TNK-BP HOLDING

TNK-BP HOLDINGAnnual Report 2006

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K-B

P H

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DIN

G A

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UA

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RT

2006

Financial Results 44Report of independent auditors 45

Consolidated balance sheet 46

Consolidated statement of income 47

Consolidated statement of cash flows 48

Consolidated statement of changes

in shareholders’ equity 49

Notes to the consolidated

financial statements 50

Reference Information 64

President and CEO Forward 2

Company Profile 4

Development Strategy 6

Highlights 8Operating environment 9

Operating highlights 12

Financial reporting 13

People 14

Corporate Social Responsibility 16

Health, Safety and Environment 18

Corporate Governance 20

Internal Control 30

Operating Results 32Upstream 33

Performance and strategy owerview 33

Licences 33

Reserves 35

Oil and condensate production 35

Upstream technology 35

Greenfield projects 36

Gas 37

Associated gas 37

Rospan International 37

Downstream 38

Refining 38

Marketing 41

Supply, trading, and logistics 42

1

TNK-BP Holding Annual Report 2006

Contents

Dear shareholder,

2006 was another good year for TNK-BP

Holding (TBH). We delivered good opera-

tional performance throughout 2006 despite

a record cold winter at the start of the year.

We again replaced considerably more oil

than we produced with new proven re-

serves. We continued to apply better tech-

nology across our asset base and we safe-

ly completed important upgrades at our re-

fineries. We also refreshed and expanded

our TNK retail presence across Russia. And

we extended and deepened our work trans-

forming the Company’s performance in

HSE, corporate governance and trans-

parency.

In addition to good operating performance

throughout 2006, we continued to stream-

line and optimise our asset portfolio. We sold

our Udmurtneft business profitably in August,

and during the year, the Company also ex-

tended the key Samоtlor production li-

cences to 2038 and acquired 19 new li-

cences in Russia. Some of these are logi-

cal step-outs to our existing production ar-

eas, whilst others are in areas that are new

to us, but which we believe are prospective.

This ongoing program is part of the contin-

uing renewal process necessary to sustain

a successful and competitive company.

We continued to grow our oil and gas pro-

duction and again outperformed our 100%

reserves replacement target. The impor-

2

President and CEO Forward

our retail marketing base into new geogra-

phies. Our financial milestones will be built

around meeting those objectives whilst en-

suring that existing operations are run effi-

ciently and continue to generate healthy cash

flow for us to invest in these new operational

priorities as well as provide healthy returns

to all our shareholders.

In support of all these important goals we

also need to accelerate the development of

our organisational capability in order to

make sure we have sufficient properly

skilled people to deliver our agenda.

As a management team we strive to con-

vert our strong operating results into equal-

ly strong shareholder returns. We want our

shareholders to have confidence in their in-

vestment based on predictability and a

track record of prudent financial manage-

ment and regular dividend payments. We be-

lieve we are steadily establishing this track

record.

In this latter connection, we have resolved

that from 2006 onwards we will disclose our

financial results on a consolidated basis ac-

cording to US GAAP standards, as well as

tance that technology plays in managing

decline rates and sustaining production

from our brownfields (fields which have

been under development for a period of

time) is critical. That’s why we are invest-

ing in better drilling technology, well work,

and reservoir management. Brownfield

production and reserves remain vital to our

future.

Managing and transforming a company as

large as ours, employing some 70 thousand

people and operating across six time

zones is challenging. Last year we contin-

ued to define and improve internal policies

and procedures which regulate how things

are done in our company. A code of busi-

ness policies was introduced across the or-

ganisation. Standards and policies for all

business streams and functions are now in

place and at work. The benefit of these

changes lies partly in delivering clarity of

expectation for all parts of our company,

and partly in common adherence to uniform

high standards of operation and behaviour.

We have some tough targets ahead of us.

Key elements include sustaining brownfield

production and developing new projects to

bring on our undeveloped production. In the

downstream we will continue to invest in the

capacity of our refineries and improve their

product yield and availability. We will expand

3


a standalone RAS basis as presented last

year. We believe this will help to better un-

derstand, evaluate, and analise results and

developments for the whole group of com-

panies within TBH.

From 2006 onwards TBH intends to hold

two general meetings per year to report on

our performance, to decide upon dividends,

and to discuss relevant issues.

We hope you will find TBH’s 2006 Annual

Report useful and interesting.

Robert Dudley

President and CEO of “TNK-BP Manage-

ment” — management company

of TNK-BP Holding


5

TBH is a leading Russian vertically inte-

grated oil and gas company. It is among the

top ten privately-owned oil companies in the

world in terms of crude production. The Com-

pany was formed in 2004–2005 through a

process of restructuring and accession of

TBH heritage companies TNK, Sidanco

and ONAKO and their respective sub-

sidiaries.

TBH has a diversified upstream and

downstream portfolio in Russia. The Сom-

pany’s upstream operations are located pri-

Moscow

VOLGA-URALS

WEST SIBERIA

NNG

Rospan

Samotlor

Uvat

RyazanRefinery

SaratovRefinery

NizhnevartovskRefinery

KrasnoleninskRefinery

Orenburg

Nyagan

VCNG

Core refining areas Project areas Core production areas

marily in West Siberia (Khanty-Mansiysk

and Yamalo-Nenets Districts, Tyumen Re-

gion) and Volga-Urals (Orenburg Region).

In 2006 the Company produced on aver-

age 1.5 million barrels of oil equivalent per

day.

The independent audit conducted by

DeGolyer and MacNaughton confirmed

that as of December 31st 2006, total

proved reserves of the Company were

7.810 billion barrels of oil equivalent on a

SEC (US Securities and Exchange Com-

mission) life-of-field basis; 8.949 billion bar-

rels of oil equivalent on a SPE (Society of

Petroleum Engineers) basis.

TBH owns four refineries with total ef-

fective capacity of 23 mln tonnes, located

in Ryazan (near Moscow), Saratov (Volga-

Urals), Nizhnevartovsk (West Siberia) and

Krasnoleninsk (West Siberia).

TBH operates a retail network of 1076 fill-

ing stations in Russia working under the

TNK brand. The Company is one of the key

suppliers to the Moscow retail market.

COMPANYPROFILE

TNK-BP’s principal strategic objective is to

become a world-class oil and gas group that

is an industry leader in Russia with a clear

focus on the sustainability and renewal of its

resources and the efficiency of its operations.

To achieve this goal, the Company is fo-

cusing on a number of key strategic priori-

ties, including:

Upstream. We aim to continue growing

combined oil and gas production and en-

hancing our operational efficiency over

time. We have also set ourselves the goal

of replacing 100% or more of current pro-

duction with new reserves to create a sus-

tainable basis for future output growth,

while also improving unit productivity met-

rics.

Downstream. We are seeking to en-

hance the flexibility and profitability of the

group’s downstream operations, principal-

ly through the continued development of

Corporate Governance and Other In-ternal Initiatives. We will continue to focus

on increasing transparency and performance

through improved corporate governance, or-

ganisational simplification, and enhanced

audit and financial reporting capabilities.

Health, Safety, and Environment. We

strive to ensure that our activities are con-

ducted with due regard for health, safety, and

the surrounding environment.

Finance.The Company’s financial strate-

gy is focused on contributing to the group’s

growth while maintaining a strong balance

sheet and enhancing financial flexibility.

sales channels for the group’s production

and higher margin products, enhancement

of the group’s refining capabilities, and tar-

geted growth of its retail businesses.

Gas. We plan to substantially enhance our

gas business as a proportion of our overall

upstream activities. We aim to achieve this

by exploiting the significant natural gas re-

sources in our portfolio and delivering gas

to the domestic and European markets (in

coordination with Gazprom and Russian

Federation policy).

Portfolio Management. We will manage

our portfolio of assets in line with the

achievement of our strategic goals and in do-

ing so may, among other things, acquire as-

sets that management believes will enhance

the value of company or divest assets that

are deemed to be non-core.

DEVELOPMENT STRATEGY

7


Oil prices(US$/bbl)

30

40

50

60

70

80

1

2

3

4

5

6

7

8

Jan. 05 Mar. 05 Apr. 05 Jul. 05 Sep. 05 Nov. 05 Jan. 06 Apr. 06 Jun. 06 Aug. 06 Oct. 06 Dec. 06

Average Spread:US$3.90/bbl

Average Brentprice grew by 19.5%

Operating environmentThe business environment for TNK-BP

Holding in 2006 was relatively stable, al-

though subject to certain risk factors that are

typical for the oil industry. These include

world crude and oil product price fluctua-

tions, exchange rates, cost inflation, and

global interest rate movements.

The most important global driver of the

Company’s business is the world oil price,

which reached an all-time high in 2006, but

also experienced significant fluctuations. The

first half of the year saw crude prices rise to

a high of almost US$75 per barrel. Howev-

er, the second half of the year saw a

marked change in sentiment, as global oil

demand slowed in reaction to higher prices,

and stock levels increased, reducing the risk

of near-term shortages. These factors com-

bined to cause a sharp decline in the Brent

strength of the oil price has helped the Russ-

ian economy to continue its recent growth

trend.

The trends in domestic oil, oil product, and

gas prices were also significant in 2006. Do-

mestic oil prices averaged US$30 per bar-

rel. In 2006, domestic refined product prices

offered higher netbacks than exports, re-

sulting in an increase in TBH refinery

throughput and higher product exports at the

expense of lower crude exports.

In the gas sector, government decisions on

gas pricing and ultimate liberalisation taken

during 2006 will have significant conse-

quences for the industry in the longer term.

oil price to below US$60 per barrel during

the second half of the year. In reaction to the

downward price trend of the second half of

2006, OPEC decided in November to cut

production by 1.2 million bpd, with a further

cut of 0.5 million bpd announced for Feb-

ruary 2007. These cuts demonstrated

OPEC’s concern about future prices given

that oil demand growth slowed to only 1%

in 2006 as a whole, while non-OPEC sup-

ply grew by 1.8% (of which half was ac-

counted for by the increase in former Sovi-

et Union supply).

In 2006 the average world oil price for the

year was a record high of US$65/bbl, which

is 19.5% higher than in 2005. The ongoing

HIGHLIGHTS

9


Brent–Urals SpreadDated BrentUrals


1110

The target for industrial prices is that they

should reach export netback parity by 2011.

This is encouraging for the development of

TBH’s gas business, though further regu-

latory and legislative work will be needed to

further reduce the risk factors for inde-

pendent producers such as TBH.

With average earnings also jumping by al-

most 25% to US$4,000 per capita during the

year, the main pressure within the economy

has been on inflation. For the first time in this

decade this was kept below 10% mainly

thanks to the appreciation of the rouble, which

strengthened by 9% against the dollar to

reach almost RUR26 per US $1 by the end

of the year. Nevertheless, sector specific cost

inflation remains a major economic risk

faced by TBH, and the industry generally.

However, while the Russian economy

continued to receive significant benefit from

higher oil pries, this was associated with a

higher tax take. Whist world oil prices in-

creased by 19.5% in 2006, export net-

backs rose by only 5%, mainly reflecting ris-

ing export duties, which account for over

90% of all additional revenues over US$25

per barrel. Growth in transport costs also in

has already started to respond, with month-

ly capex exceeding US$1 billion by the end

of 2006. Although the new tax incentives are

not immediately applicable to any produc-

tion subsidiaries of TBH, we see them as a

positive trend.

TBH affiliates and subsidiaries operate

across the Russian Federation and are

major economic contributor in many regions.

TBH aims to act as a good corporate citizen

in all areas were it operates, and in partic-

ular TBH continues to implement a broad

range of social programs, tailored for each

particular region, in order to support both its

employees and the local population.

part offset growth in revenues, accounting

for 9% of the benefit of higher oil prices.

A combination of the high tax burden and

the ongoing depletion of the more mature

brown fields in West Siberia meant that over-

all Russian oil production growth in 2006 was

relatively slow at just over 2%, although pro-

duction was also hindered by record low tem-

peratures in January and February. Lower

production growth has emphasised the

need for a new focus on greenfield rather

than brownfield development, and the state

has started to provide relevant fiscal incen-

tives to achieve this goal. In particular,

changes to the Unified Natural Resources

Production Tax (UNRPT) have reduced the

tax take on heavily depleted fields and tax

holidays for the development of new fields

in frontier areas such as East Siberia have

been introduced. The domestic oil industry

Russian Onshore Production:Moderate Growth(mbpd)

1.0

1.2

1.4

1.6

1.8

2.0

5

6

7

8

9

10

11.7%

1.8%

2003 2006

14.0%

8.9%

2004

12.9%

2.3%

2005

6.5% 1.2%

Rus

sia

TB

H

TBHRF without Sakhalin

Financial ReportingAs required by Russian legislation, TBH pre-

pares annual financial statements (“Statu-

tory Accounts”) in accordance with Russian

Accounting Standards (RAS). These are

available on our website and are subject to

shareholder approval at the Annual Gener-

al Shareholders Meeting.

In addition, consolidated financial state-

ments (“Consolidated Accounts”) have

been prepared for the TBH group of com-

panies for the first time in respect of 2006.

These have been prepared in accordance

with US Generally Accepted Accounting Prin-

ciples (US GAAP), in line with the current re-

porting policy of the TNK-BP Group.

The purpose of the Consolidated Ac-

counts is to present the financial position and

results of operations of the TBH company to-

gether with its subsidiaries and equity affil-

iates as that of a single economic entity. In

this respect, the Consolidated Accounts dif-

fer fundamentally from the Statutory Ac-

counts.

A list of subsidiaries and equity affiliates of

TBH with their respective shareholding is

provided in the Statutory Accounts.

Other major differences between the Con-

solidated Accounts and the Statutory Ac-

counts arise from differences in accounting

policy under US GAAP compared to RAS

and relate to:

• reporting and functional currency — the

Consolidated Accounts are presented in

US dollars, the functional currency of TBH

group of companies under US GAAP;

• differences in respect of accounting treat-

ment of provisions for assets retirement ob-

ligations and environmental liabilities;

• deferred tax accounting;

• elimination of the effects of intercompany

transactions;

• accounting for minority interests.

13


duction of a cleaner diesel fuel and a new

brand of gasoline (BP Ultimate).

TBH’s second largest refinery at Saratov

accounted for approximately 26% of TBH’s

oil refining operations in 2006 with an ef-

fective capacity of 6.0 million tonnes and

crude oil throughput of 5.9 million tonnes. Fol-

lowing a successful launch of a visbreaking

unit in 2004, further investment projects, po-

tentially including new technological units, are

currently being considered. The Company’s

two smallest refineries, at Nizhnevartovsk

and Krasnoleninsk, commenced operations

in late 1998 with a combined capacity of

1.6 million tonnes. Both extract light fractions

such as straight-run gasoline, gas oil, and

kerosene, and processed a combined total

of 1.55 million tones during 2006.

The Company markets its refined fuel

products in 20 large regions in Russia

(mainly the Northern, Central, and Urals fed-

eral regions) and is a market leader in each

of the regions in which it operates. As of

31 December 2006, TBH’s retail network in-

cluded 1,076 filling stations, 516 of which are

owned and operated by TBH’s marketing

subsidiaries, and the remainder of which are

operated by independent owners through job-

ber arrangements. In 2006, TBH sold more

than 1.3 million tonnes of refined fuel prod-

ucts through the network, representing ap-

proximately 20% of TBH’s total gasoline and

diesel output. TBH operates and markets un-

der the TNK brand. The Company controls

an approximate 30% share (in terms of vol-

ume) of the Moscow and Moscow region re-

tail market, the largest Russian regions in

terms of consumption.

line and most of the diesel fuel TBH produces

is sold by regional marketing subsidiaries us-

ing their retail networks (including jobbers)

and through the small wholesale market.

Other TBH refined products are primarily sold

directly to large wholesale customers.

TBH owns four refineries in Russia in the

cities of Ryazan, Nizhnevartovsk, Kras-

noleninsk, and Saratov. Together, these four

refineries have an effective capacity of ap-

proximately 23.0 million tonnes of crude oil

per year and in 2006 they refined 22.5 mil-

lion tonnes of crude oil, representing an ef-

fective average utilisation rate of 98%. TBH’s

refineries produce a variety of refined prod-

ucts, including gasoline, diesel fuel (gas oil),

jet fuel (kerosene), fuel oil (mazut), lubricants,

and bitumen.

The Ryazan refinery is TBH’s largest re-

finery and one of the largest in Russia. It ac-

counted for over a half of TBH’s oil refining

in 2006, and represented approximately

7% of the total crude oil processed at all

Russian refineries in 2006. During the year

the refinery had an effective capacity of 15.5

million tonnes and saw crude oil and other

feedstock throughput of 15.1 million tonnes.

TBH has also undertaken a comprehensive

investment programme aimed at the mod-

ernisation of the refinery which began in 2000

and was completed at the end of 2006 at a

total cost of US$631 million, which allowed

us to produce more high value petroleum

products and in particular to launch pro-

2006 TBH also initiated the acquisition of Oc-

cidental Petroleum’s fifty per cent equity stake

in the West Siberian joint venture Vanyo-

ganneft. This deal was successfully closed

in January 2007. TBH now owns100% of the

equity in the Vanyoganneft asset.

In the gas sector TBH continued its natu-

ral and associated gas production in the Ya-

mal-Nenets Autonomous District (Western

Siberia) through its Rospan subsidiary and

its key oil producing areas of Nizhnevartovsk

(Western Siberia) and Orenburg (Volga-

Urals). However, despite the sharp growth in

gas output during 2006, production of 9 bcm

only accounted for 8% of the Company’s to-

tal hydrocarbon output. The majority of the

Company’s gas production is sold, although

a portion is used to generate power for the

Company’s own operations. The output po-

tential of these regions has been enhanced

by the formation of a joint venture with Sibur

Holding in November 2006. The JV’s goal is

to increase associated gas sales and reduce

flaring in both regions.

TBH’s downstream business has three prin-

cipal areas of activity; Supply, Trading, and

Logistics; Refining; and Marketing. In 2006,

the Company exported 42.9 million tonnes

of crude oil (to Europe and the CIS), which

was the equivalent of 51% of its total sales

in volume terms over the year. The vast ma-

jority of this was transported in Transneft’s

pipeline system, with only 7% exported by

rail.

TBH also exported 20.0 million tonnes of

refined products in 2006, the equivalent of

24% of its total sales in volume terms over

the year. Domestically, TBH sells its products

through different distribution channels. Gaso-

Operating HighlightsTBH is the third largest vertically-integrated

oil company in Russia, accounting for 15%

of the country’s hydrocarbons production.

In 2006 our liquids output increased by 1%,

adjusted for disposals, to reach 74 million

tonnes (mt). Reflecting stronger growth in gas

production, TBH’s overall output of oil and gas

rose by 3% to 620 million barrels of oil equiv-

alent (mmboe) for the year.

Lower growth in 2006 (when compared with

the previous 3 years) reflects the fact that

TBH is in a transition period during which de-

clines in output at depleted brownfield assets

will increasingly be offset by growth in pro-

duction at new greenfield projects that will

boost longer-term growth. The severe winter

of 2006 also hampered production as it re-

sulted in forced shut downs in January and

February.

At the end of 2006 total proved reserves un-

der SEC methodology (on a life of field ba-

sis) were 7.810 billion barrels of oil equiva-

lent, implying that TBH replaced 129% of its

production during the year. Under SPE

methodology, total proved reserves were

8.949 billion barrels of oil equivalent, repre-

senting a 156% reserve replacement ratio.

Both SEC and SPE figures are calculated af-

ter adjustment for divestments.

Audited reserve figures included gas re-

serves for the first time in 2006 reflecting

TBH’s track record of gas sales backed by

contractual gas sales commitments.

During the year the Company continued to

optimise its asset portfolio, with the largest

transaction occurring in the summer, when

we disposed of our Udmurtneft assets. In ad-

dition the Company and its subsidiaries also

acquired 25 new exploration and production

licences, while the two Samotlor licences

were extended for 25 years to 2038. Late in

12

Building organisational capability is a key

part of our long-term business strategy. Over

the past three years we have been very suc-

cessful in identifying and using the skill sets

of personnel to deliver growth from our ma-

ture fields (the brownfield strategy), and we

are now focused on ensuring that we are

equally well-equipped with the right set of

skills for the development of greenfield

projects and our gas business in order to se-

cure the Company’s long-term future.

At the end of 2006 TBH and all its sub-

sidiaries employed approximately 70 thou-

sand people, and the Company is commit-

ted to the optimal and appropriate devel-

opment of all staff. As part of this process we

undertook a company-wide skills inventory

in 2006. As a result of this review we now

have processes in place to develop the ad-

ditional capabilities needed to deliver the

Company’s strategic objectives.

Our training system brings together cor-

porate programs for developing and en-

hancing technical and functional skills, lead-

ership, and the implementation of new busi-

ness processes. The Company is working

closely with leading universities and institutes

in Russia to develop the next generation of

professionals with the skills required for the

modern oil and gas industry.

Providing employees with a safe and

healthy working environment is also of

paramount importance for the Company. All

employees have received new, internation-

al standard personal protective equipment

(PPE) where necessary and many are un-

dergoing training on workplace safety to im-

prove safety performance. Additional in-

vestment has been made to begin the up-

grading of employee accommodation at

sights such as crew trailers and eating fa-

cilities.

The Company has also introduced a se-

ries of tools to motivate and encourage its

employees. Performance contracts have

been introduced company-wide and all em-

ployees now have annual targets or key per-

formance indicators (KPIs). An employee’s

performance is measured against their KPI

annually with each employee having the op-

portunity to participate in the Company’s suc-

cess by receiving a performance-based

bonus which contains a personal, team, and

company component. This also ensures that

individual and team goals are aligned with

the Company’s strategy.

An annual labour market salary review is

conducted every year to ensure that em-

ployee remuneration continues to be com-

petitive and will attract high caliber, experi-

enced professionals. Quarterly summary re-

views are also conducted due to the rapid-

ly changing employment market in Russia.

Employee benefits are also under contin-

uous review and are benchmarked against

other leading companies in our operating re-

gions. As a result these benefits are currently

being extended in several key areas.

PEOPLE

15


TBH recognises its responsibility as a ma-

jor investor and tax payer in Russia and is

committed to conducting its business in a so-

cially responsible manner, in particular in a

number of regions and towns where our sub-

sidiaries are the single major employers. Our

prime responsibility as a company is to cre-

ate a safe and secure workplace for our em-

ployees, enabling them to take good care of

their families.

Approximately 40% of our total social in-

vestment is targeted at the employees of the

Company, and the other 60% is spent in the

broader interests of the local communities.

The selection of social investment projects

is guided by the following principles:

• harmonisation of business and community

interests;

• delivering social programs commensurate

with the scale and scope of our business

activity;

• responding to the individual needs of

each particular region as part of a single

strategy;

• preference for long-term programs rather

than one-off charity projects;

• political neutrality.

Education. Sponsoring the Moscow

School of Management Skolkovo which

will become a major Russian center for the

teaching of MBA programs (US$2 million).

Culture. Preserving St. Petersburg’s cul-

tural heritage: financing the restoration of his-

torical buildings through the St. Petersburg

Development Fund (US$9 million).

In addition, the Company implemented

separate social programs and projects in key

regions where it operates. In most cases,

these activities were part of special agree-

ments with regional administrations and in-

cluded the renovation and building of hun-

dreds of kilometres of roads, bridges, and

electric power lines.

Our social investment spending in 2006 to-

taled US$180 million (an increase of

US$10 million on the previous year)

Some examples of investments in 2006 in-

clude:Helping the vulnerable. The acquisition

and construction of housing for socially dis-

advantaged families, together with the

Sodeistvie Foundation (US$30 million).

Health. Financing a comprehensive Rus-

sia-wide program to help the prevention and

treatment of hepatitis and HIV. This invest-

ment provided medicines for children as well

as in-patient treatment and outreach activ-

ities. In addition, the Company also sup-

ported under-financed regional medical in-

stitutions through the Children’s Aid Foun-

dation (US$8.5 million).

CORPORATE SOCIAL RESPONSIBILITY

17


TBH continuously strives to ensure that all

its activities are conducted with due regard

for health, safety and the surrounding en-

vironment. In addition to complying with all

the environmental laws and regulations

that cover its products, operations, and ac-

tivities, the Company has introduced its own

Health, Safety and Environmental Policy (the

“HSE Policy”). This targets a gradual ad-

vance in standards towards best-in-class lev-

els and an ultimate goal of no accidents, no

harm to people, and no damage to the en-

vironment. As such our HSE Policy provides

the strategic framework for our business to

conduct its operations in accordance with in-

ternational standards of environmental pro-

tection and to monitor compliance with

these principles.

During 2006 the Company took major

steps towards achieving this goal. On the en-

vironmental front, TBH has focused on

three main areas: land remediation, pipeline

integrity, and utilisation of associated gas.

The Company’s goal is to remediate all pol-

luted land. Significant progress has been

made towards this objective. A budget of

US$1.7 billion over 5 years has been allo-

cated to improving pipeline integrity, and

by the end of 2006, US$200 million of this

had been spent on pipe replacement and

anti-corrosion work. During the past three

years over 1,400 km of pipeline was re-

placed and a further 6,500 km were treat-

ed with chemicals designed to inhibit cor-

rosion that could cause further damage. As

a result, there has been a 27% decrease in

the number of leaks against 2005, an 11%

fall in the number of spills and a 25% decline

in the number of spills exceeding 1 barrel.

A further 4,500 km of pipeline is expected

to be replaced by 2011. The Company in-

tends to have applied corrosion-inhibition

treatment to over 10,000 km of its 28,000 km

system by 2010.

The establishment of a joint venture with

Sibur to process associated gas in the

Nizhnevartovsk region will allow TBH not only

to reduce its emissions from flaring but also

to monetise its gas output, and will provide

a model for associated gas utilisation proj-

ects in other regions where the Company op-

erates.

The safety of employees and contractors

has been of paramount importance to man-

agement since the Company’s inception.

Procedures and equipment have been up-

dated, a more pro-active corporate culture

towards HSE has been promoted and sen-

ior management aims to lead by example.

The benefits of this have continued to be

seen during 2006. Injury rates have contin-

ued to decline in both absolute numbers

(by 5% compared to 2005) and in terms of

frequency rates. Indeed the lost time injury

rate per 200,000 man-hours has fallen by

22% since 2004. A particular focus has been

placed on transportation safety, which was

identified as one of the high risk areas. Over

the past 2 years, for example, nearly 19,000

new seatbelts have been installed in com-

pany vehicles, defensive driving training has

been provided for more than 11,000 drivers

and more than 200 drivers have been

trained in winter driving skills. As a result, in

2006 road traffic fatalities fell by 45% and the

number of serious traffic accidents de-

creased by 22%, demonstrating a clear im-

provement driven by the Company’s active

policies in this area.

TBH has also been keen to promote im-

proved health amongst its employees, and

has adopted a new 5-year healthcare pro-

gramme. At the initial stage of this a pilot

project was undertaken at Orenburgneft in

2006 to create an organised medical serv-

ice with re-equipped first aid posts, new am-

bulances and extra training for medical as-

sistants. As a result illness frequency rate

among staff fell by 34% in 2006. In addition

the Orenburg health programme won an

award from the Russian Ministry of Health-

care for the most innovative solution to work

safety in Russia.

However, TBH’s commitment to all aspects

of its HSE policy starts at the top of the Com-

pany. Company leaders at a corporate and

regional level are mandated to be deeply in-

volved in HSE activities across the corpo-

ration, and frequently lead safety audits and

carry out site visits. Improved reporting of

safety incidents is also being encouraged in

order to provide the increased transparen-

cy essential to enable management and em-

ployees to improve HSE performance in all

areas.

HEALTH, SAFETY,AND ENVIRONMENT

19


Corporate GovernancePrinciplesThe Company recognises the importance of

good corporate governance in building a

world-class Russian company and over

time achieving a level of performance com-

parable to that of our international peers.

As a result corporate governance is viewed

as a key driver for improving our perform-

ance and investor attractiveness, strength-

ening our business reputation, increasing

Company value and ultimately resulting in

improved financial returns for all of our share-

holders.

The Company’s corporate governance

system is based on the following principles:

• recognition and protection of all share-

holders’ interests and rights

• accountability of the management to

Company’s shareholders

• timely and reliable disclosure of informa-

tion concerning all aspects of the Com-

pany’s activities relating to its performance,

risks, and financial condition

• recognition by the Company of the rights

and interests of other stakeholders besides

shareholders and observance of these

rights based on the principles of fair and

responsible mutual relations.

lished a Management Board and a number

of committees to oversee the implementa-

tion of TNK-BP Management’s responsibil-

ities. There are nine such Committees cov-

ering all aspects of Company’s business, in-

cluding operations, finance, policies, human

resources, and IT. Membership of each com-

mittee is carefully selected to ensure ap-

propriate expert representation from TNK-

BP’s business streams and supporting

functions.

The Board of Directors of TBHTBH has over 15,000 shareholders. The

Board of Directors of TBH consists of nine

directors, each of whom is elected by the

general shareholders meeting. The Board of

Directors is empowered to take decisions on

a wide range of issues including the Com-

pany’s financial reporting, asset acquisi-

tions/disposals, company shareholdings in

other entities and other issues. The full list

of the authority of the TBH Board of Direc-

tors is set out in the TBH charter, a copy of

which is available on the TNK-BP website at

http://www.tnk-bp.ru/investors/disclosure/

TNK-BP ManagementDay-to-day management of the TBH is car-

ried out by the managing company, TNK-BP

Management, which has been granted the

authority of being the sole executive body

of TBH.

The TBH executive leadership, in the form

of TNK-BP Management, is a team of pro-

fessional managers with a track record of

working in more than 50 countries world-

wide. TNK-BP Management has estab-

CORPORATE GOVERNANCE

21


22 23


TNK-BP Holding Board of DirectorsPursuant to the requirements of Federal Law

“On Joint-Stock Companies” and the TBH

Charter, the Board of Directors is elected for

one year.

The Annual General Shareholders’ Meet-

ing of TNK-BP Holding held on 28 June

2006, elected a new Board of Directors. Sev-

en of the previous Board members were re-

elected: I. Maidannik, A. Gorshkov, D. Pilch-

er, K. Sliger, P. Henshaw, B. Kondrashov,

D. Campbell.

New elections to the Board of Directors

were R. M. Bezrukov and R. Herbert.

Igor MaidannikChairman of the Board of Directors

since 2005

JSC “TNK-BP Management’s” executive

vice president, Legal, and member of its

Management Board since 2003. In 2003,

Mr. Maidannik was the head of JSC “TNK-

BP Management’s” Legal Function and

member of the OJSC “Tyumen Oil Compa-

ny’s” Management Board. He held the post

of Director of JSC “Tyumen Oil Company's”

Legal Department between 1998 and 2003.

Between 2003 and 2005, Maidannik was a

member of OJSC “Tyumen Oil Compa-

ny's” Board of Directors, and in 2002–2003

he was on the OJSC “Orenburgneft” Board

of Directors.

Roman BezrukovMember of the Board of Directors

since 2006

JSC “TNK-BP Management’s” vice pres-

ident, Mergers and Acquisitions Legal Sup-

port, since 2004. Member of the Board of Di-

rectors of OJSC “Tyumen Oil Company” be-

tween 2004 and 2005. Director of JSC

“TNK-BP Management’s” International Le-

gal Department between 2003 and 2004.

Head of OJSC “Tyumen Oil Company’s”

Corporate Law Department between 1998

and 2003.

David CampbellMember of the Board of Directors

since 2005.

Leader of JSC “TNK-BP Management's”

Vostok Business Unit since 2005. Since

2005 — member of the Boards of Directors

of OJSC “Saratov Oil Refinery” and

JSC “Orenbourggeologia”. Member of the

JSC “Orenburgneft” Board of Directors

since 2003. Member of the Boards of Di-

rectors of OJSC “Saratovneftegaz” and

OJSC "ONACO” between 2005 and 2006,

in 2004 through 2005 — chairman of the

Board of Directors of OJSC “Udmurt Oil

Company”. Chairman of the OJSC “Ud-

murtneft” Board of Directors between 2004

and 2006, between 2003 and 2005 —

Chairman of the Board of Directors of JSC

"Saratovneftegaz". From 2003 through

2005 — leader of JSC ”TNK-BP Manage-

ment’s” Udmurtia business unit. From 2001

through 2003 — leader of BP’s Fortis/Mon-

trose/Arbrout production unit, Scotland.

Peter HenshawMember of the Board of Directors

since 2005.


ident, Communications and Public Affairs

since 2003, member of the Board of Direc-

tors of JSC “TNK-BP Management” since

2004. Member of the Board of Directors of

JSC “Media-Holding “Western Siberia”

since 2006. Director of BP Trading, Moscow,

for External Relations in 2000 through

2003.

Richard HerbertMember of the Board of Directors

since 2006.


vice president, Technology, since 2006,

JSC “TNK-BP Management’s” vice presi-

dent, Exploration, between 2003 and 2006.

Chairman of the Boards of Directors of

OJSC “Uvatneft” and JSC “Radonezh Pe-

troleum” and member of the Boards of Di-

rectors of the Joint Stock Company “Gu-

bernatorial Resources Company” and JSC

"Orenburgneft" since 2006. Since 2005 —

Chairman of the Boards of Directors of

OJSC “Suzun”, OJSC "Russko-Rechen-

skoye", OJSC “Payakha” and “Tagulskoe”

LLC. Chairman of the Boards of Directors of

JSC “Vareganneftegaz” and LLC “TNK-Uvat”,

and member of the JSC “Orenbourggeolo-

gia” Board of Directors since 2004. Member

of the Board of Directors of OJSC “Tyumen

Oil Company” between 2003 and 2005.

Head of the Wytch Farm production unit, BP,

Aberdeen, between 2001 and 2003.

Alexander Gorshkov Member of the Board of Directors

since 2005.


ident, Russian Government Relations, since

2003. Acting head of JSC “TNK-BP Man-

agement's” Business Support Function in

2003. Member of the OJSC “Sidanco‘s”

Board of Directors between 2004 and 2005,

Chairman of the OJSC “Uvatneft” Board of

Directors and member of the Board of JSC

“Radonezh Petroleum” between 2003 and

2006. From 2002 untill 2003 — Project Man-

ager, Geology and Oil and Gas Production,

OJSC “Tyumen Oil Company”; from 2001

through 2002 director, Government Relations

Department, OJSC “Tyumen Oil Company”.


2524

Boris Kondrashov Member of the Board of Directors

since 2005.


vice president, Security, and member of the

Management Board of JSC “TNK-BP Man-

agement” since 2003. Member of the Board

of Directors of OJSC “Tyumen Oil Compa-

ny” and OJSC “Sidanco” between 2003 and

2004. Head of JSC “TNK-BP Manage-

ment’s” Security Function in 2003, member

of the Management Board of JSC “TNK-BP

Management” between 2002 and 2003.

Head of the Security Function, first vice pres-

ident and member of the Management

Board of OJSC “Tyumen Oil Company”, and

member of the JSC "Orenburgneft" Board

of Directors, from 2000 through 2003

Ownership of TNK-BP Holding shares by Members of the Board of DirectorsI. Maidannik, A. Gorshkov, D. Pilcher, K. Sliger, P. Henshaw, B. Kondrashov, D. Campbell and R. Herbert hold

no shares in the Company.

R. Bezrukov holds three ordinary shares (0.0000000184% of the charter capital).

David PilcherMember of the Board of Directors

since 2005.


ident, International Law, from 2003 untill

2007. Member of the Boards of Directors of

OJSC “Chernogorneft”, OJSC "TNK-Nizh-

nevartovsk" and JSC “Vareganneftegaz”

since 2006. Member of the Boards of Di-

rectors of “Nizhnevartovskoe Nefteper-

erabatyvayuschee Obyedinenie” LLC, the

Limited Liability Company “Zapsib-

nefteprodukt”, JSC “Promkataliz”, OJSC

“TD “TNK” MiP” and “ROR” Inc., and

chairman of the JSC “IRCOL” Board of Di-

rectors since 2005. Member of the Boards

of Directors of JSC “ONOS” and “CJSC

Syracuse” from 2005 untill 2006. Member of

the Board of Directors of OJSC “Tyumen Oil

Company” in 2005. Member of the JSC

“TNK-BP Management’s” Board of Directors

since 2004. Senior legal adviser of “ВР Ex-

ploration Limited” in 1999 through 2003.

Kris SligerMember of the Board of Directors

since 2005.


vice president, Strategy and New Busi-

ness Development, since 2003. Member of

the Management Board of JSC “TNK-BP

Management” since 2004. Member of the

JSC "Orenbourggeologia’s" Board of Di-

rectors since 2004. Member of the Boards

of Directors of OJSC “Tyumen Oil Compa-

ny” and OJSC “Sidanco” between 2003 and

2005. Between 2003 and 2004, Kris Sliger

was member of the JSC “TNK-BP Man-

agement” Board of Directors. From 2000

through 2003, he was BP’s vice president

for Planning, Strategy and Portfolio Invest-

ment.

Management Board of TNK-ВР Management

German Khan, executive director

Robert Dudley, President and chairman

of the Management Board

James Owen, chief financial officer

Victor Vekselberg, executive director, Gas Business Development

Tim Summers, chief operating officer


2726

Igor Maidannik, executive vice president, legal support

Sergey Brezitsky, executive vice president, Upsteam

Thomas Wright, executive vice president, Planning

and Performance Management

Anthony Considine, executive vice president, Downstream

Mikhail Osipov, executive vice president, Oilfield Services

Richard Gerbert, executive vice president, Technology

Kris Sliger, executive vice president, Strategy and New Business Development

Boris Kondrashov, executive vice president, Security

Simon Bennett, executive vice president, Support Services

Corporate Committees of TNK-BP Management for 2006

Corporate Committees

Policies and Compliance Committee The committee coordinates adoption and implementation of internal documents, reviews key documents pertaining to business ethics, ensures operation of the enterprise wide risk management system (EWRM)and the internal control system.

HR Committee The committee’s role is to develop and ensure implementation of HR policy and programs in the Company.

Contracting Policy Committee The role of this committee is to ensure efficient contracting processes in the Company. The committeeis also responsible for approval of policies, standards and process regulations in this field as well as control over their implementation.

New Business Development Committee The committee reviews various new business development initiatives and projects. It monitors the progress of new business development initiatives and the Company’s competitive position.

Operations Committee The role of the committee is to review key cross-stream and cross-functional issues pertaining to development and implementation of the business-plan. The committee also manages and ensures implementation of large-scale operational projects.

Investment Committee The committee reviews and approves all major new investment proposals and monitors large-scaleinvestment programs.

Internal Finance Committee The Committee is responsible for developing strategy and key principles of internal financing in the Company. In this regard, the Committee approves all internal financing, including financing of joint ventures.

Credit Committee The role of the Committee is to set, review and approve credit limits for contractors, analyse actual utilisation of such credit limits, and monitor accounts receivable and bad debts.

IT Committee The Committee’s role is to set IT standarts and manage major IT projects of the Company.

Corporate SecretaryThe key role of the Corporate Secretary De-

partment is to provide support to the decision

making process within TNK-BP and to ensure

that all corporate actions are compliant with

civil and corporate legislation and serve the

interests of all Company shareholders.

The functions of the Department include

organisational and legal support for share-

holder meetings and the Board of Directors,

responding to shareholders’ requests, and

legal and analytical support for the Com-

pany’s top management, including the

Boards of Directors of TBH and TNK-BP

Management.

Authorised CapitalAs of 31 December 2006 the authorised

share capital of TBH amounted to

RUR 16,296,807,136, divided into

15,846,807,136 registered ordinary shares

with a nominal value of RUR 1.00 each and

450,000,000 registered preferred shares with

a nominal value of RUR 1.00.

Structure of AuthorisedCapitalThe total number of persons listed in the TBH

Register of Shareholders as at 31 Decem-

ber 2006 was 14,891 including 16 nominal

shareholders.

Share MarketIn early December 2005 the shares of TBH

were included in the RTS Board under the

code TNBPP. The RTS Board is a data sys-

tem for the indicative quotation of securities

(shares and bonds) not listed on the Russ-

ian Trade System Stock Exchange.

Percentage of Share in ordinary shares the Capital

Novy Investments Ltd 91.3% 89.7%

Minority shareholders 3.3% 5.1%

TNK-BP Holding’s subsidiaries (CJSC Sidanco- 5.4% 5.2%Investments, CJSC Sidanko-Securities, CJSC Sidanko-Neftepererabotka, LLC Finex M)

• guarantee agreements before third parties

to assure obligations of the subsidiaries;

• miscellaneous contracts where parties to

the contracts are the Company and the

subsidiaries.

The overwhelming majority of these agree-

ments are executed within the normal

course of business. The Company em-

ploys a rigorous process, including review

by various committees, to ensure that all re-

lated parties transactions are carried out in

accordance with the law and on market

terms.

Related Parties TransactionInformation*TBH is a vertically integrated oil and gas

company. As such, the business covers all

aspects from oil and gas exploration, de-

velopment, production, transportation, re-

fining, and sales to the final consumers. This

activity requires the Company to legally in-

teract with its subsidiaries which specialise

in each step of the value chain. This inter-

action is regulated through many different

contracts which, in accordance with the ap-

plicable legislation, are recognised to be re-

lated parties’ transactions. There is a spe-

cial approval procedure for the said trans-

actions prescribed by the law.

It is possible to categorise these related

parties’ transactions as follows:

• purchases of crude oil from the sub-

sidiaries;

• crude oil refining at the company refiner-

ies and oil products sales to the sub-

sidiaries;

• services agreements between the Com-

pany and the subsidiaries;

• company funding of the subsidiaries (by

means of loans with a time limit set at a

market interest rate, capital injection);

• procurement system implementation for

the subsidiaries (to assure procurement

single-sourcing);

• centralised services provision by third

parties to the subsidiaries (agency agree-

ments between the Company and the sub-

sidiaries to arrange services by a single

service-provider);

• intra-group transfer of long-term financial

investments (transfer of shares in sub-

sidiaries to optimise the Holding’s corpo-

rate structure and settlement procedure

with the use of securities);

• licence agreements with the subsidiaries

for the trademark use rights;

Bond Placement Maturity Nominal Coupon interest Number of Number of issue date date value placed bonds repaid bonds

1 09.12.2005 28.11.2006 1,000 roubles 15%, semiannual 3,000,000 3,000,000

Dividend per share, Total dividends, Dividend payment Total dividends paidroubles million roubles completion deadline as of 31.12.2006,

million roubles

2005 dividends*

on ordinary shares 8.06 127,725 31.12.2006

on preference shares 8.06 3,627 31.12.2006

Total 131,352 124,781

First 9 months of 2006 dividends**

on ordinary shares 5.95 94,288 15.05.2007

on preference shares 5.95 2,678 15.05.2007

Total 96,966 48,167

* According to the General Shareholders Meeting's decision of 28 June 2006.** According to the General Shareholders Meeting's decision of 15 November 2006.

28 29


DividendsIn light of the Company’s successful per-

formance during the year, in June and No-

vember 2006 decisions were made to pay

a full year dividend for 2005 and an interim

dividend for the first nine months of 2006,

respectively.

Rouble-denominated BondsIn 2005, TBH issued 3 billion roubles in non-

convertible, documentary, bearer, fixed-in-

terest, “K Series” coupon bonds (State

Registration No. 4-01-55034-E of October 20,

2005). In all, 3 million bonds were placed as

a result of the conversion of TNK’s fifth issue

of documentary, bearer, fixed-interest, “K Se-

ries” coupon bonds (State Registration

No. 4-05-00168-A of November 6, 2001).

TBH’s bonds have been traded on the

Moscow Interbank Currency Exchange

(MICEX) since 22 February 2006 as non-list-

ed securities allowed for trading on MICEX.

TBH bonds were repaid in accordance with

the bond issuance decision and securities

issue prospectus on 29 November 2006.

The Company has no new rouble bond is-

suance plans at present.

Information DisclosureThe Company’s information policy is

designed to ensure easy access to infor-

mation concerning our operations for

shareholders and other stakeholders. The

fundamental principles of the Company’s

information policy are to ensure strict

compliance with the Russian Federation

legislation on information disclosure and

to disclose all material historical informa-

tion about the Company.

The Company employs a variety of in-

formation disclosure channels. In line

with Russian legislation, the Company pro-

vides information and materials in re-

sponse to shareholders’ requests, disclos-

es information in the Russian and foreign

media, presents at conferences and other

public events, issues press releases, and an-

swers to written requests from stakeholders.

The Company’s website http://www.tnk-bp.ru

is one of the least costly and most accessi-

ble means of information disclosure for the

majority of shareholders and other stake-

holders. It offers accurate and regularly up-

dated information about the financial and non-

financial results of TBH, its corporate gover-

nance practices and development strategy,

social responsibility, HSE issues, and other

material information.

* More detailed information about the related parties’ transactions approved by TNK-BP Holding’sBoard of Directors in the year 2006 is enclosed in the AGM materials pack.

INTERNAL CONTROL

Since its inception, TBH’s management

and shareholders have been committed to

ensuring that the Company is run according

to international best practice across the or-

ganisation. A key element in this process is

the maintenance of a system of internal con-

trol that establishes and monitors procedures

concerning our business activities. Accord-

ingly, the Company has continued to actively

develop the internal control system. The

Company has also introduced a Code of

Business, Ethics, which we believe to be es-

sential to achieve long-term business effi-

ciency, success, and sustainability. This is

also consistent with the obligations under-

taken by the Company in signing the World

Economic Forum’s “Partnering Against Cor-

ruption Initiative”.

Our business principles not only govern re-

lationships with third parties, but also help

improve the efficiency of the working prac-

tices within the Company. In particular,

TBH aims to manage its financial affairs to

the highest professional standards of probity

and transparency, as well as in accordance

with the law. To achieve this, the Company

has established clear procedures for setting

and monitoring plans and targets.

TBH has a clear goal to comply with the

Russian and international anti-corruption leg-

islation as well as the Company’s own anti-

corruption rules.

While it is vital to set out the Company’s

goals and standards in the sphere of busi-

ness ethics, it is equally important to ensure

that any targets are fully understood by and

shared with all employees. As such, an ex-

tensive training programme has been initi-

ated, with 1,000 senior managers having al-

ready taken part in workshops across the or-

ganisation. New employees now receive

contracts with specific requirements on

ethical behaviour and all induction courses

include ethics training.

By establishing clear principles and stan-

dards of business ethics and the methods

for monitoring activity, against these, TBH is

commited to operating in accordance with

international best practice thereby providing

increased security for shareholders, man-

agement, and employees alike.

31


TBH now owns 100% of the equity in the

Vanyoganneft asset. The Company also

continued to dispose of non-core assets by

spinning off its oilfield services division into

a separate company, thus reducing overall

company manpower by 19% and reducing

the cost base considerably.

LicencesAs of 31 December 2006, TNK-BP Holding’s

subsidiaries held a total of 180 licences,

comprising 130 production licences, 45 com-

bined exploration and production licences

and five exploration licences. While none of

the Company’s major licences will, under

their original terms, expire prior to 2013, we

have already established a programme to

actively manage the process of licence re-

newal whenever expiry does occur. This pro-

gramme includes a review of existing licence

terms to help ensure that we are in compli-

ance with those terms, and as part of this

process in 2006 two key licences regulating

production from the Samotlor oil field were

extended until 2038.

This extension was significant because the

Samotlor field accounted for 50% of the

Company’s SEC-Life-of-Field proved re-

serves as of 31 December 2006, and ap-

proximately 40% of production in 2006. We

remain confident that all of the remaining li-

cences that we intend to retain will be re-

newed upon expiration in the same way.

reserves and ensure the development of

probable reserves. Indeed, the implemen-

tation of initiatives such as water flood man-

agement, electric submersible pump (“ESP”)

optimisation, idle well recovery, and recom-

pletion and hydraulic fracturing is already en-

abling us to increase potential output from

mature fields. We are also aiming to improve

efficiency and maintain low lifting costs

through initiatives which include accessing

the lower-cost wholesale electricity market

for certain of our energy needs, improving our

in-house drilling capacity and efficiency,

developing our supply chain procurement

strategy, and leveraging our purchasing

power through the implementation of long-

term tendering programmes. In the medium

and longer-terms, we also plan to implement

development techniques utilised successfully

by BP with respect to our major greenfield

projects and to improve the Company’s re-

serve recovery capabilities of mature fields.

TBH is also improving performance by op-

timising its asset portfolio, both through ac-

quisitions and disposals. 2006 saw the sale

of Udmurtneft, but during the year the Com-

pany also purchased numerous exploration

and development licences in federal auctions

as it aims to upgrade its overall asset base

and provide a stronger foundation for long-

term growth. Late in 2006 TBH also initiat-

ed the acquisition of Occidental Petroleum’s

fifty per cent equity stake in the West Siber-

ian joint venture Vanyoganneft, and in Jan-

uary 2007 the deal was successfully closed.

Performance and StrategyOverviewTNK-BP Holding’s oil and condensate pro-

duction grew by approximately 1% in 2006,

compared to 2005 (adjusted for assets dis-

posals) and reached 74 mt (1.5 mbpd). We

expect that production will be broadly flat

through to 2009, but will grow thereafter due

to the development of a number of greenfield

projects. The Company continues to focus on

efficient growth of production volumes at our

mature (brownfield) oil fields located large-

ly in Western Siberia. At the same time, we

also plan to expand our development and ex-

ploration programmes both in new reservoirs

associated with existing fields, which we be-

lieve can be converted into production at rel-

atively low cost, and at greenfield projects,

which can provide longer term output growth.

These include projects such as the Uvat and

Bolshekhetsky fields in West Siberia, Verkhne-

chonskoe field in Eastern Siberia, and Ka-

mennoye in Nyagan. The Company will

also seek to carefully monitor opportunities

to develop undeveloped fields and other ar-

eas where licences have yet to be allocat-

ed (bluefield). Another corporate goal is to

maintain a reserves replacement rate at or

above 100% of annual production on a boe

basis.

Application of advanced technology will

also be a key part of our strategy to increase

production, maximise the recovery of proved

33


UpstreamOPERATING RESULTS


35

ReservesTBH uses two main global reserve classi-

fication systems for external reserve re-

porting and internal reserve management:

• the SEC standard, whereby reserves are

calculated through to current licence re-

newal dates. A variation of this method (the

SEC-life-of-field system) is also used,

whereby reserves are calculated through

the economic life of a field;

• the SPE criteria.

The SEC-life-of-field system is the primary

basis used for reserves management with-

in the Company.

DeGolyer and MacNaughton, a firm of in-

dependent petroleum engineers, has carried

out an independent evaluation of TNK-BP

Holding’s proved, probable, and possible re-

serves since 2003. According to DeGolyer

and MacNaughton’s evaluation as of 31 De-

cember 2006:

• under the SEC-life-of-field basis, TNK-BP

Holding had total gross proven reserves of

7.8 billion barrels of oil equivalent; and

• under SPE criteria, TNK-BP Holding had

total gross proven reserves of 8.9 billion

barrels of oil equivalent.

Only gas reserves, which have established

access to markets are reflected in TBH re-

serves base in accordance with SEC/SPE

rules. 2006 saw the first recognition of

such reserves as a result of existing con-

tractual sales commitments.

Oil and CondensateProductionTBH’s oil and condensate production in-

creased by approximately 6% in 2005 and

1% in 2006 (adjusted for assets disposals

in late 2005 and 2006).

The Company has historically derived

approximately two thirds of its production

from Western Siberia and one third from the

Volga-Urals basin. While TBH has many

fields and production subsidiaries, oil pro-

duction within the Company is relatively con-

centrated. Five of our fields account for ap-

proximately 56% of total production, while

five subsidiaries account for 80% of pro-

duction.

As of 31 December 2006, TBH had a to-

tal of 39,053 wells (including production wells,

injection wells and wells under conservation).

Production wells are used to extract oil and

associated gas, while injection wells are used

to pump water or other agents into reservoirs

in order to maintain pressure and enhance

oil recovery. For the year ended 31 Decem-

ber 2006, TBH put 340 new production

wells into operation (compared to 318 in

2005) and 50 new injection wells (against 32

wells in 2005).

34

Samotlorneftegas Orenburgneft TNK-Nizhnevartovsk

Share in the Company’s 32% 21% 11%total production in 2006

Licences Licence to develop a significant Licences to develop 98 fields Licences to develop six fields part of the Samotlor field in the Southern Urals territory in West Siberia, including in West Siberia the northern part

of the Samotlor field

Field characteristics Samotlor field was discovered The fields were discovered from The fields were discovered in 1964; production began in 1969. 1937 on; operation started in 1939. in 1965–1984 and were Average reservoir bedding: Average reservoir bedding: 2,800 m commissioned in 1969–1986.from 1,700 to 2,800 m Average reservoir bedding:

from 2,200 to 2,700 m

Field parametres as of 31 December 2006

Average water cut 93% 71% 87%

Oil production 23 mt 15.8 mt 7.9 mt485 mbpd 324 mbpd 163 mbpd

Operating wells 5,690 1,994 1,785

Injection wells 2,108 835 430

Nizhnevartovsk Oil and Gas Udmurtneft * TNK-NyaganProducing Company

Share in the Company’s 8% 5% 8%total production in 2006

Licences Licences for developing Licences for developing fields Licences for developing 12 fields in West Siberia in the territory of Udmurtia 2 fields in West Siberia

located in the Ural region.

Field characteristics The fields were discovered The fields were discovered in The fields were discovered in 1971–1997 and commissioned 1955–1973. The fields have 1962 and commissioned in 1980.in 1985–2004. Average reservoir been producing since 1969. Average reservoir bedding:bedding: 2,700 m Average reservoir bedding: 1,200 m from 1,300 to 2,800 m

Field parametres as of 31 December 2006

Average water cut 76% 87% 85%

Oil production 5.6 mt 3.6 mt 5.7 mt 114 mbpd 74 mbpd 116 mbpd

Operating wells 944 3,529 2,052

Injection wells 482 1,311 562

* In June 2006, the Company announced the sale of Udmurtneft, which was completed in August 2006.

TBH production(mboe)

Production adjusted for divestments

Actual production

Upstream TechnologyWithin TBH the upstream and technology

groups are engaged in a number of activities

designed to increase proven reserves in or-

der to enable production targets to be met.

Our production targets imply that the Com-

pany must convert approximately three billion

barrels, or between 30–40%, of its probable

reserves to proven reserves during the next

five years. As approximately two thirds of

probable and possible reserves are associ-

ated with oil fields that are currently produc-

ing (brown fields), the plan is to increase

proven reserves through drilling in proximity

to these fields and through improved reser-

voir management of the existing fields them-

selves. We believe that our brown fields still

contain significant potential both for produc-

tion growth and reserve addition.

Application of world-class technology is the

key to unlocking this potential. We have es-

tablished a dedicated in-house technology

stream which stewards technology into the

Company. Within this framework we are fo-

cused on 3D seismic, reservoir management

and drilling, well work, including hydrofrack-

ing operations and electric submersible

pumps (ESP) optimisation.

TBH is now the largest consumer of 3D

seismic data in Russia. In 2006, 3522 square

km of our production area had 3D seismic

coverage, with quality improving and cost per

trace declining significantly. The 3D data is

processed at a dedicated data processing

centre in Moscow, opened in 2003 with

WesternGeco, and analyzed at an advanced

Visual Modeling Centre (VMC), launched at

our Moscow headquarters in June 2006. As

a result, seismic data analysis allows precise

and reliable location of exploration wells, en-

hancing our exploration success rate. Thanks

to the use of this new technology, we signif-

icantly improved the impact of our exploration

drilling, achieving a success rate of finding

commercial oil of 71% in 2006 (vs. industry

average of approximately 20%).

The main procedures used to optimise

reservoir management include waterflood pat-

tern reconfiguration, conversion of producing

wells to injectors, and gas injections.

TNK-BP Holding is required to complete

exploration work and maintain levels of oil

and gas production for each field in accor-

dance with an annual work programme

which must be approved by the Federal

Service on Ecological, Technological, and

Nuclear Supervision. Furthermore, the Com-

pany is obliged to meet the requirements re-

lating to exploration activity set forth in its ex-

ploration licences and ensure that fields are

developed in accordance with agreed sched-

ules.

In 2005, the Company acquired an aggre-

gate of five new licences through participa-

tion in federal auctions, of which two licences

are production licences and the other three

are exploration and production licences. In

2006, the Company continued to participate

in federal auctions and acquired the right to

develop several deposits. In particular we ac-

quired 19 new field licences, 17 of which were

acquired through competitive bidding (li-

cences for joint use, production and explo-

ration), one was received as a result of a new

discovery and one was acquired as a result

of the acquisition of stake in licence-holding

company. In addition, in 2007 the Company

also acquired twelve new licences for geo-

logical exploration a further five licences for

the joint use of the subsoil.

TBH Main fields

Gas


37

TBH has two material gas production ac-

tivities in West Siberia: associated gas and

the gas-producing company Rospan Inter-

national.

Associated GasTBH subsidiaries produce natural and as-

sociated gas in the Company’s key oil-pro-

ducing areas — the Nizhnevartovsk Region

in West Siberia and the Orenburg Region in

the Volga-Urals basin. TBH sells most of the

gas it produces, although a small portion is

used to generate power for its own opera-

tions. Commercial gas sales were approx-

imately 12 billion cubic metres in 2006, com-

prising of 7 billion cubic metres of associated

gas and 5 billion cubic metres of dry gas.

Utilisation of associated gas in particular is

an essential part of the Company’s com-

mitment to protect the environment and ful-

fill licence obligations.

In November 2006 an important joint ven-

ture was created with Sibur Holding to

process associated gas at the Nizhnevar-

tovsk and the Belozerny gas processing

plants in West Siberia. Sibur contributed the

Nizhnevartovsk and Belozerny gas pro-

cessing plants and the infrastructure to

transport associated gas to these plants to

the new JV and TBH’s responsibility is to

supply most of the associated gas. The ag-

gregated processing capacity of the Nizh-

nevartovsk and Belozerny gas processing

plants is 8 billion cubic metres a year. Ap-

proximately 70% of gas input will come from

TBH’s fields, and the rest will be purchased

from other producers in the region. The end

products will be split: TBH will receive all the

dry, lean gas and Sibur will take 100% of the

liquid products from processing the gas.

Rospan InternationalFollowing the 2004 acquisition of a 56%

stake then held by Yukos, TBH owns 100%

of Rospan, a gas and condensate produc-

tion asset located in the Yamalo-Nenets Au-

tonomous District of Northern Russia.

Through Rospan, TBH plans to participate

further in the Russian gas market. Rospan

is developing the deep gas deposits of the

Novo-Urengoiskoe and Vostochno-Uren-

goiskoe gas condensate fields where re-

serves are estimated at 906 billion cubic me-

tres of gas and 185 million tonnes of gas

condensate and oil. Rospan’s probable

and possible gas resources are estimated

at 538 billion cubic metres according to SPE

criteria.

Rospan is currently producing gas and

condensate and supplying gas to the Russ-

ian market. In 2006 it increased production

and sales of gas by 93% (compared to 2005)

to 2.7 billion cubic metres. The Company is

planning to continue growing gas production

and sales from its existing assets and, pro-

viding agreement is reached with Gazprom,

to start full-scale development of the Com-

pany’s reserves from 2011 in order to pro-

duce up to 15 billion cubic metres of gas and

3 million tonnes of condensate a year.

36

Injecting gas is particularly beneficial as it is

a way of maintaining reservoir pressure in ad-

dition to waterflood, while at the same time

resolving the issue of associated gas utili-

sation and reducing flaring.

The Company inherited an extensive field

infrastructure in several Russian regions, in-

cluding more than 28,000 km of infield

pipelines. Over 40% of all these pipelines are

over 15 years old and so the Company has

developed and is implementing a special In-

tegrity Management Programme, which man-

ages the replacement and protection of

pipelines and other infrastructure facilities.

This is helping the Russian oil and gas in-

dustry significantly improve its safety and en-

vironmental standards.

Greenfield ProjectsGiven that TBH expects production to be

broadly flat through to 2009, the development

of greenfield projects has become the key to

the Company’s longer-term growth prospects.

As a result we are implementing a number

of projects in Western Siberia in order to bring

new fields into production in the medium term.

In addition we expect that long-term re-

serves replacement will be supported by on-

going exploration plans.

We have 16 major projects that are under

development, each of which has estimated

or actual capital expenditure in excess of

US$100 million. The four largest of them are:

• The Uvat project, located in the south of the

Tyumen Region, which contains estimated

reserves in the range of 120 to 300 million

barrels. TBH is currently appraising the

field’s reservoirs and is preparing for com-

mercial development, the first stage of

which will have a plateau production around

5 million tonnes per year by 2009–2010.

Explorationdrilling(thousand metres)

• The Bolshetetskaya depression project is lo-

cated in the Krasnoyarsk Region. An ex-

ploration programme is currently being car-

ried out in compliance with the licence re-

quirements, and seismic analysis and deep

drilling have already doubled resources to

100 million tonnes of oil (over 750 million bar-

rels). Further exploration is now planned

ahead of full field development. Site surveys

have already been completed and prepa-

rations have been started for surface con-

struction, while at the same time develop-

ment planning is in progress. Currently pro-

duction is expected to commence in 2007

and plateau in 2013 at around 170 thousand

barrels of oil equivalent per day.

• Kamennoye field is located in Tyumen re-

gion. Large oil reserves — 1.1 billion tonnes,

— were discovered there quite some time

ago, but were considered “undevelopable”.

Using leading technology such as 3D seis-

mic reservoir modeling, potential horizontal

access, injection of purified water, and oth-

er enhanced recovery methods allowed TBH

to revaluate the field’s potential. Currently

TBH explorationsuccess rate(2003–2006)

drilling and production is underway in the

least complex segments.

• Verkhnechonskoye field is a greenfield

project located in the Katangsky Region of

the Irkutsk Oblast in Eastern Siberia. The

field is estimated to contain probable and

possible reserves of approximately 1.4 bil-

lion barrels of oil according to SPE stan-

dards. Development of the field has been

hampered for many years by an absence of

transportation infrastructure, however, de-

velopment of the field is underway following

the decision of the Russian Government to

undertake the construction of an Eastern

Siberia Pacific Ocean pipeline system

(“ESPO”). A work programme for 2007 in-

cludes drilling of more than ten new wells,

establishment of oil and gas facilities and the

export infrastructure to connect to ESPO.

Production into ESPO is targeting start up

by end 2008. In addition, the purpose of the

2007 activity is to establish the Verkhne-

chonskoye field’s reservoir potential and to

determine the most efficient method for the

full scale development of the field which will

require a multi-billion dollar investment. TBH

owns a 63% stake in OJSC Verkhnechon-

skneftegaz (“VCNG”), which holds the li-

cence for development of the Verkhne-

chonskoye oil field.


39

To achieve these aims, the Company be-

lieves that it faces two principal challenges.

First, the global petroleum refining indus-

try is cyclical and highly volatile, while re-

fineries are capital-intensive assets with high

fixed costs. Competition among refineries is

primarily based on the refined product’s

price, quality, and brand image, and in

some cases on logistics or supply chains.

Second, as the trend of car owners in

Russian cities to replace their Soviet-built ve-

hicles with newer vehicles continues, Russ-

ian demand for higher quality and higher oc-

tane fuels is expected to continue to in-

crease.

TBH believes that it is well-placed to re-

spond to these challenges through:

• continually modernising and upgrading the

efficiency and safety of its refineries.

TBH’s main focus is on its largest refining

asset, the Ryazan refinery, where it has

completed a number of large-scale in-

vestment projects. However, the Compa-

ny is also developing and implementing

some upgrading projects at its other re-

fineries;

• maintaining consistent throughput by sup-

plying its refineries with its own crude oil;

• adapting its refining capabilities to meet

customer demand and new product spec-

ifications in a timely and cost-effective

manner; and

Downstream

38

TBH’s downstream operations are principally

geared toward generating the highest net-

backs for its crude oil production. Net-

backs are defined as the sales price of crude

oil or refined products less all costs such as

transportation, refining costs, taxes and

duties. As such, netbacks represent the eco-

nomic return to the Company of sales of its

different products via different sales chan-

nels. The principal objective of the Compa-

ny in the area of downstream and market-

ing is to maximise netbacks per tonne of pro-

duced crude oil. The Company is well-

placed to maximise netbacks for the fol-

lowing reasons:

• good balance, in terms of capacity and lo-

cation, between crude production and re-

fining;

• two of our refineries, the Ryazan and Sara-

tov ones, are well placed to facilitate

crude oil and refined product exports via

rail and barge. The Company is currently

making investments at both refineries to

increase their ability to rail-load oil prod-

ucts;

• TBH’s export sales contracts with cus-

tomers provide for a high level of flexibil-

ity relating to the amounts and timing of

crude oil and oil product sales;

• the Company has entered into long-term

agreements with export ports to ensure

sustainable transshipment capacity;

• we have established and regularly update

a sophisticated system to monitor and

measure the netbacks available through var-

ious sales channels. This proprietary sys-

tem constantly analyses real-time opera-

tional, logistical, cost, and pricing data to

help determine the most favourable deliv-

ery route for crude oil and refined products.

2006 product slate, average across theCompany’s refineries(%)

30.9

23.8

29.2

4.711.4

Year ended 31 December2006 % 2005 %

(thousand tonnes, except percentages)

Type of Product:

Gasoline 5,049 24 5,223 22

Diesel fuel (gas oil) 6,551 31 7,367 31

Fuel oil (mazut) 6,199 29 7,430 31

Jet fuel (kerosene) 1,007 5 1,152 5

Other products 2,414 11 2,563 11

Total 21,220 100 23,735 100

RefiningIn total TBH owns four refineries, which to-

gether account for a total effective capacity

of approximately 23 million tonnes. In 2006

these refineries processed 22.5 million

tonnes, with an effective utilisation rate

of 98%.

In its refining business, TBH aims to en-

hance the volume and quality of its refined

products to match domestic and export

product demand and to increase sales of re-

fined products in the international markets.

Annual refining throughput(mt)

Year ended 31 December2006 20051

(thousand tonnes, except percentages)

Effective capacity 23,004 28,609

Refinery input:

Crude oil 21,928 24,517

Other feedstock 0,582 0,461

Total refinery input 22,510 24,977

Conversion ratio 67% 65%

Light products output 56% 55%

Utilisation 98% 87%

1 2005 data includes data for the Orsk refinery which was sold in December 2005.

Orsk

KNPZ

NNPO

Saratov

Ryazan

Gasoline

Diesel fuel

Fuel oil

Jet kero

Other

• taking advantage of the strategic location

of its refineries, including the Ryazan re-

finery, which is well-placed to serve the

Moscow market and West-European ex-

port markets.

The increase in the share of light oil prod-

ucts over last few years has been driven by

the Ryazan refinery upgrade and the in-

stallation of a visbreaker unit at the Saratov

refinery which is used to convert heavier hy-

drocarbons into lighter hydrocarbons. TBH

expects to further increase its yield of light

oil products over the next several years as

a result of the completion of Ryazan refin-

ery modernisation project plus future mod-

ernisation plans to enhance its ability to pro-

duce gasoline, kerosene, and diesel fuel.

The Ryazan refinery is the Company’s

largest refinery which utilises distillation

and secondary conversion processes such

as cracking units to produce a broad range

of petroleum products. The Saratov refinery

is a smaller refinery with only a visbreaking

upgrading process, which produces a more

limited range of petroleum products. The

Nizhnevartovsk and Krasnoleninksy re-

fineries are small topping refineries which

utilise atmospheric distillation to produce light

fractions such as low-octane gasoline, gas

oil, and kerosene. The byproduct of ex-

tracting these light fractions is stabilised oil,

which is returned to the Transneft crude oil

pipeline system.


41

Domestically, the Company sells its products

through a number of different distribution

channels. All the gasoline and approxi-

mately 50% of the diesel produced by TBH

refineries are sold by regional marketing sub-

sidiaries through their retail networks (in-

cluding jobbers) and in the small wholesale

market. Other TBH’s refined products are pri-

marily sold directly to large wholesale cus-

tomers.

TBH markets its refined fuel products in

20 large regions in Russia (mainly the

Northern, Central and Urals federal re-

gions) and is a market leader in each of the

regions in which it operates.

TBH operates and markets under the

TNK brand.

As of 31 December 2006 TBH’s retail net-

work included 1,076 filling stations, 516 of

which are owned and operated by TBH’s

marketing subsidiaries and are operated by

independent owners through jobber arrange-

ments. In 2006, TBH sold more than 1.3 mil-

lion tonnes of refined fuel products through

the network representing approximately

20% of TBH’s total gasoline and diesel out-

put. Sales through jobbers stations ac-

counted for 2.6 mt. Of which 2.4 mt were

sold directly from refineries. Total sale of re-

fined products in 2006 was 6.8 mt (through

all sales channels including own and jobbers

gasoline stations, transit and others). This is

almost 20% higher than in 2005.

In its retail business, TBH plans to con-

centrate investment in company-owned and

company-operated outlets in the largest

metropolitan growth markets in Russia.

In Moscow and Moscow region, the largest

Russian region in terms of consumption, the

Company’s market share is approximately

30% (in terms of volume). Moscow and the

Moscow Region, represent a particularly at-

tractive opportunity due to the Ryazan re-

finery’s proximity and direct pipeline access

to Moscow. The strategy in the Moscow Re-

gion includes developing its customer base

by enhancing its commitment to high qual-

ity and service standards, expanding and op-

timising the Company’s retail network and

increasing revenue from the sale of gasoline

and convenience store products.

Marketing

40

Nizhnevartovsk Oil Refining Association LLC Krasnoleninsky Oil refinery

Share in the Company’s total 6% 1%refining volume in 2006

Effective capacity 1.4 mt 0.2 mt

Refining capacity 1.4 mt 0.14 mt

Year of commissioning 1998 1998

Location advantages Located in Western Siberia in close proximity Khanty Mansy Autonomous Regionto the Company’s upstream assets The refinery is located at the 39th kilometer

of the federal Nyagan–Khanty-Mansiysk road

Product mix Produces light fractions such as straight run Produces light fractions such as straight-run gasoline, gas oil, and kerosene. The byproduct gasoline, gas oil, and kerosene. The byproductis stabilised oil, which is returned to the crude is stabilised oil, which is returned to the crude oil pipeline system oil pipeline system

Investment projects No significant investments No significant investments are are planned in the near future planned in the near future

Ryazan Oil Refining Company Saratov Oil Refinery

Share in the Company’s 67% 26%total refining volume in 2006

Effective capacity 15.5 mt 6.0 mt

Refining throughput 15.1 mt 5.9 mt

Refining depth 64% 65%

Light products 56% 47%

Capacity utilisation 97% 99%

Year of commissioning 1960 1933

Location advantages The refinery is located 200 km southeast of Moscow. The refinery is located at the Volga river Proximity to Moscow and Russia’s western borders near the vital trunk railroadsprovides strong position in both domestic and export markets

Product mix Light products (gasoline, diesel fuel, jet fuel, and solvents) Gasoline, diesel fuel, fuel oil, bitumen Heavy products (heavy diesel fuel, bitumen, and other petrochemicals lubes and solvents) and other petrochemicals

Investment projects A comprehensive upgrading program worth in total The visbreaking unit commissioning project US$631 mln was implemented in 2000-06, with was completed in July 2004, which helped the following objectives met within its framework: increase the crude oil chemical refining • fluid catalytic cracking unit revamping was completed; ratio to 65%. • sulfuric acid production units were upgraded The Company is considering implementing

to mitigate adverse environmental footprint; further investment projects, potentially • lube selective hydrofining shop was revamped including new technological unit

and switched over to new technologies to use biodegradableand non-toxic solutions and standard methyl pyrrolidone;

• Vacuum gas oil unit was started up and alkylation and isomerisation units were commissioned;

• production of M-grade gasoline for exports to US as well as A-98 gasoline and diesel fuel with sulfur content below 50 mg/l was started

Review of TNK-BP Holding’s refinery activities in 2006


43

Beyond Moscow and the Moscow Region,

the Company will continue to expand its re-

tail network and increase its market share.

The intention is to reduce its capital invest-

ment by franchising the TNK brand. The use

of jobbers is an efficient approach to ex-

panding the retail network in the regions and

allows TBH to capture and retain a broad

market coverage. Jobbers are permitted to

use the brand name “TNK” and are required

to sell only refined products purchased

from the Company. There is a number of

check points for quality control at jobbers sta-

tions: when dispatched from the storage

tank, when delivered to the station, and then

on an ad hoc basis (usually once a month)

In 2007 the Company intends to introduce

mobile quality laboratories.

In August 2006, the Company launched a

new marketing initiative aimed at re-posi-

tioning of TNK brand in the market — re-

branding. The new branded TNK stations will

assume a “new look” with an addition of a

new colour, orange, and offer a new variety

of services, such as mini markets and cof-

fee shops. During the year about 70 stations

were rebranded to the “new look” under this

programme and another 125 owned filling

stations are expected to undergo an over-

haul in 2007.

TBH will also seek opportunities for growth

in the business-to-business markets, par-

ticularly within the bitumen, aviation and

wholesale ground fuels sectors

Supply, Trading and Logistics Russian oil companies transport approxi-

mately 90% of their crude oil through the

Russian national crude oil pipeline network

that is operated by the state-controlled

company Transneft. Each oil company de-

livers its crude oil to the Transneft network

through gathering systems which are owned

and operated by the respective oil compa-

nies, and oil is then transported to refiner-

ies or to sea terminals for shipment to var-

ious foreign destinations. Each Russian oil

producer’s allocation of pipeline capacity for

exports is restricted, with allocations based

on the Company’s respective share of total

Russian crude oil production. Historically, the

Transneft system did not have sufficient ca-

pacity to meet the total demand for crude oil

pipeline exports from Russian oil producers.

However, Transneft has made substantial in-

vestments in the development of addition-

al export routes and trans shipment termi-

nals (e.g. Primorsk port) in order to increase

capacity. As a result of these investments

spare capacity currently exists in the pipeline

system.

As it is not possible to maintain the qual-

ity of crude oil within the Transneft pipeline,

there is significant incentive for Russian pro-

ducers to segregate oil products and move

their high quality oil to the market via rail and

river barge shipment to sea terminals located

on Russia’s borders. While these options are

more expensive than transportation via the

Transneft system, they nonetheless provide

Russian oil companies with another viable

means of exporting their production. In re-

cent years there has been significant in-

vestment by OJSC Russian Railways and

shipping companies in Russia to expand rail

and barge capacity. Rail shipment is a

more widely used supply route than river

barge, which is more seasonal in nature.

42

Sales structure(%)

Crude oil export other than CIS

Refined products, export

Refined products, domestic

Crude oil domestic

Crude oil export CIS

2004 2006


45

REPORT OF INDEPENDENT AUDITORS

To the shareholders of OAO TNK-BP Holding:

In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of cash flow and

of changes in shareholders' equity present fairly, in all material respects, the financial position of OAO TNK-BP Holding and its subsidiaries

at 31 December 2006, and the results of their operations and their cash flows for the year then ended in conformity with accounting

principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s man-

agement. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these

statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we

plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing

the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.

We believe that our audit provides a reasonable basis for our opinion.

OAO TNK-BP Holding has not presented information on oil and gas exploration and production activities in accordance with State-

ment of Financial Accounting Standards No.69 that accounting principles generally accepted in the United States has determined is nec-

essary to supplement, although not required to be part of, the basic financial statements.

Moscow, Russian Federation

23 May 2007

FINANCIAL RESULTS

ZAO PricewaterhouseCoopers AuditKosmodamianskaya Nab. 52, Bld. 5115054 MoscowRussiaTelephone +7 (495) 967 6000Facsimile +7 (495) 967 6001www.pwc.ru

Consolidated Statement of Income(Expressed in millions of US Dollars)


47

Note Year ended 31 December 2006

Revenues

Sales and other operating revenues 16 32,114

Less: export duties (9,327)

Less: excise taxes (621)

Net revenues 22,166

Costs and other deductions

Taxes other than income tax 15 6,493

Operating expenses 2,744

Cost of purchased products 2,174

Transportation expenses 1,903

Selling, general and administrative expenses 1,282

Depreciation, depletion and amortisation 1,250

Exploration expenses 98

Loss on disposals and impairment of assets 42

Total costs and other deductions 15,986

Other income and expenses

Earnings from equity investments, net 9 71

Income from disposals of subsidiaries 4 2,677

Interest income and net other income 79

Exchange loss, net (104)

Interest expense (210)

Total other income and expenses 2,513

Income before income taxes and minority interest 8,693

Income taxes

Current tax expense 2,095

Deferred tax expense 20

Total income tax expense 14 2,115

Income before minority interest 6,578

Minority interest 169

Net income 6,409

Net income per share of common stock (US Dollars) 13 0.41

The accompanying notes are an integral part of these consolidated financial statements

Consolidated Balance Sheet(Expressed in millions of US Dollars, except as indicated)

46

Note 31 December 2006

Assets

Cash and cash equivalents 827

Restricted cash 5 6

Accounts and other receivables, net 7 7,921

Inventories 8 659

Other current assets 118

Total current assets 9,531

Long-term investments 9 94

Property, plant and equipment, net 10 11,259

Loans issued to related parties 489

Other long-term assets 337

Total assets 21,710

Liabilities and Shareholders’ Equity

Short-term debt and current portion of long-term debt 11 1,309

Trade accounts and notes payable 3,098

Other accounts payable and accrued expenses 12 589

Taxes payable 15 1,685

Dividends payable 1,571

Total current liabilities 8,252

Long-term debt 11 206

Asset retirement obligations 10 231

Deferred income tax liabilities 14 765

Other long-term liabilities 164

Total liabilities 9,618


Common stock (authorised and issued — 15,847 million shares, RUR 1.0 par value) 13 550

Preferred stock (authorised and issued — 450 million shares, RUR 1.0 par value) 13 16

Treasury stock, at cost 13 (239)

Additional paid-in capital 4,933

Retained earnings 6,228

Total shareholders’ equity 11,488

Commitments and contingencies 18 –

Total liabilities and shareholders’ equity 21,710


Consolidated Statement of Changes in Shareholders’ Equity (Expressed in millions of US Dollars, except as indicated)


49

Common stock Preferred stock Treasury stock Additional paid-in capital Retained earnings Total shareholders’equity

Balance at 31 December 2005 550 16 (239) 4,933 7,873 13,133

Net income – – – – 6,409 6,409

Dividends (Note 13) – – – – (8,054) (8,054)

Balance at 31 December 2006 550 16 (239) 4,933 6,228 11,488

31 December 2005 (millions of shares) 31 December 2006 (millions of shares)

Number of Ordinary shares issued 15,847 15,847

Number of Preferred shares issued 450 450

Number of Treasury shares (850) (850)


Consolidated Statement of Cash Flows(Expressed in millions of US Dollars)

48

Note Year ended 31 December 2006

Cash flows from operating activities

Net income 6,409

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation, depletion and amortisation 1,250

Deferred income tax expense 20


Loss on disposals and impairment of assets 42

Income from disposals of subsidiaries 4 (2,677)

Earnings from equity investments less distributions (16)

Non-cash provisions 26

Dry hole expenses 13

Exchange loss from financing activities 134

Other non-cash adjustments, net 49

Changes in operational working capital, excluding cash:

Accounts and notes receivable 2,353

Inventories (58)

Accounts and notes payable 1,699

Taxes payable (1,550)

Other 9

Net cash provided by operating activities 7,872

Investing activities

Capital expenditures (2,234)

Subventions used for capital expenditures (286)

Subventions received 290

Proceeds from disposals of property, plant and equipment 24

Purchase of investments (89)

Proceeds from sales of subsidiaries and joint ventures 3,262

Loans repaid 288

Loans issued (127)

Net cash used for investing activities 1,128

Financing activities

Proceeds from issuance of long-term debt 146

Repayment of long-term debt (2,125)

Proceeds from issuance of short-term debt 510

Repayment of short-term debt (557)

Change in restricted cash to secure long-term debt 9

Dividends paid to minorities (70)

Dividends paid to shareholders (6,594)

Net cash used for financing activities (8,681)

Effect of exchange rate changes on cash and cash equivalents 23

Net change in cash and cash equivalents 342

Cash and cash equivalents at beginning of period 485

Cash and cash equivalents at end of period 827


have been included in the determination of net income and are included in net exchange losses in the accompanying consolidated state-

ments of income.

As of 31 December 2006 the exchange rate was 26.33 Russian Roubles to the US dollar. The average exchange rate for 2006 was

27.19 Russian Roubles to the US dollar.

Any remeasurement of Russian Rouble amounts to US dollars should not be construed as a representation that such Russian Rouble

amounts have been, could be, or will in the future be converted into US dollars at the exchange rate shown or at any other exchange rate.

Note 3: Summary of Significant Accounting Policies

Principles of consolidation. The consolidated financial statements include the operations of all entities in which the Group directly

or indirectly owns or controls more than 50 percent of the voting stock. Joint ventures and investments in which the Group has voting

ownership interests between 20 and 50 percent and where the Group exerts significant influence are accounted for using the equity

method. Investments in other companies are accounted for at cost and adjusted for estimated impairment.

Cash equivalents. Cash equivalents include all liquid securities with original maturities of three months or less when acquired.

Accounts receivable. Accounts receivable are presented at net realisable value and include value-added and excise taxes.

Inventories. Inventories are valued at the lower of cost, using the average method, or net realisable value. Costs include applicable

purchase costs and production costs.

Property, plant and equipment. The Group follows the successful efforts method of accounting for its oil and gas properties where-

by property acquisitions, successful exploratory wells, all development costs (including development dry holes), and support equipment

and facilities are capitalized. Under this method, costs are accumulated with certain exploratory expenditures and exploratory dry holes

being expensed as incurred. The Group carries as an asset exploratory well costs when the well has found a sufficient quantity of re-

serves to justify its completion as a producing well and where the Group is making sufficient progress assessing the reserves and the

economic and operating viability of the project. Exploratory well costs not meeting these criteria are charged to expense. Production

costs, overheads and all exploration costs other than exploratory drilling are charged to expense as incurred. Acquisition costs of un-

proved properties are evaluated periodically and any impairment assessed is charged to expense.

Proved oil and gas properties and other long-lived assets are assessed for possible impairment in accordance with SFAS No. 144,

Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires long-lived assets with recorded values that

are not expected to be recovered through future cash flows to be written down to current fair value. Fair value is generally determined

from estimated discounted future net cash flows.

Depreciation, depletion and amortisation of capitalized costs of proved oil and gas properties and equipment is calculated using the

unit-of-production method for each field based upon proved reserves for property acquisitions and proved developed reserves for ex-

ploration and development costs.

Other property, plant and equipment not associated with exploration and production activities are carried at cost less accumulated de-

preciation. Depreciation of these assets is calculated on a straight-line basis as follows:

Buildings and constructions 5–33 years

Machinery and equipment 5–15 years

Maintenance and repairs and minor renewals are expensed as incurred. Major renewals and improvements are capitalized.

Asset retirement obligations. The Group incurs retirement obligations for its upstream assets. The fair values of these obligations

are recorded as liabilities on a discounted basis, which is typically at the time the assets are installed. The costs associated with these

liabilities are capitalized as part of the related assets and depleted as the reserves are produced. Over time, the liabilities are accret-

ed for the change in present value. Asset retirement obligations are not recorded for downstream facilities, because such potential ob-

ligations cannot be measured since it is not possible to estimate the settlement dates.

Environmental liabilities. Liabilities for environmental remediation are recorded when it is probable that obligations have been in-

curred and the amounts can be reasonably estimated. Environmental remediation liabilities are not discounted for the time value of fu-

ture expected payments. Environmental expenditures that have future benefit are capitalized.

Derivative instruments. The Group recognises all derivatives as either assets or liabilities in the balance sheet and measures those

instruments at fair value. The accounting for changes in fair value depends on its intended use and designation and could entail record-

ing the gain or loss through earnings of the current period, or as part of other comprehensive income and subsequently reclassifying

into earnings when the gain or loss is realised.

51

Notes to the Consolidated Financial Statements(Expressed in US Dollars, tabular amounts in millions)

50

Note 1: Organisation

OAO TNK-BP Holding (“TBH” or “the Company”) is a subsidiary of TNK-BP Limited (“TNK-BP”), a British Virgin Islands company.

TNK-BP was formed effective 29 August 2003 by the Alfa Group and the Access-Renova Group (jointly “AAR”) and BP, to hold their re-

spective interests in their Russian and Ukrainian oil and gas assets. AAR contributed its 100 percent interest in TNK Industrial Hold-

ings Limited which held a 100.0 percent interest in TNK-BP International Limited, which in turn owned a 96.1 percent interest in OAO

Tyumen Oil Company (“TNK”) and a 100.0 interest in Sborsare Management Limited, which in turn effectively held a 68 percent inter-

est in OAO Sidanco (“Sidanco”). BP contributed its 29.6 percent interest in Sidanco, 33.4 percent interest in OAO RUSIA Petroleum

(“RUSIA”) and 75.0 percent interest in BP Moscow Retail (“BP assets”) for its 50.0 percent interest in TNK-BP. BP also made a bal-

ancing payment directly to AAR in cash and BP shares, payable over three years.

In 2005, TNK-BP completed a number of steps under its corporate restructuring program. Pursuant to the program, in December 2005

TBH, a newly created holding company, accessioned TNK, Sidanco and OAO ONAKO (“ONAKO”), key holding companies of TNK-BP

in Russia. As part of this accession, TBH issued shares to the minority interest holders in these entities. Furthermore, most of the mi-

nority shareholders in 14 key subsidiaries of TNK-BP in Russia were consolidated within TBH through a voluntary share exchange pro-

gram also completed in December 2005.

As a result of these accessions and the above described share exchange, minority shareholders received approximately 5% of the

shares in TBH. All purchases of minority interests have been treated as acquisitions and accounted for using the purchase method of

accounting.

The Company through its subsidiaries (jointly referred to as “the Group”) conducts exploration and development activities and pro-

duces oil and gas in the Russian Federation, operates petroleum refineries and markets oil and petroleum products in the Russian Fed-

eration.

Note 2: Basis of Presentation

The consolidated financial statements of the Group are prepared in accordance with accounting principles generally accepted in the

United States of America (“US GAAP”).

The Company and its subsidiaries maintain their accounting records in accordance with the Regulations on Accounting and Report-

ing in the Russian Federation. The accompanying consolidated financial statements have been prepared from these accounting records

and adjusted as necessary in order to comply with US GAAP.

In preparing the consolidated financial statements in conformity with US GAAP, management makes estimates and assumptions that

affect the reported amounts of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Ac-

tual results could differ from such estimates.

Reporting and functional currency. The Company’s and all its subsidiaries’ functional currency is the US dollar as a significant por-

tion of the Group’s business is conducted in US dollars and management uses the US dollar to manage the Group’s financial risks and

exposures, and to measure its performance.

The local currency of all subsidiaries of the Group is the Russian Rouble, where their transactions and balances have been remea-

sured into US dollars in accordance with the relevant provisions of Statement of Financial Accounting Standards No. 52, Foreign Cur-

rency Translation. Consequently, monetary assets and liabilities are remeasured at closing exchange rates and non-monetary items are

remeasured at historic exchange rates and adjusted for any impairment. The consolidated statements of income and cash flows have

been remeasured at the average exchange rates for the period. Exchange differences resulting from the use of these exchange rates

Note 4: Shareholders’ Contribution and Acquisitions and Disposals

In July 2006, the Company entered into an agreement with Sinopec for the sale of its interests in a number of the Group’s subsidiariesin the Udmurtia region. The sale was completed on 10 August 2006 for cash consideration in the amount of USD 3,223 million. The Grouprecognized a gain of USD 2,653 million in relation to this transaction, which is included in income from disposals of subsidiaries in theconsolidated statement of income.

Note 5: Cash and Cash Equivalents and Supplemental Cash Flow Information

As of 31 December 2006 restricted cash included cash deposits used to secure bank debt and open letters of credit.

As of 31 December 2006 cash balances included accounts denominated in Russian Roubles of USD 282 million.

During the years ended 31 December 2006, cash payments for interest totalled USD 187 million, and payments for income

tax totalled USD 2,662 million.

Note 6: Financial Instruments

Fair values. The estimated fair values of financial instruments are determined with reference to various market information and oth-

er valuation methodologies as considered appropriate, however in the absence of quoted market values, considerable judgement is re-

quired in interpreting market data to develop these estimates. Accordingly, the estimates are not necessarily indicative of the amounts

that the Group could realise or settle in a market transaction. Certain of these financial instruments are with major financial institutions

and expose the Group to market and credit risk. The creditworthiness of these institutions is routinely reviewed and full performance is

anticipated. The methods and assumptions used to estimate fair value of each class of financial instrument are presented below.

Cash and cash equivalents, accounts receivable and accounts payable. The carrying amounts of these items are a reasonable

approximation of their fair value.

Short-term debt. Loan arrangements have both fixed and variable interest rates that reflect the currently available terms for similar

debt. The carrying value of this debt is a reasonable approximation of its fair value.

Long-term debt. Loans under bank arrangements have variable interest rates that reflect currently available terms and conditions for

similar debt. The carrying value of this debt is a reasonable approximation of its fair value. For corporate bonds issued, the future cash

flows, discounted at the Group’s incremental borrowing rate, or quoted market prices for exchange traded securities were used to de-

termine fair value. As of 31 December 2006 these bonds have a fair value of approximately USD 729 million, while the carrying value

is USD 703 million.

Note 7: Accounts and Other Receivables, Net

31 December 2006

Trade accounts and notes receivable (net of allowance for doubtful accounts of USD 27 million) 3,432

Recoverable value-added tax 3,180

Advances issued 894

Taxes receivable 320

Other receivables (net of allowance for doubtful accounts of USD 10 million) 95

Total accounts and other receivables, net 7,921

Recoverable value-added tax balances mainly relate to crude oil and petroleum products export sale activities.

Note 8: Inventories

31 December 2006

Crude oil and petroleum products 400

Materials and supplies 259

Total inventories 659

53

Pension and post-employment benefits. The Group’s mandatory contributions to the governmental pension plan are expensed when

incurred. Discretionary pensions and other post-employment benefits are not material.

Revenue recognition. Revenues from the production and sale of crude oil and petroleum products are recognised when deliveries

to customers are made, title has transferred and collectibility is reasonably assured. Purchases and sales of inventory with the same

counterparty that are entered into in contemplation of one another are combined, considered as a single arrangement and netted against

each other on the consolidated statements of income.

Income taxes. Deferred income tax assets and liabilities are recognised for future tax consequences attributable to differences be-

tween the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, in accordance with SFAS

No. 109, Accounting for Income Taxes. Deferred income tax assets and liabilities are measured using enacted tax rates in the years in

which these temporary differences are expected to reverse. Included in this calculation are deferred income taxes for unremitted earn-

ings of equity affiliates and subsidiaries on basis differences between the relevant parent company financial statement carrying amounts

and the respective tax basis of its investments in subsidiaries and equity affiliates. Management periodically assesses possible meth-

ods of remitting the earnings to the parent and adjusts the liability to the amount calculated at enacted rates corresponding to the ex-

pected method of distribution. Valuation allowances are provided for deferred income tax assets when management believes it is more

likely than not that the assets will not be realised.

Comprehensive income. Comprehensive income includes all changes in equity during a period except those resulting from invest-

ments by and distributions to the Company’s shareholders. There is no difference between the Group’s net income and comprehen-

sive income for all periods presented.

Accounting changes. In November 2004, FASB Statement No. 151, Inventory Costs, an Amendment of ARB No. 43, (SFAS 151)

was issued and became effective for the Group on 1 January 2006. The standard amends the guidance in Accounting Research Bul-

letin (ARB) No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, han-

dling costs and spoilage. In addition, the standard requires that allocation of fixed production overheads to the costs of conversion be

based on the normal capacity of the production facilities. The adoption of this standard did not have a material effect of the Group's re-

sults of operations, financial position or liquidity.

In April 2005, EITF Issue No. 04-13, Accounting for Purchases and Sales of Inventories with the Same Counterparty, (Issue 04-13),

was issued and was adopted by the Group on a prospective basis from 1 January 2006. Issue 04-13 requires that two or more legally

separate exchange transactions with the same counterparty, including buy/sell transactions, be combined and considered as a single

arrangement, when the transactions are entered into “in contemplation” of one another. The adoption of EITF No. 04-13 did not have

a material effect on the Group's results of operations, financial position or liquidity.

Recent accounting standards. In June 2006, FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), was

issued and becomes effective for the Group on 1 January 2007. This Interpretation addresses the accounting for uncertainty in income

taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.

This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measure-

ment of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, in-

terest and penalties, accounting in interim periods, disclosure, and transition. The Group does not expect that implementation of FIN

48 will have a material effect on its results of operations or financial position.

In September 2006, FASB Statement No. 157, Fair Value Measurements, was issued and becomes effective for the Group on 1 Jan-

uary 2008. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting prin-

ciples, and expands disclosures about fair value measurements. The Group does not expect that implementation of the standard will

have a material effect on its results of operations or financial position.

In September 2006, FASB Staff Position No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, was issued and be-

comes effective for the Group on 1 January 2007. This Position prohibits the use of the accrue-in-advance method of accounting for

planned major maintenance activities in annual and interim financial reporting periods. The Group does not expect that implementa-

tion of this FASB Staff Position will have a material effect on its results of operations or financial position.

In February 2007, FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amend-

ment of FASB Statement No. 115, was issued and becomes effective for the Group on 1 January 2008. This Statement permits entities

to choose to measure many financial instruments and certain other items at fair value. The Group is currently evaluating the impact of

this standard.

52

The following table provides details of the projects:

Projects Cost as of 31 December 2006 Comment

Uvat project 34 Development of the project is ongoing and oil production is expectedto start in 2009 reaching maximum production by 2012.

Verkhnechonskoye field 15 Development of the field has been hampered for many years by an absence of transportation infrastructure. However, development of the field is now being progressed following the decision of the Russian Government to undertake the construction of the Eastern Siberia Pacific Ocean pipeline.

Other Greenfields 3 Assessment for potentially commercial hydrocarbon quantitiescompleted in the majority of cases; development options identifiedand under evaluation or in process of execution.

Total costs capitalized 52

Asset retirement obligations are as follows:

Balance at 31 December 2005 253

Accretion expense 14

Liabilities incurred in the current period 1

Liabilities settled in the current period (7)

Liabilities of disposed subsidiaries (56)

Change in estimated costs and timing 26

Balance at 31 December 2006 231

Note 11: Debt

Short-term debt and the current portion of long-term debt is as follows:

31 December 2006

Obligations to banks:

US dollar denominated (composite variable interest: 2006 — Libor plus 1.6 percent) 390

Current portion of long-term debt received from third parties 703

Current portion of long-term debt received from TNK-BP controlled companies 216

Total short-term debt and the current portion of long-term debt 1,309

Short-term bank debt. As of 31 December 2006, the Group has USD 390 million of short-term bank debt. This debt was obtained

for working capital purposes, is uncollateralised and consists of loan facilities provided by Russian banks and Russian subsidiaries of

international banks. These facilities bear variable interest at a composite rate of Libor plus 1.6 percent.

Long-term debt received from third parties is as follows:

31 December 2006

Long-term debt received from third parties:

Corporate bonds:

Eurobond TNK 2007 — fixed interest debt (coupon interest rate — 11 percent, effective rate — 10.34 percent) 703

Other 47

Long-term debt received from TNK-BP controlled companies:

US dollar denominated loans 81

Russian Rouble denominated loans 237

Long-term notes payable 57

Less: current portion of long-term debt received from third parties: (703)

Less: current portion of long-term debt received from TNK-BP controlled companies: (216)

Total long-term debt 206

55

Note 9: Long-Term Investments

31 December 2006

Advances to and investments in affiliates and joint ventures: OOO JV Vanyoganneft (“Vanyoganneft”) 75

Long-term investments, at cost 19

Long-term investments 94

Vanyoganneft. As of 31 December 2006 the Group owned 50 percent of the share capital of Vanyoganneft and accounted for this in-

vestment using the equity method of accounting. The Group’s earnings from its equity investment in Vanyoganneft for the year ended

31 December 2006 amounted to USD 71 million. For the year ended 31 December 2006 the Group received cash dividends from Vanyo-

ganneft in the amount of USD 55 million. Subsequent to 31 December 2006, the Group acquired the share capital of Vanyoganneft not

previously held — see Note 20.

Note 10: Property, Plant and Equipment and Asset Retirement Obligation

Cost Accumulated DD&A Net book value

Oil and gas properties and equipment — proved 11,346 (3,240) 8,106

Oil and gas unproved properties 462 – 462

Refining and related equipment 1,488 (443) 1,045

Oil field services properties and equipment 774 (485) 289

Other assets 293 (64) 229

Assets under construction 1,128 – 1,128

Balance as of 31 December 2006 15,491 (4,232) 11,259

The Group’s oil and gas fields are situated on land belonging to governmental authorities. The Group obtains licenses from such au-

thorities and pays exploration and production taxes to explore and produce oil and gas from these fields. These licenses expire up through

2038; however, they may be extended at the initiative of the Group provided it is in compliance with the license terms. Management

expects to extend such licenses for properties expected to produce subsequent to their license expiry dates.

Included in property, plant and equipment are capitalized exploratory well costs. The following tables provide details of the changes

in the balance of these capitalized well costs as well as an aging summary of those costs.

Balance as of 31 December 2005 19

Additions to capitalized exploratory well costs pending the determination of proved reserves 33

Reclassifications to wells, facilities, and equipment based on the determination of reserves –

Capitalized exploratory well costs charged to expense –

Balance as of 31 December 2006 52

The following table provides an aging of capitalized exploratory well costs based on the date the drilling was completed and the num-

ber of projects for which exploratory well costs have been capitalized for a period greater than one year since the completion of drilling:

31 December 2006

Capitalized exploratory well costs that have been capitalized for a period of one year or less 33

Capitalized exploratory well costs that have been capitalized for a period greater than one year 19

Number of projects that have exploratory well costs that have been capitalized for a period greater than one year 2

Exploratory well costs that have been capitalized for a period of greater than one year since the completion of drilling consist of costs

in the amount of USD 19 million incurred in 2004-2005 in relation to Verkhnechonskoye field and Uvat project described below. For each

of these two projects exploratory wells have also been drilled in the proceeding 12 months and further exploration drilling is planned in

the next year.

54

Note 13: Shareholders’ Equity

The share capital of the Company comprises 15,847 million authorised and issued ordinary shares of RUR 1 par value and 450 mil-

lion authorised, issued and outstanding non-cumulative preferred shares of RUR 1 par value.

The treasury stock of the Company comprises 850 million ordinary shares, which are held at cost. The treasury stock was issued in

the course of TNK-BP’s corporate restructuring program.

Profits available for distribution to shareholders in respect of any reporting period are determined by reference to the statutory finan-

cial statements of the Company and its subsidiaries prepared in accordance with the law of the Russian Federation and denominated

in Russian roubles.

During the year ended 31 December 2006 the Group declared dividends of USD 8,054 million.

Earnings per share. The calculation of earnings per share for the reporting period was as follows:

Year ended 31 December 2006

Net income 6,409

Deduct dividends declared on preferred stock (235)

Net income available to common shareholders 6,174

Weighted average number of common shares, millions of shares 15,847

Deduct weighted average treasury shares, millions of shares (850)

Weighted average number of outstanding common shares, millions of shares 14,997

Note 14: Income taxes

TNK-BP Holding is not subject to corporate income tax on a consolidated basis. The statutory corporate income tax rate in the Russ-

ian Federation is 24 percent. The Group calculates deferred income taxes in accordance with SFAS No. 109, Accounting for Income

Taxes. For a foreign entity using the US dollar as a functional currency, SFAS No. 109 requires deferred income taxes to be computed

on non-current assets in local currencies (Russian Roubles in the Group’s case) by comparing the historical book and tax basis in lo-

cal currency after the respective depreciation but before any indexing for either book or tax purposes. The local currency deferred in-

come tax is then remeasured into US dollars using the prevailing year-end exchange rate.

Deferred income tax reflects the impact of temporary differences between the carrying values of assets and liabilities recognised for

US GAAP financial reporting purposes and such amounts recognised for statutory tax purposes. Deferred income tax assets and lia-

bilities primarily result from the difference between the carrying value of property, plant and equipment, working capital and liabilities

associated with undistributed earnings of subsidiaries.

Deferred income taxes are included in the consolidated balance sheet as follows:

31 December 2006

Other current assets 79

Other long-term assets 103

Taxes payable 191

Deferred income tax liability — non-current 765

Net deferred income tax liabilities 774

57

Eurobonds. As of 31 December 2006 the Group has USD 700 million of Eurobonds issued and outstanding. Eurobonds consist of

two issues: USD 400 million placed at par in November 2002 and additional USD 300 million placed with premium of 5.75 percent of

par value in February 2003. Eurobonds bear interest at 11.0 percent per annum payable semi-annually, are uncollateralised and ma-

ture in November 2007.

Other long-term debt received from third parties. Other long-term debt received from third parties is represented by a RUR 1,228 mil-

lion facility. This facility bears interest at the refinancing rate of the Russian Central Bank (11.0 percent as of 31 December 2006) and

matures in December 2011, with interest payable at maturity.

Long-term debt received from TNK-BP controlled companies. Apart from long-term debt received from third parties, the Group has

obtained loans from and issued notes payable to Russian and offshore TNK-BP controlled companies which are not a part of the Group.

The total amount of these liabilities as of 31 December 2006 amounted to USD 375 million, of which USD 216 million matures within 1 year.

Aggregate maturities of long-term debt outstanding as of 31 December 2006 are as follows:

31 December 2006

Debt payable to third parties:

2011 47

Debt payable to TNK-BP controlled companies

2008 12

2009 49

2010 31

2011 67

Total long-term debt 206

Note 12: Other Accounts Payable and Accrued Expenses

31 December 2006

Advances from customers 178

Salaries payable and other related costs 154

Interest accrued 30

Other 227

Total other accounts payable and accrued expenses 589

56

Note 15: Taxes other than income tax and taxes payable

Taxes other than income tax expense for the year ended 31 December 2006 comprises the following:


Unified production tax 6,067

Tax penalties and interest 144

Unified social tax 133

Property tax 104

Non-reclaimable VAT expense 22

Other taxes 23

Total taxes other than income tax 6,493

Unified production tax. The rate for the tax is adjusted depending on the market price of Urals blend and the Russian Rouble/US dol-

lar exchange rate. The tax rate as of 31 December 2006 was USD 10.85 per barrel.

Current and long-term taxes payable as of 31 December 2006 are as follows:

31 December 2006

Value-added tax 589

Unified production tax 459

Excise taxes 213

Current deferred income tax liability 191

Income taxes 125


Other taxes 63

Total taxes payable 1,691

Less: long-term taxes payable (6)

Current taxes payable 1,685

59

The following table sets out the tax effects of each type of temporary differences which give rise to deferred income tax assets and

liabilities:

31 December 2006

Long-term liabilities 106

Accounts payable 63

Property, plant and equipment 50

Inventories 26

Other 51

Deferred income tax assets 296

Property, plant and equipment 824

Unremitted earnings of subsidiaries 170

Inventories 23

Other 53

Deferred income tax liability 1,070

Net deferred income tax liability 774

In 2004 the Group entered into an agreement with the Tyumen regional authorities which granted the Group a tax concession by way

of a four percent relief to the statutory corporate income tax rate subject to the Group making qualified capital investments in the re-

gion. In 2006 the Group entered into a similar type agreement with Orenburg regional authorities. For the year ended 31 December

2006, the Group’s income tax expense in the accompanying financial statements includes a tax benefit relating to these tax conces-

sions of USD 351 million.

The tax benefit discussed above is offset by non-deductible expenses and additional interest of USD 135 million related to tax provi-

sions previously recorded. As a result, the effective tax rate of the Group approximated 24 percent for the year ended 31 December

2006.

The following table is a reconciliation of the amount of income tax expense that would result from applying the Russian statutory tax

rate to income before income taxes to total income taxes:


Income before income taxes 8,693

Notional income tax at Russian statutory rates 2,086

Increase (reduction) in income tax due to:

Domestic tax rate differences (351)

Unremitted earnings of subsidiaries 174

Gain on disposals of subsidiaries 124


Losses not carried forward 19

Other permanent differences 28

Total income taxes expense 2,115

58

The transactions and balances with TNK-BP controlled companies are as follows:

As of and for the year ended 31 December 2006

Accounts and notes receivable 3,250

Long-term interest receivable 29

Loans given 489

Trade and other accounts payable 2,572

Dividends payable 1,418

Loans received 378

Sales of crude oil 16,572

Volumes (millions of tons) 39

Sales of petroleum products 5,791


Other sales 46

Purchases of crude oil 1,270


Other purchases:

Management fees 787

Consulting services 51

Other purchases 4

The transactions and balances with other related parties are as follows:


Advances to and receivables from other related parties 10

Short-term loans given to other related parties 34

Sales of crude oil and petroleum products 81

Volumes (millions of tons) 0.3

Other sales 3

61

Note 16: Revenues

Revenues for the year ended 31 December 2006 comprise the following:


Crude oil — export (Europe and CIS) 17,939

Crude oil — domestic 1,983

Petroleum products — export (Europe and CIS) 6,153

Petroleum products — domestic 5,419

Other revenues 620

Gross sales and other operating revenues 32,114

Note 17: Related Party Transactions

The Group has the following balances in the ordinary course of business with affiliates of Alfa Group, a major shareholder of TNK-BP:

As of 31 December 2006

Cash and cash equivalents with Alfa Bank 301

The Group has the following transactions and balances in the ordinary course of business with Slavneft Group:


Trade accounts and notes receivable 30

Accounts and notes payable 11

Sales of crude oil for export 110


Sales of refined products 202


Purchases of crude oil and petroleum products 409


Refining fee 129


60

Note 19: Segment information

Presented below is information about Group’s operating segments for the year ended 31 December 2006 in accordance with SFAS

No.131, Disclosures about Segments of an Enterprise and Related Information.

The Group has three operating segments — exploration and production; refining, marketing, and distribution; and oil field services.

Management on a regular basis assesses the performance of these operating segments. The exploration and production segment ex-

plores for, develops and produces crude oil and gas. The refining, marketing and distribution segment processes crude oil into refined

products, and also purchases, sells and transports crude oil and refined petroleum products. The oil field services segment provides

support and maintenance to oil and gas facilities.

The Other segment primarily includes corporate activities. In addition, in 2006, this segment included gains from the disposal of cer-

tain subsidiaries, as is discussed in Note 4.

The operations of the Group as summarized in the segment data provided below are carried out within the Russian Federation, which

is considered as a single geographical segment by the Group.

Exploration Refining, Marketing Oil Field Other Elimination Consolidatedand Production and Distribution Services

Revenues

TNK-BP controlled companies 10,122 12,261 1 25 – 22,409

Third parties 833 8,795 73 4 – 9,705

Inter-segment 8,509 171 923 97 (9,700) –

Less export duties and excise taxes (4,943) (5,005) – – – (9,948)

Net revenues 14,521 16,222 997 126 (9,700) 22,166

Depreciation, Depletion and Amortisation (980) (129) (129) (12) – (1,250)

Interest expense (49) (193) – (9) 41 (210)

Income tax expense (811) (479) (7) (818) – (2,115)

Net Income 3,327 2,155 (56) 1,148 (165) 6,409

Total Assets 18,622 12,076 473 1,954 (11,415) 21,710

Capital expenditures (1,942) (264) (93) (4) – (2,303)

Note 20: Subsequent Events

In January 2007, the Group completed its acquisition of 50 percent of the share capital of Vanyoganneft not previously held by the Group

for USD 485 million. This acquisition will be accounted for using the purchase method. Effective 19 January 2007 the Group consoli-

dated its interests in Vanyoganneft and no longer uses the equity method of accounting.

63

Note 18: Commitments and Contingencies

Economic and operating environment in the Russian Federation. Whilst there have been improvements in economic trends in the

Russian Federation, the country continues to display certain characteristics of an emerging market. These characteristics include, but

are not limited to, the existence of a currency that is in practice not convertible in most countries and relatively high inflation. Further-

more, the tax, currency and customs legislation is subject to varying interpretations, and changes, which can occur frequently.

Gas production and marketing. Russian independent gas producers are currently only able to access the domestic gas transmis-

sion system subject to agreement with Gazprom, Russia's gas monopoly which owns and operates the system.

As of 31 December 2006, the Group’s capitalized costs related to its gas subsidiaries amounted to USD 729 million.

Taxation. Russian tax and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Man-

agement's interpretation of such legislation as applied to the transactions and activities of the Group may be challenged by the rele-

vant regional and federal authorities. Recent developments suggest that the authorities are becoming more active in seeking to enforce,

through the Russian court system, interpretations of tax legislation, which may be selective for particular taxpayers and different to the

authorities’ previous interpretations or practices. Different and selective interpretations of tax regulations by various government authorities

and inconsistent enforcement create further uncertainties in the taxation environment in the Russian Federation.

Tax declarations, together with related documentation, are subject to review and investigation by a number of authorities, each of which

may impose fines, penalties and interest charges. Fiscal periods remain open to review by the authorities for the three calendar years

preceding the year of review (one year in the case of customs). Under certain circumstances reviews may cover longer periods. In ad-

dition, in some instances new tax regulations have taken retroactive effect. Additional taxes, penalties and interest which may be ma-

terial to the financial position of the Group may be assessed in the Russian Federation as a result of such reviews.

No tax provision is accrued when, based on analysis of the current tax law, practice of the tax authorities and court precedents, man-

agement believes that the Group has complied with all tax laws and regulations and the Group’s tax and customs positions will be sus-

tained if challenged. Where management believe it is probable that a position can not be sustained, an appropriate amount has been

accrued in the accompanying consolidated financial statements.Tax audits. The Group is subject to tax audits on a periodic basis. Currently, the Russian tax authorities are conducting audits of in-

come tax and other taxes of Group subsidiaries for the years 2004 and 2005. This process is ongoing and no tax acts have yet been

received by the Group.

During the year ended 31 December 2006, the Group paid USD 1,572 million related to tax claims raised by tax authorities for the

years 2001-2003.

As of 31 December 2006, the Group has recorded a liability in the amount of USD 126 million (RUR 3.3 billion) related to outstand-

ing tax matters.

Oilfield and gasfield licenses. The Group is subject to periodic reviews of its activities by governmental authorities with respect to

the requirements of its licenses. Where appropriate, management of the Group liaise with governmental authorities to agree on reme-

dial actions and resolve any findings resulting from these reviews. Failure to comply with the terms of a license could result in fines,

penalties or license limitation, suspension or revocation.

Environmental liabilities. The enforcement of environmental regulation in the Russian Federation is evolving and the enforcement

posture of government authorities is continually being reconsidered. The Group periodically evaluates its obligations under environmental

regulations. As obligations are determined, they are recognised immediately. Potential liabilities, which might arise as a result of changes

in existing regulations, civil litigation or legislation, cannot be estimated but could be material.

The Group’s estimated environmental liability was USD 168 million as of 31 December 2006. The estimates used by management

include uncertainties about a variety of factors including the extent of necessary remediation, the technology to be used for remedia-

tion and the standards that will constitute an acceptable remediation. As additional information becomes available management will con-

tinue to adjust its estimated provision to an appropriate level. The Group’s environmental obligations could range up to USD 300 mil-

lion.

Legal contingencies.The Group is a named defendant in a number of lawsuits as well as a named party in numerous other proceedings

arising in the ordinary course of business. While the outcomes of such contingencies, lawsuits or other proceedings cannot be deter-

mined at present, management believe that any resulting liabilities will not have a materially adverse effect on the financial position or

the operating results of the Group.

62

Reference Information

64

Auditor JSC BDO Unikon

contact details:

Аddress: 125, bldg. 1, section 11, Varshavskoe shosse

Moscow, 117545, Russian Federation

Рostal address: 125, bldg. 1, section 11, Varshavskoe shosse


Telephone/fax +7 495 319 7290/5909

E-mail: [email protected]

licence:

Number: Е 000547

Date of issue: 25.06.2002

Duration: 24.06.2007

Issuing authority: Department of Treasury RF

Auditor PriceWaterhouseCoopers

contact details:

Аddress: 52, bldg 5, Kosmodamianskaya nab.,


Рostal address: 52, bldg 5, Kosmodamianskaya nab.,


Telephone/fax +7 495 967 6000/6001

licence:

Number: Е 000376


Duration: 20.05.2007

Issuing authority: Department of Treasury, RF

Additional information

“TNK-BP provides a brief overview of the key facts and

Information sheet” figures about the Company. Updated three

times a year.

“TNK-BP Today” a corporate brochure containing a comprehensive

description of the Company’s business.

Company OJSC “TNK-BP Holding”

contact details:

Аddress: 60, Oktyabrskaya str., Uvat Village, Uvat District,

Tyumen Oblast, 626170, Russian Federation

Рostal address: 60, Oktyabrskaya str., Uvat Village, Uvat District,

Tyumen Oblast, 626170, Russian Federation

Telephone/fax +7 495 777 7707/7708

Web: www.tnk-bp.ru

Corporate secretary +7 495 787 9621

Russian media +7 495 745 7846

International media +7 495 363 6580

Shareholders and +7 495 787 9630

analysts

The Management OJSC “TNK-BP Management”Organisation

contact details:

Аddress: 18, bldg. 2, Schipok str., Moscow, 115093

Рostal address: 1, Arbat str., Moscow, 119019

Telephone/fax +7 495 777 7707/7708

Web: www.tnk-bp.ru

Registrar JSC “Ircol”

contact details:

Аddress: 3/4, bldg. 1, Boyarskiy per., Moscow, 107078

Рostal address: m/b 70, Moscow, 107078

Telephone/fax +7 495 208 1515/3434

E-mail: [email protected]

Web: www.ircol.ru

Licence:

Number: 10-000-1-00250


Duration: unlimited

Issuing authority: FCSM

2007

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TNK-BP HOLDING

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