Key Risk Factors

Risk management has become an integral part of the corporate environment of Gazprom Neft, by virtue of the following processes:
  • Implementing a risk-oriented approach in all aspects of production and management;
  • Undertaking systematic analysis of identified risks;
  • Building a system to control risks and monitor the efficiency of risk-management activities;
  • Making all employees aware of Gazprom Neft’s basic principles and approaches to risk management;
  • Ensuring necessary regulatory and methodological support;
  • Distributing authority and responsibility for risk management between the Company’s structural units.

The risk management system at Gazprom Neft ensures smooth operation of the Company’s production and business processes by anticipating threats and mitigating the impact of adverse external and internal factors.

The Company has developed and formalized a uniform approach to handling risk-management processes, which is fully contained in the ‘Integrated Risk Management System’ (IRMS) corporate standard.

The Integrated Risk Management System (IRMS) of Gazprom Neft is a systematic continuous process that identifies, assesses and manages risks. Its key principle is that responsibility for management of various risks is assigned to various management levels depending on the expected financial impact of the specific risks.

As of late 2011, the Company had implemented basic IRMS processes at most of its major subsidiaries and associates, and was thus able to build a detailed Corporate Risk Chart for 2011 by consolidating risk events, from the level of individual subsidiaries/ associates to the level of the entire Company.

This approach made it possible to outline responsibility zones for risk management and monitoring at every level of corporate management, and to have customised response plans to address material risks at each subsidiary/associate and throughout the Company.

Implementation of the IRMS: Key Stages

Realization of the Integrated RiskManagement System (IRMS) at GazpromNeft began in August 2008 when the Company ’s Management Board approved a concept for implementation of the System

2008–2010 2011 2012–2013 (targets)
  1. The IRMS implementation concept was designed and approved by the Management Board; a Corporate Risk Management Policy was enacted
  2. Introduction of a new corporate standard, ‘IRMS: Procedure for identification and assessment of risks, preparing response action, and monitoring compliance’.
  3. Scope of the IRMS was expanded to cover 29 business entities (20 subsidiaries/associates, and 9 sub-divisions of the centre).

The IRMS was analysed in two stages (in June 2009 and March 2011) by Ernst & Young to ascertain its compliance with best practice.
The Gazprom Neft IRMS was acknowledged as compliant with international practice for construction of Enterprise Risk Management systems..

  1. The ‘Risk Book 2010-2011’ was complied.
  2. A Business monitoring technique for Gazprom Neft Group was designed and formalized; six-monthly monitoring of key risks and subsidiary/associate risks was enacted.
  3. Quantitative assessment was carried out for the top 10 risks at six subsidiary/affiliate units in mandatory scope of the IRMS.
  4. Standard formats for presentation of risk-related information to assist business planning were agreed and tested at the six subsidiaries/associates.
  1. Further expansion of IRMS scope: IRMS extended to 20 more business entities (subsidiaries/affiliates, and major projects) and 2 sub-divisions directly subordinate to the corporate centre.
  2. Integrating the IRMS with the project management and M&A system.
  3. Organization and support for stages of the risk management process, tied in with the business planning cycle.
  4. Developing an IT system to support IRMS The IRMS was analysed in two stages processes.
RISK FINANCIAL IMPACT LEVELS AND DISTRIBUTION OF AUTHORITY WITHIN IRMS
IRSM Process Flow Chart at Gazprom Neft Group

* Dependent on the risks severity

INDUSTRY RISKS

The main businesses of Gazprom Neft are production of crude oil and gas, oil refining, and sales of crude oil and petroleum products. The risks that confront the Company are typical for the oil and gas industry, specifically:

  • Risks related to possible change of prices for purchased materials and services;
  • Risks related to possible changes of prices for crude oil and its products;
  • Risks related to competition within the industry;
  • Risks related to geological exploration.

Risks

Description

Risk management activities

Risks related to possible change of prices for purchased materials and services

In the course of its business, Gazprom Neft utilizes the transportation infrastructure of monopolist providers of services for transportation of crude oil and petroleum products, and monopolistic suppliers of electrical energy.

The Company has no control over the infrastructure of these monopolistic providers, nor can it control the tariff rates payable. Tariff rates are controlled by Russian Government agencies, but the rates increase from year to year, creating additional costs for the Company.

The Company takes various steps to mitigate such risks:

  • Long-term planning of commodity flows, timely reservation of capacity for transport of crude oil and product volumes, and of rolling stock;
  • Optimizing distribution of commodity flows between transport types;
  • Use of alternative energy and own sources of power generation.

These efforts reduce the risks related to services and products purchased from monopolists to acceptable levels, and ensure continuity of the Company’s operations.

Risks related to possible changes of prices for crude oil and its products

The Company’s financial performance directly relates to prices for crude oil and petroleum products. The Company is unable to fully control the prices of its products, which depend on the balance of supply and demand in global and domestic markets for crude oil and petroleum products, and on the actions of supervisory agencies.

  • The Company uses a range of actions to reduce mineral extraction costs.
  • A business planning system is used to calculate different scenarios for Company key performance factors depending on global oil prices. This approach enables cost cutting by reduction or rescheduling of investment programs and by other mechanisms.

Such activities help to lower risks to an acceptable level and ensure that the Company can perform as planned

Risks associated with competition in the industry

There is tough competition between leading Russian oil and gas producers in their main lines of business, including:

  • Acquisition of sub-soil usage licences for hydrocarbon production in auction sales arranged by the Russian Government;
  • Purchase of other companies that own sub-soil licences or assets related to production of hydrocarbons;
  • Implementation of foreign projects;
  • Contracting major third-party service provides;
  • Purchase of high-tech equipment;
  • Purchase of existing retail chains and of land to build new retail outlets;
  • Expanding sales markets and sales volumes.

Management implements a portfolio of strategic projects for development of Gazprom Neft’s business in main segments, ensuring gradual strengthening of the Company’s positions in the competitive oil and gas industry environment, and lowering of risks associated with industry competition.

Risks related to geological explorationRisks related to geological exploration

A key strategic objective for the Company is to increase the quantity and quality of its hydrocarbon resource base in order to ensure satisfactory production levels, and this largely depends on the success of geological exploration.

The main risk associated with geological exploration is that target levels of hydrocarbon reserves will fail to be confirmed. An important factor is that geological surveying is carried out in various geographical regions, including some with harsh climates, which frequently causes a risk of additional costs.

Gazprom Neft has huge experience of geological surveying and use of the most advanced geophysical methods of hydrocarbon exploration and surveying, and also has modern technologies for drilling and deposit development. These capabilities reduce levels of risk due to geological factors.

ENVIRONMENTAL RISKS

Risks

Description

Risk management activities

Environmental risks

Gazprom Neft’s operations have inherent risk of damage to or pollution of the natural environment. This may give rise to civil law liability and require action to eliminate such damage.

The Company is fully aware of its responsibility before the public, and its obligation to ensure safe working conditions and protection of the natural environment. The Company ensures that its operations comply with applicable environmental standards and implements environmental protection programs.

The environmental policy of Gazprom Neft aims to comply with the provisions of the effective environmental regulations, by investing considerable funds in environmental activities, including use of technologies that minimize adverse impact on the environment. As a result, risks related to environmental pollution have been greatly reduced.

COUNTRY & REGIONAL RISKS

Risks

Description

Risk management activities

Political risks

The political situation in Russia at present is stable, with strong federal and regional executive government.

Gazprom Neft is a registered taxpayer in the city of Saint Petersburg, the second-largest city in the Russian Federation, and the capital of the Northwest Federal District, which has huge natural resource potential, advanced industries, and a dense transportation network.

Subsidiaries of Gazprom Neft are resident in the following Federal Districts: Central, Northwest, Ural, Volga, Siberia, and the Russian Far East.

On the whole, the Company views the political situation in Russia as stable and does not see any risk of negative developments at present.

Risk related to foreign assets

The Company has a number of foreign projects underway which aim to expand its production geography.

By enteringblems in nation states where the Company has assets; which may lead to a failure to a new regions the Company can obtain additional competitive advantages, but it also runs the risk of underestimating economic and political prochieve business targets.

Currently, Gazprom Neft sees the level of risks related to its foreign assets as acceptable; however, adverse changes cannot be ruled out, since such risks are beyond the Company’s control.

Corruption risks

As the Company actively enters new international markets, there are increasing risks of anti-corruption laws in the US and UK being extended to the Company.

Gazprom Neft is working on a program to control corruption risks. Essentially, the strategy is to make proactive efforts that minimize risks of liability for any lack of procedures to avert bribery. The program will assess the role of corruption risk in the Company’s risk management system, design a corporate regulation, and devise a strategy for communication support and appropriate employee training.

FINANCIAL RISKS

Management of the Company’s financial risk is the responsibility of employees acting within their respective professional spheres.

The Company’s Financial Risk Management Panel defines a uniform approach to financial risk management at the Company and its subsidiaries. Activities by the Company’s employees and the Financial Risk Management Panel minimize potential financial losses and help to achieve corporate targets.

Risks

Description

Risk management activities

Loan risk

Company management pays significant attention to management of loan risk.

Gazprom Neft has taken a number of steps to manage loan risk, including: counterpart solvency evaluation; individual lending limits depending on the counterpart’s financial situation; control of advance payments; control of accounts receivable by lines of business, etc.

Thanks to these measures, Company management is confident that there is no serious risk at present of the occurrence of losses in excess of the Company’s loan loss provisions.

The Company holds its temporarily unused cash on account at various Russian banks. It is part of Company policy to ensure that these banks are regularly checked for solvency and ranked by reliability.

Borrowing risk

Gazprom Neft efficiently controls risks associated with its borrowing activities.

The Company actively uses alternative sources of loan financing in addition to bank loans. The Company’s stable financial situation (confirmed by international rating agencies) helps it to mobilize funds in Russian and foreign banks with comparative ease.

Currency risk

Gazprom Neft generates most of its gross revenues from export sales of crude oil and petroleum products. This means fluctuation of ruble exchange rates may impact the Company’s financial and business performance.

The Company’s currency exchange risk is considerably mitigated by its foreign currency liabilities: the Company takes a large part of its loans on the international credit market in US dollars, and associated loan servicing costs are also in US dollars.

The currency structure of revenues and liabilities acts as a hedging mechanism where opposite factors offset each other. A balanced structure of currency claims and liabilities minimises the impact of currency risk factors on the Company’s financial and business performance.

Interest risk

As a major borrower, the Company is exposed to risk of changing interest rates. The international financial market remains the main source of loans, and most of the Company’s debt portfolio consists of loans and credits in US dollars. Interest rates payable on a part of existing loans is based on interbank rates (LIBOR), while the other part (its share is not fixed and may change) has no fixed interest rate and can vary. Any increase in the latter rates could lead to higher costs of debt servicing. Higher borrowing costs may have a negative impact on the Company’s solvency and liquidity ratios.

The LIBOR rate is currently on a modest upward trend, but the need for further growth stimulus in the world economy makes the probability of substantial increases (more than 1%) negligible. Therefore, taking account of the structure of Gazprom Neft’s current loan portfolio, it is fair to say that interest rate risk is at a low level for the Company.

LEGAL RISKS

Gazprom Neft acts in strict compliance with the standards of Russian law and that of other jurisdictions where it has operations.

The Company cannot rule out future adverse changes in Russian law in the long run,since most such risk-forming factors are beyond the Company’s control.

Negative impacts in this risk category are mitigated by monitoring and timely response to changes in various spheres of the law, and by ongoing interaction with legislative.and executive governments, and with social organizations on issues of interpretation, correct application and improvement of legislation.

Risks

Description

Risk management activities

Risks related to changes in tax law

Gazprom Neft is one of the largest taxpayers in the Russian Federation; it pays federal taxes, regional and local taxes, including value-added tax, corporate income tax, mineral extraction tax, corporate property tax and land tax.

In the course of its business, the Company constantly monitors all changes to tax law, and changes in interpretation and application of existing tax law. The Company also advises Government on improvement of legislation and the creation of new regulatory acts in the field of taxation.

Risks related to changes in customs regulations and duties

The Company is engaged in foreign trade, and is thus exposed to risks related to changes in laws and government regulation in the sphere of foreign trade, and to customs law specifying the procedure for passage of commodities across the customs border of the Russian Federation, as well as adoption and enforcement of customs regimes, and introduction and collection of customs duties.

Risks include the possibility that the Russian Government might change the level of customs duties (both import and export duties) payable on various commodities for which Gazprom Neft has signed foreign contracts. The main consequence of such risk would be higher costs and lower efficiency of exports.

The Company complies with customs control procedures and processes all documents required for both export and import operation. It has sufficient financial and human resources to ensure compliance with customs-related rules and regulations.

Risks related to changes in license compliance of main line of business

Evolution of current sub-soil legislation tends towards detailed regulation of sub-soil usage by the Government, more rational use of sub-soil areas, and strict compliance with legal standards of environmental protection.

Gazprom Neft operates its license areas in strict conformity with the requirements of Russian sub-soil law, and updates its license agreements to keep them compliant with relevant laws.

The Company analyses and assesses legislative initiatives by relevant ministries and departments in the sphere of sub-soil law and licensing. Proposed and discussed amendments to current legal acts will have an overall favorable effect on sub-soil practices and license-governed activities in the Russian Federation.

Gazprom Neft is not aware of any legal risks associated with loss of sub-soil rights or violation of current law due to changes in the law.

Risks related to changes in court practice on issues relevant to Company business

Gazprom Neft regularly monitors verdicts by high courts, and assesses the impact of trends in interpretation of the law by district arbitration courts. The Company proactively uses the results of such monitoring to protect its lawful rights and interests in court, and to resolve legal issues that arise from its operations. Therefore, risks related to changes in court practices are viewed as negligible.