Is Gulf Keystone Petroleum Limited Priced To Fail?

Gulf Keystone Petroleum (LSE: GKP) shares continued to fall today and now trade at 24p. This represents a spectacular fall for the company — the days of a 300p share price are long gone, and the numerous takeover rumours regarding the company have also cooled. 

Gulf Keystone’s prized asset is the Shaikan field in Kurdistan, the semi-autonomous region of Iraq. Shaikan produces 40,000 bopd, which will be increased to 100,000 bopd in the future. The problem with this is that the company isn’t being paid in full for its crude production. The Kurdistan Regional Government (KRG) is fighting an expensive war with Islamic State as well as suffering from decreased revenues due to the low oil price. This means that oil companies are pretty much last on the list to pay. 

This situation is now very serious for Gulf Keystone. The company, after raising hundreds of millions of dollars through bonds, is now beginning to pay bondholders interest. This has caused cash balances to dwindle, and if more regular payments don’t come from the KRG soon then Gulf Keystone could go bankrupt. The moment that the company cannot service the debt then the equity will be worthless and the bondholders will own the company. At 23p, it has a market cap of £240m but debt is over US$500m. 

Currently, the cash balance of the business is $48m after the last bond payment of $26m in October. The next important date is April 2016 when the company has to pay another $26m. The company must also keep its debt service reserve account above $32.5m or it will breach debt covenants. This just highlights the importance of the KRG, and that it must begin to pay Gulf Keystone on time and in full.

In the next few months, if Gulf Keystone isn’t paid for its production then April could signal the end for the company. This situation could turn into another Afren scenario, which played out this year and ended up with the equity being worth nothing. I have faith in the management at Gulf Keystone, but to a certain extent this one is out of their control. 

Buying the equity in the low 20s could create supersized returns if the situation in Kurdistan improves. The stock is almost priced to fail, and for investors that believe in the company, it seems a fantastic buy on those grounds. However, the challenges are huge and it looks like this one may go down to the wire. 

If the debt issues at Gulf Keystone put you off, then there are a few other operators in the region. Genel Energy is again a Kurdistan-focused company, but its balance sheet is acceptable compared to Gulf Keystone’s. Genel has interests in the world-class Taq Taq and Tawke fields, which produce over 250,000 bopd (86,000 bopd net to Genel). 

Buying Gulf Keystone shares now is a high risk-high reward trade, but one I would stay away from for the time being.