3rd Quarter Results (MDA)

PJSC LUKOIL

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

for the three and nine-month periods ended

30 September 2016 and 2015

The following report contains a discussion and analysis of the financial position of PJSC LUKOIL at 30 September 2016 and the results of its operations for the three and nine month periods ended 30 September 2016 and 2015, as well as significant factors that may affect its future performance. It should be read in conjunction with our International Financial Reporting Standards ("IFRS") condensed interim consolidated financial statements and notes thereto for the respective periods.

References to "LUKOIL," "the Company," "the Group," "we" or "us" are references to PJSC LUKOIL and its subsidiaries and equity affiliates. All ruble amounts are in millions of Russian rubles ("RUB"), unless otherwise indicated. Income and expenses of our foreign subsidiaries were translated to rubles at rates which approximate actual rates at the date of the transaction. Tonnes of crude oil and natural gas liquids produced were translated into barrels using conversion rates characterizing the density of crude oil from each of our oilfields and the actual density of liquids produced at our gas processing plants. Tonnes of crude oil purchased as well as other operational indicators expressed in barrels were translated into barrels using an average conversion rate of 7.33 barrels per tonne. Translations of cubic meters to cubic feet were made at the rate of 35.31 cubic feet per cubic meter. Translations of barrels of crude oil into barrels of oil equivalent ("BOE") were made at the rate of 1 barrel per BOE and of cubic feet - at the rate of 6 thousand cubic feet per BOE.

This report includes forward-looking statements - words such as "believes," "anticipates," "expects," "estimates," "intends," "plans," etc. - that reflect management's current estimates and beliefs, but are not guarantees of future results. 

Key financial and operational results

(1) Profit from operating activities before depreciation, depletion and amortization.

(2) Cash flow from operating activities less capital expenditures and acquisition of licenses.

Our financial results for the nine months of 2016 were affected by lower average hydrocarbon prices, increase in the crude oil extraction tax base rate, decline in domestic refining margins, as well as an increase in transportation tariffs.

In the nine months of 2016, our EBITDA (operating) amounted to 547 billion RUB, a decrease of 13.2% to the nine months of 2015. As far as we compensated most of the costs incurred within the West Qurna-2 project, we were eligible for significantly lower volumes of compensation crude oil, compared to the respective period of 2015, that significantly affected our EBITDA (operating). Net of the West Qurna-2 project, the Group's EBITDA (operating) decreased by 1.8% compared to the nine months of 2015. Our EBITDA (operating) was supported by the ruble devaluation to US dollar and Euro, higher international refinery throughput volumes and substantial improvement in the refined product slate.

In the nine months of 2016, our profit attributable to LUKOIL shareholders amounted to 160 billion RUB, a decrease of 55.0% to the nine months of 2015. Our profit was affected by foreign exchange loss in the nine months of 2016 compared to foreign exchange gain in the nine months of 2015 resulted from ruble volatility.

In the nine months of 2016, we continued generating strong free cash flow that amounted to 198 billion RUB, compared to 171 billion RUB in the nine months of 2015.

Business overview

LUKOIL is one of the world's largest publicly traded vertically integrated energy companies in terms of hydrocarbon reserves that amounted under SEC standards to 16.6 billion BOE at 1 January 2016 and comprised of 12.6 billion barrels of crude oil and 23.8 trillion cubic feet of gas. Most of our reserves are conventional. Our daily hydrocarbon production in the nine months of 2016 amounted to 2.2 million BOE with liquid hydrocarbons representing approximately 85% of our overall production volumes.

The primary activities of LUKOIL and its subsidiaries are oil exploration, production, refining, marketing and distribution.

Our operations are divided into three main business segments:

· Exploration and Production - which includes our exploration, development and production operations related to crude oil and gas. These activities are primarily located within Russia, with additional activities in Azerbaijan, Kazakhstan, Uzbekistan, the Middle East, Northern and Western Africa, Norway, Romania and Mexico.

· Refining, Marketing and Distribution - which includes refining, petrochemical and transport operations, marketing and trading of crude oil, natural gas and refined products, generation, transportation and sales of electricity, heat and related services.

· Corporate and other - which includes operations related to our headquarters (which coordinates the operations of Group companies), finance activities, production of diamonds and certain other activities.

Each of our segments is dependent on the other, with a portion of the revenues of one segment being a part of the costs of the other. In particular, our Refining, Marketing and Distribution segment purchases crude oil from our Exploration and Production segment. As a result of certain factors considered in the "Domestic crude oil and refined products prices" section on p. 4, benchmarking crude oil market prices in Russia cannot be determined with certainty. Therefore, the prices set for inter-segment purchases of crude oil reflect a combination of market factors, primarily international crude oil market prices, transportation costs, regional market conditions, the cost of crude oil refining and other factors. Accordingly, an analysis of either of these segments on a stand-alone basis could give a misleading impression of those segments' underlying financial position and results of operations. For this reason, we do not analyze either of our main segments separately in the discussion that follows. However, we present the financial data for each in Note 28 "Segment information" to our condensed interim consolidated financial statements.

Changes in Group structure

In line with the Company's strategy of optimizing its downstream operations in Europe, we sold petrol station networks in Poland, Latvia and Lithuania in the first quarter of 2016 and petrol stations networks in Ukraine and Estonia in 2015.

In August 2015, a Group company closed the transaction to sell its 50% interest in Caspian Investment Resources Ltd, an exploration and production company operating in Kazakhstan, to a Sinopec group company for $1,067 million (70.1 billion RUB). Related structural decrease in the Group's crude oil production amounted to approximately 20 thousand barrels per day.

Sectorial sanctions against the Russian companies

In July-September 2014, the United States ("US"), the European Union ("EU") and other countries imposed a set of economic sanctions on Russia, including certain sectoral sanctions which affect Russian oil and gas companies. Such sectoral sanctions prohibit US and the EU companies and individuals from providing, exporting, or re-exporting directly or indirectly, goods, services (except for financial services), or technology in support of exploration or production for deepwater, Arctic offshore, or shale projects on the territory of the Russian Federation.

The Company is not subject to any financial restrictions and is not currently involved in deepwater, Arctic offshore or shale projects in Russia. That is why we assess the impact of the sanctions on the Company's activities as immaterial.

Main macroeconomic factors affecting our results of operations

Changes in the international price of crude oil and refined products

The price at which we sell crude oil and refined products is the primary driver of the Group's revenues. During the nine months of 2016, the price for Brent crude oil fluctuated between $26 and $50 per barrel, reached its maximum of $50.7 in the beginning of June and minimum of $26.0 in the end of January, and averaged 24.3% less than in the nine months of 2015. Nevertheless, as a result of ruble devaluation, the prices expressed in rubles decreased less significantly.

Substantially all the crude oil the Group exports is Urals blend. The following tables show the average crude oil and refined product prices in the respective periods of 2016 and 2015.

Translated into rubles using average exchange rate for the period.

(1) The Company sells various crude oil blends on foreign markets on various delivery terms. Thus, our average realized sale price of oil on international markets differs from the average prices of Urals blend on Mediterranean and Northern Europe markets.

Domestic crude oil and refined products prices

Substantially all crude oil produced in Russia is produced by vertically integrated oil companies such as ours. As a result, most transactions are between affiliated entities within vertically integrated groups. Thus, there is no concept of a benchmark domestic market price for crude oil. The price of crude oil that is produced but not refined or exported by one of the vertically integrated oil companies is generally determined on a transaction-by-transaction basis against a background of world market prices, but with no direct reference or correlation. At any time there may exist significant price differences between regions for similar quality crude oil as a result of competition and economic conditions in those regions.

Domestic prices for refined products are determined to some extent by world market prices, but they are also directly affected by local demand and competition.

The table below represents average domestic wholesale prices of refined products in the respective periods of 2016 and 2015.

Source: InfoTEK (excluding VAT).

Changes in the US dollar-ruble exchange rate and inflation

A substantial part of our revenue is either denominated in US dollars or is correlated to some extent with US dollar crude oil prices, while most of our costs in the Russian Federation are settled in Russian rubles. Therefore, a devaluation of the ruble against the US dollar generally causes our revenues to increase in ruble terms, and vice versa. Ruble inflation also affects the results of our operations.

The following table provides data on inflation in Russia and change in the ruble-dollar and ruble-euro exchange rates.

Taxation

The rates of taxes specific to the oil industry in Russia are linked to international crude oil prices and are changed in line with them. The methods to determine the rates for such taxes are presented below.

Crude oil extraction tax rate is changed monthly and is calculated by multiplying the base rate by a coefficient reflecting average international Urals price and ruble-dollar exchange rate during the month. The base rate for 2016 is set at 857 rubles per metric tonne extracted (766 rubles for 2015).

The tax rate is zero when the average international Urals price is less than, or equal to, $15.00 per barrel. In 2016, each $1.00 per barrel increase in the international Urals price above $15.00 per barrel results in an increase in the tax rate by $0.45 per barrel ($0.40 per barrel in 2015).

The mineral extraction tax on crude oil is payable in rubles per tonne of crude oil extracted.

There are different types of tax incentives on the mineral extraction tax on crude oil applied to our fields and deposits:

· A special coefficient is applied to the standard tax rate depending on location, depletion, type of reserves, size and complexity of a particular field. This type of incentive with different coefficients is applied to our highly depleted fields (more than 80% depletion), our Yu. Korchagin field located in the Caspian offshore, the Permian layers of our Usinskoye field in Timan-Pechora producing high-viscous crude oil, our Pyakyakhinskoye field located in the Yamal-Nenets region of Western Siberia, a number of fields in the Nenets Autonomous region, as well as to our new small-sized fields (recoverable reserves less than 5 million tonnes) and fields and deposits with low permeability like V.N. Vinogradov field and Tyumen deposits;

· A fixed tax rate of 15% of the international Urals price is applied to our V. Filanovsky field, located in the Caspian offshore;

· A zero tax rate is applied to our Yaregskoye field producing extra-viscous crude oil, as well as to unconventional deposits (Bazhenov and others).

Some of the mineral extraction tax incentives are limited in time or by cumulative oil production volumes.

The table on the p. 6 illustrates the impact of mineral extraction tax incentives on the tax rate at $50 Urals price.

Natural gas extraction tax rate. The base rate amounts to 35 rubles per thousand cubic meters and is adjusted depending on average wholesale natural gas price in Russia, share of gas production in total hydrocarbon production, regional location and complexity of particular gas field.

In the nine months of 2016, actual average natural gas extraction tax rate for our major gas field - Nakhodkinskoe in Western Siberia amounted to 208 rubles per thousand cubic meters (160 rubles in the nine months of 2015). The rate for this field is subject to a special regional reducing coefficient. 

Crude oil export duty rate is denominated in US dollars per tonne of crude oil exported and is calculated on a progressive scale according to the bellow table.

The export duty rate changes every month with the rate for the next month being based on average Urals price for the period from the 15th day of the previous month to the 14th day of the current month.

Crude oil produced at some of our fields is subject to special export duty rates calculated according to special formulas, which are lower than standard rates. A reduced rate is applied to crude oil produced at our Yaregskoye field producing extra-viscous crude oil and our Yu. Korchagin field in the Caspian offshore. A zero rate applies to crude oil of our V. Filanovskogo field also located in the Caspian offshore.

The table below illustrates the impact of tax incentives for different fields and deposits in our portfolio at $50 per barrel Urals price under 2016 tax formulas.

Export duty rates on refined products are calculated by multiplying the current crude oil export duty rate by a coefficient according to the table below.

Crude oil and refined products exports from Russia are subject to two steps of customs declaration and duty payments: temporary and complete. A temporary declaration is submitted based on preliminary exports volumes and the duty is paid in rubles translated from US dollars at the date of the temporary declaration. A complete declaration is submitted after receiving the actual data on the exported volumes, but no later than six months after the date of the temporary declaration. The final amount of the export duty is adjusted depending on the actual volumes, the US dollar exchange rate at the date of the complete declaration (except for pipeline deliveries when the exchange rate at the temporary declaration date is used) and the export duty rate. If temporary and complete declarations are submitted in different reporting periods, the final amount of the export duty is adjusted in the period of submission of the complete declaration. The high volatility of the ruble-dollar exchange rates may lead to significant adjustments. For the purposes of the IFRS consolidated financial statements, data from temporary declarations at the reporting period end is translated to rubles from US dollars using the period-end exchange rate.

Crude oil and refined products exported to member countries of the Customs Union in the Eurasian Economic Union of Russia, Belarus, Kazakhstan, Armenia and the Kyrgyz Republic (Customs Union) are not subject to export duties. 

The following tables represent average enacted rates for taxes specific to the oil industry in Russia for the respective periods.

(1) Translated to rubles using average exchange rate for the period.

Excise on refined products. The responsibility to pay excises on refined products in Russia is imposed on refined product producers (except for straight-run gasoline). Only domestic sales volumes are subject to excises.

In other countries where the Group operates, excises are paid either by producers or retailers depending on the local legislation.

Excise rates on refined products in Russia are tied to the ecological class of fuel. Excise tax rates for the respective periods of 2016 and 2015 are listed below.

During the nine months of 2016, excise rates in Russia were increased twice, on 1 January and 1 April.

Income tax. The federal income tax rate is 2.0% and the regional income tax rate varies between 13.5% and 18.0%. The Group's foreign operations are subject to taxes at the tax rates applicable to the jurisdictions in which they operate.

The Company and its Russian subsidiaries file income tax returns in Russia. A number of Group companies in Russia are paying income tax as a consolidated taxpayers' group ("CTG"). This allows taxpayers to offset taxable losses generated by certain participants of a CTG against taxable profits of other participants of the CTG.

Transportation of crude oil, natural gas and refined products in Russia

The main Russian crude oil production regions are remote from the main crude oil and refined products markets. Therefore, access by crude oil production companies to the markets is dependent on the extent of diversification of the transport infrastructure and access to it. As a result, transportation cost is an important macroeconomic factor affecting our profit.

Transportation of crude oil produced in Russia to refineries and export destinations is primarily through the trunk oil pipeline system of the state-owned company, Transneft, or by railway transport.

Transportation of refined products in Russia is by railway transport and the pipeline system of Transnefteproduct. The Russian railway infrastructure is owned and operated by Russian Railways. Both these companies are state-owned. We transport the major part of our refined products by railway transport.

In Russia, gas is mostly sold at the wellhead and then transported through the Unified Gas Supply System ("UGSS"). The UGSS is responsible for gathering, transporting, dispatching and delivering substantially all natural gas supplies in Russia and is owned and operated by Gazprom.

Operational highlights

Hydrocarbon production

The table below summarizes the results of our exploration and production activities.

(1) Natural gas liquids produced at the Group gas processing plants.

(2) Compensation oil that represented approximately 27% of production from the West Qurna-2 field in the nine months of 2016 and 52% in the nine months of 2015.

(3) Excluding expenses at the West Qurna-2 field. 

We undertake exploration for, and production of, crude oil and natural gas in Russia and internationally. In Russia, our major oil producing subsidiaries are LUKOIL-Western Siberia, LUKOIL-Komi and LUKOIL-PERM. Our international upstream segment includes stakes in PSA's and other projects in Kazakhstan, Azerbaijan, Uzbekistan, Romania, Iraq, Egypt, Ghana, Cote d'Ivoire, Norway, Cameroon, Nigeria and Mexico.

Crude oil and natural gas liquids production. During the nine months of 2016, we produced (including the Company's share in equity affiliates) 69.3 million tonnes, or 508.4 million barrels, of crude oil, compared to 75.3 million tonnes, or 550.5 million barrels, of crude oil in the nine months of 2015.

In the nine months of 2016, the output of natural gas liquids at the Group gas processing plants in Western Siberia, Ural and Volgograd regions of Russia was 8.3 million BOE, compared to 9.6 million BOE in the nine months of 2015.

The following table presents our crude oil production in the nine months of 2016 and 2015 by major regions.

(1) Compensation oil that represented approximately 27% of production from the West Qurna-2 field in the nine months of 2016 and 52% in the nine months of 2015.

The main oil producing region for the Company is Western Siberia where we produced 45.7% of our crude oil in the nine months of 2016 (46.0% in the nine months of 2015).

Crude oil production in Western Siberia continued to decline due to natural depletion of reserves, increase in water cut and the Company's decision to reallocate capital to higher return projects in other regions of Russia, in particular those benefiting from tax incentives. We expect production decline rates in Western Siberia to decrease substantially as a result of our recent decision to intensify production drilling in this region. Production growth in Timano-Pechora was primarily driven by ramp-up of production at the Yaregskoye and Usinskoe fields, as well as the fields in Denisovskaya depression. Production growth in Ural region was primarily driven by successful drilling on existing brownfields and launch of new small sized fields.

The decrease in our international production was a result of lower volumes of production from the West Qurna-2 oilfield in Iraq attributable to the Company. We compensated most of the costs incurred within the project and therefore were eligible for less volumes of compensation crude oil compared to the third quarter and the nine months of 2015 (for details see p. 11).

The increase in our share in crude oil produced by equity affiliates in Russia was due to an increase in production at the Trebs and Titov oilfields by Bashneft-Polus, where the Group holds a 25.1% interest.

The decrease in our share in crude oil produced by equity affiliates outside Russia mainly resulted from the disposal of our 50% share in Caspian Investment Resources Ltd in the middle of 2015.

In October 2016, we started commercial production at two new major fields, the V. Filanovskogo field in the Caspian Sea (Volga region) and the Pyakyakhinskoye field in the Bolshekhetskaya depression (Western Siberia). Launch of these fields will enable us to significantly increase our daily hydrocarbon production with a major positive impact on our financial results due to high quality reserve base and tax incentives.

Natural and petroleum gas production. In the nine months of 2016, we produced 18,383 million cubic meters (108.2 million BOE) of gas (including our share in equity affiliates), that is 4.2% more than in the nine months of 2015. Our available for sale gas production amounted to 15,184 million cubic meters (89.4 million BOE), compared to 14,883 million cubic meters (87.6 million BOE) in the nine months of 2015.

The following table presents our available for sale gas production in the nine months of 2016 and 2015 by major regions.

Our major gas production field is the Nakhodkinskoe field, which is in natural decline. Our production at the field was 5,097 million cubic meters of natural gas in the nine months of 2016 (5,598 million cubic meters in the nine months of 2015). This decrease was partially offset by commencement of gas production at the Yu. Korchagin field. Decrease in production in Ural region was largely a result of increase in own gas consumption following the launch of new power generation unit at the Perm refinery.

Our international gas production (including our share in affiliates' production) increased by 11.8%, compared to the nine months of 2015, which resulted from the increase in production in Uzbekistan and Azerbaijan. Growth of gas production in Uzbekistan was due to launching new wells and a compressor booster station at the Gissar field. We are currently involved in construction of gas treatment facilities and gas treatment complex in the region, which completion together with further field development will enable us to significantly increase gas production in that region.

West Qurna-2 project. The West Qurna-2 field in Iraq is one of the largest crude oil fields discovered in the world, with estimated recoverable oil reserves of 12.9 billion barrels (1.8 billion tonnes). Service agreement for the West Qurna-2 field development and production was signed on 31 January 2010. Currently, the parties of the project are Iraq's state-owned South Oil Company and a consortium of contractors, consisting of a Group company (75% interest) and Iraq's state-owned North Oil Company (25% interest).

The Group launched the "Mishrif Early Oil" stage on the West Qurna-2 field and reached the production of 120 thousand barrels per day in March 2014. According to the service agreement, starting from the second quarter of 2014, we receive cost compensation. The project's target production level is 1.2 million barrels per day and the total term of the contract is 25 years.

Accounting for the cost compensation within the West Qurna-2 project in our consolidated statement of financial position and consolidated statement of profit or loss and other comprehensive income is as follows.

Capital expenditures are recognized in Property, plant and equipment. Extraction expenses are recognized in Operating expenses in respect of all the volume of crude oil production at the field regardless of the volume of compensation crude oil the Group is eligible for. As the compensation revenue is recognized, capitalized costs are amortized.

There are two steps of revenue recognition:

· The Iraqi party, on a quarterly basis, approves invoice for cost recovery and remuneration fee for which the Group is eligible in the reporting period. Amount of the invoice depends on crude oil production volumes during the period and current crude oil market prices. Approved invoice amount and the remuneration fee for the reporting quarter are recognized in crude oil sales revenue.

· Based on the approved invoices, the Iraqi party arranges schedule of crude oil shipments against its liability for cost compensation and remuneration. As this crude oil is actually shipped, its cost is recognized at current market price in Cost of purchased crude oil, gas and products. Further, revenue from sales of this crude oil, or products from its refining, is recognized in Sales (including excise and export tariffs). Unsold crude oil and refined products are recognized in Inventories.

The following table summarizes data on capital and operating cost incurred, compensation crude oil received, costs yet unrecovered and remuneration fee.

(1) Including prepayments.

The West Qurna-2 project's summary is presented below:

(1) Translated into barrels using conversion rate characterizing the density of the field.

(2) This crude oil is sold to third party customers or delivered to our refineries. After realization of these products, respective sales revenues are recognized.

(3) Excluding deferred income in the amount of $69 million in the third quarter of 2016.

(1) Translated into barrels using conversion rate characterizing the density of the field.

(2) This crude oil is sold to third party customers or delivered to our refineries. After realization of these products, respective sales revenues are recognized.

(3) Excluding deferred income in the amount of $69 million in the third quarter of 2016.

The Group is exposed to various risks due to its operations in Iraq. Management monitors the risks associated with the projects in Iraq and believes that there is no adverse effect on the Group's financial position that can be reasonably estimated at present.

Refining, marketing and trading

Refining. We own and operate four refineries located in European Russia and three refineries located outside Russia - in Bulgaria, Romania, and Italy. Moreover, we have a 45% interest in the Zeeland refinery in the Netherlands.

We own two petrochemical plants in Russia, one in Ukraine and petrochemical capacity at our refineries in Bulgaria and Italy. Currently, production at our petrochemical plant in Ukraine is suspended due to adverse economic and political environment in this country.

Compared to the nine months of 2015, the total volume of refined products produced by the Group increased by 2.8%.

In Russia, our production volumes decreased by 1.4% due to throughput optimization as a result of general weakening of refining margins in Russia driven by excise tax increases in January and April 2016. Due to completed upgrade program and throughput optimization, our Russian refineries posted strong results in the nine months of 2016 despite unfavorable macroeconomic environment. Launch of new secondary processing units in 2015 and 2016 enabled us to substantially enhance our refined product slate by reducing production of fuel oil and vacuum gasoil in favor of light products. In order to optimize dark products yield, in the nine months of 2016, we also decreased throughput volumes and redirected vacuum gas oil produced at our Perm and Ukhta refineries from export deliveries to supply catalytic cracking unit at our refinery in Nizhny Novgorod. Maintenance works at our refineries in Nizhny Novgorod and Ukhta also affected our refining volumes in the nine months of 2016.

Internationally, the production increase amounted to 10.9% against the background of low output in the first quarter of 2015 due to overhauls at our Italian refinery as well as strong refining margins.

Along with our own production of refined products we refine crude oil at third party refineries depending on market conditions and other factors. In the periods considered, we processed our crude oil at third party refineries in Belarus and Kazakhstan.

The following table summarizes key figures for our refining activities.

(1) Including refined product processed.

Marketing and trading. We are marketing our own and third-party crude oil and refined products through our wholesale and retail channels in Russia, Europe, South-East Asia, Central and North America and other regions.

In addition to our production, we purchase crude oil in Russia and on international markets. In Russia, we primarily purchase crude oil from affiliated producing companies and other producers. Then we either refine or export purchased crude oil. Crude oil purchased on international markets is normally used for trading activities, for supplying our international refineries or for processing at third party refineries.

In Russia, we purchase refined products on occasion, primarily to manage supply chain bottlenecks. Refined products purchases outside Russia are either traded or supplied to our international refineries.

We undertake trading operations on international markets through our 100% subsidiary LITASCO. We use traditional physical volumes hedging techniques to hedge our trading operations to secure margin on our trading operations. As a result of price volatility, during the nine month of 2016, loss on hedging amounted to 32 billion RUB that was offset by corresponding increase in prices for physical deliveries.

The following tables show the volumes of crude oil purchases by the Group during the periods considered.

Compared to the third quarter and the nine months of 2015, our purchases of crude oil for refining at international refineries increased by 8.9% and 27.4%, respectively, and our purchases for trading increased by 96.9% and 31.5%, respectively. Moreover, in the third quarter and the nine months of 2016, the Group received 2.6 million tonnes and 7.7 million tonnes, respectively, of compensation crude from Iraq's state-owned South Oil Company as cost compensation within the West Qurna-2 project (in the respective periods of 2015, the Group received 2.2 million tonnes and 7.0 million tonnes of compensation crude oil).

The table below summarizes figures for our refined products marketing and trading activities.

In the nine months of 2016, in line with the strategy to optimize our downstream operations, a Group company sold 100% of its interest in LUKOIL Poland, LUKOIL Baltija and LUKOIL Baltija R, distribution companies operating over 270 petrol stations in Poland, Lithuania and Latvia. In July 2015, we sold 100% of interest in LUKOIL Eesti, and in April 2015 - 100% of interest in LUKOIL Ukraine.

Exports of crude oil and refined products from Russia. The volumes of crude oil and refined products exported from Russia by our subsidiaries are summarized as follows:

In the nine months of 2016, the volume of our crude oil exports from Russia decreased by 3.9%, and we exported 40.5% of our domestic crude oil production (the same as in the nine months of 2015) and 326 thousand tonnes of crude oil purchased from our affiliates and third parties (1,200 thousand tonnes in the nine months of 2015). The decrease in crude oil exports was a result of lower domestic production. The volume of our refined products exports decreased by 11.6% compared to the nine months of 2015 due to higher domestic sales volumes driven by favorable netbacks and decreased refining volumes.

Substantially, we use the Transneft infrastructure to export our crude oil. Nevertheless, during the third quarter and nine months of 2016, we exported 2,026 thousand tonnes and 6,117 thousand tonnes, respectively, through our own infrastructure (1,937 thousand tonnes and 5,626 thousand tonnes during the third quarter and nine months of 2015). All the volume of crude oil exported that bypassed Transneft was routed beyond the Customs Union.

In the nine months of 2016, the Company exported 909 thousand tonnes of light crude oil through the Eastern Siberia - Pacific Ocean pipeline compared to 1,165 thousand tonnes in the nine months of 2015. This allowed us to preserve the premium quality of crude oil and thus enabled us to achieve higher netbacks compared to exports to traditional Western markets.

During the third quarter of 2016, our revenue from export of crude oil and refined products from Russia both to Group companies and third parties amounted to 131 billion RUB and 99 billion RUB, respectively (150 billion RUB for crude oil and 111 billion RUB for refined products in the third quarter of 2015). During the nine months of 2016, our revenue from export of crude oil and refined products from Russia both to Group companies and third parties amounted to 438 billion RUB and 285 billion RUB, respectively (545 billion RUB for crude oil and 350 billion RUB for refined products in the nine months of 2015).

Priority supply channels. We develop our priority supply channels aiming at increasing our margin on sale of refined products produced by the Group.

We own petrol stations in more than 18 countries. Most of our stations are located close to our refineries. During the nine months of 2016, we sold 7.2 million tonnes of motor fuels via our domestic retail network, or approximately 47% of our domestic motor fuel production, that represents an increase of 1.0% against the same period of 2015. Compared to the nine months of 2015, our domestic sales volumes of premium ECTO branded motor fuels increased by 33%.

During the nine months of 2016, retail sales outside Russia decreased to 3.1 million tonnes, or by 8.7%, mostly as a result of divestment of our retail networks in Poland and the Baltic states. At the same time, ECTO branded sales volumes outside Russia increased by 11%.

We supply jet fuel to airports in and outside Russia. During the nine months of 2016, jet fuel sales volumes amounted to 2.1 million tonnes, which is in line with the nine months of 2015.

We supply bunker fuel to sea and river ports in Russia. During the nine months of 2016, these sales increased by 29% to 2.3 million tonnes as a result of expansion of our market share on the Black and Baltic seas and launch of new premium products.

We produce motor oils at our refineries in Russia and undertake motor oil blending and packaging in Russia and abroad. We focus at premium branded motor and industrial oils that sales volumes increased by 30%.

Power generation. In power generation sector, we established a vertically integrated chain from generation to transportation and sale of power and heat for third party customers (commercial generation) and own consumption. We own commercial generation facilities in the Southern regions of European Russia. We also own renewable energy capacity in Russia and abroad. Our total output of commercial electrical energy was 12.9 billion kW-h in the nine month of 2016, an increase of 2.3% compared to the nine months of 2015, and our total output of commercial heat energy was approximately 8.5 million Gcal, or 3.0% less than in the nine months of 2015.

Three and nine months ended 30 September 2016 compared to three and nine months ended 30 September 2015 

The table below sets forth data from our consolidated statements of profit or loss and other comprehensive income for the periods indicated.

The analysis of the main financial indicators of the financial statements is provided below.

Sales revenues

During the third quarter of 2016, our revenues decreased by 155 billion RUB, or by 10.6%, compared to the third quarter of 2015. Our revenues from crude oil sales increased by 21 billion RUB, or by 6.3%, and our revenues from sales of refined products decreased by 169 billion RUB, or by 16.4%.

During the nine months of 2016, our revenues decreased by 555 billion RUB, or by 12.7%, compared to the nine months of 2015. Our revenues from crude oil sales decreased by 147 billion RUB, or by 12.4%, and our revenues from sales of refined products decreased by 428 billion RUB, or by 14.6%.

The main reason for the decrease in revenue was the decrease in international hydrocarbon prices as well as the decrease in refined products trading volumes. That was partially compensated for by the effect of ruble devaluation on our revenues denominated in other currencies.

Sales of crude oil

Our international crude oil sales revenue increased by 31.7%, or by 74 billion RUB, and decreased by 2.7%, or by 24 billion RUB, compared to the third quarter and the nine months of 2015, respectively. Our international sales volumes (beyond the Customs Union) increased by 4,591 thousand tonnes, or by 43.5%, in the third quarter of 2016, and by 6,166 thousand tonnes, or by 15.7%, in the nine months of 2016, mainly due to higher volumes of crude oil trading. Our average international ruble realized prices decreased by 8.2% and 15.9% compared to the third quarter and the nine months of 2015, respectively.

Our realized domestic crude oil sales price increased by 4.3% compared to the third quarter of 2015 and decreased by 6.1% compared to the nine months of 2015, while our domestic sales volumes decreased by 730 thousand tonnes, or by 23.6%, and by 2,421 thousand tonnes, or by 29.4%, respectively, following the decrease in production in Russia. As a consequence, in the third quarter and the nine months of 2016, our domestic sales revenue decreased by 20.4%, or by 8 billion RUB, and by 33.6%, or by 38 billion RUB, respectively.

Cost compensation and remuneration at the West Qurna-2 project

Included in Group's revenue is the cost compensation and remuneration fee related to the West Qurna-2 project in Iraq that decreased by 44 billion RUB and by 83 billion RUB compared to the third quarter and the nine months of 2015, respectively. The volumes of crude oil, related to cost compensation and remuneration fee, also significantly decreased to the respective periods of 2015. For details see p. 11.

Sales of refined products

Compared to the third quarter and the nine months of 2015, our revenue from the wholesale of refined products outside Russia decreased by 172 billion RUB, or by 22.2%, and by 422 billion RUB, or by 18.9%, respectively, that was both price and volume driven. During the third quarter of 2016, our dollar and ruble realized prices decreased by 12.0% and 9.7%, respectively, and during the nine months of 2016 they decreased by 25.2% and 13.8%, respectively. Compared to the third quarter and the nine months of 2015, our sales volumes decreased by 13.9% and 5.9%, respectively, largely as a result of the decrease in volumes of trading.

During the third quarter and the nine months of 2016, our dollar realized retail prices outside Russia decreased by 9.0% and 13.0%, respectively, while our ruble realized prices decreased by 6.7% in the third quarter of 2016 and increased by 0.3% in the nine months of 2016. Our sales volumes decreased by 11.6% and 8.7% as a consequence of sale of our retail networks in Eastern Europe. As a result, our international retail revenue decreased by 16 billion RUB, or by 17.5%, and by 20 billion RUB, or by 8.3%, compared to the third quarter and the nine months of 2015, respectively.

During the third quarter and the nine months of 2016, our revenue from the wholesale of refined products on the domestic market increased by 19.1%, or by 12 billion RUB, and by 1.5%, or by 3 billion RUB, respectively. Our realized prices decreased by 5.0% and 11.1%, but our sales volumes increased by 25.4% and 14.2% in the third quarter and the nine months of 2016.

During the third quarter and the nine months of 2016, our revenue from refined products retail sales in Russia increased by 6 billion RUB, or by 6.4%, and by 12 billion RUB, or by 4.6%, respectively. Our average domestic retail prices increased by 3.0% and 3.5%, while our retail volumes increased by 3.3% and 1.0%, respectively.

Sales of petrochemical products

In the third quarter of 2016, our revenue from sales of petrochemical products decreased by 2 billion RUB, or by 8.3%, due to both decrease in prices and volumes, compared to the third quarter of 2015. In the nine months of 2016 this revenue increased by 9 billion RUB, or by 19.1%, largely due to the increase in domestic output against the background of low production as a consequence of a fire at our plant in the Stavropol region of Russia at the end of the first quarter of 2014. Production at the plant was resumed in early April 2015. 

Sales of gas and gas products

Compared to the third quarter and the nine months of 2015, sales of gas and gas refined products decreased by 6 billion RUB, or by 18.4%, and by 12 billion RUB, or by 11.6%, respectively, mainly as a result of the decrease in sales prices.

Natural gas sales revenue decreased by 3 billion RUB, or by 17.6%, in the third quarter of 2016 and by 6 billion RUB, or by 11.0%, in the nine months of 2016.

Gas products revenue decreased by 3 billion RUB, or by 19.2%, and by 6 billion RUB, or by 12.3%, compared to the third quarter and the nine months of 2015, respectively.

Sales of energy and related services

During the third quarter of 2016, or revenue from sales of energy and related services didn't change significantly against the same quarter of 2015. In the nine months of 2016, this revenue increased by 4 billion RUB, or by 7.9%. In Russia, the increase was largely due to putting in operation a combined cycle gas turbine with a capacity of 135 MW at the Group's power plant in the Stavropol region of Russia in March 2015. Our international revenue increased as a result of the increase in volumes of electricity sales in Sicily, Italy.

Other sales include non-petroleum sales through our retail network, transportation services, rental revenue, crude oil extraction services, and other revenue of our production and marketing companies from sales of goods and services not related to our primary activities.

During the third quarter and the nine months of 2016, revenue from other sales increased by 1 billion RUB, or by 4.0%, and by 19 billion RUB, or by 26.6%, respectively. The non-petrol revenue of our retail network remained nearly flat to the third quarter of 2015, but increased by 2 billion RUB, or by 9.5%, compared to the nine months of 2015. Our revenue from transportation services was also flat to the third quarter of 2015, but increased by 5 billion RUB, or by 47.1%, compared to the nine months of 2015. In the third quarter and the nine months of 2016, our other sales also included revenue from sales of diamonds in the amount of 4 billion RUB and 15 billion RUB, respectively (3 billion RUB and 7 billion RUB in the third quarter and the nine months of 2015).

Operating expenses

Operating expenses include the following: