Gulf Keystone Petroleum Limited (LSE: GKP) (NASDAQOTH: GFKSY.US) generates a lot of emotive debate among UK investors — but if we ignore the firm’s dramatic history, what are the shares actually worth today, and are they undervalued relative to the firm’s peers?
What is Shaikan worth?
To come up with a meaningful value for Gulf Keystone, I’ve ignored the firm’s favoured 12bn barrel headline number. This only relates to oil in place in the Shaikan field, not to recoverable resources, and is largely meaningless in commercial terms; oil is worthless if you can’t extract it economically.
Proven and probable (2P) reserves are the globally-recognised measure of commercially viable oil and gas assets. A key valuation metric for oil companies is the enterprise value (market cap plus net debt) to reserves ratio.
On this metric, how does Gulf Keystone shape up against its Kurdistan peer, Genel Energy?
| Company | 2P reserves | Enterprise Value | EV/2P reserves |
| Gulf Keystone Petroleum | 163m barrels of oil equivalent (boe) | £1,074m | $11.00/boe |
| Genel Energy | 453m barrels of oil equivalent | £2,520m | $9.30/boe |
Sources: Company reports
Valued purely on reserves, Gulf Keystone is more expensive than Genel at the moment, despite the fact that Genel’s production is currently much higher, and profitable. Both valuations are relatively cheap — mid-cap Premier Oil is valued at $16/boe — but Kurdistan is very risky at the moment, politically and operationally.
If the current crisis in Iraq can be settled, and the remaining issues surrounding oil exports resolved, Kurdistan EV/reserve valuations might rise slightly. However, I don’t think this would be enough to deliver significant gains for Gulf Keystone shareholders.
We need more reserves
So far, Gulf Keystone has only drilled about 25% of the development wells it is planning for Shaikan. As it drills more wells, the firm should be able to convert more of its contingent resources — oil or gas that is proven to exist, but not yet shown to be commercially viable — into reserves.
Gulf Keystone currently has contingent resources including 518m barrels of oil, and it’s here that I believe the realistic upside potential for the business can be found.
For example, if half of Gulf Keystone’s contingent oil resources were converted to reserves, then Gulf Keystone’s enterprise value, at $11/boe, would rise to about £2.8bn. Even allowing for an increase in debt and dilution from the issue of new shares, that could double the firm’s share price.
That’s the good news
The bad news, for impatient investors, is that unless a takeover bid comes along, this value is only going to be realised gradually, by drilling lots of wells. In my view, Gulf Keystone is probably quite fairly valued at the moment, albeit with a lot of upside potential.
