is not going to be affected by this.

Unidentified Analyst

Thank you.

Andrey Gaidamaka

Well, it looks like if we kind of exhausted your patience from the room. We might take some questions from the lines in Internet.

Operator

Our first question comes from the line of Andrey Gromadin with JPMorgan. Please proceed with your question.

Andrey Gromadin – JPMorgan

Good morning. Thanks for the presentation. I have two questions. First on crude oil output outside of Russia, it was down more than 7% in the third quarter versus second quarter. Could you please explain what was behind that? And my second question about West Qurna, do you expect if it’s only first stage i.e. if you are not able to raise production above 300,000 barrels a day? Thank you.

Andrey Gaidamaka

Well, the bulk of decrease in – and that’s actually in MD&A, if you look into it carefully, we only posted it a couple of hours ago so probably there was not much opportunity to do that. But you will see that we have to decrease our share in Karachaganak, which is substantial producer in basically all of the members of Karachaganak consortium have to reduce their share by about 10%. And that was bought out by Kosmonai Gas, so some of that was structural change in hydrocarbons output outside of Russia. But also we had some reduction in crude oil output from our legacy Kazag project.

As far as, but at the same time like I said, we're having very significant growth from our natural gas projects in Uzbekistan, which is more than compensating those declines. It's important to understand that LUKOIL today has very diversified international portfolio that with production volume of about 230 over 230,000 barrels per day, which by itself is can rival in its size in certain U.S. lipid independence just the size of our upstream truly diversified operations outside of Russia. And that volume has been growing by about 15% CAGR and those international operations as far as our member today generate really or about $2.5 billion of EBITDA.

So the international operations of LUKOIL mostly upstream operations are generating about $2.5 billion of EBITDA per annum that’s from zero about a decade ago. In terms of the peculiarities of Iraqi project, I probably would like you also to send that specific question to irlukoil.com and, I would be happy to see how we can answer that, because there are certain confidentiality restrictions, so we’d not be very comfortable to discuss peculiarities of that project at a conference call. Thank you.

Andrey Gromadin – JPMorgan

Okay, thank you.

Andrey Gaidamaka

Any more questions of over the line?

Operator

Our next question comes from the line of Tatiana Boroditskaya with UBS. Please proceed with your question.

Tatiana M. Boroditskaya – UBS Ltd.

Good afternoon. Thank you very much for your presentation, Tatiana Boroditskaya from UBS, just several questions from me. First of all, can you please clarify throughout any further intentions to continued buyback of shares, and if you give any further details on that such as size environment, that would be great?

And secondly, can you please clarify where do you see your CapEx for 2013? and finally, do you intend to raise any debt at international markets before year-end and next year?

Andrey Gaidamaka

Very good questions. I think if we add a couple more to it, such as exactly what we are going to be doing tender on the share buyback program. And during what time period, we’ll be doing this. I think, there would be even more interesting for the investor base. but in general, I would say that the company continues to be committed to the share buyback program, that despite the fact that we do have some issues with the fact that the company has very substantial treasury shares today quasi-treasury shares, we do have some concerns about the Russian legislation how it’s developing today in terms of treatment of those quasi-treasury shares. So this is something that we’ll have to get clarity from the Russian regulators before we proceed and how we’re going to proceed with that share buyback program. It’s just for an understanding of some of the investors here, some former competitors and colleagues in Russia had some issues when they crossed 10% threshold in terms of their ownership of treasury shares and this is something that we are looking into.

So we would like to continue to build on our treasury position, but we are somewhat restricted in our ability to do so not in terms of cash, but in terms of regulatory environment. In terms of coming to the market at the moment, the Company is quite free cash flow generative and there is no pressing need for us to do so.

I would not conclude as I said in my presentation that in 2013, 2014, depending on the cash costs on our large PSA project, we might be considering such steps, but when and in what shape that’s something that we’ll have to let you know additionally.

Okay, we also have a question from Ivan Khromushin from Gazprombank. Can we put him on line?

Operator

Ivan’s line is now open.

Ivan Khromushin – Gazprombank

Hello, do you hear me?

Andrey Gaidamaka

Yes.

Ivan Khromushin – Gazprombank

There was a question from the previous, my colleague on CapEx guidance for 2013, it was not yet answered. And my question is that, I have two, how you can see that partial cancellation of the stake of treasury shares. I don’t move but maybe in part it could be a good solution. And second question is whether you plan to actually consolidate – fully consolidate West Qurna and what part of West Qurna production you will show on your accounts, I mean liquid productions, yeah it would be a safe page in light on the page of service contract? Thank you.

Andrey Gaidamaka

Well, thank you for your questions. I would say there were three questions. One is CapEx guidance, something that we obviously had very substantial decrease of CapEx compared to our guidance in 2012, which came on the back of some difference in timing, but the same time improvement of efficiency of our projects in West Qurna, in Uzbekistan, and in West Africa in terms of exploration.

So some of that CapEx that was not expanded in 2012, it’s going to roll over into 2013. At the moment, we are reevaluating that level. I do not expect that the level is going to be significant higher than the previous guidance provided in March and our presentation by our presence in March of this year in terms of long-term CapEx guidance. But this is something that we’ll have to report at a later stage when we understand better our CapEx of course on those very large DSA projects as I said. So at the moment we are not changing our CapEx guidance for 2013, yet this is something that we’ll have to come back with you a bit later.

In terms of cancellation of shares, the short answer is absolutely yes, we have considered this, we continue to consider this. Unfortunately, we have not been able to see the President in the Russian market of significant scale of cancellation of shares. Well, it is taking pretty substantial work with the regulators for us right now to work through how that can be done.

There’s a number of possibilities of usage of that treasury stock and absolutely cancellation can be a part of it. Another part of it can be further increase of in place of ownership plan, which is not going to be substantial, I mean the, from the standpoint of reduction of or the total treasury stock. But it can significantly improve and align the interest of the senior dash middle management of LUKOIL with minority shareholders.

As far as I am concerned, we’ve been having a lot of demands from the minority shareholders for such in place of ownership plan in the past. So that’s answering the question on treasury stuff.

Now in terms of West Qurna, it’s something that we do have in the slide and I just want to show you. This is exactly the slide that is showing both the impact in terms of crude production level year-by-year and CapEx and free cash flow. This is – since this project is expecting such a significant attention from our shareholders, the only project that we decided to show in such a detail and this is something that we estimate that is going to keep our accounts in its current shape without significant change in the shares in the composition of the partners in that project.

Ivan Khromushin – Gazprombank

Do you expect to fully consolidate it or might be it should be a (inaudible) after might the (inaudible)?

Andrey Gaidamaka

Well, Ivanovic I don’t think that it’s a question of speaking about fully consolidation because it’s actually quite a bit same, quite a service. I think that will account for compensation oil and our actual CapEx, so actually the impact on net income will doesn’t depend on the way either we consolidate the full figures or just the compensating oil.

Ivan Khromushin – Gazprombank

No decision taken yet on this?

Andrey Gaidamaka

I think that the way we’ll be there account for compensating oil, but actually this is not the final decision, but actually I don’t expect any significant impact of the method of consolidation on all account.

Unidentified Company Representative

I think this is something that again how that project is going to be reflected in the accounts does not effect whether it’s going to be accounted. It’s not going to be accounting or equity method is that what you are asking? So it is going to fully impact both production revenue and the cost of the company. But in terms of how exactly that’s going to be done, I would appreciate also if you could drag that question on technicalities to IR at lukoil.com and we will be able to provide you with an answer. Thank you.

Andrey Gaidamaka

Exactly we don’t watch for whether it (inaudible) in answer.

Ivan Khromushin – Gazprombank

One more question here. Could you tell us about the timing of the purchase of 20% stake in the ISAB refineries?

Andrey Gaidamaka

Looks like UBS does have a lot of people that are interested in LUKOIL, which is always very good.

Ivan Khromushin – Gazprombank

It’s a good thing right?

Andrey Gaidamaka

Absolutely I agree. But we just had another basically 20% increase in ISAB Holding in basically in September of 2012 in the third quarter. So we don’t expect anything like that to happen by the end of the year. But it’s not our decision on when our partners can come to us because they do have an option. So we’ll see when they make that decision.

Unidentified Company Representative

We also have couple of questions from Credit Suisse and one more bank. Let’s go ahead with VTB Capital. Let’s go with a question of VTB Capital first and forward by CCB.

Alexander Kirevnin – VTB Capital

Hello, it’s Alexander Kirevnin from VTB Capital. Thanks for presentation, really good result. Actually only one question left from my site. You said that the benefits of the company from different excises on Euro 3, Euro 5 motor fuels will amount from $1 billion for the next three years, and so my (inaudible) was the latest amendments included in this calculation or those $1 billion based on the previous rate before the November 2012? Thanks.

Andrey Gaidamaka

Can you once again repeat the end of the question, what amendments in November or what?

Alexander Kirevnin – VTB Capital

During November there was one amendment, which actually decreased the difference between the excises for Euro 3 and Euro 5 for motor fuels?

Unidentified Company Representative

Yes, it includes all this final amendments.

Andrey Gaidamaka

Well, it’s available in page 20 of MD&A, we have very detailed on explanation of the history and excise situation up to the nine months of 2012. It’s important to note and that is very good news that I need to report to the shareholders that after like, as our colleague from CCB has said, in November, there was a follow-up, a fairly substantial reduction of excises on high quality motor fuels in Russia. So we’ll benefit from it even further. So answering your question, yes, the November changes have been included in the calculation that we have shown here.

Alexander Kirevnin – VTB Capital

Okay. thanks a lot.

Andrey Gaidamaka

And we also had a question from CCB.

Operator

Our next question comes from the line of Zoltan Palfi with Credit Suisse. Please proceed with your question.

Zoltan Palfi – Credit Suisse

Yes, good morning gentlemen. thanks for the presentation. I have one question. is LUKOIL considering to expand its footprint in Southern Iraq in light of the various press articles that suggest that you are looking to assume operatorship of West Qurna-1? And as a follow up to that question, what’s the kind of total risk investment amount that you would still feel comfortable with in Iraq?

Andrey Gaidamaka

Well, I want to say that we are comfortable and in with our current Iraqi operations, and we consider Iraq as a very important part of our further expansion strategy. So we’ll consider any significant opportunity that comes our way in terms of that particular development. At the moment, I do not have, I would not like to comment on this.

Zoltan Palfi – Credit Suisse

I see, thanks a lot, Andrey. And can you tell us kind of what sort of risk investment number, the company would tolerate in Iraq, kind of along the lines of the $4.5 billion that you’re currently assuming for West Qurna-2, how high that number can go?

Andrey Gaidamaka

We do not have an official number in the company that we say it as sort of total level of risk investment. So it would be difficult for me to put an exact number on this. But we obviously did state that we just achieved 36, substantial decrease of about – over $1 billion of net risk capital in our Iraqi investment and this is something that obviously we were able to tolerate somewhat higher number in the past.

Zoltan Palfi – Credit Suisse

I see. Thanks very much, Andrey.

Andrey Gaidamaka

Well, with this, I probably, since we don’t have any further questions from the room; I probably would like to conclude this presentation and conference call. And thank all the participants of this conference call in the room. Those participants that were in the line and show interest in the company and special thanks for UBS to help us organize this event. Thank you very much.

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