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Genel comes up with the goods despite high risk region

The Anglo-Turkish player has carved out a very attractive niché for itself in Iraq’s Kurdistan region. And while the risks are high, NJ Watson argues, the rewards look set to be worth it

In 2011, Nathaniel Rothschild’s investment vehicle Vallares merged with a Turkish independent explorer to become Genel Energy. Since then, Genel has gone from strength to strength.

In its first 18 months as a public company, Genel has made substantial progress. From its London flotation it moved from being a financial shell company with £1.35 billion ($2.03bn) on its balance sheet to become a top-tier independent with proven and probable reserves of 445 million barrels of oil equivalent (boe) in Iraq’s Kurdistan region. Daily production has nearly doubled to 75,000 barrels a day (b/d) since the first half of 2011.

The decision to explore in what the company calls "one of the last great frontiers of global energy" has proved prescient.

The men behind Vallares – Rothschild, former BP chief executive Tony Hayward, Julian Metherell, the former head of energy investment banking at Goldman Sachs, and US hedge fund manager John Paulson – said they planned to invest funds raised in the offering in "oil and gas assets in emerging markets".

In the end, they alighted on privately held Turkish explorer Genel Energy International, owned by Mehmet Sepil, a well-established player in the semi-autonomous Iraqi region of Kurdistan. Sepil and his business partner, Mehmet Karamehmet, brought local knowledge and connections to the venture, while Vallares  provided money and operational know-how.

Sepil's Genel had been exploring in Iraq’s Kurdistan region since 2002. The Kurdistan Regional Government (KRG) was keen to attract foreign companies to exploit its estimated 45bn barrels of oil reserves. According to Metherell: "it was unusual to find assets of this quality that hadn't been bagged by the majors".

This highlights the main risk to Genel's strategy. Although still part of Iraq and nominally under the control of the central government in Baghdad, Kurdistan has for the past 20 years been a de facto self-governing state, signing more than 50 exploration and production agreements with international oil companies. Over the past few years, it has developed close relations with Turkey.

Kurdistan might have a third of Iraq's total 143bn barrels of reserves, but according to Luay al-Khatteeb, director at the Iraq Energy Institute in London: "Kurdistan is 11 years ahead of the rest of Iraq in terms of political and commercial development."

However, Baghdad regards the KRG contracts as illegal. The issue of exports to Turkey is reaching a crisis point. Baghdad, which has failed to pass a new petroleum law or resolve the dispute with the KRG. To date, the only concession Baghdad has made is to allow the export of around 190,000 b/d of Kurdish oil through the existing Iraq-Turkey pipeline, in return for an agreed level of compensation paid to the KRG, which in turn pays the developers. This allowed field development to continue, but Baghdad has frequently  failed to make payments. As a result, the KRG stopped shipping crude through the federally controlled Kirkuk-Ceyhan pipeline in December, and amended its own constitution to allow it to sell the region's production itself, should Baghdad fail to make payments within 90 days.

Moving ahead

Genel currently exports around 25,000 b/d from the Taq Taq field to Turkey by truck. Kurdistan is also building its own pipeline to Turkey, and Hayward believes the momentum for exports is gathering pace. "I think (by) the end of the year, we'll see a significant step forward in terms of Kurdistan exports entering the global oil market," Hayward told Reuters in an interview in April.

That would suit Genel. On 30 May, together with partner Gulf Keystone Petroleum, it  announced a sidetrack of the Ber Bahr-1 exploration well hit oil. Credit Suisse, which on May 31 raised its price target on Genel Energy stock to 1,246p from 1,236p, estimated the find could be roughly 100m barrels in size.

Genel and Gulf Keystone both have 40% stakes in Ber Bahr, with the KRG holding the remainder. Crucially, Ber Bahr is near the new Dohuk-Fish Khabour pipeline extension, which has a 300,000 b/d initial capacity. The Khurmala-Fish Khabour pipeline is almost complete and will be Kurdistan's first independently operated oil pipeline into Turkey. 

The Ber Bahr find follows Genel’s April announcement of a "significant oil discovery" at the Chia Surkh Block. The company said it reached a test rate of 11,950 b/d from its first of five wells in the Chia Surkh discovery area. A second test well yielded a sustained preliminary flow rate of 3,200 b/d and 8.4m cubic feet of natural gas. Hayward believes Chia Surkh could hold more than 300m barrels of oil.

Of the 49 wells Genel has drilled in Kurdistan over the past six years, more than 70% have been successful. All this contributes to a very bullish 2013 outlook . In April, Genel issued an interim trading statement that kept its production forecasts for 2013 at 45,000-55,000 b/d, compared with an average first-quarter net working interest production of 37,000 b/d, and estimates revenue will be $300m-400m.

This compares with 2012 revenue $333m and an operating profit of $60m. Profit margins were 37%. The uncertainty over Kurdistan's relationship with Baghdad has enabled Genel to acquire assets at attractive prices – close to $1.50 per barrel for reserves, according to Mateo Blumer, a portfolio manager with Flohr Asset Management. Its reserves replacement ratio stood at 356% at the end of 2012, but this is to be expected as Genel grows its resource base.

Hayward said: "Genel has started 2013 strongly with a significant oil discovery at Chia Surkh, encouraging results from our Bina Bawi appraisal wells and good progress made (at) our major projects.”

The company is now looking to invest its roughly $1bn cash pile further afield. It has bought licences in Malta, Côte d’Ivoire and Morocco, and plans to start drilling in northwestern Somalia as early as the second quarter of 2014. "There is massive opportunity for shrewd investment in the space that exists between the juniors and the majors. Genel is poised to exploit it," Hayward said.

Blumer said: "Focused on a region with incredible potential, acquiring oil assets at unusually low prices, and clearly well-capitalised, Genel represents a high-risk opportunity with enormous upside potential.”

Report card table - Genel
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