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I try and guide my investing decisions with one basic approach. There are several ways that I think about this approach. And each way of thinking is a concept I’ve borrowed from a well-known investor.

It goes like this:

  • From Warren Buffett: Rule No. 1 is don’t lose money. Rule No. 2 is don’t forget rule No. 1.
  • From former hedge fund manager Mark Sellers – Focus on the downside first; let the upside take care of itself
  • From hedge fund manager Monish Pabrai – Heads I win; tails I don’t lose much.

I want to invest in situations where, if everything works out, I make a lot of money. More importantly, though, I want to invest in situations where, if nothing works out, I don’t lose a lot of money.

As I’ve detailed in recent months I think I’ve found such an opportunity in unconventional resource companies that trade below the value of their booked reserves, but also have huge upside through their undeveloped land holdings. The value of the booked reserves provides me with downside protection. The undeveloped acreage and technological innovation provide me with a lot of upside potential.

I do a pretty good job of sticking to this approach. But every once in a while I get tempted to try and chase a higher risk idea. After all, I’m only human.

You Don’t Find New Onshore Billion-Barrel Oil Fields Every Day

We aren’t running out of oil. But we are certainly running out of giant onshore conventional oil fields that are inexpensive to produce. These days any large oil fields that are found generally have a couple of miles of ocean water sitting on top of them. Obviously finding oil under all of that blue stuff isn’t easy, and it isn’t inexpensive.

I’ve been looking at one company sitting on a multibillion-barrel oil field that has a market capitalization that doesn’t reflect it. I’m not the only one looking at this company. Rumors have been swirling that Exxon Mobil is getting ready to make an offer to buy it.

The company is Gulf Keystone Petroleum (OTCPK:GUKYF). Let me explain why this company tempts me.

Gulf Keystone Petroleum has interests in four main oil licenses in Kurdistan:

  • Shaikan – 51% ownership
  • Sheikh Adi – 80% ownership
  • Ber Bahr – 40%
  • Akri-Bijeel – 13%

GKP’s venture into Kurdistan is recent and very successful. In 2007 GKP was awarded production sharing agreements for the Shaikan and Akri Bijeel fields (in 2009 GKP was awarded Sheikh Adi and Ber Bahr). In 2008 GKP obtained 2D seismic data on Shaikan. In 2009 GKP drilled its first exploration well into Shaikan and found an elephant (major discovery).

Just How Much Oil Are We Talking About

Independent reservoir engineering firms have estimated that Shaikan’s oil in place is 8 billion to 13 billion barrels.

GKP owns 51% of this, so if we take the middle of that range it means that GKP controls 50% of 10.5 billion barrels (5.25 billion) in the Shaikan field.

I’ve read a few analyst reports on GKP and the general consensus is that 20% to 35% of this oil can be recovered. I’ll take the middle of that range and assume that 27.5% of GKP’s 5.25 billion barrels of oil in place can be recovered.

That would equal 27.5% x 5.25 billion = 1.44 billion barrels.

The market capitalization of GKP in dollars is just over 2 billion. That means that at the current share price investors are paying just over $1 per barrel of recoverable oil.

And remember this is onshore easy to produce conventional oil. Lifting costs are estimated by GKP management to be somewhere around $3 per barrel. Do you think an oil company could make some money with this oil field and oil prices around $100?

Not surprisingly, the UK newspaper the Independent reported that Exxon (NYSE:XOM) is weighing a bid for GKP. What got my attention that the rumored bid price is more than four times the current share price. I guess such a premium isn’t outrageous when one considers that my numbers above don’t even factor in the other three oil fields that GKP has an interest in, each of which have billion-barrel-plus potential.

Where is the Downside Risk?

Why is GKP a potential violation of Rule No. 1 (don’t lose money)? Because there is political risk. Not necessarily the physical risk presented by the violence in the region, but because the contracts that are signed for the licenses are actually with the Kurdistan and not Iraqi government. Baghdad has threatened in the past that these licenses are not valid.

My ability to evaluate how much risk this actually presents is limited and will likely keep me from taking more than a small (if any) position in GKP. But taking a larger position sure is tempting with potential for a buyout at a large premium happening any day.

Investing is never easy. Even when you find something that is obviously cheap, there are is usually a string attached.

Source: Gulf Keystone Is Sitting On Billion-Barrel Onshore Oilfields