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Gulf Keystone; fighting for survival or negotiating well?

By Ben Turney | Tuesday 10 February 2015

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

If there is one topic guaranteed to start a row at ShareProphets HQ it is Gulf Keystone Petroleum (GKP). We all know who is on which side and so far I’ve been fighting a losing battle. The collapse in the oil price has hurt this company, but possibly not as much as the specific challenges it faces in getting paid for the oil it produces (oh, and let’s not forget the rampaging nutters currently marauding through the region). On Friday, Gulf disappointed the market with news it had suspended oil exports, pending resolution of a “stable payment cycle”. The share price dropped sharply to settle just above the 52-week low, but are things as bad as the market implies?

Despite the decline in Gulf’s share price, the last six months or so have witnessed a marked improvement in the company’s management and operational delivery. CEO John Gerstenlauer has provided a much-needed breath of fresh air. In adopting a far more transparent communication style, he has deservedly won much praise, especially considering the well-documented problems of his predecessor, Todd Kozel.

Crucially, Mr Gerstenlauer has also matched his words with actions. He met his first major operational target, as Gulf reached the 40,000bopd production target last December. After years of broken promises and spurious hype, it was unfortunate for Mr Gerstenlauer and the company’s shareholders that this coincided with the recent lows of oil’s bear market.

Unable to rest on his laurels, market conditions have worsened significantly and it is clear that Mr Gerstenlauer now faces an even more challenging period than that he experienced last year.

There is no doubt that Gulf possesses a world-class oilfield. Shaikan is an asset that would sit proudly on any company’s balance sheet, but its shine is diminished by the material uncertainty that surrounds the company’s funding and the region’s security and politics.

Although not the only issue, the most pressing is clearly the ability of Gulf and its producing peers in Kurdistan to get paid for oil they export. Without a clearly defined and adhered to payment cycle there is little point in producing tens of thousands of barrels of oil per day.

As much as it was important that Gulf hit its 40,000bopd target at the end of last year, maintaining that level of production today is less significant. Clearly recognising this, it looks like Mr Gerstenlauer and Gulf have taken a prudent step in suspending trucking operations to supply the export market.

Switching the sales emphasis to the significantly lower margin domestic market helps cash flow in the short term, but has a second positive impact as well. Gulf has consistently reported that discussions with the Kurdish Regional Government and Ministry of Natural Resources have been cordial. This is all well and good, but there comes a point when pleasant conversations have to give way either to cash payments or hard words.

Rather than go into nuclear mode, it looks like Mr Gerstenlauer has adopted a more nuanced negotiating stance. Temporarily suspending export operations will focus Kurdish minds, if nothing else. With a war to fight and financial support yet to come from the Federal Government of Iraq, it doesn’t take a genius to work out that the KRG needs funds.

Although Gulf has been hopeful of a resolution to the payment cycle problem for a while, this latest move could be the catalyst for results. However, assuming it is, this is not likely to be a simple end to the matter.

Much is going to depend Gulf receiving payment for monies owed.

In Friday’s RNS, Mr Gerstenlauer said he expects “to receive payment for all past and ongoing oil sales from Shaikan”. With the best will in the world, it is understandable why the market might not share his optimism.

Whatever the case, it is clear that Gulf now needs to manage its finances extremely carefully. Mr Gerstenlauer has already said the company is taking a “prudent approach to its capital expenditure in 2015”. This almost certainly means that plans for reaching the company’s next major operational target of 60,000bopd are on hold.

While some might be disappointed with this, all shareholders should pay attention to the implications for the company’s bonds.

Speaking with Waseem Shakoor yesterday, the earliest maturity for Gulf’s 13% bonds is April 18th 2016. Even though these currently trade at a level just above Afren’s (AFR) there are no immediate concerns of default. This is positive and means Gulf still has some time to resolve matters with the KRG.

A possible bump in the road ahead might come in April this year, when Gulf will have to make a $26million payment on its bonds. With cash and cash equivalents of $177million on August 26th 2014, making this bond payment shouldn’t be problematic, even taking into account the increased operational spend to meet December’s milestone. However, it will take a chunk out of the company’s balance sheet. The release of the annual results, just before this payment is due, is well timed and will help shareholders assess the risks.

At 46p, Gulf isn’t quite priced to fail, but the market is highly uncomfortable with the uncertainty. As Waseem said yesterday, the bond market is sending out a loud and clear message that it doesn’t currently expect to redeem Gulf’s bonds at par. If the situation doesn’t improve over the coming months, this could pose problematic for the company when it comes to raise money. We know it is going to have to raise money, but there are now questions as to when this might be, in light of the apparent changes to the development plan.

Mr Gerstenlauer has his work cut out in the coming months, but if he is able to maintain his good run of form there is every chance he will ensure his company safely navigates through these tricky waters.  I note that TW disagrees strongly in today's Bearcast and flags up the bond valuation relative to Afren bonds. His bearishness on Gulf is, to date, 100% vindicated but maybe one day the worm will turn

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