Kurdistan consolidation? DNO's proposed offer for Gulf Keystone

On Friday 29^th July, DNO made a proposal to acquire Gulf Keystone for USD300 million in cash and shares. The tactics around the timing of this offer are unclear, given that Gulf Keystone are part way through a creditor restructuring. Negotiations during creditor processes are generally messy with the potential acquirer having to become involved in discussions with the debt holders, who hold significant power given their ability to "pull the plug" on the distressed company and/or dictate restructuring terms that lead to massive dilution of the existing shareholder base.

The offer of USD300 million, which comprises c.USD120 million in cash and the remainder in shares, represents:

• a 20% premium to the share price of $0.0109 at which, on 14^th July 2016, Gulf Keystone issued shares representing 5.6% of its share capital; and
• a 20% premium to the price at which Gulf Keystone intends to issue further shares. 

DNO further noted that the cash element of the offer would provide an early exit for noteholders and bondholders unable or unwilling to hold equity in DNO.

The acquisition of Gulf Keystone would create further scale and operational synergies for DNO in Kurdistan, and the enlarged entity would operate the Tawke and Shaikan oil fields, with current combined net production of c.89mbopd. Gulf Keystone holds a 58% stake in and operates the Shaikan oil field at a current level of ~40,000b/d, which is transported daily by road tanker to DNO's unloading and storage hub at Fish Khabur for onward pipeline transport to export markets.

For the past couple of years, Gulf Keystone's debt has dominated its story and a combination with DNO together with a clean balance sheet is likely to be viewed favourably by the KRG. However, it is noted that the heavy-oil Shaikan project is a high capex and low margin business that would generate a relatively low rate of return for DNO. As with Genel at Miran, DNO will likely need the support of a farminee to push ahead with the full field development.

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Gulf Keystone debt restructuring

On 14^th July, Gulf Keystone announced the terms of its proposed balance sheet restructuring, marking the culmination of months of discussions with the company's debt holders. The restructuring, if approved by shareholders, will be implemented by way of a debt-for-equity swap and will see existing shareholders significantly diluted.

The company has c.USD600 million of debt, comprising USD335 million of Convertible Bonds and USD266 million of Notes. The restructuring proposes:

• USD335 million of Convertible Bonds: Complete equitisation
• USD266 million of Notes: Refinanced with USD100 million of new notes (the "Reinstated Notes") and through equitisation

Pro forma capital structure

Post transaction, balance sheet debt will be reduced from c.USD600 million to USD100 million. As part of the restructuring, it is envisaged that an USD25 million equity raise be launched as an open offer to the existing shareholders, equating to 10% of the restructured entity if fully subscribed.

Existing shareholders will be significantly diluted and will hold 5% of the company post transaction (pre-open offer) and 14.5% of the company if they fully subscribe to the open offer. Convertible bondholders will represent 20% of the company and the current noteholders will hold 65.5% of the company.

Pro forma ownership

The restructuring is subject to shareholder approval and will be implemented through a UK scheme of arrangement. The board of Gulf Keystone has recommended that shareholders support the transaction, failing which, the company is expected to enter into a formal insolvency and liquidation process.

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Further payments by the KRG

DNO and Genel Energy announced on 22 March that the Tawke and Taq Taq participants have been paid by the Kurdistan Regional Government (“KRG”) for oil sales during February. News of another month of payment should help boost sentiment.

Given that the export pipeline was out of service during the second half of February, sales at Taq Taq and Tawke were down materially month-on-month at 62,091bopd and 73,124bopd, respectively. Sales into the local market from both fields were, however, invoiced at the wellhead export netback price, in line with the payment mechanism announced by the KRG on 1 February; this process helped limit the month-on-month reduction in revenues. Flows into the export pipeline resumed on 11 March.

Genel, as operator of Taq Taq received USD12.6 million for oil exports, down from January’s USD16.3million. An additional USD2.5 million payment has been made towards recovery of the receivable, down from USD3.2 million.

DNO, as operator of Tawke has reported receipt of USD11.29 million for exports, down from USD17.99 million in January. An additional USD2.17 million has been paid for past deliveries, down from USD3.46 million in January.

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KRG switches to PSC terms to conserve cash outflows to IOCs

Kurdistan exports and payments to IOCs remain unpredictable with the situation subject to change on a daily basis. The Kurdistan Regional Government’s (“KRG”) monthly export report and news flow from the E&Ps gives a glimmer into the dynamics of operating in and getting paid in Kurdistan.

On 4^th February, the KRG published its January 2016 monthly export report – the KRG exported 602mbbl/d through the Kurdistan pipeline network to the port of Ceyhan in Turkey; this is down from 644mbbl/d in December and the Q4 2015 average of 648mbbl/d. The export line was down for just one day last month. Fields operated by the KRG contributed 452mbbl/d (Q4 2015 average was 476mbbl/d), while the North Oil Company’s fields contributed 150mbbl/d (Q4 2015 172mbbl/d).

Today, Genel announced that the Taq Taq field partners have received a gross payment of USD16.3 million from the KRG for oil exported through the main export pipeline; this is down on the USD30 million paid in recent months, as the KRG employs the terms of the Kurdistan’s Production Sharing Contracts (“PSC”) for the first time, rather than an ad hoc payment system. Genel's share of the gross Taq Taq payment fell to USD9 million, from USD16.5 million. The impact of the shortfall has been softened somewhat by the payment of an additional USD3.2 million (USD1.8 million net to Genel) to cover past receivables.

The change to the PSC was clearly intended to reduce the KRG’s cash outflows, so the payment reduction should not be a surprise. The silver-lining is that payments are now linked to the oil price and the PSC provides greater certainty on asset valuations and the merits of increasing spending to help stabilise and potentially grow oil production. However the payment made in January reflects comprise of a number of components: crude quality adjustment, deduction of transportation charges, handling costs as well as the PSC terms, and in general, greater clarity on these variables will need to be disclosed in order to better forecast future cash flows.

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Kurdistan producers receive fourth consecutive payment from the KRG

Tawke processing facilities
Source: KRG

On 6^th January, DNO and Genel announced that partners of the DNO-operated Tawke field have received a gross payment of USD30 million from the Kurdistan Regional Government for oil exported through the Kurdistan Region of Iraq-Turkey pipeline. This represents the fourth export payment by the KRG since payments recommenced in September.

On 5^th January, Genel also confirmed that the Taq Taq field partners had received a gross payment of USD30 million from the KRG for oil exported through the Kurdistan Region of Iraq-Turkey pipeline with Genel’s share of the payment being USD16.5 million.

It is interesting to note that payments to the oil companies have remained flat (at USD75 million per month) during the past four months, despite a collapse in the oil price from c.USD50/bbl at the start of September to c.USD36/bbl at the end of December 2015. This means that the international oil companies' share of Kurdistan's oil revenues is slowly creeping up.

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Brent falls - impact on E&A

Brent (above) has now fallen >25% since June...what are the E&Ps going to do...

Onshore flexibility, but not in the offshore

• Longer lead times, offshore spend tends to be committed vs. onshore
• Likely see cut back in E&A instead

Delayed payments

• Kurdistan, DNO and Genel are still to be paid for pipeline exports
• Egypt, TransGlobe has built up USD185m of receivables
• Nigeria, Seplat has built up USD215m receivables as government partners/stakeholders have been slow to pay

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