Gulf Keystone Petroleum (OTCPK:OTCQX:GUKYF) is an oil and gas exploration and production company operating in Kurdistan, Northern Iraq listed on the main board of the LSE. What is most exciting about Gulf is its recent transition from explorer to producer. The company started commercial production at the backend of 2013 and the 2014 ramp up is well underway.
To demonstrate the relative value of Gulf, I have compared it side by side to its most potent regional peer, Genel Energy (OTCPK:OTCPK:GEGYF), by isolating valuation metrics based on enterprise value (EV), production (BOPD) and reserves (2P).
|Gulf Keystone Petroleum||Genel Energy|
|Enterprise Value||1,646 mln USD||4,227 mln USD|
|2P Reserves||180 mmboe||453 mmboe|
Genel is considered to be the "grown up" of the two firms due to the size of its operation, experience of its management team (CEO Tony Hayward) and backers (Nat Rothschild). While there are differences between the two companies, it is my opinion that Genel offers a steady guide stick by which to measure Gulf. Genel is a producer that is further up the development path than Gulf; they export oil via pipeline not truck and produce nearly three times the oil and have over twice the proven and probable reserves (2P).
Gulf's share price was at $1.52 (90p) at the time of writing and the EV valuation metrics show that for the current production and reserves that Gulf was valued roughly inline with Genel:
- EV/2P $9.15 vs. $9.31
- EV/BOPD $102k vs. $84k.
It is my thesis that Gulf will continue to be underpinned by current reserves and production with Genel's comparative valuation providing a floor for the share under $1.35 (80p). Any lower would mean trading at a significant discount to Genel - call it a pairs trade if you like. Both companies are in growth phase in Kurdistan; production and reserves are improving and the base valuations will also grow.
- All operators in Kurdistan could fall out of bed on major news that completely changes the operational landscape. Kurdistan is a volatile region undergoing major change; regional elections, Iraqi elections, oil deals with Turkey and Iran etc., etc.
- Genel's valuation metrics could also fall independently and as the regional bellwether drags down comparative valuations.
Gulf's management released an update on 14th May 2014 (link) outlining the end of year (2014) target production rate of 40,000 bopd and an average production rate of 25,000 bopd. That is really quite remarkable given that they only started producing oil commercially in Q4 of 2013. Management has taken time to stress that the wells are drilled, completed and tested, the oil production capacity is there and they now need to bring it online. Gulf has two production facilities online with the bulk of the 16,000 bopd production coming from Production Facility 1 (PF1). Optimization of flowlines already in place on PF1's three operational wells will improve production along with the tie in of two additional wells. PF2 has started to bring production online from one well with two more to tie in.
What enterprise value does production at 40,000 bopd equate to?
As it stands today, the net working interest is 75% being diluted further to ~52% when the government exercises back in rights. Gulf will receive cash payment when dilution occurs - yet unannounced. I shall use 75% working interest since those cash payments would, when received, modify the cash/debt position of the company and also modify the enterprise valuation metrics used for this peer comparison.
Gross production target of 40,000 gives a net working interest of 30,000 bopd. With an EV/BOPD estimate taken from Genel of $80,000 (a little lean given the international average is above $100,000) gives an EV of $2,400mln for Gulf. This EV implies a share price of $2.36 (140p) or a 55% increase from where the stock closed Tuesday. Taking $100,000 EV/BOPD as the base metric and the share price could be closer to $3.00 (175p) or 95% upside.
This ignores production from any of the other four discoveries on three permits and the further development of production above 40,000 bopd - the company is targeting 66,000 bopd in 2015 and more beyond. The producing field is called Shaikan and it has a predicted peak production rate of 250,000 - 400,000 bopd - a truly massive structure and internationally significant.
Looking at the reserve side of the valuation a share price of $2.36 (140p) would imply 2P reserves of 265mmboe taking the $9 EV/2P from Genel. This is a significant increase to the current reserves but consider the following. The Shaikan field has 597mmboe 2P+2C reserves and the 2C will mitigate to 2P as development continues (link). It is worth noting that these reserves are based only on the Jurassic producing horizons and ignores any exploration upside in the Triassic and the unexplored Permian. Furthermore, four of the five discoveries are yet to release OIP and 2P reserves. These unbooked reserves will also add to the current reserves. Let me not drift too far from the point. Reserves are expected to increase and 265mmboe is well within the bounds of expectation.
Once again, the share price seems to be resting on its lows and each time it rebounds inline with Genel's implied valuation metrics or slightly above. This comparative valuation shows the floor under Gulf's share price. I think that as production comes online over the next 6 months and reserve upgrades are announced that Gulf will enjoy a steadily rising floor under its share price looking beyond $2.36 (140p) to $3 (175p) and considerably higher.
Gulf is a production story now valued on 16,000 bopd. Between now and the end of the year shareholders will see if management can deliver on their targets and get the production rate up to 40,000 bopd. If they do then 2015 will start to look very exciting.
This stock is not without risk, Gulf operates in a politically complicated region. Gulf is drilling and producing on difficult geology in a difficult region. Goals have been missed in the past and costs have overrun. This is a high risk play but an exciting one.
Disclosure: I am long GUKYF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am actually long the London listed equivalent security GKP.
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