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How Much Lower Can Gulf Keystone Petroleum Limited Go?

Unfortunately, Gulf Keystone Petroleum’s (LSE:GKP) shares have not had a good year so far and shareholders have every right to be frustrated with the company’s performance.

But with the company’s shares down around 44% year-to-date, how much lower can Gulf Keystone go?

Running out of cash 
Oil well

Every business needs cash to function, and for oil exploration companies like Gulf Keystone, getting your hands on the cash can be a struggle.

Unfortunately, earlier this year Gulf Keystone struggled to convince the City that it could meet commitments on a $250m bond issue required in order to finance growth plans. As a result, there was much speculation that the company would run out of cash, as lenders seem reluctant to trust Gulf Keystone and the company’s management.

Luckily, Gulf Keystone was able to raise the cash it needed, albeit at a hefty price. 

In particular, Gulf Keystone’s bonds pay interest of 13% per annum. Additionally, bond holders have received freely tradable and detachable warrants for a total of more than 40m new shares; around 5% of the company’s existing diluted share base. 

However, before Gulf Keystone could announce this good news regarding the bonds, the company’s shares were hit with yet more bad news; this time in the form of a report on the company’s oil reserves. 

Less than expected

According to a competent persons report, Gulf Keystone’s, contingent and prospective resources for the Shaikan field and the company’s other petroleum interests within the Kurdistan region of Iraq, only amounted to 1.3bn barrels of oil equivalent.

1.3bn barrels may seem like a lot, although it is a far cry from the 2.5bn reserve figure estimated previously. Gulf Keystone’s working interest is 740 million barrels. 

Obviously, this revelation was a huge blow to Gulf Keystone. Nevertheless, according to the company’s management, this report only covers 26 wells, representing less than 25% of all wells currently planned for the Shaikan development. 

With only 25% of the company’s development land evaluated, there is plenty of scope for an upward revaluation of reserves.

Eyes on the prize

Still, despite concerns surrounding Gulf Keystone, the company remains focused on achieving its self-imposed production target of 40,000 barrels of oil per day during 2014.

What’s more, since crude oil exports from the Shaikan field commenced in December 2013, over 690,000 barrels of oil have been sold at international prices. Gulf Keystone has a 75% working interest in Shaikan.

Put this all together and it seems as if Gulf Keystone is on a war footing and primed for growth. Indeed, City analysts expect the company to report a pre-tax profit of £26m for 2014, followed by a profit of £61m for 2014.

Foolish summary

So overall, Gulf Keystone has been hit hard this year with an almost continual stream of bad news. However, the company now has cash to move forward with growth plans and oil is flowing from the firm’s Shaikan development. 

With all of the above factors in mind, I would say that I believe Gulf Keystone’s shares are undervalued at current levels and should surge higher as the company hits production targets. 

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Rupert does not own any share mentioned within this article.