Genel Energy: ISIL At The Gates

| About: Genel Energy (GEGYF)

Summary

The Islamic State of Iraq and the Levant has been operating near Genel Energy's operations since beginning 2014.

Fighting continues in Mosul, less than 50 km away from the company's oil fields.

The stock price has been hit by the oil price downturn and a $1.16 billion writedown for lower reserves than expected in the Taq Taq field.

Its financial position remains strong, with a debt-to-equity ratio of 0.25 and $400 million in cash. The regional government owes Genel Energy more than $700 million.

The Miran and Bina Bavi gas fields could produce 20% of Turkish gas consumption. Turkish company Bilgin Grup Dogal Gaz has acquired a 15% stake in Genel Energy.

Pessimism has invaded Genel Energy (OTCPK:GEGYF), and recently, in January 2017, the company has tested its lows. From 1100 pennies in January 2014 to the current 75, it has seen a 96% decrease in three years. In our view, the company is oversold, and the full outlook of the company, although difficult, is not as gloomy as the stock price is making it seem nowadays.

Let's start with the main factors feeding the gloomy feeling. Several consecutive shocks have hit Genel Energy since the beginning of 2014:

  • The ISIL expansion, taking Fallujah in January and Mosul in June 2014, nearly 50 km from Genel Energy's oil fields.
  • The oil price downturn of mid-2014, which hit the company as hard as it did the sector itself.
  • Then, the company cut the reserves estimate for the Taq Taq field by almost half.
  • And on top of that, the Federal Iraqi Government and the Kurdistan Regional Government had political frictions. An interruption of the oil payments to Genel Energy followed, resulting in a $700 million debt.
  • The outstanding payments led to a decrease in Genel's capex expense, ensued by a global decline in production.

In addition, if the war with ISIL were not enough, the Turkish pipeline was bombed in February 2016, causing a three weeks' cut, which contributed to feeding the gloom.

Source: Genel Energy

In our opinion, the company is oversold, and the outlook, although difficult, is not as depressed as the stock price reflects, for a number of reasons:

  1. The financial position of the company remains strong.
  2. The Kurdistan Regional Government has paid all the invoices for a year now.
  3. The Kurdistan Regional Government is paying the historical receivables. The quantity paid is 5% of the gross amount received for the oil.
  4. The Taq Taq and the Tawke fields are still in production and the pipelines are open. In the last year, the export pipelines have operated more than 90% of the time.


    Source: Genel Energy
  5. Genel Energy has even discovered more oil.
  6. The Miran and Bina Bawi gas fields have more than 10 tcf of raw gas. The Kurdistan Republic Government is interested in developing the fields, as is the Turkish government, which will diminish Turkish dependence on Russian gas. Genel Energy and the Regional Government have confirmed the terms of the Production Sharing Contracts and the Gas Lifting Agreements, which is a considerable advance for the project.

Infrastructure, Situation and Global Status

The Tawke oil field is close to the Turkish border, and the Taq Taq field is 300 kilometers away. Two pipelines connect the fields to Ceyhan, Turkey. ISIL has controlled Mosul since mid-June, which has neither affected the oil field operations nor the pipelines joining the Kurdistan Region with Turkey.

One of the main consequences of the war in Syria is the presence of more than two million refugees in the Kurdistan region. This extra population load befalls in the Kurdistan Regional Government budget. Furthermore, because of the war with ISIL, military spending has increased since 2014. At the same time, oil price started to decline, adding more pressure on the government because of the enormous dependence on oil income. All this would explain why the regional government has delayed the entitled payments.

The situation has improved now. The federal Iraqi forces are pushing back ISIL, and oil price, although still low, has increased from the lows seen in January 2016.

Regarding refugees, the situation remains critical. A political solution (peace treaty and return of the refugees home) does seem feasible in the short term. Allow me to remark one positive aspect: the political approach followed by the Kurdistan Government with regard to the refugee crisis is an example governments of the so-called developed world can follow.

Financial Position and Valuation

Genel Energy's financial position remains strong. The company's debt-to-equity ratio is only 0.25 - better than that of most of the E&Ps or integrated oil companies. Only TransGlobe Energy (NASDAQ:TGA) has a better ratio. For instance, Genel Energy's ratio is more than twice lower than that of BP Plc (NYSE:BP), not to say Apache Corp. (NYSE:APA), which has a five times greater ratio than Genel.

Source: Author's calculation. Comparison of debt and price-to-book ratios of Genel Energy with those of several oil companies

Moreover, Genel Energy has $405 million in cash. Its net debt is $240 million, which makes for a net debt-to-equity ratio lower than ten percent - the best ratio of the six oil companies analyzed, with the exception of TransGlobe Energy. Genel Energy management was speaking in the last KDI conference to invest in the gas assets, and we can believe the management team.

It is important to note that the company has $412 million of receivables from mid-2014. Prior to mid-2014, Genel has historical receivables for $300 million, which are not recorded on the balance sheet. So, basically, the KRG owes Genel Energy over $700 million.

If we look at the price-to-book ratio, we see how cheaply Genel Energy trades. Again, when compared with its peers, it has the best ratio. Twice better than Bellatrix Exploration (NYSE:BXE), the company with the second best ratio. 27 times better than Apache, and 10 times better than Suncor Energy (NYSE:SU), a magnificent company that is operating at a profit with current oil prices.

Source: Genel Energy

Taq Taq and Tawke oil fields: Genel Energy's revenues

These two oil fields are the main source of revenues for the company. From June to November, Genel Energy has received around $100 million. We consider this estimation is valid for the last half of 2016. (The company has not reported the December payment yet, albeit it will be, in high likelihood, similar to that in November.)

Source: Author's calculation, from Genel Energy's press releases

Genel Energy has received $20 million of historical receivables in the last six months. The payment proves the bona fides of the government, which has compromised to increase the delayed payments once oil price recovers.

Source: Genel Energy

The Kurdistan Region Government has interest in honoring its obligations because it wants to attract capital to the region. Since mid-2015, production has been decreasing because Genel hasn't been making investments. In addition, the Kurdistan Region Government needs to generate enough confidence to attract capital. For the same reason, Genel Energy, as contractor of the gas fields, would be in better financial shape and would attract possible partners and capital.

In our opinion, the Kurdistan Regional Government will follow this route. In fact, it has already been paying the delayed receivables for a year now.

2017 Earnings Estimate

In this section, we estimate Genel Energy's earnings for 2017. The following assumptions have been made:

  • Brent will trade at $55.
  • Oil production will be 32.2 mboed. This is in the middle of Genel Energy's estimation, which was 35-43 mboed.
  • The company will receive $35 million in cash from the historical receivables.

Source: Author's calculations

Genel Energy will receive $200 million for 2017 oil entitlements and $40 million for historical receivables.

Oil price sensitivity study

The table and pictures bellow present the sensitivity study results. As can be seen, Genel Energy would see benefits with Brent at $60-70.

Source: Author's calculations

Source: Author's calculations

Miran and Bina Bawi gas fields

The gas fields are the main assets of Genel Energy, which has a 100% interest in both fields. The development of these gas fields represents a win-win situation for the Turkey and Kurdistan Region governments:

  • Turkey will get 20% of their gas consumption of these fields, while avoiding exposition to Russian gas supply.
  • The Kurdistan Region will get important funds from sale of the gas.

Moreover, having commercial relations will help to stabilize the region. People who do business together and are benefited from it are reluctant to have instability and war.

Since 2014, the Kurdistan Region and Turkey have been speaking about plans to develop gas fields. Two factors would indicate that now the project is going ahead seriously:

  • First, Turkish gas company Bilgin Grup Dogal Gaz has bought 15 % of Genel Energy, which is the exclusive contractor for both gas fields.
  • Second, the Kurdistan Region Government and Genel Energy have confirmed the Production Sharing Contract and Gas Lifting Agreement terms. According to the terms, Genel Energy will receive a fee of $1.2 per thousand cubic feet, with a stipulated production of 1200 mmscfd.

The previous facts indicate that the project is going ahead, what would be a major breakthrough for Genel Energy.

In addition, the company has several exploration assets in the Kurdistan region, where it has found oil, as well as in Morocco and Somaliland.

Source: Genel Energy

Risks

Oil prices: The company's earnings depend on oil prices. An oil price decline will reduce Genel Energy's revenues.

Geopolitical unrest: The main activities of Genel Energy take place in the northern area of Iraq. There are two main risks in the area - the presence of ISIL and the war in Syria - which destabilize the region.

Historically, an important number of wars have affected the region. No less than eight wars have affected it in the last 50 years, including one civil war between Kurdish factions. In the last ten years, only three have been without conflict here.

Summary

Genel Energy has received three important shocks that have led to a pessimistic view of the company: the presence of ISIL near its operating region, the oil price drop and the diminution of the Taq Taq oil field reserves, which has erased $1.16 billion from its balance sheet.

Although difficult, the company's outlook is not as depressed as the stock price reflects, and there are several positive aspect to mention:

  • Genel's financial position remains strong.
  • The Regional Government, albeit slowly, is paying the delayed entitles.
  • Production in the two oil fields continues. Moreover, the company has discovered some oil.
  • In addition, Genel Energy has made significant advances in the development of the two enormous gas fields.

All these factors, together with the reduced price of the stock, lead us to conclude that the risk-reward balance, although on the adventurous side, is acceptable. Genel Energy, for us, is a buy.

Disclaimer: Genel Energy is not a Ben Graham's widow-and-orphan stock.

Disclosure: I am/we are long GEGYF.

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.

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