Gulf Keystone Petroleum, an interesting Kurdistan oil play but not for Contrarian Investor Uk at this price

Gulf Keystone (GKP) is an oil exploration company which was founded in 2001 and first listed on AIM in 2004. Its primary focus and assets are in the semi-autonomous region of Kurdistan in Northern Iraq, following the planned disposal of assets in Algeria.

Assets
In November 2007 Gulf Keystone secured interests in two production sharing contracts in the Kurdistan Region of Northern Iraq, Shaikan and Akri-Bijeel. In 2009, the Company diversified the asset base in Kurdistan with the addition of two new Production Sharing Contracts, Sheikh Adi and Ber Bahr.

Licence Working Interest
Shaikan GKP 75%
Sheikh Adi GKP 80%
Ber Bahr GKP 40%
Akri bijeel 20%

The company holds exploration and appraisal rights over six blocks and two producing fields in Algeria but an orderly exit from these assets with sales due to be completed during 2011 following approval from the Algerian government.

Key members of management team
Todd Kozel , Chairman and CEO co-founder
Ali A. Al-Qabandi, Business Development Director and co-founder
John B. Gerstenlauer, Chief Operating Officer

Key historical drilling activity and resources estimates
GKP first struck oil in the Shaikan-1 well in August 2009 and after an analysis by a largely unknown company called Dynamic Global Advisers (DGA), issued a CPR (competent persons report) in January 2010. Gross OIP (oil-in-place) estimates were confirmed in a P90-P10 range of 1.9 to 7.4 billion barrels. In January 2011 the more widely respected company Ryder Scott, reviewed DGA'S reserve estimate and confirmed a total petroleum-initially-in-place (PIIP) resources at 1.52 (P90) to 7.52 (P10) billion barrels of oil, with a mean of 4.04 billion barrels.

Shaikan-1 tested five levels from 1,450 metres through to 2,850 metres but drilling had to stop at the lowest levels because of a very high pressure zone that was above the tolerance of the drilling rig.

Current and short term drilling programme
The company is currently drilling two wells, Shaikan-2 (spudded November 2010 and due for completion in May 2011) and Sheikh Adi-1 (spudded August 2010). Two further wells are expected to spud in March (Shaikan-4 and Akri-Bijeel). The shallow Shaikan 3 drill was completed in January 2011. The 3D seismic data acquisition program has been fully completed on both the Shaikan and the Sheikh Adi structures. Data processing and seismic interpretation will continue until at least June of this year.

Shaikan-2. the first deep appraisal well being drilled with equipment able to handle a high pressure reservoir, was spudded in December 2010, with a target depth of 5,000 metres over a 6 month period. Gulf Keystone has a 75% working interest in the Block, Kalegran, has 20 percent and Texas Keystone International has the remaining 5 percent.

Litigation issues
At the end of December 2010, GKP announced that they had received notice on 23 December 2010 that Excalibur Ventures had started litigation in New York on 17 December 2010 asserting certain contractual and non-contractual claims against the Companies and claiming that Excalibur is entitled to an interest of up to 30% in the Companies' blocks in Kurdistan. On 21 December, 2010, Excalibur applied without notice to the Companies to the Commercial Court in London for a "worldwide freezing injunction" against the Companies' assets, which was refused by the Commercial Court on the basis that the Judge did not consider there was a risk of dissipation of assets. Excalibur also commenced proceedings in the Commercial Court in London on 17 December 2010 on the same grounds as in the New York City court.

Kurdistan related risks

Although the Kurdistan regional government (KRG) has an Oil and Gas Law, the Iraqi govenrment does not. In addition, the central Iraqi government did not recognise any contracts that the Kurdistan government made with oil and gas companies.

However on February 7th 2011, Kurdish officials announced a deal with Iraqi Prime Minister Nuri al-Maliki calling for Baghdad to honour contracts signed by the autonomous region with foreign firms was confirmed following a meeting in mid-January. The meeting was attended by Maliki, central government Oil Minister Abdelkarim al-Luaybi and a delegation from Kurdistan headed by (regional prime minister) Barham Saleh."

Financial health

In May 2010, GKP placed 152 million new common shares at a placing price of 75p per share raising gross proceeds of approximately $165 million (£114.2 million). These shares were placed by Mirabaud Securities, Renaissance Capital, Fox-Davies Capital Limited and Madison Williams and Company with existing and new institutional shareholders. In October 2010 there was a further placing run by Mirabaud Securities at 140p to raise $175 million (£109 million).

Gulk Keystone has cash of $215 million as of 1st January 2011 to complete 5 Shaikan appraisal wells and 3 exploration wells (Sheikh Adi, Ber Bahr, Akri Bijeel).

The company has agreed a quarterly sales contract - to sell 2,500 tons of oil, about 16,750 barrels, per week from its extended well tests - and it continues to analyse seismic data across the Shaikan area. It has sold 63,000 barrels of oil into the Kurdistan market by the end of January 2011.

SWOT analysis

Strengths

High potential assets in Kurdistan with Shaikan field estimated to hold 4 billion barrels 

Fully funded for appraisal wells and exploration activity with $215 million of cash following 2010 fund

raisings at 75p and 140p

Weaknesses

Focused on one politically unstable area of middle East, Kurdistan (though more stable than the rest of Iraq)

Export pipeline and Oil and gas legislation issues with central Iraqi government

Opportunities

Potential agreement between Kurdistan and Iraqi government on recognition of oil contracts

Further appraisal upside and exploration success from 2011 activity especially Shaikan 2

Threats

Excalibur legal action is significant unknown with potential legal costs and size of settlement not yet quantified

Further disposal of shares by directors (On February 7th, Ewen Ainsworth sold 240,000 shares and John Gerstenlauer, sold 300,000 shares)

Share price outlook

I will not be investing in Gulf Keystone for now. The risks appear too high. Directors are selling shares, following them hitting an all time high on the news that Iraq/Kurdistan may be able to reach an agreement on oil contracts and revenues (around 192p). However, political risk is still high in this area. The issues created by the Excalibur legal action are also a concern, even if they turn out to be unfounded, legal costs can be astronomic given cases are happening in the U.S. and U.K. Brokers indicate that a fair value is somewhere between 160p and 200p, and with the shares currently at £1.80 following a 6p drop on the news of director sales, current upside seems to be limited. Potentially exciting news will be expected from Shaikan-2, but target depth is not expected until May. Even if hydrocarbon shows are encountered before then, it will be several weeks away before solid news is available. Following the Excalibur litigation news GKP's shares dropped to the 135p zone, this seems a much more sensible entry point than 180p. It's a worthwhile reminder that there were substantial placings in 2010 at 75p and 140p. If I was a holder, I would be selling at these levels. Compared with Xcite and Bowleven, the downside risk is high, despite the medium term upside potential. Kurdistan is an uncertain place to drill for oil!

Given the large private investor base, I'm sure there are those who disagree with this analysis. If so, please use the comment box below. Thanks.