Fixed Income Analysis /

Kurdistan Oil & Gas: Minimising regional risk is key

    Tellimer Research
    4 November 2019
    Published byTellimer Research

    We initiate coverage of the Kurdistan exploration and production (E&P) sector, assigning Buy recommendations to OILFLO 22s, DNONO 23s, DNONO 24s and Hold recommendations to GULFKY 23s, HKNENG 24s and SNMCN 23s, as well as reiterating our Buy on GENLLN 22s. Kurdistan E&Ps can be categorised into two distinctive groups – companies with high production coming from mature highly cash-generative assets offering high returns on investment; and companies with assets at an early stage of development, low production and high capex. Leverage is generally low, but bond yields incorporate high risk premiums, reflecting Iraq country risk and a ‘surcharge’ for the Iraq-Kurdistan tensions. We suggest a bond-selection approach to minimise the country/region risk and gain exposure to operationally strong and reserve- and cash-rich E&P companies.

    Strategies that minimise Kurdistan-specific risk are most attractive. The cash flows of the companies we cover here depend on the Kurdistan Regional Government (KRG) making timely payments for its share of the produced oil; regional risk is thus one of the key valuation inputs. Investors can partially mitigate this risk by picking issuers and instruments with the right parameters and selectively adding them to a diversified portfolio for enhanced returns. Our bond-selection guidelines focus on strong stand-alone financial profiles, geographically diversified revenues and convincing relative-value trades. The most attractive investment opportunities lie at the intersection of different strategies.

    The strongest stand-alone credits: DNO, Genel and Oil Flow. DNO is our top pick in the Kurdistan E&P sector. The company offers a compelling combination of strong stand-alone credit metrics and exposure to the (relatively politically stable) North Sea region, which could become the main trigger for DNONO 23s and 24s outperformance in the next 12 months. Genel supplements its self-funding, highly profitable operations with a net cash position sufficient to repay all its debt at once. Oil Flow offers one of the shortest-term exposures to the sector, with monthly bond amortisation funded by a dedicated volume of the KRG’s oil exports. 

    Transformative growth stories: HKN and Gulf Keystone. HKN Energy is on its way to joining the ranks of the leading producers in Kurdistan, but only after significant capex outlays in 2019-20. If production increases as planned, HKN could outperform its peers in 12-18 months. Gulf Keystone’s massive oil reserves, high cash generation and substantial accumulated liquidity (which significantly exceeds outstanding debt) are offset by the absence of a long-term oil sales agreement and the potential amendment of the production-sharing contract (PSC). With these obstacles gone, Gulf Keystone could quickly close the valuation gap to DNO and Genel. 

    Risks to our recommendations stem from the uncertainty around KRG-Iraq negotiations on disputed issues, the security situation in Iraq and Kurdistan, and oil prices, which, on the way down, could complicate the political landscape more than operating environment for the E&P companies. Most break even before capex with Brent at US$25-45/bbl.