The Kurdish Crush

The Kurdistan producers are in a tough spot brought about by COVID-19 and the collapse in oil prices. Earlier this year, the KRG said it would delay payments in respect of October 2019 to February 2020 deliveries as its cash to pay producers was stuck in a Lebanese bank account with the bank itself facing liquidity issues.

The KRG had struck a deal to pay producers for the backlog later in 2020. Payments in respect sales from March 2020 were not affected and continue to be paid. However at the current low oil prices, payments to producers have slumped.

Tawke: Received USD8.5 million for April deliveries split between partners DNO and Genel. This compares to the March payment of USD34.6 million.

Taq Taq: Received USD1.9 million, down from USD4.6 million in March with Genel's net share of the payment being USD1.1 million.

Shaikan: Gulf Keystone had submitted an invoice to the KRG for a nil amount as the realised price was negative with the Shaikan crude/transportation discount being below Brent.

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Kurdistan steps up efforts to eliminate gas flaring

The Kurdistan Ministry of Natural Resources ("MNR") has asked the Shaikan field partners (Gulf Keystone and MOL) to re-submit a revised FDP for the field to address additional MNR requests on gas management.

The next well planned on the field will now be used to assess the feasibility of gas reinjection into the Jurassic formation, rather than as an originally planned Jurassic production well.

Whilst a key driver to be reservoir management and ultimate recovery rates, it is noted that the MNR is keen to eliminate flaring in Kurdistan.

Gulf Keystone has previously stated that the elimination of gas flaring is the single most complex and expensive component of the field’s development, and additional gas-handling capacity would be required to handle the gas-rich light oil in the underlying Triassic reservoir.

At nearby DNO’s Tawke field, work is scheduled to begin later this year on building the gas-gathering and processing facilities to enable reinjection of Peshkabir’s associated gas into the Tawke field, to reduce flaring and increase the latter recoverable reserves; this gas-gathering and injection system is forecast to be operational in early 2020.

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Kurdistan E&Ps get paid for January sales

Genel has announced that the Tawke and Taq Taq partners have received payment from the KRG for January oil sales.

• The Tawke partners (DNO 75% and Genel 25%) have received USD56 million and will also share in a USD13 million overriding payment

• The Taq Taq partners partners received USD8 million this month

The continuing payments by the KRG is constructive for sentiment and critical in bringing interest and investment back into the region. Many E&Ps have held off investing in the country with payments being a big concern. While the continuing payments are clearly positive, questions remain on the longer term ability of the KRG to pay producers given loss of crucial income following the referendum with the taking back of the Kirkuk area by Baghdad. For now the KRG is managing, largely with the help of investment/cash injection by Rosneft at the end of large year.

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Kurdistan payments and new oil sales agreements

Kurdistan producers receive payment for October sales
Gulf Keystone signs new oil sales agreement with the KRG

DNO has reported a payment of USD54 million for Tawke production from the Kurdistan Regional Government. This is in respect of October oil deliveries. The payment will be shared between the licence partners WHO 75% and Genel 25%. Although there is a lag in payments between production and receipt, this is viewed as normal with October sales invoiced in November and approval by the Government in December with payment the following month. The continued stream of payments demonstrates the importance of oil exports to Kurdistan, especially following the independence referendum last year which threw doubt on the region's ability to carry on managing its finances.

In December, DNO reported production from its two field on the Tawke PSC averaged 110mbopd. Production is expected to climb from these levels as operations ramp up at the Peshkabir field. With higher oil prices and continued payment, DNO could begin to undertake infill drilling on the PSC later this year.

Last week, Gulf Keystone also announced that it had agreed a new PSC-linked oil sales agreement with the Government for its Shaikan crude, reinforcing continued progress in the region around oil company activities. Under the agreement, the KRG agreed to buy crude at Brent less USD22/bbl reflecting a quality discount and transportation costs. Kurdistan crude has historically been marketed following a SOMO (Federal Iraq’s State Organisation for marketing of Oil) formula which provides for a discount of c.USD0.4/bbl of API quality. With Shaikan crude at 18˚ (vs. Brent 38˚) suggesting a USD8/bbl discount plus pipeline export costs to Ceyhan estimated at USD4/bbl, the USD22/bbl discount agreed with the KRG seems to be extremely high. This is likely due to additional discounts on Kurdistan originating crude, where the international buyer community could be thin, resulting from political sensitivities of taking on crude from the disputed region.

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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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