Genel Energy & Gulf Keystone Petroleum - buys despite the risks? Gary Newman reviews...

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Looking at the share prices of the two London listed Kurdistan oil producers, Genel Energy (GENL) and Gulf Keystone Petroleum (GKP), they seem totally disconnected with what the companies have achieved operationally. But the situation is far more complicated than it appears at first glance and when considering daily production levels and amounts of free cash flow that both companies generate. This is nothing all that new, but with oil prices having remained strong now for some time, it really makes these two companies stand out as not having tracked the upwards price curve as you might expect. Although both have seen spectacular recoveries since the Covid lows, as have pretty much all the other producers out there.

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Genel is currently producing a little over 29,000bopd, and with 2023 guidance set at 27-29,000bopd; had net cash of around $221 million at the end of last year; generated free cash flow of $233 million last year; and paid out $50 million in dividends, equivalent to $0.18/share. This is versus a market cap of £343 million. Gulf Keystone looks even more impressive, with average production of over 44,000bopd in 2022, and averaging 47,800bopd so far this year; net cash of $151 million and with no debt; and with a staggering $215 million in dividends paid out in 2022 ($415 million since 2019), equating to a yield of around 41%, and with an interim dividend of $25 million payable on March 3 – although we will see more of the future free cash flows diverted into the development of the Jurassic reservoir at Shaikan, assuming the field development plan gets approved. All of this comes at just a slightly higher price than Genel, with a market cap of £429 million. I think it would be hard for anyone to argue that the market caps of both companies aren’t far too low when you consider the fundamentals, even allowing for that both are very dependent on a small number of assets for their entire cash flow – just the Shaikan field in the case of Gulf Keystone which it owns 80% of.

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Even looking at the debt of Genel – Gulf Keystone doesn’t have any – and the October 2025 maturity bonds, these are trading at around 97% of par, which although lower than they were a year ago when they were closer to 103%, is still hardly suggestive of any concerns that the company won’t be able to repay or refinance this debt as it comes due. The sole factor here in why these companies seemingly trade at such a discount is the geo-political risk relating to payments from the Kurdistan Regional Government, whom the production sharing agreements are with. Again, that is nothing new and has been going on for years, including periods where payments have been missed and money being still owed relating to those historical payments which never happened at the time. That situation had improved greatly, and although payments are still a good few months in arrears, they have been being made regularly and the money owed from in the past had been repaid. What appears to be spooking the markets at the moment though is that the relationship between the KRG and Iraqi government has deteriorated badly recently and shows little sign of improving, and a knock on effect from all of that could be further delays to the oil payments once again – although Genel has just received $31.4 million for August 2022; and Gulf received $49.5 million shortly prior to that, also relating to last August.

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At the end of January, the Iraqi Federal Supreme Court ruled that recent payments made to the KRG as part of the federal budget were actually illegal, and it didn’t help that this was in direct contrast to orders given by the government, and means that around $250 million that was due to be sent to Erbil for last November and December won’t be paid, for the time being at least. Even more worrying potentially for oil companies operating in Kurdistan is the fact that the court specifically sited that the reason for blocking these payments is due to the KRG directly selling its crude production, via the PSCs in place, rather than it being sent to the Iraqi Federal Government, as per the 2021 agreement between the two governments, and the court ruling made back in February 2022. Currently it is hard to see an easy resolution to this dispute, as oil exports are the biggest source of income for the KRG – and exported via a pipeline to Turkey, completely missing out Iraq - but it is also heavily reliant on a portion of the federal budget. The ruling makes budget transfer orders from the previous PM al-Kadhimi, along with those from the new PM al-Sudani, illegal. This complicates things even more, as al-Sudani is reliant on the support of the Kurdish Democratic Party, and its 31 seats in parliament, when it comes to having a chance of pushing through any of his policies, and if the support of the KDP was withdrawn, it would make it difficult for his government to carry out any of its planned reforms for the country. Even more so given the fact that before forming his government, he struck a deal with the KDP, that included ending the disputes over sharing oil revenue and budget transfers to Erbil.

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Such are the concerns as to how this will all ultimately play out, Genel has already announced that it will be cutting investment until the future is clearer, in terms of regular, on-time payments being made, and Gulf Keystone is also keeping a close eye on things in terms of its current capex commitments and the possibility it could cut those if the situation deteriorates further. For Genel, things are complicated further by the fact that it launched international arbitration proceedings against the KRG for breach of the terms of the PSCs for the Bina Bawi and Miran gas fields, after the KRG failed to approve its development plans and then terminated the agreements. So, taking all of this into account – and especially in the case of Genel given its legal action against the KRG – it is much easier to see why shares in these companies appear to trade at such a big discount to fair value based on the assets and balance sheet alone. But despite all of this, I would still view both companies as Buys currently, with Genel trading at around 123p and Gulf Keystone at 198p, as I think this risk is being fully priced in, and maybe more as well – and especially with Gulf when you consider that in just three years it has returned close to its current market cap in dividends, and one of those saw oil prices very low during Covid! There is of course risk, as any sort of further delay to payments as a result of the government dispute would have a serious negative impact on the share price I would guess, even though the market clearly already sees it as a risk. The same goes with any revisions to the PSCs which see Iraq getting involved and likely worse terms than the current ones for the independent oil companies. But the flipside of that is that for both Iraq and Kurdistan to prosper, there needs to be an agreement, and the Iraqi government is very keen for that to happen and seems unlikely to force the issue on oil exports coming through them, rather than direct to Turkey, despite what the court has ruled. What is clear is that neither side will do well under the current situation – al-Sudani will be hampered in delivering any policy and getting it through parliament, whilst the KRG won’t receive the federal payments that it needs. So, I think there is also just as much chance of an agreement being reached, and if that were to happen I see substantial upside in the share prices based upon that alone. They’re certainly two companies that I’m watching closely and am tempted to take a longer term position in.

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Filed under: Genel Energy, Gulf Keystone Petroleum, Versarien, Angling Direct, MGC Pharmaceuticals

2023-02-22 15:29:49

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