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Why Are Afren Plc And Gulf Keystone Petroleum Limited Falling Today?

The 50% fall in the price of crude oil since last summer is flushing out oil producers with dangerously high levels of debt.

Two of the biggest fallers so far are former FTSE 250 member Afren (LSE: AFR), and Kurdistan pioneer Gulf Keystone Petroleum (LSE:GKP).

Shares in both firms are falling today — in this article I’ll look at why this might be, plus whether either stock is a buy.

Oil recovery stalled

Earlier this month, crude prices rose by 20% from their January lows. Brent crude for April delivery rose from $48 to more than $60, and oil stocks surged accordingly.

However, this rally appears to be fading away — perhaps because the market is still oversupplied — and Brent has now fallen back from recent highs to around $57 per barrel.

For producers like Afren and Gulf, where every dollar of cash flow is essential, this isn’t good news.

Afren deadline

The biggest risk weighing on Afren shares is that the company will be forced into administration, rendering its stock worthless.

Investors are hoping that fellow Nigerian operator Seplat will make an offer for Afren stock, but time is running out — the deadline is 5pm on 13 February — and I think an offer is unlikely.

Afren has already delayed $65m of interest payments until the end of February. After this time, the firm is likely to be in default on its debt, and may be forced into administration. If Seplat wants to buy Afren, all it has to do is make an offer to buy the firm’s debt, not its shares.

What about Gulf Keystone?

Gulf Keystone Petroleum bonds now offer a yield somewhere in the region of 30% — only slightly below those of Afren. This suggests that bond investors believe Gulf’s bonds won’t be repaid in full.

Although none of these bonds are due to be repaid until 2016 at the earliest, the firm does have $52m of interest payments due by the end of June, according to its latest accounts.

Gulf had $177m in cash at the end of August last year, but we don’t know how far this has fallen. My suspicion is that Gulf’s cash situation may be worse than expected, but we probably won’t know more until late March, when the firm’s results are due.

Is either firm a buy?

The debt problems being experienced by Afren and Gulf mean that an investment in either firm is almost pure speculation, in my view, with a high likelihood of a near-total loss.

In my view, there are many better buys available, even amongst oil stocks.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.