If ongoing protests have not been enough to unsettle bond valuations of the Oil & Gas companies operating in Kurdistan, a new round of escalation in the US-Iran relationship should. The main driver of negative sentiment weighing over the sector has been the announcement in December of the delay in payments for the August-September 2018 oil shipments to January 2020. But recent political developments have added a new layer of uncertainty to protest-stricken Baghdad, threatening to destabilise the security situation in the region and increasing geopolitical risks. We expect bond prices to drift lower ignoring the conflict-driven rally in oil prices. We downgrade DNONO 23s and DNONO 24s to Sell and reiterate our recommendations: Hold DNONO 20s, GENLLN 22s, GULFKY 23s and OILFLO 22s and Sell HKNENG 24s and SNMCN 23s (see page 2).
Geopolitical risks increase, but further escalation can still be avoided. On 3 January 2020, Major General Qassim Soleimani who led the Quds Force of Islamic Revolutionary Guards was assassinated in a US drone attack in Baghdad. In retaliation, Iran declared it will no longer abide by any of the restrictions imposed by the 2015 nuclear deal. Over the weekend, missiles landed in the Green Zone area housing Iraqi government buildings and foreign embassies. On Sunday, the Iraqi parliament supported a resolution to ask the government to terminate US military presence in the country. The news was not received well by US President Trump who threatened Iraq with financial consequences (a multi-billion bill to repay investments in the US military base) and sanctions. No major retaliation has happened yet and there are still ways to avoid further escalation.
Security risk increases. Responding to the threat of retaliation from Iran, the US halted its operations against Daesh (Islamic State) and focused on protecting its military bases and personnel in Iraq. The involvement of US troops in the area could be viewed as a factor of relative stability in the region, which has not fully recovered after the 2014-2017 Daesh insurgency. Although international military involvement of the US-led coalition, Turkey, Iran and Russia helped to restore peace in the region, economic and social challenges continue to divide the country. Popular protest in Baghdad, which started in October, continue and concerns about Iraq’s ability to stabilise the political situation and enforce law and order on its vast territory could increase if the relationship with the US deteriorates.
Risks to the KRG relationship with the Iraqi Federal Government. Since early 2018, the relationship between the federal government and Kurdistan has been improving, but the long-standing territorial, economic and legislative issues remain unresolved. The Iraqi government even started paying salaries to Kurdistan government employees. However, in 2019, Kurdistan did not deliver crude oil to Iraq as a substantial part of the government’s share of production was likely tied in oil prepayment-based financing agreements. Full information about these transactions is not available and we cannot estimate if Kurdistan has enough untied oil to deliver 250,000boepd to the federal centre in 2020. We maintain that it is economically beneficial for both parties to maximise oil production and avoid escalation. However, political turbulence in Iraq could compromise the recently adopted pragmatic approach.
Liquidity is king in Kurdistan Oil & Gas sector. Oil companies operate in Kurdistan under production sharing contracts (PSCs). Produced oil is delivered to the KRG and the companies receive their share of revenues from the government. This means that all producers bear Kurdistan’s credit risk and the ones with limited financial resources are always more at risk to any disruption in payments than those with significant cash cushions. DNO, Genel and Gulf Keystone have enough cash to protect itself from temporary disruptions. HKN and ShaMaran are in a weaker position. Limited liquidity and significant capex make them highly more sensitive to timely receipt of payments from the KRG.