Genel Energy (LSE:GENL)

Genel is a low cost oil producer in Kurdistan, one of the last places in the world with cheaply accessible oil.  They have minority stakes in 2 producing oilfields:

• Taq Taq (44% interest), produced 42680 bopd for Genel in the 9 months to Sept.
• Tawke (25% interest), produced 21000 bopd for Genel in the 9 months to Sept.

The Kurdish Regional Government (KRG) has completed a pipeline (in green) through their territory, linking to Turkey's pipes through to the port of Ceyhan, allowing exports.  Genel expects all their oil to be sold at higher export prices in 2015 (p29).

Genel has recently signed a deal to develop 2 gas fields, Miram and Bina Bawi, for export to Turkey.  Production is expected to start in 2016.

   

They are also exploring in Morocoo, Ethopia, Côte d'Ivoire  and Malta.  Exploration is a hit-or-miss affair, mostly the latter.

I'm looking at the 2 producing oilfields only.

Production Costs

Extremely low costs.  I use net production, divided by all costs on the income statement:

Revenue

Offsetting its low production costs, Genel sells its oil at far below market rate as agreed in the Production Service Contract (PSC) with the KRG.

Generally, a PSC breaks down the revenue received into 3 parts: the contractors costs, government royalty, and the profit.  The first is given to the contractor, the second to the government, and the third is split:

(Source - p26)

For Genel, to calculate their share of oil produced:

• Subtract royalties of 10%
• Genel gets to keep costs.  Specifically: production costs, exploration costs, gas marketing, development and decommissioning.  Up to 40% of the oil (excl. royalties).
• The remainder is profit oil, to be shared between Genel and KRG.  Generally, 15-16% of this goes to Genel.  The amount depends on the projects profitability, or R-Factor (accumulated revenue over accumulated costs throughout project lifetime).
• However, we have to halve Genel's share of the Profit Oil, due to KRG's 20% carried interest, as well as a 30% 'infrastructure/capacity fee'.

A summary of the PSC is on p30.  PSC details are here, with the 2010 amendment for the 30% capacity fee here.  Genel provided an example, assuming $90/barrel:

(Source - 2011 Company Presentation - p19)

I was not able to reconcile the formula with the prices and volumes given in their results.  Without knowing which costs were claimable and what the R-factor is.  The best I can say is that this is a 'cost plus' model, which gives Genel some protection from falling oil prices.  They mentioned in November that a 10% fall in oil prices would lead to a 6% fall in revenue (p12).

Averaging out over their net oil production, they were getting around $20/bbl.  For the actual barrels sold in 1H14 (before the cost of the PSC is accounted for): they said they sold most of it in Kurdistan for $60-70, and trucked the remainder to export markets for $80.

Other Financials

After the first line on the income statement, the other numbers in the financial statements are simple.

Cash at hand was 973m at 1H14, after issuing US 500m bonds, which pay 7.5% and are due in 2019. 

Capex is estimated at 300-250m in 2015.  None given afterwards.

Could they survive if oil fell to $40?  I'm estimating yes, conservatively using 1H14 figures, whey would still roughly break even on the income statement.  They still would be generating cashflow from operations, and it would cover their capex in 2015, leaving zero cash on hand.  They'd still survive, but would have to cut capex afterwards.  This does not account for increases in production, or for the PSC decreasing sensitivity to oil prices.  Check again when we get the 2014 results.

Reserves

Reserves for their 2 producing oilfields are slowly decreasing:

See if they are increased in future Annual Reports.  Look at oil only, as gas confuses things.

Valuation

I would value an oil company on a sustainable oil price.  Probably $60-70.  Can't estimate their revenue/earnings at this price because I don't understand their PSC.  Theres also too many other moving parts: production increases, reduced transportation costs due to the pipeline, and the two new gas fields.

So a rough guess first.  Since they say they sold their oil for in 1H2014 mostly at $60-70, based on the earnings in that period, their PE at a share price of 700p is around 21.  Too expensive.  

Risks

I think Kurdistan is not as dangerous as most people think; the main risks for this company are political:

• Dependent on the Iraqi Government to recognize the oil exports (recently done), and the Turkish Government to continue to accept gas imports and transport oil over their pipelines.  Although the current Turkish government seems to be friendly to the Kurds, they have a long history of conflict.
• The KRG may renegotiate the PSC, as in 2010.  Genel gained from being one of the first to move into the region, but now that larger companies are moving in, it may be more competitive.

Conclusion

I don't fully understand the company, especially its revenue.  It seems OK, with a good chance of surviving low oil prices.

Oil is a risky business.  All the E&P companies I've looked at from the majors down to the independents have a lot of risk.  None have sustainable competitive advantages.  I'll aim to buy 'a basket' of oil stocks - allocate 2% each - to try to spread the risk.  Pick ones with good finances and low production costs, that give them a reasonable chance of surviving. These aren't stocks to hold forever, just buy to take advantage of the low oil price till it recovers to a sustainable $60-70 level.

Later on, I'll check Genel's 2014 results, for their cashflows, ability-to-survive, and see if we get a better revenue estimate based on lower oil price.  Also valuations.