Volga Gas: Not For Sale – Market Conditions Force Rethink

Conclusion of Formal Sale Process

Following the announcement by the Company of a formal sale process on 5 June 2014 a number of proposals were received from interested parties. However none of the proposals have been deemed by the Board to represent a fair value for the Company.  In light of the more recent economic developments, the Board has concluded that there is unlikely to be an acceptable proposal in the immediate future. As a result, Volga Gas announces that the formal sale process has been concluded with immediate effect and, as such, Volga Gas is no longer in an offer period for the purposes of the City Code on Takeovers and Mergers.

The Board remains confident in the outlook for the Company and its potential to continue delivering value to shareholders. Considerable progress has been made in recent years to bring the Company’s main assets into production, which has resulted in strong cash generation and profitability.  On 10 July 2014 the Company announced a policy to pay up to 50% of net profits as a cash dividend, the first payment under which was made to shareholders on 24 October 2014. The Company has a robust balance sheet with no debt and the Board is confident that it can continue to operate profitably in spite of the recent strong downturn in oil and gas prices and the economic conditions currently prevailing in Russia, and will be capable of continuing with the development of its assets to the benefit of shareholders.

Operational Update

Group production during 2014 was 4,244 boepd reflecting continued steady production from the Vostochny Makarovskoye (“VM”) field offset by declines in oil production in the second half and some plant maintenance downtime during October and December 2014.  Declines in international oil prices during the period have been accompanied by a similar drop in the US dollar/Ruble exchange rate, so that while the revenues, as reported in US dollars would be expected to decline, the major part of the Group’s costs, being in Rubles, have commensurately declined in US dollar terms.  During December 2014 the selling price of its oil and condensate averaged US$31.50 per barrel compared to the average US$48.00 per barrel achieved in H1 2014.  Gas sales prices, while they have been steady in Ruble terms have fallen in US dollar terms to US$59.00 per thousand cubic metres.

Certain changes to the taxes applied to oil and gas in Russia announced during 2014 have come into effect.  The major change relevant to Volga Gas is the significant increase in the rate of Mineral Extraction Tax (“MET”) that applies to gas condensate, which has now been brought in line with the MET on crude oil.  The MET formula rate on crude oil also has increased although the actual rate charged will reflect significantly lower international oil prices which are used to calculate the rates.  Another change coming into effect in Russia is a significant reduction in oil export tax rates.  While Volga Gas would not directly benefit from this as it sells all production in domestic markets, it can be expected that domestic prices would adjust to reflect these lower export taxes, albeit in the light of the currently lower international oil prices.

Volga Gas is confident that with its competitive cost base and strong balance sheet it can continue to operate and provide positive cash flow and develop its assets with its existing resources.  Having converted much of its cash balances from Rubles to US dollars, the Group’s liquidity position remains healthy.

VM Well #3

Further to the announcement of 11 November 2014, Volga Gas agreed with the drilling contractor a cost effective means of completing the VM#3 production well.  Operations have recommenced with the aim of completing it in time to commence production during the first half of 2015.  In addition, a rig is being mobilized to drill a sidetrack to the VM#4 well which is currently not producing.  Since the drilling contracts are in Roubles, the cost to the Company of these wells in US Dollars will be significantly lower than previously budgeted.

The existing wells on the VM field continue to produce strongly and maintain current group production capacity at a level of approximately 4,500 boepd.

LPG Project

The Group in undertaking front end engineering and design work on a further enhancement to the Dobrinskoye Gas Plant to enable it to extract propane and butane (“LPG”) as a separate product stream.  Initial studies suggest that the estimated US$30 million capital cost could be recovered within 2 to 3 years from the incremental profits from this project.  Further announcements on this project will be made as it progresses towards a final investment decision.