Novatek Annual Report 2012

Plain-text annual report

ANNUAL REPORT GROWTH EFFICIENCY INNOVATION RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER GROWTH EFFICIENCY INNOVATION OAO NOVATEK ANNUAL REPORT 2012 RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER ANNUAL REPORT OAO NOVATEK 2012 CONTENTS Letter to Shareholders .......................................................................................................................... 6 Strategy ............................................................................................................................................... 11 Growth. Efficiency. Innovation ............................................................................................................. 12 Key events ........................................................................................................................................... 19 Key indicators ...................................................................................................................................... 20 01 REVIEW OF OPERATING RESULTS ...................................................................................... 23 Licenses and Reserves ....................................................................................................................... 23 Geological Exploration ........................................................................................................................ 25 Field Development .............................................................................................................................. 26 Hydrocarbon Production ..................................................................................................................... 27 Processing .......................................................................................................................................... 37 Marketing ............................................................................................................................................ 39 02 ENVIRONMENTAL AND SOCIAL RESPONSIBILITY ....................................................... 47 Environmental Protection .................................................................................................................... 47 Health and Safety ................................................................................................................................ 49 Human Resources .............................................................................................................................. 50 Social Policy and Charity .................................................................................................................... 53 03 MANAGEMENT AND CORPORATE GOVERNANCE ......................................................... 57 Corporate Governance System .......................................................................................................... 57 General Meeting of Shareholders ....................................................................................................... 58 Board of Directors .............................................................................................................................. 58 Board Committees ............................................................................................................................. 62 Management Committee ................................................................................................................... 64 Remuneration to Members of the Board of Directors and Management Committee ....................... 65 Internal Control and Audit ................................................................................................................... 65 Share Capital ....................................................................................................................................... 67 Dividends ........................................................................................................................................... 68 Information Transparency ................................................................................................................... 69 ADDITIONAL INFORMATION .................................................................................................... 70 Major Risk Factors ............................................................................................................................. 70 Information on Members of the Board of Directors and Management Committee .......................... 74 Major Transactions and Interested Party Transactions ...................................................................... 82 IFRS Consolidated Financial Statements ............................................................................................ 85 Management’s Discussion and Analysis of Financial Condition and Results of Operations .......... 160 Contact information .......................................................................................................................... 202 4 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION Yamal-Nenets Autonomous Region Russia NOVATEK IS RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER AND THE SECOND-LARGEST NATURAL GAS PRODUCER IN RUSSIA NOVATEK’S MAIN BUSINESSES ARE EXPLORATION AND PRODUCTION, PROCESSING, TRANSPORTATION AND MARKETING OF NATURAL GAS AND LIQUID HYDROCARBONS. THE COMPANY’S PRIMARY PRODUCTION AND PROCESSING ASSETS ARE LOCATED IN THE YAMAL-NENETS AUTONOMOUS REGION (YNAO), ONE OF THE LARGEST GAS PRODUCING REGIONS IN THE WORLD. 12.4 #4 #7 BLN BOE OF PROVED HYDROCARBON RESERVES UNDER SEC GLOBALLY AMONG PUBLICLY TRADED COMPANIES BY PROVED NATURAL GAS RESERVES UNDER SEC GLOBALLY AMONG PUBLICLY TRADED COMPANIES BY NATURAL GAS PRODUCTION VOLUMES 57.3 BCM OF NATURAL GAS PRODUCED IN 2012 9% OF TOTAL RUSSIAN NATURAL GAS PRODUCTION 16% OF TOTAL NATURAL GAS DELIVERIES TO THE DOMESTIC MARKET VIA THE UGSS ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 5 LEGEND – gas trunk pipeline – gas condensate pipeline of NOVATEK 3 – producing fields of NOVATEK and JVs 24 – prospective fields and license areas of NOVATEK and JVs – Purovsky plant of NOVATEK 34 5 32 33 30 31 21 Yamburg 9 Nadym 7 11 1 35 16 15 17 14 26 10 28 19 13 18 4 27 24 23 29 25 12 2 3 22 8 6 20 FIELDS AND LICENSE AREAS 1. Yurkharovskoye field 2. East-Tarkosalinskoye field 3. Khancheyskoye field 4. Olimpiyskiy license area (Sterkhovoye field) 5. South-Tambeyskoye field 6. Termokarstovoye field 7. West-Yurkharovskoye field 8. North-Khancheyskoye field 9. Yarudeyskoye field 10. Raduzhnoye field 11. New-Yurkharovskiy license area 12. Yumantilskiy license area 13. West-Urengoyskiy license area 14. North-Yubileynoye field 15. North-Russkiy license area 16. North-Russkoye field 17. West-Tazovskiy license area 18. North-Yamsoveyskiy license area 19. Ukrainsko-Yubileynoye field 20. Pilyalkinskiy license area 21. Malo-Yamalskoye field 22. West-Chaselskoye field 23. Beregovoy license area 24. Pyreinoye field 25. Khadyryakhinskiy license area 26. Samburgskiy license area 27. Yevo-Yakhinskoye field 28. Yaro-Yakhinskiy license area 29. North-Chaselskiy license area 30. Salmanovskoye (Utrenneye) field 31. Geofizicheskoye field 32. North-Obskiy license area 33. East-Tambeyskiy license area 34. North-Tasiyskiy license area 35. North-Urengoyskoye field 6 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION LETTER TO SHAREHOLDERS Dear Shareholders, OUR Core Business continued to develop successfully throughout 2012 in full conformity with the Compa- ny’s strategic objectives and priori- ties, with a focus toward a balanced growth on all key performance indi- cators and the strengthening of our competitive advantages. Achieve- ments in the reporting year, com- bined with our flexible and innova- tive approach to business, offer an excellent foundation for the efficient increase of production volumes, en- abling us to look into the future with confidence. Our main competitive advantag- es are an extensive resource base, which guarantees a steady increase in hydrocarbon production at indus- try-leading low costs, and our inte- grated production chain, which helps to maximize risk-adjusted margins and improve the sustainability of our business operations. During 2012, we increased our prov- en hydrocarbon reserves under the SEC reserve standards by one-third to approximately 12.4 billion boe and, as at the end of the current report- ing year, we ranked among the top four public companies worldwide in terms of proven natural gas re- serves. Equally impressive, NOVATEK achieved a record 842% reserve replacement rate in 2012 (three-year reserve replacement rate – 623%) demonstrating the efficacy of our ex- ploration and development program as well as completing another value accretive acquisition in close prox- imity to our existing operations and infrastructure. Our hydrocarbon reserve base is concentrated in the resource rich Yamal Nenets Autonomous Region of Russia, which is the world's largest natural gas region with well-devel- oped infrastructure, enabling us to consistently report one of the lowest cost levels in the oil and gas indus- try. Our reserve replacement costs in 2012 were RR 33.1 ($1.07) per boe and lifting costs were RR 17.8 ($0.57) per boe. A key strategic priority for the Com- pany is the steady and efficient growth of production volumes com- mensurate with our sustainable field development activities and resource base. At the end of 2012 more than 60% of our proved reserves under the SEC reserve standards were classified as "undeveloped", and our reserve life increased from 25 years to 31 years, providing an excellent base for sustainable production growth in the future. During the year, we increased our gas production by 7% and the production of crude oil and unstable gas condensate by 4%, which is consistent with our opera- tional guidance for the year. The increase in our proven reserves and production levels was support- ed by the acquisition in November 2012 of a 49% equity stake in ZAO Nortgas, which holds a production license to develop the North-Uren- goyskoye field. The field is located in close proximity to existing NOVATEK production and transportation capac- ity and has considerable potential for production growth with the planned development of the field’s Eastern ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 7 A KEY STRATEGIC PRIORITY FOR THE COMPANY IS THE STEADY AND EFFICIENT GROWTH OF PRODUCTION VOLUMES COMMENSURATE WITH OUR SUSTAINABLE FIELD DEVELOPMENT ACTIVITIES AND RESOURCE BASE. AT THE END OF 2012 MORE THAN 60% OF OUR PROVED RESERVES UNDER THE SEC RESERVE STANDARDS WERE CLASSIFIED AS "UNDEVELOPED", AND OUR RESERVE LIFE INCREASED FROM 25 YEARS TO 31 YEARS, PROVIDING AN EXCELLENT BASE FOR SUSTAINABLE PRODUCTION GROWTH IN THE FUTURE dome. The Nortgas acquisition com- plements NOVATEK’s existing asset portfolio and will enable us to achieve more ambitious targets for production growth in the medium term. We continued to invest capital to further develop our existing asset portfolio in 2012 and commissioned new production capacities as sched- uled. A fourth complex was launched in the second development phase at the Yurkharovskoye field bringing total production output at the field to its targeted plateau levels, as well as launching the first stage of a booster station to keep production at field’s maximum levels. Production of nat- ural gas and gas condensate began at the Samburgskoye field of Sever- Energia during 2012, where the first and second stages of a gas treat- ment facility were commissioned and transport infrastructure was installed. We also launched a central oil gath- ering facility at the East Tarkosalin- skoye field as part of our develop- ment plans to exploit the oil layers on this important field. We have already worked diligently and constructively in previous years to create an integrated production value chain, with our own processing facilities and diversified distribution channels. Preparations were made in 8 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 2012 for the start of construction work to expand processing capacity at the Purovsky gas condensate plant in conjunction with planned increases of unstable gas condensate output from our fields, including purchases from our joint venture partners. We also signed an agreement on strategic cooperation with OAO Russian Rail- ways, ensuring that the expansion of transport infrastructure will keep pace with planned output increases from the Purovsky processing plant. Construction of main facilities was al- most completed in the first phase of the new complex for transshipment and fractionation of gas conden- sate at the port of Ust-Luga on the Baltic Sea. The complex will allow the Company to enter new markets, expand its customer base and in- crease sales of higher value added products. We took a number of important stra- tegic steps in our commercial mar- keting of natural gas in Russia during 2012. At year-end, we acquired an 82% participation interest in OOO Gazprom mezhregiongaz Kostroma, significantly increasing the volume of our supplies to end-users in the Kostroma region. A number of new long-term contracts were also signed with major end-users, guaranteeing continued growth in the sales vol- umes of our marketable natural gas. For the first time in our history, we ex- ecuted delivery contracts for periods of up to 15 years, confirming a high level of confidence in NOVATEK’s commercial capabilities among end customers. We also managed to increase the proportional share of end-users in our total gas volumes sales mix from 55% in 2011 to 69% in 2012, which represents another important marketing achievement as well as providing sales stability in our customer relationships. We remain bullish on the natural gas markets over the long-term and expect further growth in the share of natural gas in the global energy mix despite sluggish demand growth over the past several years. Our longer- term outlook for natural gas also envisages a greater role for liquefied natural gas, or LNG, in the global supply balance. Development of LNG production and transportation will, to a large extent, be decisive for the future of the global gas market. The delivery of natural gas to the international market in the form of LNG has a key role in NOVATEK’s long-term strategy, allowing us to diversify our markets and efficiently monetize our conventional natural gas reserves on the Yamal Peninsula. In 2012, we continued implementing the Yamal LNG project, which pro- vides for construction of an LNG plant at our South-Tambeyskoye gas con- densate field. Progress in the report- ing year included the completion of front end engineering design for the field development, LNG plant and port of Sabetta, as well as finalizing of technical specifications and comple- tion of basic design of a new ARC-7 ice-class LNG tanker. Tenders were initiated for engineering, procurement and construction of the LNG plant and for the transportation of LNG. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 9 THE DELIVERY OF NATURAL GAS TO THE INTERNATIONAL MARKET IN THE FORM OF LNG HAS A KEY ROLE IN NOVATEK’S LONG-TERM STRATEGY, ALLOWING US TO DIVERSIFY OUR MARKETS AND EFFICIENTLY MONETIZE OUR CONVENTIONAL NATURAL GAS RESERVES ON THE YAMAL PENINSULA. IN 2012, WE CONTINUED IMPLEMENTING THE YAMAL LNG PROJECT, WHICH PROVIDES FOR CONSTRUCTION OF AN LNG PLANT AT OUR SOUTH-TAMBEYSKOYE GAS CONDENSATE FIELD We also commenced gas trading op- erations on the international markets. We continued to report strong fi- nancial results in 2012 underpinned by our commitment and focus on cost controls, prudent investment decisions, and commensurate with the growth profile of our operations. Our consolidated IFRS earnings per share increased to RR 22.9, or by 23% compared to the normalized level of 2011, excluding the effects of gains on disposals, and, as a result, the Board of Directors recommend- ed the General Meeting of Share- holders to approve dividends for the reporting year at RR 6.86 per share, which is 14% more than dividends for 2011. We recognize that the sustainable development of the Company de- pends on the high standards of social responsibility and our commitment to these principles. We have always been cognizant of our operational footprint to the regional development in the Far North of Russia, where our core production and processing assets are located, and we remain committed to ensure environmental integrity and industrial safety, and caring for our staff and the indige- nous peoples of the region. These are fundamental principles, which we will not compromise. We could not achieve the success we have accomplished without the contribution of every member of our 10 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION highly professional and well-organ- ized team of employees formed over the years since NOVATEK’s foundation. Human capital under- scores our solid foundation for the successful implementation of the Company’s strategic plans. On behalf of the Board of Directors and Management, we are pleased to present the Annual Report of NOVATEK for the year 2012, and we would like to thank our share- holders for their unfailing confi- dence in the Company and our long-term strategic plans. We en- deavor to continue investing capital efficiently in the development of our facilities for extraction, processing and transportation of natural gas and liquid hydrocarbons, making best use of the experiences we have gained in the past and using our competitive advantages to cre- ate shareholder value in a sustain- able manner. ALEXANDER E. NATALENKO Chairman of the Board of Directors LEONID V. MIKHELSON Chairman of the Management Committee MARK A. GYETVAY Chief Financial Officer ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 11 STRATEGY T N E M P O L E V E D E L B A N A T S U S I INCREASE HYDROCARBON PRODUCTION OPTIMIZE AND EXPAND MARKETING CHANNELS PRUDENT INVESTMENT DECISIONS GROW RESOURCE BASE CONSERVATIVE FINANCIAL POLICIES MAINTAIN LOW COST STRUCTURE EXPAND PROCESSING CAPACITY C O R P O R A T E G O V E R N A N C E Future development of Company busi- ness is associated with further work on expansion of a vertically integrated value chain: from exploration and production of hydrocarbons to the processing of liquid hydrocarbons and sale of products to end-users. Main strategic priorities of NOVATEK are: • Growth of the resource base and effi- cient reserve management; • Maintaining sustainable rates of growth of hydrocarbon production; • Maintaining a low-cost structure; • Expansion of processing capacity to maximize vertical integration and develop the hydrocarbon value chain; and • Optimization and expansion of exist- ing marketing channels, and creation of new marketing channels. The Company has a number of com- petitive advantages to implement its strategy successfully. These competitive advantages include: size and structure of the resource base; existing infra- structure close to core producing fields; a well-developed customer base for natural gas sales; own facilities for gas condensate processing and exports; and developed marketing channels for liquefied petroleum gases (LPG) and stable gas condensate. NOVATEK’s competitiveness is also supported by its high level of operating flexibility and con- sistent use of the latest technologies in production and business management. Our commitment to social responsibility and to observing the latest environmen- tal, health and safety standards are in- tegral parts of NOVATEK’s development strategy. 12 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION GROWTH 489 % RESERVE REPLACEMENT RATIO IN 2005–2012 PROVED RESERVES Developed reserves Undeveloped reserves H T W O R G 9.4 BLN BOE 4.6 BLN BOE 12.4 BLN BOE 31 YEARS RESERVE LIFE 63% SHARE OF UNDEVELOPED RESERVES 7% SHARE OF LIQUIDS 2005 2011 2012 MARKETABLE HYDROCARBON PRODUCTION CAPACITY OF THE PUROVSKY PLANT NUMBER OF NATURAL GAS END-CUSTOMERS* 184 405 2 5 74 3,482 MMBOE MMBOE MMT PER ANNUM MMT PER ANNUM 2005 2012 2005 2012 2005 2012 * Number of legal entities. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 13 12 % HYDROCARBON PRODUCTION CAGR IN 2005–2012 GROSS PRODUCTION NATURAL GAS LIQUIDS 57.3 BCM 53.5 BCM 25.2 BCM 2.6 MMT 4.1 MMT 4.3 MMT 2005 2011 2012 2005 2011 2012 REVENUES EBITDA PROFIT ATTRIBUTABLE TO SHAREHOLDERS OF OAO NOVATEK 38.4 211.0 19.4 95.2 10.1 69.5 RR BLN RR BLN RR BLN RR BLN RR BLN RR BLN 2005 2012 2005 2012 2005 2012 Revenues are net of VAT, export duties, excise and fuel taxes. EBITDA and profit are adjusted for gain (loss) on disposal of interests in subsidiaries and joint ventures. 14 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION EFFICIENCY 1.1 $/BOE RESERVE REPLACEMENT COSTS I Y C N E C F F E I HIGH QUALITY RESOURCE BASE AND USE OF STATE-OF-THE-ART TECHNOLOGIES YURKHAROVSKOYE FIELD RESERVE RECOVERY PER WELL More than 7 bcm of gas on average FLOW RATE Up to 4.5 mmcm per day THE DRILLING OF LARGE DIAMETER HORIZONTAL WELLS RESULTS IN HIGHER FLOW RATES AND LOWER LIFTING COSTS HIGHER RESERVE RECOVERY PER WELL RAISES EFFICIENCY OF THE DEVELOPMENT COSTS 0.57 $/BOE LIFTING COSTS 83 TH. BOE PRODUCTION PER EMPLOYEE 0.7 kWh ELECTRICITY CONSUMPTION PER BOE OF PRODUCTION All data is for 2012. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 15 69 INTEGRATED PRODUCTION CHAIN % SHARE OF END-USERS IN TOTAL GAS VOLUMES SALES MIX 01 EXPLORATION High efficiency due to regional specifics; base for long-term production growth 02 DEVELOPMENT AND PRODUCTION Complex of technologies for development and construction of gas condensate fields 04 CONDENSATE STABILIZATION Guarantied efficient processing of 100% of unstable gas condensate production 03 TRANSPORTATION OF UNSTABLE GAS CONDENSATE Feedstock quality maintenance 06 GAS MARKETING Additional margin and guarantied stability of the integrated chain 05 CONDENSATE FRACTIONATION (under construction as at 31 December 2012) Value added and market diversification 19.6 RR MLN EBITDA PER EMPLOYEE 06 LIQUIDS MARKETING Additional margin and guarantied stability of the integrated chain Petroleum products Stable gas condensate Liquefied petroleum gases 20% ROACE 45% EBITDA MARGIN 16 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION INNOVATION 1 DRILLING 2 DRILLING CUTTINGS PROCESSING PLANT The use of special hydrocarbon-based drilling mud allows to increase drilling speed and results in the high-precision penetration of production horizons. Geosteering technology enables to maximize the length of productive horizontal sections of our wells. Application of these technologies allows to materially increase flow rates. A unique drilling cuttings processing plant at the Yurkharovskoye field enables us to efficiently resolve the drilling cuttings utilization problem, while drilling at the coast of the Gulf of Ob, resulting in material environmental benefits and cost savings due to efficient recycling of hydrocarbon-based drilling mud. I N O T A V O N N I 4 5 3 PRODUCTION WELLS 4 TURBO-EXPANDERS A typical well casing at the Yurkharovskoye field is up to 245 mm in diameter with the length of horizontal part of the borehole exceeding 1,000 meters, which results in flow rate of up to 4.5 mmcm of gas per day. The use of large diameter and multilateral horizontal wells reduces the total number of wells required to develop the field, thereby minimizing the field’s overall capital expenditures. Turbo-expanders operating at our Yurkharovskoye field allow to materially increase the efficiency of gas treatment operations due to much lower electricity consumption and full compliance with quality requirements to marketable gas. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 17 5 METHANOL PRODUCTION FACILITY 6 ALTERNATIVE ENERGY SOURCES Methanol is an integral element of natural gas and gas condensate production process allowing to avoid hydrate formation. A unique methanol production facility at our Yurkharovskoye field eliminated the need to purchase and transport methanol to the field, thus decreasing our lifting costs and minimizing potential environmental risks. Solar panels and wind generators provide the necessary electricity to operate the telemechanic system and valves of the condensate pipeline connecting our Yurkharovskoye field with the Purovsky Plant therefore eliminating the need to build a costly high voltage power transmission line along the entire pipeline route and reducing pipeline construction time. 6 7 8 7 LPG DEHYDRATION UNIT 8 ON SPOT LOADING SYSTEM The LPG dehydration unit at our Purovsky Plant is the first of its kind to be constructed and utilized in Russia, which allows us to produce LPG to the highest quality requirements, including international standards for export purposes. NOVATEK was the first in Russia to introduce “On Spot” loading system at its Purovsky Plant to load stable gas condensate into rail tank cars. This loading system ensures the fastest loading possible (compared with gallery-type loading systems) while minimizing environmental risks. 1,157 MT OF STABLE GAS CONDENSATE DELIVERED VIA THE NORTHERN SEA ROUTE FROM THE START OF ITS USAGE RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 19 KEY EVENTS 01 04 07 Launch of the fourth stage of Phase Two development at the Yurkharovskoye field, bringing total production at the field to its target plateau. Commissioning of the first stage booster compressor station at the field. Acquisition of an 82% in- terest in OOO Gazprom mezhregiongas Kostroma, which supplies gas to a broad range of customers in Kostroma region. Successful placement of Eurobonds with total nom- inal value of $1 billion and 10-year maturity. Issue of Russian rouble bonds with total nominal value of RR 20 million and 3-year maturity. 02 Start of the first and second phases of com- mercial production at the Samburgskoye field, which is being devel- oped by the joint venture, OOO SeverEnergia. 03 Acquisition of a 49% equity stake in ZAO Nortgas, which owns a hydrocarbon production license for the North-Urengoyskoye field. 05 Start of construction work on the port of Sabetta, which will be the key transport infra- structure link in the Yamal LNG project. 06 Signing of gas supply agree- ments with end-users, in- cluding 15-year agreements with the Russian subsidiar- ies of E.ON and Fortum, a 10.5-year agreement with MMK, contracts with Mechel Group companies for 10 years and longer, a 5-year contract with OAO Severstal and a 3-year contract with OAO Mosenergo. 08 Agreement on strategic partnership up to 2020 with OAO Russian Railways, pro- viding for expansion of rail- way infrastructure to ensure guaranteed transportation of products from the Purovsky Plant. 09 Launch of the central oil treatment facility at the East Tarkosalinskoye field. 20 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION KEY INDICATORS FINANCIAL INDICATORS Total revenues(1) UNITS 2011 2012 CHANGE RR mln 175,273 210,973 20.4% Normalized profit from operations(2) RR mln 78,660 85,394 8.6% Normalized EBITDA(2) RR mln 85,401 95,166 11.4% Normalized profit attributable to shareholders of OAO NOVATEK(2) Normalized earnings per share(2) RR mln 56,707 69,518 22.6% RR 18.69 22.91 22.6% Net cash provided by operating activities RR mln 71,907 75,825 5.4% Capital expenditures Free cash flow Net debt Total debt to equity RR mln 31,161 43,554 39.8% RR mln 40,746 32,271 (20.8)% RR mln 71,647 114,067 59.2% Х 0.40 0.45 - OPERATING INDICATORS Proved natural gas reserves (SEC) Proved liquid hydrocarbon reserves (SEC) bcm mmt 1,321 1,758 33.1% 91 106 16.5% Total hydrocarbon reserves (SEC) mmboe 9,393 12,394 31.9% Gross production of natural gas bcm 53.54 57.32 Gross production of liquid hydrocarbons mt 4,124 4,287 7.1% 4.0% POSITIONS IN THE RUSSIAN GAS INDUSTRY Share in natural gas production Share in gas deliveries to the domestic market via the UGSS (1) Net of VAT, export duties, excise and fuel taxes. (2) Adjusted for gain (loss) on disposal of interests in subsidiaries. % % 8.0% 8.8% 0.8 p.p. 14.8% 16.3% 1.5 p.p. Financial data is in accordance with the consolidated IFRS financial statements. Data on reserves and production include subsidiaries and share in joint ventures. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 21 PROVED NATURAL GAS RESERVES (SEC), BCM TOTAL PROVED HYDROCARBON RESERVES (SEC), MMBOE 1,758 1,144 967 1,321 1,800 1,200 600 0 690 12,394 6,853 8,088 9,393 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 4,963 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 Proved undeveloped Proved developed Proved undeveloped Proved developed GROSS NATURAL GAS PRODUCTION, BCM GROSS LIQUIDS PRODUCTION, MMT 53.5 57.3 30.9 32.8 37.8 70 60 50 40 30 20 10 0 4.3 4.1 3.6 3.0 2.6 5 4 3 2 1 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 EBITDA*, RR BLN 100 80 60 40 20 0 95.2 85.4 56.2 36.7 39.5 PROFIT ATTRIBUTABLE TO SHAREHOLDERS OF OAO NOVATEK*, RR BLN 69.5 56.7 39.2 22.9 26.0 80 60 40 20 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 * EBITDA is adjusted for the gain (loss) on disposal of interests in subsidiaries. * Profit is adjusted for the gain (loss) on disposal of interests in subsidiaries. 842 RESERVE % REPLACEMENT RATIO IN 2012 RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 23 01 REVIEW OF OPERATING RESULTS THE FOURTH STAGE OF PHASE TWO DEVELOPMENT AT THE YURKHAROVSKOYE FIELD, OUR LARGEST PRODUCING FIELD, WAS COMMISSIONED IN OCTOBER 2012, BRINGING THE FIELD TO ITS PLANNED ANNUAL PRODUCTION PLATEAU OF 36.5 BCM OF NATURAL GAS LICENSES AND RESERVES NOVATEK’s fields and license areas are located in the YNAO of the Russian Federa- tion, which is the world’s largest natural gas producing region and accounts for approxi- mately 17% of global natural gas production and 84% of Russian natural gas produc- tion. The concentration of the Company’s producing and prospective fields, license areas and processing facilities in this region combined with the Region’s overall oil and gas infrastructure have allowed NOVATEK to minimize the risks associated with devel- oping its assets and expanding its resource base. The Company has many years of experience working in the YNAO, which has enabled it to effectively capitalize on the growth opportunities resident there to increase shareholder value. Exploration and production of hydrocarbons in Russia is subject to licensing. As of 31 December 2012, our subsidiaries and joint ventures held 35 licenses for fields and license areas, of which 30 are classified as either production or combined exploration and production licenses and five are clas- sified as exploration licenses. The duration of licenses for our core fields exceeds 20 years: the license for the Yurkharovskoye field is valid until 2034, the East-Tarko- salinskoye field expires in 2043, and the South-Tambeyskoye field in 2045. NO- VATEK is strictly observing all of its license obligations pursuant to current Russian legislation, and carries out continuous mon- itoring of license tenders in order to expand its resource base in strategically important regions. The Company’s reserves are appraised on an annual basis by independent petroleum engineers, “DeGolyer and MacNaughton” (“D&M”) under the SEC and PRMS reserves reporting standards. Most of the Compa- ny’s reserves are located onshore or can be developed from onshore locations and are attributed to the conventional categories (capable of being exploited using conven- tional technologies, in contrast to uncon- ventional gas deposits such as shale gas). As of 31 December 2012, NOVATEK’s SEC proved reserves totaled 12,394 mmboe, based on our equity ownership interest in 24 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 3.4 BLN BOE OF PROVED HYDROCARBON RESERVES ADDED IN 2012 (INCLUDING PRODUCTION) I G N T A R E P O F O W E V E R I S T L U S E R the respective fields, representing a 32% increase compared to proved reserve volumes as of the end of 2011. In 2012, we added 3,405 mmboe of proved reserves under the SEC reserves reporting stand- ards, inclusive of 2012 production, and recorded a more than eight-fold (842%) reserve replacement rate (874% for natural gas). Total proved reserves of natural gas increased to 1,758 bcm or by 493 bcm, inclusive of 2012 production. At year-end 2012, the Company’s reserve to production ratio (or R/P ratio) increased from 25 years in 2011 to 31 years. Under the PRMS reserves reporting meth- odology, the Company’s total proved re- serves increased by 4,665 mmboe, inclu- sive of 2012 production, and aggregated 15,597 mmboe. Total proved plus probable reserves (2P reserves) increased by 45% to 22,355 mmboe, including an increase of natural gas reserves by 1,054 bcm, inclu- sive of 2012 production, to 3,106 bcm. The increase in all of our reserve categories under international reserve reporting stand- ards was due to successful exploration at the Company’s fields, ongoing production drilling, the inclusion of Salmanovskoye (Utrennee) and Geofizicheskoye fields acquired in 2011 into the reserve appraisal (the reserves of these two fields increased substantially in 2012 due do exploration works conducted during the year), as well as the acquisition of an equity stake in ZAO Nortgas, which holds the license for the North-Urengoyskoye field. As of 31 December 2012, NOVATEK’s total recoverable reserves under the Russian reserve classification ABC1 + C2 totaled 4,398 bcm of natural gas and 523 mmt of liquid hydrocarbons, based on our equity ownership interest in the respective fields. In 2012, these reserves increased by 400 bcm of gas and 28 mmt of liquid hydro- carbons, inclusive of 2012 production. The growth was due to successful exploration works, which among other results allowed us to substantially increase reserves at the Salmanovskoye (Utrenneye) and Geofizich- eskoye fields, as well as our acquisition of the equity stake in ZAO Nortgas. NOVATEK continued to deliver low cost reserve growth in 2012 through strategically investing capital in development and explo- ration activities as well as strategic acquisi- tions, which enabled the Company to main- tain its position as one of the lowest cost producers in the global oil and gas industry. The Company’s total 2012 reserve replace- ment costs were RR 33.1 per boe ($1.07 per boe)(1) while our three-year and five-year reserve replacement costs amounted to RR 41.5 per boe ($1.36 per boe) and RR 34.2 per boe ($1.14 per boe), respectively. (1) At an average exchange rate of RR 31.09 per USD. ANNUAL REPORT OAO NOVATEK 2012 Exploration work 2D seismic Subsidiaries Joint Ventures 3D seismic Subsidiaries Joint Ventures Exploration drilling Subsidiaries Joint Ventures 25 GROWTH EFFICIENCY INNOVATION UNITS linear km linear km linear km 2011 376 91 285 sq. km 1,689 sq. km sq. km th. m th. m th. m 899 790 41.3 20.8 20.5 2012 CHANGE, % 7,001 7,001 0 2,799 2,258 541 36.2 26.8 9.4 1,762% 7,593% (100)% 66% 151% (32)% (12)% 29% (54)% GEOLOGICAL EXPLORATION Exploration drilling totaled 36.2 thousand meters in 2012, eight prospect- ing and exploration wells were completed leading to discovery of five new deposits and a better understanding of the geology of previously discov- ered deposits. NOVATEK aims to expand its resource base through geological exploration at fields and license areas not only in close proximity to existing transportation and production infra- structure, but also in new potentially pro- spective hydrocarbon areas. The Company ensures the efficiency of geological explo- ration work by deploying state-of-the-art technologies and relying on the experience and expertise of the specialists in its geology department, and the Company’s Scientific and Technical Center located in Tyumen. The Company uses a systematic approach to exploration and development of its fields and license areas, beginning with the col- lection and interpretation of seismic data to the creation of dynamic field models for the placement of exploration and production wells. We employ modern geological and hydrodynamic modeling as well as new well drilling and completion techniques to maximize the ultimate recovery of hydro- carbons in a cost effective manner. In 2012, full-scale exploration work began at our fields located on the Gydan Peninsula and offshore license areas in the Gulf of Ob, which were acquired in 2011. Exploration work activities also continued at fields and license areas in the Nadym-Pur-Taz region, including the Yurkharovskoye, West-Yur- kharovskoye, North-Khancheyskoye and Yarudeyskoe fields and the Khancheyskiy, Olimpiyskiy, New-Yurkharovskiy and North-Russkiy license areas. The exploration activities at these fields targeted gas con- densate and crude oil bearing Lower Cre- taceous (including Achimov) and Jurassic deposits at subsurface depths of between 2,000 to 4,400 meters. We also continued exploration work at the South-Tambeyskoye field on the Yamal Peninsula. In 2012, NOVATEK completed approximate- ly 7,000 linear kilometers of two-dimen- sional (2D) seismic and 2,799 square km of three-dimensional (3D) seismic, including seismic activities run at our joint ventures. The major growth in seismic activities as compared to 2011 was due primarily to 2D seismic work activities in the Gulf of Ob and 3D work activities on the Gydan Peninsula. Exploration drilling totaled 36.2 thousand meters in 2012, eight prospecting and ex- ploration wells were completed leading to discovery of five new deposits and a better understanding of the geology of previously discovered deposits. As a result of exploration works, production drilling and the re-appraisal of reserves (excluding the effect from the acquisition of a stake in ZAO Nortgas), our recoverable natural gas reserves under the Russian reserve classification ABC1 + C2 increased by 218 bcm. Most of the recoverable re- serve growth was at the Geofizicheskoye, Khancheyskoye, North-Khancheyskoye, Yarudeyskoe, Pyreinoye, Beregovoye, Samburgskoye, Urengoyskoye and Ya- ro-Yakhinskoye fields. 26 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION BCM3.8 NATURAL GAS PRODUCTION GROWTH IN 2012 I G N T A R E P O F O W E V E R I FIELD DEVELOPMENT Two phases of the Samburgskoye field with total annual capacity of 4.6 bcm of gas and more than 600 thousand tons of gas condensate were launched in 2012, being the first field to start commercial production at our SeverEnergia joint venture. S T L U S E R During 2012, NOVATEK’s subsidiaries in- vested RR 32.0 billion in the development and construction at our producing and pro- spective fields as part of our capital invest- ment program in order to achieve sustaina- ble hydrocarbon production growth. The fourth stage of Phase Two devel- opment at the Yurkharovskoye field, our largest producing field, was commis- sioned in October 2012, bringing the field to its planned annual production plateau of 36.5 bcm of natural gas. The first stage of a booster compressor station was also brought into operation and will enable max- imum levels of gas production to be main- tained at the field. Two phases of the Samburgskoye field with total annual capacity of 4.6 bcm of gas and more than 600 thousand tons of gas con- densate were launched in 2012, being the first field to start commercial production at our SeverEnergia joint venture. We also finalized the construction of a cen- tral oil treatment facility at the East-Tarkosa- linskoye field, where we began to success- fully exploit the field’s oil deposits. The new facility will allow us to substantially increase crude oil production at the field. Production drilling in 2012, including joint ventures, amounted to 245.2 thousand meters, which is 133% more than the meters drilled in 2011. A total of 18 natu- ral gas and 24 oil wells were completed, including six wells at the Yurkharovskoye field with average initial flow rate of 2.2 mmcm of natural gas per day. A new re- cord was set for the wellbore length at the Yurkharovskoye field following the comple- tion of a 7,100-meter well with a horizontal section of 1,200 meters. ANNUAL REPORT OAO NOVATEK 2012 Gross hydrocarbon production* GROWTH EFFICIENCY INNOVATION 27 UNITS 2011 2012 CHANGE Gas bcm 53.54 Liquid hydrocarbons mmboe mt mmboe 350.1 4,124 34.6 57.32 374.9 4,287 35.9 7.1% 4.0% Total production mmboe 384.7 410.8 6.8% * Including share in production by joint ventures. HYDROCARBON PRODUCTION Gross natural gas production increased mainly due to organic growth at the Yurkharovskoye and East-Tarkosalinskoye fields, production start-up at the Samburgskoye field, and the acquisition in November 2012 of an equity stake in ZAO Nortgas, which is developing the North- Urengoyskoye field. NOVATEK’s 2012 gross production from all fields (including the Company’s share in production of joint ventures) amounted to 411 mmboe (405 mmboe of sales produc- tion), representing an increase of 6.8% over the prior year. In 2012, total gross production of natural gas amounted to 57.3 bcm (sales produc- tion – 56.5 bcm), representing 91% of our total hydrocarbon output. The share of gas produced from the Valanginian layers (or “wet gas”) in proportion to total gas pro- duction was 72%. Gross natural gas pro- duction increased by 7.1% or by 3.8 bcm, as compared to 2011 volumes, mainly due to organic growth at the Yurkharovskoye and East-Tarkosalinskoye fields, production start-up at the Samburgskoye field, and the acquisition in November 2012 of an equity stake in ZAO Nortgas, which is developing the North-Urengoyskoye field. The Yurkharovskoye field accounted for 55% of total gas production growth due to drilling of new wells and the expansion of field infrastructure. The East-Tarkosa- linskoye field contributed about 19% of production growth due to side-tracking activities and an increase in production of associated gas, while the Samburgskoye field, launched in April 2012, contributed approximately 12%. The Nortgas acquisi- tion contributed 5% of growth in our pro- duction profile from the date of acquisition to year-end. Gross production of liquid hydrocarbons totaled 4.29 mmt (sales production – 4.27 mmt), of which 88% was unstable de-eth- anized gas condensate and 12% of crude oil. Gross production of liquids increased by 4.0% or 163 thousand tons as compared with 2011 mainly due to increased volumes of crude oil production at the East-Tarkosa- linskoye field, where the central oil treat- ment facility was launched in 2012. Our total crude oil production increased by 85.3% year-on-year. We continued to achieve some of the lowest lifting costs in the industry (expenses direct- ly related to the extraction and processing of natural gas, gas condensate and crude oil from the reservoir). Company lifting costs were RR 17.8 ($0.57) per boe in 2012. Main Producing Fields In 2012, sales production of hydrocarbons was carried out at nine fields and license areas of which, our three core fields – Yur- kharovskoye, East-Tarkosalinskoye and Khancheyskoye – accounted for approxi- mately 90% of total sales production. All of the fields are located in close proximity to the Unified Gas Supply System (UGSS), the world’s largest gas transporting infrastructure. 28 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION I G N T A R E P O F O W E V E R I PRODUCTION DRILLING AT THE YURKHAROVSKOYE FIELD S T L U S E R Yurkharovskoye field The Yurkharovskoye oil and gas conden- sate field is the main producing asset of NOVATEK, and, as of the end of 2012, the field accounted for approximately 25% of the Company’s proved natural gas reserves to SEC standards and 54% of proved de- veloped SEC reserves. In 2012, the field contributed more than 60% of our sales natural gas production and 63% of liquids production. The license for the field is valid until 2034. The field was discovered in 1970 and is located within the polar circle on the south- east shore of the Tazov peninsula. The field’s western part lies on the Tazov peninsula, while the central and eastern parts are situ- ated offshore in the Tazov Gulf. The offshore part of the field is being developed from onshore locations using horizontal wells. Proved SEC reserves as at the end of 2012 were 436.5 bcm of natural gas and 23.2 mmt of liquid hydrocarbons. Most of the gas reserves are contained in Valanginian layers and the productive layers are located over a small geographical area, which we believe enhances the efficiency of reserves devel- opment and exploitation in terms of both capital expenditures and operating costs. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 29 SALES PRODUCTION OF NATURAL GAS AT THE YURKHAROVSKOYE FIELD, BCM SALES PRODUCTION OF NATURAL GAS AT THE EAST-TARKOSALINSKOYE FIELD, BCM 32.0 34.1 24.4 40 30 20 10 0 17.7 11.5 15 10 5 0 14.7 11.5 9.7 12.2 12.7 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 Marketable production of gas and gas con- densate at the Yurkharovskoye field began in 2003, and, in 2012, reached 34.1 bcm of natural gas and 2,672 thousand tons of liquid hydrocarbons. The field development model provides for the drilling of large-di- ameter and multilateral horizontal wells, which reduces the total number of wells needed to develop the field, thereby min- imizing capital expenditures. Wells at the field are up to 245 mm in diameter and the length of horizontal parts of the borehole exceeds 1,000 meters, with initial flow rates at some producing wells average up to 4.5 mmcm of gas per day. In 2012, a total of 6 new gas and gas condensate wells were launched and the total well stock (produc- ing wells) increased to 72 by the year end. The launch of the fourth stage of Phase Two development in October 2012 has brought the field to its target production plateau of 36.5 bcm per annum of natural gas. The fourth stage consists of two low-temper- ature separation lines, each with annual capacity of 3.5 bcm of natural gas. The first stage booster compressor station consisting of three units with total capacity of 75 MW was also launched in 2012, which enables gas production at the field to be maintained at the maximum plateau level. In 2012, one test well was drilled to prepare for the future development of oil deposits at the field, and achieved an initial flow rate of 83 tons per day. East-Tarkosalinskoye field The East-Tarkosalinskoye oil and gas con- densate field was discovered in 1971 and the license for its development is valid until 2043. The field began producing crude oil in 1994 and natural gas and gas conden- sate in 1998 and 2001, respectively. At the end of 2012, proved SEC reserves of the field were 198.2 bcm of natural gas and 21.1 mmt of liquid hydrocarbons. The East-Tarkosalinskoye field is our most mature field and further field development is focused on exploiting the field’s crude oil layers and increasing crude oil produc- tion. Accordingly, we launched the central oil treatment facility in 2012 and 18 crude oil wells were drilled as part of the field’s development activities. From the central treatment facility the crude oil is transported via our pipeline to the metering station of Transneft's oil pumping station and inject- ed into the pipeline system operated by Transneft. There were 117 natural gas and 73 crude oil wells at the field at the end of 2012. Pro- duction at the field during 2012 totalled 12.7 bcm of natural gas and 984 thousand tons of liquid hydrocarbons. Khancheyskoye field (Khancheyskiy license area) The Khancheyskoye field was discovered in 1990 and is located 65 kilometers to the east of the East-Tarkosalinksoye field. The license for the Khancheyskoye field is valid until 2044. The field began producing nat- ural gas and gas condensate in 2001 and crude oil in 2007. At the end of 2012, proved SEC reserves totaled 32.6 bcm of natural gas and 3.3 mmt of liquid hydrocarbons. Drilling of a pilot hole at a production well during the year led to discovery of a new gas conden- sate deposit. Two production wells were successfully drilled in 2012 and field’s pro- 30 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 25 NUMBER OF PRODUCTION WELLS AT THE SAMBURGSKOYE FIELD AS OF 31 DECEMBER 2012 I G N T A R E P O F O W E V E R I S T L U S E R duction totalled 3.6 bcm of natural gas and 518 thousand tons of liquid hydrocarbons. Gas and condensate production at the field peaked in 2010–2011, and future potential is associated with the development of field’s crude oil reserves. Other producing fields The Company’s three core fields account- ed for approximately 90% of marketable production of hydrocarbons in 2012. The remaining volumes were produced at the following six fields and license areas: the Beregovoy license area, the Pyreinoye field, the Samburgskiy license area, the Sterkhovoye field (at the Olimpiyskiy license area), the Yumantilskiy license area and the North-Urengoyskoye field. Beregovoy license area and Pyreinoye field The Beregovoy license area and the Pyre- inoye field, which are being developed by our joint venture, OAO Sibneftegas (NO- VATEK’s share – 51%), accounted for 9% of NOVATEK’s marketable production of hydrocarbons in 2012. The Beregovoy license area, valid until 2023, is the largest asset of Sibneftegas in terms of reserves. Total proved gross reserves of the Beregovoy area as at 31 December 2012 under the SEC reserves methodology are estimated at 148.6 bcm of natural gas, of which our share is 75.8 bcm. Commercial production of natural gas at the field began in 2007 and, in 2012 the field produced 9.5 bcm of natural gas (NOVATEK’s share – 4.9 bcm). Interpretation of 3D seismic data was com- pleted in 2012, the geological field model was adjusted, and reserves were re-estimated in order to optimize the field development plan. The Pyreinoye gas condensate field, valid until 2021, has proved gross gas reserves of 19.3 bcm, as estimated under the SEC reserves methodology as at 31 December 2012, with our proportional share in the proved reserves apprised at 9.8 bcm of natural gas. Commercial gas production began at the field in 2009, and in 2012, the field produced 0.95 bcm of natural gas (NOVATEK’s share – 0.48 bcm). Interpreta- tion of 3D seismic data was completed in 2012, the geological field model was adjust- ed, and reserves were re-estimated in or- der to optimize the field development plan. One gas producing well was also drilled. Samburgskoye field (Samburgskiy license area) The Samburgskoye field is located within the Samburgskiy license area, which also encompasses four other fields (North-Yes- etinskoye, East-Urengoyskoye and North- Purovskoye fields, as well as a part of the Urengoyskoye field). The exploration and production license for the Samburgskoye field is valid until 2018 and is owned by OAO Arcticgas, a wholly owned subsidi- ary of SeverEnergia, in which we have a 25.5% economic interest (51% in SeverEn- ergia is owned by Yamal Development, a 50/50 joint venture between NOVATEK and Gazprom neft). The Samburgskoye field has proved gross gas reserves of 97.8 bcm (NOVATEK’s share – 24.9 bcm) and reserves of liquid hydrocarbons of 15.7 mmt (NOVATEK’s share – 4.0 mmt), as estimated under SEC reserves methodology at 31 December 2012. Commercial production of natural gas and unstable gas condensate began in April 2012 with various facilities commissioned into operation at the field during the year: the ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 31 first and second phases of gas treatment unit, a 46-km gas pipeline connecting the gas treatment unit to the UGSS and a 20-km gas condensate pipeline connecting the field to the pipeline that links the Yurkharovskoye field to the Purovsky processing Plant. There were 25 production wells at the end of 2012, and all of the unstable gas conden- sate produced at the field is delivered to the Purovsky Plant for further processing. North-Urengoyskoye field The North-Urengoyskoye gas condensate field, discovered in 1966, is located 25 km south of the Yurkharovskoye field. The development license for the field is held by ZAO Nortgas. In November 2012, NOVATEK acquired a 49% equity stake in ZAO Nortgas. The North-Urengoyskoye field has proved gross gas reserves of 157.3 bcm of natural gas and 21.1 mmt of liquid hydrocarbons, as estimated under SEC reserves method- ology at 31 December 2012. Our share in the proved reserves is 77.1 bcm of natural gas and 10.4 mmt of liquid hydrocarbons. Field reserves are concentrated in two domes – western and eastern. Commercial production started at the western dome in 2001, and at the end of 2012, the field infra- structure included 54 production wells, a gas treatment facility with a 5.3 bcm annual capacity and a booster compressor station with a 20 MW capacity. During 2012, the field produced 4.2 bcm of natural gas and 426 thousand tons of un- stable gas condensate (NOVATEK’s share since acquisition of its equity interest was 0.2 bcm of natural gas and 19 thousand tons of gas condensate). Preparatory work was carried out to start production at the eastern dome of the field, including con- struction of well pads, drilling of production wells, construction of gas gathering net- works and a gas treatment unit. Production launch at the eastern dome will more than double production of natural gas and triple production of gas condensate at the field. Sterkhovoye field (Olimpiyskiy license area) The Sterkhovoye field located within the Olimpiyskiy license area, the development license for which is valid until 2026, con- sists of two gas condensate layers and has proved gas reserves of 1.4 bcm and liquid hydrocarbons reserves of 0.36 mmt under the SEC reserves methodology at 31 De- cember 2012. The field is connected to the UGSS by a 14 kilometer natural gas pipeline with transportation capacity of 3.1 bcm per annum, which will also be used to transport gas produced at the Dobrovolskoye field, also located within the Olimpiyskiy license area. Hydrocarbon production at the Sterk- hovoye field began in 2009 and in 2012, amounted to 0.1 bcm of gas and 19 thou- sand tons of gas condensate. Yumantilskoye field (Yumantilskiy license area) The Yumantilskoe field is located within the Yumantilskiy license area, the development license for which is valid until 2024. Total recoverable reserves of the field under the Russian reserve classification ABC1 + C2 amounted to 3.8 bcm of gas and 0.5 mmt of liquids at the end of 2012 (reserve amounts to SEC and PRMS standards have not been estimated). Commercial produc- tion at the field began in 2001, but has been occasionally suspended due to mainte- nance works at the wells. Gas production at the field totaled 0.1 mmcm in 2012. 32 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION I G N T A R E P O F O W E V E R I KHANCHEYSKOYE FIELD S T L U S E R Prospective fields and license area In 2012, full-scale exploration work began at our fields located on the Gydan Peninsula and offshore license areas in the Gulf of Ob, which were acquired in 2011. We carried out 6,260 linear km of 2D and 759 square km of 3D seismic work at these fields and license areas. Our asset base includes a number of prospective fields and license areas at various stages of exploration and de- velopment, which provide a basis for future sustainable hydrocarbon produc- tion growth. Fields in the Nadym-Pur-Taz Region are located in close proximity to existing transportation and process- ing infrastructure, which will enable their cost-effective development. The South-Tambeyskoye field, which is an integral part of the Yamal LNG project, is located on the coast of the Gulf of Ob, enabling efficient shipment of LNG to the international markets through the Port of Sabetta. The Salmanovskoye (Utrenneye) ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 33 421 BCM PROVED NATURAL GAS RESERVES OF SEVERENERGIA FIELDS field on the Gydan Peninsula is in close proximity of the South-Tambeyskoye field, across the Gulf of Ob. SeverEnergia fields OAO Arcticgas, a subsidiary of SeverEn- ergia (51% in SeverEnergia is owned by Yamal Development, a 50/50 joint venture between NOVATEK and Gazprom neft; economic interest of NOVATEK in SeverEn- ergia is 25.5%), holds the exploration and production license for the Samburgskiy license area (which includes the Samburg- skoye, North-Yesetinskoye, East-Urengoys- koye and North-Purovskoye fields, as well as a part of the Urengoyskoye field) and for the Yaro-Yakhinskoye, North-Chaselskoye and Yevo-Yakhinskoye fields. As at 31 December 2012, the proved gross reserves of the non-producing fields of SeverEnergia under the SEC reserves methodology were estimated at 322.9 bcm of natural gas and 54.4 mmt of liq- uid hydrocarbons (with our share of 82.3 bcm of natural gas and 13.9 mmt of liquid hydrocarbons), and the largest non-pro- ducing fields in terms of reserves are the Urengoyskoye, Yaro-Yakhinskoye and North-Chaselskoye fields. In 2012, SeverEnergia began preparatory works for the construction of key infrastruc- ture at the Urengoyskoye field, including a gas treatment facility, gas pipeline to link the field to the UGSS and a gas condensate pipeline to link the field to the Yurkharov – Purovsky Plant pipeline. Geological explo- ration and development planning for other fields of SeverEnergia continued in 2012. The revision of the geological model for the fields at the Samburgskiy license area and re-estimation of their reserves carried out in 2012 led to major upward revision of resource potential of the license area. The results from testing an appraisal well at the Yaro-Yakhinskoye field resulted in a significant increase in its hydrocarbon re- serves. Testing of an exploration well at the North-Chaselskoye field led to discovery of a new gas condensate deposit. Termokarstovoye field The development license for the Termokar- stovoye field is valid until 2021 and is held by Terneftegaz, in which NOVATEK holds a 51% equity stake. The Termokarstovoye field was discovered in 1988 and consists of five gas conden- sate deposits at depths of 2,550 to 3,000 meters. Proved reserves under the SEC reserve reporting standards at the year-end 2012 amounted to 22.3 bcm of natural gas and 6.9 mmt of liquid hydrocarbons (with NOVATEK’s share of 11.4 bcm of natural gas and 3.5 mmt of liquid hydrocarbons). A decision was made to proceed with field development following successful geological exploration work carried out in 2011 and 2012. In 2012, we undertook work activities relating to field development and infrastructure, and on the project documen- tation for the field’s transport infrastructure. Preparations for construction works such as hydraulic earth filling, construction of well pads, and construction of river transport facilities for offloading of construction mate- rials were also made. North-Khancheyskoye field The license for the North-Khancheyskoye field is valid until 2029, and has been ap- prised to hold estimated proved reserves 34 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 481BCM PROVED NATURAL GAS RESERVES OF THE SOUTH-TAMBEYSKOYE FIELD I G N T A R E P O F O W E V E R I as of 31 December 2012 in accordance with SEC reserves standards of 2.5 bcm of natural gas. S T L U S E R One exploration well was drilled in 2012, leading to the discovery of one gas and one gas condensate reservoir. The field’s geological model was finalized, allowing us to proceed with field development planning and design work relating to surface facilities. Yarudeyskoye field The license for the Yarudeyskoye field is valid until 2029 and is held by Yargeo, in which NOVATEK has a 51% equity stake. Most of the recoverable reserves at the field are located in crude oil deposits. Proved reserves of the field to SEC reserves stand- ards as of 31 December 2012 totaled 4.5 mmt of liquid hydrocarbons and 7.4 bcm of natural gas (our share in proved reserves is 2.3 mmt of liquid hydrocarbons and 3.8 bcm of natural gas). Reserves according to C1+C2 Russian classification amounted to 46 mmt of liquids and 28 bcm of natural gas (NOVATEK’s share is 23 mmt of liquids and 14 bcm of natural gas). In 2012, an appraisal well was drilled at the field, which confirmed the field’s geological model and led to an increase of estimated reserves. Work on a development plan for the field was underway. North-Russkoye field The license for the North-Russkoye field is valid until 2031. Proved reserves of the field under SEC standards as of 31 December 2012 were 22.5 bcm of gas and 1.9 mmt of liquid hydrocarbons. A development plan for the field was completed in 2011, and site preparation and hydraulic earth filling were carried out in 2012. Olimpiyskiy license area The license for the Olimpiyskiy area is valid until 2026. The area includes the Sterkho- voye field, which is already in production (see “Other producing fields”), as well as the Dobrovolskoye field, Dremuchee field and part of the Urengoyskoye field. As of 31 December 2012, proved SEC reserves at Dobrovolskoye field and part of the Uren- goyskoye field were estimated at 26.1 bcm of natural gas and 2.2 mmt of liquid hydro- carbons. The results of seismic work and drilling of wells at adjacent license areas helped to clarify the geological model for the part of the Urengoyskoye field located within the Olimpiyskiy license area. The field’s drill- ing program was decided in 2012 and the project document for the field development was approved, and works were carried out on the documentation for the transport infrastructure. Production drilling at the field is planned to start in 2013. South-Tambeyskoye field (Yamal LNG project) OAO Yamal LNG, in which NOVATEK holds an 80% equity stake, holds the license for exploration and production at the South-Tambeyskoye field valid until 2045. The South-Tambeyskoye field was dis- covered in 1974 and is located in the north-eastern portion of the Yamal Penin- sula. The field has five shallow gas horizons and 37 deeper gas condensate horizons. The depth of the horizons varies from be- tween 900 to 2,850 meters. As of 31 December 2012, the field was estimated to contain 481.4 bcm of proved ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 35 235 BCM PROVED NATURAL GAS RESERVES OF THE SALMANOVSKOYE FIELD natural gas reserves and 13.4 mmt of proved liquid hydrocarbon reserves, un- der SEC reserves methodology. Our share in the reserves of the field is 385.1 bcm of gas and 10.7 mmt of liquid hydrocar- bons. Based on total proved reserves, the South-Tambeyskoye field is the largest field in our reserves portfolio. The field has already been thoroughly stud- ied with 2D and 3D seismic and exploration wells drilled, a detailed geological model and reserve appraisal have been complet- ed, which allowed us to optimize the field development plan. As a result of explo- ration works carried out in 2012 one new gas condensate deposit was discovered. Production potential of the field exceeds 27 bcm of natural gas per annum, and natural gas produced at the field is planned to be delivered to the international markets in a form of liquefied natural gas, or LNG. The field development plan provides for the drilling of approximately 200 wells at 19 well pads, construction of a gas gathering pipe- line system, gas treatment facilities and a liquefaction plant. The liquefaction plant will include three trains of 5 to 5.5 mmt annual capacity each as well as LNG storage facili- ties. The shipment infrastructure will include a jetty with two tanker loading berths at the port of Sabetta equipped with ice protec- tion facilities. LNG carriers of special design ARC-7 will be used to transport the LNG to international markets. Front-end engineering design work of the pro- ject was completed in 2012, a contractor was selected for drilling of the first production wells, two rigs were dispatched to the field, and work was carried out on preparing the well pads. Construction of cargo berths began at the port of Sabetta for receipt of building materials and LNG plant modules. Work was underway on construction of roads, fuel depot, power station and boiler house, housing facilities and canteens. A consultant was selected for issues of corporate and social responsibility, and preparations began for certification of the Yamal LNG integrated management system to ISO 14001:2004 and OHSAS 18001:2007 international standards. Tenders for LNG shipping, construction of LNG carriers and engineering, procurement and construction of the LNG plant were announced, and initial proposals were received from the partici- pants. We were also working on marketing the expected LNG production and arranging the necessary project financing. Fields and license areas on the Gydan Peninsula and the offshore Gulf of Ob Licenses for the Geofizicheskoye and Salmanovskoye (Utrenneye) fields on the Gydan Peninsula and the East-Tambeyskiy and North-Obskiy areas in the Gulf of Ob were acquired in September 2011 and are valid through 2031 and 2041, respectively. The Salmanovskoye (formerly Utrenneye) field, located in the northern part of the Gydan peninsula on the shores of the Gulf of Ob in close proximity to the South-Tam- beyskoye field, was discovered in 1980. It is the largest field by recoverable reserves that has been found to date on the Gydan Peninsula. The field contains 34 hydrocar- bon deposits, including 16 gas deposits, 15 gas condensate deposits, two oil and gas condensate deposits and one crude oil deposit. Proved reserves to SEC standards were estimated for the first time in 2012 and as of 31 December 2012 amounted to 235.2 bcm of natural gas and 8.6 mmt of liquid hydrocarbons. 36 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION I G N T A R E P O F O W E V E R I COMPRESSOR BOOSTER STATION AT THE EAST-TARKOSALINSKOYE FIELD S T L U S E R The Geofizicheskoye oil and gas conden- sate field, located in the middle part of the Gydan peninsula on the shores of the Gulf of Ob, was discovered in 1975 and contains 35 hydrocarbon deposits, includ- ing 19 gas deposits, 12 gas condensate deposits, three crude oil deposits and one crude oil and gas condensate deposit. Proved reserves under SEC standards were estimated for the first time in 2012, and as of 31 December 2012 amounted to 124.9 bcm of natural gas and 0.4 mmt of liquid hydrocarbons. In 2012, we carried out 351 linear km of 2D and 759 square km of 3D seismic work at the fields, and based on the geological and geophysical work performed, the re- serves of the fields were re-estimated and additional work was performed on their geological models. The East-Tambeyskiy and North-Obskiy licence areas, located offshore in the Gulf of Ob, have a geographical acre- age area of approximately 9,800 square km. Their resources are estimated at 1.8 tcm of natural gas of D1+D1L categories under the Russian reserve classification system. In 2012, we conducted 5,909 linear km of 2D seismic work at these licence areas. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 37 4.03 MMT OF GAS CONDENSATE PROCESSED AT THE PUROVSKY PLANT IN 2012 PROCESSING As part of our strategy to maximize margins through value added pro- jects, we continued construction of a new terminal facility at Ust-Luga, lo- cated on the Baltic Sea, for the transshipment and fractionation of stable gas condensate. Gas condensate is produced from our fields in an unstable form and requires further processing before it can be delivered to our customers. Our primary gas conden- sate processing asset is the Purovsky Plant, which has total processing capacity of five mmt of de-ethanized gas condensate per annum, which allows us to produce approx- imately 3.7 mmt of stable gas condensate and approximately 1.3 mmt of liquefied petroleum gas, or LPG per annum. The Purovsky Plant is located in the YNAO and is in close proximity to the East-Tarkosalinskoye field. We also own a system of condensate pipelines, enabling delivery of gas conden- sate from our fields to the Purovsky Plant. The Purovsky Plant is an important link in our midstream value chain that provides us complete operational control over our processing needs and access to higher yielding marketing channels for our stable gas condensate. In 2012, the Purovsky Plant received feedstock from the Yurkharovskoye, East-Tarkosalinskoye, Khancheyskoye, Sterkhovoye and Samburgskoye fields, supplied via the Company’s own con- densate pipelines, as well as from the North-Urengoyskoye field operated by ZAO Nortgas. In 2012, the Purovsky Plant processed 4.03 mmt of de-ethanized unstable gas conden- sate, or 4.3% more than in 2011, resulting in the commercial production of 3,081 mt of stable gas condensate and 903 thou- sand tons of LPG as well as approximately 17 thousand tons of methanol produced during the LPG scrubbing process. The growth in processing volumes mainly re- flects the start of deliveries to the Purovsky Plant of de-ethanized gas condensate from the Samburgskoye field in April and the North-Urengoyskoye field in November. During the year, the Purovsky Plant oper- ated at approximately 81% of full capaci- ty. We continued working on a project to expand annual capacity of the Plant to 11 mmt ahead of a scheduled increase of gas condensate production: design documen- tation was completed, orders were placed for the main equipment and preparations to start construction and assembly work were carried out. The expansion of the processing capac- ity of the Purovsky Plant does not involve the construction of any additional capac- ity for LPG production. Under our long- term agreements with OAO Sibur Holding (“Sibur”), a related party, approved by the EGM in January 2013, 100% of the light hydrocarbons produced during the gas condensate stabilization process at the Company’s Purovsky Plant will be deliv- ered to Sibur’s Tobolsk Petrochemical Complex. Sibur will process up to 1.2 mmt of light hydrocarbons on tolling terms and will redeliver the produced LPG to us for 38 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION GAS CONDENSATE PROCESSING VOLUMES AT THE PUROVSKY PLANT, MT PUROVSKY PLANT OUTPUT IN 2012, % 3,401 2,845 3,869 4,034 23% < 1% Stable gas condensate LPG Regenerated methanol 5,000 4,000 3,000 2,220 2,000 1,000 0 I G N T A R E P O F O W E V E R I S T L U S E R 2008 2009 2010 2011 2012 distribution via our existing marketing network, while the remaining volumes of light hydrocarbons will be sold to Sibur on an “ex-plant” basis. These agreements will allow us to minimize capital expenditures on the expansion of the Purovsky Plant and optimize logistics of LPG through NO- VATEK’s marketing network. The Purovsky Plant is connected to the Russian rail network at the Limbey rail station. Substantially all of the stabilized gas condensate produced at the Purovsky Plant is delivered by rail to the Port of Vitino where it is loaded onto ocean tankers for further transportation to international mar- kets. Rail transport is also used to supply LPG to the domestic market and export. In March 2012, we signed a Strategic Partnership Agreement for the period up to 2020 with OAO Russian Railways. The agreement calls for expansion of railway capacity on the “Limbey – Surgut – Tobolsk” route and guarantees the transport of 100% of the volumes produced at the Purovsky Plant taking into consideration the expected growth in its production capacity. Ust-Luga Stable Gas Condensate Transshipment and Fractionation Complex As part of our strategy to maximize margins through value added projects, we contin- ued construction of a new terminal facility at Ust-Luga, located on the Baltic Sea, for the transshipment and fractionation of stable gas condensate produced at the Purovsky Plant. The estimated fractionation capacity of the Ust-Luga complex is up to six mmt per annum. After the launch of the complex the stable gas condensate processed at the Purovsky Plant will be redirected from 77% the port of Vitino to our new complex at Ust-Luga. Main portion of the stable gas condensate will be used as feedstock to the fractionation unit for further processing into light and heavy naphtha, jet fuel, diesel fraction and heating oil, which will be sold to international export markets while the remaining volumes supplied to the facility by rail transport will be loaded onto tankers for delivery to export markets. Upon completion, the complex will include two 3-mmt per annum fractionation trains, reservoir tank farms for feedstock and pro- cessed products, rail facilities for loading and receiving finished and raw materials and two deep-water tanker berths. Work on main facilities of the first stage of the project including the first fractionation train neared completion in 2012. The complex will allow us to expand our vertically integrated chain and our customer base, as well as to increase sales of higher value added products and diversification across markets. Since the distance from the Purovsky Plant to Ust-Luga is nearly 400 km less than to Vitino we also expect savings on railroad transport costs. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 39 58.9 BCM OF NATURAL GAS SOLD IN 2012 MARKETING We continued to increase the number of end-customers buying our natural gas and for the first time in our history, we executed long-term delivery con- tracts for periods of up to 15 years. The share of sales to the end-customer segment in our total sales volumes mix rose to 69%. Natural gas sales During 2012, we supplied natural gas to 35 regions of the Russian Federation and ac- counted for 16.3% of the total natural gas de- liveries to the domestic market via the UGSS. NOVATEK's 2012 natural gas sales volumes totaled 58.9 bcm, representating an increase of 9.7% compared to 2011 sales volumes of 53.7 bcm. The share of sales to the end-cus- tomer segment in our total sales volumes mix rose to 69.3% from 54.7% in 2011. The growth in sales volumes was due to an increase in natural gas supplies to the Che- lyabinsk region, the Perm region and the Komi Republic by approximately 10.4 bcm in comparison with 2011. In 2012, our customers were located primarily in the Perm Territory, the Chelyabinsk, Orenburg, Sverdlovsk, Mos- cow, Kostroma, Kirov and Tyumen regions, the Komi Republic, the city of St-Petersburg, as well as the YNAO and Khanty-Mansyisk Autonomous Region. During 2012, our total revenues from natural gas sales increased to RR 142.6 billion or by 28.6%, as compared to 2011, due to the combination of higher volumes sold and an increase in the regulated gas tariff effective from 1 July. We continued to increase the number of end-customers buying our natural gas and for the first time in our history, we executed long-term delivery contracts for periods of up to 15 years. Contracts were signed with MMK (10.5 years), the Russian subsidiaries of E.ON and Fortum (15 years), as well as with subsid- iaries of Mechel Group (10 years and longer). Annual delivery volumes under these con- tracts are expected to represent up to 30% of our total sales in the coming years. A five-year contract was also signed with OAO Severstal, providing for total supplies of approximately 12 bcm of natural gas, as well as a three-year contract with OAO Mosener- go to supply 27 bcm of natural gas. In December 2012, we acquired an 82% stake in OOO Gazprom mezhregiongas Ko- stroma, which supplies natural gas to a wide range of consumers in the Kostroma region. This newly acquired company supplied ap- proximately 3.8 bcm of natural gas to cus- tomers in the Kostroma region during 2012, as compared with 0.8 bcm supplied directly by NOVATEK. In order to maintain production levels dur- ing periods of seasonal demand NOVATEK has entered into an agreement with OAO Gazprom for the use of their underground storage facilities on a space available basis. Historically, natural gas is injected into un- derground storage facilities during warmer periods when demand is lower and later withdrawn during periods of colder weather and increased demand. 40 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION NATURAL GAS SALES Russia I G N T A R E P O F O W E V E R I 3.19 3.22 Moscow Region 1.27 1.07 St. Petersburg S T L U S E R 24.34 18.25 Yamal-Nenets Autonomous Region 2.48 2.60 Khanty-Mansiysk Autonomous Region 3.43 3.76 Orenburg Region 2.40 2.48 Sverdlovsk Region 6.14 15.51 6.09 6.70 Chelyabinsk Region Perm Territory LEGEND Natural gas sales volumes in 2011, bcm 5.19 3.19 Natural gas sales volumes in 2012, bcm Regions with sales volumes above 1 bcm Regions with sales volumes between 0.5 to 1.0 bcm Regions with sales volumes below 0.5 bcm ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 41 NATURAL GAS SALES VOLUMES, BCM NATURAL GAS SALES REVENUES, RR BLN* 58.9 53.7 33.3 32.9 37.1 60 40 20 0 142.6 110.9 71.1 45.7 53.6 150 120 90 60 30 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 * Net of VAT. NATURAL GAS SALES VOLUMES TO END-CUSTOMERS, BCM AVERAGE NATURAL GAS PRICE, RR PER MCM* 40.8 29.3 22.4 23.7 15.8 50 40 30 20 10 0 3,000 2,500 2,000 1,500 1,000 1,372 500 0 2,422 1,914 2,067 1,628 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 BREAKDOWN OF 2012 NATURAL GAS SALES VOLUMES, % 31% 41% 5% 1% 22% * Net of VAT. REGIONAL BREAKDOWN OF 2012 NATURAL GAS SALES VOLUMES TO END-CUSTOMERS, % 22% 38% Chelyabinsk Region Perm Territory Orenburg Region Moscow Region Khanty-Mansiysk Autonomous Region Other regions 6% 8% 9% 17% Power generation companies Large industrial con- sumers Households Others Wholesale traders, ex-field 42 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION Natural gas and liquids sales volumes Total gas sales volumes, including: End customers Traders UNITS 2011 2012 CHANGE mmcm mmcm mmcm 53,667 58,880 29,332 40,806 9.7% 39.1% 24,335 18,074 (25.7)% Share of end-customers in total gas sales volumes % 54.7% 69.3% 14.6 p.p. Stable gas condensate sales volumes LPG sales volumes Crude oil sales volumes mt mt mt 2,984 2,847 880 242 905 442 (4.6)% 2.8% 82.6% I G N T A R E P O F O W E V E R I In 2012, NOVATEK withdrew 945 mmcm of natural gas from underground storage facilities during periods of high demand and injected 1,309 mmcm when space was available. At the end of 2012, the Company had 1,096 mmcm of natural gas in stor- age and available for withdrawal in future periods. We also began work during the year to establish a gas trading business on the international markets, and accordingly, agreements were signed in July 2012 for the annual supply of two bcm of natural gas to the German energy company EnBW. The supplies under these commercial trading activities began in October 2012. S T L U S E R Liquid Hydrocarbon Sales In 2012, NOVATEK continued to use the Northern Sea Route for supplies of stable gas condensate to the fast growing markets in the Asian-Pacific region. During the seasonal navigational period, we sent eight tankers through the Northern Sea Route, which delivered 487 thousand tons of stable gas condensate to consumers in China and South Korea. The Company's primary liquid hydrocar- bon sales volumes are comprised of sta- ble gas condensate and liquefied petro- leum gases. We are also producing and selling relatively small quantities of crude oil. The stable gas condensate is primarily used in the petrochemical and oil refining industries as an alternative to naphtha and light crude oil, respectively. Our LPG is sold to both the chemical processing industry, as a feedstock, and the retail and wholesale fuel markets where its high energy content, environmental safety and ease of transportation and storage make it an attractive fuel source for automobiles and residential usage. We strive to respond quickly to chang- ing market conditions by optimizing the customer base and supply geography, as well as developing and maintaining logis- tics infrastructure. Total sales volumes of liquid hydrocarbons in 2012 amounted to 4,203 thousand tons, a 2.2% increase over 2011 volumes. The growth was due to higher crude oil production and an in- crease of volumes of unstable gas con- densate processed at the Purovsky Plant. The growth in our liquids sales volumes was constrained by a significant increase in stable gas condensate inventories due to redirection of sales to Asian-Pacific region, which essentially reserves itself in the next quarter and is affected by the loading schedule at each quarter end and the destination of the cargos. Total revenues from liquids sales in- creased to RR 67.6 billion, or by 5.9%, in 2012 as compared to 2011, due to the increase in sales volumes and higher realized prices. Liquid hydrocarbons produced at the Purovsky Plant are transported by rail. At the end of 2012 we owned and leased 6,700 rail cisterns, of which 2,700 were used for the transport of LPG and 4,000 for the transport of stable gas conden- sate. Our crude oil is transported through ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 43 LIQUID HYDROCARBON SALES VOLUMES, MT LIQUID HYDROCARBON SALES REVENUES, RR BLN* 4,111 4,203 3,128 3,401 5,000 4,000 3,000 2,630 2,000 1,000 0 63.9 67.6 43.6 30.4 33.3 80 60 40 20 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 * Net of VAT, excise tax and export duties. On the domestic market, our LPG is sold through large wholesale channels, as well as our network of retail and small whole- sale stations. In 2012, large wholesale supplies to the domestic market were 323 thousand tons, representing 36% of total LPG sales volumes. The total amount of LPG sold through our domestic network of retail and small wholesale stations increased to 103 thousand tons or by 14% as compared to 2011 volumes. At the end of 2012, NOVATEK owned 66 stations in Chelyabinsk, Volgograd, Rostov and As- trakhan regions. Sales of crude oil in 2012 were 442 thou- sand tons, an 83% increase over 2011 volumes. Sixty six percent of our crude oil volumes were sold on the domestic mar- ket with the remaining volumes supplied to export markets. the trunk pipelines owned and operated by OAO Transneft. During 2012, we sold 2,847 thousand tons of stable gas condensate, a 4.6% decrease as compared to the volumes sold in 2011. The lower sales volumes reflected an increase in the stable gas condensate inventories to 461 thousand tons as at the end of the year mainly due to an increased volume of sales to the Asian-Pacific region that were in seaborne transit and not recognized as revenues in the current reporting period. More than 99% of all stable gas condensate sales volumes, or 2,821 thousand tons, were exported via the all season port of Vitino on the White Sea. Fifty-six percent of ex- port volumes were sold to countries in the Asian-Pacific region, 29% to markets in Europe, 11% to the USA and 4% to markets in South America. In 2012, NOVATEK continued to use the Northern Sea Route (NSR) for supplies of stable gas condensate to the fast growing markets in the Asian-Pacific region. Dur- ing the seasonal navigational period, we sent eight tankers through the NSR, which delivered 487 thousand tons of stable gas condensate to consumers in China and South Korea. The Company sells its LPG volumes to both the export and domestic mar- kets. In 2012, total LPG sales volumes amounted to 905 thousand tons, of which 53% were exported. Novatek Polska, our wholly owned LPG trading company in Poland, was responsible for 55% of our total LPG export sales. Other export markets for LPG were Finland, Hungary, Lithuania, Latvia, Slovakia, Romania and Turkey. 44 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION LIQUID HYDROCARBON SALES I G N T A R E P O F O W E V E R I S T L U S E R USA 22 STABLE GAS CONDENSATE SALES VOLUMES IN 2011–2012 (thousand tons) 22 Europe Asian-Pacific Region 1,023 811 Brazil 1,294 1,590 USA 300 664 South America 0 120 2011 2012 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 45 8 TANKERS WITH CONDENSATE SENT VIA THE NOTHERN SEA ROUTE IN 2012 Vitino Russia Finland 10 Netherlands Hungary Serbia Latvia Lithuania Poland Slovakia Romania Turkey China 26 South Korea Thailand 40 Singapore LIQUID HYDROCARBON SALES VOLUMES IN 2012 (thousand tons) Stable gas condensate 2,847 LPG 905 Crude oil 442 1% 47% 66% 99% 53% 34% stable gas condensate export sales LPG export sales crude oil export sales approximate # of delivery days exports domestic market 242 GRANTS AWARDED TO SCHOOLCHILDREN IN 2012 RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 47 02 ENVIRONMENTAL AND SOCIAL RESPONSIBILITY NOVATEK HAS IMPLEMENTED AN INTEGRATED MANAGEMENT SYSTEM FOR ENVIRONMENTAL PROTECTION, OCCUPATIONAL HEALTH AND SAFETY IN COMPLIANCE WITH REQUIREMENTS OF INTERNATIONAL STANDARDS NOVATEK adheres to the principles of ef- fective and responsible business conduct and considers the welfare of its employ- ees and their families, environmental and industrial safety, the creation of a stable and beneficial social environment as well as contributing to Russia’s overall economic development as priorities and responsibili- ties of the Company. In 2012, to prevent air pollution and reduce greenhouse gas emissions from flared as- sociated petroleum gas (APG) we complet- ed the construction and launch of a central oil treatment facility at our East-Tarkosalin- skoye field. The facility’s capacity allows ra- tional use of up to 700 mcm of APG per day and reduces greenhouse gas emissions by 640 mt of СО2 equivalent per annum. ENVIRONMENTAL PROTECTION NOVATEK’s core producing assets are lo- cated in the Far North, a harsh Arctic region with vast mineral resources and a fragile environment. The Company is committed to environmental protection in its operations. NOVATEK has implemented an Environ- mental, Health and Safety Policy, while at the same time an Integrated Management System for Environmental Protection, Occu- pational Health and Safety (IMS) in com- pliance with requirements of international standards has been implemented at all of our main subsidiaries. In 2012, as part of our ongoing commitment to IMS, our joint venture, Sibneftegas, was certified in ac- cordance with ISO 14001:2004 international standards. In 2012, NOVATEK continued its participa- tion in the Carbon Disclosure Project (CDP), which discloses information on greenhouse gas emissions and the energy efficiency of production, and CDP Water Disclosure Pro- ject, which discloses information on the use of water resources. The Company provides access to information regarding the effect of its operations on the environment to all our stakeholders in a wide range of federal and regional media and on the Company’s website. The protection and preservation of the ma- rine environment and natural resources is a key principle of our Environmental Policy. At the end of 2011, we acquired the licenses for the East-Tambeyskiy and North-Ob- skiy license areas and the Salmanovskoye (Utrenneye) and Geofizicheskoye fields, which are wholly or partially located in the Gulf of Ob. Following this acquisition we held public hearings on the environmental 48 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION WATER CONSUMPTION OF NOVATEK E&P COMPANIES ATMOSPHERE EMMISSIONS OF NOVATEK E&P COMPANIES mcm 1,200 800 668 400 0 mmboe 420 881 mt 30 740 280 20 521 397 140 10 10.8 11.6 0 0 mmboe 23.4 18.7 16.4 420 280 140 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 Water consumption mcm Hydrocarbon production, mmboe Atmosphere emissions, mt Hydrocarbon production, mmboe impact assessment of our planned opera- tions before the commencement of geolog- ical exploration in these license areas. We received environmental approval for our off- shore geophysical program and a baseline study of environmental components was carried out within the license areas along with the development of the environmen- tal monitoring and subsurface protection programs. on the Baltic Sea. State-of-the-art engi- neering solutions and design have been employed in the automatic closed flare sys- tems, including automatic interlock circuits, liquid valves, ultraviolet flame scanners, fault-tolerant startup and shutdown system, warning lights, multi-burner heads with built-in flame arresters, devices to prevent detonation, and pilot burners with remote spark generators and UV scanners. In 2012, innovative closed flare systems that reduce the amount of harmful emissions were designed and installed during the first phase of construction of the stable gas condensate transshipment and fractiona- tion facility at the port of Ust-Luga, located One of the Company’s priorities is the ra- tional usage of resources, including energy resources. The table below sets out the physical volumes and the Russian rouble equivalent of energy resources consumed by the Company in 2012. Energy resource consumption by the subsidiaries of NOVATEK in 2012 VOLUME RR MLN, NET OF VAT Natural gas, mmcm Electricity, MW*h Heating energy, Gcal Oil, tons Motor gasoline, tons Diesel fuel, tons Other, tons 665 269,351 202,804 543 819 4,481 42,860 320.1 766.4 197.7 12.5 25.5 131.3 103.5 I I I Y T L B S N O P S E R L A C O S I D N A L A T N E M N O R V N E I ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 49 INJURY FREQUENCY RATE (NO. OF INJURIES / MLN WORKING HOURS) ACCIDENT SEVERITY RATE (TOTAL NO. OF EMPLOYEE WORKING HRS LOST PER ACCIDENT / NO. OF ACCIDENTS) 1.50 2.0 1.5 1.0 0.5 0 0.71 0.51 0.92 0,41 1,000 800 600 400 200 0 803 260 290 248 214 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 HEALTH AND SAFETY Our strategic goal is to achieve a leading position amongst oil and gas companies on all key indicators in terms of Occupational Health and Safety. In order to accomplish this goal, the Company continually up- dates its IMS, improves employees’ qualification and applies advanced technologies. Our strategic goal is to achieve a leading position amongst oil and gas companies on all key indicators in terms of Occupation- al Health and Safety. In order to accomplish this goal, the Company continually updates its IMS, improves employees’ qualification and applies advanced technologies. In accordance with the requirements of the federal law "On Industrial Safety of Hazard- ous Production Facilities" and "Rules on the Organization and Implementation of Industrial Control for Compliance with Requirements of Industrial Safety at Hazardous Production Facilities" all of our subsidiaries have devel- oped their own rules for the organization and implementation of industrial control for com- pliance with these requirements. We have also established industrial control compliance commissions, which carry out periodic audits of departments and production facilities to comply with the EHS requirements. In 2012, 2,772 employees, including work- ers and middle management, underwent HSE training courses. The Company started providing its employees with the new protective clothing manufactured according to the technical specifications devel- oped in 2011 in order to standardize the require- ments for protective clothing at our subsidiaries. Due to the IMS effectiveness no accidents or fires were recorded at the Company’s hazardous production facilities in 2012. 50 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 41 % OF OUR SPECIALISTS AND LINE WORKERS UPGRADED THEIR RESPECTIVE QUALIFICATIONS IN 2012 I I I Y T L B S N O P S E R L A C O S I D N A L A T N E M N O R V N E I HUMAN RESOURCES In 2012, we developed and approved the Successor program, which aims to provide executives with the ability to participate in training activities aimed at developing a common understanding of the goals and the strat- egy of the Company for preparation for higher level positions within the Company. Employees are NOVATEK’s most valuable resource, allowing the Company to grow rapidly and effectively. The Company’s human resource management system is based on the principles of fairness, respect, equal opportunities for professional devel- opment, dialogue between management and employees, as well as continuous, comprehensive training and development opportunities for the Company’s employees at all levels. As of the end of 2012, NOVATEK and its subsidiaries had 5,440 employees, 40% of whom work in exploration and production and 50% in processing, transportation and marketing. Personnel Training and Development In an environment of rapidly developing technologies and management systems, our multilevel training and professional development program enables our employ- ees to contribute to raising the Company’s competitiveness. In 2012, the primary goals of training and professional development included: • developing and implementing the “Suc- cessor” program aimed at providing the Company with a talent pool of senior managers; • developing and implementing the “Steps in Discovering Talents” program for young specialists targeted at train- ing highly qualified personnel whose competence level fully meets business needs; • developing and implementing the “Tech- nical Training” program based on the results of tests in the Corporate Techni- cal Competency Assessment System for various lines of business; and • involvement of young specialists in NO- VATEK’s “Research-to-Practice Confer- ences” and the “Fuel and Energy Com- plex (FEC) Competitions”. In 2012, we developed and approved the Successor program, which aims to provide executives with the ability to participate in training activities aimed at developing a common understanding of the goals and the strategy of the Company for preparation for higher level positions within the Company. During the past year, NOVATEK continued its efforts to increase employee training, im- prove working conditions and ensure a safe environment at its production facilities. In 2012, 41% of our specialists and line workers upgraded their respective qualifications, and 52% of the Company’s engineers and tech- nicians completed employee certification and industrial safety courses. GROWTH EFFICIENCY INNOVATION 51 ANNUAL REPORT OAO NOVATEK 2012 BREAKDOWN OF PERSONNEL AS AT 31 DECEMBER 2012 33% 10% E&P Transportation and Marketing Processing Administrative 5,440 Employees 17% 40% Specialized training courses for employees of production divisions started in Sep- tember 2012 under the Technical Training program at Gubkin Russian State University Training and Research Center, the Petrole- um Learning Center at Tomsk Polytechnic University and other centers, and 81 em- ployees underwent training through the program. An on-site training program has been developed and implemented at OOO NOVATEK-Purovsky ZPK, in which 45 em- ployees took part during the year. A total of 103 people were tested under the Corporate Technical Competency Assess- ment System during the year, including 10 people during the hiring process to fill va- cant positions and 41 employees promoted to more senior positions. Six people have been included in the Technical Training pro- gram for 2013 as a result of testing newly hired employees. In 2012, we completed the first phase of the “Steps in Discovering Talents” program, whereby 47 young specialists participat- ed in training courses (Effective Training and Development, Presentation Skills and Self-Organization) for personal skills devel- opment. Mentors – employees with high professional competencies able and willing to share their experience – were assigned to young specialists to help them adapt quickly and effectively and develop suc- cessfully as professionals. A Mentorship Practicum in which 31 mentors took part was organized and held in order to build knowledge and skills of working with young specialists. During the year, young special- ists met with experts from various lines of the Company’s business. The 7th Interregional Research-to-Practice Conference for the Company’s young spe- cialists attended by 47 employees was held in Moscow in September 2012. Based on the results of the competition, 12 winners were awarded a trip to a petroleum train- ing center in Norway, and the second- and third-place winners received cash prizes. The winner nominated in the category “Best Implemented Project 2012” was awarded a cash prize, and the top seven projects advanced to the FEC 2012 Competition for Youth Projects, held by the Russian Federa- tion’s Ministry of Energy. In 2012, two of NOVATEK’s young spe- cialists who were winners of the FEC-2011 Competition received commendations from the Ministry of Energy. Social Programs The focus in employee relations is on implementing social programs. Accord- ing to the Core Concept of the Company’s social policy which was adopted in 2006, the social benefits package for employees includes the following programs: • voluntary medical insurance for employees; • therapeutic resort treatment for employ- ees and members of their families; • provision of special-purpose short-term loans; • special-purpose compensation and social support payments; • provision of special-purpose inter- est-free loans to purchase housing, and • pension program. Along with providing an optimum social benefits package, the Company is also committed to creating opportunities for em- ployees to play sports and get involved in sports and cultural events. In 2012, our em- ployees and their family members visited 52 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION EMPLOYEES OF THE PUROVSKY PLANT I I I Y T L B S N O P S E R L A C O S I D N A L A T N E M N O R V N E I exhibitions at Russia’s national museums, classical music concerts, and attended sporting events like hockey, basketball and football (soccer) games in their free time with the Company’s assistance. The Company publishes its corporate newsletter “NOVATEK”, including the “NOVATEK Family” feature, to inform employees about the Company’s activi- ties and get employees, specialists and managers actively involved in business, cultural, sports, charitable and corporate activities. In 2012, we began to publish a new corporate magazine “NOVATEK Plus” in conjunction with developing the overall corporate media within the Company. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 53 SOCIAL POLICY AND CHARITY NOVATEK continued to finance programs targeting education and youth development, support for low-income families, repair and modernization of socially important facilities and preservation of the culture heritage of the indigenous peoples of the Far North and Russia as a whole. During 2012, NOVATEK continued to contrib- ute to an improvement in the living stand- ards of local populations in the YNAO as well as the Samara, Chelyabinsk and Tyumen regions. Special priority was given to the performance of our long-term agreements with the municipalities of these regions for financing programs targeting education and youth development, support for low-income families, repair and modernization of socially important facilities and preservation of the culture heritage of the indigenous peoples of the Far North and Russia as a whole. In 2012, NOVATEK invested more than RR 1.0 billion on projects and activities related to the support of indigenous peoples, charitable contributions and educational programs. Cooperation with Indigenous Peoples of the Far North During 2012, NOVATEK provided financial support to the “Yamal for Descendants” association and its district branches. We achieved our statutory goals, including the support of the youth branch of the Associa- tion, air delivery of the nomadic population and food in remote areas, purchase and delivery of fuel to name a few items. Throughout the year, the Company also provided sponsorship assistance to the following organizations: • The Association of Minority Populations of Indigenous Peoples of the Far North, Siberia, and Far East of the Russian Federation – for legal services, training courses and seminars, and publishing; • The Administration of the YNAO for purchasing rehabilitation equipment for the disabled and for arranging diagnosis and treatment assistance for seriously ill and disabled children; • The Yamal District to fund measures on behalf of the Ilebts Territorial Community of Indigenous Peoples of the North and organize expeditions to discover sacred and ceremonial sites of Yamal’s indige- nous population; • The Tazov District for construction of a cold storage facility in the village of Gyda and purchasing snowmobiles and motor boats for residents; and • The Nadym District for the construction of a helipad in the Kutopyugan village. Educational Programs NOVATEK continued to develop the Com- pany’s continuing education program, which provides opportunities to gifted students, from the regions where we op- erate, to further their education at top rated universities, participate in NOVATEK intern- ships and, upon completion of their studies, possible employment with the Company. Recruitment and career guidance for prom- ising employees start with the “Gifted Chil- dren” program implemented at School No. 8 in Novokuybyshevsk and School No. 2 in 54 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 52 GRANTS AWARDED TO SCHOOL TEACHERS FROM THE START OF THE “GRANTS” PROGRAM I I I Y T L B S N O P S E R L A C O S I D N A L A T N E M N O R V N E I Tarko-Sale. Special classes are formed on a competitive basis from the most talented grade 10 and 11 students with above-aver- age test scores. The Company has also implemented two “Grants” programs for schoolchildren and teachers living in the Purovsky District of the YNAO. The “Grants” program for schoolchildren is an educational support program, which we have been administering since 2004. Under the program, students in grades 5 through 11 living in the districts are awarded grants from the Company to support their academic and creative development and to encourage a responsible attitude towards their studies. In 2012, the Company award- ed 242 grants. The “Grants” program for the teachers is intended to raise the prestige of the teach- ing profession and create favorable con- ditions for developing new and talented teachers. Since the program was launched, 52 teachers have received grants, including nine in 2012. In an effort to create conditions for more effective use of university and college resources in preparing students for future professional activities, the Company has developed and successfully implemented the NOVATEK-VUZ program. The program is an action plan for focused, high-quality training for specialists with higher educa- tion in key areas of expertise in order to grow the Company’s business and meet its needs for young specialists. The program is based at the St. Petersburg State Mining University, Gubkin Russian State University of Oil and Gas in Moscow and the Tyumen Oil and Gas University. Students who have passed their exams with good and excellent results receive additional monthly payments. During their studies, the students are offered paid field, engineering and directed internships. This experience allows them to apply the knowl- edge obtained at lectures and seminars to real-life situations and gain experience in the professions they’ve chosen, while the Company receives an opportunity to meet potential employees. Support of Cultural Traditions The strengthening of partnership rela- tions between the Company and Russia’s leading cultural and educational institutions, creative groups and charity funds contin- ued during the 2012 period, namely the Russian State Museum (St.Petersburg), the Moscow Kremlin Museum, the State Tret- yakov Gallery, the Multimedia Art Museum (the Moscow House of Photography Muse- um and Exhibition Complex), the Moscow Museum of Modern Art and the Samara Regional Art Museum. One of the most outstanding cultural events in Russia became an exhibition of one of the most famous artists of the 20th centu- ry, Boris Grigoriev. The project was jointly sponsored by the Russian State Museum, the State Tretyakov Gallery and NOVATEK. The Company was also a sponsor of the exhibition “Mastership of the Russian Armorer”, which was organized by the Moscow Kremlin Museum and the Samara Regional Art Museum. We also continued to support the annual International Festival “Imperial Gardens of Russia”, sponsored and staged by the Russian State Museum. In 2012, special priority was given to pro- jects and exhibitions of modern art and ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 55 dren’s Clinical Hospital at its Moscow office in collaboration with the foundation. We continued our charitable activities of the Company’s All Together volunteer move- ment founded in 2008. As in previous years, the volunteers’ participated in a number of causes including support for orphans and children with various illnesses, veterans, orphaned animals as well as support for the blood donor movement and the organiza- tion of other charitable programs. NOVATEK supported the exhibition “Arte Povera”, which was organized for the first time in Russia by the Multimedia Art Mu- seum and presented works of art from the most important Italian modern artists of the second half of the 20th century. NOVATEK also became a partner of the Moscow Mu- seum of Modern Art in 2011 and supported the large-scale exhibition project “Impos- sible Community”, which brought together 35 Russian and foreign painters, many of whom displayed their works in Moscow for the first time. NOVATEK also remained a General Partner of the Moscow Soloists Chamber Ensemble under the direction of Yuri Bashmet. Sports Projects NOVATEK has continued its support for semi-professional and high-level amateur sports programs. The Company and its subsidiaries organize regular tournaments in the most popular sports, including soc- cer, volleyball, swimming, et cetera. A team made up of Company’s employees also takes part in the annual Moscow Mini-Soc- cer Championship. The Company is the General Partner of the Dynamo Hockey Club (Moscow), the Spartak Basketball Club (St. Petersburg) and the NOVA Volleyball Team (Novokuybyshevsk). Charity The Company continued its cooperation with Chulpan Khamatova’s Gift of Life chari- table foundation in 2012. Funds raised from events are directed to children’s hospitals to buy modern medical equipment. In 2012, the Company held two blood donor sessions for children from the Russian Chil- 10 MEETINGS OF THE BOARD OF DIRECTORS WERE HELD IN 2012 RUSSIA’S LARGEST INDEPENDENT NATURAL GAS PRODUCER ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 57 03 MANAGEMENT AND CORPORATE GOVERNANCE NOVATEK STRIVES TO COMMIT TO THE HIGHEST STANDARDS OF CORPORATE GOVERNANCE. WE BELIEVE THAT SUCH STANDARDS ARE AN ESSENTIAL PREREQUISITE TO BUSINESS INTEGRITY AND PERFORMANCE AND PROVIDE A FRAMEWORK FOR SOCIALLY RESPONSIBLE MANAGEMENT OF THE COMPANY'S OPERATIONS CORPORATE GOVERNANCE SYSTEM NOVATEK strives to commit to the high- est standards of corporate governance. We believe that such standards are an essential prerequisite to business in- tegrity and performance and provide a framework for socially responsible man- agement of the Company's operations. The Company has established an ef- fective and transparent system of cor- porate governance complying with both Russian and international standards. NOVATEK's supreme governing body is the General Meeting of Sharehold- ers. The corporate governance system also includes the Board of Directors, the Board Committees, and the Manage- ment Committee, as well as the system of internal control and audit bodies. The activity of all these bodies is governed by the applicable laws of the Russian Fed- eration, NOVATEK’s Charter and internal documents available on our website (www.novatek.ru/en). NOVATEK strives to consider the principles of corporate governance outlined in the Corporate Governance Code recommend- ed by the Russian Federation’s Federal Commission for Securities Market dated 4 April 2002 №421/r. The Company follows the recommendations of the Code, as well as offering to our shareholders and inves- tors other solutions that are intended to protect their rights and legitimate interests. Since the Company's shares are listed on the London Stock Exchange in the form of depositary receipts, NOVATEK places great emphasis on the UK Financial Reporting Council’s Combined Code on Corporate Governance and follows its recommenda- tions as far as practicable. The Company adheres to the internal Corporate Governance Code approved by the Board of Directors in 2005 (Minutes No. 60 of 15 Decem- ber 2005). This Code has been elaborated on in accordance with best Russian and interna- tional practices in corporate governance, ethical norms and specific conditions of the Compa- ny's operations and in accordance with Russian legislation and the Company's Charter. 58 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION E C N A N R E V O G E T A R O P R O C D N A T N E M E G A N A M The Company also adheres to the internal Code of Business Ethics approved by the Board of Directors in 2011 (Minutes No. 133 of 24 March 2011). The Code establishes general norms and principles governing the conduct of members of the Board of Direc- tors, Management Committee and Revision Commission, as well as NOVATEK's man- agement and employees, which were elab- orated on the basis of moral and ethical val- ues and professional standards. The Code also determines the rules which govern mu- tual relationships inside the Company and NOVATEK's relationships with its subsidiaries and joint ventures, shareholders, investors, the government and public, consumers, suppliers, and other stakeholders. NOVATEK’s corporate governance practic- es make it possible for its executive bodies to effectively manage ongoing operations in a reasonable and good faith manner and solely to the benefit of the Company and its shareholders. GENERAL MEETING OF SHAREHOLDERS The General Meeting of Shareholders is NOVATEK's supreme governing body. The activity of the General Meeting of Shareholders is governed by the laws of the Russian Federation, the Company's Charter, and the Regulations on the Gen- eral Meetings approved by NOVATEK’s General Meeting of Shareholders in 2005 (Minutes No. 95 of 28 March 2005) with amendments. The Guidelines were elab- orated in accordance with Russian leg- islation, the Company's Charter and the recommendations of the Russian Corpo- rate Code of Conduct. The General Meeting of Shareholders is responsible for the approval of annual reports, annual financial statements, the distribution of profit, including dividends payout, the election of Board of Directors and Revision Commission, approval of the Company’s Auditor and other corporate and business matters. On 27 April 2012, the Annual General Meeting of Shareholders approved the annual report, annual financial statements (in accordance with Russian Accounting Standards), distribution of profit and the size of dividends based on the results of FY2011. The meeting also elected the Board of Directors, Chairman of the Man- agement Committee and the Revision Commission, as well as approved re- muneration to members of the Board of Directors, Revision Commission and the Company's auditor for 2012. On 16 October 2012, the Extraordinary Gen- eral Meeting of Shareholders approved the amount of interim dividend for the first six months of 2012 and a long-term contract for natural gas purchase from OAO SIBUR Holding. BOARD OF DIRECTORS The Board of Directors (the Board) activi- ty is governed by the laws of the Russian Federation, the Company's Charter and the Regulations on the Board of Directors approved by NOVATEK’s General Meeting of Shareholders in 2005 (Minutes No. 96 of 17 June 2005) with amendments. The Board carries out the overall strategic management of the Company's activity on behalf of and in the interests of all its ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 59 Board and Committee meetings attendance in 2012 MEMBER INDEPENDENCE BOARD OF DIRECTORS AUDIT COMMITTEE CORPORATE GOVERNANCE AND REMUNERATION COMMITTEE STRATEGY AND INVESTMENTS COMMITTEE Alexander Natalenko independent* Leonid Mikhelson executive Andrei Akimov Burckhard Bergmann Mark Gyetvay Yves-Louis Darricarrere Kirill Seleznev Ruben Vardanian Gennady Timchenko independent ** independent ** executive independent** independent ** independent *, ** independent ** 10/10 10/10 9/10 10/10 10/10 9/10 6/10 10/10 10/10 3/3 3/3 3/3 4/4 4/4 4/4 4/4 4/4 4/4 2/4 3/4 * ** Independent Director in accordance with the UKLA Combined Code. Independent Director in accordance with the Corporate Governance Code recommended by the RF Federal Commission for Securities Market. shareholders, and ensures the Company’s efficient performance in order to increase its shareholder value. The Board determines the Company's strategy and priority lines of business, endorses long-term and annual business plans, reviews financial performance, in- ternal control, risk management and other matters within its competence, includ- ing optimization of corporate and capital structure, approval of major transactions, making decisions on investment projects and recommendations on the size of dividend per share and its payment pro- cedure, and convening General Meeting of Shareholders. The members of the Board are elected by the General Meeting of Shareholders. The current members of the Board were elected at the Annual General Meeting of Shareholders on 27 April 2012. The Board of Directors is comprised of nine mem- bers, of which seven are non-executive directors. Six directors are considered to be independent in accordance with the Corporate Governance Code recommend- ed by the Russian Federation’s Federal Commission for Securities Market, and two in accordance with requirements of the UK Financial Reporting Council’s Com- bined Code on Corporate Governance. The Board Chairman is Alexander Egor- ovich Natalenko. The Chairman is respon- sible for leading the Board and ensuring its effectiveness. The members of NOVATEK's Board have a wide range of expertise as well as sig- nificant experience in strategic, financial, commercial and oil and gas activities. The Board members hold regular meet- ings with NOVATEK's senior management to enable them to acquire a detailed understanding of NOVATEK’s business activities and strategy and the key risks. In addition to these formal processes, Directors have access to the Company’s medium-level managers for both formal and informal discussions to ensure regular exchange of information they need to par- ticipate in the Board meetings and make balanced decisions in a timely manner. Board activities during the year To ensure the Company’s efficient per- formance, the Board meetings shall be convened on a regular basis at least once every two months. In 2012, the Board met 10 times, of which 6 meetings were held in absentia. During the year, the following key issues were discussed and respective decision made: • reviewed and approved the Company's 2011 full year operating and financial results; • approved the acquisition as well as the applicable financing of a 49% equity stake in ZAO Nortgas; • recommended a full year dividend for 2011, based on full year financial results, and an interim dividend for first half 2012, based on interim financial results for that period; • approved Russian rouble bond registra- tion with the total nominal value of RR 45 billion; • approved the acquisition of an 82% in- terest in OOO Gazprom mezhregiongas Kostroma; and • reviewed and approved NOVATEK's business plan for 2013. 60 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION BOARD OF DIRECTORS OF NOVATEK AS AT 31.12.2012 MR. ALEXANDER Y. NATALENKO MR. ANDREI I. AKIMOV Born in 1946 Born in 1953 Chairman of NOVATEK’s Board of Directors Member of NOVATEK’s Board of Directors Member of the Audit Committee Member of the Corporate Governance and Remuneration Committee Member of the Board of Directors of OAO Rosgeologia Chairman of the Audit Committee Chairman of the Management Board of “Gazprombank” (OAO) MR. LEONID V. MIKHELSON Born in 1955 Member of NOVATEK’s Board of Directors Chairman of the Management Committee E C N A N R E V O G E T A R O P R O C D N A T N E M E G A N A M ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 61 DR. BURCKHARD BERGMANN Born in 1943 Member of NOVATEK’s Board of Directors Member of the Corporate Governance and Remuneration Committee Member of the Strategy and Investments Committee Board Member of the Presidium of the German-Russian Chamber of Commerce MR. YVES LOUIS CHARLE JUSTIN DARRICARRERE Born in 1951 MR. MARK A. GYETVAY Born in 1957 Member of NOVATEK’s Board of Directors Member of the Corporate Governance and Remuneration Committee Executive Vice President of Total S.A. President of Total Exploration & Production Member of NOVATEK’s Board of Directors Chairman of the Strategy and Investments Committee Member and Deputy Chairman of the Management Committee Chief Financial Officer MR. KIRILL G. SELEZNEV MR. GENNADY N. TIMCHENKO MR. RUBEN K. VARDANIAN Born in 1974 Born in 1952 Born in 1968 Member of NOVATEK’s Board of Directors Member of NOVATEK’s Board of Directors Member of NOVATEK’s Board of Directors Member of the Strategy and Investments Committee Member of the Strategy and Investments Committee Member of the Management Board, Director of Gas and Liquid Hydrocarbons Marketing and Processing Department of OAO “Gazprom” General Director of OOO “Gazprom Mezhregiongaz” Chairman of the Corporate Governance and Remuneration Committee Member of the Audit Committee Co-head of Sberbank CIB 62 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION Committees membership as of 31 December 2012: AUDIT COMMITTEE STRATEGY AND INVESTMENTS COMMITTEE CORPORATE GOVERNANCE AND REMUNERATION COMMITTEE Chairman Andrei Akimov Mark Gyetvay Ruben Vardanian Members Ruben Vardanian Burckhard Bergmann Alexander Natalenko Alexander Natalenko Yves-Louis Darricarrere Burckhard Bergmann BOARD COMMITTEES The Company has three Board Commit- tees: the Audit Committee, the Strategy and Investments Committee and the Corporate Governance and Remuneration Committee. The Committees’ activities are governed by the Committees Charters approved by the Board of Directors. The specific terms of reference for each of the Board Commit- tees are available on our website. The Committees play a vital role in ensur- ing that the high standards for corporate governance are maintained throughout the Company and that specific decisions are analyzed and the necessary recommen- dations are issued prior to general Board discussions. The minutes of the Commit- tees meetings are circulated to the Board members and are accompanied by any necessary materials and explanatory notes. In order to carry out their duties, the Com- mittees may request information or doc- uments from members of the Company's executive bodies or heads of the Compa- ny’s relevant departments. For the purpose of considering any issues being within their competence, the Committees may engage experts and advisers having necessary professional knowledge and skills. E C N A N R E V O G E T A R O P R O C D N A T N E M E G A N A M Gennady Timchenko Kirill Seleznev Strategy and Investments Committee The primary function of the Strategy and Investments Committee is to develop and give recommendations to the Board for determining of priorities of the Company's operations and assessing the effectiveness of investment projects and their impact on NOVATEK's shareholder value. In carrying out its responsibilities and assisting the members of the Board in discharging their duties, the Strategy and Investment Committee is responsible for but not limited to: • analyzing concepts, programs, and plans of the Company's strategic devel- opment and giving recommendations to the Board; • developing recommendations to the Board with respect to any transactions with assets the value of which exceeds 5% of the Company’s assets book value, as calculated in accordance with the accounting data as of the last reporting date; • developing recommendations to the Board following the consideration of investment projects proposed by the Company's executive bodies for imple- mentation; and • developing recommendations to the Board for utilization of the Company's reserves and provisions. In 2012, the Strategy and Investments Committee met four times. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 63 Corporate Governance and Remuneration Committee Audit Committee The primary function of the Audit Commit- tee is the control over financial and busi- ness operations of the Company and as- sistance to the Board in exercising effective control by assessing: • the accuracy, transparency, and com- pleteness of the Company's financial statements prepared in accordance with Russian and International accounting standards; • the candidature of the Company's exter- nal auditor; • the independent auditor’s report with re- spect to the Company's annual financial statements; • the efficiency of the Company’s internal control procedures and proposals for their improvement. The Audit Committee works actively with the Revision Commission, external auditor and Company's executive bodies, inviting NOVATEK’s managers responsible for the preparation of the financial statements to attend the Committee meetings. In 2012, the Audit Committee met three times. The primary function of the Corporate Governance and Remuneration Commit- tee is to improve the corporate governance system and to review the Company’s prac- tices and policies to ensure compliance of the Company's business practices and internal regulatory documents with appli- cable standards of corporate governance and Russian and international best practice standards. The Corporate Governance and Remuneration Committee is also responsi- ble for determining the policy for executive remuneration and for the remuneration and benefits of individual executive directors and senior executives as well. In order to assist the Board, the Committee performs the following functions: • develop and regularly review our corpo- rate governance documents and docu- ments regulating corporate conflicts; • develop recommendations with respect to our dividend policy and distribution; • evaluate the Company's Investor Rela- tions and Shareholder communications polices; • develop procedures for and perform an annual evaluation of the work performed by the Board; and • determine the annual compensation for the Board and the Revision Commission members. In 2012, the Corporate Governance and Re- muneration Committee met four times. 64 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION E C N A N R E V O G E T A R O P R O C D N A T N E M E G A N A M MANAGEMENT COMMITTEE NOVATEK’s Management Committee is a collegial executive body responsible for the day-to-day management of the Company’s operations. The Management Committee is governed by the laws of the Russian Federation, NOVATEK’s Char- ter, decisions of the General Meetings of Shareholders and the Board of Directors and by other internal documents. More information regarding the Management Committee’s competence is provided in the Management Committee Regulations approved by NOVATEK’s General Meeting of Shareholders in 2005 (Minutes No. 95 of 28 March 2005). Members of the Management Committee are elected by the Board of Directors from among the Company's key employees. The Management Committee is subordinated to the Board of Directors and the General Meeting of Shareholders. Chairman of the Management Committee is responsible for leading the Committee and ensuring its effectiveness as well as organizing the Management Committee meetings and implementing decisions of the General Meeting of Shareholders and the Board. The Management Committee is currently comprised of eight members elected by the Board of Directors (Minutes No. 118 of 3 December 2009 and Minutes No. 113 of 24 March 2011). The Chairman of the Management Committee is Leonid Viktorovich Mikhelson. Management Committee of NOVATEK as at 31.12.2012 Leonid Mikhelson Chairman Mikhail Popov Vladimir Baskov Alexander Fridman First Deputy Chairman, Commercial Director Deputy Chairman Deputy Chairman Mark Gyetvay Deputy Chairman, Chief Financial Officer Tatyana Kuznetsova Deputy Chairman, Director of the Legal Department Iosif Levinzon Kirill Yanovskiy Deputy Chairman Director for Finance and Strategy ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 65 Remuneration paid to members of the Board of Directors and Management Committee BOARD OF DIRECTORS(1) MANAGEMENT COMMITTEE Total paid, including: 105.5 1,297.5 Salaries Bonuses Fees Other property advancements - - 105.0 0.5 495.8 786.5 - 15.2 (1) Some members of NOVATEK’s Board of Directors are simultaneously members of the Management Committee. Payments to such members in relation to their activities as members of the Management Committee are included in the total payments to members of the Management Committee. REMUNERATION TO MEMBERS OF THE BOARD OF DIRECTORS AND MANAGEMENT COMMITTEE The procedure for and criteria of calculating remuneration to members of NOVATEK’s Board of Directors, as well as the compen- sation of their expenses, are prescribed in the Company’s Charter and Regulations on NOVATEK’s Board of Directors. The procedure for and criteria of calculating remuneration to the Chairman and mem- bers of NOVATEK’s Management Commit- tee, as well as the compensation of their expenses, are prescribed in the Regula- tions for the Management Committee and the employment contracts they sign with the Company. INTERNAL CONTROL AND AUDIT The Company has a system of internal control over financial and business oper- ations with the respect to modern interna- tional best practices. The system of internal control consists of the Audit Committee, the Revision Commission, the Chairman of the Management Committee, the Management Committee, the Company's management and the Internal Audit Division. The objects of internal control are OAO NOVATEK, its subsidiaries and joint ven- tures, and their subdivisions, as well as their activities. The goals, objectives and internal control procedures are established by the Regu- lations on NOVATEK’s Internal Control, ap- proved by the Board of Directors (Minutes No. 114 of 31 August 2009). Revision Commission Revision Commission consisting of four members is elected at the Annual Gener- al Meeting of Shareholders for a period of one year. The competence of the Revision Commission is governed by the Russian Federation Law On Joint Stock Compa- nies No. 208-FZ as well as the Company's Charter and the Regulations on the Revi- sion Commission Procedures approved by the General Meeting of Shareholders (Minutes No. 95 of 28 March 2005). The Revision Commission is an internal control body responsible for oversight of the Company’s financial and business activities, management bodies, officers, divisions, departments, branches, and representative offices. The Revision Commission audits the Company’s financial and business perfor- mance for the year, as well as for any other period as may be decided by its members or other persons authorized in accordance with Russian Federation law and the Regula- tions for NOVATEK’s Revision Commission. The results are presented in the form of revisions Auditing Commission. In 2012, the Revision Commission held one documentary revision of financial and business activity of the Company for the year 2011. As a result the conclusions about the reliability of the data contained in the Company’s 2012 Financial Statements and 2012 Annual Report were prepared and submitted to the Annual General Meeting of Shareholders. 66 Internal Audit Division NOVATEK’s Internal Audit Division is working on raising assurances to achieve the strategic goals of the Company and effectiveness of its corporate governance. The Internal Audit Division is guided by the Code of Ethics of the Institute of Internal Auditors and International internal audit standards. The Division reports directly to the Chair- man of the Management Committee and the Audit Committee. The Internal Audit Division operates on the basis of the annu- al strategic schedule of revisions based on risk assessment and the approval of the Chairman of the Management Committee and annually provides to the Chairman of the Management Committee and the Audit Committee the results of its activities. In performing its functions, the Internal Audit Division is guided by the principles of independence and objectiveness. NO- VATEK’s internal standards envisage full access of the Internal Audit Division em- ployees to all functions, records, property and personnel of the Company in imple- menting their audit tasks. According to the results of audits, the Division develops plan-actions to eliminate identified risks and to implement proposals for optimization of the financial and busi- ness activity. External Auditor The Annual General Meeting of Share- holders appoints an external auditor to conduct independent review of NO- VATEK’s financial statements. The Audit Committee gives recommendations to the Company's Board of Directors re- garding the candidatures of external auditors and the price of their services. Based on the Committee’s recommen- dations, the Board proposes the auditor’s candidature for the consideration and for approval by the Annual General Meeting of Shareholders. ZAO PricewaterhouseCoopers Audit was approved as the Company’s external au- ditor to conduct independent audit of the Company's financial statements for 2012. In selecting the auditor’s candidature, attention shall paid to level of their pro- fessional qualifications, independence, possible risk of any conflict of interest, terms of the contract, and an amount of remuneration requested by the candi- dates. The Audit Committee oversees the external auditor’s independence and objectivity as well as the quality of the audit conducted. The Committee annu- ally provides to the Board of Directors the results of review and evaluation of the audit opinion regarding the Company's fi- nancial statements. The Audit Committee meets with the auditor's representatives at least once per year. NOVATEK’s management is aware of and accepts recommendations on independ- ence of the external auditor by placing certain restrictions on such auditor's involvement in providing non-audit ser- vices. Remuneration paid to the principle auditors for auditing and other services is specified in the Note 22 to the con- solidated financial statements prepared in accordance with IFRS standards for 2012. growthefficiencyinnovationannUaL rePortoao novateK2012ManageMent anDcorPorate governanceANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 67 SHARE CAPITAL Our share capital is RR 303,630,600 and consists of 3,036,306,000 ordinary shares, each with a nominal value of RR 0.1. As of 31 December 2012, NOVATEK did not have privileged shares. Our shares are traded in US dollars and Russian roubles on the MICEX-RTS Stock Exchange and have an A1 listing (symbol: NVTK). The Federal Financial Market Service issued to NOVATEK a permit for circu- lation beyond Russian Federation of 910,589,000 ordinary shares comprising 29.99% of the Company’s share capital. Our Global Depositary Receipts (GDR) are listed on the London Stock Exchange (sym- bol: NVTK). Each GDR represents 10 ordi- nary shares. As of 31 December 2012, NO- VATEK’s GDRs were issued on 910,588,780 ordinary shares comprising 29.99% of the Company’s share capital. Equity stakes in NOVATEK’s share capital and the number of shares owned by members of the Board of Directors and Management Committee EQUITY STAKE AS OF 31 DECEMBER 2012(1), % NUMBER OF SHARES Board of Directors Alexander Natalenko Andrei Akimov Burckhard Bergmann Ruben Vardanian Mark Gyetvay Yves-Louis Darricarrere Leonid Mikhelson Kirill Seleznev Gennady Timchenko Management Committee Vladimir Baskov Alexander Fridman Tatyana Kuznetsova Iosif Levinzon Mikhail Popov Kirill Yanovskiy - - - - - - 0.6754 - - 0.0288 0.0817 0.1944 - 0.1440 0.1051 - - - - - - 20,506,542 - - 874,408 2,481,049 5,903,035 - 4,372,038 3,192,530 (1) The equity stakes are given based on the records in the register of NOVATEK’s shareholders in accordance with the Russian Federation laws. 68 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 6.86 RR PER SHARE RECOMMENDED DIVIDEND FOR 2012 DIVIDENDS NOVATEK’s dividend policy is based on keeping the balance between the Com- pany’s business goals and shareholder’s interests. A decision to pay dividends as well as the size, payout time and form of the dividend is passed by the Annual General Meeting of Shareholders accord- ing to the recommendation of the Board of Directors. Dividends are paid twice a year; their size depends on market con- ditions, cash flow and the Company’s capital structure and investment program. NOVATEK is strongly committed to its dividend policy. On 19 March 2013, the Board of Direc- tors of OAO NOVATEK recommended to the Annual General Meeting of Share- holders to pay dividends for FY 2012 in the amount of RR 3.86 per ordinary share or RR 38.6 per one Global Depos- itary Receipt (GDR), exclusive of RR 3.0 of interim dividends per ordinary share or RR 30.0 per one GDR for the first six months of 2012. Thus, should the General Meeting of Shareholders approve the above recom- mended dividend, the dividends for 2012 will total RR 6.86 per ordinary share (RR 68.6 per one GDR), and the total amount of dividends payable for 2012 will be RR 20,829,059,160. The amount of paid dividends accrued for the years 2007 to 2011, and for the first six months of 2012 is reported as of 31 December 2012 in the table below. Partial payment of the accrued dividends was made due to provision by sharehold- ers (nominee holders) of incorrect postal and/or banking details and insufficient information regarding banking or postal details of shareholders. Accrued and paid dividends on NOVATEK shares for the period from 2007 to 2012 DIVIDEND ACCRUAL PERIOD AMOUNT OF DIVIDENDS, TOTAL AMOUNT OF RR PER SHARE DIVIDENDS ACCRUED, RR TOTAL AMOUNT OF DIVIDENDS PAID, RR 2007 2008 2009 2010 2011 First 6 months of 2012 2.35 2.52 2.75 4.00 6.00 3.00 7,135,319,100 7,135,293,833 7,651,491,120 7,651,310,957 8,349,841,500 8,349,681,894 12,145,224,000 12,144,967,156 18,217,836,000 18,217,663,073 9,108,918,000 9,108,864,267 E C N A N R E V O G E T A R O P R O C D N A T N E M E G A N A M ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 69 INFORMATION TRANSPARENCY NOVATEK is committed to providing ob- jective, reliable, and consistent informa- tion about the Company and its activities to all stakeholders and also complies with modern standards for information disclosure while adhering to a maximum level of transparency. The Regulations on Information Policy approved by the Board of Directors (Minutes No. 45 of 10 May 2005), define main principles for disclos- ing information and increasing information transparency. Material information about the Company is disclosed in a timely manner in the form of press releases through authorized dis- closure in accordance with the applicable laws of Russian Federation and United Kingdom. The Company discloses quar- terly financial statements in accordance with the International Financial Reporting Standards (“IFRS”), Management’s Dis- cussion and Analysis of Financial Condi- tion and Results of Operations as well as various presentations for investors. In addition to press releases and material facts, the Company's website provides detailed information on all aspects of its activities, including our Sustainability Re- port. We regularly participate in informa- tion disclosure on greenhouse gas emis- sions and energy efficiency of production – the Carbon Disclosure Project (CDP), and on the use of water resources – the CDP Water Disclosure Project, as well as other industry’s publications and studies. The Company maintains an ongoing dia- logue with shareholders and investors in order to ensure full awareness of invest- ment community about its activities. The main channels of communica- tion with the investment community are through the Chairman of the Management Committee, Deputy Chairman (the Chief Financial Officer) and the Investor Rela- tions department. The Company’s repre- sentatives meet on a regular basis with key financial audiences to discuss issues of interest to them. In accordance with principles of its unified information policy, NOVATEK conducts an active, ongoing dialog with represent- atives of media outlets. The information disclosed to mass media comprises all aspects of the Company's activities, including financial and operating results and projects under development, as well as socially or environmentally important aspects. NOVATEK actively involves in a variety of outside Exhibitions and Conferences. During 2012, representatives of the Com- pany participate in more than 15 exhibi- tions, conferences and round tables and gave seven presentations on key industry issues. One of the most important events was the Second International Confer- ence – Yamal LNG starts marine transpor- tation LNG in Arctic, which was organized by NOVATEK. According to the confer- ence participants, among which were heads of the relevant Russian ministries and institutions as well as scientists and businessmen from Russia, Europe and the Asian-Pacific Region, the conference was highly organized. 70 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION ADDITIONAL INFORMATION MAJOR RISK FACTORS The risks provided herein are by no means exhaustive and only reflect the Company’s own opinions and estimates. Industry Risks The major risks associated with the Russian domestic gas market are largely attributable to the extensive government regulation of prices for natural gas sold on the domestic market as well as Gazprom’s dominant position in the industry. The following factors may adversely affect the Company’s operations, or its financial and eco- nomic performance: • Government regulation of natural gas sales prices on the domestic market for Gazprom companies; • Dependence on throughput capacity of trunk pipelines; • Potential increases in government-regulated tariffs for pipeline transportation of natural gas and crude oil as well as railway transporta- tion; • Decline in world prices for liquid hydrocarbons; • The Company’s dependence on OAO AK Transneft and OAO Russian Railways for the use of liquid hydrocarbons’ distribution net- works; and • Increasing competition in the Russian natural gas industry from independent natural gas producers and vertically integrated compa- nies. NOVATEK implements specific measures to minimize the potential impact of industry risks. In particular, the Company is actively building pro- ductive partnerships with key service suppliers, expanding its customer base, actively searching for purchasers of natural gas at agreed prices and entering into long-term contracts with them. In addition, NOVATEK strives to diversify its mar- keted product line to include gas condensate, crude oil and petroleum derivatives, along with the marketing of natural gas. Country and Regional Risks NOVATEK is a Russian company operating in a number of Russian regions. Country risk is defined by the fact that Russia is still an emerging economy. Despite the positive trend in the Russian economy; strong GDP growth, po- litical stability, improving living standards, etc., the country’s economy is still developing. The Russian economy is commodity-based and oriented towards export of raw materials, which explains the dependence of the country’s industrial output on the demand for raw materials in world markets. The Company produces and processes hydro- carbons on the territory of Western Siberia, a re- gion with a challenging climate. The Company’s vulnerability to region-specific impacts is insig- nificant and is completely accounted for through the management of the Company’s financial and economic operations. The Company has built an efficient system of interaction between its production and marketing units and its principal production facilities are concentrated in close proximity to the transportation networks in use. Risks related to possible military conflicts, state of emergency announcements, or strikes, are non-existent, as the Company operates in eco- nomically and socially stable regions. Financial Risks NOVATEK’s financial performance is subject to financial risks associated with the fluctuation of foreign currency exchange rates, as the Com- ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 71 pany borrows funds in foreign denominated currencies and markets a portion of its products internationally. With respect to the fluctuation of the Russian rouble in relation to other currencies, the mar- keting of products internationally substantially extensively reduces this risk and balances out the adverse effects of the national currency’s exchange value fluctuations. The inflow of export profits will secure mainly payment of outstanding amounts due therefore, currency risks will not substantially impact the Company’s operations. In the case of an interest rate decline, repayment of outstanding amounts on existing loans and credits may become less attractive in compari- son with current offers in the loan market. In this event, the Company will undertake to replace ex- isting debt facilities with current market offers on better terms and conditions, including borrowing costs. Overall interest rate growth may affect the Com- pany’s borrower liabilities, subject to change under specific conditions. The resulting dynamic behavior in the borrowed funds value restricts their use as a source of funds throughout “ex- pensive loan” periods. Interest rate shifts in specific sectors of the debt market will result in the Company diver- sifying its funding sources and switching to market sectors with more attractive financial resources. Commodity Price Risks Commercial trading strategy for natural gas, sta- ble gas condensate, LPG, crude oil and related oil products is centrally managed in the Compa- ny. Changes in commodity prices could nega- tively or positively affect the Company’s results of operations. As an independent natural gas producer, NO- VATEK is not subject to the government’s reg- ulation of natural gas prices. Nevertheless, the Company’s prices are strongly influenced by the prices regulated by the Federal Tariffs Service (FTS), a governmental agency. The Company sells all of its crude oil and gas condensate under spot contracts. Gas conden- sate volumes sold to the US, European, South America and Asian Pacific markets are based on benchmark reference prices of light oil WTI and Brent or naphtha. Crude oil sold internationally is priced based on benchmark reference crude oil prices of Brent, plus a margin or a discount and on a transaction-by-transaction basis for vol- umes sold domestically. As a result, NOVATEK’s revenues from the sales of liquid hydrocarbons are subject to commodity price volatility based on fluctuations or changes in benchmark refer- ence prices. Presently, the Company does not use commodity derivative instruments for trading purposes to mitigate price volatility. Credit Risk Credit risk refers to the risk exposure of the Company to a potential financial loss due to the default of counterparties on their contractual ob- ligations. NOVATEK mitigates credit risk through the management of its cash and cash equiva- lents, including short-term deposits with banks, as well as credit exposure to customers, includ- ing outstanding trade receivables and commit- ted transactions. Cash and cash equivalents are deposited only with banks that are considered by the Company at the time of deposit to have minimal risk of default. The Company’s trade and other receivables consist of a large number of customers, spread across diverse industries and geographical areas. Most of NOVATEK’s international liquid sales are made to customers with independent 72 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION external ratings. Almost all domestic sales of liquid hydrocarbons are made on a 100 percent prepayment basis. Although the Company does not require collateral in respect of trade and other receivables, it has developed standard credit payment terms and constantly monitors the sta- tus of trade receivables and the creditworthiness of the customers. Liquidity Risk Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity risk is to ensure that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed condi- tions, without incurring unacceptable losses or risking damage to the Company’s reputation. In managing its liquidity risk, NOVATEK main- tains adequate cash reserves and debt facilities, continuously monitors forecasted and actual cash flows and matches the maturity profiles of financial assets and liabilities. The Compa- ny prepares various financial plans (monthly, quarterly and annually), which ensures that the Company has sufficient cash on demand to meet expected operational expenses, financial obligations and investing activities for a period of 30 days or more. The Company has also en- tered into a number of short-term credit facilities, such as credit lines and overdraft facilities, which can be drawn down to meet short-term financ- ing needs. To fund cash requirements of a more permanent nature, the Company will normally raise long-term debt in international and domes- tic markets. Inflation Risks The change in the consumer price index has an impact on NOVATEK’s profitability and as a consequence, its financial standing and ability to pay on liabilities and securities. This factor is not considered a major risk to our business due to the fact that the tariff policy of the Russian Federation contem- plates a gradual increase in the domestic gas prices commensurate with the growth in inflation rates. NOVATEK may not be able to predict the inflation level, since apart from the consumer price level, it is necessary to take into account the change in real purchasing power of the Russian rouble, the pricing conditions in liquid hydrocarbon export markets and the government policy in relation to tariffs for natural gas. NOVATEK monitors the consumer price index and takes this factor into account when deter- mining its selling prices. Risks Related to the Impact of the Global Financial Crisis The main risks relating to the impact of global financial crisis are Russian rouble devaluation and a decrease in demand for natural gas as a result of a decline in Russian industrial output. A staged increase of the regulated domestic price for natural gas planned by the Russian government, combined with foreign currency denominated revenue received from export sales of liquids and cost reduction due to the decrease of domestic prices for materials and services, mitigate the consequences of potential Russian rouble devaluation for NOVATEK. The search for new customers along with pro- vision of more flexible terms and conditions to existing contracts and stable demand from our main end-customer segment, public utilities, enable the Company to compensate for the slump in the domestic demand for natural gas from industrial consumers. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 73 Legal Risks Risk Insurance The Company’s operations are susceptible to risks resulting from changes in the statutory regulation of the following spheres: • Currency laws (in areas concerning export/im- port and borrowings operations); • Tax laws (in areas regulating taxation systems and rates applicable to companies in general, and to companies marketing natural gas and liquid hydrocarbons, specifically); • Customs laws (in areas concerning the export of liquid hydrocarbons and their derivatives); • Licensing requirements for natural resource extraction. Operational Risks The Company is not involved in any significant litigation and the risks pertaining to such litigation are minor. The Company and its affiliates hold long-term field development licenses. Certain risks exist for the Company’s operations associated with field exploration and development. Exploration drilling incorporates multiple risks, including the risk of non-availability of commercial reserves. Information on the Company’s fields’ reserves is provided as estimated, subject to cer- tain factors and assumptions. Actual production volumes across fields, along with the cost-effec- tiveness of reserve exploitation, may deviate from estimated figures. The Company’s operations require substantial investment into field exploration and development, followed by the production, transportation, and processing of natural gas, oil, and gas conden- sate. Insufficient funding for these and other expenditures may affect the Company’s financial standing and performance results. Risk insurance is an integral part of NOVATEK’s risk management system. In 2012, the insurance coverage guaranteed adequate protection against the risks of damage to our business. Insurance is provided by reputable domestic insurance companies that have the highest insurance ratings in Russia (Standard & Poor`s BBB-/ Stable on National Scale: ruAA +) with risk reinsurance by major international insurance companies. The Company fully complies with the applicable legal requirements in terms of mandatory insur- ance, such as third-party liability insurance of owners of hazardous facilities and vehicles. To reduce the risks of financial losses the Com- pany utilizes the following voluntary insurance products: • Insurance of the risk of damage/loss of property; • Management liability insurance. The risks of damage/loss of property resulting from accidents are fully insured. Full cost recovery with a franchise is in place. Following the assess- ments made in 2011 we insured our production equipment on new terms providing for better cov- erage of risks. Since 1 January 2012 the property insurance is applied at replacement cost, which results in better compensation of potential damag- es. For more than 7 years NOVATEK has procured its top management liability insurance against possible claims by third parties for any losses incurred through wrong actions or decisions. The overall limit on such insurance coverage is 150 million U.S. dollars. In 2012, the Company began developing a com- prehensive program for business interruption insurance. The new program is estimated to cover all of our main producing entities. 74 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION INFORMATION ON MEMBERS OF NOVATEK’S BOARD OF DIRECTORS AND MANAGEMENT COMMITTEE MR. ALEXANDER Y. NATALENKO Born in 1946 MR. LEONID V. MIKHELSON Born in 1955 Chairman of NOVATEK’s Board of Direc- tors and member of its Audit Committee and its Corporate Governance and Remu- neration Committee Mr. Natalenko completed his studies at the Irkutsk State University in 1969 with a primary focus in Geological Engineering. Subsequently, he worked with the Yago- dinskaya, Bagdarinskaya, Berelekhskaya, Anadirskaya and East-Chukotskaya geo- logical expeditions. In 1986, Mr. Natalenko headed the North-East Industrial and Ge- ological Association and, in 1992, he was elected president of АО "Magadan Gold & Silver Company". He subsequently held various executive positions in Russian and foreign geological organizations. From 1996 to 2001, Mr. Natalelnko held the position of Deputy Minister of Natural Resources of the Russian Federation. He is a member of the Board of Directors of ZAO GC VERTEX. In 2012, Mr. Natalenko was elected member of the Board of Directors of OAO Rosgeo- logia. Currently, Mr. Natalenko is Chairman of NOVATEK's Board of Directors. He is also a member of the Audit Committee and Corporate Governance and Remuneration Committee of NOVATEK’s Board of Direc- tors. Mr. Natalenko is the recipient of the State Prize of the Russian Federation and an Honored Geologist of Russia. Member of NOVATEK’s Board of Direc- tors, Chairman of NOVATEK’s Manage- ment Committee Mr. Mikhelson received his primary de- gree from the Samara Institute of Civil Engineering in 1977, where he specialized in Industrial Civil Engineering. That same year, Mr. Mikhelson began his career as foreman of a construction and assembling company in Surgut, Tyumen region, where he worked on the construction of the first section of Urengoi-Chelyabinsk gas pipe- line. In 1985, Mr. Mikhelson was appointed Chief Engineer of Ryazantruboprovodstroy. In 1987, he became General Director of Kuibishevtruboprovodstroy, which in 1991, was the first company in the region to sell its shares and became a private company, AO SNP NOVA. Mr. Mikhelson remained SNP NOVA’s Managing Director from 1987 through 1994. Subsequently, he became a General Director of the management com- pany “Novafininvest”. Since 2002, Mr. Mikhelson has served as a member of the Board of Directors and Chairman of the Management Committeeof NOVATEK. From March 2008 to December 2010, he has been a member of the Board of Directors of OAO Stroytransgas. From 2009 to 2010 he was the Chairman of the Board of Directors of ОАО Yamal LNG and from 2008 to 2011 he was a member of the Board of Directors of OOO Art Finance. He is the Chairman of the Board of Directors of ZAO SIBUR Holding and a member of the Supervisory Board of the OAO Russian Regional Development Bank. Mr. Mikhelson is the recipient of the Russian Federation’s Order of the Badge of Honor. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 75 MR. ANDREI I. AKIMOV Born in 1953 DR. BURCKHARD BERGMANN Born in 1943 Chairman of the Management Board of "Gazprombank" (OAO), Member of NOVATEK’s Board of Directors and Chairman of its Audit Committee Mr. Akimov graduated from the Moscow Financial Institute in 1975 where he special- ized in international economics. Between 1974 and 1987, Mr. Akimov held various executive positions in the Bank of Foreign Trade (“Vneshtorgbank”) of the USSR. From 1985 to 1987 he served as Deputy Gen- eral Director of Vneshtorgbank’s branch in Zurich (Switzerland) and between 1987 and 1990, Mr. Akimov headed Donau Bank in Vienna (Austria). From January 1991 to November 2002 he was Managing Director of financial company, IMAG GmbH Vienna (Austria) and, at the same time, served as an Advisor to the Chairman of Vneshtorg- bank. Since 2003, Mr. Akimov has been the Chairman of the Management Committee of Gazprombank (OAO). He is a member of the Board of Directors of ZAO Geros- gaz, Carbon Trade & Finance SICAR S.А. and Chairman of the Supervisory Board of Gazprombank (Switzerland) Ltd. Since June 2011, Mr. Akimov has been a member of the Board of Directors of OAO Gazprom and since October 2011, he has been the Chairman of the Board of Directors of ОAO Rosneftegaz. Currently, he is a Chairman of the Audit Committee of OAO NOVATEK. Member of NOVATEK’s Board of Di- rectors, its Corporate Governance and Remuneration Committee and its Strat- egy and Investments Committee, Board Member of the Presidium of the Ger- man-Russian Chamber of Commerce, Member of the Advisory Board of the Union of German Science Funds Dr. Bergmann studied physics at the Frei- burg and Aachen Universities from 1962 to 1968 and was awarded a Doctorate in Engi- neering by Aachen University of Technology in 1970. From 1968 to 1969, Dr. Bergmann worked at the German Federal Ministry for Research and Technology and from 1969 to 1972 – at the J lich Nuclear Research Center. In 1972, Dr. Bergmann joined Ruhr- gas AG (from 1 July 2004 – E.ON Ruhrgas AG), heading the LNG Purchasing Depart- ment. In 1978, he became Head of the Gas Purchasing Division responsible for gas purchasing, commercial aspects of gas transmission and storage. In 1980, he was elected as a member of the Management Board of E.ON Ruhrgas AG, serving from June 1996 as its Vice-Chairman and from June 2001 to February 2008 as its Chair- man. From March 2003 to February 2008 he was also a member of the Management Board of E.ON AG. Dr. Bergmann is also a member of the Board of Directors (Supervisory Board) of: Allianz Lebensversicherungs-AG, Com- merzbank AG, Contilia GmbH, Telenor ASA. In addition, he is a member of the Adviso- ry Boards for Dana Gas International, IVG Immobilien AG. He has been elected as Chairman of the Advisory Board of Jaeger Grund und Dienste GmbH& Co KG and 76 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION Mr. Vardanian is Co-founder of the Moscow-based Skolkovo School of Management and is represented on its Coordinating Council. The school was established on the initiative of Mr. Varda- nian and several Russian businessmen. Between 2006 and 2011, Mr. Vardanian was President of the Skolkovo School of Management. Mr. Vardanian is also a member of the President’s Council on Implementation of National Projects and Demographic Policy, President’s International Advisory Committee on Establishment of Inter- national Financial Center in the Russian Federation. He is a member of the RF Government’s Competition and Entrepre- neurship Council. The World Economic Forum (Davos) included Mr. Vardanian in a list of “100 fu- ture world leaders”. He was also included in the Top-22 Business Leaders of Russia for three consecutive years (rating by the “Kommersant” newspaper and Manag- ers Association). Mr. Vardanian, graduated with honors from Moscow State University with a degree in Economics. In 2000, he also completed executive management courses at INSEAD (Fontainebleau, France) and, in 2001 and 2005, he com- pleted the courses at Harvard Business School (USA). member of the Board of Trustees of RAG Foundation since 2012. Dr. Bergmann holds the following distinc- tions: Commander of the Royal Nor- wegian Order of Merit (1997); Honorary Consul of the Russian Federation in the State of North Rhine-Westphalia a For- eign Member of the Academy of Tech- nological Sciences of the Russian Fed- eration (2003); Order of Merit of the State of North Rhine-Westphalia (2004) as well as a winner of Director of the Year, Moscow (2007). In June 2011, by means of presidential Decree he became a recipient of the Order of the Friendship of Peoples award for significant contribution in development of the Russian-German relations. MR. RUBEN K. VARDANIAN Born in 1968 Member of NOVATEK’s Board of Direc- tors, Chairman of its Corporate Gover- nance and Remuneration Committee and member of its Audit Committee Ruben Vardanian is Co-head of Sberbank CIB. Prior to closing the deal to merge Sberbank of Russia and Troika Dialog in January 2012 he was Chairman of the Board of Directors of Troika Dialog, where he was working since its foundation. Mr. Vardanian is a Board member of several companies: OAO AvtoVAZ, OAO KAMAZ, OAO NOVATEK, OAO SIBUR Holding, Joule Unlimited, Inc (a pioneer in production of renewable fuel based on solar energy) and others. He is also Board Chairman of several companies: OAO Rosgosstrakh, ZAO AmeriaBank ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 77 MR. MARK A. GYETVAY Born in 1957 Member of NOVATEK’s Board of Direc- tors and Chairman of its Strategy and Investments Committee, Member and Deputy Chairman of NOVATEK’s Man- agement Committee Chief Financial Officer Mr. Gyetvay studied at Arizona State Uni- versity (Bachelor of Science, Accounting, 1981) and later at Pace University, New York (Graduate Studies in Strategic Man- agement, 1995). After graduation, Mr. Gyetvay worked in various capacities at a number of independent oil and gas com- panies (Champlin Petroleum Co., Texas, Ensource Inc. and MAG Enterprises, Colorado, and Amerada Hess Corpora- tion, New Jersey) where he specialized in financial and economic analysis for both upstream and downstream segments of the petroleum industry. In 1994, Mr. Gyetvay began his work at Coopers and Lybrand, as Director, Strategic Energy Advisory Services. He subsequently moved to Moscow in 1995 with Coopers & Lybrand to lead the oil and gas practice. He was admitted as a partner of PricewaterhouseCoopers Global Energy where he assumed the role of client service engagement part- ner, Utilities and Mining practice, based in Russia (Moscow office). Mr. Gyetvay was an engagement partner on various energy and mining clients providing over- all project management, financial and operational expertise, maintaining and supporting client service relationships as well as serving as concurring partner on transaction services to the petroleum sector. Mr. Gyetvay is a Certified Public Account- ant, a member of the American Institute of Certified Public Accountants and an associate member of the Society of Pe- troleum Engineers. In 2003, Mr. Gyetvay became a member of NOVATEK’s Board of Directors and is also a Chairman of the Strategy and Investments Committee of NOVATEK’s Board of Directors. Since 2004–2008, he has been Chief Financial Officer and, in August 2007, Mr. Gyetvay was elected to NOVATEK’s Management Committee and, in July 2010, he became Deputy Director of NOVATEK’s Management Committee. MR. YVES LOUIS CHARLE JUSTIN DARRICARRERE Born in 1951 Executive Vice President, Total S.A., President, Total Exploration & Produc- tion, Member of NOVATEK’s Board of Directors and its Corporate Govern- ance and Remuneration Committee After two years lecturing at the Ecole Nationale Superieure des Mines de Paris, Yves-Louis Darricarrere began his career in Elf Aquitaine in 1978, first in the Min- ing Division in Australia and later in the Exploration & Production Branch, where he was appointed successively Country Representative for Australia and Egypt at head office; Managing Director of the subsidiaries in Egypt and Colombia; Director Business development and new ventures, then Finance Director of the Exploration & Production Branch and of the Oil and Gas directorate. In 1998, he was appointed Deputy Director-General of Elf Exploration-Production responsible 78 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION for Europe and the United States and was nominated a member of the Man- agement Committee of Elf-Aquitaine. In 2000, he was appointed Senior Vice-President for Exploration & Pro- duction Northern Europe and became a member of the Total Group Management Committee. On 1 September 2003, Yves-Louis Dar- ricarrere was nominated to the Group’s Executive Committee and was appointed President of Total Gas & Power, and on 14 February 2007, he became President of Total Exploration & Production. Yves-Louis Darricarrere is a graduate of the Ecole Nationale Superieure des Mines and the Institut d’Etudes Politiques in Paris and holds a master’s degree in economic science. He is Chevalier de la Legion d’Honneur (Knight of the French Legion of Honour). MR. KIRILL G. SELEZNEV Born in 1974 Member of the Management Board, Di- rector of Gas and Liquid Hydrocarbons Marketing and Processing Department of OAO “Gazprom”, General Director of OOO Gazprom Mezhregiongaz, Mem- ber of NOVATEK’s Board of Directors and its Strategy and Investments Com- mittee Mr. Seleznev graduated from the D.F. Ustinov Baltic State Institute of Tech- nology in 1997 and, in 2002, received a degree in Finance and Credit from the St. Petersburg State University. Upon completion of his university studies, Mr. Seleznev managed OOO "Baltic Finance Company", OAO Investment and Finan- cial Group "Management Investments Development" and OAO "St. Peters- burg Sea Port", all of which are located in St. Petersburg, Russia. In 2000, Mr. Seleznev was appointed as Chief of the Tax Group at ОАО "Baltic Pipeline Sys- tem", St. Petersburg, Russia. Between 2001 and 2002, Mr. Seleznev held the position of Deputy Chief of Staff of the Management Board and Assistant to Chief Executive Officer of OAO Gazprom, in Moscow, Russia. Since 2002, he has been the head of the Gas and Liquid Hydrocarbons Marketing and Process- ing Department of OAO Gazprom and a Member of the OAO Gazprom Man- agement Board. Since 2003, Mr. Se- leznev has been the General Director of OOO Gazprom Mezhregiongaz. Mr. Seleznev is also a member of the Board of Directors and Supervisory Board of several other entities. Since 2006, Mr. Seleznev has been a member of NOVATEK’s Board of Directors. MR. GENNADY N. TIMCHENKO Born in 1952 Member of NOVATEK’s Board of Direc- tors and its Strategy and Investments Committee In 1976, Mr. Timchenko graduated with a Masters of Science from the Mechanical University in Leningrad. He began his ca- reer at the Izjorskii Factory in Leningrad, an industrial plant which made compo- nents for the energy industry. Between 1982 and 1988, he was a Senior Engineer at the Ministry of Foreign Trade. Mr. Tim- chenko has more than 20 years of ex- perience in Russian and International ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 79 energy sectors and he has built interests in trading, logistics and transportation related companies. In 1988, Mr. Timchenko became a vice president of Kirishineftekhimexport, the export and trading arm of the Kirishi refinery in the Leningrad region. In 1991, he worked for Urals Finland which spe- cialized in oil and petrochemical trading. Between 1994 and 2001, Mr. Timchenko was managing Director of IPP OY Fin- land and IPP AB Sweden. In 1997, he co-founded Gunvor, a leading independ- ent oil-trading company. Mr. Timchenko was a member of the Board of Directors of OOO Transoil and OOO BalttransSer- vice. Since 2009, he has been a mem- ber of NOVATEK’s Board of Directors. Mr. Timchenko is also the Chairman of the Board of Directors and President of the Ice Hockey Club SKA St-Petersburg, as well as the Chairman of the Board of Directors of OOO Kontinental Hockey League. MR. VLADIMIR A. BASKOV Born in: 1960 Deputy Chairman of NOVATEK’s Man- agement Committee In 1986, Mr. Baskov graduated from the Moscow Higher Police School of the USSR. In 2000, he completed courses at the Management Academy at the Rus- sian Ministry for Internal Affairs. From 1981 to 2003, he served in various de- partments within the Russian Ministry for Internal Affairs. From 1991 to 2003, Mr. Baskov held managerial positions within the aforementioned Ministry's organiza- tional structures. In 2003 he was ap- pointed Director of the Business Support Department for NOVATEK. In 2005 he was appointed Deputy Chairman of NO- VATEK’s Management Committee and in August 2007 he became a member of NOVATEK’s Management Committee. Candidate of Legal Sciences. He was awarded the Order For Personal Cour- age, the Russian Federation’s Order of the Badge of Honor and other state and departmental awards: Honorary Diplo- mas of the President of the Russian Fed- eration, the Ministry of Internal Affairs, the Governor of the Moscow Region. He also has the awards of the Russian Orthodox Church (Order of Holy Prince Daniel of Moscow and a medal of St. Sergius). MRS. TATYANA S. KUZNETSOVA Born in: 1960 Deputy Chairman of NOVATEK’s Man- agement Committee, Director of NO- VATEK’s Legal Department Ms. Kuznetsova graduated from the Far East State University with a degree in Law. From 1986, she was Senior Legal Advisor for a legal bureau. In 1993, Ms. Kuznetsova became Deputy General Director for Legal Issues and from 1996, Marketing Director for OAO Purneftegas- geologiya. In 1998, she was appointed Deputy General Director of OAO Nord- pipes. Since 2002, she has been Director of the Legal Department for NOVATEK. Since 2005, she has been the Deputy Chairman of NOVATEK’s Management Committee – Director of NOVATEK’s Le- gal Department and in August 2007, she became a member of NOVATEK’s Man- agement Committee. 80 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION MR. IOSIF L. LEVINZON Born in: 1956 MR. MIKHAIL V. POPOV Born in: 1969 First Deputy Chairman of NOVATEK’s Management Committee, Commercial Director Mr. Popov studied at the Gubkin State Academy of Oil and Gas until 1992 and in 1994, graduated from the Kiev Institute of National Economy. In 1992, he held the position of Deputy Chairman of AO Bankomsvyaz’s Managing Committee (Kiev). In 2002, he was appointed Direc- tor of the Capital Construction Depart- ment and Deputy General Director of OAO Novafininvest. From 2003, Mr. Pop- ov served as Director of Crude Oil and Oil Products Department of OAO NOVATEK. In 2004, Mr. Popov was elected First Deputy Chairman of NOVATEK’s Man- agement Committee. Since August 2007, he has been a member of the Manage- ment Committee and since May 2011, he has been NOVATEK’s First Deputy Chair- man-Commercial Director. Deputy Chairman of NOVATEK’s Management Committee Mr. Levinzon graduated from the Tyu- men Industrial Institute specializing in geology and is a Candidate of Geo- logical and Mineralogical Science. He continued postgraduate studies in Perm State Technical University. From 1978 to 1987, he was the Head of the Urengoy oil expedition and from 1987 to 1996 he was the General Director of Purnefte- gasgeologiya. From 1996 to 2005, Mr. Levinzon was the Deputy Governor, 1st Deputy Governor and Vice-Governor of the Yamal-Nenets Autonomous Region. From 2005 to 2006, Mr. Levinzon was an Advisor to the Chairman of the Fed- eration Council of the Federal Assembly of the Russian Federation. From 2006 to 2009, Mr. Levinzon was an Advisor on Corporate and Strategic Development at ZAO OSTER and also at ZAO Investgeo- servis. Since August 2009, Mr. Levinzon held the position of Deputy Chairman of NOVATEK’s Management Committee and in December 2009 he was elected a member of NOVATEK’s Management Committee. Mr. Levinzon is a recipient of the Honored Geologist of Russia, the Or- der of the Badge of Honor and the Order of the Friendship of Peoples awards and has been awarded the Certificate of Merit from the Governor of the Yamal-Nenets Autonomous Region. ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 81 MR. ALEXANDER M. FRIDMAN Born in: 1951 MR. KIRILL N. YANOVSKIY Born in: 1967 Deputy Chairman of NOVATEK’s Man- agement Committee In 1973, Mr. Fridman graduated from the Gubkin Institute of Oil and Gas in Mos- cow, with a degree in Oil and Gas Fields Development and Exploitation. Since 1984, he was employed by various Gaz- prom companies: as Chief Engineer of Nadymgazprom, Head of the Production and Technical Department of the Indus- trial Association, and Chief Engineer of Mostransgaz’s Kaluga Department for Gas Transportation and Underground Storage. From 1992 to 2003, he was First Deputy General Director of a joint venture established by OAO Gazprom and DKG- EAST (Hungary). Since 2003 Mr. Frid- man was the Deputy General Director of Novafininvest. In 2004, Mr. Fridman was elected Deputy Chairman of the Man- agement Committee of OAO NOVATEK. In August 2007, became a member of NOVATEK’s Management Committee. Member of NOVATEK’s Management Committee, Director for Finance and Strategy In 1991, Mr. Yanovskiy graduated from the Gubkin Institute of Oil and Gas in Moscow. From 1992, he headed a de- partment of the Yugorsky Joint-Stock Bank. From 1995, he headed the Securi- ties Department at the Neftek Joint-Stock Commercial Bank. Since 2002, he has been Director of NOVATEK’s Financial Planning, Analysis and Control Depart- ment. In August 2007, Mr. Yanovskiy was elected to NOVATEK’s Management Committee and in 2007 was appointed Deputy Director for Finance and Strategy. Since May 2011 he has been Director for Finance and Strategy . 82 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION MAJOR TRANSACTIONS AND INTERESTED PARTY TRANSACTIONS In 2012, the Company consummated several major interested party trans- actions: Loan Agreement; Subscription Agreement; Paying Agency Agreement; Trustee and Agents Fee Side Letter; and Fee Side Letter (the “Transaction”); Scope of the Transaction: The Loan Agreement between Novatek Finance Limited (the “Lender”) and OAO NOVATEK (the “Borrower”) whereby OAO NOVATEK borrows an amount of funds equal to those received from the placement of relevant Eurobond tranche and the loan participation notes and undertakes to repay the principal amount and accrued interest pursuant to the terms and conditions of the Loan Agreement, as well as pay a specified fee, reimburse expenses in relation to loan provision and make other payments, includ- ing indemnity, and assume other obligations provided for by the Loan Agreement; Subscription Agreement between Novatek Finance Limited (the “Issuer”), OAO NO- VATEK (the “Borrower”) and Barclays Bank plc and Goldman Sachs International, and/or their affiliates, and/or other entities designat- ed in addition to or instead of these entities, and/or other entities specified in the Sub- scription Agreement (collectively referred to as the “Joint Lead Managers”), whereby: tions precedent set forth in the Subscription Agreement, and (b) OAO NOVATEK provides representa- tions and warranties regarding inter alia its business activity, as well as complete- ness and reliability of information about such business activity contained in the Prospectus prepared in accordance with international practices for the Transaction purposes, and assumes unlimited liability to pay indemnity and reimburse specific expenses as expressly provided, and other obligations envisaged by the Subscription Agreement; Paying Agency Agreement between No- vatek Finance Limited (the “Issuer”), OAO NOVATEK (the “Borrower”) and other parties specified therein, whereby paying and other agencies are appointed and the procedure of Eurobonds servicing and redemption is defined, and OAO NOVATEK undertakes to make certain payments and assumes obligations provided for by the Paying Agency Agreement; The Trustee and Agents Fee Side Letter and the Fees Side Letter between Novatek Finance Limited, OAO NOVATEK and other parties to these Letters providing for the payment of fees and other amounts in rela- tion to raising funds in accordance with the Loan Agreement in the amount and man- ner specified in such Letters; (a) Novatek Finance Limited acting as an issuer undertakes to issue and sell Eu- robonds, with proceeds channeled to finance one or more loans, and the Joint Lead Managers acting as initial buyers undertake to subscribe to and pay for Eu- robonds (or procure such subscription and payment) subject always to meeting condi- Deadline for obligations performance under the transaction: until the parties fully dis- charge their obligations. Parties and beneficiaries to the transaction: OAO NOVATEK (the “Borrower”); Novatek Finance Limited (the “Lender”); Barclays Bank plc and Goldman Sachs International; ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 83 The price (money value) of asset being the scope of the Transaction equals to the total amount, which includes the aggregate amount of the principle debt on the loans of 1,000,000,000 (one billion) US dollars, inter- est on the loan / each of the loans raised, calculated based on an annual interest rate of up to 4.4220% per annum, provided that the loan / each loan is granted for up to 10 years, as well as the fees of the trustee, agents and other persons comprising less than 50% of the Company’s assets’ book value as of the last accounting date. The asset value as of the end of the ac- counting period (quarter, year) preceding the transactions date (agreement date) for which financial statements are prepared in accordance with the Russian Federation laws: RR 265,835,437,000. The transaction is considered to be a major transaction. Transaction date (agreement date) – 10.12.2012. The transaction was approved by NO- VATEK’s Board of Directors (Minutes No. 153 of 19.11.2012). In 2012, the Company consummated the following related party transactions the amount of which exceeds 2 per- cent of the Company’s assets’ book value as of the last accounting date: 1. Gas supply contract entered into by and between OAO SIBUR Holding (the “Suppli- er”) and OAO NOVATEK (the “Buyer”). The transaction’s material terms and con- ditions: • Between January 1, 2013 and December 31, 2022, inclusively, the Supplier under- takes to deliver Natural Gas to the Gas Delivery Points specified in the Gas Sup- ply Contract, and the Buyer undertakes to accept and timely pay for the Gas; • Gas supply volume: up to 69,700,000,000 cm. • Deadline for obligations performance under the transaction and information on obligations performance: The gas supply contract is valid with respect to gas deliveries until 31 December 2012 inclusively; and with respect to other ob- ligations until they are fully discharged; • The transaction amount in Russian roubles is calculated for the period from 2013 through 2022, including the effec- tive VAT (18%), and shall not exceed RR 360,000,000,000; Interested parties: NOVATEK’s Board Mem- ber Ruben Karlenovich Vardanian; Chair- man of NOVATEK’S Management Commit- tee and NOVATEK’s Board Member Leonid Viktorovich Mikhelson; NOVATEK’s Board Member Gennady Nikolaevich Timchenko. The transaction was approved by resolution of OAO NOVATEK’s Extraordinary General Meeting of Shareholders (Minutes No. 116 of 17.10.2012). 2. Deed of Indemnity governed by the Eng- lish law (the “Deed”); The transaction’s material terms and con- ditions: • Parties: OAO NOVATEK, GPB-Financial Services LTD, SIB (Cyprus) Limited and/ or their affiliates. • Subject of the transaction: In view of raising by OAO NOVATEK of one or several loans from Novatek Finance Limited funded through the issue 84 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION Interested parties: NOVATEK’s Board Mem- ber Andrei Igorevich Akimov; NOVATEK’s Board Member Ruben Karlenovich Varda- nian; The transaction was approved by NO- VATEK’s Board of Directors (Minutes No. 154 of 06.12.2012). and placement of Novatek Finance Limited loan participation notes (Eu- robonds) in one or several tranches in the international capital markets for the total amount of USD 1,500,000,000 (One billion five hundred million) (or its equivalent in any other currency) with an annual interest rate of up to 9% and for the period of up to 10 years for each of the loans, OAO NOVATEK assumes obligations to reimburse and compensate certain expenses under the Deed as provided therein within the below stated liability cap to GPB-Financial Services LTD, SIB (Cyprus) Limited and/or their affiliates and other parties to which there will be applicable the Deed provisions relating to reimbursement or compen- sation of possible expenses, and OAO NOVATEK assumes other liabilities envisaged by the Deed. • Beneficiaries: GPB-Financial Services LTD, SIB (Cyprus) Limited and/or their affiliates and other parties to which there will be applicable the Deed provisions relating to reimbursement or compensa- tion of possible expenses. • Price of the transaction: The Deed price shall be commensurate with the market level and shall be determined based on the scope of aggregate liabilities of OAO NOVATEK assumed under the Deed, in the amount of RR 5.2 billion which is less than 2% of OAO NOVATEK’s asset book value as of 30 September 2012, the last accounting date before the date of transaction. The Deed terms not defined in this item as the Deed material terms may be amend- ed as agreed by the relevant Parties to the Deed. IFRS CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED 31 DECEMBER 2012 AND 2011 AND INDEPENDENT AUDITOR’S REPORT CONTENTS Page Independent Auditor’s Report ................................................................................................................................... 3 Consolidated Statement of Financial Position ........................................................................................................... 4 Consolidated Statement of Income ............................................................................................................................ 5 Consolidated Statement of Comprehensive Income .................................................................................................. 6 Consolidated Statement of Cash Flows ..................................................................................................................... 7 Consolidated Statement of Changes in Equity ........................................................................................................... 9 Notes to the Consolidated Financial Statements: Note 1. Organization and principal activities ....................................................................................................... 11 Note 2. Basis of presentation ............................................................................................................................... 11 Note 3. Summary of significant accounting policies ........................................................................................... 12 Note 4. Critical accounting estimates and judgments .......................................................................................... 21 Note 5. Acquisitions and disposals ...................................................................................................................... 24 Note 6. Property, plant and equipment ................................................................................................................ 29 Note 7. Investments in joint ventures................................................................................................................... 30 Note 8. Long-term loans and receivables ............................................................................................................. 33 Note 9. Inventories ............................................................................................................................................... 34 Note 10. Trade and other receivables..................................................................................................................... 34 Note 11. Prepayments and other current assets ...................................................................................................... 35 Note 12. Cash and cash equivalents ....................................................................................................................... 36 Note 13. Long-term debt ........................................................................................................................................ 36 Note 14. Pension obligations ................................................................................................................................. 38 Note 15. Short-term debt and current portion of long-term debt ........................................................................... 40 Note 16. Trade payables and accrued liabilities ..................................................................................................... 40 Note 17. Shareholders’ equity................................................................................................................................ 41 Note 18. Share-based compensation program ........................................................................................................ 42 Note 19. Oil and gas sales ...................................................................................................................................... 43 Note 20. Transportation expenses .......................................................................................................................... 43 Note 21. Taxes other than income tax.................................................................................................................... 44 Note 22. General and administrative expenses ...................................................................................................... 44 Note 23. Materials, services and other ................................................................................................................... 45 Note 24. Purchases of natural gas and liquid hydrocarbons .................................................................................. 45 Note 25. Finance income (expense) ....................................................................................................................... 46 Note 26. Income tax ............................................................................................................................................... 47 Note 27. Financial instruments and financial risk factors ...................................................................................... 49 Note 28. Contingencies and commitments ............................................................................................................ 57 Note 29. Principal subsidiaries and joint ventures ................................................................................................. 59 Note 30. Related party transactions ....................................................................................................................... 60 Note 31. Segment information ............................................................................................................................... 62 Note 32. Exploration for and evaluation of mineral resources .............................................................................. 65 Note 33. Subsequent events ................................................................................................................................... 65 Note 34. New accounting pronouncements ........................................................................................................... 66 Unaudited supplemental oil and gas disclosures ...................................................................................................... 69 Contact Information ................................................................................................................................................. 74 OAO NOVATEK Consolidated Statement of Income (in millions of Russian roubles, except for share and per share amounts) Notes Year ended 31 December: 2011 2012 19 20 21 24 6 22 23 25 25 7 26 Revenues Oil and gas sales Other revenues Total revenues Operating expenses Transportation expenses Taxes other than income tax Purchases of natural gas and liquid hydrocarbons Depreciation, depletion and amortization General and administrative expenses Materials, services and other Exploration expenses Net impairment expenses Change in natural gas, liquid hydrocarbons and work-in-progress Total operating expenses Net gain (loss) on disposal of interest in subsidiaries Other operating income (loss) Profit from operations Finance income (expense) Interest expense Interest income Foreign exchange gain (loss) Total finance income (expense) Share of profit (loss) of joint ventures, net of income tax Profit before income tax Income tax expense Current income tax expense Net deferred income tax expense Total income tax expense Profit (loss) Profit (loss) attributable to: Non-controlling interest Shareholders of OAO NOVATEK Basic and diluted earnings per share (in Russian roubles) Weighted average number of shares outstanding (in thousands) 210,246 727 174,811 462 210,973 175,273 (60,848) (16,846) (17,483) (11,185) (10,936) (7,216) (2,022) (325) 1,086 (125,775) (60) 196 (48,329) (16,559) (5,994) (9,277) (8,218) (5,947) (1,819) (782) 105 (96,820) 62,948 207 85,334 141,608 (3,236) 1,731 4,491 2,986 (2,150) 3,392 (3,945) (2,703) (2,105) (3,880) 86,215 135,025 (16,142) (632) (16,774) (12,467) (3,267) (15,734) 69,441 119,291 (17) 69,458 22.89 3,034,245 (364) 119,655 39.45 3,033,302 The accompanying notes are an integral part of these consolidated financial statements. 5 OAO NOVATEK Consolidated Statement of Comprehensive Income (in millions of Russian roubles) Profit (loss) 69,441 119,291 (cid:3) Year ended 31 December: 2011 2012 Other comprehensive income (loss) after income tax: Currency translation differences Other comprehensive income (loss) Total comprehensive income (loss) Total comprehensive income (loss) attributable to: Non-controlling interest Shareholders of OAO NOVATEK (395) (395) 313 313 69,046 119,604 (17) 69,063 (364) 119,968 The accompanying notes are an integral part of these consolidated financial statements. 6 OAO NOVATEK Consolidated Statement of Cash Flows (in millions of Russian roubles) Profit before income tax Adjustments to profit before income tax: Depreciation, depletion and amortization Net impairment expenses Net foreign exchange loss (gain) Net loss (gain) on disposal of assets Interest expense Interest income Share of loss (profit) in joint ventures, net of income tax Net change in other non-current assets and long-term receivables Change in pension obligations Other adjustments Working capital changes Decrease (increase) in trade and other receivables, prepayments and other current assets Decrease (increase) in inventories Increase (decrease) in trade payables and accrued liabilities, excluding interest and dividends payable Increase (decrease) in other taxes payable Total effect of working capital changes Income taxes paid Notes Year ended 31 December: 2011 2012 86,215 135,025 7 11,499 325 (4,491) 101 3,236 (1,731) 2,105 780 709 (195) (8,086) (1,425) 5,014 (624) (5,121) (17,607) 9,475 782 3,945 (62,811) 2,150 (3,392) 3,880 1,132 120 82 (6,103) (132) 567 1,120 (4,548) (13,933) Net cash provided by operating activities 75,825 71,907 Cash flows from investing activities Purchases of property, plant and equipment Prepayments for participation in tender for mineral licenses Purchases of inventories intended for construction Acquisition of subsidiaries net of cash acquired Acquisition of joint ventures Additional capital contributions to joint ventures Proceeds from disposals of subsidiaries net of cash disposed Interest paid and capitalized Loans provided Repayments of loans provided Interest received 6 5, 7 8 5 (37,378) - (1,938) 184 (42,697) (5,213) 302 (2,698) (4,818) 8,102 2,030 (25,335) (6,870) (773) (4,188) (21,176) (3,955) 11,796 (3,508) (6,729) 13,166 929 Net cash (used for) provided by investing activities (84,124) (46,643) Cash flows from financing activities Proceeds from long-term debt Proceeds from short-term debt Repayments of long-term debt Repayments of short-term debt Interest paid Dividends paid Acquisition of non-controlling interest Capital contributions to the Group’s subsidiaries by non-controlling shareholders Sales of treasury shares Purchases of treasury shares 81,149 - (40,412) - (2,320) (19,718) (16,290) 497 - (303) 44,885 3,700 (8,552) (21,321) (818) (15,166) (14,817) - 354 - 17 5 17 17 Net cash (used for) provided by financing activities 2,603 (11,735) 7 OAO NOVATEK Consolidated Statement of Cash Flows (in millions of Russian roubles) Net effect of exchange rate changes on cash, cash equivalents Net increase (decrease) in cash, cash equivalents Cash and cash equivalents at beginning of the period Cash, cash equivalents at end of the period Notes Year ended 31 December: 2011 2012 285 (5,411) 23,831 18,420 64 13,593 10,238 23,831 The accompanying notes are an integral part of these consolidated financial statements. 8 l a t o T y t i u q e - n o N t s e r e t n i g n i l l o r t n o c O A O y t i u q E o t e l b a t u b i r t t a K E T A V O N s r e d l o h e r a h s d e n i a t e R s g n i n r a e y c n e r r u C n o i t a l s n a r t s e c n e r e f f i d t e s s A n o s u l p r u s n o i t a u l a v e r s n o i t i s i u q c a n i - d i a p l a t i p a c l a n o i t i d d A s e r a h s y r u s a e r T e r a h s l a t i p a c y r a n i d r O r e b m u N ) s d n a s u o h t n i ( s e r a h s y r a n i d r o f o 6 8 7 , 7 6 1 7 6 6 , 0 2 9 1 1 , 7 4 1 0 1 8 , 0 1 1 ) 0 2 1 ( 7 1 6 , 5 5 6 8 , 0 3 ) 6 4 4 ( 3 9 3 4 8 1 , 3 3 0 , 3 1 1 0 2 y r a u n a J 1 3 1 3 - 3 1 3 - 1 9 2 , 9 1 1 ) 4 6 3 ( 5 5 6 , 9 1 1 5 5 6 , 9 1 1 4 0 6 , 9 1 1 ) 4 6 3 ( 8 6 9 , 9 1 1 5 5 6 , 9 1 1 2 2 3 ) 6 6 1 , 5 1 ( - - 2 2 3 2 2 3 ) 6 6 1 , 5 1 ( ) 6 6 1 , 5 1 ( 6 8 2 6 8 2 - - 0 2 5 - 0 2 5 - ) 0 7 6 , 1 3 ( ) 0 2 9 , 9 1 ( ) 0 5 7 , 1 1 ( ) 0 5 7 , 1 1 ( - 3 1 3 3 1 3 - - - - - - - (cid:3) - - - - - - - - (cid:3) - - - - - - - (cid:3) - - - - - 5 5 3 5 6 1 - - (cid:3) - - - - - - - - (cid:3) - - - - - s e c n e r e f f i d n o i t a l s n a r t y c n e r r u C ) s s o l ( t i f o r P ) s s o l ( e m o c n i e v i s n e h e r p m o c l a t o T n o s e i r a i d i s b u s n i n o i t p i r c s b u s t s e r e t n i g n i l l o r t n o c - n o n s e r a h s l a n o i t i d d a f o t c a p m I g n i l l o r t n o c - n o n f o n o i t i s i u q c A ) 5 e t o N ( t s e r e t n i ) 7 1 e t o N ( s d n e d i v i D n o i t a c i f i s s a l c e r n o i t p o l l a c y t i u q E 4 5 1 , 1 ) 7 1 e t o N ( s e r a h s y r u s a e r t f o s e l a S 2 8 6 , 1 4 2 9 6 6 3 1 0 , 1 4 2 1 7 8 , 3 0 2 3 9 1 7 1 6 , 5 0 2 2 , 1 3 ) 1 8 2 ( 3 9 3 8 3 3 , 4 3 0 , 3 1 1 0 2 r e b m e c e D 1 3 1 1 0 2 r e b m e c e D 1 3 d e d n e r a e y e h t r o F . s t n e m e t a t s l a i c n a n i f d e t a d i l o s n o c e s e h t f o t r a p l a r g e t n i n a e r a s e t o n g n i y n a p m o c c a e h T ) s e r a h s f o r e b m u n r o f t p e c x e , s e l b u o r n a i s s u R f o s n o i l l i m n i ( y t i u q E n i s e g n a h C f o t n e m e t a t S d e t a d i l o s n o C K E T A V O N O A O 9 l a t o T y t i u q e - n o N t s e r e t n i g n i l l o r t n o c O A O y t i u q E o t e l b a t u b i r t t a K E T A V O N s r e d l o h e r a h s d e n i a t e R s g n i n r a e y c n e r r u C n o i t a l s n a r t s e c n e r e f f i d t e s s A n o s u l p r u s n o i t a u l a v e r s n o i t i s i u q c a n i - d i a p l a t i p a c l a n o i t i d d A s e r a h s y r u s a e r T e r a h s l a t i p a c y r a n i d r O r e b m u N ) s d n a s u o h t n i ( s e r a h s y r a n i d r o f o 2 8 6 , 1 4 2 9 6 6 3 1 0 , 1 4 2 1 7 8 , 3 0 2 3 9 1 7 1 6 , 5 0 2 2 , 1 3 ) 1 8 2 ( 3 9 3 8 3 3 , 4 3 0 , 3 2 1 0 2 y r a u n a J 1 1 4 4 , 9 6 ) 7 1 ( 8 5 4 , 9 6 8 5 4 , 9 6 - ) 5 9 3 ( - ) 5 9 3 ( - ) 5 9 3 ( 6 4 0 , 9 6 ) 7 1 ( 3 6 0 , 9 6 8 5 4 , 9 6 ) 5 9 3 ( 7 9 4 ) 3 0 3 ( 2 0 1 7 9 4 - 2 0 1 - - ) 3 0 3 ( - - - ) 3 2 7 , 9 1 ( - ) 3 2 7 , 9 1 ( ) 3 2 7 , 9 1 ( - - - - - - (cid:3) - - - - - - - (cid:3) - - - - - - - (cid:3) - - - - ) 3 0 3 ( - - (cid:3) - - - - - - - - - - - ) 5 2 9 ( s e c n e r e f f i d n o i t a l s n a r t y c n e r r u C ) s s o l ( t i f o r P n o s e i r a i d i s b u s n i n o i t p i r c s b u s t s e r e t n i g n i l l o r t n o c - n o n s e r a h s l a n o i t i d d a f o t c a p m I s e r a h s y r u s a e r t f o e s a h c r u P ) 7 1 e t o N ( ) 5 e t o N ( s e i r a i d i s b u s f o n o i t i s i u q c A ) 7 1 e t o N ( s d n e d i v i D ) s s o l ( e m o c n i e v i s n e h e r p m o c l a t o T 1 0 3 , 1 9 2 1 5 2 , 1 0 5 0 , 0 9 2 6 0 6 , 3 5 2 ) 2 0 2 ( 7 1 6 , 5 0 2 2 , 1 3 ) 4 8 5 ( 3 9 3 3 1 4 , 3 3 0 , 3 2 1 0 2 r e b m e c e D 1 3 2 1 0 2 r e b m e c e D 1 3 d e d n e r a e y e h t r o F . s t n e m e t a t s l a i c n a n i f d e t a d i l o s n o c e s e h t f o t r a p l a r g e t n i n a e r a s e t o n g n i y n a p m o c c a e h T ) s e r a h s f o r e b m u n r o f t p e c x e , s e l b u o r n a i s s u R f o s n o i l l i m n i ( y t i u q E n i s e g n a h C f o t n e m e t a t S d e t a d i l o s n o C K E T A V O N O A O 0 1 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 1 ORGANIZATION AND PRINCIPAL ACTIVITIES OAO NOVATEK (hereinafter referred to as “NOVATEK”) and its subsidiaries (hereinafter jointly referred to as the “Group”) is an independent oil and gas company engaged in the acquisition, exploration, development, production and processing of hydrocarbons with its core oil and gas operations located and incorporated in the Yamal-Nenets Autonomous Region (“YNAO”) of the Russian Federation. The Group sells its natural gas on the Russian domestic market at unregulated market prices (except for deliveries to residential customers); however, the majority of natural gas sold on the domestic market is sold at prices regulated by the Federal Tariffs Service, a governmental agency. The Group’s stable gas condensate and crude oil sales volumes are sold on both the Russian domestic and international markets, and are subject to fluctuations in benchmark crude oil prices. Additionally, the Group’s natural gas sales fluctuate on a seasonal basis due mostly to Russian weather conditions, with sales peaking in the winter months of December and January and troughing in the summer months of July and August. The Group’s liquids sales volumes comprising stable gas condensate, crude oil and oil and gas products remain relatively stable from period to period. In December 2012, the Group acquired an 82 percent participation interest in OOO Gazprom mezhregiongas Kostroma, a Russian regional natural gas trader, to support and expand natural gas sales opportunities in the Kostroma Region of the Russian Federation (see Note 5). In December 2012, the Group established a wholly owned subsidiary, OOO NOVATEK Moscow region, to support the Group’s current natural gas deliveries as well as to expand potential sales opportunities in the Moscow region of the Russian Federation. In December 2012, the Group disposed of its wholly owned non-core subsidiary, OOO Purovsky Terminal (see Note 5). In November 2012, the Group acquired a 49 percent ownership interest in ZAO Nortgas, an oil and gas producing company, which holds the license for the North-Urengoyskoye field located in the YNAO (see Note 5). During 2012, the Group signed long-term natural gas purchase and sales contracts with third parties to commence commercial trading activities in the European market. The contracts were signed for a period of ten years starting from 1 October 2012 with the expected total volume of natural gas traded over this period of approximately 20 billion cubic meters (see Notes 27, 31). In January and June 2012, the Group merged its wholly owned subsidiaries OOO Yamalenergogas and OOO Gazprom mezhregiongas Chelyabinsk into its wholly owned subsidiaries OOO NOVATEK-Perm and OOO NOVATEK-Chelyabinsk, respectively. The mergers did not affect the Group’s consolidated financial and operational results. 2 BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) under the historical cost convention. In the absence of specific IFRS guidance for oil and gas producing companies, the Group has developed accounting policies in accordance with other generally accepted accounting principles for oil and gas producing companies, mainly US GAAP, insofar as they do not conflict with IFRS principles. The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise judgment in the process of applying the Group’s accounting policies. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 4. Most of the Group entities prepare their statutory financial statements in accordance with the Regulations on Accounting and Reporting of the Russian Federation. The Group’s consolidated financial statements are based on the statutory records with adjustments and reclassifications recorded in the consolidated financial statements for the fair presentation in accordance with IFRS. The principal adjustments primarily relate to (a) depreciation, depletion and amortization, and valuation of property, plant and equipment, (b) consolidation of subsidiaries, (c) business combinations, (d) accounting for income taxes, and (e) valuation of unrecoverable assets, expense recognition and other provisions. 11 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 2 BASIS OF PRESENTATION (CONTINUED) Functional and presentation currency. The consolidated financial statements are presented in Russian roubles, the Group’s reporting (presentation) currency and the functional currency for the majority of Group’s entities. The assets and liabilities (both monetary and non-monetary) of the Group entities whose functional currency is not the Russian rouble are translated into Russian roubles at the closing exchange rate at each balance sheet date. All items included in the shareholders’ equity, other than profit or loss, are translated at historical exchange rates. The financial results of these entities are translated into Russian roubles using average exchange rates for each reporting period. Exchange adjustments arising on the opening net assets and the profits for the reporting period are taken to a separate component of equity until the disposal of the foreign operation and reported as currency translation differences in the consolidated statement of changes in equity and the consolidated statement of comprehensive income. Exchange rates used in preparation of this consolidated financial statements for the entities whose functional currency is not the Russian rouble were as follows: Russian roubles to one currency unit At 31 December 2012 At 31 December 2011 Average rate for the year ended 31 December: 2011 2012 US dollar (“USD”) Polish Zloty (“PLN”) 30.37 9.87 32.20 9.47 31.09 9.56 29.39 9.94 Exchange rates, restrictions and controls. Any re-measurement of Russian rouble amounts to US dollars or any other currency should not be construed as a representation that such Russian rouble amounts have been, could be, or will in the future be converted into other currencies at these exchange rates. Reclassifications. Certain reclassifications have been made to the comparative figures to conform to the current period presentation with no effect on profit for the period or shareholder’s equity. The export sales of liquefied petroleum gas for the year ended 31 December 2012 are presented net of excise and fuel tax. Accordingly, liquefied petroleum gas sales and excise and fuel tax expenses for the year ended 31 December 2011 were decreased by RR 998 million. 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation. Subsidiaries are those companies and other entities (including special purpose entities) in which the Group, directly or indirectly, has an interest of more than one half of the voting rights or otherwise has power to govern the financial and operating policies so as to obtain benefits. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are consolidated from the date on which control is transferred to the Group (acquisition date) and are deconsolidated from the date that control ceases. The acquisition method of accounting is used to account for the acquisition of subsidiaries. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. The Group measures non-controlling interest on a transaction by transaction basis, either at: (a) fair value, or (b) the non-controlling interest’s proportionate share of net assets of the acquiree. Goodwill is measured by deducting the net assets of the acquiree from the aggregate of the consideration transferred for the acquiree, the amount of non-controlling interest in the acquiree and fair value of an interest in the acquiree held immediately before the acquisition date. Any negative amount (“negative goodwill”) is recognized in profit or loss, after management reassesses whether it identified all the assets acquired and all liabilities and contingent liabilities assumed and reviews appropriateness of their measurement. Acquisition-related costs are recognized as expenses rather than included in goodwill. 12 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The consideration transferred for the acquiree is measured at the fair value of the assets given up, equity instruments issued and liabilities incurred or assumed, including fair value of assets or liabilities from contingent consideration arrangements but excludes acquisition related costs such as advisory, legal, valuation and similar professional services. Transaction costs incurred for issuing equity instruments are deducted from equity; transaction costs incurred for issuing debt are deducted from its carrying amount and all other transaction costs associated with the acquisition are expensed. Intercompany transactions, balances and unrealized gains on transactions between group companies are eliminated; unrealized losses are also eliminated unless the cost cannot be recovered. The Group and all of its subsidiaries use uniform accounting policies consistent with the Group’s policies. Non-controlling interest is that part of the net results and of the equity of a subsidiary attributable to interests which are not owned, directly or indirectly, by the Group. Non-controlling interest forms a separate component of the Group’s equity. Changes in the Group’s ownership interest in a subsidiary that do not result in the loss of control are accounted for as equity transactions. Disposals of subsidiaries, associates or joint ventures. When the Group ceases to have control or significant influence, any retained interest in the entity is re-measured to its fair value, with the change in carrying amount recognized in profit or loss. The fair value is the initial carrying amount for the purposes of subsequently accounting for the retained interest as an associate, joint venture or financial asset. In addition, any amounts previously recognized in other comprehensive income in respect of that entity are accounted for as if the Group had directly disposed of the related assets or liabilities. This may mean that amounts previously recognized in other comprehensive income are recycled to profit or loss. If the ownership interest in an associate is reduced but significant influence is retained, only a proportionate share of the amounts previously recognized in other comprehensive income are reclassified to profit or loss where appropriate. Acquisition of non-controlling interests. The difference between the purchase consideration and the carrying amount of non-controlling interests acquired is recognized within equity to account for acquisitions of non- controlling minority stakes. Investments in associates and joint ventures. Associated companies and joint ventures are entities over which the Group has significant influence or joint control, respectively, but which it does not control. Generally, significant influence exists when the Group has between 20 and 50 percent of voting rights. Associated companies and joint ventures are accounted for using the equity method and are initially recognized at cost. The difference between the cost of an acquisition and the share of the fair value of the associate’s identifiable net assets represents goodwill upon acquiring the associated company. Dividends received from associates and joint ventures reduce the carrying value of the investment in associates and joint ventures. The carrying amount of associates and joint ventures includes goodwill identified on acquisition less accumulated impairment losses, if any. Other post-acquisition changes in the Group’s share of net assets of an associate or joint venture are recognized as follows: (a) the Group’s share of profits or losses is recorded in the consolidated profit or loss for the year as share of result of associates or joint ventures; (b) the Group’s share of other comprehensive income is recognized in other comprehensive income and presented separately; and (c) all other changes in the Group’s share of the carrying value of net assets of associates or joint ventures are recognized in profit or loss within the share of result of associates or joint ventures. When the Group’s share of losses in an associate or joint ventures equals or exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognize further losses, unless it has incurred obligations or made payments on behalf of the associate. Unrealized gains on transactions between the Group and its associates and joint ventures are eliminated to the extent of the Group’s interest in the associates and joint ventures; unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of associates and joint ventures have been changed where necessary to ensure consistency with the policies adopted by the Group. 13 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Non-current assets held for sale. Non-current assets classified as held for sale are measured at the lower of carrying amount and fair value less selling costs. Non-current assets are classified as held for sale if their carrying amounts will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and the asset is available for immediate sale in its present condition. Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification. Property, plant and equipment are not depreciated once classified as held for sale. Property, plant and equipment. Property, plant and equipment are carried at historical cost of acquisition or construction and adjusted for accumulated depreciation, depletion, amortization and impairment. The Group follows the successful efforts method of accounting for its oil and gas properties and equipment whereby property acquisitions, successful exploratory wells, all development costs and support equipment and facilities are capitalized. Unsuccessful exploratory wells are charged to expense at the time the wells are determined to be non-productive. Production costs, overheads and all exploration costs other than exploratory drilling and license acquisition costs are charged to expense as incurred. Acquisition costs of unproved properties are evaluated periodically and any impairment assessed is charged to expense. The Group’s principal oil and gas reserves have been independently estimated by internationally recognized petroleum engineers whereas other oil and gas reserves of the Group have been determined based on estimates of mineral reserves prepared by management in accordance with internationally recognized definitions. The present value of the estimated costs of dismantling oil and gas production facilities, including abandonment and site restoration costs, are recognized when the obligation is incurred and are included within the carrying value of property, plant and equipment, subject to depletion using the unit-of-production method. Costs of minor repairs and maintenance are expensed when incurred. Cost of replacing major parts or components that extend the life of property, plant and equipment items are capitalized and depreciated over the estimated remaining life of the major part or component. All components that are replaced are written off. The cost of self-constructed assets includes the cost of direct materials, direct employee related costs, a pro-rata portion of depreciation of assets used for construction and an allocation of the Group’s overhead costs. At each reporting date management assesses whether there is any indication of impairment in respect of property, plant and equipment. If any such indication exists, management estimates the recoverable amount, which is determined as the higher of an asset’s fair value less selling costs and its value in use. The carrying amount is reduced to the recoverable amount and the impairment loss is recognized in the consolidated statement of income. An impairment loss recognized for an asset in prior years is reversed if there has been a change in the estimates used to determine the asset’s recoverable amount. Gains and losses on disposals of property, plant and equipment are determined by comparing proceeds with the carrying amount. Gains and losses are recognized in the consolidated statement of income. Exploration costs. Exploration costs (geological and geophysical expenditures, expenditures associated with the maintenance of non-proven reserves and other expenditures relating to exploration activity), excluding exploratory drilling expenditures and license acquisition costs, are charged to the consolidated statement of income as incurred. License acquisition costs and exploratory drilling costs are recognized as assets until it is determined whether proved reserves justifying their commercial development have been found. If no proved reserves are found, the capitalized drilling costs are charged to the consolidated statement of income. License acquisition costs and exploratory drilling costs recognized as assets are reviewed for impairment on an annual basis. The cost of 3-D seismic surveys used to assist production, increase total recoverability and determine the desirability of drilling additional development wells within proved reservoirs are capitalized as development costs. All other seismic costs are expensed as incurred. 14 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Depreciation. Depreciation, depletion and amortization of oil and gas properties and equipment (except for processing facilities) is calculated using the unit-of-production method for each field based upon proved developed reserves for development costs, and total proved reserves for costs associated with acquisitions of proved properties. A portion of the reserves used for depreciation, depletion and amortization calculations include reserves expected to be produced beyond license expiry dates. Management believes that there is requisite legislation and past results (or experience) to extend mineral licenses at the initiative of the Group and, as such, intends to extend its licenses for properties expected to produce beyond the current license expiry dates. Property, plant and equipment, other than oil and gas properties and equipment, are depreciated on a straight-line basis over their estimated useful lives. Land and assets under construction are not depreciated. The estimated useful lives of the Group’s property, plant and equipment, other than oil and gas properties and equipment, are as follows: Machinery and equipment Processing facilities Buildings Years 5-15 20-30 25-50 Intangible assets. Intangible assets that have a finite useful life are amortized using the straight-line method over the period of their useful life. There were no intangible assets with indefinite useful lives held by the Group at the reporting dates. Effective interest method. The effective interest method is a method of calculating the carrying value of a financial asset or a financial liability held at amortized costs and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts future cash payments and receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying value of the financial asset or financial liability. Financial assets. The Group classifies its financial assets in the following categories: financial assets at fair value through profit or loss, held-to-maturity, loans and receivables, and available-for-sale. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition. Subsequent reclassification of financial assets is made only as a result of a change in intention or ability of management to hold the financial assets. Financial assets are recognized initially at fair value, normally being the transaction price plus, in the case of financial assets not at fair value through profit or loss, directly attributable transaction costs. The subsequent measurement of financial assets depends on their classification. (a) Financial assets at fair value through profit or loss Financial assets at fair value through profit or loss are financial assets held for trading. A financial asset is classified in this category if acquired principally for the purpose of selling in the short-term. Derivative instruments are also categorized as held for trading unless they are designated as hedges. Financial assets carried at fair value through profit or loss are initially recognized at fair value and transaction costs are expensed in the consolidated statement of income. Gains or losses arising from changes in the fair value of the “financial assets at fair value through profit or loss” category are presented in the consolidated statement of income within other operating income (loss) in the period in which they arise. Dividend income from financial assets at fair value through profit or loss is recognized in the consolidated statement of income as part of other operating income (loss) when the Group’s right to receive payments is established. 15 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (b) Held-to-maturity investments Held-to-maturity investments include quoted non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group has both the intention and ability to hold to maturity. After initial measurement, the held-to-maturity investments are measured at amortized cost using the effective interest method. Gains and losses are recognized in the consolidated statement of income when the investments are derecognized or impaired, as well as through the amortization process. Held-to-maturity investments are included in current assets, except for maturities greater than 12 months after the balance sheet date. These are classified as non-current assets. There were no such investments held by the Group at the reporting dates. (c) Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Financial assets classified as loans and receivables are carried at amortized cost using the effective interest method. Gains and losses are recognized in the consolidated statement of income when the loans and receivables are derecognized or impaired, as well as through the amortization process. Loans and receivables are included in current assets, except for maturities greater than 12 months after the balance sheet date which are classified as non-current assets. (d) Available-for-sale financial assets Financial assets classified as available-for-sale are non-derivatives financial assets that are either designated in this category or are not classified in any of the other categories. After initial recognition, financial assets classified as available-for-sale are measured at fair value, with gains and losses recognized in other comprehensive income and accumulated in revaluation reserve in equity until the investment is derecognized or determined to be impaired, at which time the cumulative gain or loss previously recorded in equity is recognized in consolidated statement of income as a reclassification adjustment from other comprehensive income. Changes in the fair value of monetary securities denominated in a foreign currency and classified as available-for- sale financial assets are analyzed between translation differences resulting from changes in amortized cost of the security and other changes in the carrying amount of the security. The translation differences on monetary securities are recognized in consolidated statement of income, while translation differences on non-monetary securities are recognized in other comprehensive income. Changes in the fair value of monetary and non-monetary securities classified as available-for-sale are recognized in other comprehensive income. When securities classified as available-for-sale are sold or impaired, the accumulated fair value adjustments recognized in equity are included in the consolidated statement of income as a reclassification adjustment from other comprehensive income. The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. A prolonged decline in the fair value of the security below its cost is considered as an indicator that the securities are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss (measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognized in consolidated statement of income) is recognized in the consolidated statement of income as a reclassification adjustment from other comprehensive income. Impairment losses recognized in the consolidated statement of income on equity instruments are not reversed. There were no available-for-sale investments held by the Group at the reporting dates. Financial liabilities. Financial liabilities are classified at initial recognition as either financial liabilities at fair value through profit or loss, derivative instruments designated as hedging instruments in an effective hedge or as financial liabilities measured at amortized cost. There were no derivative instruments designated as hedging instruments by the Group at the reporting dates. The measurement of financial liabilities depends on their classification, as follows: 16 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (a) Financial liabilities at fair value through profit or loss Derivative instruments, other than those designated as effective hedging instruments, are classified as held for trading and are included in this category. These financial liabilities are carried on the consolidated statement of financial position at fair value with gains or losses recognized in the consolidated statement of income. (b) Financial liabilities measured at amortized cost All other financial liabilities are included in this category and initially recognized at fair value. For interest-bearing debt, the fair value of the liability is the fair value of the proceeds received net of associated issue costs. After initial recognition, other financial liabilities are subsequently measured at amortized cost using the effective interest method. This category of financial liabilities includes trade and other payables and debt in the consolidated statement of financial position. Derivative instruments. Derivative financial instruments are contracts: (a) whose value changes in response to the change in one or more observable variables; (b) that do not require any material initial net investment; and (c) that are settled at a future date. Accordingly, contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments with the exception of contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the Group’s expected purchase, sale or usage requirements, are accounted for as financial instruments. Gains or losses arising from changes in the fair value of derivatives are recognized in the consolidated income statement within other operating profit (loss). Derivative instruments are carried as assets when the fair value is positive and as liabilities when the fair value is negative. Derivative assets or liabilities expected to be recovered, or with the legal right to be settled more than twelve months after the reporting date are classified as non-current, with the exception of derivative financial instruments held for the purpose of being traded. The amounts of assets and liabilities associated with derivatives are presented without netting assets and liabilities with the same counterparty except where the right of offset and intent to net exist. The estimated fair values of derivative financial instruments are determined with reference to various market information and other valuation methodologies as considered appropriate, however considerable judgment is required in interpreting market data to develop these estimates. Accordingly, the estimates are not necessarily indicative of the amounts that the Group could realize in a current market situation. Derivatives embedded in other non-derivative financial instruments or in non-financial host contracts are recognized as separate derivatives when their risks and economic characteristics are not closely related to those of the host contracts, and the host contracts are not carried at fair value. Where there is an active market for a commodity or other non-financial item subject of a purchase or sale contract, a pricing formula will, for instance, be considered to be closely related to the host purchase or sales contract if the price formula is based on the active market in question. A price formula with indexation to other markets or products will however result in the recognition of a separate derivative. Where there is no active market for the commodity or other non-financial item in question, the Group assesses the characteristics of such a price related embedded derivative to be closely related to the host contract if the price formula is based on relevant indexations commonly used by other market participants. This applies to the Group’s liquid hydrocarbons and domestic natural gas sales and purchases agreements. Contracts are assessed for embedded derivatives when the Group becomes a party to them, including at the date of a business combination. Such embedded derivatives are measured at fair value at each period end, and the changes in fair value are recognized in profit or loss for the period. Income taxes. Effective 1 January 2012, Russian tax legislation introduced an option to prepare and file a single, consolidated income tax declaration. According to the new legislation, the taxpayers’ group should be comprised of a holding company and any number of entities with at least 90 percent ownership in each (direct or indirect). To be eligible for registration, the taxpayers’ group must be registered with tax authorities and meet certain conditions and criteria. The tax declaration can be submitted then by any member of the group. Management has chosen to adopt this option, as discussed in Note 26. 17 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In prior periods, Russian legislation did not contain the concept of a “consolidated tax payer” and, accordingly, the Group’s entities were subject to Russian taxation on an individual company basis. Income taxes have been provided for in the consolidated financial statements in accordance with Russian legislation enacted or substantively enacted as of end of the reporting period. The income tax charge or benefit comprises current tax and deferred tax and is recognized in the consolidated statement of income unless it relates to transactions that are recognized, in the same or a different period, in other comprehensive income or directly in equity. Current tax is the amount expected to be paid to or recovered from the tax authorities in respect of taxable profits or losses for the current and prior periods. Deferred tax assets and liabilities are recognized in full for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. In accordance with the initial recognition exemption, deferred taxes are not recorded for temporary differences on initial recognition of an asset or a liability in a transaction other than a business combination if the transaction, when initially recorded, affects neither accounting nor taxable profit. Deferred tax balances are measured at tax rates enacted or substantively enacted at the balance sheet date which are expected to apply to the period when the temporary differences will reverse or when the tax loss carry forwards will be utilized. Deferred tax assets and liabilities are netted only with respect to individual companies of the Group. Deferred tax assets for deductible temporary differences and tax loss carry forwards are recorded only to the extent that it is probable that future taxable profit will be available against which the deductions can be utilized. Deferred income tax is provided on post acquisition retained earnings of subsidiaries or joint ventures, except where the Group controls the subsidiary’s dividend policy and it is probable that the difference will not reverse through dividends or otherwise in the foreseeable future. Any resultant deferred income tax is measured at the expected tax rate. Inventories. Natural gas, gas condensate, crude oil and related products inventories are valued at the lower of cost or net realizable value. The cost of inventories includes applicable purchase costs of raw materials, direct operating costs, and related production overhead expenses and is recorded on a first-in-first-out (FIFO) basis. Net realizable value is the estimate of the selling price in the ordinary course of business, less selling expenses. Materials and supplies inventories are carried at amounts which do not exceed their respective recoverable amounts in the normal course of business. Trade and other receivables. Trade receivables are represented by amounts due from regular customers in the ordinary course of business (production and marketing of natural gas, gas condensate, crude oil and related products). Trade and other receivables are recognized initially at fair value and subsequently measured at amortized cost using the effective interest method and include value-added taxes. Trade receivables are analyzed for impairment on a debtor by debtor basis. A provision for impairment of receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of receivables. The amount of the provision is the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate. The amount of the provision is recognized in the consolidated statement of income within operating expenses. Subsequent recoveries of amounts previously written off are credited against the amount of the provision in the consolidated statement of income. Cash and cash equivalents. Cash and cash equivalents comprises cash on hand, cash deposits held with banks, investments which are readily convertible to known amounts of cash and which are not subject to significant risk of change in value and have an original maturity of three months or less. For purposes of the presentation of the statement of cash flows bank overdrafts are deducted from cash and cash equivalents. Bank overdrafts are shown within short-term debt in current liabilities on the consolidated statement of financial position. Treasury shares. Where any Group company purchases NOVATEK’s equity share capital (treasury shares), the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to OAO NOVATEK shareholders until the shares are cancelled or reissued. Where such shares are subsequently reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to OAO NOVATEK shareholders. Treasury shares are recorded at weighted average cost. Gains or losses resulting from subsequent sales of shares are recorded in the consolidated statement of changes in equity, net of associated costs including taxation. 18 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Dividends. Dividends are recognized as a liability and deducted from shareholders’ equity at the balance sheet date only if they are declared before or on the balance sheet date. Dividends are disclosed when they are proposed before the balance sheet date or proposed or declared after the balance sheet date but before the consolidated financial statements are authorized for issue. Value added tax (VAT). Output VAT related to sales is payable to the tax authorities on the earlier of (a) collection of the receivables from customers or (b) delivery of the goods or services to customers. Input VAT related to purchases is generally recoverable against output VAT upon receipt of the VAT invoice. The tax authorities permit the settlement of VAT on a net basis. VAT related to sales and purchases which is not settled or recovered at the balance sheet date (VAT payable and VAT recoverable) is recognized on a gross basis and disclosed separately within current assets and current liabilities. Where a provision has been made for the impairment of receivables, the impairment loss is recorded for the gross amount of the debtor, including VAT. Borrowings. Borrowings are recognized initially at fair value, net of transaction costs incurred. Borrowings are subsequently stated at amortized cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognized in the consolidated statement of income over the period of the borrowings using the effective interest method. Interest costs on borrowings and exchange differences arising from foreign currency borrowings (to the extent that they are regarded as an adjustment to interest costs) used to finance the construction of property, plant and equipment are capitalized during the period of time that is required to complete and prepare the asset for its intended use. All other borrowing costs are expensed. Trade and other payables. Trade payables are accrued when the counterparty performed its obligations under the contract. Trade payables are recognized initially at fair value and subsequently measured at amortized cost using the effective interest method. Provisions for liabilities and charges. Provisions are recognized when the Group has a present legal or constructive obligation as a result of past events; when it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate of the amount of the obligation can be made. Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision is recognized even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be low. Provisions are measured at the present value of the expenditures expected to be required to settle the obligation using a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. Provisions are reassessed at each reporting date and changes in the provisions resulting from the passage of time are recognized in the consolidated statement of income as interest expense. Where the Group expects a provision to be reimbursed, the reimbursement is recognized as a separate asset but only when the reimbursement is virtually certain. Asset retirement obligations. An asset retirement obligation is recognized when the Group has a present legal or constructive obligation to dismantle, remove and restore items of property, plant and equipment whose construction is substantially completed. The amount of the obligation is the present value of the estimated expenditures expected to be required to settle the obligation, determined using discount rates reflecting adjustments for risks specific to the obligation. Changes in the obligation resulting from the passage of time are recognized in the consolidated statement of income as interest expense. Changes in the obligation, reassessed at each balance sheet date, related to a change in the expected pattern of settlement of the obligation, or in the estimated amount of the obligation or in the discount rates, are treated as a change in an accounting estimate in the period. Such changes are reflected as adjustments to the carrying value of property, plant and equipment and the corresponding liability. 19 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Group’s exploration, development and production activities involve the use of wells, related equipment and operating sites, oil and gas gathering and treatment facilities and in-field pipelines. Generally, licenses and other regulatory acts require that such assets be decommissioned upon the completion of production, i.e. the Group is obliged to decommission wells, dismantle equipment, restore the sites and perform other related activities. The Group’s estimates of these obligations are based on current regulatory or license requirements, as well as actual dismantling and related costs. The Group’s management believes that due to the limited history of gas condensate processing plants activities, the useful lives of these assets are indeterminable (while certain of the operating components and equipment have definite useful lives). Because of these reasons, and the lack of clear legal requirements as to the recognition of obligations, the fair value of an asset retirement obligation for such processing facilities cannot be reasonably estimated and, therefore, legal or contractual asset retirement obligations related to these assets are not recognized. Due to continuous changes in the Russian regulatory and legal environment, there could be future changes to the requirements and contingencies associated with the retirement of long-lived assets. Foreign currency transactions. Transactions denominated in foreign currencies are converted into the functional currency of each entity of the Group at the exchange rates prevailing on the date of transactions. Exchange gains and losses resulting from foreign currency re-measurement into the functional currencies are included in the determination of profit (loss) for the reporting period. Monetary assets and liabilities denominated in foreign currencies are converted into the functional currency of each entity of the Group by applying the year end exchange rate and the effect is stated in the consolidated statement of income. Non-monetary assets and liabilities denominated in foreign currencies valued at cost are converted into the functional currency of each entity of the Group at the initial exchange rate. Non-monetary assets that are re- measured to fair value, recoverable amount or realizable value, are translated at the exchange rate applicable to the date of re-measurement. Revenue recognition. Revenues represent the fair value of consideration received or receivable for the sale of goods and services in the normal course of business, net of discounts, value-added tax and export duties. Revenues from oil and gas sales are recognized when such products are shipped or delivered to customers in accordance with the contract terms, the price is fixed or determinable, and the title has transferred. Services are recognized in the period in which the services are rendered. Interest income is recognized as the interest accrues as related to the net carrying amount of the financial asset. General and administrative expenses. General and administrative expenses represent overall corporate management and other expenses related to the general management and administration of the business unit as a whole. They include management and administrative compensation, legal and other advisory expenses, insurance of properties, social expenses and compensatory payments of general nature not directly linked to the Group’s oil and gas activities, charity and other expenses necessary for the administration of the Group. Employee benefits. Wages and salaries, bonuses, voluntary medical insurance, paid annual and sick leaves are accrued in the period in which the associated services are rendered by the employees of the Group. Compensation at dismissals, vocational support payments, and other allowances are expensed when incurred. The Group contributes to the Russian Federation State social insurance fund and State pension plan on behalf of its employees based on gross salary payments. Mandatory contributions to the State social insurance fund and the State pension plan, which is a defined contribution plan, are expensed when incurred and are included in payroll expenses in the consolidated statement of income. The Group also incurs employee costs related to the provision of benefits such as health and social infrastructure and services, employees meals, transportation, and other services. These amounts principally represent an implicit cost of employing production workers and, accordingly, are charged to payroll expenses in the consolidated statement of income. 20 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Share based compensation. The Group accounts for share-based compensation in accordance with IFRS 2, Share- based Payment. The fair value of the employee services received in exchange for the grant of the equity instruments is recognized as an expense. The total amount to be expensed over the vesting period is determined by reference to the fair value of the instruments granted measured at the grant date. Pension obligations. The Group operates a non-contributory post-employment defined benefit plan based on employees’ years of service and average salary (see Note 14). The liability recognized in the consolidated statement of financial position in respect of the defined benefit pension plan is the present value of the defined benefit obligations at the balance sheet date, together with adjustments for unrecognized past service costs. The present value of the pension obligations are determined by discounting the estimated future cash outflows and then attributing such present value to years of service of the respective employees. The defined benefit obligations are calculated annually by independent actuaries using the projected unit credit method. The discount rate was determined by reference to Russian rouble denominated bonds issued by the Government of the Russian Federation chosen to match the duration of the post-employment benefit obligations. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are recorded to the consolidated statement of income in the period in which they arise. Past service costs are amortized on a straight-line basis over the vesting period. Earnings per share. Earnings per share are determined by dividing the profit or loss attributable to OAO NOVATEK shareholders by the weighted average number of shares outstanding during the reporting period. Segment reporting. Operating segments are defined as components of the Group where separate financial information is available and reported regularly to the Group’s chief operating decision maker (hereinafter referred to as “CODM”, represented by the Management Committee of NOVATEK). Segments whose revenues, results or assets are ten percent or more of the total segments are reported separately. 4 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS Consolidated financial statements prepared in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Management reviews these estimates and assumptions on a continuous basis, by reference to past experiences and other factors considered as reasonable which form the basis for assessing the book values of assets and liabilities. Adjustments to accounting estimates are recognized in the period in which the estimate is revised if the change affects only that period or in the period of the revision and subsequent periods, if both periods are affected. Management also makes certain judgments, apart from those involving estimations, in the process of applying the Group’s accounting policies. Actual results may differ from such estimates if different assumptions or circumstances apply. Judgments and estimates that have the most significant effect on the amounts reported in these consolidated financial statements and have a risk of causing a material adjustment to the carrying amount of assets and liabilities within the next financial year are described below. Useful lives of property, plant and equipment. Management assesses the useful life of an asset by considering the expected usage, estimated technical obsolescence, residual value, physical wear and tear and the operating environment in which the asset is located. Differences between such estimates and actual results may have a material impact on the amount of the carrying values of the property, plant and equipment and may result in adjustments to future depreciation rates and expenses for the period. 21 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 4 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS (CONTINUED) Fair values of financial assets and liabilities. The fair value of financial assets and liabilities, other than financial instruments that are traded in an active market, is determined by applying various valuation methodologies. Management uses its judgment to make assumptions based on market conditions existing at each balance sheet date. Discounted cash flow analysis is used for various loans and receivables as well as debt instruments that are not traded in active markets. The effective interest rate is determined by reference to the interest rates of instruments available to the Group in active markets. In the absence of such instruments, the effective interest rate is determined by reference to the interest rates of active market instruments available adjusted for the Group’s specific risk premium estimated by management. For derivative contracts where observable information is not available, fair value estimations are determined using mark-to-market models and other acceptable valuation methods, for which the key inputs include future prices, volatility, price correlation, counterparty credit risk and market liquidity. Fair values of the Group’s derivative commodity contracts and sensitivities to price assumptions are presented in Note 27. Deferred income tax asset recognition. Management assesses deferred income tax assets at each balance sheet date and determines the amount recorded to the extent that realization of the related tax benefit is probable. In determining future taxable profits and the amount of tax benefits that are probable in the future management makes judgments and applies estimations based on prior years taxable profits and expectations of future income that are believed to be reasonable under the circumstances. Estimation of oil and gas reserves. Engineering estimates of oil and gas reserves are inherently uncertain and are subject to future revisions. The Group estimates its oil and gas reserves in accordance with rules promulgated by the Securities and Exchange Commission (SEC) for proved reserves. Accounting measures such as depreciation, depletion and amortization charges, impairment assessments and asset retirement obligations that are based on the estimates of proved reserves are subject to change based on future changes to estimates of oil and gas reserves. Proved reserves are estimated by reference to available reservoir and well information, including production and pressure trends for producing reservoirs. Furthermore, estimates of proved reserves only include volumes for which access to market is assured with reasonable certainty. All proved reserves estimates are subject to revision, either upward or downward, based on new information, such as from development drilling and production activities or from changes in economic factors, including product prices, contract terms or development plans. Proved reserves are defined as the estimated quantities of oil and gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic conditions. In some cases, substantial new investment in additional wells and related support facilities and equipment will be required to recover such proved reserves. Due to the inherent uncertainties and the limited nature of reservoir data, estimates of underground reserves are subject to change over time as additional information becomes available. In general, estimates of reserves for undeveloped or partially developed fields are subject to greater uncertainty over their future life than estimates of reserves for fields that are substantially developed and depleted. As those fields are further developed, new information may lead to further revisions in reserve estimates. Oil and gas reserves have a direct impact on certain amounts reported in the consolidated financial statements, most notably depreciation, depletion and amortization as well as impairment expenses. Depreciation rates on oil and gas assets using the units-of-production method for each field are based on proved developed reserves for development costs, and total proved reserves for costs associated with the acquisition of proved properties. Assuming all variables are held constant, an increase in proved developed reserves for each field decreases depreciation, depletion and amortization expenses. Conversely, a decrease in the estimated proved developed reserves increases depreciation, depletion and amortization expenses. Moreover, estimated proved reserves are used to calculate future cash flows from oil and gas properties, which serve as an indicator in determining whether or not property impairment is present. Although the possibility exists for changes or revisions in estimated reserves to have a critical effect on depreciation, depletion and amortization charges and, therefore, reported net profit for the year, it is expected that in the normal course of business the diversity of the Group’s asset portfolio will mitigate the likelihood of this occurring. 22 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 4 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS (CONTINUED) Impairment of non-financial assets. Management assesses whether there are any indicators of possible impairment of all non-financial assets at each reporting date based on events or circumstances that indicate the carrying value of assets may not be recoverable. Such indicators include changes in the Group’s business plans, changes in commodity prices leading to unprofitable performances, changes in product mixes, and for oil and gas properties, significant downward revisions of estimated proved reserves. Other non-financial assets are tested for impairment when there are indicators that the carrying amounts may not be recoverable. When value in use calculations are undertaken, management estimates the expected future cash flows from the asset or cash generating unit and chooses a suitable discount rate in order to calculate the present value of those cash flows. Information about the carrying amounts of major classes of non-financial assets – property, plant and equipment and long-term investments is presented in Notes 6 and 7. Impairment provision for trade receivables. The impairment provision for trade receivables is based on management’s assessment of the probability of collection of individual customer accounts receivable. Significant financial difficulties of the customer, probability that the customer will enter bankruptcy or financial reorganization, and default or delinquency in payments are considered indicators that the receivable is potentially impaired. Actual results could differ from these estimates if there is deterioration in a major customer’s creditworthiness or actual defaults are higher than the estimates. When there is no expectation of recovering additional cash for an amount receivable, it is written off against the associated provision. Future cash flows of trade receivables that are evaluated for impairment are estimated on the basis of the contractual cash flows of the assets and the experience of management in respect of the extent to which amounts will become overdue as a result of past loss events and the success of recovery of overdue amounts. Past experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect past periods and to remove the effects of past conditions that do not exist currently. Pension obligations. The cost of defined benefit pension plans and related current service costs are determined using actuarial valuations. The actuarial valuations involve making demographic assumptions (mortality rates, age of retirement, employee turnover and disability) as well as financial assumptions (discount rates, expected rates of return on assets, inflation forecasts, future salary and pension increases). Due to the long term nature of these plans, such estimates are subject to significant uncertainty. Asset retirement obligations. Management makes provision for the future costs of decommissioning oil and gas production facilities, pipelines and related support equipment based on the best estimates of future cost and economic lives of those assets. Estimating future asset retirement obligations is complex and requires management to make estimates and judgments with respect to removal obligations that will occur many years in the future. Changes in the measurement of existing obligations can result from changes in estimated timing, future costs or discount rates used in valuation. The Group also assesses its liabilities for site restoration at each consolidated statement of financial position date in accordance with the guidelines of IFRIC 1, Changes in Existing Decommissioning, Restoration and Similar Liabilities. The amount recognized as a provision is the best estimate of the expenditures required to settle the present obligation at the consolidated statement of financial position date based on current legislation where the Group’s respective operating assets are located, and is also subject to change because of modifications, revisions and changes in laws and regulations and their interpretation thereof. As a result of the subjectivity of these provisions there is uncertainty regarding both the amount and estimated timing of incurring such costs. Fair value assessment of OAO Yamal LNG. As further discussed in Note 5, the Group ceased control of Yamal LNG effective 6 October 2011, but retained joint control and, consequently, was required to fair value the remaining interest in Yamal LNG in accordance with IFRS. The fair value of the investment in Yamal LNG was calculated based on a discounted cash flow model for the Yamal LNG project. The discounted cash flow model included a number of key assumptions, the sensitivities of which are included in Note 5. 23 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 5 ACQUISITIONS AND DISPOSALS Acquisition of OOO Gazprom mezhregiongas Kostroma On 28 December 2012, the Group acquired an 82 percent participation interest in OOO Gazprom mezhregiongas Kostroma, a Russian regional natural gas trader, to support and expand natural gas sales opportunities in the Kostroma region in the Russian Federation, for total cash consideration of RR 554 million, which was subsequently paid in 2013. At the date of acquisition, the company held three percent of its participation interest in the form of treasury shares, which were eliminated upon consolidation and, accordingly, the Group’s effective participation interest in Gazprom mezhregiongas Kostroma was 84.54 percent. Management has assessed the fair value of identifiable assets and liabilities and calculated that no goodwill arose on the acquisition. The following table represents the net fair values comprising 100 percent of the assets and liabilities of Gazprom mezhregiongas Kostroma: OOO Gazprom mezhregiongas Kostroma Non-current assets Trade receivables Other current assets Cash and cash equivalents Non-current liabilities Trade payables Other current liabilities Total identifiable net assets Purchase consideration Fair value of the Group’s interest in net assets (RR 655 million at 84.54% ownership) Goodwill Fair values at the acquisition date 735 895 12 296 (129) (1,096) (58) 655 554 (554) - The financial and operational activities of Gazprom mezhregiongas Kostroma would have had an effect of an additional RR 6.7 billion in the Group’s revenues and immaterial effect on the Group’s profit before tax, if the acquisition occurred on 1 January 2012. Disposal of OOO Purovsky Terminal In December 2012, the Group disposed of its 100 percent participation interest in OOO Purovsky Terminal, its non- core subsidiary, to a third party for RR 97 million, which was fully paid in December 2012. The Group recognized a loss on the sale before income tax of RR 60 million. Prior to the disposal, the Group included balances and results of the operations of the disposed subsidiary within “exploration, production and marketing” in the Group’s segment information. 24 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 5 ACQUISITIONS AND DISPOSALS (CONTINUED) Acquisition of ZAO Nortgas On 27 November 2012, the Group acquired 49 percent of the outstanding ordinary shares of ZAO Nortgas, an oil and gas company located in the YNAO, for total cash consideration of RR 42,697 million (USD 1,375 million), which was fully paid in November 2012. Nortgas holds a production license for the North-Urengoyskoye field, which expires in 2018. Estimated proved reserves of the field appraised by DeGolyer and MacNaughton under the PRMS and SEC reserve methodologies at 31 December 2012 totalled approximately 186 billion and 157 billion cubic meters of natural gas and 25 million and 21 million tons of hydrocarbon liquids, respectively. As described above, the Group acquired 49 percent of the ownership interest in Nortgas; however, the Charter stipulates that key financial and operating decisions regarding its business activities are subject to unanimous approval by the Board of Directors. Consequently, the voting mechanism effectively establishes joint control over Nortgas and the Group accounts for the investment under the equity method. At 31 December 2012, in accordance with IAS 31, Interest in Joint Ventures, the Group assessed preliminary fair values of the identified assets and liabilities of Nortgas. In the consolidated financial statements for the year ended 31 December 2012, the fair value of purchase consideration and the fair value of the identifiable acquired assets and liabilities are preliminary as the Group is in the process of finalizing the fair value estimates for certain assets and liabilities, primarily for property, plant and equipment. Management is required to finalize the fair value determination within 12 months of the date of acquisition. Any revisions to the provisional values will be reflected as of the acquisition date. The following table represents the preliminary fair values comprising 100 percent of the assets and liabilities of Nortgas: ZAO Nortgas Property, plant and equipment Other non-current assets Trade receivables Other current assets Cash and cash equivalents Long-term debt Other non-current liabilities Short-term debt Dividends payable Other current liabilities Total identifiable net assets Purchase consideration Preliminary fair value of the Group’s interest in net assets (RR 87,137 million at 49% ownership) Preliminary goodwill Preliminary fair values at the acquisition date 130,135 1,623 2,312 2,246 966 (14,378) (22,055) (1,341) (9,700) (2,671) 87,137 42,697 (42,697) - Subsequent to the acquisition, the Group signed a purchase contract to buy 50 percent of total natural gas produced by Nortgas starting from 1 January 2013 at a predetermined price reflecting current ex-field market price for the region subject to indexation based on the relevant Federal Tariffs Service (FTS) prices. In addition, the Group signed the contract until 31 December 2015 to purchase 100 percent of the unstable gas condensate produced by Nortgas at ex-field prices based on benchmark crude oil and oil products market quotes adjusted for quality and respective tariffs for transportation and processing. 25 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 5 ACQUISITIONS AND DISPOSALS (CONTINUED) Acquisition of OOO Gazprom mezhregiongas Chelyabinsk In November 2011, the Group acquired a 100 percent participation interest in OOO Gazprom mezhregiongas Chelyabinsk to expand and market natural gas sales in the Chelyabinsk Region of the Russian Federation for cash consideration of RR 1,550 million, which was fully paid in December 2011. Gazprom mezhregiongas Chelyabinsk is responsible for the sale of natural gas to industrial and residential customers in the Chelyabinsk region, one of the top ten Russian regions in terms of natural gas consumption. Management has assessed the fair value of identifiable assets and liabilities and calculated that no goodwill arose on the acquisition. The following table represents the net fair values of the assets and liabilities of Gazprom mezhregiongas Chelyabinsk: OOO Gazprom mezhregiongas Chelyabinsk Property, plant and equipment Other non-current assets Trade receivables Other current assets Cash and cash equivalents Non-current liabilities Trade payables Other current liabilities Total identifiable net assets Purchase consideration Goodwill Fair values at the acquisition date 321 1,230 2,112 205 654 (232) (2,364) (376) 1,550 1,550 - Acquisition of additional equity stake in OAO Yamal LNG On 26 May 2009, the Group entered into the contract to acquire 51 percent of the outstanding ordinary shares of OAO Yamal LNG, an exploration stage oil and gas company located in the north-eastern part of the Yamal peninsula, YNAO. In September 2011, the Group exercised two call options, acquired in 2009 and 2011, and, as a result, increased its equity stake in Yamal LNG to 100 percent through a purchase of additional 49 percent shares of the company for the total consideration of RR 31,670 million (USD 986 million), of which RR 15,101 million (USD 482 million) was paid in 2009-2011 and RR 16,290 million (USD 504 million) was paid in 2012. As a result of these transactions, the Group reduced non-controlling interest by RR 19,920 million and recorded a difference of RR 11,750 million directly to retained earnings. Disposal of ownership interest in OAO Yamal LNG On 5 October 2011, the Board of Directors of OAO NOVATEK approved the sale of a 20 percent stake in Yamal LNG, the Group’s wholly owned subsidiary, to TOTAL S.A., the strategic partner in the Yamal LNG project (the “Project”). Prior to that date, the proposed sale received the necessary approvals from the Russian Federation’s Strategic Investment Committee and Federal Anti-Monopoly Service. On 6 October 2011, the Group entered into a Sales contract and signed a new shareholder’s agreement (the “Shareholders’ agreement”) with TOTAL E&P YAMAL SAS, an affiliate of TOTAL S.A., establishing the framework for joint cooperation in exploring and developing the South-Tambeyskoye field (held by Yamal LNG) located in the YNAO. 26 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 5 ACQUISITIONS AND DISPOSALS (CONTINUED) Total consideration for the 20 percent stake in Yamal LNG to be paid by TOTAL E&P YAMAL comprises of three tranches: i. ii. iii. first tranche – a cash payment of USD 425 million to NOVATEK upon the contract conclusion (payment received in October 2011); second tranche – a cash payment of USD 375 million through additional capital contributions to the ordinary share capital of Yamal LNG, of which USD 170 million was received in 2011 and the remainder USD 205 was received in 2012; and third tranche – an additional cash payment ranging from USD nil to USD 500 million depending on the amount of the Project’s capital expenditure through additional capital contribution to the ordinary share capital of Yamal LNG; the final amount of the additional payment will be determined based on the result of the Final Investment Decision. Management has assessed that it is most likely that the full USD 500 million will need to be paid. If the actual amount is less than the amount assessed then the associated consideration and gain recognized for the disposal of the 20 percent stake would need to be adjusted. In addition, TOTAL E&P YAMAL agreed to compensate past costs of USD 11 million, incurred by NOVATEK in respect of the Project prior to finalization of contractual terms and conditions, through an additional capital contribution to the ordinary share capital of Yamal LNG, which was paid in December 2011. The Shareholders’ agreement further stipulates that additional financing for the Project, if needed, will be partly exercised in a form of disproportional loans from shareholders. Management is unable to quantify at this time the likelihood, amount, timing or interest rate for these loans and, based on this assessment, has determined that their fair value cannot be measured reliably at this moment. The Shareholders’ agreement also permits the Group to subsequently reduce its shareholding in Yamal LNG to 51 percent based on certain pre-specified terms and governance structure. Presently, the Group has retained an 80 percent interest in Yamal LNG after the transaction; however, the Shareholders’ agreement stipulates that key strategic, operational and financial decisions are subject to approval by eight out of nine members of the Board of Directors. As a result of these changes, the Group’s effective control over Yamal LNG ceased on 6 October 2011. The Group has determined Yamal LNG to be a joint venture and will account for this investment under the equity method. Based on the Shareholders’ agreement and the provisions of the Sales contract, the Group recorded the disposal of a 20 percent interest in Yamal LNG for total consideration of RR 36,893 million realizing a gain of RR 62,831 million, net of associated income tax of RR 117 million. The following table summarizes the consideration details and shows the components of the gain from the sale of the ownership interest in Yamal LNG: First tranche (USD 425 million at exchange rate of 32.64 to USD 1.00) Compensation of past costs (80 percent of USD 11 million at exchange rate of 32.64 to USD 1.00) Second tranche (80 percent of USD 375 million at exchange rate of 32.64 to USD 1.00) Third tranche (80 percent of USD 500 million at exchange rate of 32.64 to USD 1.00 discounted at 0.884 percent per annum) Total consideration Less: carrying amount of the Group’s 20 interest in the net assets Add: fair value adjustment relating to the retained investment in joint venture Gain on the sale of ownership interest RR million 13,871 294 9,790 12,938 36,893 (8,208) 34,263 62,948 27 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 5 ACQUISITIONS AND DISPOSALS (CONTINUED) In accordance with IAS 27, Consolidated and Separate Financial Statements, the Group re-measured its retained investment in Yamal LNG at fair value at the date of ceasing control, with the change in value of RR 34,263 million recognized as an additional gain from disposal as reflected in net gain on disposal of interest in subsidiaries in the consolidated statement of income. The fair value of the investment in Yamal LNG was based on a discounted cash flow model for the Yamal LNG project. The significant assumptions in the discounted cash flow model are: forecasted prices for liquefied natural gas (“LNG”); anticipated production volumes; future capital expenditures required to build necessary infrastructure and drill production wells; and the discount factor used in the fair value calculation. The key sensitivities in relation to the discounted cash flows are: • • • • future LNG prices were based on estimated Brent prices using growth rates as forecasted by the World Bank. If these estimated future prices were to decrease by one percent for each year in the cash flow projection then, assuming that other parameters remain unchanged, the fair value of the retained interest in Yamal LNG and the associated gain on the revaluation would be reduced by RR 6,903 million; future production was based on estimates of proved and probable reserves. If production volumes were to be one percent lower in the cash flow projection then, assuming that other parameters remain unchanged, the fair value of the retained interest in Yamal LNG and the associated gain on the revaluation would be reduced by RR 4,903 million; future capital expenditure over the life of the project has been estimated based on preliminary engineering and costing estimates. If the level of capital expenditure were to be one percent higher in the cash flow projection then, assuming that other parameters remain unchanged, the fair value of the retained interest in Yamal LNG and the associated gain on the revaluation would be reduced by RR 3,904 million; and the discount rate was assumed to be 11.9% (in US dollar terms). If the discount rate was increased by half of one percent (to 12.4%) then, assuming that other parameters remain unchanged, the fair value adjustment and the associated gain on the revaluation would be reduced by RR 21,139 million. Below is a breakdown of major classes of assets and liabilities at the date of disposal: OAO Yamal LNG Property, plant and equipment Other non-current assets Cash and cash equivalents Other current assets Other non-current liabilities Short-term debt Other current liabilities Total identifiable net assets at disposal RR million 45,867 1,404 1,846 1,135 (810) (8,100) (300) 41,042 The aforementioned property, plant and equipment in the amount of RR 45,867 million (including the costs of mineral rights aggregating RR 39,714 million) was included in the line “Disposal of subsidiaries, net” as disclosed in Note 6. Short-term debt in the amount of RR 8,100 million, which was owed to the Group was settled in December 2011 ahead of its maturity schedule. The following table reconciles the carrying value of Yamal LNG prior to disposal and the carrying value of the retained investment in the entity recorded under the equity method of accounting in these consolidated financial statements: OAO Yamal LNG Carrying value of the net assets at disposal Add: Group’s proportion of proceeds from additional shares emissions Less: carrying amount of the Group’s 20 interest in the net assets Add: fair value adjustment relating to the retained investment in joint venture The carrying value of equity investment RR million 41,042 23,022 (8,208) 34,263 90,119 28 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 5 ACQUISITIONS AND DISPOSALS (CONTINUED) Prior to the disposal, the Group included balances and results of the operations of the disposed subsidiary within “exploration, production and marketing” in the Group’s segment information. 6 PROPERTY, PLANT AND EQUIPMENT Movements in property, plant and equipment, for the years ended 31 December 2012 and 2011 are as follows: Cost Accumulated depreciation, depletion and amortization Oil and gas properties and equipment Assets under construction and advances for construction 193,411 16,022 Other 4,236 Total 213,669 (26,926) - (1,170) (28,096) Net book value at 1 January 2011 166,485 16,022 Acquisition of subsidiaries Additions Transfers Depreciation, depletion and amortization Disposal of subsidiaries, net Impairment Disposals, net Cost Accumulated depreciation, depletion and amortization 108 10,140 15,455 (9,026) (40,136) (513) (549) 183 27,869 (20,216) - (5,665) (107) (439) 3,066 30 22 4,761 (424) (66) - (216) 185,573 321 38,031 - (9,450) (45,867) (620) (1,204) 177,788 17,647 8,603 204,038 (35,824) - (1,430) (37,254) Net book value at 31 December 2011 141,964 17,647 7,173 166,784 Acquisition of subsidiaries Additions Transfers Depreciation, depletion and amortization Disposal of subsidiaries, net Disposals, net Reclassifications Cost Accumulated depreciation, depletion and amortization 24 1,564 21,608 (10,882) (14) (69) 1,415 33 41,522 (22,414) - - (1,493) - 23 468 806 (503) (32) (49) (1,415) 80 43,554 - (11,385) (46) (1,611) - 202,420 35,295 8,031 245,746 (46,810) - (1,560) (48,370) Net book value at 31 December 2012 155,610 35,295 6,471 197,376 Included within the oil and gas properties and equipment balance at 31 December 2012 and 2011 are proved properties of RR 28,205 million and RR 22,355 million, net of accumulated depreciation, depletion and amortization of RR 11,744 million and RR 10,300 million, respectively. Included within the oil and gas properties and equipment balance at 31 December 2012 and 2011 are unproved properties of RR 7,753 million and RR 14,061 million, respectively. The Group’s management believes these costs are recoverable and has plans to explore and develop the respective unproved properties. Included within assets under construction and advances for construction are advances to suppliers of equipment of RR 3,836 million and RR 3,781 million at 31 December 2012 and 2011, respectively. 29 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 6 PROPERTY, PLANT AND EQUIPMENT (CONTINUED) Included in additions to property, plant and equipment for the years ending 31 December 2012 and 2011 are capitalized interest and foreign exchange differences of RR 2,839 million and RR 4,145 million, respectively. The interest capitalization rates for 2012 and 2011 used for additions were 6.8 percent and 7.1 percent, respectively. In September 2011, the Group purchased, through participation in a tender process, exploration and production licenses for the Salmanovskoye (Utrenneye) and Geofizicheskoye fields and geological studies, exploration and production licenses for the North-Obskiy and East-Tambeyskiy license areas for a total payment of RR 6,870 million, which were included in additions to oil and gas properties. In October 2011, the Group ceased control of OAO Yamal LNG as described in Note 5 and has recorded a disposal aggregating RR 45,867 million as “Disposal of subsidiaries, net” in property, plant and equipment. The Group retained 80 percent of Yamal LNG and has recorded its proportional share in investments in joint ventures (see Note 7). Reconciliation of depreciation, depletion and amortization (DDA): Depreciation, depletion and amortization of property, plant and equipment Add: DDA of intangible assets Less: DDA included in general and administrative expenses (see Note 22) Less: DDA capitalized in the course of intra-group construction services DDA as presented in the consolidated statement of income Year ended 31 December: 2012 2011 11,385 244 (314) (130) 11,185 9,450 111 (198) (86) 9,277 At 31 December 2012 and 2011, no property, plant and equipment was pledged as security for the Group’s borrowings. Impairment of RR nil million and RR 620 million was recognized in respect of oil and gas properties and equipment for the years ended 31 December 2012 and 2011, respectively. Capital commitments are disclosed in Note 28. (cid:3) (cid:3) 7 INVESTMENTS IN JOINT VENTURES Joint ventures: OAO Yamal LNG ZAO Nortgas OOO Yamal Development (consolidated) OAO Sibneftegas ZAO Terneftegas At 31 December 2012 At 31 December 2011 96,736 42,586 24,430 24,160 1,224 89,549 - 8,100 24,187 1,193 Total investments in joint ventures 189,136 123,029 OAO Yamal LNG. As discussed in Note 5, on 6 October 2011, the Group sold a 20 percent stake in OAO Yamal LNG and signed a new Shareholder’s agreement with TOTAL E&P YAMAL, establishing the framework for joint cooperation in exploring and developing the South-Tambeyskoye field (held by Yamal LNG) located in the YNAO. The Group retained an 80 percent interest in Yamal LNG after the transaction; however, the Shareholders’ agreement stipulates that key strategic, operational and financial decisions are subject to approval by eight out of nine members of the Board of Directors. As a result of these changes, the Group’s effective control over Yamal LNG ceased on 6 October 2011, following which the Group has determined Yamal LNG to be a joint venture and accounts for it under the equity method. 30 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 7 INVESTMENTS IN JOINT VENTURES (CONTINUED) ZAO Nortgas. As discussed in Note 5, on 27 November 2012, the Group acquired 49 percent of the outstanding ordinary shares of ZAO Nortgas, an oil and gas company holding the production license for the North- Urengoyskoye field located in the YNAO for RR 42,697 million. The Charter of Nortgas stipulates that key financial and operating decisions regarding its business activities are subject to unanimous approval by the Board of Directors. Consequently, the voting mechanism effectively establishes joint control over Nortgas. The Group accounts for it under the equity method. OOO Yamal Development. The Group holds a 50 percent participation interest in OOO Yamal Development, its joint venture with OAO Gazprom Neft, a subsidiary of OAO Gazprom, and accounts for its share of the joint venture using the equity method. Yamal Development holds a 51 percent participation interest in OOO SeverEnergia, which through its wholly owned subsidiary OAO Arkticheskaya gazovaya kompaniya holds a number of exploration and production licenses, located in YNAO (see Note 28). The Charter of SeverEnergia stipulates that key financial and operational decisions regarding its business activities are subject to approval by six out of the seven members of the Board of Directors, i.e. none of the participants have a preferential voting right. As a result, the Group has determined SeverEnergia as a joint venture of Yamal Development; the assets and liabilities of SeverEnergia and its financial results are included in the assets, liabilities and financial results of Yamal Development under the equity method in the disclosure of summarized financial information about the Group’s investments in joint ventures. OAO Sibneftegas. The Group holds 51 percent ownership in OAO Sibneftegas, an oil and gas company, which holds a number of exploration and production licenses, located in the YNAO (see Note 28). The Charter of Sibneftegas stipulates that key financial and operational decisions regarding its business activities are subject to approval by nine out of the eleven members of the Board of Directors, that means effectively the unanimous approval by both shareholders. Consequently the voting mechanism effectively establishes joint control over Sibneftegas. The Group accounts for it under the equity method. ZAO Terneftegas. The Group holds 51 percent ownership in ZAO Terneftegas, its joint venture with TOTAL E&P ACTIVITIES PETROLIERES, established for joint cooperation in exploring and developing the Termokarstovoye gas condensate field (held by Terneftegas) located in the YNAO. The Shareholders’ agreement stipulates that key financial and operational decisions shall be subject to unanimous approval by both shareholders and none of the participants have a preferential voting right. Consequently, the Group’s interest in Terneftegas is accounted for using the equity method. The table below summarizes the movement in the carrying amounts of the Group’s joint ventures: At 1 January Share of profit (loss) of joint ventures before income tax Share of income tax (expense) benefit Share of profit (loss) of joint ventures, net of income tax Acquisitions of joint ventures (see Note 5) Contributions to equity Disposals of subsidiaries resulting in recognition of joint ventures Losses (reversals) recognized in excess of investments in joint ventures, reclassified to long-term loans receivable for these companies Year ended 31 December 2012 2011 123,029 (2,221) 116 (2,105) 42,697 25,515 - - 27,026 (4,725) 845 (3,880) - 10,000 90,121 (238) At 31 December 189,136 123,029 31 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 7 INVESTMENTS IN JOINT VENTURES (CONTINUED) In 2012, the equity of Yamal LNG was increased through disproportional contribution by its participants totalling RR 23,811 million in accordance with the Shareholders’ agreement, of which RR 9,167 million was attributable to NOVATEK (see Note 8). As a result of disproportional contributions, the Group’s shareholding did not change notably. In February 2012, the charter capital of Yamal Development was increased by converting RR 32,697 million of loans provided to the company by its participants, of which RR 16,348 million was attributable to NOVATEK (see Note 8). In June 2011, the charter capital of Yamal Development was increased by RR 20 billion through the conversion of loans, provided to the company by its participants, of which RR 10 billion was attributable to NOVATEK. As a result of each transaction, the participants’ pro-rata share in the joint venture increased. As discussed in Note 5, in October 2011, the Group’s effective control over Yamal LNG ceased and subsequent to that event, the Group classified Yamal LNG as a joint venture and recognized its carrying value in line ‘Disposals of subsidiaries resulting in recognition of joint ventures’. At 31 December 2012 and 2011, the Group’s interests in its joint ventures and their summarized financial information, relating to the Group’s interest, were as follows: As at and for the year ended 31 December 2012 Yamal LNG Nortgas Yamal Development (consolidated) SeverEnergia Less: investment and share of profit of Yamal Development in SeverEnergia Sibneftegas Terneftegas Non- current liabilities 15,326 22,838 Non- current assets 96,586 64,904 24,421 42,493 Current assets 3,378 1,899 9 1,322 Current liabilities Net assets Revenues Profit (loss) Interest held 708 1,379 83,930 42,586 51 365 (1,811) (110) 80% 49% 50% 25.5% - 16,799 - 2,993 24,430 24,023 - 1,297 (19) 11 (24,023) 37,931 3,479 - 1,056 1,053 - 13,984 3,220 - 843 88 (24,023) 24,160 1,224 (1,297) 5,272 1 (11) (27) 30 - 51% 51% Total 245,791 8,717 72,167 6,011 176,330 5,689 (1,937) As at and for the year ended 31 December 2011 Non- current assets Current assets Non- current liabilities Current liabilities Net assets Revenues Profit (loss) Interest held Yamal LNG Yamal Development (consolidated) SeverEnergia Less: investment and share of loss of Yamal Development in SeverEnergia Sibneftegas Terneftegas 85,529 1,946 20,542 240 66,693 32 (707) 80% 24,340 37,068 109 1,264 - 5,933 16,349 8,376 8,100 24,023 - - (1,662) (224) 50% 25.5% (24,023) 40,046 1,713 - 640 164 - 15,469 668 - 1,030 16 (24,023) 24,187 1,193 - 3,661 - 224 (1,571) (74) - 51% 51% Total 164,673 4,123 42,612 26,011 100,173 3,693 (4,014) 32 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 7 INVESTMENTS IN JOINT VENTURES (CONTINUED) At 31 December 2012 and 2011, the Group’s investment in Yamal LNG totaled RR 96,736 million and RR 89,549 million, which differed from its share in the net assets of RR 83,930 million and RR 66,693 million, respectively, as noted above. These differences of RR 12,806 million and RR 22,856 million, respectively, relate to the Group’s share in the second and third tranches recognized as part of the consideration for the disposal of the 20 percent interest in Yamal LNG (see Note 5). All of the joint ventures listed above are registered in the Russian Federation. (cid:3) (cid:3) 8 LONG-TERM LOANS AND RECEIVABLES (cid:3) Russian rouble denominated loans US dollar denominated loans Total Less: current portion of long-term loans Total long-term loans Long-term receivables Long-term interest receivable Total long-term loans and receivables At 31 December 2012 At 31 December 2011 8,564 4,366 12,930 (428) 12,502 394 254 13,150 9,737 220 9,957 (634) 9,323 22,027 780 32,130 Russian rouble denominated loans. At 31 December 2012 and 2011, the Russian rouble denominated loans included loans to OAO Sibneftegas, the Group’s joint venture, in the amount of RR 8,564 million and RR 9,737 million, respectively (see Note 30). The loans had interest rates ranging from 9.5 percent to 10 percent per annum (weighted average interest rate of 9.93 percent and 9.88 percent at 31 December 2012 and 2011, respectively) and are repayable until November 2014. US dollar denominated loans. At 31 December 2012 and 2011, the US dollar denominated loans included loans to ZAO Terneftegas, the Group’s joint venture, in the amount of USD 48 million and USD 7 million, respectively. The loans bear an interest rate of 3.88 percent per annum, which can be adjusted in the subsequent years subject to certain conditions. The loans and interest are repayable after the commencement of commercial production. In November 2012, the Group provided a shareholder loan to OAO Yamal LNG, the Group’s joint venture, in the amount of USD 96 million at an interest rate of 5.09 percent per annum, which can be adjusted in subsequent years subject to certain conditions. The loans and interest are repayable after the commencement of commercial production. Long-term receivables. In November 2011, the shareholders of OAO Yamal LNG made a decision to increase its equity through a disproportional subscription to the entity’s additional shares emissions in the aggregated amount of RR 17,046 million. The legal procedures to register the new charter were not completed at 31 December 2011 and, accordingly, the Group’s share of RR 3,955 million paid in 2011 was recognized as long-term receivables. In January 2012, the Group paid the remaining RR 2,507 million. In April 2012, the new charter was formally registered (see Note 7). In November 2011, the participants of (cid:584)(cid:584)(cid:584) Yamal Development, the Group’s joint venture, made a decision to pro-ratably increase its equity by converting the part of the loan provided to the company in the amount of RR 32,697 million to equity. The legal procedures to register the new charter were not completed at 31 December 2011 and, accordingly, the Group’s share of RR 16,348 million was recognized as long-term receivables. In February 2012, the new charter was formally registered (see Note 7). No provisions for impairment of long-term loans and receivables were recognized in the consolidated statement of financial position at 31 December 2012 and 2011. 33 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 9 (cid:3) INVENTORIES Natural gas and hydrocarbon liquids at cost Materials and supplies at cost Materials and supplies at net realizable value (net of provisions of RR 29 million and RR 31 million at 31 December 2012 and 2011, respectively) Other inventories Total inventories At 31 December 2012 At 31 December 2011 2,239 583 256 13 3,091 1,146 400 133 4 1,683 No impairment expenses were recorded during the years ended 31 December 2012 and 2011. No inventories were pledged as security for the Group’s borrowings or payables at both dates. (cid:3) (cid:3) 10 TRADE AND OTHER RECEIVABLES Trade receivables (net of provision of RR 406 million and RR 133 million at 31 December 2012 and 2011, respectively) Other receivables (net of provision of RR 4 million and RR 14 million at 31 December 2012 and 2011, respectively) Interest on loans receivable Total trade and other receivables At 31 December 2012 At 31 December 2011 14,250 2,158 1 16,409 14,900 1,703 96 16,699 The carrying values of trade and other receivables approximate their respective fair values. The related exposure to credit risk at the consolidated statement of financial position date is the carrying value of each class of receivables mentioned above. The Group holds letters of credit in banks with investment grade rating as security for trade receivables in amount RR 1,610 million and RR 1,706 million at 31 December 2012 and 2011, respectively. Also the Group holds as a collateral 100 percent participation interest in OOO BIAXPLEN NK (formerly OOO NOVATEK-Polymer) for other receivables from OAO SIBUR Holding. The Group does not hold any other collateral as security for trade and other receivables (see Note 27 for credit risk disclosures). Trade and other receivables that are less than three months past due are generally not considered for impairment unless other indicators of impairment exist. Trade and other receivables of RR 277 million and RR 478 million at 31 December 2012 and 2011, respectively, were past due but not impaired. The Group has expanded its natural gas sales to a larger number of mid- to small-sized customers as a result of the recent acquisitions of regional gas traders. The Group has assessed the payment history of these accounts and recognized impairment where deemed necessary. The ageing analysis of these past due but not impaired trade and other receivables are as follows: Up to 90 days past-due 91 to 360 days past-due Over 360 days past-due Total past due but not impaired Not past due and not impaired Total trade and other receivables At 31 December 2012 At 31 December 2011 185 85 7 277 16,132 16,409 343 135 - 478 16,221 16,699 34 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 10 TRADE AND OTHER RECEIVABLES (CONTINUED) Movements on the Group provision for impairment of trade and other receivables are as follows: At 1 January Additional provision recorded Acquisition of subsidiaries Disposal of subsidiaries Receivables written off as uncollectible Provision reversed At 31 December Year ended 31 December: 2012 2011 147 272 124 (3) (130) - 410 - 92 76 - (1) (20) 147 The provision for impaired trade and other receivables has been included in the consolidated statement of income in net impairment expense. (cid:3) (cid:3) 11 PREPAYMENTS AND OTHER CURRENT ASSETS At 31 December 2012 At 31 December 2011 Financial assets Russian rouble denominated loans Cash restricted in the form of guarantee Commodity derivatives Short-term bank deposits (with original maturity over three months) Non-financial assets Deferred export duties for stable gas condensate and liquefied petroleum gas Recoverable value-added tax Deferred transportation expenses for natural gas Prepayments and advances to suppliers (net of provision of RR 13 million and RR 12 million at 31 December 2012 and 2011, respectively) Prepaid taxes other than income tax Deferred transportation expenses for stable gas condensate and liquefied petroleum gas Other current assets 428 1,959 451 10 2,718 1,992 1,902 6,479 1,523 1,067 38 6,859 - - 17 922 1,550 1,139 3,322 668 413 60 Total prepayments and other current assets 18,567 14,950 At 31 December 2011, the Russian rouble denominated loans included a loan provided by NOVATEK proportionally with other participants to OOO SeverEnergia, the Group’s related party, in the amount of RR 6,225 million (see Note 30). The loan bore an annual interest rate of MosPrime plus three percent and was fully repaid in March 2012. 35 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 12(cid:3) CASH AND CASH EQUIVALENTS Cash at current bank accounts Russian rouble denominated deposits (average interest rate 4.7% p.a. and 4.5% p.a. for 2012 and 2011, respectively) US dollar denominated deposits (average interest rate 0.6% p.a. and 0.8% p.a. for 2012 and 2011, respectively) Other currency denominated deposits Total cash and cash equivalents At 31 December 2012 At 31 December 2011 8,206 4,223 5,686 305 18,420 7,958 4,986 10,822 65 23,831 All deposits have original maturities of less than three months (see Note 27 for credit risk disclosures). 13 LONG-TERM DEBT US dollar denominated bonds Russian rouble denominated bonds Russian rouble denominated loans US dollar denominated loans Total Less: current portion of long-term debt Total long-term debt At 31 December 2012 At 31 December 2011 67,998 29,960 24,821 9,708 132,487 (34,682) 97,805 39,982 9,971 24,966 20,559 95,478 (20,298) 75,180 At 31 December 2012 and 2011 the Group’s long-term debt by facility is as follows: Eurobonds – Ten-Year Tenor (repayable in 2022) Russian rouble denominated bonds (repayable in 2015) Eurobonds – Ten-Year Tenor (repayable in 2021) Eurobonds – Five-Year Tenor (repayable in 2016) Sberbank three-year loan (repayable in 2013) Russian rouble denominated bonds (repayable in 2013) Sberbank credit line facility Nordea Bank Sumitomo Mitsui Banking Corporation Europe Limited UniCredit Bank Gazprombank Total At 31 December 2012 At 31 December 2011 30,232 19,969 19,620 18,146 14,984 9,991 9,837 6,075 3,633 - - 132,487 - - 20,776 19,206 14,966 9,971 - 6,439 7,685 6,435 10,000 95,478 Eurobonds. In December 2012, the Group issued Eurobonds in the amount of USD 1 billion. The Eurobonds were issued with an annual coupon rate of 4.422 percent, payable semi-annually. The bonds have a ten-year tenure and are repayable in December 2022. In February 2011, the Group issued Eurobonds in an aggregate amount of USD 1,250 million. The Eurobonds were issued at par in two tranches, a five-year USD 600 million bond with a coupon rate of 5.326 percent and a ten-year USD 650 million bond with a coupon rate of 6.604 percent. The coupons are payable semi-annually. The bonds are repayable in February 2016 and February 2021, respectively. 36 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 13 LONG-TERM DEBT (CONTINUED) Sberbank. In December 2011, the Group obtained a RR 40 billion credit line facility from OAO Sberbank available to withdraw until March 2012 which was subsequently extended until June 2012. In June 2012, the Group withdrew RR 10 billion under the facility until December 2014 at an interest rate of 8.9 percent per annum. The remaining part of the credit line was not utilized. The facility includes the maintenance of certain restrictive financial covenants. In December 2010, the Group received a three-year Russian rouble denominated loan from OAO Sberbank in the amount of RR 15 billion at an interest rate of 7.5 percent per annum. The loan is repayable in December 2013 and includes the maintenance of certain restrictive financial covenants. Gazprombank. In November 2009, the Group obtained a three-year Russian rouble denominated loan from OAO Gazprombank in the amount of RR 10 billion at an interest rate of eight percent per annum. The loan was fully repaid in January 2012 ahead of its maturity schedule. Sumitomo Mitsui Banking Corporation Europe Limited. In April 2011, the Group obtained a US dollar denominated loan from Sumitomo Mitsui Banking Corporation Europe Limited in the amount of USD 300 million at an interest rate of LIBOR plus 1.45 percent per annum (1.76 percent and 2.03 percent at 31 December 2012 and 2011, respectively). The loan is payable until December 2013 and includes the maintenance of certain restrictive financial covenants. Nordea Bank. In November 2010, the Group obtained a US dollar denominated loan from OAO Nordea Bank in the amount of USD 200 million at an interest rate of LIBOR plus 1.9 percent per annum (2.11 percent and 2.18 percent at 31 December 2012 and 2011, respectively). The loan is repayable until November 2013 and includes the maintenance of certain restrictive financial covenants. UniCredit Bank. In October 2009, the Group obtained a US dollar denominated loan from ZAO UniCredit Bank in the amount of USD 200 million at an interest rate of LIBOR plus 3.25 percent per annum. In October 2012, the loan was fully repaid in accordance with its maturity schedule. Syndicated term loan facility. In November 2012, the Group obtained an unsecured syndicated term loan facility in the amount of USD 667 million. The facility bore an interest rate of LIBOR plus one percent for the first six months and was repayable in May 2014. In December 2012, the loan was repaid ahead of its maturity schedule. Russian rouble denominated bonds. In October 2012, the Group issued three-year non-convertible Russian rouble denominated bonds in the amount of RR 20 billion with a coupon rate of 8.35 percent per annum, payable semi- annually. The bonds are repayable in October 2015. In June 2010, the Group issued three-year non-convertible Russian rouble denominated bonds in the amount of RR 10 billion with a coupon rate of 7.5 percent per annum, payable semi-annually. The bonds are repayable in June 2013. The fair values of long-term debt at 31 December 2012 and 2011 were as follows: Eurobonds – Ten-Year Tenor (repayable in 2022) Eurobonds – Ten-Year Tenor (repayable in 2021) Russian rouble denominated bonds (repayable in 2015) Eurobonds – Five-Year Tenor (repayable in 2016) Sberbank three-year loan (repayable in 2013) Russian rouble denominated bonds (repayable in 2013) Sberbank credit line facility Nordea Bank Sumitomo Mitsui Banking Corporation Europe Limited UniCredit Bank Gazprombank Total 37 At 31 December 2012 At 31 December 2011 30,543 23,201 20,198 19,567 14,745 10,005 9,928 6,041 3,617 - - 137,845 - 21,150 - 19,414 14,539 10,000 - 6,256 7,561 6,439 9,928 95,287 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 13 LONG-TERM DEBT (CONTINUED) The fair value of the long-term loans was determined based on future cash flows discounted at the estimated risk- adjusted discount rate. The fair value of the corporate bonds was determined based on market quote prices (Level 1 in the fair value measurement hierarchy described in Note 27). Scheduled maturities of long-term debt at 31 December 2012 were as follows: Maturity period: 1 January to 31 December 2014 1 January to 31 December 2015 1 January to 31 December 2016 1 January to 31 December 2017 After 31 December 2017 Total long-term debt (cid:3) (cid:3) 14 PENSION OBLIGATIONS RR million 9,837 19,970 18,146 - 49,852 97,805 In February 2007, the Group announced the implementation of a post-employment benefit program for its retired employees. Under the pension program, employees who are employed by the Group for more than three years (extended to five years effective 1 February 2011) and retire from the Group on or after the statutory retirement age will receive lump sum retirement benefit and monthly payments from NOVATEK for life unless they are actively employed. The amounts of payments to be disbursed depend on the average salary, duration and location of employment. The program is effective from 1 January 2007 and applies to employees who retire after that date. The program represents an unfunded defined benefit plan and is accounted for as such under provisions of IAS 19, Employee Benefits. The impact of the program on the consolidated financial statements is disclosed below. The amounts recognized in the consolidated statement of financial position and included in other non-current liabilities are determined as follows: At 31 December 2012 At 31 December 2011 Present value of the defined benefit obligations Unrecognized past service cost Defined benefit plan liability recognized in the consolidated statement of financial position 1,532 (132) 1,400 The movements in the present value of the defined benefit obligations are as follows: At 1 January Interest cost Benefits paid Current service cost Past service cost Actuarial (gain) loss Lump sum retirement benefit At 31 December Year ended 31 December: 2012 2011 810 54 (18) 91 - 256 339 1,532 38 810 (146) 664 758 48 (13) 88 - (71) - 810 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 14 PENSION OBLIGATIONS (CONTINUED) The amounts recognized in the consolidated statement of income are as follows: Current service cost Interest cost Actuarial (gain) loss Amortization of past service cost Lump sum retirement benefit Defined benefit plan (benefits) costs recognized in operating expenses of which the following amounts were included as employee compensation in: Materials, services and other General and administrative expenses Year ended 31 December: 2012 2011 91 54 256 13 339 753 278 475 88 48 (71) 55 - 120 46 74 The Group recognized a loss of RR 32 million and RR 9 million as a result of experience adjustments on plan liabilities during the years ended 31 December 2012 and 2011, respectively, included in actuarial (gain) loss. The principal actuarial assumptions used at 31 December 2012 and 2011 are as follows: Weighted average discount rate Projected annual increase in employee compensation Expected increases to pension benefits At 31 December 2012 At 31 December 2011 6.4% 5.2% 5.2% 7.4% 5.8% 5.8% The assumed average salary and pension payment increases for Group employees have been calculated on the basis of inflation forecasts, analysis of increases of past salaries and the general salary policy of the Group. Inflation forecasts have been estimated to reduce from 6.5 percent for 2013 to 4.9 percent in 2017 and subsequent years. Mortality assumptions are based on the Russian mortality tables published by the State Statistics Committee from the years 1986 to 1987, which management believes are the most conservative and prudent Russian whole-population mortality tables available. Management has assessed that reasonable changes in the most significant actuarial assumptions will not have a significant impact on the consolidated statement of income or the liability recognized in the consolidated statement of financial position. 39 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 15(cid:3) SHORT-TERM DEBT AND CURRENT PORTION OF LONG-TERM DEBT Short-term debt and current portion of long-term debt. At 31 December 2012 and 2011, short-term debt and current portion of long-term debt consisted only of the current portion of long-term debt in the amount of RR 34,682 million and RR 20,298 million, respectively. Available credit facilities. The Group’s available credit facilities at 31 December 2012 were as follows: BNP PARIBAS Bank (a) Credit Agricole Corporate and Investment Bank (a) UniCredit Bank (a) Sberbank (a) Par value USD 100 million USD 100 million USD 350 million RR 30 billion Total available credit facilities (a) – interest rates are predetermined or negotiated at time of each withdrawal. Within one year 3,037 3,037 - 30,000 36,074 Expiring Between 1 and 3 years - - 10,630 - 10,630 The Group also maintained available funds under short-term credit lines in the form of bank overdrafts with various international banks for RR 7,327 million (USD 175 million and EUR 50 million) and RR 6,278 million (USD 195 million) at 31 December 2012 and 2011, respectively, on variable interest rates subject to the specific type of credit facility. (cid:3) (cid:3) 16 TRADE PAYABLES AND ACCRUED LIABILITIES At 31 December 2012 At 31 December 2011 Financial liabilities Trade payables Interest payable Other payables Commodity derivatives Non-financial liabilities Advances from customers Salary payables Other liabilities 9,959 1,464 718 43 1,227 251 2,263 5,187 1,009 16,615 - 743 210 1,158 Trade payables and accrued liabilities 15,925 24,922 At 31 December 2011, other payables included RR 16,244 million, relating to the acquisition of a 49 percent equity stake in (cid:584)(cid:570)(cid:584) Yamal LNG, which was fully repaid in June 2012. 40 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 17 SHAREHOLDERS’ EQUITY Ordinary share capital. Share capital issued and paid in consisted of 3,036,306,000 ordinary shares at 31 December 2012 and 2011 with a par value of RR 0.1 each. The total authorized number of ordinary shares was 10,593,682,000 shares at both dates. Treasury shares. In accordance with the Share Buyback Programs authorized by the Board of Directors, the Group’s wholly-owned subsidiary, Novatek Equity (Cyprus) Limited, during 2012 and earlier has purchased ordinary shares of OAO NOVATEK in the form of Global Depository Receipts (GDRs) on the London Stock Exchange (“LSE”) and ordinary shares on Moscow Interbank Currency Exchange (MICEX) through the use of independent brokers. At 31 December 2012 and 2011, the Group held in total (both shares and GDRs) 2,894 and 1,969 thousand ordinary shares at a total cost of RR 584 million and RR 281 million, respectively. The Group has decided that these shares do not vote. During the year ended 31 December 2012, the Group purchased in total 925 thousand ordinary shares (both shares and GDRs) at a total cost of RR 303 million. During the year ended 31 December 2011, the Group sold 115,424 GDRs (1,154 thousand ordinary shares) for RR 520 million, recognizing gain of RR 355 million, which were recorded within additional paid-in capital in the consolidated statement of changes in equity. Dividends. Dividends (including tax on dividends) declared and paid were as follows: Dividends payable at 1 January Dividends declared (*) Dividends paid (*) Dividends payable at 31 December Dividends per share declared during the year (in Russian roubles) Dividends per GDR declared during the year (in Russian roubles) (*) – excluding treasury shares. Year ended 31 December: 2012 2011 - 19,723 (19,718) 5 6.50 65.0 - 15,166 (15,166) - 5.00 50.0 The Group declares and pays dividends in Russian roubles. Dividends declared in 2012 and 2011 were as follows: Final for 2011: RR 3.50 per share or RR 35.0 per GDR declared in April 2012 Interim for 2012: RR 3.00 per share or RR 30.0 per GDR declared in October 2012 Total dividends declared in 2012 Final for 2010: RR 2.50 per share or RR 25.0 per GDR declared in April 2011 Interim for 2011: RR 2.50 per share or RR 25.0 per GDR declared in October 2011 Total dividends declared in 2011 10,627 9,109 19,736 7,591 7,591 15,182 Distributable retained earnings. In accordance with Russian legislation, NOVATEK distributes profits as dividends or transfers them to reserves (fund accounts) on the basis of financial statements prepared in accordance with Russian Accounting Rules. Russian legislation identifies the net profit as basis of distribution. For 2012 and 2011, the net statutory profits of NOVATEK as reported in the published annual statutory reporting forms were RR 28,830 million and RR 39,714 million, respectively. The closing balances of the accumulated profit including the respective years net statutory profit totalled RR 149,719 million and(cid:3)RR 120,889 million at 31 December 2012 and 2011, respectively. Accumulated profits legally distributable are based on the amounts available for distribution in accordance with the applicable legislation and as reflected in the statutory financial statements of the individual entities of the Group. These amounts may differ significantly from the amounts calculated on the basis of IFRS. 41 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 18 SHARE-BASED COMPENSATION PROGRAM On 12 February 2010, Management Committee of NOVATEK approved a share-based compensation program (the “Program”) for a limited number of the Group’s senior and key management, as well as high-potential managers, but excluding the members of the Management Committee, which aims to encourage participants to take an active interest in the future development of the Group and to provide material incentive to create shareholders value in OAO NOVATEK. The Program was established in accordance with the Concept of the Long-Term Incentive of Senior Employees approved by the Board of Directors on 25 September 2006 and the Share Buyback Program for three one-year vesting periods ending 31 January 2011, 2012, and 2013. The Program is established as a cash-settled payment program and references the Group’s GDRs, which are publicly traded on the LSE under the ticker symbol “NVTK”. At 31 December 2012 and 2011, the Program covered 134 and 146 employees, respectively. Each participant is assigned a pre-determined number of GDRs in accordance with their respective job classification grade and the entitlement for the cash-settled share-based payment cannot be transferred to another person. The cash-settled payments will only be awarded if the participant is employed with the Group at the date of payment. Each participant is granted share appreciation rights, as part of their remuneration package, and may elect to get paid in cash at the end of each vesting period or to defer payment to the subsequent vesting periods during the Program life. Each payment is based on the sale of the allocated GDRs and is calculated as the difference between the GDRs market price at time of sale and the Program’s pre-defined price set at USD 48.62 relating to the one- third of the total number of GDRs assigned to each participant during the vesting period, including any deferrals from prior vesting periods. The grant date is defined as 31 March 2010 and represents the date when all participants agreed to a share-based payment arrangement. In November 2012, the Group extended the Program’s tenor for an additional one-year vesting period ending 31 January 2014 with no change to other terms and conditions. Total amount of GDRs granted at 31 December 2010 Granted Exercised Forfeited Total amount of GDRs granted at 31 December 2011 Granted Exercised Forfeited Total amount of GDRs granted at 31 December 2012 Number of GDRs Weighted average or closing price (LSE), USD per GDR 382,368 - (104,728) (36,984) 240,656 - (112,305) (11,140) 117,211 119.5 - 105.0 - 125.2 - 144.2 - 119.3 In accordance with IFRS 2, Share-based payment, the Group re-measures the employees’ services rendered and the liability incurred at the fair value of the liability. Until the liability is settled, the Group re-measures the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognized in profit or loss for the period. The liability is measured, initially and at the end of each reporting period until settled, at the fair value of the share appreciation rights, by applying an option pricing model based on Monte- Carlo simulations, and to the extent to which the employees have rendered service to date. 42 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 18 SHARE-BASED COMPENSATION PROGRAM (CONTINUED) The fair value of the Program is determined based on the following assumptions: Expected volatility Risk-free interest rate Expected option life (years) Exercise price per GDR (USD) 2012 43.04% - 0.96 48.62 2013 43.04% 0.22% 0.96 48.62 Expected volatility is calculated based on the historical volatility of the price per GDR for the historical period equal to the expected life of the Program (1.1 years). Risk-free interest rate is based on a benchmark USD curve including Deposit Rates (DEPO), Forward Rate Agreements (FRA) and Interest Rate Swaps (IRS). The fair value of the share-based payments is recognized as a payable to the employees over the vesting period and any changes in the fair value of the liability recognized in the consolidated statement of income. The amounts recognized by the Group in respect of the Program are as follows: Expenses included in General and administrative expenses Year ended 31 December: 2012 2011 121 235 Liabilities included in At 31 December 2012 At 31 December 2011 Other non-current liabilities Trade payables and accrued liabilities Total share-based compensation program liabilities (cid:3) (cid:3) 19 OIL AND GAS SALES Natural gas Stable gas condensate Liquefied petroleum gas Crude oil Oil and gas products Total oil and gas sales (cid:3) (cid:3) 20 TRANSPORTATION EXPENSES Natural gas transportation to customers Liquid hydrocarbons transportation by rail Liquid hydrocarbons transportation by tankers Crude oil transportation to customers Other Total transportation expenses 43 57 181 238 226 244 470 Year ended 31 December: 2012 2011 142,613 46,684 15,599 5,000 350 110,932 46,778 14,436 2,479 186 210,246 174,811 Year ended 31 December: 2012 2011 45,925 10,537 3,742 527 117 60,848 34,441 9,791 3,647 281 169 48,329 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 21 TAXES OTHER THAN INCOME TAX The Group is subject to a number of taxes other than income tax, which are detailed as follows: Unified natural resources production tax (UPT) Property tax Other taxes Total taxes other than income tax Year ended 31 December: 2012 2011 14,833 1,754 259 16,846 14,523 1,742 294 16,559 The unified natural resources production tax for natural gas production was set at a rate of RR 251 and RR 237 per thousand cubic meters for 2012 and 2011, respectively. The unified natural resources production tax rate for gas condensate was set for 2011 at the level of 17.5 percent of gas condensate revenues recognized by the producing entities. Effective 1 January 2012, the approach set by the Tax Code of the Russian Federation was changed and a tax rate of RR 556 per ton of gas condensate produced was set. Under the Tax Code, the tax rate for the unified natural resources production tax for crude oil is calculated by reference to an average price for Urals blend and an average exchange rate over the relevant tax period. According to the amendments to the Tax Code, effective from 1 January 2012, a zero UPT rate is set for crude oil produced at fields located in the YNAO to the north of the 65th degree of the northern latitude. The Group’s East- Tarkosalinskoye and Khancheyskoye fields are located within the applicable geographical area; therefore, the zero UPT rate was applied for the crude oil produced at these fields effective from 1 January 2012. 22 GENERAL AND ADMINISTRATIVE EXPENSES Employee compensation Legal, audit, and consulting services Social expenses and compensatory payments Depreciation – administrative buildings Business trips expense Fire safety and security expenses Repair and maintenance expenses Rent expense Board remuneration Insurance expense Bank charges Other Total general and administrative expenses Year ended 31 December: 2012 2011 6,869 1,274 1,001 314 292 199 168 113 105 86 82 433 10,936 4,650 774 1,212 198 218 178 115 140 103 58 58 514 8,218 44 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 22 GENERAL AND ADMINISTRATIVE EXPENSES (CONTINUED) Auditors’ fees and services. ZAO PricewaterhouseCoopers Audit has served as the Group’s independent external auditor for each of the reported financial years. The independent external auditor is subject to re-appointment at the Annual General Meeting of shareholders based on the recommendations from the Board of Directors. The following table presents the aggregate fees for professional services and other services rendered by ZAO PricewaterhouseCoopers Audit to the Group included within legal, audit, and consulting services: Year ended 31 December: 2012 2011 40 4 44 Year ended 31 December: 2012 2011 3,808 1,598 457 412 271 186 99 385 7,216 39 1 40 2,953 1,435 405 309 237 184 99 325 5,947 5,854 - 140 5,994 Audit services fee (audit of the Group’s consolidated financial statements and the statutory audit of the parent company) Non-audit services Total auditors’ fees and services 23 MATERIALS, SERVICES AND OTHER Employee compensation Repair and maintenance services Electricity and fuel Materials and supplies Security expenses Transportation expenses Processing fees Other Total materials, services and other (cid:3) (cid:3) 24 PURCHASES OF NATURAL GAS AND LIQUID HYDROCARBONS Natural gas Unstable gas condensate Other liquid hydrocarbons Total purchases of natural gas and liquid hydrocarbons Year ended 31 December: 2012 2011 14,706 2,498 279 17,483 Natural gas purchases included volumes procured from OAO Sibneftegas, the Group’s joint venture, pro-rata to its total production (see Note 30). From January 2012, the Group began purchasing natural gas from its related party OAO SIBUR Holding at prices based on the market prices in the region of purchases (see Note 30). In November 2012, the Group began purchasing unstable gas condensate from ZAO Nortgas, the Group’s joint venture from November 2012, at ex-field prices based on benchmark crude oil and oil products market quotes adjusted for quality and respective tariffs for transportation and processing (see Note 30). In April 2012, the Group began purchasing unstable gas condensate from OOO SeverEnergia, a related party,(cid:3)at ex- field prices based on benchmark crude oil and oil products market quotes adjusted for quality and respective tariffs for transportation and processing (see Note 30). 45 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 25 FINANCE INCOME (EXPENSE) Interest expense (including transaction costs) 6.604% USD 650 million Eurobonds February 2021 7.5% RR 15 billion Sberbank December 2013 5.326% USD 600 million Eurobonds February 2016 7.5% RR 10 billion Bonds June 2013 8.9% RR 10 billion Sberbank December 2014 8.35% RR 20 billion Bonds October 2015 LIBOR+1.45% USD 300 million Sumitomo Mitsui Banking Corporation Europe Limited December 2013 LIBOR+1.9% USD 200 million Nordea Bank November 2013 LIBOR+3.25% USD 200 million UniCredit Bank October 2012 (1) 4.42% USD 1 billion Eurobonds December 2022 8% RR 10 billion Gazprombank November 2012 (1) Other interest expenses (2) Subtotal Less: capitalized interest Interest expense (on historical cost basis) Effects of discounting of long-term financial liabilities Provisions for asset retirement obligations: effect of the present value discount unwinding Total interest expense (1) – interest rates were reduced during the periods. (2) – including credit facility with interest rates negotiated at time of each withdrawal. Interest income Interest income on loans issued Interest income on cash and cash equivalents Interest income (on historical cost basis) Long-term financial assets: effect of the present value discount unwinding Total interest income Year ended 31 December: 2012 2011 1,355 1,143 1,022 772 520 355 148 133 71 69 42 72 5,702 (2,698) 3,004 - 232 3,236 1,165 1,144 879 772 - - 148 125 215 - 805 169 5,422 (3,709) 1,713 212 225 2,150 Year ended 31 December: 2012 2011 1,051 444 1,495 236 1,731 2,828 355 3,183 209 3,392 46 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 26 INCOME TAX Reconciliation of income tax. The table below reconciles actual income tax expense and theoretical income tax, determined by applying the statutory tax rate to profit before income tax. Profit before income tax Theoretical income tax expense at statutory rate of 20 percent Increase (decrease) due to: Non-temporary differences in respect of share of losses of joint ventures Non-deductible expenses Russian entities’ taxation at lower income tax rate Foreign entities’ taxation at lower income tax rate Deferred taxes write-off Tax benefit relating to priority investment projects in the YNAO Disposal of 20 percent interest in Yamal LNG Other non-temporary differences Year ended 31 December: 2012 2011 86,215 17,243 135,025 27,005 421 546 (117) (107) (21) (1,709) - 518 776 686 (118) (226) 342 - (12,473) (258) Total income tax expense 16,774 15,734 In 2012, one of Group’s investment projects in the YNAO was included by the YNAO authorities in the list of priority projects, which allows the Group’s subsidiary, that carried out the project, to apply a reduced income tax rate of 15.5 percent. Domestic and foreign components of current income tax expense were: Russian Federation income tax Foreign income tax Total current income tax expense Year ended 31 December: 2012 2011 16,011 131 16,142 12,364 103 12,467 Effective income tax rate. The Group’s Russian statutory income tax rate for 2012 and 2011 was 20 percent. For the years ended 31 December 2012 and 2011, the consolidated Group’s effective income tax rate was 19.5 percent and 11.7 percent, respectively. Excluding the effect of 20 percent disposal of Yamal LNG, the Group’s effective income tax rate for the year ended 31 December 2011 was 21.7 percent. The Group did not file a consolidated tax return for 2011. Instead, each legal entity filed separate tax returns with various tax authorities, primarily in the Russian Federation. Effective 1 January 2012, Russian tax legislation introduced an option to submit a single consolidated income tax return, and, accordingly, in April 2012, the Group’s management registered NOVATEK and its core Russian producing subsidiaries as a consolidated group of taxpayers for 2012 and thereafter. The Group has recorded a deferred tax liability in respect of the temporary difference associated with the investment in Yamal LNG at a zero tax rate as management expects that the carrying value of the investment in Yamal LNG would be recovered primarily through dividends taxable at zero tax rate and also potentially partially through a sale of an additional equity stake in the entity. The Group did not recognize deferred taxes related to a future sale as the tax base in respect of potential interest in Yamal LNG to be sold is assessed to be equal to its carrying amount. Deferred income tax. Differences between IFRS and Russian statutory tax regulations give rise to certain temporary differences between the carrying value of certain assets and liabilities for financial reporting purposes and for income tax purposes. 47 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 26 INCOME TAX (CONTINUED) Deferred income tax balances are presented in the consolidated statement of financial position as follows: Long-term deferred income tax asset (other non-current assets) Long-term deferred income tax liability Net deferred income tax liability At 31 December 2012 At 31 December 2011 1,062 (13,969) 660 (12,805) (12,907) (12,145) Deferred income tax assets expected to be realized within twelve months of 31 December 2012 and 2011 were RR 983 million and RR 462 million, respectively. Deferred tax liabilities expected to be reversed within twelve months of 31 December 2012 and 2011 were RR 629 million and RR 199 million, respectively. Movements in deferred income tax assets and liabilities during the years ended 31 December 2012 and 2011 are as follows: At 31 December 2012 Statement of Income effect Acquisitions Disposals At 31 December 2011 Property, plant and equipment Intangible assets Other (15,902) (398) (714) (1,124) 51 (496) - (125) (5) Total deferred income tax liabilities (17,014) (1,569) (130) Tax losses carried forward Inventories Asset retirement obligation Trade payables and accrued liabilities Other Total deferred income tax assets 1,474 1,077 577 809 170 4,107 Net deferred income tax liabilities (12,907) 95 438 30 327 47 937 (632) 4 - - - - 4 (126) 11 - - 11 - (15) - - - (15) (4) At 31 December 2011 Statement of Income effect Acquisitions Disposals (14,789) (324) (213) (15,326) 1,375 654 547 482 123 3,181 (12,145) At 31 December 2010 Property, plant and equipment Intangible assets Other (14,789) (324) (213) (3,827) 23 (53) - (265) (13) 138 - - (11,100) (82) (147) Total deferred income tax liabilities (15,326) (3,857) (278) 138 (11,329) Tax losses carried forward Inventories Asset retirement obligation Trade payables and accrued liabilities Other 1,375 654 547 482 123 603 (167) 131 27 (4) Total deferred income tax assets 3,181 590 16 - - 3 8 27 Net deferred income tax liabilities (12,145) (3,267) (251) (519) (83) (80) - (2) (684) (546) 1,275 904 496 452 121 3,248 (8,081) 48 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 26 INCOME TAX (CONTINUED) At 31 December 2012, the Group had recognized deferred income tax assets of RR 1,474 million (31 December 2011: RR 1,375 million) in respect of unused tax loss carry forwards of RR 7,370 million (31 December 2011: RR 6,875 million). Tax losses can be carried forward for relief against taxable profits for 10 years after they are incurred, subject to certain limitations. In determining future taxable profits and the amount of tax benefits that are probable in the future management makes judgments including expectations regarding the Group’s ability to generate sufficient future taxable income and the projected time period over which deferred tax benefits will be realized. 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS The accounting policies for financial instruments have been applied to the line items below: Financial assets Loans and receivables Non-current Long-term loans Trade and other receivables Long-term deposits Current Trade and other receivables Russian rouble denominated loans Short-term bank deposits Cash restricted in the form of guarantee Cash and cash equivalents At fair value through profit or loss Non-current Commodity derivatives Current Commodity derivatives Total assets Financial liabilities At amortized cost Non-current Long-term debt Current Current portion of long-term debt Trade and other payables At fair value through profit or loss Non-current Commodity derivatives Current Commodity derivatives Total liabilities 49 At 31 December 2012 At 31 December 2011 12,502 648 3 16,409 428 10 1,959 18,420 148 451 9,323 22,806 1 16,699 6,859 17 - 23,831 - - 50,978 79,536 At 31 December 2012 At 31 December 2011 97,805 34,682 12,141 592 43 75,180 20,298 22,811 - - 145,263 118,289 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED) Derivative instruments. Certain foreign long-term natural gas purchase and sales contracts were entered into for trading purposes on active markets that do not meet the expected own-use requirements. These contracts include pricing terms that are based on a variety of commodities and indices and volume flexibility options that collectively qualify them under the scope of IAS 39, Financial instruments: recognition and measurement, although the activity surrounding these contracts involves the physical delivery of natural gas. Such contracts are recognized in the statement of financial position at fair value with movements in fair value recognized in the income statement. The Group determines the fair values of these financial commodity derivative contracts using the mark-to-market and mark-to-model methods and as such, the Group evaluates the quality and reliability of the assumptions and data used to measure fair value in accordance with IFRS 7, Financial instruments: Disclosures, in the three hierarchy levels as follows: i. ii. iii. quoted prices in active markets (Level 1); inputs other than quoted prices included in Level 1 that are directly or indirectly observable in the market (externally verifiable inputs) (Level 2); and inputs that are not based on observable market data (unobservable inputs). These inputs reflect the Group’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (Level 3). The fair values of natural gas derivative contracts are estimated using internal models and other valuation techniques due to the absence of quoted prices or other observable, market-corroborated data, for the duration of the contracts. Valuations were derived from quoted market prices for the periods in which market quotes are available; thereafter, forward natural gas prices were developed by reference to equivalent oil and oil products prices on other analogous markets. For periods beyond observable market prices the fair values of the long-term contracts were calculated using the market yield curve at the reporting date. Due to the assumptions underlying their fair value, the gas contracts are categorized as Level 3 in the fair value hierarchy, described above. At 31 December 2012, the Group recognized RR 599 million of assets and RR 635 million of liabilities related to long-term natural gas contracts in the consolidated statement of financial position. For the year ended 31 December 2012, a loss of RR 36 million was included within other operating income (loss) representing non- cash mark-to-market net movements in fair values on these derivative instruments during the reporting period. Trading operations under these contracts in 2012 resulted in the net income of RR 112 million that was recognized in the consolidated income statement within other operating profit (loss). The fair value of natural gas derivative contracts is sensitive to price changes in the event of a one-off shift step in the market. The table below represents the effect on the fair value estimation of these derivative contracts that would occur from price changes by RR 201.14 (five Euros) by 1 megawatt-hour: Sensitivity summary Market shift from 2014 sensitivity Market shift from 2019 sensitivity Price decrease Price increase 2,454 2,011 (3,379) (2,695) Financial risk management objectives and policies. In the ordinary course of business, the Group is exposed to market risks from fluctuating prices on commodities purchased and sold, prices of other raw materials, currency exchange rates and interest rates. Depending on the degree of price volatility, such fluctuations in market prices may create volatility in the Group’s financial results. To effectively manage the variety of exposures that may impact financial results, the Group’s overriding strategy is to maintain a strong financial position. The Group’s principal risk management policies are established to identify and analyze the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to these limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Group’s activities. 50 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED) Market risk. Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates, commodity prices and equity prices, will affect the Group’s financial results or the value of its holdings of financial instruments. The primary objective of mitigating these market risks is to manage and control market risk exposures, while optimizing the return on risk. The Group is exposed to market price movements relating to changes in commodity prices such as crude oil, gas condensate, liquefied petroleum gas and natural gas (commodity price risk), foreign currency exchange rates, interest rates, equity prices and other indices that could adversely affect the value of the Group’s financial assets, liabilities or expected future cash flows. (cid:3) (a) Foreign exchange risk The Group is exposed to foreign exchange risk arising from various exposures in the normal course of business, primarily with respect to the US dollar. Foreign exchange risk arises primarily from future commercial transactions, recognized assets and liabilities when assets and liabilities are denominated in a currency other than the functional currency. The Group’s overall strategy is to have no significant net exposure in currencies other than the Russian rouble or the US dollar. Foreign currency derivative instruments may be utilized to manage the risk exposures associated with fluctuations on certain firm commitments for sales and purchases, debt instruments and other transactions that are denominated in currencies other than the Russian rouble, and certain non-Russian rouble assets and liabilities. The carrying amounts of the Group’s financial instruments are denominated in the following currencies: At 31 December 2012 Financial assets Non-current Long-term loans receivable Trade and other receivables Commodity derivatives Long-term deposits Current Trade and other receivables Russian rouble denominated loans Short-term bank deposits Commodity derivatives Cash restricted in the form of guarantee Cash and cash equivalents Financial liabilities Non-current Long-term debt Commodity derivatives Current Current portion of long-term debt Trade and other payables Commodity derivatives Russian rouble 8,136 562 - - 9,604 428 - - - 8,251 US dollar Other Total 4,366 67 - - 4,794 - - - 1,959 9,740 - 19 148 3 2,011 - 10 451 - 429 12,502 648 148 3 16,409 428 10 451 1,959 18,420 (29,818) - (24,963) (9,135) - (67,987) - (9,719) (1,400) - - (592) - (1,606) (43) (97,805) (592) (34,682) (12,141) (43) Net exposure at 31 December 2012 (36,935) (58,180) 830 (94,285) 51 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED) At 31 December 2011 Financial assets Non-current Long-term loans receivable Trade and other receivables Long-term deposits Current Trade and other receivables Russian rouble denominated loans Short-term bank deposits Cash and cash equivalents Financial liabilities Non-current Long-term debt Other non-current liabilities Current Current portion of long-term debt Trade and other payables US dollar Other Total Russian rouble 9,103 22,761 - 8,692 6,859 - 10,774 220(cid:3) 14(cid:3) - 7,618(cid:3) -(cid:3) - 12,113(cid:3) (24,937) - (10,000) (4,949) (50,243)(cid:3) -(cid:3) (10,298)(cid:3) (17,799)(cid:3) - 31 1 389 - 17 944 - - - (63) 9,323 22,806 1 16,699 6,859 17 23,831 (75,180) - (20,298) (22,811) Net exposure at 31 December 2011 18,303 (58,375) 1,319 (38,753) The Group chooses to provide information about market risk and potential exposure to hypothetical loss from its use of financial instruments through sensitivity analysis disclosures in accordance with IFRS requirements.(cid:3) The sensitivity analysis depicted in the table below reflects the hypothetical loss that would occur assuming a 10 percent increase in exchange rates and no changes in the portfolio of instruments and other variables at 31 December 2012 and 2011, respectively: Effect on pre-tax profit Increase in exchange rate 2012 2011 Year ended 31 December: RUB / USD 10% (5,818) (5,838) The effect of a corresponding 10 percent decrease in exchange rate is approximately equal and opposite. (cid:3) (b) Commodity price risk The Group’s overall commercial trading strategy in natural gas and liquid hydrocarbons is centrally managed. Changes in commodity prices could negatively or positively affect the Group’s results of operations. The Group manages the exposure to commodity price risk by optimizing its core activities to achieve stable price margins. Natural gas supplies on the Russian domestic market. As an independent natural gas producer, the Group is not subject to the government’s regulation of natural gas prices, except for those volumes sold to residential customers. Nevertheless, the Group’s prices for natural gas sold are strongly influenced by the prices regulated by the Federal Tariffs Service (FTS), a governmental agency. In November 2006, the FTS approved and published a plan to liberalize the price of natural gas sold on the Russian domestic market by the year 2011. 52 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED) In February 2011, the Government of the Russian Federation announced certain revisions to the domestic natural gas market liberalization plan. According to the revised plan, the target date to implement full liberalization of the domestic natural gas market is planned on 1 January 2015; however, the Government reserves the right to amend or change the proposed timetable. As part of the plan, in June 2012, the FTS approved an increase of 15 percent in the regulated prices effective 1 July 2012. According to the Government’s program, the regulation of the domestic natural gas price after 2015 will be based on the net-back parity of natural gas prices on the domestic and export markets. Management believes it has limited downside commodity price risk for natural gas and does not use commodity derivative instruments for trading purposes. All of the Group’s natural gas purchase and sales contracts in the domestic market are entered to meet supply requirements to fulfil contract obligations or for own consumption and are not within the scope of IAS 39, Financial instruments: recognition and measurement. However, to effectively manage the margins achieved through its natural gas trading activities, management has established targets for volumes sold to wholesale traders, end-customers and eventually to the natural gas exchange when trading commences. Natural gas foreign trading activities. The Group purchases and sells natural gas on the European market under long-term supply contracts based on formulas with reference to benchmark natural gas prices quoted for the North- Western European natural gas hubs, crude oil and oil products prices and/or a combination thereof. As a result, the Group’s results from natural gas trading are subject to commodity price volatility based on fluctuations or changes in the respective benchmark reference prices. Natural gas foreign trading activities are exercised by Novatek Gas & Power GmbH, the Group’s wholly owned subsidiary, and are managed within the Group’s integrated trading function. Liquid hydrocarbons. The Group sells all its crude oil and gas condensate under spot contracts. Gas condensate volumes sold to the US, European, South American and Asian-Pacific Region (hereinafter referred to as “APR”) markets are based on benchmark reference crude oil prices of WTI, Brent IPE and Dubai (or a combination thereof) or Naphtha Japan and Naphtha CIF NWE, respectively, plus a margin or discount, depending on current market situation. Crude oil sold internationally is based on benchmark reference crude oil prices of Brent dated, plus a discount and on a transaction-by-transaction basis for volumes sold domestically. As a result, the Group’s revenues from the sales of liquid hydrocarbons are subject to commodity price volatility based on fluctuations or changes in the crude oil benchmark reference prices. All of the Group’s liquid hydrocarbon purchase and sales contracts are entered to meet supply requirements to fulfil contract obligations or for own consumption and are not within the scope of IAS 39, Financial instruments: recognition and measurement. (cid:3) (c)(cid:3)(cid:3) Cash flow and fair value interest rate risk The Group is subject to interest rate risk on financial liabilities with variable interest rates. To mitigate this risk, the Group’s treasury function performs periodic analysis of the current interest rate environment and depending on that analysis management makes decisions whether it would be more beneficial to obtain financing on a fixed-rate or variable-rate basis. In cases where the change in the current market fixed or variable interest rates is considered significant management may consider refinancing a particular debt on more favorable interest rate terms. Changes in interest rates impact primarily debt by changing either their fair value (fixed rate debt) or their future cash flows (variable rate debt). Management does not have a formal policy of determining how much of the Group’s exposure should be to fixed or variable rates. However, at the time of raising new debts management uses its judgment to decide whether it believes that a fixed or variable rate would be more favorable over the expected period until maturity. 53 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED) The interest rate profiles of the Group’s interest-bearing financial instruments at the reporting dates were as follows: At fixed rate At variable rate Total debt At 31 December 2012 At 31 December 2011 122,779 9,708 132,487 74,919 20,559 95,478 The Group centralizes the cash requirements and surpluses of controlled subsidiaries and the majority of their external financing requirements, and applies, on its consolidated net debt position, a funding policy to optimize its financing costs and manage the impact of interest rate changes on its financial results in line with market conditions. In this way, the Group is able to ensure that the balance between the floating rate portion of its debt and its cash surpluses has a low level of exposure to any change in interest rates over the short term. This policy makes it possible to significantly limit the Group's sensitivity to interest rate volatility. The Group’s financial results are sensitive to changes in interest rates on the floating rate portion of the Group’s debt portfolio. If the interest rates applicable to floating rate debt were to increase by 100 basis points at the reporting dates, assuming all other variables remain constant, it is estimated that the Group’s profit before taxation would decrease by the amounts shown below: Effect on pre-tax profit Increase by 100 basis points Year ended 31 December: 2012 2011 97 206 The effect of a corresponding 100 basis points decrease in interest rate is approximately equal and opposite. The Group is examining various ways to manage its cash flow interest rate risk by using a combination of floating and fixed interest rates. No swaps or other similar instruments were in place as of 31 December 2012 and 2011, or during 2012 and 2011. (cid:3) Credit risk. Credit risk refers to the risk exposure that a potential financial loss to the Group may occur if a counterparty defaults on its contractual obligations. Credit risk is managed on a Group level and arises from cash and cash equivalents, including short-term deposits with banks, as well as credit exposures to customers, including outstanding trade receivables and committed transactions. Cash and cash equivalents are deposited only with banks that are considered by the Group at the time of deposit to minimal risk of default. The Group’s trade and other receivables consist of a large number of customers, spread across diverse industries and geographical areas. Most of the Group’s international liquid sales are made to customers with independent external ratings; however, if the customer has a credit rating below BBB, the Group requires the collateral for the trade receivable to be in the form of letters of credit from banks with an investment grade rating. All domestic sales of liquid hydrocarbons are made on a 100 percent prepayment basis. Although the Group generally does not require collateral in respect of trade and other receivables, it has developed standard credit payment terms and constantly monitors the status of trade receivables and the creditworthiness of the customers. As a result of recent acquisitions of Russian regional natural gas trading companies, the Group’s exposure to small and medium-size industrial users and individuals has increased. The Group monitors the recoverability of these debtors by analyzing the ageing of receivables by type of customers and their respective prior payment history. 54 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED) The maximum exposure to credit risk is represented by the carrying amount of each financial asset in the consolidated statement of financial position. The table below highlights the Group’s trade and other receivables to published credit ratings of its counterparties and/or their parent companies: Moody’s, Fitch and/or Standard & Poor’s At 31 December 2012 At 31 December 2011 Investment grade rating Non-investment grade rating No external rating Total trade and other receivables 7,208 4,825 4,376 9,059 1,581 6,059 16,409 16,699 The table below highlights the Group’s cash and cash equivalents balances to published credit ratings of its banks and/or their parent companies: Moody’s, Fitch and/or Standard & Poor’s At 31 December 2012 At 31 December 2011 Investment grade rating Non-investment grade rating No external rating Total cash and cash equivalents 16,887 1,526 7 18,420 19,381 4,358 92 23,831 Investment grade ratings classification referred to as Aaa to Baa3 for Moody’s Investors Service, and as AAA to BBB- for Fitch Ratings and Standard & Poor’s. Liquidity risk. Liquidity risk is the risk that the Group will not be able to meet its financial obligations as they fall due. The Group’s approach to managing liquidity is to ensure that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation. In managing its liquidity risk, the Group maintains adequate cash reserves and debt facilities, continuously monitors forecast and actual cash flows and matches the maturity profiles of financial assets and liabilities. The Group prepares various financial plans (monthly, quarterly and annually) which ensures that the Group has sufficient cash on demand to meet expected operational expenses, financial obligations and investing activities for a period of 30 days or more. The Group has entered into a number of short-term credit facilities. Such credit lines and overdraft facilities can be drawn down to meet short-term financing needs. To fund cash requirements of a more permanent nature, the Group will normally raise long-term debt in available international and domestic markets. All of the Group’s financial liabilities represent non-derivative financial instruments. The following tables summarize the maturity profile of the Group’s financial liabilities, except of natural gas derivative contracts, based on contractual undiscounted payments, including interest payments: At 31 December 2012 Debt at fixed rate Principal (*) Interest Debt at variable rate Principal (*) Interest Trade and other payables Less than 1 year Between 1 and 2 years Between 2 and 5 years More than 5 years Total 25,000 7,589 9,719 116 12,141 10,000 6,097 38,224 11,062 50,115 11,279 123,339 36,027 - - - - - - - - - 9,719 116 12,141 Total financial liabilities 54,565 16,097 49,286 61,394 181,342 55 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 27 FINANCIAL INSTRUMENTS AND FINANCIAL RISK FACTORS (CONTINUED)(cid:3) At 31 December 2011 Debt at fixed rate Principal (*) Interest Debt at variable rate Principal (*) Interest Trade and other payables Less than 1 year Between 1 and 2 years Between 2 and 5 years More than 5 years 10,000 4,748 10,303 366 22,811 25,000 3,825 10,302 135 - 19,318 6,298 20,927 5,655 - - - - - - Total 75,245 20,526 20,605 501 22,811 Total financial liabilities 48,228 39,262 25,616 26,582 139,688 (*) – differs from long-term debt (See Note 13) for transaction costs. The following table represents the maturity profile of the Group’s derivative commodity contracts based on undiscounted cash flows: At 31 December 2012 Cash inflow Cash outflow Net cash flows Less than 1 year Between 1 and 2 years Between 2 and 5 years More than 5 years Total 23,150 (22,678) 23,600 (23,175) 69,289 (68,593) 108,742 (107,598) 224,781 (222,044) 472 425 696 1,144 2,737 Capital management. The primary objectives of the Group’s capital management policy is to ensure a strong capital base to fund and sustain its business operations through prudent investment decisions and to maintain investor, market and creditor confidence to support its business activities. At the reporting date, the Group had investment grade credit ratings of Baa3 (stable outlook) by Moody’s Investors Service, BBB- (stable outlook) by Fitch Ratings, as well as a credit rating of BBB- (stable outlook) by Standard & Poor’s. To maintain its credit ratings, the Group has established certain financial targets and coverage ratios that it monitors on a quarterly and annual basis. The Group manages its liquidity on a corporate-wide basis to ensure adequate funding to sufficiently meet group operational requirements. All external debts are centralized at the parent level, and all financing to Group entities is facilitated through inter-company loan arrangements or additional contributions to share capital. The Group has a stated dividend policy that distributes at least 30 percent of its parent company’s non-consolidated statutory net profit determined according to Russian accounting standards. However, the dividend for a specific year is determined after taking into consideration future earnings, capital expenditure requirements, future business opportunities and the Group current financial position. Dividends are recommended by the Board of Directors and approved by the NOVATEK’s shareholders. The Group defines the term “capital” as equity attributable to OAO NOVATEK shareholders plus net debt (total debt less cash and cash equivalents). There were no changes to the Group’s approach to capital management during the year ended 31 December 2012. At 31 December 2012 and 2011, the Group’s capital totalled RR 404,117 million and RR 312,660 million, respectively. 56 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 28 CONTINGENCIES AND COMMITMENTS Operating environment. The Russian Federation continues to display some characteristics of an emerging market. These characteristics include, but are not limited to, the existence of a currency that is in practice not convertible in most countries outside of the Russian Federation, and relatively high inflation. The tax, currency and customs legislation is subject to varying interpretations, frequent changes and other legal and fiscal impediments contribute to the challenges faced by entities currently operating in the Russian Federation. The future economic direction of the Russian Federation is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory, and political developments. The Group’s business operations are primarily located in the Russian Federation and are thus exposed to the economic and financial markets of the country. Commitments. At 31 December 2012, the Group had contractual capital expenditures commitments aggregating approximately RR 22,476 million (at 31 December 2011: RR 17,805 million) mainly for ongoing development activities at the Yurkharovskoye field (through 2015), development at the North-Russkoe field (through 2014), both the Salmanovskoye (Utrenneye) and the Geofizicheskoye fields (through 2016), phase three construction of the Purovsky Gas Condensate Plant (through 2013), construction of the terminal for the transshipment and fractionation of stable gas condensate (through 2013) and ongoing development of the East-Tarkosalinskoye (through 2014) and Khancheyskoye fields (through 2013) all in accordance with duly signed agreements. Furthermore, the Group’s share in capital commitments for its interests in joint ventures aggregates approximately RR 31,411 million (at 31 December 2011: RR 5,850 million) for development of the South-Tambeyskoye (through 2014), Termokarstovoye (through 2016), North-Urengoiskoye (through 2015) and Samburgskoye (through 2014) fields. Taxation. Russian tax, currency and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Correspondingly, the relevant regional and federal tax authorities may periodically challenge. Management’s interpretation of such taxation legislation as applied to the Group’s transactions and activities. Furthermore, events within the Russian Federation suggest that the tax authorities may be taking a more assertive position in its interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged. As a result, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances reviews may cover longer periods. As at 31 December 2012, management believes that its interpretation of the relevant legislation is appropriate and that it is probable that the Group’s tax, currency and customs positions will be sustained. Where management believes it is probable that a position cannot be sustained, an appropriate amount has been accrued. Mineral licenses. The Group is subject to periodic reviews of its activities by governmental authorities with respect to the requirements of its mineral licenses. Management cooperates with governmental authorities to agree on remedial actions necessary to resolve any findings resulting from these reviews. Failure to comply with the terms of a license could result in fines, penalties or license limitation, suspension or revocation. The Group’s management believes any issues of non-compliance will be resolved through negotiations or corrective actions without any material adverse effect on the Group’s financial position, results of operations or cash flows. 57 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 28 CONTINGENCIES AND COMMITMENTS (CONTINUED) The Group’s oil and gas fields and license areas are situated on land located in the Yamal-Nenets Autonomous Region. Licenses are issued by the Federal Agency for the Use of Natural Resources of the Russian Federation and the Group pays unified natural resources production tax to produce crude oil, natural gas and unstable gas condensate from these fields and contributions for exploration of license areas. The principal licenses of the Group and its joint ventures and their expiry dates are: Field License holder License expiry date Yurkharovskoye Salmanovskoye (Utrenneye) Geofizicheskoye East-Tarkosalinskoye North-Russkoe Khancheyskoye Urengoiskoye (within the Olimpiyskiy license area) Malo-Yamalskoye Yarudeyskoye South-Tambeyskoye North-Urengoyskoye Urengoiskoye (within the Samburgskiy and Yevo-Yakhinskiy license areas) Samburgskoye Yaro-Yakhinskoye North-Chaselskoye Termokarstovoye Beregovoe Pyreinoye Subsidiaries: OOO NOVATEK-Yurkharovneftegas OOO NOVATEK-Yurkharovneftegas OOO NOVATEK-Yurkharovneftegas OOO NOVATEK-Tarkosaleneftegas OOO NOVATEK-Tarkosaleneftegas OOO NOVATEK-Tarkosaleneftegas OOO NOVATEK-Tarkosaleneftegas OAO Tambeyneftegas OOO Yargeo Joint ventures: OAO Yamal LNG ZAO Nortgas OAO Arkticheskaya gazovaya kompaniya (Subsidiary of OOO SeverEnergia) OAO Arkticheskaya gazovaya kompaniya (Subsidiary of OOO SeverEnergia) OAO Arkticheskaya gazovaya kompaniya (Subsidiary of OOO SeverEnergia) OAO Arkticheskaya gazovaya kompaniya (Subsidiary of OOO SeverEnergia) ZAO Terneftegas OAO Sibneftegas OAO Sibneftegas 2034 2031 2031 2043 2031 2044 2026 2019 2029 2045 2018 2018 2018 2018 Life of field 2021 2023 2021 Management believes the Group has the right to extend its licenses beyond the initial expiration date under the existing legislation and intends to exercise this right on all of its fields. Environmental liabilities. The Group and its predecessor entities have operated in the oil and gas industry in the Russian Federation for many years. The enforcement of environmental regulation in the Russian Federation is evolving and the enforcement posture of government authorities is continually being reconsidered. The Group periodically evaluates its obligations under environmental regulations and, as obligations are determined, they are recognized as an expense immediately if no future benefit is discernible. Potential liabilities arising as a result of a change in interpretation of existing regulations, civil litigation or changes in legislation cannot be estimated. Under existing legislation, management believes that there are no probable liabilities, which will have a material adverse effect on the Group’s financial position, results of operations or cash flows. Legal contingencies. The Group is subject of, or party to a number of court proceedings (both as a plaintiff and a defendant) arising in the ordinary course of business. In the opinion of management, there are no current legal proceedings or other claims outstanding, which could have a material effect on the result of operations or financial position of the Group. 58 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 29 PRINCIPAL SUBSIDIARIES AND JOINT VENTURES The principal subsidiaries and joint ventures of the Group and respective ownership in the ordinary share capital at 31 December 2012 and 2011 are set out below: Ownership percent at 31 December: 2012 2011 Country of incorporation Principal activities Subsidiaries OOO NOVATEK-Yurkharovneftegas OOO NOVATEK-Tarkosaleneftegas OOO NOVATEK-Purovsky ZPK OOO NOVATEK-Transervice OOO NOVATEK-Ust-Luga OOO NOVATEK-AZK OOO NOVATEK-Chelyabinsk (formerly OOO Yamalgazresurs-Chelyabinsk) OOO Gazprom mezhregiongas Chelyabinsk (merged into OOO NOVATEK-Chelyabinsk in June 2012) 100 100 100 100 100 100 100 - OOO Gazprom mezhregiongas Kostroma 84.54 OOO NOVATEK-Perm OOO Yamalenergogas (merged into OOO NOVATEK-Perm in January 2012) OOO Yargeo Novatek Gas & Power GmbH Novatek Polska Sp. z o.o. Joint ventures OAO Yamal LNG OAO Sibneftegas ZAO Terneftegas OOO Yamal Development OOO SeverEnergia (includes a producing subsidiary, see Note 7) ZAO Nortgas 100 - 51 100 100 80 51 51 50 25.5 49 59 100 100 100 100 100 100 100 100 - 100 100 51 100 100 80 51 51 50 25.5 - Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Switzerland Poland Russia Russia Russia Russia Russia Russia Exploration and production Exploration and production Gas Condensate Processing Plant Transportation services Construction of transhipment and fractionation facilities Wholesale and retail trading Trading and marketing Trading and marketing Trading and marketing Trading and marketing Trading and marketing Exploration and development Trading and marketing Trading and marketing Exploration and development Exploration and production Exploration and development Holding company Holding company Exploration and production OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 30 RELATED PARTY TRANSACTIONS Transactions between NOVATEK and its subsidiaries, which are related parties of NOVATEK, have been eliminated on consolidation and are not disclosed in this Note. For the purposes of these consolidated financial statements, parties are generally considered to be related if one party has the ability to control the other party, is under common control, or can exercise significant influence over the other party in making financial and operational decisions. Management has used reasonable judgments in considering each possible related party relationship with attention directed to the substance of the relationship, not merely the legal form. Related parties may enter into transactions, which unrelated parties might not, and transactions between related parties may not be affected on the same terms, conditions and amounts as transactions between unrelated parties. Related parties – joint ventures(cid:3) Transactions (cid:584)(cid:570)(cid:584) Sibneftegas: Interest income on loans issued Oil and gas products sales Purchases of natural gas OOO Yamal Development: Interest income on loans issued OOO SeverEnergia: Interest income on loans issued Purchases of unstable gas condensate ZAO Terneftegas: Interest income on loans issued OAO Yamal LNG (from October 2011): Interest income on loans issued Other revenues (operator services sales) ZAO Nortgas (from 27 November 2012): Purchases of unstable gas condensate Year ended 31 December: 2012 2011 901 41 (5,272) - 145 (1,956) 45 17 97 (312) 1,023 39 (3,661) 1,325 247 - 5 167 15 - In October 2011, the Group disposed of a 20 percent equity stake in OAO Yamal LNG, and in accordance with the new shareholders’ agreement lost effective control over the entity, but joint control was retained (see Note 5); therefore, subsequent to that event, the Group’s balances and transactions with this entity are disclosed as related parties – equity investments. Related parties – joint ventures (cid:3) Balances (cid:584)(cid:570)(cid:584) Sibneftegas: Long-term loans receivable Interest on long-term loans receivable Short-term loans receivable Trade payables and accrued liabilities OOO Yamal Development: Long-term loans and receivables OOO SeverEnergia: Short-term loans receivable Interest on short-term loans receivable Trade payables and accrued liabilities At 31 December 2012 At 31 December 2011 (cid:3) 8,136 187 428 705 - - - 398 9,103 775 634 387 16,348 6,225 94 - 60 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 30 RELATED PARTY TRANSACTIONS (CONTINUED) Related parties – joint ventures (cid:3) Balances ZAO Terneftegas: Long-term loans receivable Interest on long-term loans receivable OAO Yamal LNG: Long-term loans receivable Long-term receivables Interest on long-term loans receivable ZAO Nortgas (from 27 November 2012): Trade payables and accrued liabilities At 31 December 2012 At 31 December 2011 (cid:3) 1,451 50 2,915 - 17 368 220 5 - 3,955 - - In September 2011, the Chairman of the Management Committee of NOVATEK acquired a controlling stake in OAO SIBUR Holding. As a result, the Group’s balances and transactions with this company and its subsidiaries following that date were disclosed as related parties – parties under control of key management personnel. In October 2012, the Group signed an agreement for the transport of stable gas condensate from the Purovsky Gas Condensate Plant to the Port of Vitino on the White Sea with OOO Transoil, an entity under control of a member of the Board of Directors of NOVATEK. The Group’s balances and transactions with this company are disclosed below as related parties – parties under control of key management personnel of the Group. Related parties – parties under control of key management personnel Year ended 31 December: 2012 2011 Transactions OAO SIBUR Holding and its subsidiaries (from 1 October 2011): Natural gas sales Purchases of natural gas Purchases of liquid hydrocarbons OOO Transoil: Liquid hydrocarbons transportation by rail 2,042 (9,434) (45) (472) - - - - Related parties – parties under control of key management personnel At 31 December 2012 At 31 December 2011 Balances OAO Pervobank: Cash and cash equivalents OAO SIBUR Holding and its subsidiaries: Long-term receivable Trade and other receivables Trade payables and accrued liabilities Prepayments and other current assets OOO Transoil: Trade payables and accrued liabilities Prepayments and other current assets 1,224 - 1,568 826 1,690 170 61 4,066 1,424 248 - - - - 61 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 30 RELATED PARTY TRANSACTIONS (CONTINUED) Key management compensation. The Group paid to key management personnel (members of the Board of Directors and the Management Committee) short-term compensation, including salary, bonuses, and excluding dividends the following amounts. Related parties – members of the key management personnel Board of Directors Management Committee (cid:3) Total compensation Year ended 31 December: 2012 2011 105 1,282 1,387 103 1,242 1,345 Such amounts include personal income tax and are net of payments to non-budget funds made by the employer. Some members of key management personnel have direct and/or indirect interests in the Group and receive dividends under general conditions based on their respective shareholdings. The Board of Directors consists of nine members. The Management Committee consisted of 15 members until 24 March 2011 and was subsequently reduced to eight members. 31 SEGMENT INFORMATION The Group’s activities are considered by the chief operating decision maker (hereinafter referred to as “CODM”, represented by the Management Committee of NOVATEK) to comprise one operating segment: “exploration, production and marketing”. Segment information is provided to the CODM in accordance with Regulations on Accounting and Reporting of the Russian Federation (“RAR”) with reconciling items largely representing adjustments and reclassifications recorded in the consolidated financial statements for the fair presentation in accordance with IFRS. The CODM assesses reporting segment performance based on income before income taxes, since income taxes are not allocated. No business segment assets or liabilities (except for capital expenditures for the period) are provided to the CODM for decision-making. Segment information for the year ended 31 December 2012 is as follows: For the year ended 31 December 2012 References External revenues Operating expenses Other operating income (loss) Interest expense Interest income Foreign exchange gain (loss) a a - e c f f Exploration, production and marketing Segment information as reported to CODM 211,885 (130,558) (292) (5,231) 1,479 4,358 211,885 (130,558) (292) (5,231) 1,479 4,358 Reconciling items (912) 4,783 428 1,995 252 133 Total per consolidated financial statements 210,973 (125,775) 136 (3,236) 1,731 4,491 Segment result 81,641 81,641 6,679 88,320 Share of profit (loss) of joint ventures, net of income tax Profit before income tax Depreciation, depletion and amortization Capital expenditures b, c f 15,286 36,021 15,286 36,021 (3,787) 7,533 (2,105) 86,215 11,499 43,554 62 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 31 SEGMENT INFORMATION (CONTINUED) Reconciling items mainly related to: a. b. c. d. e. f. different methodology of liquefied petroleum gas sales recognition under IFRS and the RAR which requires reclassification of external revenues and expenses for RR 951 million under IFRS; different methodology in calculating depreciation, depletion and amortization for oil and gas properties between IFRS (units of production method) and management accounting (straight-line method), which resulted in reversal of RR 3,987 million in operating expenses under IFRS; different methodology in the classification of depreciation, depletion and amortization for operating assets, which have not completed their statutory registration, between IFRS and management accounting, which resulted in the reclassification of RR 147 million from other operating income (loss) to depreciation, depletion and amortization in operating expenses under IFRS; different methodology in recognizing expenses relating to natural gas storage services and payroll (including share-based payments, pension obligation, discounting loans to employee and bonus accruals) between IFRS and management accounting, which resulted in additional transportation expenses of RR 216 million and additional payroll expenses of RR 1,962 million recorded in operating expenses under IFRS; different methodology in recognizing of exploration expenses, which resulted in the reversal of operating expenses of RR 2,364 million under IFRS; and different methodology in interest capitalization policy and certain recognition policy differences in capital expenditures between IFRS and management accounting, which resulted in additional capitalized interest and foreign exchange differences of RR 2,156 million and additional capital expenditures of RR 5,377 million under IFRS. Segment information for the year ended 31 December 2011 is as follows: For the year ended 31 December 2011 References External revenues Operating expenses Other operating income (loss) Interest expense Interest income Foreign exchange gain (loss) a a - e c, f g g Exploration, production and marketing Segment information as reported to CODM 176,340 (101,659) 12,950 (5,392) 3,137 (4,368) 176,340 (101,659) 12,950 (5,392) 3,137 (4,368) Reconciling items (1,067) 4,839 50,205 3,242 255 423 Total per consolidated financial statements 175,273 (96,820) 63,155 (2,150) 3,392 (3,945) Segment result 81,008 81,008 57,897 138,905 Share of profit (loss) of joint ventures, net of income tax Profit before income tax Depreciation, depletion and amortization Capital expenditures b, c g 12,925 30,510 12,925 30,510 (3,450) 7,521 (3,880) 135,025 9,475 38,031 63 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 31 SEGMENT INFORMATION (CONTINUED) Reconciling items mainly related to: a. b. c. d. e. f. g. different methodology of liquefied petroleum gas sales recognition under IFRS and the RAR which requires reclassification of external revenues and expenses for RR 998 million under IFRS; different methodology in calculating depreciation, depletion and amortization for oil and gas properties between IFRS (units of production method) and management accounting (straight-line method), which resulted in reversal of RR 3,892 million in operating expenses under IFRS; different methodology in the classification of depreciation, depletion and amortization for operating assets, which have not completed their statutory registration, between IFRS and management accounting, which resulted in the reclassification of RR 280 million from other operating income (loss) to depreciation, depletion and amortization in operating expenses under IFRS; different methodology in recognizing expenses relating to natural gas storage services and payroll (including share-based payments, pension obligation, discounting loans to employee and bonus accruals) between IFRS and management accounting, which resulted in additional transportation expenses of RR 37 million and additional payroll expenses of RR 233 million recorded in operating expenses under IFRS; different methodology in the recognition of impairment expenses between IFRS and management accounting, which resulted in net reversal of RR 755 million recorded in operating expenses under IFRS; different methodology in recognizing the gain on disposal of ownership interest in OAO Yamal LNG between IFRS and management accounting, which resulted in additional gain of RR 49,589 million recorded in other operating income (loss) under IFRS; and different methodology in interest capitalization policy and certain recognition policy differences in capital expenditures between IFRS and management accounting, which resulted in additional capitalized interest and foreign exchange differences of RR 3,942 million and additional capital expenditures of RR 3,579 million under IFRS. Geographical information. The Group operates in the following geographical areas: • Russian Federation – exploration, development, production and processing of hydrocarbons, and sales of natural gas, stable gas condensate, crude oil and related products; • USA – sales of stable gas condensate; • • Europe – sales of stable gas condensate, liquefied petroleum gas and crude oil; and Asian-Pacific Region (“APR”) – sales of stable gas condensate. Geographical information for the years ended 31 December 2012 and 2011 is as follows: For the year ended 31 December 2012 Russian Federation Europe USA APR Other Export duty Subtotal Total Outside Russian Federation Natural gas Stable gas condensate Liquefied petroleum gas Crude oil Oil and gas products 142,613 319 5,968 3,215 350 - 22,857 12,137 3,661 - - 8,614 - - - - 46,351 - - - - 3,597 - - - - (35,054) (2,506) (1,876) - - 142,613 46,684 15,599 5,000 350 46,365 9,631 1,785 - Oil and gas sales 152,465 38,655 8,614 46,351 3,597 (39,436) 57,781 210,246 Other revenues 642 85 - - - - 85 727 Total external revenues 153,107 38,740 8,614 46,351 3,597 (39,436) 57,866 210,973 64 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 31 SEGMENT INFORMATION (CONTINUED) For the year ended 31 December 2011 Russian Federation Europe USA APR Other Export duty Subtotal Total Outside Russian Federation Natural gas Stable gas condensate Liquefied petroleum gas Crude oil Oil and gas products 110,932 46 5,728 1,458 186 - 28,265 11,024 2,143 - - 17,920 - - - - 35,642 - - - - - 10 - - - (35,095) (2,326) (1,122) - - 46,732 8,708 1,021 - 110,932 46,778 14,436 2,479 186 Oil and gas sales 118,350 41,432 17,920 35,642 10 (38,543) 56,461 174,811 Other revenues 323 139 - - - - 139 462 Total external revenues 118,673 41,571 17,920 35,642 10 (38,543) 56,600 175,273 Revenues are based on the geographical location of customers even though all revenues are generated from assets located in the Russian Federation. Substantially all of the Group’s operating assets are located in the Russian Federation. Major customers. For the years ended 31 December 2012 and 2011, the Group has one and two major customers to whom individual annual revenues exceed 10 percent of total external revenues, which on an aggregate basis represent 19 percent and 30 percent of total external revenues, respectively. (cid:3) (cid:3) 32 EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES Net book value of assets value at 1 January Additions Disposals Reclassification in proved properties Transfers Net book value of assets at 31 December Liabilities Cash flows used for operating activities Cash flows used for investing activities 33 SUBSEQUENT EVENTS Year ended 31 December: 2012(cid:3) 2011 16,251 1,212 (940) (7,192) (584) 8,747 1,483 1,174 1,730 6,372 13,500 (1,921) (574) (1,126) 16,251 650 1,469 10,093 On 20 February 2013, the Group issued four-year non-convertible Russian rouble denominated Eurobonds in the amount of RR 14 billion with a coupon rate of 7.75 percent per annum. On 28 February 2013, the Group repaid a Russian rouble denominated loan in the amount of RR 15 billion obtained from OAO Sberbank. The loan was repaid ahead of its maturity schedule. On 1 March 2013, the Group repaid the US dollar denominated loan in the amount of US 200 million obtained from OAO Nordea bank. The loan was repaid ahead of its maturity schedule. 65 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 34 NEW ACCOUNTING PRONOUNCEMENTS The Group has reviewed new and revised accounting pronouncements that have been issued but are not yet effective for the Group and determined that the following may have an impact on the Group. IFRS 9, Financial Instruments: Classification and Measurement. IFRS 9, issued in November 2009, replaces those parts of IAS 39 relating to the classification and measurement of financial assets. IFRS 9 was further amended in October 2010 to address the classification and measurement of financial liabilities and in December 2011 to (i) change its effective date to annual periods beginning on or after 1 January 2015 and (ii) add transition disclosures. Key features of the standard are as follows: (cid:120) Financial assets are required to be classified into two measurement categories: those to be measured subsequently at fair value, and those to be measured subsequently at amortized cost. The decision is to be made at initial recognition. The classification depends on the entity’s business model for managing its financial instruments and the contractual cash flow characteristics of the instrument. (cid:120) An instrument is subsequently measured at amortized cost only if it is a debt instrument and both (i) the objective of the entity’s business model is to hold the asset to collect the contractual cash flows, and (ii) the asset’s contractual cash flows represent payments of principal and interest only (that is, it has only “basic loan features”). All other debt instruments are to be measured at fair value through profit or loss. (cid:120) All equity instruments are to be measured subsequently at fair value. Equity instruments that are held for trading will be measured at fair value through profit or loss. For all other equity investments, an irrevocable election can be made at initial recognition, to recognize unrealized and realized fair value gains and losses through other comprehensive income rather than profit or loss. There is to be no recycling of fair value gains and losses to profit or loss. This election may be made on an instrument-by-instrument basis. Dividends are to be presented in profit or loss, as long as they represent a return on investment. (cid:120) Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward unchanged to IFRS 9. The key change is that an entity will be required to present the effects of changes in own credit risk of financial liabilities designated at fair value through profit or loss in other comprehensive income. While adoption of IFRS 9 is mandatory from 1 January 2015, earlier adoption is permitted. The Group is considering the implications of the standard, the impact on the Group and the timing of its adoption by the Group. IFRS 10, Consolidated Financial Statements (issued in May 2011 and effective for annual periods beginning on or after 1 January 2013), replaces all of the guidance on control and consolidation in IAS 27, Consolidated and separate financial statements, and SIC-12, Consolidation—special purpose entities. IFRS 10 changes the definition of control so that the same criteria are applied to all entities to determine control. This definition is supported by extensive application guidance. IFRS 11, Joint Arrangements, (issued in May 2011 and effective for annual periods beginning on or after 1 January 2013), replaces IAS 31, Interests in Joint Ventures, and SIC-13, Jointly Controlled Entities—Non-Monetary Contributions by Ventures. Changes in the definitions have reduced the number of types of joint arrangements to two: joint operations and joint ventures. The existing policy choice of proportionate consolidation for jointly controlled entities has been eliminated. Equity accounting is mandatory for participants in joint ventures. 66 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 34 NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED) IFRS 12, Disclosure of Interest in Other Entities, (issued in May 2011 and effective for annual periods beginning on or after 1 January 2013), applies to entities that have an interest in a subsidiary, a joint arrangement, an associate or an unconsolidated structured entity. It replaces the disclosure requirements currently found in IAS 28, Investments in associates. IFRS 12 requires entities to disclose information that helps financial statement readers to evaluate the nature, risks and financial effects associated with the entity’s interests in subsidiaries, associates, joint arrangements and unconsolidated structured entities. To meet these objectives, the new standard requires disclosures in a number of areas, including significant judgments and assumptions made in determining whether an entity controls, jointly controls, or significantly influences its interests in other entities, extended disclosures on share of non-controlling interests in group activities and cash flows, summarized financial information of subsidiaries with material non-controlling interests, and detailed disclosures of interests in unconsolidated structured entities. The Group will adopt IFRS 10, IFRS 11 and IFRS 12 from January 1, 2013. The adoption of IFRS 10 and IFRS 12 is not expected to have a material impact on the Group’s financial position or operations but will require additional disclosures to be presented in the consolidated financial statements. IFRS 13, Fair value measurement, (issued in May 2011 and effective for annual periods beginning on or after 1 January 2013), aims to improve consistency and reduce complexity by providing a revised definition of fair value, and a single source of fair value measurement and disclosure requirements for use across IFRSs. The adoption of this standard is not expected to have a material impact on the Group’s financial position or operations. IAS 27, Separate Financial Statements, (revised in May 2011 and effective for annual periods beginning on or after 1 January 2013), was changed and its objective is now to prescribe the accounting and disclosure requirements for investments in subsidiaries, joint ventures and associates when an entity prepares separate financial statements. The guidance on control and consolidated financial statements was replaced by IFRS 10, Consolidated Financial Statements. The adoption of this amendment is not expected to have a material impact on the Group’s financial position or operations. IAS 28, Investments in Associates and Joint Ventures, (revised in May 2011 and effective for annual periods beginning on or after 1 January 2013). The amendment of IAS 28 resulted from the International Accounting Standards Board’s (“Board”) project on joint ventures. When discussing that project, the Board decided to incorporate the accounting for joint ventures using the equity method into IAS 28 because this method is applicable to both joint ventures and associates. With this exception, other guidance remained unchanged. The adoption of this amendment is not expected to have a material impact on the Group’s financial position or operations. Amendments to IAS 1, Presentation of Financial Statements (issued June 2011, effective for annual periods beginning on or after 1 July 2012), changes the disclosure of items presented in other comprehensive income. The amendments require entities to separate items presented in other comprehensive income into two groups, based on whether or not they may be reclassified to profit or loss in the future. The suggested title used by IAS 1 has changed to ‘statement of profit or loss and other comprehensive income’. The Group expects the amended standard to change presentation of its consolidated financial statements, but have no impact on measurement of transactions and balances. Amended IAS 19, Employee Benefits (issued in June 2011, effective for periods beginning on or after 1 January 2013), makes significant changes to the recognition and measurement of defined benefit pension expense and termination benefits, and to the disclosures for all employee benefits. The standard requires recognition of all changes in the net defined benefit liability (asset) when they occur, as follows: (i) service cost and net interest in profit or loss; and (ii) remeasurements in other comprehensive income. The Group does not expect these amendments to have a material impact on the Group's financial position or operations. 67 OAO NOVATEK Notes to the Consolidated Financial Statements (in Russian roubles, [tabular amounts in millions] unless otherwise stated) 34 NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED) Amendments to IFRS 7, Disclosures—Offsetting Financial Assets and Financial Liabilities (issued in December 2011 and effective for annual periods beginning on or after 1 January 2013). The amendment requires disclosures that will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements, including rights of set-off. The amendment will have an impact on disclosures but will have no effect on measurement and recognition of financial instruments. Amendments to IAS 32, Offsetting Financial Assets and Financial Liabilities (issued in December 2011 and effective for annual periods beginning on or after 1 January 2014). The amendment added application guidance to IAS 32 to address inconsistencies identified in applying some of the offsetting criteria. This includes clarifying the meaning of ‘currently has a legally enforceable right of set-off’ and that some gross settlement systems may be considered equivalent to net settlement. The Group is considering the implications of the amendment, the impact on the Group and the timing of its adoption by the Group. Improvements to International Financial Reporting Standards (issued in May 2012 and effective for annual periods beginning on or after 1 January 2013). The improvements consist of changes to five standards. IFRS 1 was amended to (i) clarify that an entity that resumes preparing its IFRS financial statements may either repeatedly apply IFRS 1 or apply all IFRSs retrospectively as if it had never stopped applying them, and (ii) to add an exemption from applying IAS 23, Borrowing costs, retrospectively by first-time adopters. IAS 1 was amended to clarify that explanatory notes are not required to support the third balance sheet presented at the beginning of the preceding period when it is provided because it was materially impacted by a retrospective restatement, changes in accounting policies or reclassifications for presentation purposes, while explanatory notes will be required when an entity voluntarily decides to provide additional comparative statements. IAS 16 was amended to clarify that servicing equipment that is used for more than one period is classified as property, plant and equipment rather than inventory. IAS 32 was amended to clarify that certain tax consequences of distributions to owners should be accounted for in the income statement as was always required by IAS 12. IAS 34 was amended to bring its requirements in line with IFRS 8. IAS 34 will require disclosure of a measure of total assets and liabilities for an operating segment only if such information is regularly provided to chief operating decision maker and there has been a material change in those measures since the last annual consolidated financial statements. The Group does not expect these amendments to have a material impact on the Group's financial position or operations. 68 OAO NOVATEK Unaudited Supplemental Oil and Gas Disclosures UNAUDITED SUPPLEMENTAL OIL AND GAS DISCLOSURES The accompanying consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”). In the absence of specific IFRS guidance, the Group has reverted to other relevant disclosure standards, mainly US GAAP, that are consistent with norms established for the oil and gas industry. While not required under IFRS, this section provides unaudited supplemental information on oil and gas exploration and production activities but excludes disclosures regarding the standardized measures of discounted cash flows related to oil and gas activities. The Group’s exploration and production activities are mainly within the Russian Federation; therefore, all of the information provided in this section pertains to this country. The Group operates through various oil and gas production subsidiaries, and also has an interest in oil and gas companies that are accounted for under the equity method. Oil and Gas Exploration and Development Costs The following tables set forth information regarding oil and gas acquisition, exploration and development activities. The amounts reported as costs incurred include both capitalized costs and costs charged to expense during the years ended 31 December 2012 and 2011 (amounts in millions of Russian roubles). Costs incurred in exploration and development activities Acquisition of unproved properties Exploration costs Development costs Total costs incurred in exploration and development activities The share of the Group in joint ventures Capitalized costs relating to oil and gas producing activities Wells and related equipment and facilities Support equipment and facilities Uncompleted wells, equipment and facilities Total capitalized costs relating to oil and gas producing activities Less: accumulated depreciation, depletion and amortization Net capitalized costs relating to oil and gas producing activities The share of the Group in joint ventures Year ended 31 December: 2012 2011 - 2,028 29,988 32,016 80,777 7,053 2,447 23,493 32,993 2,051 At 31 December 2012 At 31 December 2011 157,048 38,922 17,312 213,282 (46,131) 167,151 226,887 145,063 30,717 12,862 188,642 (35,540) 153,102 150,449 The Group has reclassified capitalized costs relating to oil and gas producing activities of Yamal LNG due to cessation of control on 6 October 2011 and the subsequent accounting of its activities under the equity method (see Note 5). 69 OAO NOVATEK Unaudited Supplemental Oil and Gas Disclosures UNAUDITED SUPPLEMENTAL OIL AND GAS DISCLOSURES (CONTINUED) Results of Operations for Oil and Gas Producing Activities The Group’s results of operations for oil and gas producing activities are shown below. The results of operations for oil and gas producing activities do not include general corporate overhead or its associated tax effects. Income tax is based on statutory rates. In the following table, revenues from oil and gas sales are comprised of the sale of the Group’s hydrocarbons and include processing costs, related to the Group’s processing facilities as well as transportation expenses to the customer (amounts in millions of Russian roubles). Revenues from oil and gas sales Lifting costs Transportation expenses Taxes other than income tax Depreciation, depletion and amortization Exploration expenses Year ended 31 December: 2012 2011 184,629 162,975 (7,599) (57,888) (16,546) (10,589) (2,022) (5,403) (46,216) (16,307) (8,937) (1,819) Total production costs (94,644) (78,682) Results of operations for oil and gas producing activities before income tax Less: related income tax expenses Results of operations for oil and gas producing activities Share of profit (loss) of joint ventures Total results of operations for oil and gas producing activities Proved Oil and Gas Reserves 89,985 (17,997) 71,988 729 72,717 84,293 (16,859) 67,434 (555) 66,879 The Group’s oil and gas reserves estimation and reporting process involves an annual independent third party reserve appraisal as well as internal technical appraisals of reserves. The Group maintains its own internal reserve estimates that are calculated by qualified technical staff working directly with the oil and gas properties. The Group’s technical staff periodically updates reserve estimates during the year based on evaluations of new wells, performance reviews, new technical information and other studies. The Group estimates its oil and gas reserves in accordance with rules promulgated by the Securities and Exchange Commission (SEC) for proved reserves. The oil and gas reserve estimates reported below are determined by the Group’s independent petroleum reservoir engineers, DeGolyer and MacNaughton (“D&M”). The Group provides D&M annually with engineering, geological and geophysical data, actual production histories and other information necessary for the reserve determination. The Group’s and D&M’s technical staffs meet to review and discuss the information provided, and upon completion of this process, senior management reviews and approves the final reserve estimates issued by D&M. The following reserve estimates were prepared using standard geological and engineering methods generally accepted by the petroleum industry. The method or combination of methods used in the analysis of each reservoir is tempered by experience with similar reservoirs, stages of development, quality and completeness of basic data, and production history. 70 OAO NOVATEK Unaudited Supplemental Oil and Gas Disclosures UNAUDITED SUPPLEMENTAL OIL AND GAS DISCLOSURES (CONTINUED) The following information presents the quantities of proved oil and gas reserves and changes thereto as at and for the years ended 31 December 2012 and 2011. Extensions of production licenses are assumed to be at the discretion of the Group. Management believes that proved reserves should include quantities which are expected to be produced after the expiry dates of the Group’s production licenses. The Group’s licenses for exploration and production expire between 2018 and 2045, with the most significant licenses for Yurkharovskoye and East-Tarkosalinskoye fields, expiring in 2034 and 2043, respectively. Legislation of the Russian Federation states that, upon expiration, a license is subject to renewal at the initiative of the license holder provided that further exploration, appraisal, production or remediation activities are necessary and provided that the license holder has not violated the terms of the license. Management intends to extend its licenses for properties expected to produce beyond the license expiry dates. Proved reserves are defined as the estimated quantities of oil and gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic conditions. In some cases, substantial new investment in additional wells and related support facilities and equipment will be required to recover such proved reserves. Due to the inherent uncertainties and the limited nature of reservoir data, estimates of underground reserves are subject to change over time as additional information becomes available. Proved developed reserves are those reserves which are expected to be recovered through existing wells with existing equipment and operating methods. Undeveloped reserves are those reserves which are expected to be recovered as a result of future investments to drill new wells, to re-complete existing wells and/or install facilities to collect and deliver the production. Net reserves exclude quantities due to others when produced. The reserve quantities below include 100 percent of the net proved reserve quantities attributable to the Group’s consolidated subsidiaries and the Group’s ownership percentage of the net proved reserves quantities of the joint ventures. A portion of the Group’s total proved reserves are classified as either developed non-producing or undeveloped. Of the non-producing reserves, a portion represents existing wells which are to be returned to production at a future date. For convenience, reserves estimates are provided both in English and Metric units. 71 OAO NOVATEK Unaudited Supplemental Oil and Gas Disclosures UNAUDITED SUPPLEMENTAL OIL AND GAS DISCLOSURES (CONTINUED) Net proved reserves of natural gas are presented below. Net proved reserves Group’s share in joint ventures Billions of cubic feet Billions of cubic meters Billions of cubic feet Billions of cubic meters Total net proved reserves Billions of cubic meters Billions of cubic feet Reserves at 31 December 2010 41,585 1,178 6,057 171 47,642 1,349 Changes attributable to: Revisions of previous estimates Extension and discoveries Disposals Reclassifications Production (106) 3,398 (3,331) (13,323) (1,676) (3) 97 (95) (377) (48) 370 676 - 13,323 (190) 11 19 - 377 (5) 264 4,074 (3,331) - (1,866) 8 116 (95) - (53) Reserves at 31 December 2011 26,547 752 20,236 573 46,783 1,325 Changes attributable to: Revisions of previous estimates Extension and discoveries Acquisitions (*) Production 231 738 12,717 (1,781) 6 21 360 (50) (9) 1,018 2,729 (211) - 29 77 (6) 222 1,756 15,446 (1,992) 6 50 437 (56) Reserves at 31 December 2012 38,452 1,089 23,763 673 62,215 1,762 Net proved developed reserves (included above) At 31 December 2010 At 31 December 2011 At 31 December 2012 22,515 20,763 20,053 Net proved undeveloped reserves (included above) At 31 December 2010 At 31 December 2011 At 31 December 2012 19,070 5,784 18,399 638 588 568 540 164 521 2,536 2,348 3,222 3,521 17,888 20,541 71 66 91 100 507 582 25,051 23,111 23,275 709 654 659 22,591 23,672 38,940 640 671 1,103 (*) – the acquisitions include the first time reserve estimation for the Salmanovskoye (Utrenneye) and Geofizicheskoye fields, that were acquired late in 2011 and additionally explored in 2012. The net proved reserves reported in the table above included reserves of natural gas attributable to non-controlling interest of 128 billion of cubic feet and 4 billion of cubic meters and 120 billion of cubic feet and 4 billion of cubic meters at 31 December 2012 and 2011, respectively. 72 OAO NOVATEK Unaudited Supplemental Oil and Gas Disclosures UNAUDITED SUPPLEMENTAL OIL AND GAS DISCLOSURES (CONTINUED) Net proved reserves of crude oil, gas condensate and natural gas liquids are presented below. Net proved reserves Millions of barrels Millions of metric tons Group’s share in joint ventures Millions of barrels Millions of metric tons Total net proved reserves Millions of metric tons Millions of barrels Reserves at 31 December 2010 566 68 103 13 669 81 Changes attributable to: Revisions of previous estimates Extension and discoveries Disposals Reclassifications Production 10 116 (34) (138) (35) Reserves at 31 December 2011 485 Changes attributable to: Revisions of previous estimates Extension and discoveries Acquisitions (*) Production Reserves at 31 December 2012 2 13 78 (35) 543 Net proved developed reserves (included above) At 31 December 2010 At 31 December 2011 At 31 December 2012 304 282 269 Net proved undeveloped reserves (included above) At 31 December 2010 At 31 December 2011 At 31 December 2012 262 203 274 1 14 (4) (16) (4) 59 - 1 9 (4) 65 36 33 32 32 26 33 4 38 - 138 - 283 (37) 40 85 (1) 370 - - 26 103 283 344 1 4 - 16 - 34 (4) 3 10 - 43 - - 3 13 34 40 14 154 (34) - (35) 768 (35) 53 163 (36) 913 304 282 295 365 486 618 2 18 (4) - (4) 93 (4) 4 19 (4) 108 36 33 35 45 60 73 (*) – the acquisitions include the first time reserve estimation for the Salmanovskoye (Utrenneye) and Geofizicheskoye fields, that were acquired late in 2011 and additionally explored in 2012. The net proved reserves reported in the table above included reserves of crude oil, gas condensate and natural gas liquids attributable to non-controlling interest of 17 million of barrels and 2 million of metric tons and 16 million of barrels and 2 million of metric tons at 31 December 2012 and 2011, respectively. In November 2012, the Group acquired 49 percent of the outstanding ordinary shares of ZAO Nortgas, which holds license on North-Urengoyskoye field (see Note 5). In October 2011, the Group’s effective control over OAO Yamal LNG, the holder of the South-Tambeyskoye field, ceased. As a result, the Group’s interest in Yamal LNG is accounted for using the equity method (see Note 5). 73 OAO NOVATEK Contact Information OAO NOVATEK was incorporated as a joint stock company in accordance with the Russian law and is domiciled in the Russian Federation. The Group’s registered office is: Ulitsa Pobedy 22a 629850 Tarko-Sale Yamal-Nenets Autonomous Region Russian Federation The Group’s office in Moscow is: Ulitsa Udaltsova 2 119415 Moscow Russian Federation Telephone: Fax: 7 (495) 730-60-00 7 (495) 721-22-53 www.novatek.ru 74 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations as of 31 December 2012 and for the year then ended in conjunction with our audited consolidated financial statements as of and for the years ended 31 December 2012 and 2011. The consolidated financial statements and the related notes thereto have been prepared in accordance with International Financial Reporting Standards (IFRS). The financial and operational information contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” comprises information of OAO NOVATEK and its consolidated subsidiaries (hereinafter jointly referred to as “we” or the “Group”). OVERVIEW We are Russia’s largest independent natural gas producer and the second-largest producer of natural gas in Russia after Gazprom, in each case according to the Central Dispatch Administration of the Fuel and Energy Complex (the “CDU-TEK”) for 2012. In terms of proved natural gas reserves, we are also the second largest holder of natural gas resources in Russia after Gazprom, under the Petroleum Resources Management System (“PRMS”) reserve reporting methodology. Our exploration, development, production and processing of natural gas, gas condensate and crude oil have been conducted primarily within the Russian Federation, and, in accordance with Russian law, we sell our produced natural gas volumes exclusively in the Russian domestic market. We export our stable gas condensate directly to international markets, while our liquefied petroleum gas (“LPG”) and crude oil are generally delivered to both international (including the Commonwealth of Independent States (“CIS”)) and domestic markets. RECENT DEVELOPMENTS In February 2013, the Group issued four-year Russian rouble denominated Eurobonds in the aggregate amount of RR 14 billion with the annual coupon rate of 7.75%. In December 2012, the Group acquired 82% of equity interest in OOO Gazprom mezhregiongas Kostroma (“Gazprom mezhregiongas Kostroma”) to support and expand natural gas sales opportunities in the Kostroma region. Gazprom mezhregiongas Kostroma is a regional natural gas trader in the Kostroma region of the Russian Federation. In December 2012, the Group established OOO NOVATEK Moscow region, a wholly owned subsidiary, to support the Group’s current natural gas deliveries to the Moscow region, as well as to expand sales in the region. In December 2012, the Group issued ten-year USD denominated Eurobonds in the aggregate amount of USD one billion with a coupon rate of 4.422% per annum. In November 2012, the Group acquired a 49% ownership interest in ZAO Nortgas (“Nortgas”) for total consideration of USD 1,375 million. Nortgas is a Russian oil and gas production company that holds the production license for the North-Urengoyskoye field (expires in 2018), located in the Yamal Nenets Autonomous Region (“YNAO”), which is located in a close proximity to our transport and processing infrastructure. The estimated proved reserves appraised under the PRMS reserve methodology totalled 186 billion cubic meters (bcm) of natural gas and 25 million tons of liquid hydrocarbons as of 31 December 2012, for combined total of 1.4 billion barrels of oil equivalent. In October 2012, we launched the fourth stage of the second phase development at our Yurkharovskoye field, which allows achieving design production capacity of the field. The fourth stage complex includes two gas treatment trains with total annual capacity of seven billion cubic meters. The fourth stage launch increases natural gas production at the field to a plateau level of 36.5 bcm per annum. 1 In 2012, the Group signed long-term natural gas purchase and sales contracts with third parties on the European market. The gas purchase and sales contracts have been signed for a period of 10 years starting from 1 October 2012 with the total volume of natural gas supplied over this period is estimated to be approximately 210 terawatt-hours (or approximately 20 bcm). The financial result from natural gas trading activities, including the effect from changes in fair value of gas contracts, was recorded in the consolidated statement of income within other operating profit (loss). During 2012, our joint venture OOO SeverEnergia (“SeverEnergia”) launched the first and the second phases of the Samburgskoye field with combined annual natural gas production capacity of approximately 4.6 bcm and 650 thousand tons of gas condensate. In November 2011, the Group acquired OOO Gazprom mezhregiongas Chelyabinsk (“Gazprom mezhregiongas Chelyabinsk”), a regional natural gas trader, serving the Chelyabinsk region of the Russian Federation, to support and expand the Group’s natural gas sales commercial operations in this region. In September 2011, the Group increased its equity interest in OAO Yamal LNG from 51% to 100% and subsequently disposed of a 20% interest in the company in October 2011 to TOTAL S.A., the Group’s strategic partner in the Yamal LNG project. The Yamal LNG project plans to construct a natural gas liquefaction plant comprising three trains of 5.5 million tons per annum to exploit the hydrocarbon resources of the South- Tambeyskoye field, located on the Yamal peninsula. In June 2011, the Group took part in a tender organized by the Federal Agency for the Use of Natural Resources of the Russian Federation for four licenses in the YNAO: exploration and production licenses for the Salmanovskoye (Utrenneye) and Geofizicheskoye fields, as well as geological studies and production licenses for the North-Obskiy and East-Tambeyskiy license areas. In August 2011, the Russian Government approved the transfer of these licenses to us for RR 6.9 billion in total consideration. The estimated proved reserves at our Salmanovskoye (Utrenneye) and Geofizicheskoye fields appraised under the PRMS reserve methodology totalled 492 billion cubic meters (bcm) of natural gas and 14 million tons of liquid hydrocarbons as of 31 December 2012. Our combined resources at North-Obskiy and East-Tambeyskiy license areas according to the Russian reserve classification category D1 totalled 1,763 bcm of natural gas and 221 million tons of liquid hydrocarbons. 2 SELECTED DATA millions of Russian roubles except as stated Financial results Total revenues (net of VAT, export duties, excise and fuel taxes) Operating expenses Profit attributable to shareholders of OAO NOVATEK Normalized profit attributable to shareholders of OAO NOVATEK (1) EBITDA (2) Normalized EBITDA (3) Normalized EBITDAX (4) Earnings per share (in Russian roubles) Normalized Earnings per share (in Russian roubles) (5) Operating results Natural gas sales volumes (million cubic meters) Stable gas condensate sales volumes (thousand tons) Liquefied petroleum gas sales volumes (thousand tons) Crude oil sales volumes (thousand tons) Total hydrocarbons production (million barrels of oil equivalent) (6) Total daily production (thousand barrels of oil equivalent per day) (6) Cash flow results Net cash provided by operating activities Capital expenditures (7) Free cash flow (8) Year ended 31 December: 2011 2012 Change % 210,973 (125,775) 69,458 69,518 95,106 95,166 97,188 22.89 22.91 58,880 2,847 905 442 405.1 1,107 75,825 43,554 32,271 175,273 (96,820) 119,655 56,707 148,349 85,401 87,220 39.45 18.69 53,667 2,984 880 242 380.6 1,043 71,907 31,161 40,746 20.4% 29.9% (42.0%) 22.6% (35.9%) 11.4% 11.4% (42.0%) 22.6% 9.7% (4.6%) 2.8% 82.6% 6.4% 6.1% 5.4% 39.8% (20.8%) (1) Normalized profit attributable to shareholders of OAO NOVATEK represents profit attributable to shareholders of OAO NOVATEK excluding net gain (loss) on disposal of interest in subsidiaries. (2) EBITDA represents profit (loss) attributable to shareholders of OAO NOVATEK adjusted for the add-back of net impairment expenses (reversals), income tax expense and finance income (expense) from the Consolidated Statement of Income, income (loss) from changes in fair value of derivative financial instruments from the “Financial instruments and financial risk factors” in the notes to the consolidated financial statements and depreciation, depletion and amortization from the Consolidated Statement of Cash Flows. (3) Normalized EBITDA represents EBITDA excluding net gain (loss) on disposal of interest in subsidiaries. (4) Normalized EBITDAX represents EBITDA as adjusted for the add-back of exploration expenses and excludes net gain (loss) on disposal of interest in subsidiaries. (5) Normalized Earnings per share represents Earnings per share adjusted for net gain (loss) on disposal of interest in subsidiaries. (6) Total hydrocarbons production and total daily production are calculated based on net production, including our proportionate share in the production of our joint ventures. (7) Capital expenditures represent additions to property, plant and equipment excluding prepayments for participation in tender for mineral licenses. (8) Free cash flow represents the excess of Net cash provided by operating activities over Capital expenditures. 3 Reconciliation of adjusted (cid:40)(cid:37)(cid:44)(cid:55)(cid:39)(cid:36)(cid:3) (cid:68)(cid:81)(cid:71)(cid:3) (cid:40)(cid:37)(cid:44)(cid:55)(cid:39)(cid:36)(cid:59)(cid:3) (cid:87)(cid:82)(cid:3) (cid:83)(cid:85)(cid:82)(cid:191)(cid:87) OAO NOVATEK is as follows: (loss) attributable to shareholders of millions of Russian roubles (cid:51)(cid:85)(cid:82)(cid:191)(cid:87)(cid:3)(cid:11)(cid:79)(cid:82)(cid:86)(cid:86)(cid:12)(cid:3)(cid:68)(cid:87)(cid:87)(cid:85)(cid:76)(cid:69)(cid:88)(cid:87)(cid:68)(cid:69)(cid:79)(cid:72)(cid:3)(cid:87)(cid:82)(cid:3)(cid:86)(cid:75)(cid:68)(cid:85)(cid:72)(cid:75)(cid:82)(cid:79)(cid:71)(cid:72)(cid:85)(cid:86)(cid:3)(cid:82)(cid:73)(cid:3)(cid:50)(cid:36)(cid:50)(cid:3)(cid:49)(cid:50)(cid:57)(cid:36)(cid:55)(cid:40)(cid:46) Depreciation, depletion and amortization Net impairment expenses Loss (income) from changes in fair value of derivative financial instruments Total finance expense (income) Total income tax expense EBITDA Net loss (gain) on disposal of interest in subsidiaries Normalized EBITDA Exploration expenses Normalized EBITDAX Year ended 31 December: 2011 2012 Change % 69,458 11,499 325 36 (2,986) 16,774 95,106 60 95,166 2,022 97,188 119,655 9,475 782 - 2,703 15,734 (42.0%) 21.4% (58.4%) n/a n/a 6.6% 148,349 (35.9%) (62,948) 85,401 1,819 87,220 n/a 11.4% 11.2% 11.4% 4 SELECTED MACRO-ECONOMIC DATA Exchange rate, Russian roubles for one US dollar (1) 1 quarter 2 quarter 3 quarter 4 quarter Year 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 Change Y-o-Y, % At the beginning of the period At the end of the period Average for the period Depreciation (appreciation) of Russian rouble to US dollar 32.20 29.33 30.26 30.48 28.43 29.27 29.33 32.82 31.01 28.43 28.08 27.99 32.82 30.92 32.01 28.08 31.88 29.05 30.92 30.37 31.08 31.88 32.20 31.23 32.20 30.37 31.09 30.48 32.20 29.39 5.6% (5.7%) 5.8% (8.9%) (6.7%) 11.9% (1.2%) (5.8%) 13.5% (1.8%) 1.0% (5.7%) 5.6% n/a (1) According to the Central Bank of Russian Federation (CBR). The average rates are calculated as the average of the daily exchange rates on each business day (which rate is announced by the CBR for each such business day) and on each non- business day (which rate is equal to the exchange rate on the previous business day). (cid:404)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:404)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:404) Crude oil prices, USD / bbl 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 1 quarter 2 quarter 3 quarter 4 quarter Year Change Y-o-Y, % WTI (2) At the end of the period Average for the period 103.0 103.0 106.7 94.6 85.0 93.5 95.4 102.3 92.1 92.2 79.2 89.5 91.8 88.2 98.8 94.1 91.8 94.2 98.8 95.1 (7.1%) (0.9%) Brent (3) At the end of the period Average for the period 123.5 118.6 116.9 105.4 94.5 108.3 111.5 117.0 111.0 109.5 105.2 113.4 110.0 110.1 106.5 109.4 110.0 111.7 106.5 111.3 Urals (3) At the end of the period Average for the period 120.0 116.9 113.1 102.6 94.2 106.6 110.1 113.7 109.9 108.9 102.3 111.5 108.1 108.8 104.3 108.7 108.1 110.4 104.3 109.1 3.3% 0.4% 3.6% 1.2% (2) Based on New York Mercantile Exchange Light Sweet prices provided by Reuters to Platts. (3) Based on Brent (Dtd) prices and Russian Urals/ESPO spot assessments prices as provided by Reuters to Platts. ESPO stands for East Siberian Pipeline Ocean crude oil. (cid:404)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:404)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:404) Propane-butane mix prices, USD / ton (4) 1 quarter 2 quarter 3 quarter 4 quarter Year 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 Change Y-o-Y, % At the end of the period Average for the period 837.5 782.6 740.0 734.6 612.5 786.4 814.0 795.9 812.5 720.7 890.0 834.4 840.0 829.6 808.5 847.5 840.0 779.8 808.5 803.5 3.9% (2.9%) (4) Based on spot prices for propane-butane mix at the Belarusian-Polish border (DAF, Brest) as provided by Argus. (cid:404)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:404)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:404) Export duties, USD / ton (5) 1 quarter 2 quarter 3 quarter 4 quarter Year 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 Change Y-o-Y, % Crude oil, stable gas condensate 411.2 400.8 At the end of the period Average for the period LPG 365.0 343.0 419.8 443.0 462.1 446.5 393.8 366.6 444.1 442.5 396.5 406.6 406.6 403.7 396.5 404.3 406.6 408.9 (2.5%) (1.1%) At the end of the period Average for the period 157.3 180.0 150.2 166.1 237.1 197.4 189.8 137.0 76.2 92.7 192.0 182.6 197.4 187.4 221.8 218.3 197.4 164.4 221.8 176.0 (11.0%) (6.6%) (5) Export duties are determined by the Government of the Russian Federation in US dollars and are paid in Russian roubles. 5 CERTAIN FACTORS AFFECTING OUR RESULTS OF OPERATIONS Current financial market conditions The economic instability in the Euro-Zone has appeared to subside with the various measures taken by the respective governments, Central Banks and other quasi-governmental financial institutions. Although the main financial and economic issues plaguing the Euro-Zone over the twelve months remains in the forefront of present discussions, we will continue to monitor the credit situation very closely and take various measures, we deem necessary, to ensure the integrity of our financial condition and mitigate counter-party credit exposure from our natural gas and liquid hydrocarbon sales. In addition, we continue to take proactive steps to ensure the safety of our excess funds deposited with both domestic and international banks, as well as limit our risk exposure from prepayments to various service providers. Presently, our cash and deposits are diversified and maintained in banks that we believe are well capitalized in accordance with international capital adequacy rules. We have reviewed our capital expenditure program for the upcoming year and have concluded that we have sufficient liquidity, through current internal cash flows and short-term borrowing facilities, to adequately fund our core natural gas business operations and planned capital expenditure program. Management will continue to closely monitor the economic environment in Russia, as well as the domestic and international capital markets to determine if any further corrective and/or preventive measures are required to sustain and grow our business. In addition, we will continue to assess the trends in the capital markets for opportunities to access long-term funding at a reasonable cost to the Group commensurate with our investment grade credit ratings and our capital requirements. Exchange rate volatility between the Russian rouble and the US dollar exchange rate may significantly influence the Group’s reporting financial results due to the fact that a significant portion of our long-term debt is denominated in US dollars (see “Profit attributable to shareholders and earnings per share” below). Natural gas prices As an independent natural gas producer, we are not subject to the Russian Government’s regulation of natural gas prices, except for those volumes delivered to residential customers, although the prices we can achieve on the domestic market are strongly influenced by the prices regulated by the Federal Tariffs Service (“FTS”), a governmental agency, and present market conditions. In February 2011, the Government of the Russian Federation announced certain revisions to the domestic natural gas market liberalization plan. According to the revised plan, the target date for full liberalization of the domestic natural gas market is 1 January 2015 but there are various Governmental discussions indicating that this program may be further extended. The regulation of the domestic natural gas price prior to 2015 will be based on the netback parity of natural gas prices on the domestic and export markets. As part of the liberalization plan, the FTS increased the regulated price for natural gas by 15% effective from 1 January 2011 and 1 July 2012, respectively. According to the Russian Government Directive No.1205 on Improvement of State Gas Price Regulation as of 31 December 2010, starting from 2013 natural gas prices for sales to end-customers on the domestic market (excluding residential customers) are set for each region of the Russian Federation on a quarterly basis using a price formula within the range of maximum and minimum wholesale price. The maximum and minimum wholesale gas prices may be revised semiannually – as of 1 January and 1 July. In addition, the wholesale gas prices may be recalculated twice a year (as of 1 April and 1 October) based on changes in oil products prices on the European markets within a range of +/-3% from the average prices set previously. According to the Forecast of Socio-economic Development for 2013, the regulated natural gas prices will be increased by 15% effective in 2013, 2014 and 2015. The FTS under the Governmental decisions may modify the percentages published, as well as to potentially prolong the timetable toward market price liberalization based on market conditions and other factors. 6 The specific terms for delivery of natural gas affect our average realized prices. Natural gas sold “ex-field” is sold primarily to wholesale gas traders, in which case the buyer is responsible for the payment of gas transportation tariffs. Sales to wholesale gas traders allow us to diversify our natural gas sales without incurring additional commercial expenses. Historically, we have realized higher prices and net margins for natural gas volumes sold directly to end-customers, as the gas transportation tariff is included in the contract price and no retail margin is lost to wholesale gas traders. However, the historical norm may or may not prevail in the present or future market situations. In December 2011, we commenced natural gas sales to residential customers at regulated prices in the Chelyabinsk region as a result of the acquisition of a regional gas trader Gazprom mezhregiongas Chelyabinsk. In December 2012, we acquired a regional gas trader Gazprom mezhregiongas Kostroma and commenced natural gas sales to residential customers at regulated prices in the Kostroma region in 2013. We disclose such sales within our end-customers category. In 2012, our average natural gas price to end-customers and ex-field price increased by 7.4% and 9.1%, respectively, whereas our average transportation expense for the delivery of natural gas to end-customers increased by 2.2% primarily due to a 7.0% increase in the average transportation tariff set by the FTS effective 1 July 2012 (see “Transportation tariffs” below). As a result, our average netback price on end-customers sales increased by 11.9%, while our total average natural gas price excluding transportation expense increased by 11.3% compared to respective prices in 2011. The following table shows our average realized natural gas sales prices (net of VAT), excluding volumes purchased for resale in the location of our end-customers: Russian roubles per mcm Average natural gas price to end-customers (1) Average natural gas transportation expense for sales to end-customers Average natural gas netback price on end-customer sales Average natural gas price ex-field (wholesale traders) Total average natural gas price excluding transportation expense (1) Includes cost of transportation. Year ended 31 December: 2011 2012 Change % 2,821 (1,234) 1,589 1,518 1,566 2,627 (1,207) 1,420 1,392 1,407 7.4% 2.2% 11.9% 9.1% 11.3% Crude oil, stable gas condensate, liquefied petroleum gas and oil products prices Crude oil, stable gas condensate, LPG and oil products prices on international markets have historically been volatile depending on, among other things, the balance between supply and demand fundamentals, the ability and willingness of oil producing countries to sustain or change production levels to meet changes in global demand and potential disruptions in global crude oil supplies due to war, geopolitical developments, terrorist activities or natural disasters. The actual prices we receive for our liquid hydrocarbons on both the domestic and international markets are dependent on many external factors beyond the control of management, such as movements in international benchmark crude oil prices. Crude oil that we sell bound for international markets is transported through the OAO AK Transneft (“Transneft”) pipeline system where it is blended with other crude oil of varying qualities to produce an export blend commonly referred to as “Urals blend”, which normally (or historically) trades at a discount to the international benchmark Brent crude oil. Volatile movements in benchmark crude oil prices can have a positive and/or negative impact on the ultimate prices we receive for our liquids volumes sold on both the domestic and international markets, among many other factors. Our stable gas condensate, LPG and crude oil and oil products’ prices on both international and domestic markets include transportation expense in accordance with the specific terms of delivery. In 2012, our stable gas condensate export delivery terms were cost and freight (CFR), or delivery to the port of destination ex-ship (DES), or delivery at point of destination (DAP), or priced at cost, insurance and freight (CIF), while in 2011 our delivery terms were either CFR, DES, DAP, CIF or delivery at terminal (DAT). Our average stable gas condensate export contract price, including export duties, in 2012, was approximately USD 933 per ton compared to approximately USD 931 per ton in 2011. 7 In 2012, as well as in 2011, our crude oil export delivery terms were DAP (Feneshlitke, Hungary). Our average crude oil export contract price, including export duties, was approximately USD 786 per ton compared to USD 787 per ton in 2011. The following table shows our average realized stable gas condensate and crude oil sales prices (net of VAT and export duties, where applicable; prices in US dollars were translated from Russian roubles using the average exchange rate for the period): Russian roubles or US dollars per ton Stable gas condensate Net export price, RR per ton Net export price, USD per ton Domestic price, RR per ton Crude oil Net export price, RR per ton Net export price, USD per ton Domestic price, RR per ton Year ended 31 December: 2011 2012 Change % 16,432 528.5 12,489 11,935 383.9 10,985 15,676 533.4 13,818 10,983 373.7 9,792 4.8% (0.9%) (9.6%) 8.7% 2.7% 12.2% In 2012, as well as in 2011, our LPG export delivery terms were DAP at the border of the customer’s country, carriage paid to (CPT) the Port of Temryuk (southern Russia) and free carrier (FCA) at terminal points in Poland. In 2012, our average export contract price for LPG produced at the Purovsky Gas Condensate Plant (“Purovsky Plant”), including export duties and excluding excise and fuel taxes expense, was approximately USD 817 per ton compared to USD 829 per ton in 2011. In 2012, as well as in 2011, we sold 426 thousand tons of our LPG on the domestic market at an average price of RR 14,011 per ton and RR 13,458 per ton, respectively, including volumes purchased for resale and sold through our wholly owned subsidiary OOO NOVATEK-AZK (“NOVATEK-AZK”). In 2012, we sold approximately nine thousand tons of methanol produced by our production subsidiaries to our joint ventures and third parties at an average price of RR 10,659 per ton as compared to sales of approximately four thousand tons at an average price of RR 10,000 per ton in 2011. The following table shows our average realized LPG and methanol sales prices, excluding LPG trading activities. Prices in the table below are shown net of VAT, export duties, excise and fuel taxes expense, where applicable. Prices in US dollars were translated from Russian roubles using the average exchange rate for the period. Russian roubles or US dollars per ton LPG Net export price, RR per ton Net export price, USD per ton Domestic price, RR per ton Methanol Domestic price, RR per ton Year ended 31 December: 2011 2012 Change % 20,109 646.8 14,009 19,199 653.3 13,458 4.7% (1.0%) 4.1% 10,659 10,000 6.6% 8 Transportation tariffs Natural gas We transport our natural gas through our own pipelines into the Unified Gas Supply System (“UGSS”), which is owned and operated by OAO Gazprom, a Russian Government controlled monopoly. Transportation tariffs for the use of the UGSS by independent producers are set by the FTS. In accordance with the methodology of calculating transportation tariffs for natural gas produced in the Russian Federation for shipments to consumers located within the customs territory of the Russian Federation and the member states of the Customs Union Agreement (Belarus, Kazakhstan, Kyrgyzstan and Tajikistan), the transportation tariff consists of two parts: a rate for the utilization of the trunk pipeline and a transportation rate per mcm per 100 kilometers (km). The rate for utilization of the trunk pipeline is based on an “input/output” function, which is determined by where natural gas enters and exits the trunk pipeline and includes a constant rate for end-customers using Gazprom’s gas distribution systems. The constant rate is deducted from the utilization rate for end-customers using non-Gazprom gas distribution systems. Effective from 1 January 2011, the FTS approved a 9.3% average increase in the transportation tariff for natural gas and the rate for utilization of the trunk pipeline averaged between RR 44.97 to RR 1,964.13 (excluding VAT) per mcm and the transportation rate was RR 11.23 (excluding VAT) per mcm per 100 km. Effective from 1 July 2012, the FTS approved a 7.0% average increase of the transportation tariff for natural gas and the rate for utilization of the trunk pipeline averaged between RR 50.78 to RR 1,995.44 (excluding VAT) per mcm and the transportation rate was RR 12.02 (excluding VAT) per mcm per 100 km. According to the Forecast of Socio-economic Development of the Russian Federation for 2013 announced in September 2012 by the Ministry of Economic Development of the Russian Federation, the transportation tariff for natural gas produced by independent producers will be increased in 2013, 2014 and 2015 as of the same date as the increase in the regulated natural gas prices (expected to be 1 July) and will not exceed the forecasted inflation rate (excluding the effect of possible property tax benefit cancellation for OAO Gazprom). According to preliminary estimates of the Ministry of Economic Development, the transportation tariff will be increased by 5.4% effective from 1 July 2013, by 5.0% effective from 1 July 2014 and by 4.8% effective from 1 July 2015 (excluding the effect of possible property tax benefit cancellation for OAO Gazprom). Crude oil We transport most of our crude oil through the pipeline network owned and operated by Transneft, Russia’s state-owned monopoly crude oil pipeline operator. The FTS sets tariffs for transportation of crude oil through Transneft’s pipeline network, which includes transport, dispatch, pumping, loading, charge-discharge, transshipment and other services. The FTS sets tariffs for each separate route of the pipeline network, so the overall expense for the transport of crude oil primarily depends on the length of the transport route from the producing fields to the ultimate destination, transportation direction and other factors. Crude oil transportation tariffs were increased in September and November 2011 on average by approximately 2.9% and 5.0%, respectively, and in November 2012 on average by approximately 5.5%. Stable gas condensate and LPG We transport our stable gas condensate (from the Purovsky Plant to the Port of Vitino on the White Sea or to customers on the domestic markets) and LPG (from the Purovsky Plant to the customers on the domestic market) by rail which is owned and operated by Russia’s state-owned monopoly railway operator – OAO Russian Railways. Our transportation tariffs for transport by rail are set by the FTS and vary depending on product and length of the transport route. For our stable gas condensate and LPG transportation purposes we use our own rail cars and rail cars rented from independent Russian transportation companies. In 2012 and 2011, we applied the discount co-efficients to existing rail road transportation tariffs related to export deliveries of stable gas condensate and LPG shipped from the Limbey rail station. In 2011, the discount co-efficient for stable gas condensate was set at 0.89 for companies with annual shipped volumes of 2,600 thousand tons or more, and the discount co-efficient for LPG was set at 0.68 for delivered annual volumes of 415 thousand tons or more. In 2012, the discount co-efficient for stable gas condensate was set at 0.89 for companies with annual shipped volumes of 3,000 thousand tons or more, and the discount co-efficient for LPG was set at 0.71 for delivered annual volumes of 445 thousand tons or more. 9 We deliver our stable gas condensate to international markets using the loading and storage facilities at the Port of Vitino on the White Sea and tankers for transportation to US, European, South American and countries of the APR. The cost of tanker transportation is generally determined by the distance to the final destination, tanker availability, seasonality of deliveries and standard shipping terms, all in accordance with general industry practice. Our tax burden and obligatory payments We are subject to a wide range of taxes imposed at the federal, regional, and local levels, many of which are based on revenue or volumetric measures. In addition to income tax, significant taxes to which we are subject include VAT, unified natural resources production tax (“UPT”, commonly referred as “MET” – mineral extraction tax), export duties, property tax, payments to non-budget funds and other contributions. In practice, Russian tax authorities often have their own interpretation of tax laws that rarely favours taxpayers, who have to resort to court proceedings to defend their position against the tax authorities. Differing interpretations of tax regulations exist both among and within government ministries and organizations at the federal, regional and local levels, creating uncertainties and inconsistent enforcement. Tax declarations, together with related documentation such as customs declarations, are subject to review and investigation by a number of authorities, each of which may impose fines, penalties and interest charges. Generally, taxpayers are subject to an inspection of their activities for a period of three calendar years immediately preceding the year in which the audit is conducted. Previous audits do not completely exclude subsequent claims relating to the audited period. In addition, in some instances, new tax regulations have been given retroactive effect. We have not employed any tax minimization schemes using offshore or domestic tax zones in the Russian Federation. UPT In 2012, according to the Russian Tax Code, the UPT rate for natural gas was set at RR 251 per mcm (consisting of base rate of RR 509 per mcm and a reducing co-efficient for independent natural gas producers of 0.493) as compared to RR 237 per mcm in 2011. In November 2012, the amendments to the Russian Tax Code were passed into law, according to which the UPT rates were changed effective from 1 January 2013. According to these amendments, the UPT rate for natural gas produced by independent natural gas producers was set at RR 265 per mcm effective from 1 January 2013, RR 402 per mcm from 1 July 2013, RR 471 per mcm from 1 January 2014 and RR 552 per mcm from 1 January 2015. In addition, the Government of the Russian Federation is currently considering replacing the existing approach to the calculation of the UPT rate for natural gas with a formula that takes into account the category of extracted gas, field’s location, access to export markets and dynamics in regulated prices and transportation tariffs. The proposed change in the tax calculation may take place in the nearest future; however, the discussions are not yet completed as of the date of the issuance of our financial statements. In 2011, the UPT rate for gas condensate was set at 17.5% of gas condensate revenues recognized by the producing entities. Effective from 2012, the approach to the taxation of produced gas condensate was changed, and the UPT rate for gas condensate for 2012 was set at RR 556 per ton. According to the amendments to the Russian Tax Code, approved in November 2012, the UPT rate for gas condensate for 2013, 2014 and 2015 was set at RR 590, RR 647 and RR 679 per ton, respectively. The UPT rate for crude oil is linked to the Urals benchmark crude oil price and changes every month. It is calculated in US dollar and translated and paid in Russian roubles using the monthly average exchange rate established by the Central Bank of Russia. The Russian Tax Code provides for reduced or zero UPT rate for crude oil produced in certain geographical areas. We did not use the reduced or zero UPT rates from the production of crude oil prior to 1 January 2012. According to the amendments to the Russian Tax Code, effective from 1 January 2012, a zero UPT rate is set for crude oil produced at fields located in the YNAO to the north of the 65th degree of the northern latitude. Our East-Tarkosalinskoye and Khancheyskoye fields are located in the mentioned geographical area; therefore, we applied the allowed zero UPT rate for crude oil produced at these fields effective from 1 January 2012. 10 Export duties We are subject to export duties on our exports of stable gas condensate, LPG and crude oil. The Government of the Russian Federation sets the export customs duties for exported liquids on a monthly basis. The export duty rate for stable gas condensate and crude oil is calculated based on the average Urals crude oil price for the period from the 15th calendar day in the previous month to the 14th calendar day of the current month and is set for the following month after the current calendar month. The export duty rate for LPG is calculated based on the average LPG price at the Polish border (DAF, Brest) for the period from the 15th calendar day in the previous month to the 14th calendar day of the current month and is set for the following month after the current calendar month (see “Selected macro-economic data” above). Social insurance tax Effective from 1 January 2012, the social insurance tax rate for contributions to the Pension Fund of the Russian Federation decreased from 26% to 22%, but the maximum taxable base per each employee was increased from RR 463 thousand to RR 512 thousand of annual salary. In addition, effective from 1 January 2012, a new insurance rate of 10% was implemented for amounts above the maximum taxable base of RR 512 thousand. Effective from 1 January 2013, the maximum taxable base per each employee was increased to RR 568 thousand of annual salary. 11 OIL AND GAS RESERVES We do not file with the SEC nor are obliged to report our reserves in compliance with these standards. However, we have consistently disclosed proved oil and gas reserves as unaudited supplemental information in the Group’s IFRS audited consolidated financial statements. We also provide additional information about our hydrocarbon reserves based on the widely-industry accepted PRMS reserves reporting classification, which in addition to total proved reserves discloses information on our probable and possible reserves. Our proved reserves estimates are appraised by the Group’s independent petroleum engineers, DeGolyer and MacNaughton (“D&M”). The Group’s total proved reserves, comprised of proved developed and proved undeveloped reserves as of 31 December 2012 and 2011, were appraised using both reporting and disclosure requirements promulgated by the SEC and the PRMS reserves reporting classification. Proved reserves disclosed in the “Unaudited Supplemental Oil and Gas Disclosures” in the Group’s IFRS consolidated financial statements are presented under SEC reserve reporting methodology based on 100% of the reserves attributable to all consolidated subsidiaries (whether or not wholly owned), as well as our proportionate share of proved reserves accounted for by the equity method based on our equity ownership interest. The tables below provide a comparison of the Group’s estimated reserves under SEC and PRMS reserve classifications attributable to all consolidated subsidiaries and joint ventures based on the Group’s equity ownership interest in the respective fields. Thus the proved reserves disclosure as noted above do not reconcile to the proved reserves in the consolidated financial statements. Based on our equity ownership interest in the fields Natural gas SEC PRMS Billions of cubic feet Billions of cubic meters Billions of cubic feet Billions of cubic meters Total proved reserves at 31 December 2010 40,415 1,144 46,245 1,310 Changes attributable to: Revisions of previous estimates, extensions and discoveries Acquisitions (1) Disposals (2) Production Total proved reserves at 31 December 2011 including subsidiaries including joint ventures Changes attributable to: Revisions of previous estimates, extensions and discoveries Acquisitions of prior periods (3) Acquisitions of current period (4) Production Total proved reserves at 31 December 2012 including subsidiaries including joint ventures 3,284 8,161 (3,331) (1,866) 46,663 26,427 20,236 1,970 12,717 2,729 (1,992) 62,087 38,324 23,763 94 231 (95) (53) 1,321 748 573 56 360 77 (56) 1,758 1,085 673 4,580 11,861 (4,841) (1,866) 55,979 27,417 28,562 2,920 17,386 3,221 (1,992) 77,514 44,062 33,452 129 336 (137) (53) 1,585 776 809 83 492 91 (56) 2,195 1,248 947 (1) Acquisitions in 2011 represent reserves attributable to increased equity interest in Yamal LNG from 51% to 100%. (2) Disposals in 2011 represent reserves attributable to the disposal of a 20% interest in Yamal LNG to TOTAL S.A. (3) Acquisitions of prior periods represent reserves attributable to licenses acquired in 2011 (Salmanovskoye (Utrenneye) and Geofizicheskoye fields), which were appraised in 2012 and include exploration surveys made after acquisition. (4) Acquisitions of current period represent reserves attributable to our acquisition of a 49% equity stake in our joint venture Nortgas completed in 2012. 12 Based on our equity ownership interest in the fields Total proved reserves at 31 December 2010 Changes attributable to: Revisions of previous estimates, extensions and discoveries Acquisitions (1) Disposals (2) Production Total proved reserves at 31 December 2011 including subsidiaries including joint ventures Changes attributable to: Revisions of previous estimates, extensions and discoveries Acquisitions of prior periods (3) Acquisitions of current period (4) Production Total proved reserves at 31 December 2012 including subsidiaries including joint ventures Crude oil, gas condensate and natural gas liquids SEC PRMS Millions of barrels Millions of metric tons Millions of barrels Millions of metric tons 604 133 84 (34) (35) 752 469 283 17 78 85 (36) 896 526 370 73 16 10 (4) (4) 91 57 34 0 9 10 (4) 106 63 43 761 170 125 (51) (35) 970 571 399 89 119 100 (36) 1,242 706 536 93 20 15 (6) (4) 118 70 48 9 14 12 (4) 149 86 63 (1) Acquisitions in 2011 represent reserves attributable to increased equity interest in Yamal LNG from 51% to 100%. (2) Disposals in 2011 represent reserves attributable to the disposal of a 20% interest in Yamal LNG to TOTAL S.A. (3) Acquisitions of prior periods represent reserves attributable to licenses acquired in 2011 (Salmanovskoye (Utrenneye) and Geofizicheskoye fields), which were appraised in 2012 and include exploration surveys made after acquisition. (4) Acquisitions of current period represent reserves attributable to our acquisition of a 49% equity stake in our joint venture Nortgas completed in 2012. Our total SEC proved reserves, as presented in the tables above, differ from the total net proved reserves as reported in the “Unaudited Supplemental Oil and Gas Disclosures” in the Group’s IFRS consolidated financial statements, in that total net proved reserves as presented in the Group’s IFRS consolidated financial statements include net proved reserves of natural gas and liquids attributable to non-controlling interest in our subsidiaries. A reconciliation between total proved reserves at 31 December 2012 under the SEC reserve classification as reflected in the “Unaudited Supplemental Oil and Gas Disclosures” in the Group’s IFRS consolidated financial statements and total proved reserves in the tables above is set forth below: Under SEC classification Total proved reserves at 31 December 2012 presented in “Oil and Gas Reserves” above Net proved reserves of natural gas and liquids attributable to non-controlling interest Total net proved reserves per Natural gas Crude oil, gas condensate and natural gas liquids Billions of cubic feet Billions of cubic meters Millions of barrels Millions of metric tons 62,087 1,758 896 106 128 4 17 2 “Unaudited Supplemental Oil and Gas Disclosures” 62,215 1,762 913 108 13 The following table provides for our combined SEC and PRMS proved reserves on a total barrel of oil equivalent basis. Based on our equity ownership interest in the fields Total proved reserves: At 31 December 2010 At 31 December 2011 At 31 December 2012 including subsidiaries including joint ventures Combined natural gas, crude oil, gas condensate and natural gas liquids in millions of barrels of oil equivalent PRMS SEC 8,088 9,393 12,394 7,623 4,771 9,325 11,337 15,597 8,866 6,731 The PRMS reserve classification standards allows for the reporting of reserves estimates for probable and possible reserves as presented in the following table: Under PRMS classification (based on our equity ownership interest in the fields) Probable reserves: At 31 December 2010 At 31 December 2011 At 31 December 2012 including subsidiaries including joint ventures Possible reserves: At 31 December 2010 At 31 December 2011 At 31 December 2012 including subsidiaries including joint ventures Natural gas Billions of cubic feet Billions of cubic meters Crude oil, gas condensate and natural gas liquids Millions of barrels Millions of metric tons 18,748 18,471 32,168 21,515 10,653 14,867 17,187 24,664 14,752 9,912 531 523 911 609 302 421 487 698 418 280 587 652 801 456 345 915 1,000 1,193 734 459 73 81 98 56 42 117 127 146 92 54 The Group’s PRMS proved reserves attributable to consolidated subsidiaries and joint ventures based on the Group’s equity ownership interest in the respective fields aggregated approximately 2.2 trillion cubic meters (“tcm”) of natural gas and 149 million tons of crude oil, gas condensate and natural gas liquids as of 31 December 2012. Combined, these proved reserves represent approximately 15.6 billion barrels of oil equivalent. Our total PRMS proved reserves in barrels of oil equivalent basis attributable to consolidated subsidiaries and joint ventures based on the Group’s equity ownership interest in their respective fields have increased by 37.6% during 2012. The increase was primarily due to the first-time appraisal of the reserves of the Salmanovskoye (Utrenneye) and Geofizicheskoye fields acquired in 2011, which also included exploration surveys performed on these fields in 2012, and the acquisition of a 49% equity stake in Nortgas. As we continue to invest capital into the development of our fields, we anticipate that we will increase our resource base as well as migrate reserves among the reserve categories. The increase in the Group’s PRMS probable and possible reserves during 2012 was also primarily due to the appraisal in 2012 of reserves attributable to the Salmanovskoye (Utrenneye) and Geofizicheskoye fields and the acquisition of a 49% equity stake in Nortgas (holder of the production license for the North-Urengoyskoye field). The Group’s reserves are all located in the Russian Federation, in the Yamal-Nenets Autonomous Region (Western Siberia), thereby representing one geographical area. 14 The below table contains information about reserve/production ratios for the years ended 31 December 2012 and 2011 under both reserves reporting methodologies based on our equity ownership interest in the fields attributable to consolidated subsidiaries and joint ventures: Number of years (based on our equity ownership interest in the fields) Total proved reserves to production Total proved and probable reserves to production Total proved, probable and possible reserves to production SEC At 31 December: 2012 2011 31 - - 25 - - PRMS At 31 December: 2012 2011 39 55 69 30 40 51 The increase in our reserve/production ratios was primarily due to an increase in our reserves estimates at 31 December 2012 as compared to 31 December 2011. The increase was mainly attributable to the reserves acquired as previously noted, which more than offset our increase in production. The Group’s oil and gas estimation and reporting process involves an annual independent third party appraisal as well as internal technical appraisals of reserves. The Group maintains its own internal reserve estimates that are calculated by qualified technical staff working directly with the oil and gas properties. The Group periodically updates reserves estimates during the year based on evaluations of new wells, performance reviews, new technical information and other studies. The Group provides D&M annually with engineering, geological and geophysical data, actual production histories and other information necessary for reserve determinations. The method or combination of methods used in the analysis of each reservoir is tempered by experience with similar reservoirs, stages of development, quality and completeness of basic data, and production history. Our reserves estimates were prepared using standard geological and engineering methods generally accepted in the petroleum industry. The Group’s and D&M’s technical staffs meet to review and discuss the information provided, and upon completion of the process, senior management reviews and approves the final reserves estimates issued by D&M. The Reserves Management and Assessment Group (“RMAG”) is comprised of qualified technical staff from various departments – geological and geophysical, gas and liquids commercial operations, capital construction, production, financial planning and analysis and includes technical and financial representatives from the Group’s subsidiaries, which are the principal holders of the mineral licenses. The person responsible for overseeing the work of the RMAG is a member of the Management Board. The approval of the final reserve estimates is the sole responsibility of the Group’s senior management. 15 OPERATIONAL HIGHLIGHTS Oil and Gas Production Costs Oil and gas production costs are derived from our results of operations for oil and gas producing activities as reported in the “Unaudited Supplemental Oil and Gas Disclosures” in our consolidated financial statements and relate to our consolidated subsidiaries. Oil and gas production costs do not include general corporate overheads or their associated tax effects. The following tables set forth certain operating information with respect to our oil and gas production costs during the years presented in millions of Russian roubles and on a boe basis in Russian roubles and US dollars: millions of Russian roubles Production costs: Lifting costs Taxes other than income tax Transportation expenses Total production costs before DDA Depreciation, depletion and amortization (“DDA”) Total production costs RR per boe Production costs: Lifting costs Taxes other than income tax Transportation expenses Total production costs before DDA Depreciation, depletion and amortization Total production costs USD per boe (1) Production costs: Lifting costs Taxes other than income tax Transportation expenses Total production costs before DDA Depreciation, depletion and amortization Total production costs Year ended 31 December: 2011 2012 Change % 6,505 16,546 57,888 80,939 10,589 91,528 5,347 16,307 46,216 67,870 8,937 76,807 21.7% 1.5% 25.3% 19.3% 18.5% 19.2% Year ended 31 December: 2011 2012 Change % 17.8 45.3 158.4 221.5 29.0 250.5 15.5 47.2 133.8 196.5 25.9 222.4 14.8% (4.0%) 18.4% 12.7% 12.0% 12.6% Year ended 31 December: 2011 2012 Change % 0.57 1.46 5.09 7.12 0.94 8.06 0.53 1.61 4.55 6.69 0.88 7.57 7.5% (9.3%) 11.9% 6.4% 6.8% 6.5% (1) Production costs in US dollars per boe were translated from Russian roubles per boe using the average exchange rate for the period (see “Selected macro-economic data” above). Production costs represent the amounts directly related to the extraction of natural gas and liquids, gas condensate and crude oil from the reservoir and other related costs; including production expenses, taxes other than income tax (production taxes), insurance expenses and shipping, transportation and handling costs to end- customers. The average production cost on a barrel of oil equivalent basis is calculated by dividing the applicable costs by the respective barrel of oil equivalent of our hydrocarbons produced during the year. Natural gas, gas condensate and crude oil volumes produced by our fields are converted to a barrel of oil equivalent based on the relative energy content of each fields’ hydrocarbons. 16 Our lifting costs, as presented in the tables above, differ from lifting costs as reflected in the “Unaudited Supplemental Oil and Gas Disclosures” in the Group’s IFRS consolidated financial statements, in that the lifting costs as presented in the Group’s IFRS consolidated financial statements include changes in balances of natural gas and hydrocarbon liquids to more appropriately match costs incurred to revenues under the IFRS matching principles. A reconciliation of lifting costs as reflected in the “Unaudited Supplemental Oil and Gas Disclosures” in the Group’s IFRS consolidated financial statements is set forth below: millions of Russian roubles Lifting costs presented in “Oil and Gas Production Costs” above Change in balances of natural gas and hydrocarbon liquids stated at cost in the Group’s Consolidated Statement of Financial Position Lifting costs per “Unaudited Supplemental Oil and Gas Disclosures” Year ended 31 December: 2011 2012 Change % 6,505 1,094 7,599 5,347 21.7% 56 n/a 5,403 40.6% 17 Hydrocarbon sales volumes Our natural gas sales volumes increased primarily due to a combination of increased production at our core fields and purchases from our related party OAO SIBUR Holding (“SIBUR”), which were partially offset by an increase in natural gas inventory balances in 2012 as compared to a decrease in 2011. Liquids sales volumes increased due to the initiation of unstable gas condensate purchases from the Group’s joint ventures, as well as the increase in crude oil production, which were partially offset by an increase in liquids inventory balances in 2012 as compared to a decrease in 2011. Our liquids inventory balances tend to fluctuate periodically due to loading schedules and final destinations of stable gas condensate shipments. Natural gas sales volumes millions of cubic meters Production from (subsidiaries): Yurkharovskoye field East-Tarkosalinskoye field Khancheyskoye field Other fields Total natural gas production Purchases from the Group’s joint ventures Total production and purchases from Group’s joint ventures Other purchases Total production and purchases Purovsky Plant, own usage and methanol production Decrease (increase) in UGSF, UGSS and own pipeline infrastructure Total natural gas sales volumes Sold to end-customers Sold ex-field Year ended 31 December: 2011 2012 Change % 34,054 12,742 3,647 64 50,507 5,335 55,842 3,533 59,375 (126) (369) 58,880 40,806 18,074 32,035 12,151 3,263 72 47,521 5,384 52,905 6.3% 4.9% 11.8% (11.1%) 6.3% (0.9%) 5.6% 841 320.1% 53,746 (109) 30 53,667 29,332 24,335 10.5% 15.6% n/a 9.7% 39.1% (25.7%) In 2012, our total natural gas production increased by 2,986 mmcm, or 6.3%, to 50,507 mmcm from 47,521 mmcm in 2011 primarily due to increases in production at our core producing fields (Yurkharovskoye, East-Tarkosalinskoye and Khancheyskoye). We were able to increase natural gas production at the Yurkharovskoye field resulting from the field’s ongoing development activities and the launch of the fourth stage of the second phase development in October 2012 (see “Recent developments” above). The increase in natural gas production at the East-Tarkosalinskoye and Khancheyskoye fields in 2012 was due to increased demand resulting in a greater utilization of the field’s production capacity. In January 2012, we commenced purchasing natural gas from our related party, SIBUR, and purchased 3,533 mmcm during the year. In December 2011, we purchased 841 mmcm of natural gas from third parties in the Chelyabinsk region, the price of which included the cost of transportation to this region, through our subsidiary Gazprom mezhregiongas Chelyabinsk, a regional gas trader acquired in November 2011. The purchases were made according to pre-existing contractual obligations and, effective January 2012 we did not purchase natural gas under these agreements. Purchases from SIBUR in 2012 and from third parties in 2011 are disclosed as “Other purchases” in the table above. In 2012, we used 75 mmcm of natural gas as feedstock for the production of methanol compared to 63 mmcm in 2011. A significant portion of the methanol we produce is used for our own internal purposes to prevent hydrate formation (condensation) during the production, preparation and transportation of hydrocarbons. 18 Liquids sales volumes thousands of tons Production from (subsidiaries): Yurkharovskoye field East-Tarkosalinskoye field Khancheyskoye field Other fields Total liquids production Purchases from: The Group’s joint ventures Other Total production and purchases Losses and own usage (1) Decreases (increases) in liquids inventory balances Total liquids sales volumes Stable gas condensate export Stable gas condensate domestic Subtotal stable gas condensate LPG export LPG CIS LPG domestic LPG sold through domestic retail and small wholesale stations Subtotal LPG Crude oil export Crude oil domestic Subtotal crude oil Oil products domestic Subtotal oil products Year ended 31 December: 2011 2012 Change % 2,672 984 518 19 4,193 259 38 4,490 (49) (238) 4,203 2,821 26 2,847 479 - 323 103 905 149 293 442 9 9 2,718 808 560 25 4,111 - 6 4,117 (37) 31 4,111 2,981 3 2,984 453 1 336 90 880 93 149 242 5 5 (1.7%) 21.8% (7.5%) (24.0%) 2.0% n/a n/m 9.1% 32.4% n/a 2.2% (5.4%) n/m (4.6%) 5.7% n/a (3.9%) 14.4% 2.8% 60.2% 96.6% 82.6% 80.0% 80.0% (1) Losses associated with processing at the Purovsky Plant, as well as during railroad, trunk pipeline and tanker transportation. In 2012, our liquids production increased by 82 thousand tons, or 2.0%, primarily due to an increase in crude oil production at the East-Tarkosalinskoye field that was partially offset by a decrease in gas condensate production at our core producing fields. Natural declines in the concentration of gas condensate at our mature fields are expected due to decreasing reservoir pressure at the current gas condensate producing horizons. Starting from 1 November 2012, we commenced purchasing of unstable gas condensate from Nortgas, which became our joint venture from the end of November 2012. Purchases from Nortgas in November 2012 are disclosed as “Other purchases” and purchases in December 2012 are disclosed as “Purchases from the Group’s joint ventures” in the table above. In April 2012, we commenced purchasing unstable gas condensate from our joint venture, SeverEnergia, after the launch of the first phase of Samburgskoye field’s development activities. 19 RESULTS OF OPERATIONS FOR THE YEAR ENDED 31 DECEMBER 2012 COMPARED TO THE YEAR ENDED 31 DECEMBER 2011 The following table and discussion is a summary of our consolidated results of operations for the years ended 31 December 2012 and 2011. Each line item is also shown as a percentage of our total revenues. millions of Russian roubles Total revenues (net of VAT, export duties, excise and fuel taxes) including: natural gas sales liquids’ sales Operating expenses Net gain (loss) on disposal of interest in subsidiaries Other operating income (loss) Profit from operations Finance income (expense) Share of profit (loss) of joint ventures, net of income tax Profit before income tax Total income tax expense Profit (loss) Non-controlling interest Profit attributable to shareholders of OAO NOVATEK Normalized profit attributable to shareholders of OAO NOVATEK Year ended 31 December: 2012 210,973 142,613 67,633 % of total revenues 100.0% 67.6% 32.1% 2011 175,273 110,932 63,879 % of total revenues 100.0% 63.3% 36.4% (125,775) (59.6%) (96,820) (55.2%) (60) 196 85,334 2,986 (2,105) 86,215 (16,774) 69,441 17 (0.1%) 0.1% 40.4% 1.5% (1.0%) 40.9% (8.0%) 32.9% 0.0% 62,948 207 141,608 (2,703) (3,880) 135,025 (15,734) 119,291 364 35.9% 0.1% 80.8% (1.6%) (2.2%) 77.0% (8.9%) 68.1% 0.2% 69,458 32.9% 119,655 68.3% 69,518 33.0% 56,707 32.4% 20 Total revenues The following table sets forth our sales (net of VAT, export duties, excise and fuel taxes expense, where applicable) for the years ended 31 December 2012 and 2011: millions of Russian roubles Natural gas sales End-customers Ex-field sales Stable gas condensate sales Export Domestic Liquefied petroleum gas sales Export CIS Domestic Crude oil sales Export Domestic Oil and gas products sales Domestic Total oil and gas sales Other revenues Total revenues Natural gas sales Year ended 31 December: 2011 2012 Change % 142,613 115,180 27,433 46,684 46,365 319 15,599 9,631 - 5,968 5,000 1,785 3,215 350 350 110,932 77,046 33,886 46,778 46,732 46 14,436 8,698 10 5,728 2,479 1,021 1,458 186 186 210,246 174,811 727 462 210,973 175,273 28.6% 49.5% (19.0%) (0.2%) (0.8%) 593.5% 8.1% 10.7% n/a 4.2% 101.7% 74.8% 120.5% 88.2% 88.2% 20.3% 57.4% 20.4% In 2012, our revenues from sales of natural gas increased by RR 31,681 million, or 28.6%, compared to 2011 due primarily to an increase in our average realized natural gas price and, to a lesser extent, due to an increase in our total sales volumes. The increase in our average realized natural gas price was driven by a combination of increases in the regulated FTS price tariff for natural gas by 15% effective from 1 July 2012 and in our proportion of end-customer sales to total natural gas sales volumes. Our proportion of natural gas sold to end-customers to total natural gas sales volumes increased to 69.3% in 2012 as compared to 54.7% in 2011. The increase was due to higher natural gas deliveries to the Chelyabinsk region through our regional natural gas trader acquired in November 2011. In 2012, our average netback price on end-customers sales, excluding volumes purchased for resale in the location of our end-customers, increased by 11.9% as compared to 2011, while our average realized end- customers sales price increased by 7.4%. The increase in our average realized end-customers sales netback price was primarily due to a 15% increase in the regulated FTS price for natural gas effective from 1 July 2012 combined with a 7% increase in the average transportation tariff set by the FTS effective from 1 July 2012 (see “Transportation tariffs” above). Our average realized ex-field price was higher by 9.1% than in 2011. 21 Stable gas condensate sales In 2012, our revenues from sales of stable gas condensate decreased by RR 94 million, or 0.2%, compared to 2011 primarily due to a decrease in volumes sold, that was partially offset by an increase in our average realized prices in Russian roubles. Our total stable gas condensate sales volumes decreased by 137 thousand tons, or 4.6%, due to a combination of an increase in the stable gas condensate inventory balance in 2012 as compared to a decrease in 2011 (see “Change in natural gas, liquid hydrocarbons and work-in-progress” below) and a decrease in gas condensate production at our core fields, that was partially offset by unstable gas condensate purchases from our joint ventures in 2012. During 2012, we exported 2,821 thousand tons of stable gas condensate, or 99.1% of our total sales volumes, to the APR, Europe, the United States and South America with the remaining 26 thousand tons sold domestically. In 2011, we exported 2,981 thousand tons of stable gas condensate, or 99.9% of our total sales volumes, to the APR, Europe and the United States, with the remaining three thousand tons sold domestically. In 2012, our average realized net export price for stable gas condensate, excluding export duties and translated to US dollars from Russian roubles using the average annual exchange rate, decreased by USD 4.9 per ton, or 0.9%, to USD 528.5 per ton (CFR, DES, DAP and CIF) from USD 533.4 per ton (CFR, DES, DAP, CIF and DAT) in 2011 due to an increase in average annual exchange rate of Russian rouble against the US dollar approximately by 5.8% in 2012 as compared to 2011, that was partially offset by a 0.4% decrease in our average export duty per ton and an 0.2% increase in our average export contract price in US dollars. Liquefied petroleum gas sales In 2012, our revenues from sales of LPG increased by RR 1,163 million, or 8.1%, compared to 2011 due to both increases in our average realized prices and volumes sold. In 2012, we sold 479 thousand tons of LPG, or 52.9% of our total LPG sales volumes, to export markets as compared to 453 thousand tons, or 51.5%, in 2011. In 2012, as well as in 2011, our export sales volumes of LPG representing greater than 10% of total LPG export volumes were to customers located in Poland and Finland. Our average realized LPG net export price, excluding export duties, excise and fuel taxes expense and translated to US dollars from Russian roubles using the average annual exchange rate, decreased by USD 6.5 per ton, or 1.0%, to USD 646.8 per ton in 2012 (DAP, CPT and FCA) compared to USD 653.3 per ton in 2011 (DAP, CPT and FCA) primarily due to an increase in the average annual exchange rate of Russian rouble against the US dollar, that was partially offset by a decrease in our average export duty per ton by 3.5%. The reduction in our average contract price by 1.4% was due to a decrease in the underlying benchmark prices on international markets used in the price formulation in 2012 compared to 2011. In 2012, we sold 426 thousand tons of LPG, or 47.1% of our total LPG sales volumes, on the domestic market at an average price of RR 14,011 per ton (excluding VAT) representing an increase of RR 553 per ton, or 4.1%, compared to 2011. Crude oil sales In 2012, our revenues from sales of crude oil increased by RR 2,521 million, or 101.7%, compared to 2011 primarily due to an increase in sales volumes and, to a lesser extent, an increase in our average realized prices. Our crude oil sales volumes increased by 200 thousand tons, or 82.6%, to 442 thousand tons from 242 thousand tons in 2011 due primarily to an increase in crude oil production at our East-Tarkosalinskoye field. The majority of our crude oil sales volumes, accounting for 66.3% in 2012, were sold domestically at an average price of RR 10,985 per ton (excluding VAT) representing an increase of RR 1,193 per ton, or 12.2%, compared to 2011. The remaining 33.7% of our crude oil volumes were sold to export markets at an average price of USD 383.9 per ton (DAP, excluding export duties) representing an increase of USD 10.2 per ton, or 2.7%, compared to 2011. The increase in the average realized net export price (excluding export duties and translated to US dollars from Russian roubles using the average annual exchange rate) was due to an increase in average annual exchange rate of Russian rouble against the US dollar approximately by 5.8% and a 1.7% decrease in our average export duty per ton. 22 Oil and gas products sales Oil and gas products sales include trading operations with oil products on the domestic market through our retail stations and methanol sales to third parties. In 2012, our revenue from sales of oil and gas products increased by RR 164 million, or 88.2%, to RR 350 million from RR 186 million in 2011. Our revenues from oil products trading operations through our retail stations on the domestic market increased by RR 103 million, or 70.1%, to RR 250 million in 2012 compared to RR 147 million in 2011 primarily due to an increase in volumes sold. In 2012, we sold approximately nine thousand tons of oil products (diesel fuel and petrol) for an average price of RR 29,054 per ton, compared to sales of approximately five thousand tons for an average price of RR 27,232 per ton in 2011. In 2012, our revenue from methanol sales increased by RR 61 million, or 156.4%, to RR 100 million from RR 39 million in 2011 primarily due to an increase in volumes sold. Other revenues Other revenues include geological and geophysical research services, rent, sublease, transportation, handling, storage and other services. In 2012, other revenues increased by RR 265 million, or 57.4%, to RR 727 million from RR 462 million in 2011. The increase was primarily comprised of a RR 162 million increase in revenue from transportation, handling and storage services, as well as a RR 99 million increase in revenues from geological and geophysical research services provided primarily to our joint ventures. In addition, in 2012, we recognized RR 69 million of revenue by re-charging a part of icebreaking expenses to the third parties as compared to RR 131 million of revenue for the sublet of a leased tanker in 2011. The remaining increase of RR 66 million in other revenues was made up of various immaterial items. 23 Operating expenses In 2012, our total operating expenses increased by RR 28,955 million, or 29.9%, to RR 125,775 million compared to RR 96,820 million in 2011 primarily due to an increase in transportation expenses and purchases of natural gas and liquid hydrocarbons. As a percentage of total operating expenses, our non-controllable expenses, such as transportation and taxes other than income tax, decreased to 61.8% in 2012 compared to 67.0% in 2011 primarily due to a significant increase in purchases of natural gas from our related party, SIBUR, and purchases of unstable gas condensate from our joint ventures in 2012 (see “Purchases of natural gas and liquid hydrocarbons” below). In 2012, total operating expenses as a percentage of total revenues increased to 59.6% in 2012 compared to 55.2% in 2011, as shown in the table below. The increase in our operating expenses as a percentage of total revenues was caused by two main reasons. In January 2012, we commenced purchasing natural gas, which included the cost of transportation, for subsequent resale to the regions where our end-customers are located, and there was an increase in the UPT rate for natural gas effective 1 January 2012, while the regulated price for natural gas was increased effective 1 July 2012. millions of Russian roubles Transportation expenses Taxes other than income tax Subtotal non-controllable expenses Purchases of natural gas and liquid hydrocarbons Depreciation, depletion and amortization General and administrative expenses Materials, services and other Exploration expenses Net impairment expenses Change in natural gas, liquid hydrocarbons and work-in-progress Year ended 31 December: 2012 60,848 16,846 77,694 17,483 11,185 10,936 7,216 2,022 325 (1,086) % of total revenues 28.8% 8.0% 36.8% 8.3% 5.3% 5.2% 3.4% 1.0% n/m n/m 2011 48,329 16,559 64,888 5,994 9,277 8,218 5,947 1,819 782 (105) % of total revenues 27.6% 9.4% 37.0% 3.4% 5.3% 4.7% 3.4% 1.0% n/m n/m Total operating expenses 125,775 59.6% 96,820 55.2% Non-controllable expenses A significant proportion of our operating expenses are characterized as non-controllable expenses since we are unable to influence the increase in regulated tariffs for transportation of our hydrocarbons or the rates imposed by federal, regional or local tax authorities. In 2012, non-controllable expenses of transportation and taxes other than income tax increased by RR 12,806 million, or 19.7%, to RR 77,694 million from RR 64,888 million in 2011. The change in transportation expenses was primarily due to an increase in the natural gas volumes sold to end-customers in which we incurred transportation expenses, and excluded volumes of natural gas purchased for resale in the location of our end-customers. Taxes other than income tax increased primarily due to an increase in natural gas production volumes, as well as a 5.9% increase in the natural gas production tax rate effective from 1 January 2012 that was partially offset by the application of a zero UPT rate for crude oil from 1 January 2012 (see “Our tax burden” above). As a percentage of total revenues, our non-controllable expenses marginally decreased to 36.8% in 2012 compared to 37.0% in 2011. 24 Transportation expenses In 2012, our total transportation expenses increased by RR 12,519 million, or 25.9%, compared to 2011. million of Russian roubles Natural gas transportation to customers Liquid hydrocarbons transportation by rail Liquid hydrocarbons transportation by tankers Crude oil transportation to customers Other Total transportation expenses Year ended 31 December: 2011 2012 Change % 45,925 10,537 3,742 527 117 60,848 34,441 9,791 3,647 281 169 48,329 33.3% 7.6% 2.6% 87.5% (30.8%) 25.9% In 2012, our transportation expenses for natural gas increased by RR 11,484 million, or 33.3%, to RR 45,925 million from RR 34,441 million in 2011. The change was mainly due to a 30.8% increase in our natural gas sales volumes to end-customers, for which we incurred transportation expense, and excluding volumes of natural gas purchased for resale in the location of our end-customers, as well as a 7% average increase in the natural gas transportation tariff set by the FTS effective 1 July 2012 (see “Transportation tariffs” above). We do not incur transportation expenses in respect of natural gas volumes purchased for resale in the location of our end-customers, as the purchase price includes the cost of transportation. Our average transportation distance for natural gas sold to end-customers fluctuates period-to-period and depends on the location of end-customers and the specific routes of transportation. In 2012, our total expenses for liquids transportation by rail increased by RR 746 million, or 7.6%, to RR 10,537 million from RR 9,791 million in 2011 due to higher average liquids transportation tariffs that was partially offset by a decrease in our stable gas condensate volumes sold and transported via rail. In 2012, our combined liquids volumes sold and transported via rail decreased by 115 thousand tons, or 3.0%, to 3,749 thousand tons from 3,864 thousand tons in 2011 due primarily to an increase in stable gas condensate inventory balance during 2012 compared to a decrease in 2011. The transportation costs incurred in respect of liquids volumes recognized as part of our inventory balance or in transit are capitalized in current assets as future period expenses until the recognition of such volumes as sold. In 2012, our weighted average transportation tariff for liquids delivered by rail increased by 11.0% to RR 2,811 per ton from RR 2,533 per ton in 2011 primarily due to a 6.0% increase in rail tariffs for the domestic market set by the FTS effective 1 January 2012, an increase in rail tariffs for LPG transportation on the territory of CIS to export markets and a decrease in stable gas condensate share in total liquids volumes sold and transported via rail. The change in the share of stable gas condensate volumes in our total liquids volumes delivered by rail affects our weighted average rail tariff due to the relatively low transportation expense for stable gas condensate compared to other liquids. Our weighted average transportation tariff for liquids delivered by rail fluctuates period-to-period and depends on products type and the geography of deliveries. Total transportation expense for liquids delivered by tankers to international markets increased by RR 95 million, or 2.6%, to RR 3,742 million in 2012 from RR 3,647 million in 2011. The increase was due to a change in the mix in geographical regions where we sold our stable gas condensate that was partially offset by a 5.4% decrease in volumes sold as a result of inventory movements and a decrease in unstable gas condensate production. In 2012, we sold 56.4% of our total stable gas condensate export volumes to APR, 28.7% to Europe, 10.6% to the United States and 4.3% to the South America, whereas in 2011, we sold 43.4% to APR, 34.3% to Europe and 22.3% to the United States. 25 Taxes other than income tax millions of Russian roubles Unified natural resources production tax Property tax Other taxes Total taxes other than income tax Year ended 31 December: 2011 2012 Change % 14,833 1,754 259 16,846 14,523 1,742 294 16,559 2.1% 0.7% (11.9%) 1.7% In 2012, taxes other than income tax increased by RR 287 million, or 1.7%, primarily due to an increase in the unified natural resources production tax expense. In 2012, our UPT expense for natural gas increased by RR 1,446 million, or 12.8%, due to both a 5.9% increase in the natural gas production tax rate effective from 1 January 2012 (from RR 237 per mcm to RR 251 per mcm) and a 6.3% increase in our natural gas production volumes. In addition, our UPT for unstable gas condensate production increased by RR 119 million, or 6.2%, due primarily to a change in the UPT rate (see “Our tax burden” above). In 2012, we applied a zero UPT rate for crude oil produced at our East-Tarkosalinskoye and Khancheyskoye fields due to changes in the Russian Tax Code effective from 1 January 2012 (see “Our tax burden” above). In 2011, we incurred RR 1,255 million of UPT expense for crude oil produced. Purchases of natural gas and liquid hydrocarbons millions of Russian roubles Natural gas Unstable gas condensate Other liquid hydrocarbons Total purchases of natural gas and liquids hydrocarbons Year ended 31 December: 2011 2012 Change % 14,706 2,498 279 17,483 5,854 - 140 5,994 151.2% n/a 99.3% 191.7% In 2012, our purchases of natural gas and liquid hydrocarbons increased by RR 11,489 million, or 191.7%, to RR 17,483 million from RR 5,994 million in 2011. The increase of RR 8,852 million, or 151.2%, was related to purchases of natural gas, of which the major part related to purchases of natural gas from SIBUR, a related party, commencing from 1 January 2012. During 2012, we commenced purchasing unstable gas condensate from our joint ventures SeverEnergia and Nortgas, which accounted for RR 2,498 million of total purchases in 2012. We had no purchases of unstable gas condensate in 2011. In 2012, our purchases of other liquid hydrocarbons increased by RR 139 million, or 99.3%, to RR 279 million from RR 140 million in 2011 due to the expansion of trading activities at our wholly owned subsidiary NOVATEK-AZK. Other liquid hydrocarbons purchases represent our purchases of oil products (diesel fuel and petrol) and LPG. Depreciation, depletion and amortization In 2012, our depreciation, depletion and amortization (“DDA”) expense increased by RR 1,908 million, or 20.6%, to RR 11,185 million from RR 9,277 million in 2011 as a result of an increase in our depletable cost base, as well as a 5.8% increase in our total hydrocarbon production (excluding our proportionate share in the production of joint ventures) in barrels of oil equivalent basis. The Group accrues depreciation and depletion using the “units of production” method for producing assets and straight-line method for other facilities. In 2012, our DDA per barrel of oil equivalent was RR 26.4 compared to RR 23.1 in 2011. The increase in our DDA charge calculated on a barrel of oil equivalent basis was due to the capitalization of costs related to the launch of the fourth stage of the second phase development at our Yurkharovskoye field and ongoing crude oil development activities at the East-Tarkosalinskoye field, as well as a decrease in our proved reserves estimates as of 31 December 2012 compared to 31 December 2011, used as the denominator in the calculation of the DDA under the “units of production” method, at our core producing fields. 26 Our reserve base, used as the denominator in the calculation of the DDA charge under the “units of production” method, is only appraised on an annual basis as of 31 December and does not fluctuate during the year, whereas our depletable cost base does change each quarter due to the ongoing capitalization of our costs throughout the year. General and administrative expenses In 2012, our general and administrative expenses increased by RR 2,718 million, or 33.1%, to RR 10,936 million compared to RR 8,218 million in 2011. The main components of these expenses were employee compensation, legal, audit, and consulting services and social expenses and compensatory payments, which, on aggregate, comprised 83.6% and 80.7% of total general and administrative expenses in the years ended 31 December 2012 and 2011, respectively. millions of Russian roubles Employee compensation Legal, audit, and consulting services Social expenses and compensatory payments Depreciation – administrative buildings Business trip expenses Fire safety and security expenses Repair and maintenance expenses Rent expense Insurance expense Bank charges Other Total general and administrative expenses Year ended 31 December: 2011 2012 Change % 6,869 1,274 1,001 314 292 199 168 113 86 82 538 10,936 4,650 774 1,212 198 218 178 115 140 58 58 617 8,218 47.7% 64.6% (17.4%) 58.6% 33.9% 11.8% 46.1% (19.3%) 48.3% 41.4% (12.8%) 33.1% Employee compensation increased by RR 2,219 million, or 47.7%, to RR 6,869 million in 2012 as compared to RR 4,650 million in 2011. The increase was primarily due to an indexation of base salaries by 6.0% effective 1 July 2012, increases in the average number of employees, insurance contributions to the non-budget funds, as well as an increase in bonuses accrued to key management for the results achieved in 2012. The increase in average number of employees resulted from the acquisition of a regional gas trader in November 2011 and the expansion of activities at our Ust-Luga project. Our insurance contributions to the non-budget funds increased in 2012 compared to 2011 due to the change of insurance contributions to the Pension Fund of the Russian Federation effective from 1 January 2012 (see “Our tax burden” above). In addition, our expenses related to defined benefit pension plan increased by RR 401 million in 2012 compared to 2011 primarily due to an indexation of future payments, an increase in number of retirement age employees and the recognition in 2012 of additional lump sum retirement benefits. The aforementioned increases were partially offset by a decrease of RR 114 million in the recognition of charges related to NOVATEK’s share-based compensation program for the Group’s senior and key management. Legal, audit, and consulting services expenses increased by RR 500 million, or 64.6%, to RR 1,274 million compared to RR 774 million in 2011 largely due to consulting services related to our recent acquisitions, as well as an increase in services to prolong and acquire software solutions for our core subsidiaries. In 2012, our social expenses and compensatory payments decreased by RR 211 million, or 17.4%, to RR 1,001 million compared to RR 1,212 million in 2011 primarily due to the fact, that we did not consolidate compensatory payments of Yamal LNG in 2012 as a result of a disposal of a 20% interest in Yamal LNG in October 2011 and the consolidation of the company under the equity method starting from that date. Social expenses and compensatory payments in 2012 were primarily related to our donations to sport clubs and activities, educational schools, as well as continued support for charities and social programs in the regions where we operate. Social expenses and compensatory payments fluctuate period-on-period depending on the funding needs and the implementation schedules of specific programs we support in the regions where we operate. In 2012, depreciation of administrative buildings increased by RR 116 million, or 58.6%, primarily due to the completion and opening of our new Moscow head-office in May 2011. Fixed assets of administrative nature are depreciated on a straight-line basis over their estimated useful lives. 27 Fire safety and security expenses increased by RR 21 million, or 11.8%, to RR 199 million in 2012 from RR 178 million in 2011 as a result of the opening of our new Moscow head-office in May 2011, as well as an increase in rates charged for security services. Repair and maintenance expenses increased by RR 53 million, or 46.1%, to RR 168 million in 2012 from RR 115 million in 2011 primarily due to start of maintenance and repair works of administrative fixed assets rented by our subsidiaries, OOO NOVATEK-Chelyabinsk and NOVATEK-Ust-Luga. In 2012, our rent expense decreased by RR 27 million, or 19.3%, to RR 113 million from RR 140 million in 2011 primarily due to the relocation of Moscow head-office employees to our new office building in May 2011. The decrease was partially offset by the consolidation of the regional gas trader acquired in November 2011, which rents an office space for its employees and additional office space rented by NOVATEK-Ust-Luga since May 2012. Insurance expenses increased by RR 28 million, or 48.3%, to RR 86 million in 2012 from RR 58 million in 2011 due to insuring of recently launched fixed assets at our production subsidiaries. Bank charges increased by RR 24 million, or 41.4%, to RR 82 million in 2012 from RR 58 million in 2011 primarily due to service charges applied to letters of credit, as well as commission services fees charged by banks for the acceptance of payments from residential customers of natural gas at our recently acquired subsidiaries, supplying natural gas in the regional markets. In 2012, other general and administrative expenses decreased by RR 79 million, or 12.8%, to RR 538 million from RR 617 million in 2011 primarily due to a RR 63 million decrease in expenses related to the termination at the end of 2011 of the concession agreement at El-Arish concession area located in Egypt, which was partially offset by the RR 27 million increase in expenses related to our participation in international economic, geological and oil and gas forums and exhibitions, and RR 19 million increase in expenses related to the advertising. The remaining decrease of RR 62 million was made up of other immaterial expense items of an administrative nature. Materials, services and other In 2012, our materials, services and other expenses increased by RR 1,269 million, or 21.3%, to RR 7,216 million compared to RR 5,947 million in 2011. The main components of this expense category were employee compensation and repair and maintenance services, which on aggregate comprised 74.9% and 73.8% of total materials, services and other expenses in 2012 and 2011, respectively. millions of Russian roubles Employee compensation Repair and maintenance services Electricity and fuel Materials and supplies Security expenses Transportation expenses Processing fees Other Total materials, services and other Year ended 31 December: 2011 2012 Change % 3,808 1,598 457 412 271 186 99 385 7,216 2,953 1,435 405 309 237 184 99 325 5,947 29.0% 11.4% 12.8% 33.3% 14.3% 1.1% 0.0% 18.5% 21.3% Our employee compensation increased by RR 855 million, or 29.0%, to RR 3,808 million compared to RR 2,953 million in 2011. The increase was primarily due to a 6.0% indexation of base salaries effective from 1 July 2012 and an increase in the average number of employees. The increase in the average number of employees was the result of the acquisition of a regional gas trader Gazprom mezhregiongas Chelyabinsk in November 2011 and an expansion of our trading activities at NOVATEK-AZK. In addition, in 2012 our expenses related to defined benefit pension plan increased by RR 232 million as compared to 2011 primarily due to changes in actuarial assumptions, as well as recognition of additional lump sum retirement benefit in 2012. Repair and maintenance services increased by RR 163 million, or 11.4%, to RR 1,598 million in 2012 compared to RR 1,435 million in 2011. The increase was primarily related to on-going repair works at our wholly owned subsidiaries OOO NOVATEK-Tarkosaleneftegas and the OOO NOVATEK-Purovsky ZPK and was consistent with our ongoing maintenance schedules. 28 In 2012, electricity and fuel expenses increased by RR 52 million, or 12.8%, to RR 457 million from RR 405 million in 2011. The increase was primarily due to an increase in electricity and fuel volumes used by our production subsidiaries resulting from recently completed infrastructure projects, as well as higher electricity rates in 2012 as compared to 2011. Materials and supplies expense increased by RR 103 million, or 33.3%, to RR 412 million in 2012 from RR 309 million in 2011 mainly due to an increase in materials used for repair works of our production assets and own rail cars used for transportation of LPG. Security expenses increased by RR 34 million, or 14.3%, to RR 271 million in 2012 from RR 237 million in 2011 largely due to additional security services related to recently completed infrastructure projects at our production subsidiaries and an increase in security services rates effective from January 2012. Transportation expenses related to the delivery of materials and equipment to our fields marginally increased by RR two million, or 1.1%, to RR 186 million in 2012 from RR 184 million in 2011. In 2012, other material, services and other expenses increased by RR 60 million, or 18.5%, to RR 385 million from RR 325 million in 2011 primarily due to increases in ecological and feasibility studies services provided to our production subsidiaries. Exploration expenses In 2012, we incurred RR 2,022 million of exploration expenses of which RR 851 million was related to the capitalized cost of two exploratory wells at the West-Urengoyskoye and North-Yubileynoye license areas, written-off in accordance with our successful efforts accounting policy. In addition, we also recognized RR 428 million as exploration expense related to 3-D seismic activities, which were not classified as development costs in accordance with our accounting policy. In 2011, we incurred RR 1,819 million of exploration expenses of which RR 740 million related to the capitalized cost of three exploratory wells at the Raduzhniy and Yarudeiskiy licence areas, written-off in accordance with our successful efforts accounting policy. Net impairment expense In 2012, we recognized net impairment expense of RR 325 million, of which the significant portion was related to the impairment of trade accounts receivable for natural gas sold to small industrial companies and residential customers. In 2011, we recognized net impairment expense of RR 782 million, of which RR 548 million was related to the write-off of assets at the Middle-Chaselskiy license area and RR 120 million to the impairment of our investments at the El-Arish project. Change in natural gas, liquid hydrocarbons and work-in-progress In 2012, we recorded a reversal of RR 1,086 million to change in inventory expense as compared to a reversal of RR 105 million in 2011: millions of Russian roubles Natural gas Stable gas condensate Other Increase (decrease) in operating expenses due to change in inventory balances and work-in-progress Year ended 31 December: 2011 2012 (228) (897) 39 (1,086) (112) 91 (84) (105) In 2012, we recorded a reversal to our operating expenses of RR 228 million primarily due to a 369 mmcm increase in our natural gas inventory balance. Our volumes of natural gas injected into Gazprom’s underground gas storage facilities fluctuate period-to-period depending on market conditions, storage capacity constraints and our development plans to sustain and/or grow production during periods of seasonality. 29 In addition, in 2012, we recorded a reversal of RR 897 million to our operating expenses due to a 233 thousand tons increase in our inventory balance of stable gas condensate in transit and storage and an increase in the cost of stable gas condensate per ton. The following table highlights movements in our inventory balances: Inventory balances in transit or in storage At 31 December 2012 At 1 January Increase / (decrease) At 31 December 2011 At 1 January Increase / (decrease) Natural gas (millions of cubic meters) including Gazprom’s UGSF Liquid hydrocarbons (thousand tons) including stable gas condensate 1,129 1,096 563 461 760 732 325 228 369 364 238 233 760 732 325 228 790 761 356 264 (30) (29) (31) (36) Net gain (loss) on disposal of interest in subsidiaries In 2012, we recognized a net loss of RR 60 million on the disposal of the Groups’ wholly owned, non-core subsidiary OOO Purovsky Terminal in December 2012. In 2011, we realized a net gain of RR 62,948 million on the disposal of a 20% equity interest in OAO Yamal LNG to TOTAL S.A., our strategic partner in the Yamal LNG project. The net gain is comprised of a net gain on disposal of RR 28,685 million and a gain of RR 34,263 million due to the revaluation to fair value of our remaining 80% equity interest. Other operating income (loss) In 2012, we recognized other operating income of RR 196 million. In October 2012, we commenced trading operations for the purchase and sale of natural gas on the European market. As a result, in the fourth quarter of 2012, we purchased and sold approximately 4.7 terawatt-hours of natural gas. The total effect from natural gas trading operations on the European market and from the changes in fair values of long-term contracts, which were classified as derivative instruments in accordance with IAS 39 “Financial instruments: recognition and measurement”, in 2012 resulted in the recognition of net income in the amount of RR 76 million. The remaining other operating income of RR 120 million was primarily related to penalties charges received from our suppliers due to non-compliance of their contractual obligations and other immaterial profit and loss items. In 2011, we recognized other operating income of RR 207 million of which RR 192 million related to insurance compensation received in respect of an insured accident in 2010. Profit from operations As a result of the factors discussed above, our profit from operations decreased by RR 56,274 million, or 39.7%, to RR 85,334 million in 2012, compared to RR 141,608 million in 2011. Our profit from operations, adjusted for non-recurring transactions, primarily excluding the net gain (loss) on disposal of interest in subsidiaries, increased by RR 6,734 million, or 8.6%, to RR 85,394 million in 2012 from RR 78,660 million in 2011. In 2012, our profit from operations, excluding the net gain (loss) on disposal of interest in subsidiaries, as a percentage of total revenues decreased to 40.5% compared to 44.9% in 2011 primarily due to the commencement in January 2012 of natural gas purchases for resale in the regions where our end-customers are located and the lower trading margins we received for these volumes. In addition, our operating expenses exceeded the growth rate of our total revenues during the year due primarily to the UPT rate for natural gas, which was increased effective from 1 January 2012, while the regulated price for natural gas was increased effective from 1 July 2012. 30 Finance income (expense) In 2012, we recorded net finance income of RR 2,986 million as compared to a net finance expense of RR 2,703 million in 2011 due primarily to the appreciation of the Russian rouble relative to the US dollar in 2012 compared to the depreciation of the Russian rouble relative to the US dollar in 2011. loans amounted to RR 5,702 million compared to In 2012, our total accrued interest expense on RR 5,422 million in 2011. In 2012 and 2011, we capitalized RR 2,698 and RR 3,709 million, respectively, of interest expense to the cost of our property, plant and equipment construction account in accordance with the Group’s accounting policy. In addition, we recognized as part of interest expense RR 232 million and RR 225 million related to the unwinding of the present value discount related to provisions of asset retirement obligations in 2012 and 2011, respectively, and RR 212 million related to the effect of discounting of long-term financial liabilities in 2011. Interest income decreased by RR 1,661 million, or 49.0%, to RR 1,731 million in 2012 from RR 3,392 million in 2011 due to a decrease in loans provided to our joint ventures. In February 2012, the loan as well as the accrued interest on this loan provided to our joint venture OOO Yamal Development was converted to charter capital. In 2012, we recorded a net foreign exchange gain of RR 4,491 million compared to a net foreign exchange loss of RR 3,945 million in 2011 due primarily to the revaluation of our US dollar denominated borrowings. The Russian rouble appreciated by 5.7% against the US dollar during 2012 compared to the depreciation of the Russian rouble by 5.6% in 2011. We will continue to record foreign exchange gains and losses each period based on the movements between exchange rates and the currency denomination of our debt portfolio. Share of profit (loss) of joint ventures, net of income tax In 2012, our proportionate share of loss of joint ventures decreased to RR 2,105 million compared to a loss of RR 3,880 million in 2011. In 2012, our proportionate share of loss relating to our joint venture Yamal Development decreased by RR 1,643 million due to the conversion of loans received by the company to charter capital in February 2012, which resulted in a decrease in interest expense. In 2012, our proportionate share of loss relating to our joint venture Sibneftegas decreased by RR 1,544 million due to increases in natural gas sales prices effective from 1 January and 1 July 2012. The losses we recognized in Sibneftegas were primarily due to the revaluation of oil and gas properties acquired to fair value and the subsequent amortization of those costs under IFRS. In 2012, we recognized our share of the losses in our joint venture Yamal LNG amounting to RR 1,811 million as compared to a loss of RR 707 million in 2011 due primarily to an increase in compensatory payments related to the Yamal LNG project. Income tax expense Our overall consolidated effective income tax rates (total income tax expense calculated as a percentage of our reported IFRS profit before income tax) were 19.5% and 11.7% for the years ended 31 December 2012 and 2011, respectively. After excluding the effect of 20% disposal of Yamal LNG, the Group’s effective income tax rate for the year ended 31 December 2011 was 21.7%. The decrease in the effective income tax rate in 2012 as compared to 2011 was due to the application of a reduced income tax rate of 15.5% in respect of the Group’s priority investment project in YNAO. The Russian statutory income tax rate for both periods was 20%. The difference between our effective and statutory income tax rates is primarily due to certain non-deductible expenses or non-taxable income. 31 Profit attributable to shareholders and earnings per share Our profits attributable to shareholders and earnings per share tend to fluctuate periodically due to one-off events or extraordinary items that require adjustments to exclude these events to normalize earnings and to make period-on-period comparisons more meaningful. As a result of the factors discussed above, our profit for the period decreased by RR 49,850 million, or 41.8%, to RR 69,441 million in 2012 from RR 119,291 million in 2011. The profit attributable to shareholders of OAO NOVATEK decreased by RR 50,197 million, or 42.0%, in 2012 from RR 119,655 million in 2011. The profit attributable to shareholders of OAO NOVATEK, adjusted to exclude the net gain (loss) on disposal of subsidiaries, increased by RR 12,811 million, or 22.6%, to RR 69,518 million in 2012 from RR 56,707 million in 2011. to RR 69,458 million Our weighted average basic and diluted earnings per share, calculated from the profit attributable to shareholders of OAO NOVATEK, decreased by approximately RR 16.56 per share, or 42.0%, to RR 22.89 per share in 2012 from RR 39.45 per share in 2011. Our weighted average basic and diluted earnings per share, calculated from the profit attributable to shareholders of OAO NOVATEK, adjusted to exclude the net gain (loss) on disposal of subsidiaries, increased by RR 4.22 per share, or 22.6%, to RR 22.91 per share in 2012 from RR 18.69 per share in 2011. 32 LIQUIDITY AND CAPITAL RESOURCES The following table shows our net cash flows from operating, investing and financing activities for the years ended 31 December 2012 and 2011: millions of Russian roubles Net cash provided by operating activities Net cash provided by (used in) investing activities Net cash provided by (used in) financing activities Year ended 31 December: 2011 2012 Change % 75,825 (84,124) 2,603 71,907 (46,643) (11,735) 5.4% 80.4% n/a Liquidity and credit ratios 31 December 2012 31 December 2011 Change, % Current ratio Total debt to total equity Long-term debt to long-term debt and total equity Net debt to total capitalization (1) Net debt to EBITDA (2) Net debt to Normalized EBITDA (2) Interest coverage ratio (3) 1.06 0.45 0.25 0.26 1.20 1.20 24 1.16 0.40 0.24 0.20 0.48 0.84 42 (8.6%) 12.5% 4.2% 30.0% 150.0% 42.9% (42.9%) (1) Net debt represents total debt less cash and cash equivalents. Total capitalization represents total debt, total equity and deferred income tax liability. (2) Net debt to EBITDA and to Normalized EBITDA ratios are calculated as Net debt divided by EBITDA or Normalized EBITDA for the last twelve months. (3) Interest coverage ratio is calculated as Normalized EBITDA divided by interest expense, including capitalized interest, less interest income from the Consolidated Statement of Income. Net cash provided by operating activities In 2012, our net cash provided by operating activities increased by RR 3,918 million, or 5.4%, to RR 75,825 million compared to RR 71,907 million in 2011 mainly due to higher natural gas sales volumes and prices that was partially offset by an increase in income tax payments. Net cash provided by (used in) investing activities In 2012, our net cash used in operating activities increased by RR 37,481 million, or 80.4%, to RR 84,124 million compared to RR 46,643 million in 2011, due primarily to the payment for shares of our joint venture Nortgas, which was acquired in November 2012, as well as an increase in our cash used for purchases of property, plant and equipment and ongoing development activities at our fields. Net cash provided by (used in) financing activities In 2012, our net cash provided by financing activities was RR 2,603 million compared to net cash used in financing activities of RR 11,735 million in 2011. In 2012, cash provided by new borrowings increased by RR 32,564 million to RR 81,149 million from RR 48,585 million in 2011, which was partially offset by an increase in repayment of debts by RR 10,539 million from RR 29,873 million in 2011 to RR 40,412 million in 2012. Our cash used to pay dividends increased by RR 4,552 million in 2012 compared to 2011. The remaining change was related to repayment of interest on debts and other miscellaneous categories. 33 Working capital Our net working capital position (current assets less current liabilities) at 31 December 2012 was a positive RR 3,113 million compared to RR 8,202 million at 31 December 2011. The change of our net working capital position was primarily due to the increase in the current portion of long-term debt as of 31 December 2012. In February 2013, the Group issued four-year, Russian rouble denominated Eurobonds in the amount of RR 14 billion the proceeds from which were used to refinance our current portion of long-term debt (see “Debt obligations” below). The Group’s management believes that it presently has and will continue to have the ability to generate sufficient cash flows (from operating and financing activities) to repay all current liabilities and to finance the Group’s capital construction programs. Capital expenditures Our total capital expenditures on property, plant and equipment for the years ended 31 December 2012 and 2011 were as follows: millions of Russian roubles Capital expenditures Prepayments for participation in tender for mineral licenses per consolidated statement of cash flows Total additions to property, plant and equipment per Note “Property, plant and equipment” in the Group’s IFRS Consolidated Financial Statements Year ended 31 December: 2011 2012 Change % 43,554 31,161 39.8% - 6,870 n/a 43,554 38,031 14.5% Our total capital expenditures (including capitalized 3-D seismic surveys) represent our investments in developing our oil and gas properties. The following table shows the expenditures at our main fields and processing facilities for the years ended 31 December 2012 and 2011: millions of Russian roubles Yurkharovskoye field Gas Condensate Fractionation Complex and Transshipment Facility (Ust-Luga) East-Tarkosalinskoye field Purovsky Plant Khancheyskoye field North-Khancheyskiy license area Salmanovskoye (Utrenneye) field North-Russkiy license area Olimpiyskiy license area Geofizicheskoye field West-Urengoiskiy license area North-Yamsoveiskiy license area South-Tambeyskoye field Other Capital expenditures Year ended 31 December: 2011 2012 14,067 11,801 7,157 1,443 1,017 982 819 657 599 343 327 316 - 4,026 43,554 11,403 3,923 2,430 1,369 612 147 - 574 345 30 515 169 4,148 5,496 31,161 Total capital expenditures on property, plant and equipment in 2012 increased by RR 12,393 million, or 39.8%, to RR 43,554 million from RR 31,161 million in 2011. The increase was primarily related to the construction of processing assets at Ust-Luga, ongoing development activities and the launch of the fourth stage of the second phase development at our Yurkharovskoye field, as well as further field development on the crude oil layers at the East-Tarkosalinskoye and Khancheyskoye fields. The increase was partially offset by the fact, that we did not consolidate capital expenditures related to South-Tambeyskoye field in 2012 as a result of the disposal of a 20% equity interest in Yamal LNG in October 2011, which is accounted for under the equity method starting from that date. 34 Debt obligations We utilize a variety of financial instruments to ensure the flexibility of our financing strategy. This includes maintaining a debt portfolio with a balance of short-term and long-term financing, a mix of fixed and floating interest rate instruments and a debt portfolio denominated in either Russian roubles or US dollars. Subsequent events In February 2013, the Group placed Russian rouble denominated Eurobonds in the amount of RR 14 billion with a four-year maturity and an annual coupon rate of 7.75%. In February 2013, we repaid a RR 15 billion loan from OAO Sberbank ahead of its maturity schedule. In March 2013, we repaid a USD 200 million loan from OAO Nordea Bank ahead of its maturity schedule. Overview Our total debt increased from RR 95,478 million at 31 December 2011 to RR 132,487 million at 31 December 2012, or by RR 37,009 million. We periodically utilize credit facilities to supplement our internally generated cash flows for the financing of capital expenditures related to the development of our fields and to construct and/or expand processing assets such as the Purovsky Plant and Ust-Luga, as well as acquisitions of new oil and gas assets. The increase in our total debt was largely due to the placement of a ten-year, US dollar denominated Eurobond in December 2012 to finance the Nortgas acquisition. Our total debt position (net of unamortized transaction costs) at 31 December 2012 and 31 December 2011 was as follows: Facility Amount Maturity Interest rate Year ended 31 December: 2011 2012 Eurobonds Ten-Year Russian rouble Bonds Eurobonds Ten-Year Eurobonds Five-Year Sberbank Russian rouble Bonds Sberbank Nordea Bank Sumitomo Mitsui (1) UniCredit Bank Gazprombank (2) Total USD 1 billion RR 20 billion USD 650 million USD 600 million RR 15 billion RR 10 billion RR 10 billion December 2022 October 2015 February 2021 February 2016 December 2013 June 2013 December 2014 USD 200 million November 2013 December 2013 USD 300 million October 2012 USD 200 million November 2012 RR 10 billion 4.422% 8.35% 6.604% 5.326% 7.5% 7.5% 8.9% LIBOR+1.9% LIBOR+1.45% LIBOR+3.25% 8.0% 30,232 19,969 19,620 18,146 14,984 9,991 9,837 6,075 3,633 - - 132,487 (1) Sumitomo Mitsui Banking Corporation Europe Limited. (2) The loan from OAO Gazprombank was repaid ahead of maturity schedule in January 2012. Maturities of long-term loans Scheduled maturities of our long-term debt at 31 December 2012 were as follows: Maturity schedule: 1 January to 31 December 2014 1 January to 31 December 2015 1 January to 31 December 2016 1 January to 31 December 2017 After 31 December 2017 Total long-term debt - - 20,776 19,206 14,966 9,971 - 6,439 7,685 6,435 10,000 95,478 RR million 9,837 19,970 18,146 - 49,852 97,805 35 Available credit facilities At 31 December 2012, the Group had available funds under short-term credit lines in the form of bank overdrafts with various international banks in the aggregate amount of RR 7,327 million (USD 175 million and EUR 50 million) on variable interest rates subject to the specific type of credit facility. At 31 December 2012, the Group also had funds available under credit facilities with interest rates predetermined or negotiated at time of each withdrawal: BNP PARIBAS Bank Credit Agricole Corporate and Investment Bank UniCredit Bank Sberbank (1) Total available credit facilities Par value USD 100 million USD 100 million USD 350 million RR 30 billion Expiring Within one year Between 1 and 3 years 3,037 3,037 - 30,000 36,074 - - 10,630 - 10,630 (1) The period of availability of the credit line facility ended 31 January 2013. Management believes it has sufficient internally generated cash flows, as well as access to available external borrowings (both short- and long-term) to fund its capital expenditure program, service its existing debt and meet its current obligations as they become due. 36 QUALITATIVE AND QUANTITATIVE DISCLOSURES AND MARKET RISKS We are exposed to market risk from changes in commodity prices, foreign currency exchange rates and interest rates. We are exposed to commodity price risk as our prices for crude oil and stable gas condensate destined for export sales are linked to international crude oil prices and other benchmark price references. We are exposed to foreign exchange risk to the extent that a portion of our sales, costs, receivables, loans and debt are denominated in currencies other than Russian roubles. We are subject to market risk from changes in interest rates that may affect the cost of our financing. From time to time we may use derivative instruments, such as commodity forward contracts, commodity price swaps, commodity options, foreign exchange forward contracts, foreign currency options, interest rate swaps and forward rate agreements, to manage these market risks, and we may hold or issue derivative or other financial instruments for trading purposes. Foreign currency risk Our principal exchange rate risk involves changes in the value of the Russian rouble relative to the US dollar. As of 31 December 2012, the total amount of our long-term debt denominated in US dollars was RR 67,987 million, or 51.3% of our total borrowings at that date. Changes in the value of the Russian rouble relative to the US dollar will impact our foreign currency-denominated costs and expenses and our debt service obligations for foreign currency-denominated borrowings in Russian rouble terms, as well as receivables at our foreign subsidiaries. We believe that the risks associated with our foreign currency exposure are partially mitigated by the fact that a portion of our total revenues, approximately 24.8% in 2012, is denominated in US dollars. As of 31 December 2012, the Russian rouble appreciated by approximately 5.7% against the US dollar since 31 December 2011. A hypothetical and instantaneous 10% depreciation in the Russian rouble in relation to the US dollar as of 31 December 2012 would have resulted in an estimated non-cash foreign exchange loss of approximately RR 7,771 million on foreign currency denominated borrowings held at that date. Commodity risk Substantially all of our crude oil, stable gas condensate and LPG export sales are sold under spot market contracts, and our export prices are primarily linked to international crude oil prices. External factors such as geopolitical developments, natural disasters and the actions of the Organization of Petroleum Exporting Countries affect crude oil prices and thus our export prices. The weather is another factor affecting demand for natural gas. Changes in weather conditions from year to year can influence demand for natural gas and to some extent gas condensate and oil products. From time to time we may employ derivative instruments to mitigate the price risk of our sales activities. In our consolidated financial statements all derivative instruments are recorded at their fair values. Unrealized gains or losses on derivative instruments are recognized within other operating income (loss), unless the underlying arrangement qualifies as a hedge. The Group purchases and sells natural gas on the European market under long-term contracts based on formulas with reference to benchmark natural gas prices quoted for the North-Western European natural gas hubs, crude oil and oil products prices and/or a combination thereof. Therefore, the Group’s financial results from natural gas trading activities are subject to commodity price volatility based on fluctuations or changes in the respective benchmark reference prices. Pipeline access We transport substantially all of our natural gas through the Unified Gas Supply System (“UGSS”) owned and operated by OAO Gazprom, which is responsible for gathering, transporting, dispatching and delivering substantially all natural gas supplies in Russia. Under existing legislation, Gazprom must provide access to the UGSS to all independent suppliers on a non-discriminatory basis provided there is capacity available that is not being used by Gazprom. In practice, Gazprom exercises considerable discretion over access to the UGSS because it is the sole owner of information relating to capacity. There can be no assurance that Gazprom will continue to provide us with access to the UGSS; however, we have not been denied access in prior periods. 37 Ability to reinvest Our business requires significant ongoing capital expenditures in order to grow our production and meet our strategic plans. An extended period of reduced demand for our hydrocarbons available for sale and the corresponding revenues generated from these sales would limit our ability to maintain an adequate level of capital expenditures, which in turn could limit our ability to increase or maintain current levels of production and deliveries of natural gas, gas condensate, crude oil and other associated products; thereby, adversely affecting our financial and operating results. Off balance sheet activities As of 31 December 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements. 38 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 199 FORWARD–LOOKING STATEMENTS This Annual Review includes ‘forward-looking • the effects of competition in the domestic and information’ within the meaning of Section 27A of export oil and gas markets; the US Securities Act of 1933, as amended, and • our ability to successfully implement any of our Section 21E of the US Securities Exchange Act of business strategies; 1934, as amended. Certain statements included in • the impact of our expansion on our revenue this Annual Report and Accounts, including, without potential, cost basis and margins; limitation, statements concerning plans, objectives, • our ability to produce target volumes in the goals, strategies, future events or performance, event, among other factors, of restrictions on and underlying assumptions and other statements, which are other than statements of historical facts. The words “believe,” “expect,” “anticipate,” “intends,” “estimate,” “forecast,” “project,” “will,” “may,” “should” and similar expressions identi- our access to transportation infrastructure; • the effects of changes to our capital expenditure projections on the growth of our production; • potentially lower production levels in the future than currently estimated by our management fy forward-looking statements. Forward-looking and/or independent petroleum reservoir engi- statements include statements regarding: strate- neers; gies, outlook and growth prospects; future plans • inherent uncertainties in interpreting geophysi- and potential for future growth; liquidity, capital cal data; resources and capital expenditures; growth in • changes to project schedules and estimated demand for our products; economic outlook and completion dates; industry trends; developments of our markets; the • our success in identifying and managing risks impact of regulatory initiatives; and the strength of to our businesses; our competitors. The forward-looking statements • the effects of changes to the Russian legal in this Annual Review are based upon various as- framework concerning currently held and any sumptions, many of which are based, in turn, upon newly acquired oil and gas production licenses; further assumptions, including without limitation, management’s examination of historical operating trends, data contained in our records and oth- er data available from third parties. Although we • changes in political, social, legal or economic conditions in Russia and the CIS; • the effects of technological changes; • the effects of changes in accounting standards believe that these assumptions were reasonable or practices. when made, these assumptions are inherently subject to significant uncertainties and contingen- This list of important factors is not exhaustive. When cies, which are difficult or impossible to predict and relying on forward-looking statements, one should are beyond our control. As a result, we may not carefully consider the foregoing factors and other achieve or accomplish these expectations, beliefs uncertainties and events, especially in light of the or projections. In addition, important factors that, in political, economic, social and legal environment in our view, could cause actual results to differ mate- which we operate. Such forward-looking statements rially from those discussed in the forward-looking speak only as of the date on which they are made. statements include: • changes in the balance of oil and gas supply Accordingly, we do not undertake any obligation to update or revise any of them, whether as a result of new information, future events or otherwise. We do and demand in Russia and Europe; not make any representation, warranty or prediction • the effects of domestic and international oil and gas price volatility and changes in regulatory that the results anticipated by such forward-looking statements will be achieved, and such forward-look- conditions, including prices and taxes; ing statements represent, in each case, only one 200 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION of many possible scenarios and should not be Mentions in this Annual Report of “OAO NOVATEK”, viewed as the most likely or standard scenario. The “NOVATEK”, “the Company”, “we” and “our” refer information and opinions contained in this document to OAO NOVATEK and/or its subsidiary enterprises, are provided as at the date of this review and are depending upon the context, in which the terms subject to change without notice. are used. ABBREVIATIONS barrel bln bcm boe km LNG LPG mboe mcm mln mmboe mmcm mmt mt PRMS RR SEC sq. th. ton UGSS YNAO one stock tank barrel, or 42 US gallons of liquid volume billion billion cubic meters barrels of oil equivalent. For natural gas, we use the conversion factor of one mcm equals 6.54 barrels. kilometer(s) liquified natural gas liquified petroleum gases thousand boe thousand cubic meters million million boe million cubic meters million metric tons thousand metric tons Petroleum Resources Management System Russian rouble United States Securities and Exchange Commission square thousand metric ton Unified Gas Supply System Yamal-Nenets Autonomous Region CONVERSION FACTORS 1000 cubic meters of gas = 6.54 boe. coefficients depending on the liquids density at To convert crude oil and gas condensate re- each field. serves from tons to barrels we used various ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION 201 RESPONSIBILITY STATEMENT I hereby confirm that to the best of my knowledge: (a) the set of financial statements, which has been prepared in accordance with International Accounting Standards, gives a true and fair view of the assets, liabilities, financial position and profit or loss of the undertakings included in the consolidation as a whole as required by the Disclosure and Transparency Rule (DTR) 4.1.6R, (b) the management report includes a fair review of the information required by DTR 4.1.9R, being a balanced and comprehen- sive analysis of development and perfor- mance of the business and the position of the company and the undertakings includ- ed in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that the company faces. Mark Gyetvay, Chief Financial Officer 202 ANNUAL REPORT OAO NOVATEK 2012 GROWTH EFFICIENCY INNOVATION CONTACT INFORMATION LEGAL ADDRESS 22 A Pobedy Street, Tarko-Sale, Yamal-Nenets Autonomous Region, 629850, Russia OFFICE IN MOSCOW 2, Udaltsova Street, 119415, Moscow, Russia CENTRAL INFORMATION SERVICE Tel: +7 495 730-6000 Fax: +7 495 721-2253 E-mail: novatek@novatek.ru PRESS SERVICE Tel: +7 495 721-2207 E-mail: press@novatek.ru INVESTOR RELATIONS Tel: +7 495 730-6013 Fax: +7 495 730-6000 E-mail: ir@novatek.ru WEBSITE: www.novatek.ru (Russian version) www.novatek.ru/eng (English version) REGISTRAR ZAO “Computershare Registrar” 8 Ivana Franko Street, Moscow Russia 121108 Tel: +7 (495) 926-8160 Fax: +7 (495) 926-8178 E-mail: info@nrcreg.ru GDR PROGRAM ADMINISTRATOR Deutsche Bank Trust Company Americas 60 Wall Street, New York, New York 100056, USA London +44 20 7547 6500 New York +1 212 250 9100 Moscow +7 495 797 5209 INDEPENDENT AUDITOR ZAO PricewaterhouseCoopers Audit White Square Office Center, Butyrsky Val 10, 125047 Moscow, Russia Tel: +7 495 967-6000 Fax: +7 495 967-6001 INDEPENDENT RESERVES AUDITOR DeGolyer and MacNaughton 5001 Spring Valley Road, Suite 800, East Dallas, Texas 75244, USA Tel: +1 214 368-6391 Fax: +1 214 369-4061 E-mail: degolyer@demac.com www.novatek.ru

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