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Summary

  • A range of near-term catalysts that are all significant.
  • Current reserves and production underpin valuation around 80p.
  • These catalysts could provide significant upside but not without significant risk.

Gulf Keystone Petroleum (OTCPK:GUKYF, Gulf) is high-risk high-volatility oil and gas exploration and production company with the focus of its operation in the Kurdish region of Iraq - Kurdistan. The security of the company is listed on the main board of the LSE as GKP and also OTCPK in the US as GUKYF. I shall refer to the USD price buit include the underlying pense price also.

I wrote recently about what I consider to be the baseline valuation based on current production and 2P reserves (link); $1.35-$1.70 (80p-100p).

I'd like to demonstrate a range of near-term catalysts that could and should have a significant impact on Gulf. For balance I have attempted to provide both up and downside commentary but I am a shareholder and on balance consider the upside opportunity to outweigh the downside.

This list is by no means complete but outline the key events on my watch-list:

  • Akri-Bijeel Reserve Upgrade
  • Shaikan PF-2 Production
  • Payment for Shaikan Exports
  • SH-7 Drill Result
  • SA-3 Drill Result
  • Changes to Field Ownership

Catalyst: Akri-Bijeel Reserve Upgrade
Timeline: End of April 2014 (Overdue)

The Operator MOL is due to submit its Field Development Plan (NYSE:FDP) to the Ministry of Natural Resources (NYSE:MNR) for the Akri-Bijeel and Bakrman discoveries (link). MOL will be updating the current OIP and reserve numbers associated with these assets of which Gulf have a 20% working interest (12.8% diluted working interest). Gulf's own auditor current attributed 371mmboe to Bijeel with 5mmboe 2C reserves net to Gulf.

  • Upside - MOL have stated that the current Gulf estimates are out of date and very conservative. Given that they intended to spud 6 development wells this year and to have production exit rate for 2014 of 10,000 bopd and more beyond I would hope these numbers to be significantly improved.

    My own working estimates are currently 2,000-2,500mmboe gross OIP. 12-25mmboe 2P and 25-50mmboe 2C reserves net working interest to Gulf. 5% to 15% upgrade in 2P reserves could be possible not mentioning further upside as development and appraisal continue.

  • Downside - The FDP could be delayed, development could be dragged out, Gulf's share of costs could blow out and a cash squeeze put on the company but from a reserve upgrade perspective the downside is limited since the reserves declared currently are low.

Catalyst: Shaikan PF-2 Production
Timeline: April/May 2014

Gulf has a stated production target rate of 40,000 bopd by the end of 2014 and that requires 2 production facilities (PF1 & PF2) that are fully operational and running at name-plate capacity of 20,000 each. PF-1 is currently at 16,500 bopd. PF-2 is undergoing commissioning for quite some time but production has been telegraphed to start shortly and to ramp up in a steady fashion to take Gulf past the 40,000 bopd target rate.

  • Upside - I believe that the current valuation is underpinned by current production and that the market has no faith in the stated production targets being met on time and on budget. The market has been told 40,000 by the end of the year. It is key that management get this facility online, on time and on budget. This catalyst will spawn other further catalysts; 5k, 10k, 15k, 20k bopd production milestones, further well tie ins etc. Each one would demonstrate a well-managed scale up to 40,000 bopd and would build confidence regarding future production growth. That confidence should be reflected in the valuation of the company. I believe that based on 40,000 bopd future production that the current valuation is unvalued by 30-40% but the market needs to see solid progress.

  • Downside - If PF-2 is delayed then the end of year target will be pushed out and disappointment will continue. The valuation will continue to only reflect the current production and not production growth. The financial planning will all shift requiring more debt or fund raisings to develop Gulf's assets since current plans rely on some degree upon increasing revenue from production. It cannot be overstated how key PF-2 and the production growth is to Gulf's future.

Catalyst: Payment for Shaikan Exports

Timeline: unclear

Gulf started trucking crude to Turkey in December 2013 and my understanding is that 5 tankers full of Shaikan crude have departed Turkey and more are being tendered to market. Regardless of the specific shipments we do know that Gulf expects to be paid inline with the terms of its Production Sharing Agreements (NYSE:PSA) by the Kurdish Regional Government (NYSE:KRG) and no confirmation of payment yet. Others have a more detailed understanding of the PSA but I haven't confirmed the payment details myself so I shall make no statements regarding timelines.

This is not a unique problem for Gulf; other operators have shipped crude via pipeline through Iraq and payments from Baghdad have and do prove problematic. Others now ship crude via a 2nd pipeline going north direct to Turkey but that crude is currently stored and not being marketed whilst the politics are worked out - no payment again. "Route to market" including timely payment is a significant impediment to operators in the region.

  • Upside - The entire Kurdish oil industry would rally hard on clarification of route to international market and payment. Investors, pundits, operators and importantly the people of Iraq have waited a long time and the Iraqi elections could bring things to a head.

  • Downside - The recent elections could bring things to an apparent head and the regional players could just kick this can down the road again and one of the most significant impediments to investors in this region will persist as will the market discount applied to the regional operations.

Catalyst: SH-7 Drill Result

Timeline: Q2 2014, June.

The current 2P reserves are based on only Jurassic producing horizons and SH-7's goal to drill the unexplored lower Triassic and Permian horizons. It was spudded in June 2013 and is expected to be at target depth soon.

  • Upside - Has the potential to add to current OIP and potential reserves on Shaikan if they have any success in the lower horizons.

  • Downside - Like all oil exploration there is the chance that the well finds nothing. There is the chance the well finds something but that something is not commercial. There is also the chance that operationally the well fails to yield any results due to some complicated reason. The geology offers a number of challenges to drillers and this is a high risk industry.

Catalyst: SA-3 Drill Result

Timeline: unclear - at current drilling rate it could reach target depth mid-June 2014 but that's my own estimate not the company's.

Spudded in December 2013 with the intention of appraising Jurassic targets and evaluating the Triassic also. At last report the drill was at 2,240m in the Jurassic. Currently reserves booked for Sheikh Adi field at 2,256mmboe gross OIP and 127mmboe 2C net to Gulf - no 2P.

  • Upside - 80% net working interest means that any increase in OIP, the recovery factors, the 2C reserves or booking of new 2P reserves would significantly increase the baseline valuation of Gulf. 25mmboe 2P would increase Gulf's 2P reserves by ~15% for example. 25mmboe 2P is not massive given the OIP is already at 2,256mmboe. If you use the recovery factor from Shaikan and back the net working interest and the conservative 2C/2P split from the recent CPR report you can see numbers like 50mmboe 2P and 100mmboe 2C without any increase the OIP - exciting prospect indeed.

  • Downside - The same as SH-7. The well could fail, it could find nothing, it could find data that actual challenges the current understanding of the SA field. It could be a total failure and a waste of money. That's the oil business at heart.

Catalyst: Changes to Field Ownership

Timeline: Overdue

The MNR have the right to back in other operators into the Shaikan and Akri-Bijeel assets. The fully diluted working interest of which is well known. The back in rights (BIR) for Shaikan was supposed to have been announced by now but it's widely accepted that the announcement could be delayed as Gulf have given a degree of flexibility in the interest of a strong working relationship with the MNR.

These BIRs are significant for 2 reasons; cash and new blood into the development. Any 3rd party backing in needs to pay a portion of the development costs to date and their share of development going forward. The development of Shaikan to phase 1 is ~$700mln USD (or thereabouts) and full development many more times that. So these rights, the payments and importantly which major, independent or state oil company would be joining is of huge significance.

  • Upside - Cash to assist with development of assets and any major buying into these assets lends further support to any valuation attributed to Gulf's assets.

  • Downside - No cash coming to Gulf beyond oil sales and forced to cover all development costs alone.

Conclusion

It's never boring being an investor in Gulf or the Kurdish region of Iraq. Let's see what the next 1 to 7 months bring. It's my belief that by the time a lot of this shakes out the days of $1.70 (100p) valuation will be long behind investors. Growing production with significantly increased reserves valued at international prices will support a share price a good deal higher then it is today.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

Source: Gulf Keystone Petroleum: Near-Term Catalysts

Additional disclosure: I am actually long the LSE listed security GKP.