Oil companies in Kurdistan
Macroeconomy

Special situation: Oil companies in Kurdistan

Turkey halts Kurdistan’s northern crude exports

  • Iraqi Kurdistan is one of the highest producing regions at about 440,000 b/d
  • Kurdistan Regional Government’s oil revenue is key for the region
  • Baghdad’s aspiration to get a grip on all national production get closer
  • Several oil and gas public companies operate exclusively in the Iraqi Kurdistan

Oil production in Kurdistan

The Kurdistan Regional Government (KRG) does not publish its production figure but it is estimated that the region’s oil output has already slipped from about 468,000 bpd in 2019 to 445,000 last year and 434,000 in the first quarter of 2022, according to reports by Deloitte. The three major oilfields are Tawke, Khurmala and Taq Taq. The main reason is a lack of investment caused by the political turmoil and security concerns in the region that have sparked fear among oil and gas companies. The KRG estimates the natural decline of the three major oilfields between 15% and 20% per year, while other oil fields like Shaikan showing a decline as low as 6-10%. The region is in dire need of steady levels of investment to maintain the production.

The situation is difficult for oil and gas companies willing to do business in Iraq. Between 2020 and 2021, BP, Shell, Lukoil and ExxonMobil announced their plans to sell their assets in the country and leave it. The worsened security situation, delayed payments, excessive bureaucracy and rising risk of breaking international sanctions against Iran due to a growing presence of Iranian oil in Iraqi export infrastructure are the main causes of the exodus.

In July and August 2022, a series of rocket attacks on the project to expand the Khor Mor gasfield operated by Pearl Consortium in the Kurdistan region sent the U.S. contractors working on its expansion packing. These contractors had replaced previous US and Turkish contractors that withdrew due to other attacks. The lack of security in the area is also another cause of delays in different projects.

The KRG has signed a contract with domestic energy company KAR Group to build a pipeline from Khor Mor via the regional capital Erbil to the city of Dohuk, close to the Turkish border, running parallel to an existing pipeline.The region is desperately in need of more gas to generate electricity and end almost daily power blackouts. Of Kurdistan’s 13 power stations, five are gas powered and are only working at about 50% to 70% capacity because of shortages. Power blackouts are commonplace, meaning domestic expansion would likely be the immediate priority.

However, the most relevant political parties controlling the KRG, Kurdistan Democratic Party (KDP) and Patriotic Union of Kurdistan (PUK), have evidenced their differences in the last years, including the disputes for KDP’s nomination of a candidate for the Iraqi presidency, historically held by the PUK. Additionally, the PUK says revenue from oil exports, which account for most of Kurdistan’s government income, are unfairly distributed among the provinces by the KDP-controlled administration.

Hence, the situation in the region in the last years is far from stable and the instability has affected oil and gas production and investments. Nevertheless, oil and gas production is a key industry for the region and, with the proper level of investment, the region can increase production above the natural decline.

Baghdad-Kurdistan Regional Government dispute

Under the Iraqi constitution, the region is entitled to a portion of the national budget. But the arrangement collapsed in 2014 when the Kurds seized control of Iraq’s main northern oilfields in Kirkuk from the Islamic State and began selling crude from there independently. Kurdistan began direct oil sales to world markets in mid-2015 after accusing the central government in Baghdad of depriving the region of funds to pay state and army salaries, even though it had been instrumental in defeating Islamic State. In 2018, Iraqi forces retook disputed territories, including the oil city of Kirkuk, and Baghdad resumed some budget payments but they have been sporadic.

Yet, in February 2022, Iraq’s federal court declared the KRG’s oil and gas legislation “unconstitutional” and invalidated the KRG’s contracts with foreign oil firms. After this ruling, Iraq’s federal oil ministry said in 2022 that US companies (Schlumberger, Baker Hughes and Halliburton) were already in the process of liquidating and exiting tenders and contracts in the Kurdistan region to comply with the ruling.

Additionally, Baghdad opened a case at the International Chamber of Commerce’s International Court of Arbitration, claiming that Turkey violated a 1973 pipeline transit agreement by allowing the exports without Baghdad’s consent. Turkey’s state-owned Botas informed Baghdad that pumping operations were suspended at around 12:30 local time on Saturday, 25th of March, at pumping station 3 (PS3) on the Turkish side of the pipeline, the source said. Turkey also said following Friday’s ruling that it would not allow shipments carrying crude from Iraqi Kurdistan to leave Ceyhan without Baghdad’s consent.  According to an article in Reuters, Turkey was ordered to pay around $1.5bn, according to a person familiar with the case who asked to comment anonymously as they were not authorized to speak.

In a statement, Iraq’s oil ministry said Baghdad, through its State Oil Marketing Organization (SOMO), was the “only party” that would manage exports through Ceyhan. The ministry said it will discuss “mechanisms for exporting Iraqi oil through [Turkey’s] Ceyhan port with the concerned authorities in the Kurdistan region as well as with the Turkish authorities” in a manner that guarantees exports will be sustained and international commitments met.

The KRG prime minister Masrour Barzani’s reaction to Baghdad’s statement was to publish a tweet acknowledging the ruling: “Our recent understandings with Baghdad have laid the groundwork for us to overcome the arbitration ruling today. A team from the KRG will visit Baghdad for talks tomorrow to build on the goodwill of our discussions

Iraqi Kurdistan depends on the link through Turkey to export its crude oil, and the Paris court ruling will further tighten the noose on the KRG as it continues to negotiate with Baghdad over an authoritative legal framework for the country’s oil sector. The government of Iraqi Prime Minister Mohammed Shia al-Sudani and the KRG have held several rounds of talks but have yet to reach an agreement on the framework. Considering both Iraq’s federal 2022 and ICC’s ICA 2023 rulings, Baghdad should have the upper hand in future talks.

On the 27th of March, a spokesperson of the US State Department said during a press conference that Washington has “urged the governments of Turkey and Iraq to resume the flow of oil through the Iraq-Turkey pipeline, and disruptions to global energy supply would not serve anyone’s interest.”

Companies operating in Iraqi Kurdistan

Some companies are still operating in the region despite the series of court’ decisions. As it was mentioned before, a combination of attacks on oil and gas fields plus Iraq’s federal court ruling pushed most US companies to leave the region. We have searched for these companies and made a compilation of the public companies operating in the area. It is important to stress that all of these companies have traditionally suffered delays in payments from the KRG.

 

ShaMaran TSX:SMN

The Company has a 27.6% participating interest in the Atrush block and an 18% participating interest in the Sarsang block, both in the Kurdistan Region of Iraq, containing the producing oil fields: Atrush, Swara Tika and East Swara Tika. ShaMaran belongs to the universe of commodity companies of the Lundin family. The market is paying a premium over peers due to Lundin’s involvement in the company. Thus, it has a secondary listing in Sweden.

ShaMaran 2022 Results
  • Market Capitalization: $133.84m
  • Production: 12,104 bopd (100% Kurdistan)
  • Revenue: $176.6m
  • Net Income: $114.9m
  • Operational cash flow: $105.2m
  • FCF: ($30.9m)
  • Cash: $107.8m
  • Debt: $269.1m
  • Receivables: $88.2m (55% of net debt)
  • Market reaction: -17.75%

Genel Energy LON:GEN

Genel has low-cost production from four fields in the Kurdistan Region of Iraq – Taq Taq, Sarta, and Tawke (Tawke and Peshkabir). As at 31 December 2022, Genel had estimated net proven and probable (2P) reserves of 92 MMbbls.

Genel Energy also has exploration assets in Somaliland and Morocco. An appraisal drill is expected in Somaliland in 2023.

Genel Energy 2022 results
  • Production: 30,150 bopd (100% Kurdistan)
  • Revenue: $432.7m
  • Net Income: ($7.3m)
  • Operational cash flow: $412.4m
  • Cash: $494.6m
  • Debt: $274.0m
  • Receivables: $121.7m (55% of net cash)
  • Market reaction: -6.1%

Gulf Keystone Petroleum Limited LON: GKP

Gulf Keystone is the operator of the Shaikan Field (80% WI), one of the largest developments in the Kurdistan Region of Iraq. It has traditionally struggled with delayed payments by the KRG. In 2022 GKP distributed a gigantic dividend of $215m (41% of market capitalisation at that time) and again $25m in early 2023. Still, it remains in a strong financial position.

Gulf Keystone Petroleum 2022 results
  • Market Capitalization: $383.36m
  • Production: 44,202 bopd (100% Kurdistan)
  • Revenue: $460.1m
  • Net Income: $266.1m
  • Operational cash flow: $374.3m
  • FCF: $266.5m
  • Cash: $119.4m
  • Debt: 0
  • Receivables: $176.2m (147% of net cash)
  • Market reaction: -15.9%

DNO ASA OSL:DNO

Kurdistan: Gross production from the Tawke license, containing the Tawke and Peshkabir fields, averaged 107,102 bopd during 2022 (108,713 bopd in 2021). The Tawke field contributed 45,065 bopd (46,933 bopd in 2021) and the Peshkabir field contributed 62,037 bopd (61,780 bopd in 2021).

North Sea: DNO had diversified production across 10 fields in the North Sea of which eight are in Norway and two in the UK. Net production averaged 13,314 boepd during 2022 (12,942 boepd in 2021), of which 13,035 boepd were attributable to Norway and 279 boepd to the UK (12,469 boepd and 473 boepd, respectively, in 2021).

Africa: In October 2022, DNO acquired Mondoil Enterprises LLC and its 33.33% indirect interest in privately-held Foxtrot International LDC. whose principal assets are operated stakes in offshore production of gas and associated liquids in Côte d’Ivoire. Foxtrot International holds a 27.27 percent interest in and operatorship of Block CI-27 containing the country’s largest reserves of gas, produced together with condensate and oil, from four offshore fields tied back to two fixed platforms, meeting more than three-quarters of the country’s gas needs. Foxtrot International also operates an exploration license offshore Côte d’Ivoire, Block CI-12 in which it holds a 24 percent interest.

Middle East: Production start-up at the Yaalen field at Block 47 in Yemen remains on hold due to force majeure. At year-end 2022, gross 2C resources at Block 47 stood at 6.2 MMbbls (4.8 MMbbls on a net basis), unchanged from year-end 2021.

DNO is the most diversified company on the list and its presence in Africa and the North Sea will keep producing revenue despite the halt of its Iraqi operations.

DNO 2022 results
  • Production: 97,310 bopd (82% Kurdistan)
  • Revenue: $1,377m ($820m Kurdistan)
  • Net Income: $384.9m
  • Operational cash flow: $1,056.3m
  • Cash: $954.3m
  • Debt: $554.8m
  • Receivables: $437.8m (109.4% of net cash)
  • Market reaction: -14.2%

Forza Petroleum – TSE:FORZ

An oil and gas company focused on the Hawler license area in the Kurdistan Region of Iraq. Forza Petroleum is effectively controlled by Zag Oil and Gas, a privately held company based in the Kurdistan Region of Iraq that provides a broad range of engineering and construction services to the energy sector. Its ultimate controlling party is Baz Karim. It has more than 80% of the outstanding shares, and thus, any investor should consider that Zag is not aligned with the rest of the shareholders. 

Forza Petroleum 2022 results
  • Market Capitalization: $84.4m
  • Production: 14,500 boepd (100% Kurdistan)
  • Revenue: $323.8 million
  • Net Income: ($138m)
  • Operational cash flow: $111.9m
  • FCF: $46.4m
  • Cash: $71.1m
  • Debt: $76.2m
  • Receivables: $62.5m (1,225% of net debt)
  • Market reaction: -7%

Comparison of Metrics – oil companies in Kurdistan

Metrics oil companies operating in Kurdistan

Other oil companies operating in Kurdistan

The MOL Group owns 20% in Shaikan field (operated by GKP), and a 10% in Pearl Petroleum (operator of the Khor Mor field producing ~100,000 boepd). Similarly, OMV owns a 10% of Pearl Petroleum, and has operating Bina Bawi, Shorish and Mala Omar blocks. ExxonMobil still owns stakes in several fields in Iraqi Kurdistan.

Summary of oil companies operating in Kurdistan

The list of companies exposed have suffered with the delayed payments by the KRG as their receivables show. ShaMaran is the only company with a considerable net debt position that may put the company in jeopardy, should the situation last several months. ShaMaran has the backing of the Lundin family that could open new liquidity lines, but none has been announced yet. Forza Petroleum’s debt consists of a contingent payment for acquisition and it was already looking for additional liquidity before the ICC’s ICA ruling. 

At first glance, all of these companies appear to be inexpensive. However, are these companies cheap enough in the current situation? Yes, their multiples are low, but, do they worth the risk? The most relevant risks are described below.

Most of the attention has been put on the recent ruling of the ICC’s ICA. But, another aspect to consider is the reaction to the 2022 ruling of Iraq’s federal court, which could signal a total change of control over the licenses. If all licenses issued by the KRG were voided by the Iraqi Government, the companies mentioned above might lose all or most of their production. The largest US oil services companies already left the region due to the decision of the Iraqi court, which shows that the US government is not interested in contesting the ruling. However, by pledging in light of that ruling, these companies aligned with Baghdad’s interest to regain control over the fields. Once an agreement is reached, these fields will need service companies to deploy the necessary investment to stabilize and increase production. By having left the region after the first court decision, these companies and other US companies) may count on the support of the Iraqi government to replace the companies operating in the region. We estimate that the worst situation with the cancellation of all licenses issued by the KRG has a low likelihood with a very high severity on these companies. In our opinion, this high risk has not been properly considered in today’s share prices.

Contrary to this, Turkey is losing an important source of income for the country that has left the Ceyhan operating on fumes. Also, the proposed new gas projects in the Kurdistan region include a gas pipeline to feed Turkey’s industry and electricity plant. This would incentivise the Turkish diplomats to work for a quick resolution of the Kurdistan-Baghdan dispute and to resume the oil and gas exports as soon as possible, which would minimize the risk of a total overhaul of the licenses and fields.

The situation is complex and the impact on the companies included above is almost impossible to comprehend at this moment. The negotiation between the KRG and the Iraqi government will be held upon a new balance of forces, now the position of power has switched back to Baghdad. These companies are facing weeks and months of idle production until the agreement is announced, and such an agreement has been almost impossible for years. The US Department of State is supportive of these talks and has urged both parties to reach an agreement to avoid disruptions to the global energy supply. How the situation will evolve from here is not easy to predict. We estimate that the worst situation with months of lost production has a high likelihood with a very high severity on these companies. In our opinion, this very high risk is not reflected in today’s share prices.

Also, if these risks do not materialize and these companies can resume operations soon and with all the regulatory uncertainties resolved, investors could benefit from this special situation. It is important to remember that the market has offered lower multiples to the oil companies operating in Iraqi Kurdistan compared to other regions. Besides recovering the levels prior to the news of the last ruling, these companies could experience a re-rate, as the risk of more delayed payments and the validity of their licenses would not be challenged in the future. From our perspective, it is a challenging situation that may take time to resolve, and it is not easy to predict the outcome. It is true that there is considerable upside if things go well, but the risks are more than notable. That is why we do not take part in / nor will we take part in any of these companies. However, we thought it was a special and interesting situation to discuss here.


Disclaimer 1: The situation between the Kurdistan Regional Government and the Iraqi National Government is complex and not the subject of this article. The information presented here comes from online sources and it is not intended to provide a detailed analysis of the geopolitical situation in the region. All information contained here does not reflect the reality of the conflict in depth and should not be considered as a source for any conclusion.

Disclaimer 2: The authors do not have a long or short position in any of the companies mentioned in the article at the moment of writing the article. This article does not constitute any recommendation and has been prepared only for informative purposes.

Note: Every week we publish investment thesis, macroeconomic articles and comment the market situation in the recently launched blog section. You can follow us to receive an email each Sunday with the publications of the week. 

As always, thank you for reading

Authors: Alejandro Varas (Alxo), Antonio Lujano

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