GKP Dalesman 20 Dec ' bear case '

I posted this over on Advfn it applies equally here

Good morning fieryNo problem - your posts make me think and re-evaluate which is always a good thing!
The downside caseThere is without doubt political risk, no one on these boards can deny that. The question then becomes can I live with this particular factor? If I take my NAV calculations (there is little point in doing a DCF at this stage) political risk represents a discount of around 115%; that is, I perceive a fair value of around £2 based on the last DGA report. This is currently discounted by over 100%. This implies that the market is factoring in a less than 50% chance that the KRG contracts will be ratified.Is this realistic?

IMO the political risk is very much smaller than a binary play. The Kurds have taken a direct stake in companies like Vast, they have worked in close cooperation with over 25 companies from all over the world, they have taken independent council on the legality of the contracts and they are building their own refinery along with muting the possibility of their own pipeline to Turkey. The 48in export pipeline runs through KRG territory - it might be owned by the IOM but effectively the pipeline is controlled by the Kurds and if push came to shove they could cut it.

Now add in the external political influences. The Americans have given their backing to the Kurds, the high level interest taken by the Obama administration in this particular difficulty and their pledge to stand by the Kurds - 'we will not abandon you' is significant and the political risk decreases as it is in everyones interests to resolve this problem. So far American companies have not been successful in the bidding auctions. The KRG may have within its territory up to 50% of all oil in Iraq. To ignore this resource would be inept and Iraq needs the revenue stream. Add into this mix the fact that security, standards of living, infrastructure and education are all much better in the KRG and we begin to see a scenario emerging that says the place to be for a multi-national is not the troubled south with its on going security problems but the stable north. A friend who is heavily invested here brought to my attention the role of remote imaging in oil exploration.

You will find this exploration tool mentioned in both Gennel and Vasts presentations. It is without a shadow of doubt that the US knew long before the Iraq invasion about the potential of the north, their remote sensing technology leads the world. The question then boils down to this - will the US walk away from Iraq and the KRG without having secured a piece of the oil pie that they have known about for over 20 years? I could go into the link between Cheney, Hunt oil and TK once again but I think that my central point is clear. Given all of the above and the fact that the Kurds are a proud and intelligent people (My niece is married to an Iraqi Kurd who ran the UK arm of a huge multinational telecom company) I personally put the political risk at being well below that currently being factored in by the market.

Ergo I sleep soundly at night.

Downside 2Lack of money
With all E&Ps this is always a factor. Almost by definition they are always short of money and need to raise funds to continue. When GKP's only asset was Algeria this was a major worry for me. They had 173mboe booked but the resource was in Algeria where things move at a snails pace and where Sonatrach seem to put barriers in the path of small E&Ps - the delayed production from the northern blocks is a case in point. To succeed there you need to have clout. Having exited GKP at 44p on the way down to 5p (I held when GKP was 90p on Algeria alone)I dismissed GKP as a fit place to risk Mr and Mrs Dalesmans hard earned cash! In the meantime GKP had got BG as a partner - here we had a company with sufficient clout and financial resources to take a project through to completion.
Things were looking up for GKP and then they had obtained two blocks in Kurdistan. That on its own was not enough for me to throw dosh at the company, more DD was required.

The appointment of Adnan Samarrai was significant for me :Country Manager - KurdistanMr.Samarrai holds a B.Sc degree in geology and has been an active member of the American Association of Petroleum Geologists since 1972. He has over 45 years experience in the oil and gas industry in Iraq including wide experience in petroleum geology and drilling technology. He joined the Iraq Petroleum Co. (IPC) in the early sixties before joining the Iraq National Oil Company (“INOC”) in 1972 where he held the position of Chief Exploration Geologist until his retirement in 1998. Since his retirement from INOC Mr Samarrai has worked as Consulting Geologist to both BG International and Exploration Consultant Ltd (ECL) before joining Gulf Keystone firstly as a consultant and subsequently as the Country Manager for Kurdistan in November 2006.
Looking at the blocks they were right next door to Hunt oil to which we know TK has connections. Now we had a senior geologist who knows the territory from the ground. At this point in time the risks re GKP were much greater than they are now - no discovery but very prospective blocks, local expertise secured, Hunt oil next door and BG batting for GKP in Algeria.
On Hoils discovery I posted on TMF that GKP was de-risked and under valued, and set out the upside as I saw it; the share price was just over 5p.Returning to the funding issue. We now have 2.8 billion of OIP identified by the DGA report. That alone is enough to secure further funding given the arguments I have set out above.

We are about to enter a new phase in the life of GKP - we are about to become a producer with a $2.5m cash flow per month with oil being sold into the local market. The shift from Explorer to Producer is small but again significant in that it secures necessary cash flow but more importantly demonstrates to a buyer what can be done in KRG. The extended flow test will significantly firm up the numbers and while we wait, the drill bit is turning as I write this at AB.

Under these circumstances the funding issue will go away and I would not be surprised if it went away quickly!These two components make up the bear case for me. I hope that I have put a cogent case together to explain why I hold and accumulate GKP.

GKP is not without risk - what share is - but for me it represents the best company on the block in terms of upside and like Warren Buffet I am prepared to be patient while the market catches up!

Kind regards