#GKP Gulf Keystone : The Kozelcoaster

The Journey so Far

2007 : GKP awarded two Production Sharing Contracts for Shaikan and Akri-Bijeel blocks in the Kurdistan region of Iraq

2009 : Shaikan-1 announced as a major discovery
2010 : First well on the Akri-Bijeel block Bijell-1 announced as a discovery
First Shaikan domestic oil sales commenced. Sheikh Adi-1 exploration well spudded
2011 : 420% P90, 181% P10 increase in gross OIP estimate for Shaikan with range of 8.0billion (P90) to 13.4 bn (P10) barrels
Sheikh Adi preliminary resource evaluation by DGA of 1 billion (P90) to 3 billion (P10) barrels of gross OIP
2012 : 14 wells drilled across the four blocks. Second exploration well on Sheikh Adi announced as a discovery.
Shaikan appraisal completed with Shaikan 5 and 6. DGA upgrade gross OIP volumes to 12.4 (P10), 13.7 (mean) and 15 (P90) BILLION barrels. Declared as a Commercial Discovery
Placement of senior unsecured convertible bonds due October 2017 for the amount of US$275 million
2013 : Shaikan Field Development Plan approved in June
Bakrman-1 exploration well on the Akri-Bijeel block announced as a discovery
Ber Bahr-1 exploration well on the Ber Bahr block announced as a discovery
Appointment of Non-Executive Chairman Simon Murray. Appointment of five new Non-Executive Directors
Deutsche Bank appointed to help GKP move to the main market
Excalibur Court Case successfully defended.

Summary of Licences and developments to date:

Shaikan – GKP 75% & Operator

Shaikan FDP was approved in June 2013 and commercial production began mid-July. Production had reached 12,400 bopd by early September. The upgrade of production facilities at PF-1, and planned PF-2 (early 2014) will enable GKP to increase this to 40,000 bopd. The plan is then to grow this to 150,000bopd by 2016 and 250,000bopd by 2018 but this will need additional facilities and a pipeline. Shaikan 10 development well is currently drilling and the first deep exploration well Shaikan-7 also spudded this year (June) and will take 9 months. The potential is to add between 1 and 5 billion barrels of gross OIP to already discovered resources. Progress has been made on the development of a regional independent export infrastructure, expected to be completed by the end of 2013

Sheikh Adi block - GKP 80% & Operator / Regional Government 20% carried interest
The Sheikh Adi block lies to the west of Shaikan and was declared a commercial discovery in 2012. GKP believes that the Shaikan field shows signs of a significant extension into the Sheikh Adi block. There could be important synergies across the acreage. The first evaluation of the block had a range of 1.0 billion (P90) to 3.0 billion (P10) barrels of gross OIP. The second exploration well Sheikh Adi-2 was successful, achieving stabilised flow rates of 4,235 bopd from four zones. Construction of the drilling location for 2014 Sheikh Adi-3 appraisal well is ongoing. 70km of additional 2D seismic data has been acquired and two additional exploration leads are targeting potential extensions of the Atrush and Swara Tika discoveries.

Ber Bahr - GKP 40% / Genel 40% & Operator / Regional Government 20% carried interest
The Ber Bahr block lies to the north-west and is also on trend with Shaikan and the Sheikh Adi blocks. The first Ber Bahr-1 exploration well encountered a 300m oil column! Two drill stem tests failed to flow however. The original well has been successfully side tracked and achieved a sustainable flow rate of 2100 STB/day of 15 API oil. The operator's estimates of recoverable reserves are 50-100 million barrels. Appraisal and early production is expected in 2014.

Akri-Bijeel - Kalegran 80% & Operator / GKP 20%
The Akri-Bijeel block is situated to the east of the Shaikan. The Kurdistan Regional Government has an option to nominate a 3rd party interest of up to 20% and a further option to nominate a government interest of up to 20%. Two discoveries have been made to date, firstly the Bijell 1 discovery in 2010 - announced a commercial discovery with 2.4 billion (P50) barrels of gross OIP. Secondly the Bakrman-1 discovery in 2012 - announced a Triassic discovery Feb 2013. Initial results indicate a significant reservoir. Construction and commissioning of an EWT facility for the Bijell discovery is complete, although a sidetrack will be required before production can recommence. This is due in Q1 2014. The EWT will have a capacity of 10,000bopd, expected by the end of 2014. An appraisal well Bijell-2 is ongoing and will be tested in Q1 2014, and 2 further appraisals are planned in 2014. A sale of the GKP’s 20% working interest in the Akri-Bijeel block is being sought and would add important cash towards GKP’s cost of capital in 2014.


Other Recent Developments

GKP have been locked in a lengthy legal battle with Excalibur Ventures who were claiming ownership of part of GKP. On 10 September 2013 all claims by Excalibur were dismissed. This was an important ruling. The court set a date (13 Dec) for handing down its judgment and for any consequential matters, including compensation to be paid to GKP. Importantly the hearing will also clarify whether Excalibur will seek to appeal. Until this matter is closed, a move to the main listing for GKP is on hold. Deutsche Bank AG was confirmed as appointed in connection with this move but frustratingly investors were not told of the likely delay because of the Excalibur uncertainty. This was a sloppy omission as it must have been clear at the time but an RNS this week has finally spelt out that.. “the board of Gulf Keystone expects conclusion of the proposed admission to trading on the Main Market to be as soon as practicable in 2014” rather than “by the end of 2013” as they initially stated.

As if a very public court case isn’t bad enough, earlier this year there was significant mudslinging between the board and institutions, which were unhappy with the corporate governance of GKP. This got very public and very messy. Finally it was agreed to split Todd Kozel’s role to allow him to concentrate on the CEO role, and a non-executive chairman, Simon Murray C.B.E. was appointed. After the public trashing by the board of some of the NED nominations, they were then appointed! Makes you wonder how they now work with each other.

Future potential share price catalysts:

• If the 13th Dec Excalibur hearing confirms compensation and if there is no right to appeal the way will be open to a full market listing
• Potential for confirmation of increased stable 20,000 bopd production from Shaikan PF-1 by the end of 2013
• Confirmation of Shaikan PF-2 work being finished, commissioned and producing. Completion of the connections between PF-2 and the Shaikan 2, 5 and 10 wells to increase production by an additional 20,000 bopd during 2014.
• Confirmation of a cash-neutral approach to further development wells, including up to eight on Shaikan in 2014 and decisions on additional Shaikan production facilities (PF-3 and -4)
• Confirmation of a sale of the 20% interest in the Akri-Bijeel block and discovery.
• A move to the main listing of the stock market from AIM and potential for funds buying in, hoped for in early 2014.
• Results from the Shaikan-7 exploration well, targeting deeper Triassic and Permian horizons in the Shaikan block - likely May onwards 2014
• Results of the appraisal of the Sheikh Adi discovery and additional exploration prospects on the block

Funding and Valuation matters

Finances
According to the Financial Results, as at 30 June 2013 GKP made a loss after tax of $26.4 million (2012: $31.4 million). At the end of June they had cash and cash equivalents of $141.2 million and by the 16th September this had decreased to $101million. Significant capital is required for the 2014 work programme and funding remains an important consideration when investing here. According to Edison cash could be tight by the end of 2013. Capex, G&A, debt servicing and operating expenditure for the remainder of 2013 is expected to cost around $180m and GKP may therefore need more funds before the year end. There are a number of ways which this could be provided and GKP have indicated that dilution should not need to be one of them. Then again we’ve heard that before from many AIM companies so proceed with extreme caution is my opinion. However, non dilutive options include:

• Compensation from Excalibur for the court case. Edison estimate this could be in the region of c.$30m.
• Back-in rights compensation from a 3rd party could account for $100m, although timing on this is not clear.
• A sale of the Akri-Bijeel 20% interest is sought. GKP assigns a book value of $70m to the block. Edison expect the block to sell for well above this and estimate a risked value of $220m for Bijell and Bakrman, using a discount factor of 12%.
• GKP could instigate a corporate debt facility. The company estimates $150m may be possible. This could be higher if Shaikan production is running at a stable 20,000bopd by the end of 2013.

In the September half year report the financial summary gives a medium term goal of financing activities from production cash flows. What medium term means is not clear and in the short term GKP will either need to secure a debt facility, one or all of the above to happen, or will surely have to raise funds through equity.

Cash required for 2014

Cash outflows in 2014 are estimated by Edison to be around $550m, with a capex bill of around $500m. The vast majority of this will be spent on Shaikan in order to increase production to 150,000bopd by 2016. Costs to achieve this are assumed to be c$380-400m (net) for every 40,000 increase in capacity. This leaves the rest for the drilling at Sheikh-Adi, Ber Bahr and Akri-Bijeel. However, if the 3rd party and KRG do not back-in to their licences in 2013 then the capex bill for Shaikan could rise from $380m to around $520m.

Prices achieved for Shaikan crude

GKP have estimated a relatively pessimistic $20 per barrel discount to Brent. Once blended with lighter crudes a lower discount should be achieved nevertheless Edison assume a 20% discount (for both Bijell and Shaikan) in their valuation. If this was changed to 10% the value of the Shaikan development increases by around 9% so it is important to hear more about this discount as production builds.

Valuation

Based on all of the above, Edison’s core NAV stands at 218p. They have included a more smoothed ramp-up to 2018, an increased discount to Brent, and increased capex costs, all of which decrease their valuation of Shaikan. Ber Bahr is included in their core development NAV alongside Shaikan and Bijell. They do not include any rebate from Excalibur as a result of GKP’s victory. With further exploration happening at Sheikh-Adi for potential extensions of the Swara Tika and Atrush discoveries and the deeper Permian horizon potential being tested by the Shaikan-7 well GKP is still exposed to potentially significant upside in the coming 12 months. Edison arrive at a full exploration NAV of 249p/share and a fully unrisked value for the company of around 390p/share.

Broker targets are generally north of the current share price and range from 170p to 283p:

Date	Broker name	New	Price	Old price target	New price target	Broker change
14-Nov-13	HSBC	Overweight	162.50p	185.00p	185.00p	Upgrade
14-Oct-13	Goldman Sachs	Buy	182.75p	283.00p	283.00p	Upgrade
10-Oct-13	Westhouse Securities	Sell	181.00p	170.00p	170.00p	Reiteration
10-Oct-13	HSBC	Neutral	181.00p	185.00p	185.00p	Upgrade
26-Sep-13	Macquarie	Neutral	196.00p	173.00p	173.00p	Reiteration
23-Sep-13	Canaccord Genuity	Hold	202.00p	210.00p	216.00p	Reiteration
19-Sep-13	Westhouse Securities	Sell	200.00p	170.00p	170.00p	Reiteration
12-Sep-13	HSBC	Underweight	206.50p	185.00p	185.00p	DownGrade

To buy or not to buy, that is the question

The sense I get from watching all of the shenanigans unfold is that to invest in GKP is to accept that you are an irrelevant part of the rollercoaster story. You therefore ride the rollercoaster most of the time blind. Regular and clear shareholder communication and good corporate PR seem to be some way down the list of priorities and in my opinion investment here involves handing your money over to a group of people who you know nothing about, who move in circles that an average small time investor has no understanding of, and who probably work in ways which no doubt sail quite close to the edge of acceptability. GKP are no doubt literally sitting on a sea of oil and the operations and discussions must be highly complex. Add to this the considerable and uncertain political risk of the regional government’s position in Iraq. Now also consider the substantial capital and other costs that are required to bring the production up to self financing levels. To this, add the likelihood of Excalibur winning the right to appeal. Consider the lengthened move to the main market as a result of this. Add to this the significant infrastructure which is needed to bring all this oil out to export. And through all this, be aware that PI's are likely to have relatively infrequent and potentially selective investor communications, and you may conclude that there are is a compelling list of reasons to leave GKP well alone.

On the other hand, here is still an independent oil company, surrounded by NOC’s and majors. Sitting on somewhere around 20,000,000,000 (that’s 20BILLION) barrels of oil!!! Producing somewhere towards 20,000bopd by year end and planning to increase this by 40,000bopd every year until 2018 when they will be pumping a whopping 250,000 barrels per day. That’s 5 times what Xcite Energy plan to produce by the same time.

The heady days of GKP rising from 20p to 420p are over, and yet the share price is languishing back around the 155p mark and is underpinned by substantial resources which someone is going to produce. If GKP get to their 2016 targets and remain independent, the share price will be many times north of here. And if they are not, then someone will have come along and bought them out, which will no doubt be for more than 155p a share. There are many shareholders who have been in GKP for years, waiting patiently for pay day. Is it possible to join the ride at this late stage and reap significant returns over a much shorter timescale?

But risk in my opinion is substantial. Just like the warnings before joining a rollercoaster, sorry Kozelcoaster, this is not one for those of a nervous disposition, the pregnant, elderly, widows or orphans, those with back problems, sleep disturbance, heart conditions, or financially insecure. Potentially a white knuckle ride with plenty of upside but with a few more twists and stomach lurching turns along the way no doubt. Enjoy the ride if you get on board.

To see Mr Kozel's style in action, watch this video of him on CNBC in September 2013  click here