Gazprom – a flexibility test. Speech by Alexey Miller at the Annual General Shareholders Meeting

Statement by the Chairman of the Management Committee of OAO Gazprom Alexey Miller at the annual General Shareholders Meeting.

June 26, 2009, Moscow

Esteemed shareholders, colleagues and partners!

On behalf of the Management Committee of Open Joint Stock Company Gazprom, and my personal behalf, I welcome you to the annual General Shareholders Meeting.

You have been given detailed materials about the activities of OAO Gazprom and its subsidiaries in 2008: the annual report, the accounting statements, the conclusion of the Audit Commission, the auditor's report and other materials.

It is proposed that the Shareholders Meeting approve:

  • the annual report of OAO Gazprom for 2008.
  • the annual accounting statements of OAO Gazprom.
  • distribution of profits, and the proposals of the Board of Directors about the size, schedule and form of dividend payouts for 2008.

It is also proposed that we approve the amount of remuneration to the members of the Board of Directors and the members of the Audit Commission. The amounts of the remuneration are given in the materials that were presented to you.

It is proposed that ZAO PricewaterhouseCoopers Audit – the winner of the open contest among audit companies – be approved as the auditor for performing the obligatory annual audit of OAO Gazprom's accounting statements.

Esteemed shareholders!

The year 2008 was a crucial stage in the development of Gazprom as a global energy leader. Our operating highlights for the year vividly demonstrate the result of the Company's offensive strategy in all of the business areas. Gazprom is increasing the replenishment of the mineral resource base, exploring new gas production regions, expanding and modernizing the gas transmission system, diversifying the supply routes and sales markets, developing the core activities.

However, the global financial and economic crisis hasn't bypassed Russia and its energy industry.

Nevertheless, on the background of the unfavorable financial and economic trends worldwide, our Company has again shown high reliability, stability and potential for sustainable development. We use all of the advantages of the vertical integration for responding with promptness and flexibility to changes in the market situation. This means that the long-term business strategy we have been pursuing in the last years was and still is sound.

Our present-day task is to retain the accumulated potential and not to lose new opportunities emerging in the period of crisis.

Crisis is a flexibility test.

Let us take a closer look at the results we have achieved by today's Shareholders Meeting as well as at our tactical and strategic plans for the future.

Esteemed shareholders!

The world's largest natural gas reserves are a crucial competitive advantage of Gazprom. The mineral resource base replenishment is also a top priority of our business. Last year Gazprom's A+B+C1 gas reserves increased by 11 per cent to more than 33 trillion cubic meters, oil reserves grew by 6 per cent to 1 billion 600 million tons. This was possible due to two factors.

Firstly, owing to the geological exploration activities our gas reserves exceeded production levels for the fourth year in a row. Hydrocarbon reserves added in 2008 through geological exploration amounted to over 583 billion cubic meters of gas and 61 million tons of oil and gas condensate. The reserve replenishment ratio was 1.06 – gas and 1.53 – liquid hydrocarbons. Thus, we accomplished the task – the ratio is more than 1.

Secondly, in accordance with the decisions of Russia's Government OAO Gazprom obtained 10 exploration and development licenses for fields of federal significance on the Yamal and Gydan Peninsulas, in the shelf of the Sea of Okhotsk and in the Republic of Sakha-Yakutia, with their overall A+B+C1 reserves estimated at 3.3 trillion cubic meters of gas and 143 million tons of liquid hydrocarbons.

Expanded replenishment of the mineral resource base through geological exploration remains a key strategic task for Gazprom. A priority business area – activities that will enable to enhance the development efficiency of fields already in operation or fields planned to be developed in the near future, including those under new licenses. Particular attention will still be placed on geological exploration in the regions where the launch of production will mean access to new markets for Gazprom. Russia's Far East and foreign projects in Vietnam, Libya and Venezuela are worthy of mention here.

Esteemed shareholders!

In 2008 Gazprom Group produced 549.7 billion cubic meters of natural and associated gas. In the first half of the year gas production exceeded the target by 5.5 billion cubic meters and in the second half Gazprom was forced to cut output by 16.8 billion cubic meters versus the target. This stemmed from decreased consumption in the domestic and foreign markets, and annual gas production went down to the year 2007 level.

We have always reiterated: in its operations Gazprom is market-oriented. Gas won't be produced until it is sold. Where are now those analysts who complained everywhere only a year ago that Gazprom invests insufficiently in production? We invest sufficiently! Our strategy is right. Relying on the balance method, Gazprom has always invested in gas production and transportation as much as needed for the fulfillment of already signed contracts and has never been guided by demand projections unsecured by purchase guarantees. As a result, we have a sufficient reserve of production capacity and don't suffer from its excessive amount.

Today Gazprom establishes new gas production centers in eastern Russia.

We'll soon get down to exploiting the resources of the Yamal Peninsula – in Russia's contemporary history it is the largest energy project unparalleled in terms of complexity. By scale and significance this project is comparable to the development of fields in Western Siberia back in the 1970s. It lays the foundation necessary for further growth of gas production in Russia. Commercial field development on Yamal will make it possible to bring annual gas production here to 310–360 billion cubic meters by 2030.

I'll stress it once again that we will launch new capacities in accordance with a market situation. This doesn't exclude the possibility of adjusting the lead times of production projects already in operation. Thus, the decision was taken to put off the commissioning of the Bovanenkovskoye field startup complex till 2012.

We have repeatedly said that the crisis won't have an impact on our investment program. Incredible as it may seem, but this is indeed true. By contrast to most companies that turned out to be physically unable to finance their projects, we are adjusting our plans not because there is a lack of money but because projected capacities won't be in demand.

Esteemed shareholders!

Gazprom owns the world's largest gas transmission system capable of continuously conveying gas over long distances and flexibly responding to consumer demand fluctuations.

In 2008 the gas transmission system was fed with 714.3 billion cubic meters of gas, of which 111.2 billion cubic meters came from independent companies. Gas transportation services were provided to 31 companies.

This year transportation volumes have reduced. This is an additional opportunity for us to upgrade overloaded sections, enlarge “narrow segments” and increase the gas supply flexibility. Expansion and upgrading activities are in progress on the Urengoy gas transit hub, Zapolyarnoye – Urengoy, SRTO – Torzhok, SRTO – Ural, Pochinki – Gryazovets and Gryazovets – Vyborg gas pipelines. Gas supply is being expanded to the Moscow region – construction work has been completed on the Kasimovskoye UGS facility – Voskresensk gas pipeline.

In 2008 Gazprom started building the Bovanenkovo – Ukhta gas trunkline system. This new advanced multi-line gas transmission network has unique technical specifications and is designed to transport 140 billion cubic meters of gas from Yamal.

In order to enhance the reliability and flexibility of gas exports Gazprom has come up with the initiative to implement new gas transportation projects – Nord Stream and South Stream. These projects will enable not only to diversify the routes of Russian gas exports and reduce the transit risks, but also to secure extra opportunities for boosting gas deliveries.

In June 2008 the deal was closed for Gasunie (Netherlands) to become a shareholder in Nord Stream AG – the company responsible for constructing, operating and managing the Nord Stream gas pipeline. Thus, Nord Stream has transformed from a bilateral arrangement between Russia and Germany into a pan-European project. This is particularly evident, given that 11 companies from 7 European countries are now involved in its implementation e.g. under procurement contracts.

As part of preparations for the execution of the South Stream gas transportation project, in 2008 OAO Gazprom and Italy's ENI set up on a par a Special-Purpose Company, South Stream AG, for performing a feasibility study for the offshore section of the project.

In order to implement the onshore segment of the project, in 2008 the intergovernmental agreements were entered into with Bulgaria, Serbia, Hungary and Greece. Similar intergovernmental agreements are being agreed on with Slovenia and Austria. The accord has been reached with the project partners to boost the throughput of the gas pipeline to 63 billion cubic meters per annum. Consequently, in 2015 South Stream will be supplying around 35 per cent of overall Russian gas exports to Europe.

The implementation of these projects is Gazprom's strategic investment in increasing the European energy security. It is a well thought-out and economically substantiated decision planned over the long-term.

However, there has been a lot of speculation lately in Europe about the energy source diversification. It is expected to raise the market competition and the natural gas supply security. But granting physical access to new resources, for instance by means of new gas transport corridors, doesn't imply instantaneous appearance of reliable long-term sources.

In a variety of countries with considerable hydrocarbon reserves the export potential is minimal due to a number of factors. Such factors include domestic demand, political instability, lack of experience in oil and gas infrastructure development & operation and in contract servicing.

Therefore, Europe's aspirations for the diversification of gas suppliers are understandable but shouldn't become a fetish. The priority of the European policy in favor of granting access to new resources to the detriment of stronger ties with conventional suppliers, such as Russia, may lead to a paradoxical result. There will be more diversification but less stability and reliability.

On its part, Gazprom is paying close attention to projects that generate new markets for the Company. Within phase one of the Eastern Gas Program Gazprom has started developing the Sakhalin – Khabarovsk – Vladivostok gas transmission system. The first startup complex of the gas pipeline will be brought online in the third quarter of 2011. The Sakhalin – Khabarovsk – Vladivostok gas pipeline is a strategic project in eastern Russia. It enables not only to meet the priority demand for gas in a number of Russia's regions in the Far East, but also to lay the infrastructure basis for expanded Russian natural gas supplies from the region of Vladivostok to new, competitive – versus the conventional – markets in Asia-Pacific. For instance, to the market of China that shows growing demand even under the crisis conditions.

Esteemed shareholders!

Europe remains the most crucial export market for Gazprom. Over 65 per cent of Russia's gas exports are destined for the countries of this region. In the second half of last year the price of Russian natural gas supplied for export purposes beat the record high of USD 500 per 1,000 cubic meters. Sales beyond the former Soviet Union reached 184.4 billion cubic meters in 2008, 9.4 per cent up on 2007. And this is despite the global crisis that had a strong negative effect on the world energy market at the end of last year.

In the past few months the situation has stabilized and has shown positive momentum: we are seeing persistent growth of hydrocarbon prices and consumption. This gives us ground to assert that the energy sector has already passed the “crisis bottom”. While the first quarter of 2009 saw a substantial decline in exports, up-to-date supply requests from foreign consumers are practically in line with the last year's level.

The extension of long-term contracts and expansion of gas supply under the “take-or-pay” arrangement is a fundamental instrument for Gazprom to retain and boost export volumes. It is well known that our contracts are based on the risk sharing principle: the buyer bears the volume risk and the seller – the price risk. The drastic decline in European gas demand at the turn of the year 2008/2009 is not yet a cause for this approach to be put in question. We believe that the risk sharing scheme currently fixed in contracts is balanced and any attempt to change it will disrupt this balance.

The ongoing liberalization of the European gas market opens new opportunities for Gazprom to realize extra profit from gas sales to end users. The utilization of underground gas storage (UGS) facilities on the territory of European countries also enables to substantially enhance the flexibility of export deliveries and to increase the sales of Russian gas.

Gazprom supplies the liberalized market of the UK with around 7.55 billion cubic meters of Russian gas per annum. Over the last few years gas deliveries to the UK have tripled. Guaranteed supply is our competitive advantage on the British market. By 2011 Gazprom plans to account for a 10 per cent share of this market.

Gazprom's strategy of getting access to the end user is being developed in the CIS markets as well.

I would like to emphasize the positive outcomes of our strategic cooperation with the Armenian counterparts. Throughout a number of years gas has been successfully supplied and sold in the Armenian market by ArmRosgazprom joint venture. In 2008, 2.1 billion cubic meters of gas was marketed in Armenia, an 11.2 per cent rise versus 2007.

Since last year OOO Gazprom sbyt Ukraina subsidiary has been supplying natural gas directly to Ukraine's industrial consumers. In 2008 gas deliveries amounted to 3.3 billion cubic meters.

In 2008 Gazprom transited in its relationships with the CIS countries to the contract terms and pricing mechanisms similar to those applicable in European countries. In particular, our Ukrainian partners have entered under these terms into the long-term gas supply and transit contracts till 2019. We are aware of the problems that our Ukrainian counterparts are facing now, but the contracts must be fulfilled and cannot be modified.

The strategic partnership between Gazprom and Central Asian countries allows securing maximally efficient gas exports from the former Soviet Union over the long-term. In 2008 Gazprom purchased 66.1 billion cubic meters of gas in Turkmenistan, Uzbekistan and Kazakhstan. We also have good relations with Azerbaijan. We hope that in the course of the forthcoming visit to Baku, scheduled for the next week, we will come to new significant agreements.

OAO Gazprom has updated its marketing strategy for the liquefied natural gas markets. Starting from 2005 Gazprom has supplied liquefied natural gas to the USA, the UK, South Korea, Japan, Mexico, China and India, with 28 shipments totaling more than 1.7 million tons of LNG effectuated over this period. Regular exports of Russian LNG began since the launch of the Sakhalin II project in February 2009.

So, Japan is already receiving Russian LNG and is striving for deeper cooperation. The Memorandum recently signed with Japan's Agency for Natural Resources and Energy contemplates joint studies of possibilities for utilizing Russian natural gas in the Far East. This relates to production of liquefied gas, compressed gas and synthetic liquid fuels. LNG supplies have also been launched to the Republic of Korea. This week we have signed the Agreement on joint studies of the project for gas supply from the vicinity of Vladivostok. The dialogue with our Chinese partners is in progress. By now, it has received a new impetus at the state level.

At the follow-up stages of Gazprom's export strategy we intend to implement new LNG production projects in Russia and other countries, with LNG to be marketed on our own. Phase one of the Shtokman field development is projected to produce 7.5 million tons of LNG per annum in addition to gas intended for the Nord Stream gas pipeline. Gazprom is also considering the possibility of establishing LNG production on the Yamal Peninsula.

In its international activities Gazprom is keen to create the full-cycle transnational chains from the upstream to the downstream. The execution of projects based on asset swaps and value chains (from production to the end user) bolsters the positions of Gazprom as a global player in the energy market.

A vivid example of such cooperation is the partnership with Germany's BASF and E.ON. Our joint activities span production (Yuzhno-Russkoye field), transportation (Nord Stream gas pipeline) and the work with end users (gas supplies through Wingas, a joint venture with BASF, and power generation projects with E.ON).

An emphasis should be put on our activities at the Achimov deposits of the Urengoyskoye field in cooperation with Germany's Wintershall. We are accumulating the experience in field development at big depths and in complex geological structures as well as working out a model of relations with foreign partners, whereby the work is done jointly, but the license is retained by Gazprom.

We are also going to apply this model during phase one of the Shtokman gas and condensate field to be implemented jointly with France's Total and Norway's Statoil. The investment decision for this project is scheduled to be taken next year.

Our cooperation with the Italian partners is advancing to a qualitatively new level as well. We are creating an integrated chain embracing production projects in Russia (SeverEnergia project), transportation projects (South Stream project) and joint projects in third countries (Libya).

This week, within the Russian President's visit to Nigeria, Gazprom and the Nigerian National Petroleum Corporation set up on par a joint venture.

The joint venture will construct gas transport and power generation infrastructure in Nigeria, design and develop an associated petroleum gas gathering and processing system as well as subsequently build the Nigerian part of the Trans-Sahara gas pipeline.

Gazprom is expanding cooperation with its Turkish partners. Over the last years Gazprom has regularly met extra gas demand of Turkey during the autumn-winter period. Consideration is being given to the signing of a contract and the construction of a new gas pipeline – Blue Stream II.

Esteemed shareholders!

Russia is the largest and potentially the most attractive market for Gazprom. Under the crisis conditions our primary goal is maintaining and expanding the domestic demand for energy carriers in parallel with introducing cutting-edge energy conservation technologies.

In 2008 Gazprom supplied Russian consumers with 287 billion cubic meters of gas. Receipts from domestic gas sales have grown by 18.7 per cent versus 2007 to RUB 474.3 billion.

The Gasification Program for Russia's Regions remains Gazprom's largest project aimed at the domestic market expansion.

The Program has been implemented for more than four years by now. During this period Gazprom has invested over RUB 72 billion for gasification purposes. Construction was completed on 696 inter-settlement gas pipelines with a total length of over 11,000 km.

In 2008 Gazprom channeled RUB 24 billion to gasify 64 Russian regions. The Program will progress further. In 2009 it is planned to expand the Gasification Program to another 5 regions.

Gazprom has launched the Eastern Program, the key priority of which is gasification of the Far East and Eastern Siberia. The long-awaited gas will reach the residents of the Primorsky and Khabarovsk Krais, Sakhalin and Kamchatka in the short-term.

Esteemed shareholders!

In 2008 Gazprom continued developing and improving the efficiency of its oil business.

Based on the year 2008 results Gazprom Neft has retained its leadership position in terms of efficiency among Russian vertically-integrated oil companies.

Gazprom Neft's consolidated production grew in 2008 by 7.3 per cent to 46.3 million tons. The company's earnings increased over the same period by 52 per cent to over USD 33 billion and the net profit climbed by 12 per cent to USD 4 billion 658 million.

According to its operating results for 2008 the company has boosted oil refining.

In 2008 the preparations started for Gazprom Neft to engage in the exploitation of Gazprom's oil resources both through the handover of oil licenses and involvement in production as operator.

In 2008 the agreements were reached for the acquisition of a 51 per cent stake in the oil company Naftna Industrija Srbije from the Government of the Republic of Serbia. Gazprom Neft obtained two refineries and a network of over 500 filling stations in Southern Europe.

Filling networks under Gazprom's trademark will finally emerge on the Russian market. This year will see the launch of a program targeted at upgrading the appearance of Gazprom Neft's filling stations. They will be all in the corporate colors: white, indigo and blue!

Esteemed shareholders!

In 2007–2008 Gazprom Group managed to achieve its strategic goals with regard to the power generation business. Gazprom established control over Mosenergo and became the majority stakeholder in OGK-2, OGK-6 and TGC-1. Their installed generating capacity is around 36,000 MW.

After the vertical integration of Gazprom's energy assets is completed, Gazprom will become the largest energy utility in Russia. The synergy effect of Gazprom's penetration in the power sector is conditioned by the fact that while electric power plants consume one third of Russia's natural gas, the efficiency of most of them is below 35 per cent. Gazprom has tackled this challenge – new generating facilities are being built with the use of cutting-edge technologies. Combined-cycle gas turbines with the efficiency of around 53 per cent being installed at new generating facilities enable to considerably reduce fuel consumption.

In general, Gazprom accounted for over 90 per cent of Russia's aggregate capacities launched in 2008. Gazprom has become the largest and most reliable investor in the Russian power industry. From 2009 to 2013 Gazprom plans to invest around RUB 250 billion in the construction of electric power plants.

For the purpose of streamlining the corporate structure Gazprom is carrying out structural reform. In 2008 the Company completed the consolidation of its companies by areas of activity.

In order to ensure the Company's structural transparency and visual identification in Russia and abroad, Gazprom continued its efforts aimed at renaming its subsidiaries and transiting to a single corporate style. The work is to be finished in 2009–2010.

Gazprom Group keeps divesting non-core assets. Based on the year 2008 results the Group earned RUB 36.7 billion from their divestiture.

In 2008 the consolidated receipts from Gazprom Group's sales amounted to RUB 3.6 trillion, a 43 per cent rise versus 2007.

However, due to a sharp decline in the value of shares issued by Gazprom owned companies – Gazprom Neft, Mosenergo, OGK-2, OGK-6 and others – Gazprom's net profit has dropped by 52 per cent versus 2007 down to RUB 173.0 billion.

Based on the year 2008 results, in pursuance of the Russian Government's directive the Board of Directors recommends that RUB 0.36 per share be paid out to the shareholders as dividends.

Esteemed shareholders!

The gigantic resource base, proactive forward-looking policy both in the foreign and domestic markets, ability to build up production of increasingly more new energy resources in accordance with the market requirements – all this is a guarantee of Gazprom's sustainable development, a reliable base for long-term capitalization growth and confidence in the future for our shareholders.

Gazprom flexibly adjusts its plans under changing external conditions, but our long-term strategy remains unchanged. Crises come and go, but Gazprom keeps moving forward!

Thank you!