OPPORTUNITIES IN RUSSIA AND CIS V.M.Sokolsky LUKOIL-Neftekhim Закрытое акционерное общество Chem Systems Seminars Annual European Conference 2003 Positioning

OPPORTUNITIES IN RUSSIA AND CIS

V.M.SokolskyLUKOIL-Neftekhim

Закрытое акционерное общество

Chem Systems SeminarsAnnual European Conference 2003

Positioning for Improvement: Exploiting Uncertainty12-13 February 2003, London, U.K.

“ЛУКОЙЛ-Нефтехим”

Current size of the Russian chemical industryPersonnel – 842,000 people

Sales– about 380 billion rubles (2002)

Using official exchange rate, it is $12 billion worth of chemicals, or 0.6 per cent of the global chemical output (country rank 20)

Making allowance for purchasing power of currencies and using a step-up factor, it is about $32 billion, or 1.8 per cent of the global output (country rank 16)

Закрытое акционерное общество“ЛУКОЙЛ-Нефтехим”

Index of chemical production in Russia, 1990-2002


0,30

0,40

0,50

0,60

0,70

0,80

0,90

1,00

1,10

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Production of organic chemicals in Russia, 1990-2002


0250500750

10001250150017502000225025002750300032503500

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 *2002

tons

methanol ethylene benzene plastics

synthetic rubber chemical f ibres paints detergents

Production of inorganic chemicals in Russia, 1990-2002


0100020003000400050006000700080009000

1000011000120001300014000150001600017000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 *2002

tons

soda ash caustic soda sulphuric acid ammonia fertilizers

Sectoral breakdown of chemicals in RussiaRussia

Inorganic chemicals19%

Organic chemicals7%

Mineral fertilisers21%

Pharmaceuticals10%

Perfumery and cosmetics

13%

Dyestuffs2% Other chemicals

1%Paints and varnishes

3%

Soaps and detergents

3%

Synthetic resins and plastics

6%

Synthetic rubber12%

Chemical f ibers3%


Over 2/3 of the output is represented by basic chemicals, fertilisers and commodity polymers. Russia’s chemical industry structurally supplements that of West Europe, carrying a huge synergy potential

Russia’s foreign trade in chemicals


• Main export items: methanol, ammonia, mineral fertilisers, caprolactam, PVC, polyethylene, synthetic rubber• Main import items: engineering plastics, fibers, dyestuffs, paints, pharmaceuticals, perfumery and cosmetics

• Export share in production: large-tonnage polymers – 30-37, methanol – 45, fertilisers – 81. • Import share in consumption: all plastics – 19, paints – 20, dyestuffs – 50, fibers – 56, drugs, perfumery and cosmetics – up to 60-70

• Russia’s positive balance of trade in chemicals stands at $2 billion a year. With all products internationally classified as chemicals, the

balance is negative – from $1 billion to $3 billion (by various sources)

• Russia’s main foreign trade partners are West European countries

Russia’s chemical exports, 1994-2002 (1)


0

100200

300

400

500600

700

800

1994 1995 1996 1997 1998 1999 2000 2001 2002

tons

Soda ash Caustic soda

Caprolactam Synthetic resins and plastics

Synthetic rubber Chemical fibers

Detergents

Russia’s chemical exports, 1994-2002 (2)


0100020003000400050006000700080009000

100001100012000

1994 1995 1996 1997 1998 1999 2000 2001 2002

tons

Mineral fertilisers Ammonia Methanol

Russia’s chemical imports, 1994-2002


050

100150200250300350400450500550600650

1994 1995 1996 1997 1998 1999 2000 2001 2002

tons

Synthetic resins and plastics Plastic goods

Paints Detergents

Pesticides Synthetic rubber

Chemical fibers

Regional distribution of the Russian chemical industry

The European Russia can be split into 4 regions of chemical industry, I.e. Volga-Urals super-region (56% of the national output) plus Central (21%), Northern (6%) and Southern regions (2%)

The Asian Russia has 2 main chemical regions, i.e. Western (10%) and Eastern Siberia (5%). Note, the Russian Far East is almost void of chemicals.

Each of the above regions has a number of chemical clusters within its borders.


Major players in the industry• Petrochemical subsidiaries of oil & gas companies –

SIBUR (Gazprom) and LUKOIL-Neftekhim (LUKOIL)• Individual petrochemical plants within oil & gas

companies - YuKOS, Surgut, TNK, Tatneft, Itera, etc.• Agrochemical cartels and associations –

Agrokhimholding, Fosagro, Evrokhim, etc.• Individual producers of petchems, fertilisers and other

basic chemicals – Plastkard, TOAZ, etc.• Individual producers of fine chemicals – incl

subsidiaries of foreign companies


The role of state in the industryNon-privatized enterprises account for only 1 per cent in the total

number of plants and less than 5 per cent in their output. However, the role of the state in chemicals is much higher since:

• Dozens of chemical plants are controlled by the state as their main shareholder (Dzerzhinsk Korund, Berezniki Soda, Sterlitamak Kaustik, Volgograd Khimprom, Cherepovets Azot, etc.)

• Over 100 chemical plants are controlled by the state-owned holdings – SIBUR, Mezhregiongas, etc. (Tomsk, Tobolsk and other plants)

• Almost all petrochemical plants in Tatarstan and Bashkiria are controlled by the governments of these republics

The share of the state controlled enterprises in the Russian chemicals is probably 35-40 per cent


Investment activity of Russian and foreign companies, 1990-2002

Since 1990, the Russian companies have built about 20 new petchem plants with a combined capacity of over 2 million tpa (incl benzene, methanol, MTBE, LABS, VCM and PP units)

Foreign companies preferred purchasing existing facilities in market-oriented sectors with a quick payback - such as detergents, pharmaceuticals, perfumery and cosmetics, tyres, etc.

As a result, the Russian detergent industry is now dominated by Procter & Gamble, Henkel and Unilever with plants in Tula (30% of the national output), Saratov, St Petersburg and Perm regions

Pharma, cosmetic and perfumery industries also abound in foreign firms - Searle, ICN, Gedeon Richter, Unilever and others with plants in Moscow, St Petersburg, Chelyabinsk, Kursk and other regions


Projects to be completed until 2005 - EB (230), styrene (200), PS (150), PTA (230), PET (80), polyester fibers (162)

Projects to be completed after 2005 include methanol (1,400), MTBE (132), styrene (160), ethylene and PE (each up to over 1,000) and PP (around 1,000)

To make the list of projects longer and more realistic, the country badly needs foreign direct investments, particularly from the West

Funds in the West are known to be more readily available and cheaper than in Russia. Also, these often bring in advanced technology and high managerial skills.


Some new petrochemical projects

Russia’s strengths and opportunities –feedstocks, energy and labour (2002)Crude oil reserves – from 7 to 14 billion tons, production –

379 million tons, prices - $100-120 per tonRefined products capacity – 282 million tpa, production 178

million ton, naphtha price - $160-190 per tonNatural gas reserves – 60 trillion m3 (1/3 of the world total),

production – 588 billion m3, prices – $23.5 per 1,000 m3Electricity: capacity – 215,000 MWt, production – 890 billion

kwt-h, price - 2 US cents per kwt-hLabour: monthly salary in chemicals of about $100 (vs $250

in fuel industry)


Russia’s strengths and opportunities – market size and potential• Population of about 150 million people, with GDP

amounting to $400-450 billion • Economic growth in 1999-2002 - above global average (in

2002 – 4.2%) with good outlook for further growth• Chemical consumption of up to $35-40 billion with high

growth potential - due to low per capita consumption • Good links with other FSU countries (with population of

150 million people and GDP of $300 billion)• Old-established links with CEE countries (with

population of 130 million people and GDP of $750 billion)


Russia’s strengths and opportunities – political and economic factors

• Increased political stability

• Market character of the national economy

• Prevalence of private sector and high level of competiton in chemicals and other industries

• Continued commitment to the policy of reforms (tax, banking, etc.)


Russia’s strengths and opportunities – taxes and customs

Russia’s taxes are among world’s lowest:

• Corporate income tax – 24% (reduced from 35%)• Personal income tax – 13% (cut from 12-35%)• Social security tax - 16-36% (cut from 38%)• Transport tax - insignificance (cut from 1%)• Sales tax of 5% - to be axed soon• Property tax – 2% (unchanged)• VAT – 20% (unchanged)

Russia’s admission to WTO will remove custom barriers


Russia’s weaknesses & threats

• Low technical level of the existing plants - old processes, small and highly worn units, overmanning

• Capital mobilization problems - expensive loans, import duties on equipment, etc.

• Institutional problems – state monopolies, regulated prices, customs and duties, etc.

• Limited size of the domestic market at present• Long distances separating key producing areas from the

main feedstock sources and markets• Poor infrastructure for delivery of feedstocks & products• The lack of information about the plants and markets


What to develop?

• Aromatic chain. Exportable surplus of 250-300 ktpa. High domestic demand and growing import of derivatives incl PET, PS, etc.

• Olefin chain. Cheap feedstocks (NGL and naphtha). High demand and growing import of derivatives incl PE, PP and PS.

• Methanol chain. High demand for derivatives (MTBE potential stands at 3 million tpa). New promising outlets incl MTO.


Where to develop?

Non-freezing seaports - particularly oil and gas terminals (St Petersburg, Kaliningrad, Novorossiysk, Odessa)

Major petro- and gas-chemical centres in Russia (Budyonnovsk, Saratov, Volgograd, Perm, Nizhnekamsk), Ukraine (Kalush, Gorlovka) and Belarus (Novopolotsk)

Existing and potential gas processing centres in the European Russia (Astrakhan, Budyonnovsk, Cherepovets, Murmansk) and in Western Siberia (Surgut, Tobolsk, etc.)


With whom to develop?

In petrochemicals,

LUKOIL-Neftekhim is a partner

of the first choice


LUKOIL-Neftekhim status and structureLUKOIL-Neftekhim is LUKOIL’s petrochemical subsidiary which

currently operates the following companies:

• Stavrolen (Budyonnovsk) – a producer of olefins, benzene, VAM and HDPE

• Saratovorgsintez (Saratov) – a producer of ACN, PAN fibres, phenol, acetone and MMA

• LUKOR (Kalush) – a producer of chlorine, caustic soda, olefins, aromatics, VCM and HDPE

• VARS (Ventspils) – ACN terminal• Stavrochem (Budapest) and LUKOIL Chemical (Antwerp) -

trading companies

Petrochemical part of Neftokhim (Burgas) is also expected to be operated by LUKOIL-Neftekhim


Some LUKOIL-Neftekhim locations


LUKOIL-Neftekhim’s range of products

• Olefins, aromatics and other basic petrochemicals - ethylene, propylene, C4 stream, benzene, phenol, acetone

• Monomers - VCM, acrylonitrile, MMA, VAM

• Polymers - HDPE, PAN fibers



Ethylene 1,050Propylene 450Benzene 215Polyethylene 500 VCM 370ACN 180 PAN fibers 37MMA 28

LUKOIL-Neftekhim capacities for some products, 000 tpa

LUKOIL-Neftekhim size of operations

• Total annual sales: over $500 million (excluding chemical sales of Neftokhim)

• Annual total chemical production capacity: around • 3 million tons

• Annual total sales of chemicals: 2 million tons

• Monthly shipments of chemicals: over 100,000 metric tons to more than 50 countries


LUKOIL-Neftekhim sales policy

Domestic market is of primary importance due to: 1) better access, 2) higher prices, 3) faster growth

LUKOIL-Neftekhim share in the domestic market: HDPE - 40%, ACN - 95%, PAN fibres - 30%, phenol - 20%

Yet, because of limitations of the domestic market, about 50 per cent of the output is exported

In future, LUKOIL-Neftekhim will retain its primary orientation to the domestic market coupled with high export sales and exposure to global factors


LUKOIL-Neftekhim strategyIts core is an evolutionary development with a

focus on:

• Close linkage with LUKOIL

• Modernisation and debottlenecking

• Improving feedstock supply and marketing systems

• Expansion in existing and new product segments


Linkage with LUKOIL

• Material flows. LUKOIL-Neftekhim draws most of its feedstocks from LUKOIL and ships some chemicals to the latter. With good feedstock supply, LUKOIL-Neftekhim has a strong competitive advantage over other companies. It also eases LUKOIL’s dependence on fuel markets.

• Financial flows. For development projects, LUKOIL-Neftekhim can use both its own resources and financial assistance from LUKOIL. Being a profitable company, it has been continuously contributing to LUKOIL’s total profits.

• Corporate culture. LUKOIL-Neftekhim is a part of LUKOIL Group of companies developing a corporate culture similar to that of the largest vertically integrated Western companies.


Improvements in feedstock supply system Introducing lighter feedstocks at Budyonnovsk and Kalush

Using new sources of crude oil and refined products :

• CPC oil pipeline running from the Northern Caspian - with a possibility of building a new refinery in the south of Russia.

• LUKOIL’s sources of supply in the Black Sea & Mediterranean area incl Romania, Iraq, Egypt, etc.

Using own sources of natural gas making allowance for:

• Availability of ethane-rich gas reserves in the Northern Caspian, in proximity to Budyonnovsk site and export markets

• Expected gas production of up to 10 billion m3 a year


Improvements in the marketing system

Better market researchBroader trading practice

• developing a system incorporating existing and planned storage and distribution centres in Europe

• trading through dealers and own trading companies• getting direct access to customers

Improvements in quality and transportation of products

• improving range of products and grades • certifying products and quality control systems by

international standards• elaborating new efficient delivery schemes


Expansion in existing and new segmentsExpansion in existing product segments - by building/acquiring new

assets. Projects under study include new crackers and polyolefin plants at Budyonnovsk, Kalush and Saratov.

The aim is to consolidate LUKOIL-Neftekhim’s market share and exploit its competitive advantages in feedstocks.

Expansion in new product segments, aimed at increasing vertical integration with a focus on the following projects:

At Budyonnovsk – polypropylene (100 ktpa) and HDPE gas pipesAt Saratov – sodium cyanide (20 ktpa) and PMMA (25 ktpa) At Kalush – PVC (150 ktpa) and polypropylene (100 ktpa)

The aim is to add value to chemicals produced and increase flexibility under the changing market conditions


Summary

LUKOIL-Neftekhim accounts for 3% of LUKOIL total sales with petchems share in sales of world oil majors varying from 10% to 25%. Hence, the company has a high growth potential.

LUKOIL-Neftekhim is a company intending to operate on a global scale abiding by international standards of corporate management.

LUKOIL-Neftekhim intends to cooperate with other companies, particularly with leaders in technology and other areas

Possible areas of cooperation are joint production of chemicals, feedstock supply and marketing arrangements.


THANK YOU FOR

YOUR ATTENTION!


Documents

OPPORTUNITIES IN RUSSIA AND CIS V.M.Sokolsky LUKOIL-Neftekhim Закрытое акционерное общество Chem Systems Seminars Annual European Conference 2003 Positioning