Market Risks

RISKS ASSOCIATED WITH THE POSSIBLE CHANGE IN PRICES FOR PURCHASED RAW MATERIALS AND SERVICES

In the process of its business operations, Gazprom Neft uses the infrastructure of monopoly service providers for the transportation of oil and petroleum products and the supply of electricity.

The Company has no control over the infrastructure of these monopoly service providers and the amount of tariffs charged. It should be noted that although tariffs are regulated by the oversight of the authorities of the Russian Federation, tariffs are increased each year despite this fact. This leads to increased costs for the Company.

At the same time, additional expenses may arise as a result of the following factors:

• the incompatibility of Russia’s broad gauge rail system with the rail systems of neighbouring countries during rail transportation
• the mixing of the Company’s oil with that of other companies during transportation by trunk pipeline, which diminishes its quality and consequently its value
• the violation of vessel arrival and departure schedules during transportation by marine vessels as well as the failure to meet loading and unloading deadlines in the event of icing during severe winters

The Company has implemented a number of proactive measures aimed at mitigating the impact of such risks:

• long-term planning of commodity flows and the timely provisioning of the cumulative flow of oil and petroleum products as well as the necessary rolling stock
• the optimal redistribution of commodity flows by transportation type
• measures to use alternative and internal sources of electricity generation

These measures make it possible to reduce risks associated with the use of external services and the acquisition of goods from monopoly providers to an acceptable level and ensure the Company’s continuity in operations.

RISKS ASSOCIATED WITH THE POSSIBLE CHANGE IN OIL AND PETROLEUM PRODUCT PRICES

The Company’s financial indicators are directly related to the price level of crude oil and petroleum products. The price level depends on a number of factors which the Company cannot fully control. Such factors include:

• the volume of oil reserves explored as well as global and regional supply of and demand for crude oil and petroleum products
• Russian and foreign government requirements and actions
• the impact of global production levels and prices from oil exporting countries (OPEC)
• the military and political situation and/or instability resulting from the escalation of hostilities or acts of terrorism, including in the United States, the Middle East, the CIS and other resource producing regions
• prices and the availability of alternative and competing types of fuel;
• prices and the availability of new technologies
• weather and climatic conditions, natural disasters and industrial accidents

Comprehensive measures have been prepared to reduce the cost of extracting minerals.

The Company has a business planning system which at its core has a scenario-based approach when determining the Company’s key performance indicators dependant on oil prices on the global market. This approach makes it possible to cut costs, including by reducing them or carrying them over to future periods of investment programmes.

These measures enable the Company to reduce risks to an acceptable level and fulfil obligations it has undertaken.

RISKS ASSOCIATED WITH INDUSTRY-WIDE COMPETITION

There is intense competition in the Russian oil and gas industry between the leading Russian oil and gas companies in the main areas of production and economic activities, including:

• the acquisition of licenses for the right to use subsoil resources to produce hydrocarbons
• the acquisition of other companies that own licenses for the right to use subsoil resources to produce hydrocarbons or that own existing assets associated with production raw hydrocarbons
• the implementation of foreign projects
• the hiring of leading independent service companies
• the acquisition of high-tech equipment
• the hiring of experienced and the most qualified specialists
• access to critical transportation infrastructure
• the acquisition of existing retail sales network enterprises and land plots for the construction of new ones
• the expansion of sales markets and sales volumes

In addition, there is competition from the suppliers of alternative energy sources, including eco-friendly sources such as solar energy and wind energy.

Gazprom Neft has extensive experience in geological exploration work and employing the latest geophysical methods for prospecting and hydrocarbon exploration as well as advanced technologies in drilling and the development of fields which serve to diminish the probability of such risks.

The implementation of the portfolio of strategic projects by management aimed at developing key areas of OJSC Gazprom Neft activities ensures the gradual strengthening of the Company’s positions in the oil and gas industry by ensuring a reduction in risks associated with competition.

RISKS CAUSED BY ECONOMIC INSTABILITY IN THE INDUSTRY

Sustained in large part by the production and export of large volumes of oil and natural gas, the Russian economy is particularly sensitive to price fluctuations of crude oil, natural gas and other raw materials commodities on the global market. Negative oil price dynamics on the global market and a slowdown in the Russian economy may have an adverse effect on the Company’s business.

Over the past decade, the Russian economy has at different times experienced:

• a significant decline in GDP
• high inflation
• high levels of corruption
• a price slump on hydrocarbon markets
• instability on the currency market
• a high level of state debt versus GDP
• unstable lending terms and liquidity restrictions given the weakened banking sector
• fictitious bankruptcies in the industry for the misappropriation of property
• tax evasion practices
• weak diversification and a high dependency on global raw commodity prices
• a significant increase in unemployment and underemployment
• ethnic and religious conflicts
• a low level of personal income for a significant portion of the Russian population
• a high level of depreciation of the main infrastructural production facilities

In order to mitigate the negative effects of these factors on the Company’s performance results, work is being conducted to expand sales markets and increase the volume of products sold in foreign countries. The Gazprom Neft companies also provide support to the country’s economy as major taxpayers and take part in large-scale infrastructure and socially significant projects. The Company is constantly improving production and working on improving performance efficiency, including by implementing investment projects and updating and modernising fixed assets.