10 Oct 2006 07:01
OJSC OC Rosneft10 October 2006 OJSC Rosneft Oil Company Interim Consolidated Financial Statements As of and for the three and six months ended June 30, 2006 and 2005 OJSC Rosneft Oil Company Consolidated Balance Sheets (in millions of US dollars, except share amounts) Notes June 30, 2006 December 31, (unaudited) 2005 _________________________________ASSETSCurrent assets:Cash and cash equivalents 4 $ 1,166 $ 1,173Restricted cash 25 23Short-term investments 5 571 165Accounts receivable, net 6 3,209 2,858Inventories 889 814Deferred tax assets 14 54 48Prepayments and other current assets 897 897 ______________________Total current assets 6,811 5,978 ______________________Non-current assets:Long-term investments 7 579 436Long-term bank loans granted, net 79 63Acquired debt receivable, net 8 456 -Oil and gas properties, net 9 21,944 20,939Property, plant and equipment, net 2,151 2,030Construction-in-progress 492 509Goodwill 3 44 35Deferred tax assets 14 12 8Other non-current assets, net 138 18 ______________________Total non-current assets 25,895 24,038 ______________________ Total assets $ 32,706 $ 30,016 ======================LIABILITIES AND SHAREHOLDERS' EQUITYCurrent liabilities:Accounts payable and accrued liabilities 10 $ 2,000 $ 1,358Short-term loans and current portion of long-term debt 11 3,840 4,005Income and other tax liabilities 3,045 2,810Deferred tax liabilities 14 44 40Other current liabilities 28 32 ______________________Total current liabilities 8,957 8,245 ______________________ Asset retirement obligations 15 619 566Long-term debt 11 8,558 8,198Deferred tax liabilities 14 3,814 3,696Other non-current liabilities 19 18 ______________________Total liabilities 21,967 20,723 ______________________Minority interest 1,851 1,860 ______________________Shareholders' equity: 12Common stock par value 0.01 RUR (shares issued and outstanding: 9,092,174,000 as ofboth June 30, 2006 and December 31, 2005) 20 20Additional paid-in capital 19 19Retained earnings 8,849 7,394 ______________________Total shareholders' equity 8,888 7,433 ______________________Total liabilities and shareholders' equity $ 32,706 $ 30,016 ====================== The accompanying notes to the interim consolidated financial statements are an integral part of these statements. See Accountants' Review Report OJSC Rosneft Oil Company Consolidated Statements of Income (in millions of US dollars, except earnings per share data) Notes Three Three Six Six months months months months ended June ended June ended June ended June 30, 2005 30, 2006 30, 2005 30, 2006 as restated (unaudited) (unaudited) (unaudited) (unaudited) ______________________________________________________RevenuesOil and gas sales 18 $ 6,344 $ 3,729 $ 11,557 $ 6,720Petroleum products and processing fees 18 2,407 1,669 4,626 2,980Support services and other revenues 89 103 173 164 _____________________________________________Total 8,840 5,501 16,356 9,864 Costs and expenses Production and operating expenses 519 411 940 768Cost of purchased oil and petroleum products andrefining costs 557 175 1,102 305General and administrative expenses 181 100 348 186Pipeline tariffs and transportation costs 764 538 1,457 896 Exploration expenses 63 39 98 64Depreciation, depletion and amortization 408 361 792 698Accretion expense 8 9 16 17Taxes other than income tax 1,866 1,176 3,440 2,200Export customs duty 13 2,629 1,305 4,793 2,143 _____________________________________________Total 6,995 4,114 12,986 7,277 _____________________________________________Operating income 1,845 1,387 3,370 2,587 Other income /(expenses)Interest income 22 23 60 37Interest expense (170) (200) (373) (391)Loss on disposal of property, plant and equipment (13) - (17) (2)(Loss)/gain on disposal of investments (5) 1 (5) (9)Gain on disposal of share in CJSC Sevmorneftegaz 7 - 1,303 - 1,303Equity share in affiliates' profits 11 11 19 20Dividends and income/(loss) from joint ventures - (5) 1 3Other income/(expenses), net 20 (7) (6) (60)Foreign exchange (loss) / gain (118) 145 (277) 159 ____________________________________________Total other income / (expenses) (253) 1,271 (598) 1,060 ____________________________________________Income before income tax 1,592 2,658 2,772 3,647Income tax expense 14 (484) (690) (819) (947) - - ____________________________________________Income before minority interest 1,108 1,968 1,953 2,700 Minority interest in subsidiaries' earnings, net of tax (31) (306) (74) (314) ____________________________________________Net income $ 1,077 $ 1,662 $ 1,879 $ 2,386 ============================================Earnings per share (in US$) - basic and diluted $ 0.12 $ 0.18 $ 0.21 $ 0.26 Weighted average number of shares outstanding (inthousands) 9,092,174 9,092,174 9,092,174 9,092,174 The accompanying notes to the interim consolidated financial statements are an integral part of these statements. OJSC Rosneft Oil Company Consolidated Statement of Changes in Shareholders' Equity For the six months ended June 30, 2006 (in millions of US dollars) Common Additional Retained Shareholders' stock paid-in earnings equity capital ___________________________________________________Balance at December 31, 2005 $ 20 $ 19 $ 7,394 $ 7,433 =================================================== Net income for the period (unaudited) - - 1,879 1,879 Dividends declared on common stock (unaudited) - - (424) (424) ___________________________________________________Balance at June 30, 2006 (unaudited) $ 20 $ 19 $ 8,849 $ 8,888 =================================================== The accompanying notes to the interim consolidated financial statements are an integral part of these statements. OJSC Rosneft Oil Company Consolidated Statements of Cash Flows (in millions of US dollars) Six months Six months ended June 30, ended June 30, 2006 2005 (unaudited) as restated (unaudited) _____________________________Operating activitiesNet income $ 1,879 $ 2,386Reconciliation of net income to net cash providedby operating activities:Effect of foreign exchange 230 (57)Gain on disposal of share in CJSC Sevmorneftegaz - (1,303)Depreciation, depletion and amortization 792 698Dry well expenses 4 49Loss on disposal of property, plant and equipment 17 2Deferred income tax (135) (40)Accretion expense 16 17Equity share in affiliates' profits (19) (20)Increase in allowance for doubtful accounts and bank loans granted 6 5Minority interests in subsidiaries' earnings 74 314 Changes in operating assets and liabilities net ofacquisitions:Increase in accounts receivable (360) (923)Increase in inventories (75) (197)(Increase) / decrease in restricted cash (2) 4Increase in prepayments and other current assets - (156)(Increase) / decrease in other non-current assets (112) 4Increase in long-term bank loans granted (14) (57)Increase in interest payable 98 72Increase in accounts payable and accrued liabilities 192 139Increase in income and other tax liabilities 235 255Decrease in other current and non-current liabilities (3) (25) _____________________________Net cash provided by operating activities 2,823 1,167 _____________________________Cash flows from investing activitiesCapital expenditures (1,403) (895)Acquisition of licenses (464) -Proceeds from disposals of property, plant and equipment 12 16Acquisition of short-term investments (459) (56)Proceeds from sale of short-term investments 53 119Acquisition of entities and additional shares in subsidiaries, net of cash acquired (145) (159)Proceeds from sale of long-term investments 15 52Acquisition of debt receivable (463) -Acquisition of long-term investments (51) (18) _____________________________Net cash used in investing activities $ (2,905) $ (941) _____________________________ The accompanying notes to the interim consolidated financial statements are an integral part of these statements. OJSC Rosneft Oil Company Consolidated Statements of Cash Flows (continued) (in millions of US dollars) Six months Six months ended June 30, ended June 30, 2006 2005 (unaudited) as restated (unaudited) _____________________________Cash flows from financing activitiesProceeds from short-term debt $ 99 $ 366Repayment of short-term debt (604) (369)Proceeds from long-term debt 2,185 93Repayment of long-term debt (1,623) (733)Dividends paid - (8) _____________________________Net cash, provided by / (used in) financing activities 57 (651) _____________________________ Decrease in cash and cash equivalents (25) (425)Cash and cash equivalents at beginning of period 1,173 1,033Effect of foreign exchange on cash and cash equivalents 18 (19) _____________________________Cash and cash equivalents at end of period $ 1,166 $ 589 ============================= Supplementary disclosures of cash flow informationCash paid for interest (net of amount capitalized) $ 314 $ 258Cash paid for income taxes $ 933 $ 788 Supplementary disclosure of non-cash activitiesIncome tax offsets $ - $ 37 The accompanying notes to the interim consolidated financial statements are an integral part of these statements. OJSC Rosneft Oil Company Notes to Interim Consolidated Financial Statements As of and for the three and six months ended June 30, 2006 and 2005(all amounts in tables are in million of US dollars, except as noted otherwise) 1. Nature of Operations Open Joint Stock Company ("OJSC") Rosneft Oil Company ("Rosneft") and itssubsidiaries, (collectively the "Company" or the "Group"), are principallyengaged in exploration, development, production and sale of crude oil and gasand refining, transportation and sale of petroleum products in the RussianFederation ("RF") and in certain international markets. 2. Significant Accounting Policies Form and Content of the Interim Consolidated Financial Statements The Company maintains its books and records in accordance with accounting andtaxation principles and practices mandated by the Russian legislation. Theaccompanying interim consolidated financial statements were derived from theCompany's Russian statutory books and records with adjustments made to presentthem in accordance with accounting principles generally accepted in the UnitedStates of America ("US GAAP"). The interim consolidated financial statements included herein are unaudited andhave been prepared in accordance with US GAAP for interim financial reporting ofpublic companies (primarily Accounting Principle Board Opinion 28 (APB 28)"Interim Financial Reporting"). These interim consolidated financial statementsshould be read in conjunction with the Company's 2005 audited consolidatedfinancial statements and the notes related thereto. In the opinion ofmanagement, the financial statements reflect all adjustments of a normal andrecurring nature necessary to present fairly the Company's financial position,results of operations and cash flows for the interim periods. The results of operations for six months ended June 30, 2006 may not beindicative of the results of operations for the full year. These interimconsolidated financial statements contain information updated through September29, 2006. The accompanying interim consolidated financial statements differ from thefinancial statements issued for statutory purposes in Russia in that theyreflect certain adjustments, not recorded in the Company's statutory books,which are appropriate to present the financial position, results of operationsand cash flows in accordance with US GAAP. The principal adjustments relate to:(1) recognition of certain expenses; (2) valuation and depreciation of property,plant and equipment; (3) foreign currency translation; (4) deferred incometaxes; (5) valuation allowances for unrecoverable assets; (6) accounting for thetime value of money; (7) accounting for investments in oil and gas property andconveyances; (8) consolidation principles; (9) recognition and disclosure ofguarantees, contingencies, commitments and certain assets and liabilities; (10)accounting for asset retirement obligations; (11) business combinations andgoodwill/negative goodwill. The impact on the consolidated statement of income of the OJSC Yuganskneftegazpurchase price allocation adjustment recorded in the third quarter of 2005 hasbeen accounted for retrospectively from January 1, 2005. As a result,consolidated statements of income and cash flows for six months ended June 30,2005 were restated to reflect the effect of final purchase price allocation ofOJSC Yuganskneftegas acquisition which was made in the interim consolidatedfinancial statements for nine months ended September 30, 2005. Form and Content of the Interim Consolidated Financial Statements (continued) Certain amounts contained in the consolidated statements of income and cashflows for six months ended June 30, 2005 were reclassified to conform to thecurrent period presentation. The following is a summary of the income statement line items impacted by therestatement discussed above and certain reclassifications made: Six months ended June 30, Six months 2005 ended as June 30. previously 2005 reported Adjustments and as restated (unaudited) reclassifications (unaudited) __________________________________________ Production and operating expenses and cost of purchased oil and petroleumproducts and refining costs $ 1,081 $ (8) $ 1,073General and administrative expenses 176 10 186Pipeline tariffs and transportation costs 799 97 896Exploration expenses 49 15 64Depreciation, depletion and amortization 600 98 698Export customs duty 2,189 (46) 2,143Total costs and expenses 7,111 166 7,277 Operating income 2,753 (166) 2,587 Interest income 33 4 37Interest expense (382) (9) (391)Equity share in affiliates' profits 10 10 20Other expenses, net (72) 12 (60)Foreign exchange gain 26 133 159Total other income 910 150 1,060Income before income tax 3,663 (16) 3,647Income tax expense (914) (33) (947)Income before minority interest 2,749 (49) 2,700Minority interest in subsidiaries' earnings, net of tax (310) (4) (314)Net income 2,439 (53) 2,386Earnings per share (in US$) - basic and diluted $ 0,27 $ (0,01) $ 0,26 Management Estimates The preparation of the financial statements in conformity with US GAAP requiresmanagement to make estimates and assumptions that affect the reported amounts ofassets and liabilities in the balance sheet as well as the amounts of revenuesand expenses recognized during the reporting periods. Certain significantestimates and assumptions for the Company include: estimation of economicallyrecoverable oil and gas reserves; rights to and recoverability and useful livesof long-term assets and investments; impairment of goodwill; allowances fordoubtful accounts receivable; asset retirement obligations; legal and taxcontingencies; environmental remediation obligations; recognition and disclosureof guarantees and other commitments; fair value measurements; ability to renewoperating leases and to enter into new lease agreements; classification ofcertain debt amounts. Some of the most significant estimates are made inconnection with the acquisition of OJSC Yuganskneftegaz. Management believes ithas a reasonable and appropriate basis for its judgment pertaining to itsestimates and assumptions. However, actual results could differ from thoseestimates. Foreign Currency Translation The management of the Company has determined the US Dollar as the functional andreporting currency for the purpose of financial reporting under US GAAP.Monetary assets and liabilities have been translated into US dollars using theofficial exchange rate as of the balance sheet date. Non-monetary assets andliabilities have been translated at historical rates. Revenues, expenses andcash flows are translated into US dollars at average exchange rates prevailingon transaction dates. Gains and losses resulting from the re-measurement into US dollars are includedin the "Foreign exchange (loss)/gain" in the consolidated statement of income. As of June 30, 2006, December 31, 2005, and as of June 30, 2005, the CentralBank of Russian Federation official rates of exchange ("CBR rate") were 27.08rubles, 28.78 rubles and 28.67 rubles per US dollar respectively. As ofSeptember 29, 2006 the official rate of exchange was 26.75 rubles per US dollar. The translation of local currency denominated assets and liabilities into USdollars for the purposes of these financial statements does not indicate thatthe Company could realize or settle, in US dollars, the reported values of theseassets and liabilities. Likewise, it does not indicate that the Company couldreturn or distribute the reported US dollar value of capital to itsshareholders. Principles of Consolidation The consolidated statements include business transactions of the subsidiaries inwhich the Company directly or indirectly owns more than 50% of common votingstock, or on which it otherwise exercises control. All intercompany transactionsand balances have been eliminated. Investments in other significant entities inwhich the Company normally owns between 20% and 50% are generally accounted forunder the equity method since the Company does not have absolute control, butrather significant influence. Investments in other companies are accounted forat cost and adjusted for estimated impairment. The Company analyzed the application of Financial Accounting Standards Board("FASB") Interpretation ("FIN") 46R, Consolidation of Variable-Interest Entities(VIEs), for potential consolidation of companies. FIN 46R was applied fromJanuary 1, 2004 for VIEs created after December 31, 2003, and from January 1,2005, for all other VIEs. The application of FIN 46R did not have a significantimpact on the Company's operations and financial position. Minority Interest Minority interests in the net assets and net results of consolidatedsubsidiaries are shown under "Minority interest" in the accompanyingconsolidated balance sheets and statements of income. For majority-ownedsubsidiaries that incur losses, the Company recognizes 100% of the losses, afterfirst reducing the related minority interests' balances to zero, unless minorityshareholders committed to fund the losses. Further, when a majority-ownedsubsidiary becomes profitable, the Company recognizes 100% of profits until suchtime as the excess losses previously recorded have been recovered. Thereafter,the Company recognizes profits in accordance with the underlying ownershippercentage. The actual ruble-denominated balances attributable to minorityinterests may differ from these amounts presented in these consolidatedfinancial statements. Cash and Cash Equivalents Cash represents cash on hand and in the Company's bank accounts and interestbearing deposits which can be effectively withdrawn at any time without priornotice or penalties reducing the principal amount of the deposit. Accounts Receivable Trade accounts receivable are stated at their principal amounts outstanding netof allowances for doubtful debts. Specific allowances are recorded against tradereceivables whose recovery or collection has been identified as doubtful.Estimates of allowances require the exercise of judgment and the use ofassumptions. Earnings per Share Basic earnings per share is calculated by dividing net earnings attributable tocommon shares by the weighted average number of common shares outstanding duringthe corresponding period. In the absence of any securities-to-shares conversiontransactions, the amount of basic earnings per share stated in these financialstatements is equal to the amount of diluted earnings per share. Inventories Inventories, consisting primarily of crude oil, petroleum products and materialsand supplies, are stated at the lower of weighted average cost of acquisition ormarket value. Market value shall not exceed net realizable value (i.e. the priceat which inventories can be sold after allowing for the cost of completion andsale), and shall not be lower than net realizable values less the amount ofmargin. Financial Investments All debt and equity securities held by the Company are classified into one ofthe following three categories: trading securities; available-for-salesecurities; held-to-maturity securities. Trading securities are purchased and held principally for the purpose of sale inthe nearest future. Held-to-maturity securities represent financial instrumentsthat the Company has both the intent and the ability to hold to maturity. Allother securities, which do not fall into these two categories are classified asavailable-for-sale securities. Trading securities and available-for-sale securities are carried at fair(market) value. Held-to-maturity securities are stated at amortized cost.Unrealized gains or losses on trading securities are included in theconsolidated statements of income. Unrealized gains and losses onavailable-for-sale securities less related tax effects are recorded as aseparate component of comprehensive income until the date of disposal. Realized gains and losses from the sale of available-for-sale securities arereported separately for each type of security. Dividends and interest income arerecognized in the consolidated statements of income on an accrual basis. Investments in shares or interests of companies where the Company has less than20% equity interest and no significant influence, which are not publicly tradedand whose market value is not readily available are carried at cost. If the decline in fair value of an investment below its carrying value is otherthan temporary, the carrying value of the investment is reduced and a loss inthe amount of any such decline is recorded. Cost method investments areevaluated for impairment when events or changes in circumstances occur which mayhave a significant effect on the fair value of these investments. Sale and Repurchase Agreements and Securities Lending Sale and repurchase agreements are treated as secured financing transactions.Securities sold under sale and repurchase agreements are included in tradingsecurities. The corresponding liability is presented within short-term debt. Thedifference between the sale and repurchase price is treated as interest and isaccrued over the life of repurchased agreements using the effective interestmethod. Oil and Gas Properties In accordance with Statement of Financial Accounting Standard ("SFAS 19"),Financial Accounting and Reporting by Oil and Gas Producing Companies (SFAS 19),oil and gas properties and the related expenses are recognized under thesuccessful efforts method. This method prescribes that exploration costs,including geological and geophysical costs and the costs of dry holes, arecharged to expense when incurred. Exploratory well costs (including costs associated with stratigraphic testwells) are temporarily capitalized pending determination of whether potentiallyeconomic oil and gas reserves have been discovered by the drilling effort. Thelength of time necessary for this determination depends on the specifictechnical or economic difficulties in assessing the recoverability of thereserves. If a determination is made that the well did not encounter oil and gasin economically viable quantities, the well costs are expensed and are reportedin "exploration expenses". Exploratory drilling costs are temporarily capitalized pending determination ofwhether the well has found proved reserves if both of the following conditionsare met: • The well has found a sufficient quantity of reserves to justify, if appropriate, its completion as a producing well, assuming that the required capital expenditure is made; and • Satisfactory progress toward ultimate development of the reserves is being achieved, with the Company making sufficient progress assessing the reserves and the economic and operating viability of the project. The Company evaluates the progress made on the basis of regular project reviewswhich take into account the following factors: • First, if additional exploratory drilling or other exploratory activities (such as seismic work or other significant studies) are either underway or firmly planned, the Company deems there to be satisfactory progress. For these purposes, exploratory activities are considered firmly planned only if they are included in the Company's three-year exploration plan/budget. At June 30, 2006, exploratory drilling costs capitalized on this basis were not material. • In cases where exploratory activity has been completed, the evaluation of satisfactory progress takes into account indicators such as the fact that costs for development studies are incurred in the current period, or that governmental or other third-party authorizations are pending or that the availability of capacity on an existing transport or processing facility awaits confirmation. At June 30, 2006, exploratory drilling costs capitalized on this basis were not material. Should the project be deemed economically viable, it is then transferred to thedevelopment stage, otherwise the costs are expensed. Costs, including "internal" costs relating to drilling and equipping ofdevelopment wells, including development dry holes, as well as costs requiredfor drilling and equipping of injection wells in the process of oil and gasreserves development, are capitalized. These costs are included in oil and gasproperties in the consolidated balance sheet. Property, Plant and Equipment Property, plant and equipment are stated at historical cost, net of accumulateddepreciation. The cost of maintenance, repairs, and replacement of minor itemsof property is charged to operating expenses. Renewals and betterments of assetsare capitalized. Upon sale or retirement of property, plant and equipment, the cost and relatedaccumulated depreciation are eliminated from the accounts. Any resulting gainsor losses are included in the statement of income. Depreciation, Depletion and Amortization Depletion expense of acquisition costs of proved oil and gas properties iscalculated using the unit-of-production method based on total proved reserves.Depletion expense of other capitalized costs related to oil and gas productionis calculated using the unit-of production method based on proved developedreserves. Management of the Company considers each extraction division as theappropriate level for these calculations. Acquisition costs of unproved properties are not amortized. These costs arereclassified as proved properties when the relevant reserve reclassification ismade. Acquisition costs of unproved properties are reviewed for impairment. Incase of impairment these costs are expensed when incurred. Depreciation and amortization charges with respect to property, plant andequipment other than oil and gas properties is computed using the straight-linemethod and based on their useful lives. Depreciation, Depletion and Amortization (continued) Depreciation rates are applied to similar types of buildings, machinery andequipment having similar economic characteristics, as shown below: Asset Group Average Useful Life_______________________________________________________________Buildings and constructions 30-35 yearsPlant and machinery 15 yearsVehicles and other equipment 6 yearsService vessels 20 yearsOffshore drilling assets 20 years Interests in Joint Operations A joint operation is a contractual arrangement whereby two or more parties(participants) undertake an economic activity that is subject to joint control.Joint control is only exercised when strategic, financial and operatingdecisions relating to the joint activity are made unanimously by all theparties. A joint venture is as a registered company, partnership or any otherlegal form for the purposes of handling joint operations. Financial results, assets and liabilities arising from interests in jointventures are recognized in these consolidated financial statements using theequity method of accounting. Under the equity method, investments in jointventures are recognized at the cost of financial investments increased by anychange to the share of net assets from the date of inception of a joint venture,less distributed earnings and impairment of financial investments. Theconsolidated statements of income include the Company's share in gains andlosses arising from joint ventures. The Company discontinues the use of the equity method of accounting from thedate on which it ceases to have joint control over, or have significantinfluence in, a jointly-controlled entity, or when its interest in ajointly-controlled entity is reclassified to assets held for sale. Certain activities of the Company (mainly oil exploration and production) areconducted through interests in joint projects, where the parties exercise jointcontrol over the assets without a legal entity being established. Income,expenses, assets and liabilities arising from participation in joint projectsare included in the consolidated financial statements on a pro rata basiscorresponding to the participation share. A part of an interest in a jointly-controlled oil and gas exploration andproduction entity may be assigned to other participants or third parties. Inwhich case, in accordance with SFAS 19, Financial Accounting and Reporting byOil and Gas Producing Companies, such assignment is performed and accounted forunder an arrangement called a "carried interest" whereby the assignee agrees tocarry all costs of drilling, developing, and operating the property. Theassignee is also entitled to all of the revenue from hydrocarbon production fromthe property, excluding any third party interest, until all of the assignee'scosts, including the contractual rate of return, have been recovered, at suchtime the assignor will resume its participation in operating expenses andincome. Impairment of Long-Lived Assets Long-lived assets, including blocks with proved oil and gas reserves, areassessed for potential impairment in accordance with SFAS 144, Accounting forthe Impairment or Disposal of Long-Lived Assets. Oil and gas properties are assessed whenever events or circumstances indicatepotential impairment. If the carrying value of oil and gas properties is not recoverable throughundiscounted cash flows, an impairment is recognized. The impairment isdetermined on the basis of the estimated fair value of oil and gas propertieswhich, in turn, is measured by discounting future net cash flows or withreference to current market prices of oil and gas properties, if available.Discounted future cash flows from oil and gas fields are based on the mostreliable management estimates of future prices that rely on recent actual pricesand published prices for forward transactions; such prices are applied toforecast production volumes at particular fields with further discounting forthe expected risk level. Forecast production volumes shall be understood asreserves, including probable reserves that are proposed to be extracted using aknown amount of capital expenditures. Production volumes and prices correspondto the internal plans and forecasts, as well as other data in the publishedfinancial statements. Assumptions regarding future prices and costs used toassess oil and gas properties for impairment differ from those used in thestandard procedure for discounting net cash flows from proved oil and gasreserves. Grouping of assets for the purpose of depreciation is performed on the basis ofthe lowest level of identifiable cash flows that are largely independent of thecash flows from other groups of assets - as a rule, for oil and gas propertiessuch level is represented by the field, for refining assets - by the wholerefining unit, for service stations - by the facilities. Long-lived assetsintended by management for use during a period not exceeding one year arerecorded at the lower of depreciated value or fair value, less selling expenses. Acquisition costs of unproved oil and gas properties are assessed for impairmenton a regular basis and any estimated impairment is charged to expenses. Recoverability of oil and gas properties attributable to the refining, marketingand distribution segment is generally assessed on the basis of expected futurecash flows from key operating units, usually entire legal entities. Since assetsof this segment (particularly refining units) represent an integrated set ofoperations, this condition is taken into account in measuring the value ofparticular units or the extent of their utilization to generate other cashflows. Business Combinations The Company accounts for its business acquisitions under the purchase method ofaccounting. The total cost of acquisitions is allocated to the underlyingassets, including intangible assets, and liabilities based on their respectiveestimated fair values. Determining the fair value of assets acquired andliabilities assumed requires management's judgment and often involves the use ofsignificant estimates and assumptions, including assumptions with respect tofuture cash inflows and outflows, discount rates, license and other asset livesand market multiples, among other items. Goodwill and Other Intangible Assets Goodwill represents the excess of the acquisition cost over the fair value ofnet assets acquired. The excess of the fair value of the acquired share of netassets over their acquisition cost represents negative goodwill and is allocatedamong the non-current assets acquired, excluding investments and deferred taxassets, which may result in their value being reduced to zero. For investees accounted for under the equity method, the excess of the cost toacquire a share in those entities over the fair value of the acquired share ofnet assets as of the acquisition date is treated as embedded goodwill and isconsidered in computing the Company's equity share in income/loss of equityinvestees. In accordance with requirements of SFAS 142, Goodwill and Other IntangibleAssets, goodwill and intangible assets with indefinite useful lives are notamortized. Instead, they are tested at least annually for impairment. Intangible assets that have a finite useful life are amortized using thestraight-line method over the shorter of their useful life or the termestablished by legislation. Capitalized Interest Interest expense related to the use of borrowed funds used for capitalconstruction projects and acquisition of properties, plant and equipment iscapitalized provided such interest expense could have been avoided if theCompany had not made capital investments. Interest is capitalized only duringthe period when construction activities are actually in progress and until theresulting properties are put into operation. The Company capitalizedUS$ 51 million and US$ 35 million of interest expenses on loans and borrowingsin the first six months of 2006, and 2005. Leasing Agreements Capital leases, which transfer to the Company substantially all the risks andbenefits incidental to ownership of the leased item, are capitalized at theinception of the lease at the fair value of the leased property or, if lower, atthe present value of the minimum lease payments. Lease payments are apportionedbetween the interest charges and reduction of the lease liability so as toachieve a constant rate of interest on the remaining balance of the liabilities.Interest charges are charged directly to the consolidated statements ofoperation and comprehensive income. Capitalized leased assets are depreciated over the shorter of the estimateduseful life of the asset or the lease term unless leased assets are capitalizedbecause the terms of the lease agreement grant the Company ownership rights overthe leased assets by the end of the lease term or containing a bargain purchaseoption. In the latter cases capitalized assets are depreciated over theestimated useful life of the asset regardless of the lease term. Leases where the lessor retains substantially all the risks and benefits ofownership of the assets are classified as operating leases. Operating leasepayments are recognized as an expense in the consolidated statements ofoperation and comprehensive income on a straight-line basis over the lease term. Asset Retirement Obligations The Company has conditional asset retirement obligations associated with itscore business activities. The nature of the assets and potential obligations areas follows: Exploration and Production - The Company's exploration, development andproduction activities involve the use of the following assets: wells, relatedequipment and operating sites, oil gathering and treatment facilities, tankfarms and in-field pipelines. Generally, licences and other regulatory actsrequire that such assets be decommissioned upon the completion of production.According to these requirements, the Company is obliged to decommission wells,dismantle equipment, restore the sites and perform other related activities. TheCompany's estimates of these obligations are based on current regulatory orlicence requirements, as well as actual dismantling and other related costs.Asset retirement obligations are calculated in accordance with the provisions ofSFAS 143, Accounting for Asset Retirement Obligations. Refining, Marketing and Distribution - This business segment covers refiningoperations, marine and other distribution terminals, and retail sales. TheCompany's refining operations consist of major petrochemical operations andindustrial complexes. These industrial complexes have been in operation forseveral decades. The Company's management believes that given the nature of theoperations, the useful lives of these industrial complexes are indeterminable,while certain of their operating components and equipment have definite usefullives. Legal or contractual asset retirement obligations related topetrochemical, oil refining, marketing and distribution activities are notrecognized due to the limited history of such activities in these segments, thelack of clear legal requirements as to the recognition of obligations, as wellas the fact that useful lives of such assets are not determinable. The Company's marine and other distribution terminals, including its retailnetwork, operate under the regulatory requirements of local authorities andlease arrangements. These requirements generally provide for elimination of theconsequences of the use of those assets, including dismantling of equipment,restoration of land, etc. The Company's estimate of conditional asset retirementobligations takes into account the above requirements. SFAS 143 calls for measurements of asset retirement obligations to include, as acomponent of expected costs, an estimate of the price that a third party woulddemand, and could expect to receive, for bearing the uncertainties andunforeseeable circumstances inherent in the obligations, sometimes referred toas a market-risk premium. To date, the oil and gas industry has few examples of credit-worthy thirdparties which are willing to assume this type of risk, for a determinable price,on major oil and gas production facilities and pipelines. Therefore, becausedetermining such a market-risk premium would be an arbitrary process, it hasbeen excluded from the SFAS 143 estimates. Due to continuous changes in the Russian regulatory and legal environment, therecould be future changes to the requirements and contingencies associated withthe retirement of long-lived assets. Fair Value of Financial Instruments SFAS 107, Disclosures about Fair Value of Financial Instruments, defines thefair value of a financial instrument as the amount at which the instrument couldbe exchanged in a current transaction between willing parties, other than in aforced or liquidation sale. Financial assets and financial liabilities recognized in the accompanyingconsolidated balance sheets include cash and cash equivalents, short-term andlong-term investments, accounts receivable and payable, short-term debt andother current and non-current assets and liabilities. The Company, using available market information, management's estimates andappropriate valuation methodologies, has determined the approximate fair valuesof financial instruments. Income Taxes Russian legislation does not contain the concept of a 'consolidated tax payer'and, accordingly, the Company is not subject to Russian taxation on aconsolidated basis but rather on an individual company basis. Income taxes areprovided on taxable profit as determined under the Russian Federation Tax Code.Deferred income tax assets and liabilities are recognized in the accompanyingconsolidated financial statements in the amount determined by the Company usingthe liability method in accordance with SFAS 109, Accounting for Income Taxes.This method takes into account future tax consequences, based on the effectivetax rate, associated with differences between the carrying values of assets andliabilities and their taxable base, which gives immediate income statementeffect to changes in income tax laws, including changes in the tax rates. Avaluation allowance for a deferred tax asset is recorded when managementbelieves that it is more likely than not that this tax asset will not berealized. The Company follows the provisions of APB 28, "Interim Financial Reporting", toarrive at the effective tax rate. The effective tax rate is the best estimate ofthe expected annual tax rate to be applied to the taxable income for the currentreporting period. The rate is based on the currently enacted tax rate (24%) andincludes estimates of the annual tax effect of permanent differences and therealization of certain deferred tax assets. Recognition of Revenues Revenues are recognized when title passes from the seller to the customer, thecontract price is fixed or determinable and collectibility of the receivable isreasonably assured. Specifically, domestic sales of crude oil and gas, as wellas petroleum products and materials are recognized when title passes. For exportsales, title generally passes at the border of the Russian Federation and theCompany covers transportation expenses, duties and taxes on those sales.Revenues include excise taxes and custom duties (see Note 13). Sales of support services are recognized as services performed provided that theservice price can be determined and no significant uncertainties regarding thereceipt of revenues exist. Revenues are shown net of value added tax. Transportation Expenses Transportation expenses recognized in the consolidated statement of incomerepresent all expenses incurred in the transportation of crude oil and petroleumproducts via the Trasneft pipeline network, as well as by railway and othertransport means. Refinery Maintenance Costs The Company recognizes the costs of overhauls and preventive maintenanceperformed with respect to oil refining assets as expenses when incurred. Environmental Liabilities Environmental expenditures are expensed or capitalized, depending upon theirfuture economic benefit. Expenditures that relate to an existing conditioncaused by past operations, and do not have a future economic benefit, areexpensed. Liabilities for these expenditures are recorded on an undiscountedbasis when environmental assessments or clean-ups are probable and the costs canbe reasonably estimated. Guarantees The fair value of a guarantee is determined and recorded as a liability at thetime when the guarantee is issued. The initial guarantee amount is subsequentlyremeasured to reflect the changes in the underlying liability. The expense isincluded in the related line items of the consolidated income statement, basedon the nature of the guarantee. When the likelihood of performing on a guaranteebecomes probable, a liability is accrued, provided it is reasonably determinableon the basis of the facts and circumstances at that time. Comprehensive Income The Company applies SFAS 130, Reporting Comprehensive Income, which establishesstandards for the calculation and reporting of the Company's comprehensiveincome (net income plus all other changes in net assets from non-owner sources)and its components in consolidated financial statements. As of June 30, 2006 and 2005, there were no other comprehensive income itemsand, therefore, comprehensive income for the first six months of 2006 and 2005equals net income. Accounting for Contingencies Certain conditions may exist as of the date of these consolidated financialstatements which may further result in a loss to the Company, but which willonly be resolved when one or more future events occur or fail to occur. TheCompany's management makes an assessment of such contingent liabilities which isbased on assumptions and is a matter of opinion. In assessing loss contingenciesrelating to legal or tax proceedings that involve the Company or unassertedclaims that may result in such proceedings, the Company, after consultation withlegal or tax advisors, evaluates the perceived merits of any legal or taxproceedings or unasserted claims as well as the perceived merits of the amountof relief sought or expected to be sought therein. If the assessment of a contingency indicates that it is probable that a losswill be incurred and the amount of the liability can be estimated, then theestimated liability is accrued in the Company's consolidated financialstatements. If the assessment indicates that a potentially material losscontingency is not probable, but is reasonably possible, or is probable butcannot be estimated, then the nature of the contingent liability, together withan estimate of the range of possible loss if determinable and material, would bedisclosed. Accounting for Contingencies (continued) Loss contingencies considered remote are generally not disclosed unless theyinvolve guarantees, in which case the nature of the guarantee would bedisclosed. However, in some instances in which disclosure is not otherwiserequired, the Company may disclose contingent liabilities or other uncertaintiesof an unusual nature which, in the judgment of management after consultationwith its legal or tax counsel, may be of interest to shareholders or others. Recent Accounting Standards In June 2006, FASB issued Interpretation ("FIN") 48, Accounting for Uncertaintyin Income Taxes, an interpretation of FAS 109. FIN 48, which is the mostsignificant change to accounting for income taxes since the adoption of theliability approach, creates a single model to address uncertainty in taxpositions. FIN 48 clarifies the accounting for income taxes by prescribing theminimum recognition threshold a tax position is required to meet before beingrecognized in the financial statements. The statement also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. In addition, FIN 48 clearlyscopes out income taxes from FAS 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006.Differences between the amounts recognized in the statements of financialposition prior to the adoption of FIN 48 and the amounts reported after adoptionshould be accounted for as a cumulative-effect adjustment recorded to thebeginning balance of retained earnings. The cumulative effect adjustment wouldnot apply to those items that would not have been recognized in earnings, suchas the effect of adopting FIN 48 on tax positions related to businesscombinations. The Company is currently evaluating the impact FIN 48 will have on the Company'sfinancial statements. In June 2006, the FASB's Emerging Issues Task Force ("EITF") reached a consensuson Issue 06-3 ("EITF 06-3"), How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF 06-3 affirmed that the presentation of taxes on either a gross basis or a net basis is an accounting policy decision that should be disclosed pursuant to APB Opinion No. 22, Disclosure of Accounting Policies. A company should disclose the amount of those taxes that is recognized on a gross basis if those amounts are significant. The Company expects that EITF 06-3 will not have a material impact to the Company's financial statements. In September 2006, the FASB issued SFAS 157, Fair Value Measurements. Thestandard defines fair value, establishes a framework for measuring fair value,and expands disclosures about fair value measurements. SFAS 157 applies underother accounting pronouncements that require or permit fair value measurements.Accordingly, this Statement does not require any new fair value measurements.The guidance is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. The Company will apply this standard forfinancial statements issued for fiscal year beginning from January 1, 2008. TheCompany has not identified the impact this standard will have on the Company'sfinancial position and results of operations. 3. Significant Acquisitions OJSC Rosneft-Krasnodarneftegaz In the first half of 2005, the Company acquired 33,337,187 common shares (38.66%of the total number of common shares) and 17,633,509 preferred shares (61.63% ofthe total number of preferred shares) in OJSC Rosneft-Krasnodarneftegaz, thusincreasing its share in the share capital ofOJSC Rosneft-Krasnodarneftegaz to 95.46%. The purchase price of the above sharesamounted to US$ 110 million and was paid in cash. The fair value of net assets acquired amounted to US$ 239 million based on areport of an independent appraiser. Because the fair value of the net assetsacquired exceeded the purchase price, negative goodwill existed which has beenallocated proportionately between oil and gas properties and mineral rights. Thefinal purchase price allocation did not have a material effect on the carryingvalues of assets acquired and liabilities assumed. OJSC Nakhodka Oil Seatrade Port In June 2006, the Company acquired 97.51% equity shareholding in IJSC NakhodkaOil Seatrade Port. The purchase price amounted to US$ 19.5 million and was paidin cash. The purchase price was allocated to the fair value of assets acquiredand liabilities assumed, the resulting goodwill amounted to US$ 9.5 million,which the Company attributes to synergy effect from the future integration withthe operations of the Company's subsidiary LLC Rosneft-Nakhodkanefteprodukt. The results of operations of OJSC Nakhodka Oil Seatrade Port are not material towarrant pro-forma presentation. OJSC Rosneft - Tuapsenefteprodukt In January 2006, the Company, through one of its subsidiaries, purchased anadditional 39.26% of the voting stock (30.24% of the share capital) of OJSCRosneft - Tuapsenefteprodukt, a consolidated subsidiary. The purchase priceamounted to US$ 100 million and was paid in cash. After the purchase, theCompany's share in OJSC Rosneft - Tuapsenefteprodukt increased from 50.67% to89.93% of voting shares (from 38.00% to 68.24% of the share capital). Thepurchase price was fully allocated to the fair value of assets acquired andliabilities assumed. This allocation is preliminary and will be adjusted uponcompletion of the valuation of properties, plant and equipment. OJSC Daltransgaz In February 2006, the Company purchased 25% of the additional issue of shares byOJSC Daltransgaz, an equity investee, for RUR 722 million (US$ 26 million at theexchange rate as of date of settlement), thus maintaining its interest in OJSCDaltransgaz of 25% plus one share. See also Note 20. 4. Cash and Cash Equivalents Cash and cash equivalents comprise the following: June 30, 2006 December 31, (unaudited) 2005 _____________________________Cash in hand and cash in bank - RUR $ 130 $ 414Cash in hand and cash in bank - foreign currencies 146 394Deposits and other 890 365 _____________________________Total cash and cash equivalents $ 1,166 $ 1,173 ============================= Cash accounts denominated in foreign currencies represent primarily cash in US$. Deposits and other represent primarily bank deposits denominated in RUR. 5. Short-Term Investments Short-term investments comprise the following: June 30, 2006 December 31, (unaudited) 2005 _____________________________Short-term loans granted $ 99 $ 27Loans to related parties 34 32Trading securities Short-term promissory notes 1 7 Corporate and state bonds 93 74 Other 23 10Settlements on notes with related party - 7Bank deposits 320 3Investments for resale - 2Other 1 3 _____________________________Total short-term investments $ 571 $ 165 ============================= State bonds primarily represent federal loan bonds issued by the Ministry ofFinance of the Russian Federation with maturity ranging from June 2007 toNovember 2021, coupon yields in 2005 ranging from 8.0% to 11.0% p.a. and yieldsto maturity ranging from 6.2% to 7.9% p.a. depending on the issue. Bank deposits represent RUR-denominated deposits with the term of more than 3months bearing interest rate of 6.0% p.a. Corporate bonds represent bonds issued by large Russian corporations withmaturity ranging fromJuly 2007 to February 2010 and interest rates ranging from 11.00% to 14.65%. Unrealized gains and losses on available-for-sale securities are notsignificant. 6. Accounts Receivable, Net Accounts receivable comprise the following: June 30, 2006 December 31, (unaudited) 2005 _____________________________Trade receivables $ 1,068 $ 935Value added tax receivable 1,552 1,477Other taxes 67 88Banking loans to customers 488 305Other 112 122Less: allowance for doubtful accounts (78) (69) _____________________________Total accounts receivable, net $ 3,209 $ 2,858 ============================= The Company's trade accounts receivable are denominated primarily in US dollars.Credit risk is managed through the use of letters of credit, and requestingadvance payments from customers for the majority of sales. Value added tax receivable (VAT) primarily includes input VAT assosiated withexport sales, which is reimbursed from the budget in accordance with Russian taxlegislation. 7. Long-Term Investments Long-term investments comprise the following: June 30, 2006 December 31, (unaudited) 2005 _____________________________Equity method investmentsPolar Lights Company LLC $ 114 $ 94CJSC Kaspiy-1 30 29JV Rosneft-Shell Caspian Ventures Limited 22 21OJSC Daltransgaz 37 11IJSC Verkhnechonskneftegaz 228 231Other 9 4 _____________________________Total 440 390 _____________________________ Available for sale securitiesRussian government bonds 1 2Long-term promissory notes 13 7 Held-to-maturity securitiesLong-term loans granted 14 2Long-term loans to equity investees 68 21Investments in joint operations 17 4Cost method investments 26 10 _____________________________Total long-term investments $ 579 $ 436 ============================= Equity share in income/(loss) of material investments recorded using the equitymethod: Participation Share in income/(loss) of equity investees interest __________________________________________ (percentage) Six months ended Six months ended as June 30, 2006 June 30, 2005 of June 30, 2006 (unaudited) (unaudited) ____________________________________________________________ Polar Lights Company LLC 50.00 $ 20 $ 13OJSC Daltransgaz 25.00 - -JV Rosneft-Shell Caspian Ventures Limited 51.00 1 22Rosneft-Stroytransgaz LLC 50.00 (1) (13)CJSC Kaspiy-1 45.00 1 -OJSC Verkhnechonskneftegaz 25.94 (3) -Other 1 (2) ________________________________Total equity share $ 19 $ 20 ================================ CJSC Sevmorneftegaz In January 2002, the Company, through OJSC Rosneft-Purneftegaz, and OJSCGazprom, throughCJSC Rosshelf jointly established CJSC Sevmorneftegaz with equal shares inequity. The cost of investment in CJSC Sevmorneftegaz was US$ 17 thousand. CJSCSevmorneftegaz is primarily engaged in exploration and production activities onthe Prirazlomnoye and Shtokmanovskoye oil and gas condensate fields. In December 2004, it was resolved to sell the Company's share in the project tothe other participant (the "Buyer") and full payment was received under theshare purchase agreement. At December 31, 2004 and 2003 this investment wasclassified under equity method investments. Title to shares inCJSC Sevmorneftegaz was transferred to the Buyer in the first half of 2005.Under the share purchase provisions, the Buyer had the right to notify theCompany in writing, not later than the end of June 2005, of its intention tosell the acquired share back to the Company and the Company was obliged to takeback and pay for such share. The Buyer did not exercise its right to repurchaseat the time stipulated in the contract, therefore in June 2005 the Companyrecorded a gain on the sale of the interest in CJSC Sevmorneftegaz in the amountof US$ 1,303 million. Polar Lights Company LLC ("PLC") PLC is a limited liability company owned 50% by Conoco Phillips Timan-PechoraInc., and 50% by the Company. PLC is primarily engaged in the development of theArdalin and satellite fields in the Timan-Pechora Basin located 125 kilometerssouth of the Barents Sea above the Arctic Circle. Development of the Ardalinfield commenced in late 1992 and the first oil was produced in 1994. JV Rosneft-Shell Caspian Ventures Limited JV Rosneft-Shell Caspian Ventures Limited ("JV") is a joint venture in which theCompany holds a 51% interest. The Articles of Incorporation of this jointventure stipulate, however, that key decisions regarding its business shall besubject to unanimous approval by both participants and none of the participantshas a preferential voting right. JV Rosneft-Shell Caspian Ventures Limited (continued) On February 6, 1997, the Company, through the JV, signed an agreement with eightoil and gas companies and government agencies of the Russian Federation and theRepublic of Kazakhstan for the establishment of Caspian Pipeline Consortium("CPC"). The purpose of the consortium is to design, finance, construct andoperate a pipeline from the oil fields located in Western Kazakhstan throughRussia to the port of Novorossiysk. The interest of the JV in the CPC is 7.5%.In October 2001, the CPC pipeline was put in operation. CJSC Kaspiy-1 In 1997, a subsidiary of the Company made a contribution to the share capital ofCJSC Kaspiy-1, which was founded to construct an oil refinery in Makhachkala(Dagestan Republic). The refinery has been commissioned in 2006. OJSC Daltransgaz OJSC Daltransgaz is an operator for the program to supply gas to the SakhalinRegion and the Khabarovsk and Primorye Territories. OJSC Verkhnechonskneftegaz OJSC Verkhnechonskneftegaz holds the licence for the development of theVerkhnechonskoye oil and gas condensate deposit, which is the largest oildeposit in the Irkutsk region. 8. Acquired Debt Receivable, Net The Company and a group of banks led by Societe Generale S.A. entered into anagreement granting the Company the right to claim the outstanding balance duefrom Yukos Oil Company under a syndicated loan of US$ 1,000 million. Under thisagreement, the right to claim the debt and other rights and benefits peroriginal loan agreement between the bank syndicate and Yukos Oil Company weretransferred from the banks to the Company in March 2006 upon the payment of theoutstanding loan principal, accumulated interest (up to the date of repayment),legal and other fees in the amount totaling US$ 483 million. In particular the Company took over from the bank syndicate the claimantposition in the court hearings, in Amsterdam Arbitration court, with respect tothe collection the outstanding debt balance. The carrying value of the receivable is stated net of allowance for losses inthe amount of US$ 27 million. No interest is being accrued on this balance. 9. Oil and Gas Properties, Net Oil and gas properties comprise the following: June 30, 2006 December 31, (unaudited) 2005 ______________________________ Wells and related facilities $ 13,930 $ 12,606Mineral rights 11,163 10,723Pipelines 1,053 1,057Equipment under capital lease 175 214 ______________________________Total cost 26,321 24,600Less: accumulated depletion (4,377) (3,661) ______________________________Total oil and gas properties, net $ 21,944 $ 20,939 ============================== Mineral rights include costs to acquire unproved properties in the amount ofUS$ 1,823 million as of June 30, 2006 and US$ 1,382 million as of December 31,2005. The Company plans to explore and develop the respective fields. TheCompany's management believes these costs are recoverable. OJSC Yuganskneftegaz in its operating activities enters into short-term leasecontracts for a significant number of wells and related equipment andfacilities. These agreements are entered into with the owners of the wells,equipment and facilities, which are certain subsidiaries of Yukos Oil Company.All of the lease agreements are cancellable in nature and most expire within oneyear. The inability of the Company to extend these lease agreements and/orotherwise obtain rights to use the wells and related facilities in the oilproduction may have material adverse consequences for the Company's ability toextract and recover a portion of the carrying value of the $7,903 million in oiland gas properties and the $9,291 million in mineral rights acquired in thebusiness combination. During 2005, all the expired lease contracts were extendedfor a period of up to one year. The Company's management plans to attempt tofurther extend the above leases. Following a claim brought byOJSC Yuganskneftegaz in March 2006, the Moscow Arbitration Court ruled that the100% ownership interest in one of the subsidiaries, which is the mostsignificant lessor, should be transferred from Yukos Oil Company to OJSCYuganskneftegaz. This ruling was upheld in the appeal hearings on June 1, 2006,which made it legally binding and enforceable. However, given the current YukosOil Company bankruptcy proceedings, such transfer may only be effected with theapproval of the bankruptcy receiver. The Company believes that it will likely beable to continue to extract minerals from the related sites. Sakhalin-1 The Company's primary investment in a PSA is through the Sakhalin-1 project (PSA1), which is operated by ExxonMobil, one of the PSA participants. In February2001, the Company signed an agreement with Oil and Natural Gas Corporation("ONGC") in relation to its interest in the PSA 1 which reduced the Company'sinterest to 20%. The Company records the investment in its retained share underthe "carried interest" method. Commercial hydrocarbon production under PSA 1commenced in October 2005. Accordingly, the Company's share in hydrocarbonreserves was reclassified as proved developed reserves. See also Note 20. 10. Accounts Payable and Accrued Liabilities Accounts payable and accrued liabilities comprise the following: June 30, 2006 December 31, (unaudited) 2005 _____________________________Trade accounts payable $ 772 $ 649Salary and other benefits payable 157 157Advances received 202 192Dividends payable 485 60Banking customer accounts 301 252Yukos Oil Company debt acquisition liability - 27Other 83 21 _____________________________Total accounts payable and accrued liabilities $ 2,000 $ 1,358 ============================= The Company's accounts payable are denominated primarily in RUR. Dividendspayable mainly represent dividends payable to Rosneft shareholders which weredeclared in June 2006. 11. Short-Term Loans and Long-Term Debt Short-term loans and borrowings comprise the following: June 30, 2006 December 31, (unaudited) 2005 ______________________________Loans and borrowings - US$ denominated Bank loans $ 246 $ 794Customer deposits 23 42Other - 3 Loans and borrowings - RUR denominated Bank loans 7 9Promissory notes payable 746 657Customer deposits 140 96Other 501 453 _____________________________ 1,663 2,054Current portion of long-term debt 2,177 1,951 _____________________________Total short-term loans and current portion of long-term debt $ 3,840 $ 4,005 ============================= The rate of interest on the Company's short-term loans denominated in US$ wasfrom LIBOR plus 2% to LIBOR plus 2.81% p.a. The RUR denominated loans generallybear an annual interest rate ranging from 2.5% to 8% p.a. Promissory notes are primarily payable on demand and bear an interest rateranging from 0% to 18%. Interest free promissory notes are recorded at amortizedcost. Customer deposits represent fixed-term deposits placed by customers with theCompany's subsidiary bank, denominated in RUR and foreign currencies. Customerdeposits denominated in RUR bear an interest rate ranging from 4% to 12.6% p.a.Customer deposits denominated in foreign currencies bear an interest rateranging from 3% to 11% p.a. Other RUR-denominated borrowings primarily include four loans provided to OJSCYuganskneftegaz by YUKOS Capital S.a.r.l., which bear interest of 9% p.a. andmature in 2007. As of June 30, 2006 and December 31, 2005 these loans areclassified as current since the creditor demanded early repayment of these loansdue to non-compliance with the terms of the loan agreements. Long-term debt comprises the following: June 30, 2006 December 31, (unaudited) 2005 _______________________________Bank loans - US$ denominated $ 5,315 $ 4,220Bank loans raised for funding the acquisition of OJSC Yuganskneftegaz - US$ denominated 5,259 5,743Borrowings - US $ denominated 43 49Customer deposits - US$ denominated 11 8Borrowings - RUR denominated 9 9Customer deposits - RUR denominated 66 60Bonds of the subsidiary bank - RUR denominated 3 20Other long-term liabilities - RUR denominated 29 40 _______________________________ 10,735 10,149Current portion of long-term debt (2,177) (1,951) _______________________________Total long-term debt $ 8,558 $ 8,198 =============================== The rates of interest on the Company's long-term bank loans denominated in US$were from 4.35% to 12.92% p.a. Weighted average interest rates on these loanswere LIBOR plus 0.74% and LIBOR plus 2.19%, as of June 30, 2006 and as ofDecember 31, 2005, respectively. These loans are primarily secured by contractsfor the export of crude oil. In January 2006, a subsidiary of the Company registered in Cyprus signed a loanagreement with a major international bank for an amount of EUR 188 million orUS$ 236 million using the CBR rate as of June 30, 2006. The loan bears aninterest rate of EURIBOR plus 0.35%. The first drawdown was made during the 1sthalf of 2006 in the amount of EUR 95.5 million or US$ 119.8 million using theCBR rate as of June 30, 2006. Funds borrowed are to be invested in theconstruction of ice-reinforced tankers for crude oil transportation purposes innorth-western regions of the Russian Federation. The loan is scheduled to berepaid within the twelve years following the completion of tanker construction. In February 2006, the Company signed a loan agreement with a syndicate ofWestern banks for US$ 2,000 million with a term of 5 years. The loan bearsinterest at LIBOR plus 0.65% p.a. The loan funds were used to repay loans withless favorable terms. As of June 30, 2006 the bank loans raised for funding the acquisition of OJSCYuganskneftegaz represent a long-term loan obtained through a government-ownedbank at a rate of LIBOR plus 0.7% p.a. repayable in equal monthly installments.It is scheduled for repayment in 2011 and is secured by pledging the Company'sreceivables under a long-term contract for the supply of crude oil (see Note17). Weighted average interest rates on US$ denominated borrowings were 8.59% and8.54% as of June 30, 2006 and December 31, 2005, respectively. Customer deposits include fixed-term RUR and foreign currency denominatedcustomer deposits placed with the Company's subsidiary bank which matureprimarily in the first half of 2007 and are included in the current portion oflong-term debt. The RUR-denominated deposits bear an interest rate ranging from1.2% to 12.5% p.a. Deposits denominated in foreign currencies bear an interestrate 9% p.a. As of June 30, 2006 other long-term liabilities include primarily interest-freepromissory notes which mature in 2007. The promissory notes are stated atamortized cost and are included in the current portion of long-term debt. The Company is obliged to comply with a number of restrictive financial andother covenants contained within its loan agreements. Restrictive covenantsinclude maintaining certain financial ratios. As a result of the Company'sacquisition of OJSC Yuganskneftegaz in December 2004, and the resulting debtincurred and assets and liabilities, including contingent liabilities,consolidated, the Company was not in compliance with various financial and othercovenants of existing loan agreements as of that date. As of December 31, 2004 the long-term portion of the debt outstanding under loanagreements which were in default amounted to US$ 1,661 million. This debtcontinued to be reflected as long-term in nature in the December 31, 2004consolidated balance sheet. In July 2005, the creditors waived violationsrelated to restrictive financial ratios and agreed to amend the financial ratiocovenants in line with the Company's new structure and new scope of activities.The creditors also waived other events of default arising from the breach ofother covenant provisions. To date, the creditors have provided waivers relatingto these provisions which have been granted on condition that the Companyfurnishes to the creditors, by no later than December 31, 2006, acceptableevidence that the Company has: 1. Discharged in full, or restructured, OJSC Yuganskneftegaz's tax liabilities for 2004 (which should not be in excess of a set limit), 2. Discharged in full, or restructured, OJSC Yuganskneftegaz's tax liabilities for the periods 1999 to 2003, 3. Discharged in full, or restructured, the indebtedness to YUKOS Capital S.a.r.l. in the amount of US$ 494 million, 4. Discharged in full, or restructured, the guarantee claims of Societe General S.A. related to a US$ 1,600 million loan (see Note 17). These conditions also apply to certain new borrowings obtained throughout 2005and also subsequent to that date. Thus, as of June 30, 2006 and December 31,2005, long-term borrowings, for which creditors waived events of default arisingfrom the breach of certain covenant provisions, amounted to US$ 2,231 millionand US$ 2,831 million, respectively. This debt continues to be reflected aslong-term in nature in June 30, 2006 and December 31, 2005 consolidated balancesheets. The Company's management believes that the conditions referred to above will becompletely or partially fulfilled before the end of 2006. If certain conditionsremain unfulfilled, the Company will apply for the extension of waivers. TheCompany believes that the probability of such extensions being granted is high. The aggregate maturity of long-term debt outstanding as of June 30, 2006 is asfollows (assuming the debt will not be called by creditors ahead of scheduledmaturities): (unaudited) ______________Up to December 31, 2006 $ 1,1212007 2,2642008 2,5452009 2,4502010 2,1042011 and after 251 ______________Total long-term debt $ 10,735 ============== 12. Shareholders' Equity In June 2006, the annual general meeting of shareholders approved dividends onthe Company's common shares for 2005 in the amount of RUR 11.3 billion or US$424 million at the CBR rate as at the date of decision, which corresponds to US$0.05 per share. See also Note 20. 13. Revenue Related Taxes Revenues include export customs duty composed of: Three months Three months Six months Six months ended June ended June ended June ended June 30, 2006 30, 2005 30, 2006 30, 2005 (unaudited) (unaudited) (unaudited) as restated (unaudited) ____________________________________________________ Oil and gas salesExport customs duty $ 2,306 $ 1,093 $ 4,140 $ 1,848 Petroleum products salesand processing feesExport customs duty 323 212 653 295 ____________________________________________________Total revenue related taxes $ 2,629 $ 1,305 $ 4,793 $ 2,143 ==================================================== 14. Income Tax Income taxes comprise the following: Three months Three months Six months Six months ended June ended June ended June ended June 30, 2006, 30, 2005, 30, 2006 30, 2005, as (unaudited) (unaudited) restated (unaudited) (unaudited) ____________________________________________________Current income tax expense $ 541 $ 672 $ 954 $ 987Deferred income tax benefit (57) 18 (135) (40) ____________________________________________________Total income tax $ 484 $ 690 $ 819 $ 947 ==================================================== The Company does not file a consolidated tax return, rather each legal entityfiles separate tax returns with various authorities, primarily in the RussianFederation. Temporary differences between these consolidated financial statements and taxrecords gave rise to the following deferred income tax assets and liabilitiescomprise the following: June 30, December 31, 2006 2005 (unaudited) ________________________Deferred income tax asset arising from tax effect of: PSA 1 deferred deductible expenses $ 103 $ 101Asset retirement obligations 49 54Property, plant and equipment 87 75Accounts receivable 18 9Accounts payable and accruals 22 32Other 94 56 ________________________Total 373 327Valuation allowance for deferred income tax asset (306) (271) ________________________Deferred income tax asset 67 56 ________________________Deferred income tax liability arising from taxeffect of:Mineral rights (2,275) (2,172)Property, plant and equipment (1,584) (1,564) ________________________Deferred income tax liability (3,859) (3,736) ________________________Net deferred income tax liability $ (3,792) $ (3,680) ======================== OJSC Yuganskneftegaz paid income tax during 2006 at lower rates subject to a 4%income tax exemption under the regional laws. These laws provide that the incometax exemptions are granted to the oil and gas producing companies, which makecapital investments, agreed with regional administrations, within the respectiveregion and participate in various social projects, therefore increasing benefitsto the regional budget. These exemptions are granted on an annual basis. Consistent with the prior periods the most significant reconciling items betweentheoretical income tax expense and recorded tax expense remain (1) change invaluation allowance for deferred tax assets, (2) income tax related interest,(3) effect of income tax preference (discussed above), and (4) foreign exchangeeffects. 15. Asset Retirement Obligations For the first six months ended June 30, the movement of asset retirementobligations is as follows: 2006 (unaudited) ___________Asset retirement obligations as $ 566of the beginning of the reporting periodRecognition of additional obligations for new wells 2Accretion expense 16Increase as a result of change in estimates 35 ___________Asset retirement obligations as of the end of the reporting period $ 619 =========== 16. Related Party Transactions In the course of its usual activity, the Company regularly enters intotransactions with other enterprises which are directly or indirectly controlledby the Russian Government. Such enterprises are business units of RAO UES, OJSCGazprom, OJSC Russian Railways, OJSC Sberbank, Vnesheconombank, OJSCVneshtorgbank, CJSC Gazprombank, OJSC Transneft and federal agencies includingtax authorities. Management considers these business relations as part ofregular activities in the Russian Federation and believes that they will remainunchanged in the foreseeable future. Total amounts of transactions with companies controlled by the RussianGovernment for each of the reporting periods ending June 30, as well as relatedparty balances as of June 30, 2006 andDecember 31, 2005 are provided in the table below: Six months Six months ended June 30, ended June 30, 2006 2005 (unaudited) (unaudited) ____________________________Revenues Oil and gas sales $ 3 $ 9Sales of petroleum products and processing fees 107 37Support services and other revenues 2 1 ____________________________ $ 112 $ 47 ============================ Costs and expenses Production and operating expense $ 8 $ 4Pipeline tariffs and transportation costs 937 474Other expenses 11 6 ____________________________ $ 956 $ 484 ============================Other operations Sale of short-term and long-term investments $ 4 $ 8Acquisition of short-term and long-term 1 72investmentsProceeds from short-term and long term debt 2,889 1,171Repayment of short-term and long term debt 4,405 1,035Deposits placed 8,759 161Deposits paid 7,999 170Borrowings issued 84 561Repayment of borrowings issued 23 563Interest expense 212 227Interest income $ 9 $ - June 30, 2006 December 31, (unaudited) 2005 ____________________________ Assets Cash and cash equivalents $ 694 $ 376Accounts receivable and other current assets 7 203Prepayments 85 154Short-term and long-term investments 511 - ____________________________ $ 1,297 $ 733 ============================Liabilities Accounts payable $ 4 $ 4Short-term and long-term debt (including interest) 5,683 6,890 ____________________________ $ 5,687 $ 6,894 ============================ Total amounts of transactions with other related parties (other than thecompanies controlled by the Russian Government), primarily equity investees andjoint ventures, for each of the reporting periods ending June 30, as well asrelated party balances as of June 30, 2006 and December 31, 2005 are provided inthe table below: Six months Six months ended June 30, ended June 30, 2006 2005 (unaudited) (unaudited) ____________________________Revenues Oil and gas sales $ 15 $ 6Sales of petroleum products and processing 37 8feesSupport services and other revenues 18 23 ____________________________ $ 70 $ 37 ============================ Costs and expenses Pipeline tariffs and transportation costs $ 9 $ 6Production and operating expense - 3Other expenses 25 16 ____________________________ $ 34 $ 25 ============================ Other operations Sales of short-term and long-term investments $ 18 $ 162Acquisition of short-term and long-term 46 27investmentsProceeds from short-term and long term debt 4 60Repayment of short-term and long term debt 29 60Deposits placed - 17Deposits paid - 6Borrowings issued 81 40Repayment of borrowings issued 3 42Interest expense 3 20Interest income 6 2Dividends received $ 3 $ 1 June 30, 2006 December 31, (unaudited) 2005 ____________________________Assets Accounts receivables and other current assets $ 22 $ 13Prepayments 7 -Short-term and long-term investments 243 128 ____________________________ $ 272 $ 141 ============================Liabilities Accounts payable $ 26 $ 24Short-term and long-term debt (including interest) 19 2 ____________________________ $ 45 $ 26 ____________________________ 17. Commitments and Contingencies Russian Business Environment Whilst there have been improvements in the Russian economic situation, such asan increase in gross domestic product and a reduced rate of inflation, Russiacontinues economic reforms and development of its legal, tax and regulatoryframeworks as required by a market economy. The future stability of the Russianeconomy is largely dependent upon these reforms and developments and theeffectiveness of economic, financial and monetary measures undertaken by thegovernment. In addition laws and regulations, including interpretations,enforcement and judicial processes, continue to evolve in Russia. Other laws andregulations and certain other restrictions producing a significant effect on theCompany's industry, including, but not limited to the following issues: rightsto use subsurface resources, environmental matters, site restoration,transportation and export, corporate governance, taxation, etc. Taxation Legislation and regulations regarding taxation in Russia continue to evolve. Thevarious legislation and regulations are not always clearly written and theirinterpretation is subject to the opinions of the local, regional and nationaltax authorities. Instances of inconsistent opinions are not unusual. The current regime of penalties and interest related to reported and discoveredviolations of Russia's laws, decrees and related regulations is severe. Interestand penalties are levied when an understatement of a tax liability isdiscovered. As a result, penalties and interest can result in amounts higherthan unreported taxes. In Russia tax declarations remain open and subject to inspection for a period ofup to three years. The fact that a year has been reviewed does not close thatyear, or any tax declaration applicable to that year, from further review duringthe three-year period. Taxation (continued) Russian transfer pricing rules were introduced in 1999, giving Russian taxauthorities the right to make transfer pricing adjustments and impose additionaltax liabilities in respect of all controlled transactions, provided that thetransaction price differs from the market price by more than 20%. Controlledtransactions include transactions between related entities and certain othertypes of transactions between independent parties, such as foreign tradetransactions with significant (by more than 20%) price fluctuations. The Russiantransfer pricing rules are vaguely drafted, leaving wide scope forinterpretation by Russian tax authorities and courts. Due to the uncertaintiesin interpretation of transfer pricing legislation, the tax authorities maychallenge the Group's prices and propose an adjustment. If such priceadjustments are upheld by the Russian courts and implemented, the Group's futurefinancial results could be adversely affected. In addition, the Group could facesignificant losses associated with the assessment of prior tax underpaid andrelated interest and penalties, which could have an adverse effect on theGroup's financial condition and results of operations. The Management believesthat such transfer pricing related tax contingencies are remote rather thanpossible or probable and cannot be reasonably estimated. During 2004 several tax audits of OJSC Yuganskneftegaz for 1999-2003 years tookplace and their results have been appealed in court (see the "Litigation"caption below). During 2005 tax audits of several subsidiaries for the years 2002-2003 tookplace. The results of these tax audits are currently being appealed with the taxauthorities. The Company believes that the resolution of these matters will notresult in any material tax payments. Several large subsidiaries are currently being inspected by tax audits for theyears 2004-2005. The Company believes that the results of these tax audits willnot outcome in any material tax payments. Overall, management believes that the Company has paid or accrued all taxes thatare applicable. Where uncertainty exists, the Company has accrued taxliabilities based on management's best estimate of the probable outflow ofresources embodying economic benefits, which will be required to settle theseliabilities. Possible liabilities which were identified by management at thebalance sheet date as those that can be subject to different interpretations ofthe tax laws and regulations are not accrued in the interim consolidatedfinancial statements. Capital Commitments The Company and its subsidiaries are engaged in ongoing capital projects forexploration and development of production facilities and modernization ofrefineries and the distribution network. The budgets for these projects aregenerally set on an annual basis. Depending on the current market situation,actual expenditures may vary from the budgeted amounts. Environmental Matters Due to the nature of its business, Rosneft and its subsidiaries are subject tofederal legislation regulating environmental protection. The majority ofenvironmental liabilities arise as a result of accidental oil spills and leaksthat pollute land, and air pollution. The Company considers fines paid and otherenvironmental liabilities as immaterial, given the scale of its operations. In the course of its operations, the Company seeks to comply with internationalenvironmental standards and monitors compliance therewith on a regular basis.With a view to improve environmental activities, the Company takes a number ofmeasures to mitigate the adverse impact of its current operations on theenvironment. Legislation that regulates environmental protection in the Russian Federation isevolving, and the Company evaluates its liabilities in accordance therewith.Currently it is not possible to reasonably estimate the liabilities of theCompany which may be incurred should the legislation be amended(if amended at all). The management believes that, based on the existing legislation, the Company isunlikely to have liabilities that need to be accrued in addition to the amountsalready recognized in the interim consolidated financial statements and that mayhave a material adverse effect on the operating results or financial position ofthe Company. Pension Plans For the first six months of 2006 and 2005 the Company contributed to thecorporate pension fund under the defined contribution plan US$ 10 million andUS$ 6.7 million, respectively. Social Commitments The Company possesses social infrastructure assets for use by employees. Inaccordance with the Presidential Edict on privatization in Russia, the Companyis required to transfer social infrastructure assets to the relevant local cityadministrations without significant consideration. Accordingly, as the Companydoes not have ownership of these assets, they are not recorded in the interimconsolidated financial statements. However, the Company is required to maintainthese assets. The Company incurred US$ 19 million and US$ 32 million in social infrastructureand similar expenses for the first six months of 2006 and 2005, respectively.These expenses are presented as other expenses in the consolidated statement ofincome. Insurance The Company insured its assets through the insurance company SK Neftepolis LLC. As of June 30, 2006 and December 31, 2005 the amount of coverage on assets undersuch insurance amounted to US$ 1,977 million and US$ 1,420 million,respectively. Russian insurance providers do not offer business interruption insurance.Currently, it is not a common practice in Russia to obtain such insurance. Guarantees and Indemnity As of June 30, 2006 the Company has provided guarantees for certain debtagreements. In accordance with the loan agreements, the Company is obliged toperform on the guarantee and to pay the bank all amounts of outstandingguaranteed liabilities, including interest, upon the bank's request. The Company cannot substitute guarantees issued by any novation agreement ormutual offset. The Company's obligations under guarantees issued are valid incase of any change in loan agreements. After the full payment and settlement of all obligations under the guarantees,the Company has the right to subrogate its respective part of all bank claimsagainst the debtor in accordance with the loan agreement. In the event theCompany makes payments under guarantees issued, it has a right to claim theamounts paid from the debtor. The Company's outstanding guarantees as of June 30, 2006 are as follows: Beneficiary Bank Loan Maturity Contractual Amount of debtor date principal outstanding amount liability (principal amount) as of June 30, 2006_____________________________________________________________________________Societe Generale Yukos S.A (as Facility Agent) Oil Company May 29, 2009 $ 1,600 $ 656 ABN AMRO OJSC Rosneftegaz December 30, 2008 $ 7,500 $ 7,377 In May 2005, Moravel Investments Limited, an affiliate of Yukos Oil Company,filed an arbitral claim against OJSC Yuganskneftegaz in the London Court ofInternational Arbitration for the recovery of US$ 662 million pertaining to theloan of US$ 1,600 million from Societe Generale S.A. The Company is contestingthe claim vigorously. The case was heard in July 2006 and the Company iscurrently awaiting the decision, which is expected within six months. TheCompany believes that the probability of any payments under the above guaranteeis remote. On March 17, 2006 the Moscow Arbitration Court ruled that theguarantee agreement signed by OJSC Yuganskneftegaz with respect to Yukos OilCompany loan received from Societe Generale S.A. in the amount of US$1,600 million was invalid. This ruling was upheld on May 15, 2006 by the 9thAppeal Arbitration Court in appeal hearings, which made it legally binding andenforceable. Though this resolution may be further appealed by Yukos Oil Companyin accordance with generally accepted legal practices the management believesthat this ruling supports the Company's position in the London Court ofInternational Arbitration. See also Note 20. Litigation, Claims and Assessments In 2002 an option agreement was entered into between Total E&P Vankor (Total)and Anglo-Siberian Oil Company Limited (ASOC) under which Total had aconditional option to buy the latter's 60% stake in Taimyrneft LLC which ASOCheld through Anglo-Siberian Oil Company Limited (Cyprus) (ASOC Cyprus) for US$ 1million. ASOC and ASOC Cyprus belong to the Rosneft International Group. Totalobtained injunctions in various jurisdictions to prevent ASOC Cyprus fromtrading in the shares of Taimyrneft LLC. In 2005 Total filed for arbitrationunder the option agreement requesting the specific performance under the optionagreement or alternatively damages of US$ 424 million. The Company's managementbelieves that the claim is without merit and the option is not exercisable.Beyond professional fees, which are not material to the Company, it is unclearwhether any further liabilities will be incurred but the Company's managementdoes not believe these will be material. The decision of the arbitration isexpected no earlier than in November 2006. During 2004 Total E&P Vankor filed a claim against ASOC Cyprus for US$ 640million under the sale and purchase agreement for 52% share in Eniseineft LLC.Total alleged that under the terms of a sale agreement, the shareholding inEniseineft LLC should have been sold to them. The Company has contested this onthe grounds that the relevant conditions precedent to the sale had not been met.The arbitration proceedings were completed during late 2005 and a decision isexpected in October 2006. The Company is a co-defendant in the litigation in the USA in respect of theacquisition of OJSC Yuganskneftegaz. This litigation was brought by certainholders of American Depository Receipts ("ADRs") of Yukos Oil Company seekingUS$ 3 million in damages due to the fall in market value of the ADRs. TheCompany believes that this claim is without merit. The Company is also a co-defendant in litigation in the Moscow Arbitration Courtwith respect to the auction for the common shares of OJSC Yuganskneftegaz. Thislitigation was brought by Yukos Oil Company. The claimant is seeking to recoverall the common shares of OJSC Yuganskneftegaz and also damages in the totalamount of RUR 388 billion (approximately US$ 14 billion at the CBR rate as ofJune 30, 2006). The court hearings have been postponed for an indefinite period.The Company believes that this claim is without merit. The Company's subsidiaries are involved in other litigations which arise fromtime to time in the course of their business activities. The Company'smanagement believes that the ultimate result of these litigations will notsignificantly affect the operating results or financial position of the Company. License Agreements In accordance with certain license agreements or separate agreements concludedfrom time to time with the local and regional authorities the Company isrequired to maintain certain levels of expenditures for health, safety andenvironmental protection, as well as maintain certain level of capitalexpenditures. Generally these expenditures are within the normal operating andcapital budgets and are accounted for when incurred in accordance with existingaccounting policies for respective costs and expenses. Oil Supplies In January 2005, the Company entered into a long-term contract until 2010 withChina National United Oil Corporation for export supplies of crude oil in thetotal amount of 48.4 million tonnes to be delivered in equal annual amounts. Theprices are determined based on usual commercial terms for crude oil deliveries. 18. Segment Information Presented below is information about the Company's operating segments inaccordance with SFAS 131, Disclosures about Segments of an Enterprise andRelated Information. The Company determines its operating segments based ondifferences in the nature of their operations. The performance of theseoperating segments is assessed by management on a regular basis. The explorationand production segment is engaged in field exploration and development andproduction of crude oil and natural gas. The refinery, marketing anddistribution segment is engaged in processing crude oil and other hydrocarbonsinto petroleum products, as well as purchasing, sale and transportation of crudeoil and petroleum products. The other activities segment consists of banking,finance services, drilling services, construction services and other activities.Substantially all of the Company's operations are conducted in the RussianFederation. Further, the geographical regions within the Russian Federation havesubstantially similar economic and regulatory conditions. Therefore, the Companyhas not presented any separate geographical disclosure. The segments are combinations of subsidiaries. The significant accountingpolicies applied to each segment are consistent with those applied to theinterim consolidated financial statements. Sales transactions for goods andservices between the segments are carried out using prices agreed upon betweenRosneft and its subsidiaries. Operating segments during the three months ended June 30, 2006 are as follows: Refining, Exploration marketing and and Other Total production distribution activities elimination Consolidated (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) _____________________________________________________________ Revenues from external customers $ 116 $ 8,659 $ 65 $ - $ 8,840Intersegmental revenues 2,927 324 173 (3,424) - _____________________________________________________________Total revenues $ 3,043 $ 8,983 $ 238 $ (3,424) $ 8,840 ============================================================= Operating expenses and cost of purchased oil and petroleum products $ 405 $ 614 $ 57 $ - $ 1,076Depreciation, depletion and amortization $ 288 $ 117 $ 3 $ - $408Operating income $ 371 $ 4,763 $ 135 $ (3,424) $ 1,845 Total other income, net (253) __________Income before income tax $ 1,592 ========== Operating segments during the three months ended June 30, 2005 (as restated) areas follows: Refining, Exploration marketing and and Other Total production distribution activities elimination Consolidated (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) _____________________________________________________________ Revenues from external $ 79 $ 5,378 $ 44 $ - $ 5,501customersIntersegmental revenues 2,496 179 72 (2,747) - _____________________________________________________________Total revenues $ 2,575 $ 5,557 $ 116 $ (2,747) $ 5,501 ============================================================= Operating expenses and cost of purchased oil andpetroleum products $ 316 $ 250 $ 20 $ - $ 586Depreciation, depletion and amortization $ 322 $ 36 $ 3 $ - $ 361Operating income $ 715 $ 3,355 $ 64 $ (2,747) $ 1,387 Total other income, net 1,271 _________Income before income tax $ 2,658 ========= Operating segments during the six months ended June 30, 2006 are as follows: Refining, Exploration marketing and and Other Total production distribution activities elimination Consolidated (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) _____________________________________________________________Revenues from external customers $ 233 $ 16,018 $ 105 $ - $ 16,356Intersegmental revenues 5,606 533 302 (6,441) - _____________________________________________________________Total revenues $ 5,839 $ 16,551 $ 407 $ (6,441) $ 16,356 =============================================================Operating expenses and cost of purchased oil andpetroleum products $ 711 $ 1,264 $ 67 $ - $ 2,042Depreciation, depletion and amortization $ 555 $ 231 $ 6 $ - $ 792Operating income $ 976 $ 8,576 $ 259 $ (6,441) $ 3,370 Total other income, net (598) _________Income before income tax $ 2,772 ========= Total assets $ 23,971 $ 7,317 $ 1,418 $ - $ 32,706 Operating segments during the six months ended June 30, 2005 are as follows (asrestated): Refining, Exploration marketing and and Other Total production distribution activities elimination Consolidated (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) _____________________________________________________________Revenues from external customers $ 169 $ 9,626 $ 69 $ - $ 9,864Intersegmental revenues 4,197 356 145 (4,698) - _____________________________________________________________Total revenues $ 4,366 $ 9,982 $ 214 $ (4,698) $ 9,864 =============================================================Operating expenses and $ 601 $ 439 $ 33 $ - $ 1,073costof purchased oil andpetroleum productsDepreciation, depletion $ 627 $ 67 $ 4 $ - $ 698and amortizationOperating income $ 892 $ 6,264 $ 129 $ (4,698) $ 2,587 Total other expenses, net 1,060 __________Income before income tax $ 3,647 ==========Total assets $ 21,267 $ 4,600 $ 1,172 $ - $ 27,039 Below is a breakdown of revenues by domestic and export sales, with aclassification of export sales based on the direction of shipment. Three months Three months Six months Six months ended June ended June ended June ended June 30, 2006 30, 2005 30, 2006 30, 2005 (unaudited) (unaudited) (unaudited) (unaudited) __________________________________________________Oil and gas salesDomestic sales of crude oil $ 21 $ 177 $ 79 $ 434Domestic sales of gas 44 47 94 87Export sales of crude oil - CIS 345 353 740 672Export sales of crude oil - Europe 4,597 2,616 8,344 4,772Export sales of crude oil - Asia 1,337 536 2,300 755 __________________________________________________Total oil and gas sales $ 6,344 $ 3,729 $ 11,557 $ 6,720 ================================================== Petroleum productsDomestic sales $ 954 $ 621 $ 1,869 $ 1,163Export sales of petroleum products - CIS 48 15 86 20Export sales of petroleum products - Europe 780 751 1,590 1,232Export sales of petroleum products - Asia 625 282 1,081 565 __________________________________________________Total petroleum products $ 2,407 $ 1,669 $ 4,626 $ 2,980 ================================================== 19. Fair Value of Financial Instruments and Risk Management The Company, in connection with its current activities, is exposed to variousfinancial risks, such as foreign currency risks, interest rate risks and creditrisks. The Company manages these risks and monitors its exposure on a regular basis.The Company does not use hedge or derivative financial instruments. The fair value of cash and cash equivalents, accounts receivable and accountspayable, promissory notes receivable and liquid securities approximates theircarrying value recognized in these financial statements. The Company'smanagement believes that accounts receivable recorded net of allowance fordoubtful accounts will be recovered in full during an acceptable time period.The fair value of long-term accounts receivable included in other non-currentassets approximates the discounted amounts recognized in these financialstatements and is calculated using the estimated market interest rate forsimilar operations. The fair value of long-term debt differs from amountsrecognized in the consolidated financial statements. The estimated fair value oflong-term debt discounted using the estimated market interest rate for similarfinancial liabilities amounted to US$ 10,095 million and US$ 10,026 million asof June 30, 2006 and December 31, 2005, respectively. These amounts include allfuture cash outflows related to the repayment of long-term loans, includingtheir current portion and interest expenses. A substantial portion of the Company's sales revenues is received in US dollars.In addition, substantial financing and investing activities, obligations andcommitments are also undertaken in US dollars. However, significant operatingand investing expenditures, other obligations and commitments as well as taxliabilities are undertaken in rubles. As a result of the US dollar drop againstthe ruble, the Company is exposed to the corresponding currency risk, which isconsiderably mitigated by the recent increase in oil prices. 20. Subsequent Events In the third quarter of 2006 the Company won a number of auctions for theexploration and development of oil and gas fields in Krasnoyarsk Territory andKomi Republic. Total cost of licenses amounted to RUR 8.54 billion (US$315 million at the CBR rate as of June 30, 2006). In July 2006, Rosneft shareholders completed the initial public offering (IPO)of the common shares of OJSC Rosneft Oil Company in Russia and global depositaryreceipts (GDR) issued with respect to such shares on the London Stock Exchange.1,126,357,616 common shares of the Company were sold in the course of theoffering. In addition, 285,064,359 newly issued common shares of the Companywere placed during the IPO. The Company's net proceeds from the offeringamounted to approximately US$ 2.2 billion from the sale of such shares, whichwill be accounted as additional paid-in capital. In September 2006, the Federal Service for Financial Markets of Russiaregistered the increase of the Company's charter capital resulting from the IPO.The Company's charter capital was increased by 285,064,359 common shares. In July 2006, OJSC Rosneftegaz early repaid the loan in the amount of US$ 7.5billion whereby the Company was a guarantor. Therefore, the Company's guaranteeliability discontinued (see Note 17). On July 31, 2006 the Company paid approximately US$ 1.37 billion to ONGC asreturn of investment made by ONGC in prior years to finance the Company's sharein Sakhalin 1 project (see Note 9). After the repayment to ONGC, the Companyregained the right to the revenue proportionate to its share in the project. In July 2006, the Company acquired 25.49% of the common stock of OJSCVserossiysky Bank Razvitiya Regionov (VBRR) for RUR 333 million (US$ 12 millionat the NBR rate as of June 30, 2006), increasing its share in the VBRR chartercapital to 76.47%. In September 2006, shareholders meeting of VBRR approvedadditional issue of 223 500 shares each 10 000 RUR at par which will all beacquired by OJSC Rosneft Oil Company. The total par value of the shares to beacquired is US$ 83 million at the CBR rate as of June 30, 2006. On August 1, 2006 Moscow Arbitration Court declared Yukos Oil Company bankruptand introduced receivership for the term of one year. In August 2006, the Company purchased 25% of the additional issue of shares byOJSC Daltransgaz, an equity investee, for RUR 525 million (US$ 19 million at theexchange rate as of date of settlement), thus maintaining its interest in OJSCDaltransgaz of 25% plus one share. This information is provided by RNS The company news service from the London Stock Exchange
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