There is a very good reason why the Gulf Keystone Petroleum (LSE: GKP) share price has dropped 40% this year. It is that the very future of independent oil and gas firms in Iraqi Kurdistan hangs in the balance.
Gulf Keystone is one such producer, with its most notable exploration and production field in the region being Shaikan. For me, this means that the stock is a huge risk/reward play.
Huge legal risk
For years, the federal government of Iraq has disputed the right of the semi-autonomous Kurdistan government to sell oil independently. The oil from fields in Kurdistan has historically been transported through a pipeline running into the Turkish port of Ceyhan.
Consequently, the Iraq-Turkey Pipeline (ITP) was shut down on orders from Iraq’s federal government in Baghdad on 25 March.
This followed a ruling by the International Court of Arbitration that Turkey cannot allow independent oil exports from Iraqi Kurdistan. Instead, all such exports must be approved by the federal government of Iraq.
There seems little chance of this approval being granted. In February 2022, Iraq’s Federal Supreme Court ruled that independent sales of oil and gas by Iraqi Kurdistan were unconstitutional.
Massive blow to independent firms
Gulf Keystone looked on track to deliver another year of strong profitable growth in production and robust cash flow generation. March production before the pipeline suspension averaged around 53,700 barrels per day. There were also plans to bring on further production in the second half of this year.
The suspension of the ITP has also resulted in a gross production deferment to date of around 1.6m barrels. It has also exacerbated delays in payments to Gulf Keystone from the Iraqi Kurdistan government of $102m.
Fighting a rear-guard action
Given all this, Gulf Keystone is focusing on preserving liquidity and is targeting a reduction of costs across the business. At the same time, it is ensuring the long-term reliability of its oil and gas assets in Iraqi Kurdistan.
From now to the end of the year, the firm expects net capital expenditure of $35m-$40m. For the whole year, net capital expenditure is currently estimated at $80m-$85m. Before the ITP shutdown, the estimate was $160m-$175m.
Dividend under review
Before the closure of the pipeline, Gulf Keystone had offered a very healthy dividend yield in addition to strong share price growth. In 2022, the dividend yield was over 9%, in 2021 over 39% (yes, thirty-nine), and in 2020 over 7%.
As of now, the company is ‘considering’ the previously declared final 2022 dividend of $25m.
The company believes that the pipeline shut-in is temporary, and that the Iraqi Kurdistan government will resume more normal payments.
For me, the Iraq oil sector, north and south, is a particularly uncertain operating environment. It is beset by legal wranglings between the federal government in the south and the semi-autonomous government in the north.
Gulf Keystone may be right that this dispute will end at some point. However, there is no telling when and in my view it is only likely to be replaced by another dispute.
I have holdings elsewhere in the oil sector, which offer good dividend yields and share price growth potential. For me, the risks in Gulf Keystone outweigh the rewards. For others, it may be worth a very speculative punt.
