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Oil has been showing signs of weakness in recent months after hitting highs of nearly $140/barrel for Brent earlier this year, and has suffered over concerns about the economic situation in many countries in the coming months. The risk of a global slowdown was just highlighted by poor economic data coming out of China in terms of its GDP growth, which caused a big drop in the Asian markets, but really that shouldn’t have come as a big surprise given all that has been going on and the fact that China is still effectively shutdown to outsiders as a result of Covid protocols, plus of course the fact that this data was delayed until after its leader, Xi Jinping, secured a third term in power. Whilst things look bad currently, with many countries reporting booming inflation and poor economic data (such as the recent manufacturing data for the UK and elsewhere in Europe), the markets tend to be forward-looking and barring any further major unexpected economic shocks, I believe a lot of this is now being factored into the current oil price. The flipside to all of that is that OPEC+ seems very keen to keep prices up at these levels, as seen by the recent production cuts of up to 2 million barrels per day that it has announced, and which are contrary to what Western nations such as the US want to see.
At the same time, the US is continuing to release oil from its Strategic Petroleum Reserve, and which is now close to its lowest level in 30 years, following the release of more than 165 million barrels so far this year in an attempt to keep a lid on soaring prices. That still leaves around 400 million barrels in the reserve, and after the upcoming mid-term elections it will be interesting to see if these attempts to keep fuel prices low continue. Plans have already been announced to start refilling the SPR soon, with a price in the $67-72/barrel range already discussed and, with such a floor being set, I’m not convinced that the price will actually get that low if there is pressure on the US to start replenishing those reserves. These are just some of the factors in play at the moment and obviously we can only guess at what is going to happen in the future, but currently I’m not really seeing anything that makes me think that oil prices are going to drop fast any time soon – especially with the Russia-Ukraine conflict dragging on and seemingly not heading towards any resolution. On that basis, much like when we saw oil prices overshoot to the upside after the post-Covid bounce and similar happening with the prices of shares in oil producers, I think we are now seeing the opposite where there has been fear surrounding the demand for oil in the next year or two of potential economic turmoil, and plenty of profit-taking by those who benefitted from the big gains. On that basis, rather than selling oil stocks now, I can see value in buying decent producers, especially as some of them have almost halved in price since the highs that they hit earlier this year. There is plenty of choice in this sector and most will act as a leveraged play on future oil prices - so what extent will depend on hedging policies, or lack there of - but there are some which I see as more attractive than others, and especially if you are willing to take on some geo-political risk as well.
Gulf Keystone Petroleum (GKP) very much falls into that category, with its shares now trading at just 204p versus a high of 321p as recently as early June, and although the fact that it operates in Kurdistan adds risk due to the dispute between the government there (KRG) and Iraq over policy and revenue when it comes to oil production, that situation has been ongoing for many years and if anything the foreign companies operating there are in a better situation than in the past given the regular payments being made now under production sharing contracts with the KRG. There is of course though always a risk of a proper flare-up of this strained relationship, and although I’d expect intervention from the international community if that were to occur - given that Kurdistan is viewed as autonomous and has its own government - there is never any guarantee, and the finances of the KRG are of great importance when it comes to continuing regular payments for the oil that Gulf Keystone produces. In the past that has been an issue. In my opinion that risk though is already more than being reflected in the current share price and market cap of circa £440 million – last week the company received a $50.7 million net payment for its oil production during June from its 80%-owned Shaikan operation, and currently I see no reason why that won’t continue.
The Shaikan field has been performing strongly, with production up by 3.6% to 45,000bopd gross during the first half of the year, inline with full year guidance of 44,000 to 47,000bopd, and with operating expenses of $2.9-3.3/barrel. The company, plus its 20% partner MOL, is looking to significantly boost that production going forwards as well, and in addition to workovers of its current wells, plus SH-15 coming online, longer term it is looking to implement its latest field development plan for Shaikan, which was submitted in late 2021 and is currently awaiting approval. Should approval be granted this would see phase one of this development take gross production up to the 85,000-95,000bopd level, whilst at the same time finding a solution for the gas that would also be produced, and which includes exporting and selling it, as well as the potential for reinjection, as opposed to the current flaring which the company is aiming to gradually phase out. None of this is going to happen overnight, and even if and when approval is granted for the FDP, implementation of it would still take at least three years not to mention costing anything up to $925 million gross. But it is good to see that the company has ambitions for significant growth in the coming years, and given the fact that it is now debt-free - following the redemption of the last $100 million of outstanding bonds in August - and had $112 million in the bank at the end of August.
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That doesn’t sound like a big cash pile, but to put it into context and show the cash generation that the company is capable of when oil prices are strong, it has also paid out $215 million in dividends so far in 2022 – a very nice yield for anybody invested. Whilst the company continues to generate these levels of cash flow, and until the FDP is approved, I would expect these impressive dividends to continue, even if not to the level recently seen, and they make the shares an even more attractive prospect as not only have you got the potential for your capital to grow over the longer term, in the meantime you will also be receiving a significant income from your investment. As I’ve already mentioned, Gulf Keystone certainly isn’t without risk, both from oil prices as well as the potential for the situation to flare up with the Iraqi government and any potential fallout from that in terms of either production itself, or the regular flow of payments relating to that production. But I also think that the current discount being applied to the value of this company is too high, and I see value in investing at the current share price level of around 204p in spite of the potential risks.
Filed under: Gulf Keystone, DeepVerge, Whitbread, Corero, Scancell, Various Eateries, Cloudbreak Discovery
2022-10-25 15:27:22