Why Gulf Keystone Petroleum Limited Is A Bad Share For Novice Investors

One of my key rules for novice investors is that you really should avoid companies you don’t understand, as I explained when I took a look at Barclays the other day. I mean, some of those sliced-and-diced derivative investment instruments — I don’t even understand enough to tell if they even exist, and as we found in the banking crisis, a lot of them effectively didn’t.

But oil and gas… well, that exists for sure — and we all know the value of fossil fuels! So why not an investment in an oil & gas exploration company, like Gulf Keystone Petroleum (LSE: GKP)?

After all, it’s delving in the Kurdistan region of Iraq. And while I would never suggest that’s why we went to war there (perish the thought!), getting our hands on some of the region’s oil is, at least, a bit of compensation for our efforts, isn’t it?

What about the business?

But as well as understanding the product, you need to understand the business. And do you understand enough to get a clue to the value of a firm’s oily riches? I don’t, and judging by the number of failures, half the experts in the industry don’t either.

Actually, on a simpler level, it’s a very easy business to understand. You raise a shedload of capital, and spend it digging holes until it’s all gone. Or you strike oil. Whichever comes first. And if you do strike oil, what usually happens is you sell the interests to a production company for a bigger shedload of cash than you started out with, and you go digging again.

Having said that, to be fair to Gulf Keystone, the company has found oil and is in the process of developing production and transport facilities to exploit it — but there aren’t many ways out of Kurdistan at the moment. And the firm is still burning its way through that investment capital — there’s no profit expected before 2014, and even then it’s going to start off small.

The risks multiply

If the risks of the actual exploration activity itself weren’t bad enough, wherever there’s a hoard of very valuable stuff of some kind, there will be people after it — often by legal and political means.

Gulf Keystone’s progress has been dogged by just such a problem, after its former exploration partner Excalibur Ventures claimed it was entitled to a share of Gulf Keystone’s Shaikan oil field. Thankfully for Gulf, a court verdict earlier this month came down against Excalibur, so that oil is all its own. But such disputes are still a risk, and the Gulf share price did suffer for a while — and we had no idea which way it would turn out.

In a related field, gold miner Centamin Egypt has faced legal challenges from the Egyptian government over its rights to mine and export the shiny stuff, and that did some damage to the share price. Political? You bet. And in Kurdistan, Gulf Keystone is not exactly in one of the world’s most politically stable spots.

Just say no

Novice investors can do well investing in the oil & gas, but when you’re just getting started I really would suggest steering clear of Gulf Keystone and other similar exploration companies, as it’s really just a gamble. I’ll look at better prospects for novices later in this series.

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> Alan does not own any shares mentioned in this article.