Background and motivation
In my last articles I have investigated production costs of the world's most important oil mayors (Part I, Part II). Those costs were an average across thousands of oil and gas wells all over the world. Here I want to take a look at production costs of one of the world's booming oil regions: Kurdistan, a country that was called "New Dubai" more than once. To do so, I have investigated production of the two biggest independent companies active in Kurdistan: Genel (OTCPK:GEGYF) and DNO (OTCPK:DTNOF).
Oil is hardly ever produced as pure liquid. Normally it comes as a mixture with natural gas and gas condensate. Although I only consider companies here, that mainly lift oil, they also produce significant amounts of gas. Hence, it does not make much sense to apply costs to the production of oil alone. To deal with this issue the concept of barrel oil equivalent (NYSE:BOE) has been perceived. 6000 cubic feet of gas at standard conditions are about one boe. All costs mentioned below refer to one boe, meaning that are the costs related to the production of 1 bbl of oil, 6000 scf of natural gas or a combination of both. The price for 1 barrel of oil is around $100 (depending on the exact blend),the price for 1000 scf of gas is about $6. This means, oil companies will rather go for 1 boe of oil than for 1 boe of gas ($100 versus $36). As there are also fields that only produce gas, this article tends to underestimate the costs of oil production.
Commonly, costs are divided in costs that can directly be related to production (cost of sales) and costs that cannot directly be related to output (overhead). However, many oil companies are also active in downstream and midstream or other economic sectors [e.g. ExxonMobil (NYSE:XOM) in chemical engineering]. Hence, I have divided sales, general and administration expenses (SG&A) by total revenues and multiplied it with the revenue of the E&P division to get SG&A for E&P. I did the same for any similar type of cost (marketing expenses, R&D) and for financial expenses. Depreciation of assets, on the other hand, can be directly linked to oil production.
Costs of sales are divided into 3 sub-categories:
- Exploration costs
- Lifting costs
- Non-income related taxes
Lifting costs are the costs associated with the operation of oil and gas wells to bring hydrocarbons to the surface after wells (facilities necessary for the production of oil) have been drilled. This figure includes labor costs, electricity costs and maintenance costs.
Exploration costs are costs related to all attempts to find hydrocarbons. This category includes cost for geological surveys and scientific studies as well as drilling costs.
Non-income related taxes: as production of hydrocarbons is such a lucrative business, governments also want to have their shares. There exists an abundance of different model how the state can profit from hydrocarbon production (profit sharing, royalties, etc.).
It might be, that different companies use different categories for the same type of expenses, but eventually the sum of all costs should be their total cost for producing 1 boe.
The following figure shows the pattern of the cost model:
Application on 2 IOCs active in Iraqi Kurdistan
I have applied the cost model for the 2 biggest independent enterprises active in Iraqi Kurdistan: Genel and DNO. While all of Genel's production comes from Kurdistan, DNO got 55% of its production in 2013 from Kurdistan with a rising tendency. There is no other company that got a significant share of its total production from Kurdistan, although Western Zagros is expected to start its production in late 2014/early 2015. Although the Kurdistan Regional Government holds working interest in oil fields (e.g. Tawke), there is no Kurdish NOC. Genel publishes its results in $, while I had to apply a conversion rate of $1 = NOK5.71 for DNO.
The results can be found in the table below:
Implication for the investor
Total production costs are indeed extremely low compared to the costs of the oil mayors, especially when considering the fact that only liquids are produced. DNO's Kurdish production costs are a bit biased as they also include a significant share of Yemen and Oman. The company stated lifting costs for Kurdistan to be $5.3 per barrel of oil. Genel did not pay any taxes in 2013, neither production taxes nor income taxes. The company states in its report, that all tax due has been paid on behalf of the group by the government from the government's own share of revenue. This may also be the reason for the low prices Genel got, but there is no information available in the company's annual report. The tax issue naturally biases the company's production costs, but cannot really change the big picture: Kurdistan seems indeed to be one of the last regions on this planet that is accessible for Western oil companies, where it is possible to produce 'cheap oil' onshore.
There is one downside that can be seen from my calculations: the low realized price for the oil (even if one would add up 50% to Genel). The reason or this lies in the political situation. Kurdistan is still a part of Iraq and relationships between Baghdad and Erbil (Kurdistan's regional capital) are strained. In 2013 most revenues were generated by export to Turkey via trucks, not a very efficient method. To allow for higher export rates and to realize higher prices on the world market, a pipeline was built from the Taq Taq field to Faysh Khabur on the Turkey-Iraqi border, where further connection to the port of Ceyhan is available. Although the first oil was already transported through this pipeline and loaded into tankers, that did not mean an end to the troubles of Kurdish oil producers. This soon became clear, when a Texas judge ordered to seize 1 million barrel of oil on behalf of the Iraqi government. Although the decision was overruled quite soon, the front line between Baghdad and Erbil is clear. Anyway, in the meantime a significant amount of Kurdish oil was sold internationally.
Apart from the inter-Iraq struggles, there is also the danger of the Islamic State. In my opinion, it is only temporary, as it is in no Arabian country's interest to allow the rise of a caliphate. Nevertheless, a further advance of the IS fighters could have harmed all Kurdish oil producers significantly. After the start of the American bombing, the best IS can expect is a stalemate, but further advance is extremely unrealistic. Paradoxically, the advance of this terror group might eventually lead to the independence of Kurdistan, as Western countries are arming the Kurdish Peshmerga forces now. When the immediate threat of IS is finally over, it is questionable whether Erbil still wants to be governed by Baghdad, especially as the Peshmerga seized Kirkuk with its oil fields in June.
In my previous articles I have always emphasized rising production costs that form a natural lower boundary for the oil price, which I estimated to be about $50. It is clear, that production costs from Kurdistan are way below this number. They might even serve to give an estimate for production costs for other Arabian countries where no numbers are available. Nevertheless, to significantly move the oil price Kurdistan's reserves are not sufficient on the long term. According to estimates, Kurdistan (alone without Iraq) would be the country with the 10th largest proven oil reserves. Oil production is expected to reach 2 million bpd in 2019, but with wealth consumption in Kurdistan should also rise (world oil production in 2013: 90.3 million bpd).
Disclosure: The author is long DTNOF.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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