PJSC Tatneft. Annual report 2017
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PJSC Tatneft. Annual report 2017

Possible main risks

G4-2

Country and regional risks

The Company is registered and performs most of its activities in the Russian Federation. The main production assets of the Company are located, and the main production activities are performed in the Republic of Tatarstan, which is a constituent entity of the Russian Federation. The political situation in the Russian Federation and in particular in the Republic of Tatarstan is stable. Estimated risks of possible military conflict, the imposition of a state of emergency or a strike in the region of the main activities of the Company are low. At the same time, the Company has approved procedures that can be used in case of an emergency to reduce the impact of such situations on the life, health, and safety of the employees and residents of the regions of its activities, as well as production activities of the Company. The geographical region of the main activities of the Company does not have a great likelihood of natural disasters that would significantly affect normal production. During planning and implementation of works aimed at production, treatment, transportation and storage of oil and gas, oil and gas products, as well as materials used for production, the Company takes into account the geographical specifics of the region, including the climate. The Company has approved procedures and policies aimed at prompt elimination of negative consequences for the Company’s activities, which may result from natural disasters such as floods, earthquakes, mudslides, or hurricane winds. The Company has modern technical monitoring procedures aimed at preventing negative consequences of natural disasters and notification of the population of the region of the Company’s activities of the probability of such consequences. The region of the main activities of the Company is not a remote one in terms of transport and other infrastructure.

Financial risks

The main financial risks of the Company’s activities pertain to currency exchange rate fluctuations, inflation, and the situation on financial markets and the stability of the banking system.

Significant changes in foreign currency exchange rates increase the liabilities of the Company denominated in foreign currency and the expenses to service them, resulting in decreased profits and reduced ability of the Company to service its debts. Significant devaluation of Russian ruble can hinder performance of the Issuer’s obligations. As a result of significant changes in foreign currency exchange rates, Company liquidity indices may change, including in an unfavorable manner. Changes in interest rates may affect the Company’s operations aimed at borrowing money. In particular, in the case of bank loans with a floating interest rate, an increase in interest rates on the international market would result in increased interest payments, which would negatively affect the financial condition of the Company. Reduction in the level of interest rates on the Russian market, all other conditions being equal, may reduce the efficiency of current borrowings of the Company at a fixed interest rate.

Currency risks

The Company is exposed to risks of adverse change in currency exchange rates, primarily fluctuation of the rate of the ruble to the US dollar. This results from the fact that a significant share of the Company’s income is denominated in USD, while most of its expenses are in rubles. The currency structure of the Company’s debt generally reflects the structure of its income, which reduces the dependency on currency exchange rate fluctuation.

Impact of inflation

The current level of inflation causes no significant negative impact on the financial condition of the Issuer. It is impossible to predict the critical level of inflation for the Company, as in addition to the level of consumer prices, it is necessary to take into account changes in the real purchasing power of the ruble, the situation on the Russian and international oil markets, or the situation on the markets for materials and services for the oil industry, and future state policy as regards tariffs.

Financial markets

In accordance with the current development strategy of the Company through 2025, it is planned to finance the main investments in development out of operating income (equity capital). In some cases, the Company uses borrowed funds, and the possibility to do this at acceptable rates and in the required amounts depends on the situation on the financial markets. In particular, changes in interest rates can affect the Company’s borrowing and the service of its current debt: in the event of bank loans with a floating interest rate, an increase in the overall level of interest rates on the market would result in increased requirements for funds to pay interest. When planning its activities and developing budgets, the Company takes into account the current and forecast situation on the financial markets and maintains access to a wide range of sources of financing to ensure the ability to borrow funds under the optimum conditions.

In some cases, the Company places a part of its funds in financial instruments whose cost depends on the situation on the market. These financial instruments can vary in terms of their risk and profitability. The Company implements a balanced policy in the area of free cash placement, monitors risks associated with such investments, but is unable to always guarantee the results expected from such investments.

Risks of the banking system

The Company’s cash is held in accounts and is placed as deposits in banks of the Russian Federation. The Company implements a diversified approach to placement of its free cash. The Company has faced situations of suspension of normal activities and withdrawal of licenses from lending institutions in which its cash was placed. By the abovementioned diversification and monitoring of the condition of lending institutions in which the funds are placed, the Company reduces the risk of their loss.

The Company, being the majority shareholder of ZENIT Banking Group (ZBG), takes into account relevant risks. Such risks include all potential significant factors associated with the situation on the financial markets and stability of the banking system in case of drastic deterioration of the global macroeconomic situation and development of the RF economy, international sanctions, inflation, significant currency fluctuations, as well as unfavorable legislative changes. The Company provides expert assessment of the amount of each risk, its probability and measures offered for its reduction and management. Regarding the Company participation in corporate governance of the ZBG, ZBG transformation is being implemented with a focus on a risk-oriented management approach and an established internal control system, which is additionally audited by an international consultant.

Legal risks

Tatneft is a subject of foreign economic activity, among other things, exporting oil and oil products, equipment, and services outside of the Russian Federation and investing funds in projects abroad. Thus any change in legislation of the Russian Federation or other countries where the Company operates, in the area of currency regulation or control, as well as the rules of customs control or duties that may restrict the possibility of repatriating funds, import or export of goods and equipment or may require compliance with preliminary or subsequent procedures associated with currency transactions or customs procedures can complicate activities of the Company and result in additional expenses. In the Company’s view, the risks of an unfavorable change in currency regulation and the rules of customs control in the Russian Federation are not significant at present. Taking into account the importance of the oil industry in the economy of the Russian Federation, tax payments of the Company are significant. Changes in tax legislation can significantly affect the Company’s activities, the profitability of its operations, its financial condition, and the cost of its securities. The majority of taxes and duties, especially the mineral tax and customs duty on oil and oil product exports, are charged based on gross values (production or export volumes), regardless of the profitability of the Company’s operations. Applicable legislation provides for certain privileges for the Company regarding these taxes and duties in connection with oil production at ultra-mature fields and development of super-viscous oil fields, the economic efficiency of which largely depends on the existence of oil reserves. At present, mechanisms of oil industry taxation on the basis of profitability are being developed in the Russian Federation that provide for introduction of a tax on additional income from production of raw hydrocarbons, which is planned for preliminary application to certain pilot projects, as well as additional changes in the use of export duties on oil and oil products (up to their complete cancellation). These possible changes may cause either a positive or negative impact on the financial indices and investment projects of the Company. For performance of its activities, the Company obtains licenses for exploration and production of oil and gas, operations of hazardous production facilities, and other types of activities in accordance with applicable legislation. At present, the Company does not expect any significant changes associated with the licensing of exploration and production at oil and gas fields, operations of hazardous production facilities, including oil and gas treatment plants, that would result in a significant negative impact on activities of Tatneft or its subsidiaries. The Company is a defendant in some court cases, and a claimant and third party in other proceedings that arise in the course of its normal economic activities.

Reputational risk

Due to the fact that the main products sold by the Company (oil, oil and gas products) are homogeneous and produced in strict compliance with applicable requirements and standards, and the Company itself is one of the largest Russian oil companies with a history of more than 65 years, perception of the financial stability and financial condition of the Company by the main counterparties (buyers) of Company products has no significant impact on their decisions as regards cooperation with the Company. At the same time, perception of consumers of the Company’s products and the quality of its products and services affect the sales and profitability of this segment. The Company continuously monitors the quality of oil and gas products sold via the filling station network, is expanding the range of services provided at filling stations, and is taking other measures to improve the quality of service. Furthermore, the Company continuously informs clients and counterparties of its activities by way of publications and press releases on the internet, in the media, as well as via mobile applications. Clients of the filling station network are provided with free phone lines for feedback and complaints as regards the quality of products and services. The Company has adopted and is implementing procedures aimed at prompt responses to complaints and claims of clients in order to eliminate their causes. In addition to regular disclosure of information (obligatory and voluntary), upon request of clients and counterparties, and in view of the requirements of legislation, the Company provides all necessary information on its financial condition and sustainability.

Industry risks

Risk of oil and oil product prices

Incomes, profitability, and future growth largely depend on current prices for oil and oil products. In the past, oil and oil product prices varied significantly due to multiple factors, including:

  • • International and regional supply and demand (as well as expectations of future supply and demand) for oil and oil products
  • Weather conditions
  • National and foreign state regulation, including export restrictions and taxes
  • Prices and availability of alternative fuels
  • Prices and availability of new technologies
  • Ability of the members of Organization of Petroleum Exporting Countries (OPEC) and other oil-producing countries to set and maintain certain levels of production and prices
  • Political and economic events in oil-producing regions, in particular the Middle East
  • The international and regional economic situation

For many years, prices for crude oil and oil products were relatively high, but in recent years, they have fallen significantly. Prices for oil and oil products change in opposite directions. Reduction in prices for oil and oil products unfavorably affects the performance and financial condition of the Company. Regardless of a certain stabilization of oil prices that took place recently, reduction in prices from current levels may result in reduced amounts of profitable oil production by the Company, which would result in a reduced amount of reserves of the Company effective for development and reduction in the economical efficiency of programs aimed at prospecting and exploration. It should be mentioned that regardless of the development of alternative sources of energy and a potential increase in the number of electric vehicles, in the medium term, the Company does not expect that these will be able to significantly replace oil and oil products, while the demand for oil and oil products will continue to grow largely due to the emerging economies. Thus the Company does not expect significant deterioration of the situation in the industry in terms of the demand structure.

Technical and technological risks

Exploration, development and equipment of new fields, maintenance of existing wells, drilling of new ones, as well as preparation, transportation, and processing of oil and gas constitute an extremely complex and expensive process. Additional expenses are required for reservoir recovery improvement, which is especially important for the Company. In the future, as fields are depleted, special methods for enhanced oil recovery will become more important. Thus, the economic effectiveness of field exploration and development will largely depend on the ability of the Company to use the most effective and affordable technologies. The Company pays special attention to development and application of cutting-edge technologies in the areas of exploration, production, preparation, transportation, and processing of oil and gas, being one of the leaders in innovation in this area in Russia. The Company and its subsidiaries and affiliates use complex process systems and facilities for production, preparation, transportation, and processing of oil and gas, which are classified as hazardous production facilities. The Company takes all necessary measures to ensure safe operation of such production facilities, complies with all applicable norms and requirements, applies the best practices in this area and provides liability insurance for a number of facilities.

Transportation

As the majority of oil production regions in Russia are located far from the main markets of oil and oil products, oil companies depend on the level of development of transport infrastructure, as well as its accessibility. The Company transports the majority of crude oil that it sells on foreign and domestic markets via the system of arterial pipelines under contracts signed with Transneft and its subsidiary structures, in which the main obligations of the parties are specified, including the right of Transneft to mix or replace oil of the Company with oil of other producers. A significant part of the oil transported via the pipeline is supplied to sea ports for subsequent transportation by sea. Russian sea terminals have certain restrictions associated with geographic location, weather conditions, and capacity. Transportation of oil products within Russia is mainly carried out by rail. The railway infrastructure of the Russian Federation is owned and controlled by Russian Railways. Transneft and Russian Railways are joint stock companies with state participation. As the activity of the above companies belongs to the area of natural monopolies, their tariff policy is defined by state authorities to ensure a balance of the interests of the state and those of all parties involved in the transportation process. Tariffs of natural monopolies are set by the Federal Antimonopoly Service of the Russian Federation (FAS of Russia). The size of the tariff depends on the route of transportation, amount of supply, distance to the destination, and some other factors. FAS of Russia revises tariffs at least once a year. The Company closely monitors the development and maintenance of transport infrastructure required to deliver oil and oil products to buyers, as well as the tariff policy, and actively participates in relevant industrial discussions and initiatives.

Environmental risks

The oil and gas sector of the economy is exposed to a high degree of environmental risk. When environmental standards are violated, there is a risk of fines. Additionally, federal and regional environmental standards can be revised and become stricter. The Company has a comprehensive program of measures aimed at mitigating unfavorable situations associated with industrial risks. This includes continuous monitoring, analysis, and forecasting of oil prices with relevant adjustment of strategic development plans. The Company continuously implements and introduces new technical and organizational measures to minimize the impact of technical and environmental risks.

Strategic risk

The activity and financial performance of the Company depend on multiple factors, including ones pertaining to changes in the situation in energy carrier markets, state policy, primarily tax policy, development of technology, and the dynamics of the labor market. Decisions of management bodies of the Company associated with development (strategy) are prepared based on all available information with regard to possible development scenarios and tend to take into account all reasonably predictable possibilities of changes and assumptions used for such planning. Given the availability of a high-tech oil production and processing base firmly established over many years, the Company has a reliable platform for development and adjusts its plans when necessary. At the same time, since the Company’s implementation of its main investment projects usually takes several years, significant negative changes in the conditions underlying decisions about the implementation of certain projects can negatively affect the performance and profitability of the Company.

Risks associated with the activity of the Issuer

No other risks associated with the activity of the Issuer beyond those described above were detected by the Company.