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Gulf Keystone – a positive end to a difficult week

By Ben Turney | Saturday 14 June 2014

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.

A difficult week for Gulf Keystone’s (GKP) shareholders finished off with what looks like a positive production update concerning the company’s prolific Shaikan license in Kurdistan. Yesterday, I spoke with the company to confirm a few facts surrounding the latest RNS. In particular I wanted to seek clarification concerning the issues I raised a month ago about the discrepancy between Gulf’s CPR production target for 2014 and the targets the company has since provided, after a few months of operations. In short there has been a reduction in expectations, but this isn’t necessarily bad news, as I explain below. The main point I took away from my conversation was that the company genuinely believes it is on course to deliver its 40,000bopd production target by the end of this year.

This is the first time I have spoken directly with Gulf. It’s only a stock I became interested in, once the company released its CPR and a significant number of exasperated shareholders gave up and sold out.

There are two points to make about those events in March, which led to a dramatic decline in Gulf’s share price. First, as is nearly always the case, when too many people publicly expect something to happen in the market it nearly never occurs. Second, and much more positively for Gulf as a target to put money into, the release of the CPR gave us all some figures to base an investment decision upon. Gone were the fantasy numbers and rumours bandied around for years, to be replaced by a clear benchmark against which we could judge performance.

Moving back to yesterday’s conversation, I wasn’t entirely certain how well my call would be received. As you are probably aware, one or two of our editorial team are not fans of Gulf (putting it mildly!). It seems whenever we talk about Gulf the words “basket” and “case” inevitably make it into the conversation.

I appreciate a lot of the criticism aimed at Gulf, but this is a company, which started life as a minnow and ended up with one of the most exciting oil discoveries of recent times, anywhere in the world. Yes, the company is carrying a lot of debt (and will have to take on more) and yes CEO Todd Kozel earns far too much (and is probably lucky even to be in a job), but behind all of this is Shaikan.

The original CPR for Shaikan estimated that gross annual production for this field would average 25,000bopd in 2014. It is now clear the company isn’t going to make this target. The obvious implication of this is what this means for Gulf’s financial model.

April’s debt funding package was expensive and reflected the market’s concerns about the risks involved in Gulf’s Kurdish operations. We know that Gulf is going to have to come back to market (probably in early 2015, by my guess) to raise the next lot of capital it needs to fund the stage of development following the current one. The question for investors is, if Gulf fails to meet its original goal, will the company be able to demonstrate sufficient operational progress by the next time it passes round the begging bowl, that it can persuade a sceptical market of genuine value?

There are likely to be two factors, which will have the greatest bearing on answering this question. First, of course, will be the increased production rate at Shaikan. On this, Gulf looks reasonably secure. In its words “development plans to increase Shaikan production capacity to 40,000 gross barrels of oil per day ("bopd") by year-end 2014 are on track”. Assuming Shaikan is producing 40,000bopd by the start of 2015, then I imagine sentiment towards Gulf’s stock will improve greatly.

The second factor concerns money, specifically payments received by Gulf for oil sold. It is worth mentioning that the company confirmed to me that it is fully funded through to the 40,000bopd target. No-one expects Gulf to be self sustaining. It is far too early in the life of Shiakan to expect that. However, it is imperative that Gulf demonstrates it can set up, what it calls, “a steady payment cycle”. It is too early to judge the extent to which Gulf has been able to establish this, but news yesterday of the payments received has to be a step in the right direction.

On Thursday, I called Gulf as a buy at 75p, in response to an overreaction to the crisis in northern Iraq. This is certainly a risky gamble, as who knows what is going to happen next there. Yesterday, Gulf closed at 81.5p, but, on a fundamental basis alone, there is a growing argument that this price could act as a floor for this loved and loathed stock.

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