Tuesday, November 23, 2010

Oil Stocks Exposed to Kurdistan

I thought it would be useful to look at some of the Western oil companies that are focused on Kurdistan. I think these could be good oil stocks to buy. They are interesting for a number of reasons, most of which are predicated on a successful resolution of disagreements between the central Government and the Kurdistan Regional Government (KRG)

  1. They tend to be characterised by being smaller companies who moved in on the market when the central Government said they wouldn’t allow any of the companies with KRG licences to take on development projects in the rest of the country.  This means that these companies are potential takeover targets once the political issues are resolved.
  2. There is likely to be significant upside potential due to de-risking once/if this process takes place.
  3. Iraq is oil rich and Kurdistan is under explored. The early movers have advantages.
 Oil Companies Involved in Kurdistan

The four companies identified are DNO (Norwegian), Gulf Keystone Petroleum, Heritage Oil and Sterling Energy. I have added a link below to some Goldman Sachs research whereby you can source forecasts and outlook or these stocks.

Before going any further, it should be understood that this idea is a speculative one, based on a successful resolution of the problem between the KRG and central Government. The standoff centres on licences issued by the KRG with these oil companies. The licences are based on Product Share Contracts (PSC) which central Government has consistently said it would not ratify. Naturally, as they are not ratified, export licences have not been issued. Furthermore, the PSCs may be torn up or be made subject to significant revisions in the political horse trading process with the central Government.

Kurdistan Production Share Contracts

Essentially, the PSCs are seen by some as being on more favourable terms to the Oil companies than would be the case under typical Iraqi service agreements. Furthermore, the KRG are effectively getting a subsidy from the rest of Iraq in order to pay the contractors exploration and developmental costs, because these costs are paid centrally from revenues emanating from total Iraqi production. Currently, Kurdistan’s oil production is proportionally lower than the rest of Iraq per head.

My hunch is that these licences will be ratified but there could be pressure to renegotiate contracts downwards for the contractors. With a new Government formed and the necessity of Baghdad to garner Oil revenues, I consider it unlikely that they will seek instability by not ratifying. Furthermore, Kurdistan remains a pet project of US foreign policy, even though the politically powerful Oil majors are not there yet. The pressure to get their oil industry developed will be significant. However, quantifying this viewpoint is not easy, although I note that Goldman Sachs ascribe a 50% political risking to the NPV calculations. I suspect the outcome could be more benign than the risks implied by Goldman Sachs.

Iraq/Kurdistan Oil Contract Dispute

The reason I suspect that they will be benign is that, the PSC agreements appear to be generous, but not overly so. According to Peter Wells when comparing Iraq’s Technical Service Contracts (TSC) with Kurdistan’s PSC agreements

The contrast with the KRG is considerable. The KRG’s PSCs have been awarded by opaque, secret negotiations to companies with, in the main, very limited major international field operating experience. The profit sharing terms of the KRG PSC are simplistic by the standards of modern PSCs and yield lower revenues and value to the state than PSCs in
comparable countries.”

Furthermore, if we look at figures 4 & 5 you will see that his modelling produces 97% of state take under the PSC but around 99% under the TSC. This isn’t a huge percentage difference to the State, but it is to the contractors share. In other words, assuming $60 a barrel of oil, he might get $5bn instead of $8bn under this model.

However, in his response to this paper, Muhammed Mazeel al-Aboudi articulates the KRG position on Iraq’s TSC agreements

“The contracts are, therefore, not in the best interest of Iraq – even with the important budget needs. These will be long-term contracts and need to be properly offered, reviewed, and approved in accordance with the Constitution and an oil and gas law that is in accord with the Constitution.

In the Kurdistan Region, by contrast, IOCs will, on average, receive a “gross undiscounted profit” figure of just $1.58 (at NPV of 10%) for each barrel of oil discovered and produced from any large field discoveries – almost 40% less than $2.20/B in the case of Ministry of Oil proposed contracts. “

So, by way of contrast, the KRG argue that the Iraq TSC agreements are too generous! I’ve included a link to the KRG’s views below.

Stocks to Buy and Benefit from Oil in Kurdistan

I think the important point is that the KRG thinks –or at least they say-that their contracts are not unfavourable relative to Iraq TSC. With the political wind moving behind the KRG it could mean that they get what they have already signed up for.

Of the four companies noted, Sterling Energy appears to be an also ran. They have had disappointing results in Kurdistan and the potential uplift is minimal. Gulf Keystone Petroleum appears to have the largest upside potential from a successful resolution. Heritage Oil is very interesting but contains the added risk of a tax dispute with the Ugandan Government over the sale of some of its assets. Since the idea here is to gain exposure to Kurdistan specifically, this might preclude an aggressive position with Heritage Oil. DNO is very interesting. Although the evaluation discount does not appear to be large, they have assets in production and would give good upside potential given successful political resolution.


Al-Aboudi, Muhammed Mazeel Iraq’s TSC And PSC Agreements – A Good Deal For Iraq?’ http://mepep.com/postedarticles/oped/v53n03-5OD01.htm

Kurdistan Regional Government Website

Wells, Peter Iraq’s Technical Service Contracts-A Good Deal for Iraq?’ http://www.iraqoilforum.com/wp-content/uploads/2009/12/Iraqs-Technical-Service-Contracts.pdf

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