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Back in September I wrote a piece on Genel Energy (GENL) here, at the time I issued a Hold recommendation with the price at 90p. Since then the shares have slumped further with traders now swapping these shares at just 71p. At the time of my original article I advised potential investors to consider buying around 80p ceteris paribus, I thought it was worth revisiting Genel given we are now significantly below that level.
What has happened since?
The oil price has risen thanks to OPEC’s deal to cut production. You can see though from figure 1 below that the Genel share price has failed to track oil by a margin of 40%! So what else has gone on?
The sharp decline in Genel’s share price was on the back of the most recent trading update in October 2016, i.e. for the 9 months to September 2016. It revealed that production from crown jewel Taq Taq is declining rapidly. In Figure 2 below I have tried to piece together all of the available information to get a view of production and after adjusting for pipeline downtime. The results are not good, Taq Taq has declined from approximately 80,000 Boe gross per day at the start of the year to 50,000 boe in October. If you follow the trend line this would be below 40,000 Boe a day , i.e a 50% yearly decline by the time Genel close the books in 2016. This is an increasingly worrying trend and even attempts at slowing the decline don’t seem to be assisting a great deal. Genel have drilled two side‐track wells, TT‐27x and TT‐07z in 2016 with the company admitting that these have only succeeded in ‘partially offsetting the decline from existing wells’. This is pretty disastrous for Genel given that Taq Taq contributes around 70% of the groups revenue.
Is there anything that can be done to improve productivity at Taq Taq?
As at year end and based on the last Competent Persons Report (CPR) I estimate around 120 million barrels gross left at Taq Taq, but based on the decline rates one does start questioning whether this is very optimistic indeed. As a result Genel are currently working on a revised Field Development Plan and CPR which should identify how to maximise production from Taq Taq. Maximising production doesn’t come without a price tag though, this will almost certainly require a significant CAPEX investment.
What valuation can we place on Taq Taq in light of the declining production?
Taq Taq had an NPV of $406m as at Dec 2015 based on the Taq Taq CPR (see page 29). Let’s start by revisiting the key inputs in Fig 3 below:
The oil price assumptions look pretty robust, the 2016 average rate is current $42.5 vs $42.28 above. We may see average oil price reach around $46 in 2016 and perhaps $55 in 2017 so perhaps some upside in the valuation here. The production figures are way down though on expectations, 80,000 boe per day was assumed in the CPR for 2016 whereas Genel now expects 60-65k Boe, a production decline which was not expected until 2018 in the CPR. Given the vast amounts of uncertainty over the revised CPR and FDP I’ve decided to revert to the 1P NPV valution of $152m, adjusted for $70m of NPV relating to 2016 production. This gives a valuation of $82m for 1P. Given the large uncertainty over the 2P reserves I have now risked this by 70% in the valuation below, Fig 4. This could be excessively bearish and of course the ‘Risk’ factor is heavily subjective here.
What about the arrears? Is Genel any closer to setling the debt with the KRG?
Another depression on the share price is the continued payment irregularity and the continued lack of real progress made on recovering arrears from the KRG. From the start of this year a repayment mechanism commenced whereby an amount equal to 5% of the oil sales each month would be paid to reduce prior arrears. Based on $210 net revenue expected for 2016 this is only around $10m though. Genel are owed a total of $812m from the KRG of which $412m is on the balance sheet, so at this rate 40 years to repay or 80 years if you include the already impaired receivable!
To make matters worse there doesn’t seem to be much in the way of hope for repayment in the near term, the KRG oil minister was recently quoted as saying “stop complaining… or take your money elsewhere. You get paid 60 days late… so do our peshmerga.”
With no real progress on the horizon I’m now risking the $412m payable by 50% in my valuation in Fig 4, it will be interesting to see if the auditors force Genel to take a similar write down in the 2016 annual accounts.
Is there anything else to be concerned about?
Genel has net debt at present of around $240m and total debt of $640m. This is unsecured debt repayable in May 2019. Not an immediate concern here and there should be no issues with servicing this debt in the near term. There could be a longer term issue though of getting this refinanced, certainly at the same rate. The bonds are currently trading at 80$ vs a par of $100.
The final risk is any strengthening of sterling vs the dollar, being relevant as Genel’s shares are quoted in sterling. We are at 20 year lows GBP:USD and an improvement in the outlook for GBP is possible which will reduce the valuation further in Fig 4.
Is there anything for the bulls?
My fundamental concern here remains the same as earlier in the year, the financing of Kurdish exploration/appraisal and Gas assets which is where the future value is. Genel does not have the balance sheet to execute these projects and resolve the issues at Taq Taq. The big issue with the gas and exploration projects is though they require tons of up front CAPEX, the gas projects require $2.5bn alone. This would require a combination of equity, debt and JV partner entry to get this financing away. In a situation where the KRG are not paying Genel I can’t see this being possible nor worth proceeding with in this uncertain environment. I have been generous and assigned various risked valuations to the ‘sundry assets’ in figure 4 below, but there is a chance that they could sit on the shelf for a long time. That said it is the season of miracles, if the KRG do settle the arrears then all of a sudden it’s game on.
I may also be overly pessimistic on the Taq Taq issues above and consequently my risking on the reserves. The field is in steep decline but with an appropriate field development plan it could be that 2P reserves are still in play and the 3P and contingent resources are also given a future. Genel do have a cash pile of $400m and this would go a long way to developing it’s share of Taq Taq. A coherent FDP and CAPEX plan may together with regular payments from the KRG may also trigger a major re-rate.
Final obvious point, price of oil increasing would also help and improve valuations. However, there are far better/safer plays on oil price that this stock in my opinion.
My valuation is 68p which in my view means the shares are trading around the right level . However, most of the valuation relates to risked assets, stripping these out gives a valuation for the ‘core business’ closer to 20p, so a lot of value is still placed on future hope despite the heavy riskings already used.
I also believe sentiment will come into play here, the Taq Taq CPR is almost certainly likely to see a downgrade in reserves and consequently we could see further impairment on Taq Taq in the 2016 reports. This combines with the already confirmed impairment of $100m+ on Chia Surkh which Genel stated in October would be written down to nominal value. This lot is going to be hard to stomach and I expect significant selling pressure which will take us towards 60p or lower if all of my above assumptions are correct.
SELL – Target 60p
There are bags of potential in this stock and Genel have lots of promising assets to develop. The major catalyst here is for the KRG to create an environment suitable for investment, settling the areas of IOCs in full. This would trigger a major re-rate. In the near term though I see significant selling pressure, particularly if Taq Taq takes another reserve downgrade. It is advisable to keep this company on your watchlist and be prepared to BUY once certainty over Taq Taq improves and certainly if payment issues with KRG are resolved.
Disclaimer – I have a LONG position in this stock equal to 2% of my net assets at time of publish but plan to exit this position. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.