Genel slumps further – it’s a sell from me

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


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?

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Figure 1 – Genel Share Price vs. Brent Crude

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.

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Figure 2 – Genel Production adjusted for Pipeline Downtime

 

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:

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Fig 3 – CPR 2P Case – Assumptions

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.

Latest Valuation

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.

genel-val
Fig 4 – ShareInvestors Valuation

SUMMARY

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.

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Genel Energy – Is there a future for long suffering Investors?

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


Genel Energy is a company I have followed since its IPO in 2012 and I’m sorry to say I’ve owned its shares on many occasions. I was always hoping that Genel was about to turn the corner, on a micro level the company had so much upside but it has been the macro events that have really punished Genel. Shareholders have inevitably suffered, those unfortunate people who bought into the IPO are now looking a 90% loss from the £10.00 issue price. The steady decline is charted below in fig 1, it shows a company capitalised at over $2bn at its peak to just £250m today, where shares are trading hands at just 90p. Genel does have net debt though, so the true Enterprise Value is around £500m.

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Fig 1 – Genel Share Price


What’s the background on Genel?

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Fig 2 – Genel Activities, Source: Genel

Genel is the operator of the Taq Taq field in Iraqi Kurdistan and non operating partner in the Tawke field in the same region. These two fields give Genel 2P reserves of 264m boe and the production from these two assets as at June 2016 was a respectable 56,000 boe per day. Genel also has two promising gas assets in its portfolio, namely Miran and Bina Bawi which have contingent resources of 4.3tcf and 7.1tcf respectively.

The company also has some sundry exploration assets, in Morocco and Somaliland. At present these are fairly uninteresting and no exploration wells are currently scheduled.

What went wrong for Genel?

Genel has suffered the perfect storm of sustained low oil prices and its host not paying for the oil, due to itself not being able balance its own books because of the same low oil price. The Kurdistan Regional Government (KRG) has been erratic in paying Genel at best, even suspending all payments for a period in 2015. As a result Genel is currently owed around $350m from the KRG. I am certainly not going to criticise the KRG here, with the Islamic State moving in next door at the same time as a collapse in the oil price – it is a difficult one to manage. 

Genel’s issues were compounded when the Taq Taq wells started to go into decline in 2015. This forced Genel into reviewing the field model which ultimately led to the Taq Taq field’s reserves being cut in half in February 2016. The financial result here was a $1bn impairment charge to the December 2015 accounts.

Is the worse over with? Can Shareholders expect to make up any losses?

The short answer is – maybe. I’ve put together an overview of the material value streams, these are based on current 2P figures, i.e. reserves which can be accessed within the existing field development plan and with CAPEX which I expect to be covered by the Cash From Operations and current cash balances. I’ve also included the financing and Plc costs.

As you can see there is a 35% upside from the current share price of 91p. That said investors should be nervous about the risk of further reserve downgrades, ISIS knocking on the door, KRG payment delays and a whole host of other risks, thus the shares trading at a discount to NPV of 35% is reasonable to me.

Caveat – These are my estimates so please do your own sanity checks!

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Fig 3 – My NPV estimates


What about the Gas Assets and Other Upsides though?

There are plenty of other upsides, where we could look to identify further value. The additional possible reserves, i.e. 3P on Taq Taq are worth $595m alone per the CPR, the Gas Assets or Miran and Bina Wawi also have an NPV of over $1bn per a recent UBS broker report. There are also other exploration opportunities in the region with the potential to add value. The big issue though with all of these projects is though they require up front CAPEX, the gas project requires $2.5bn alone. Clearly Genel in a position of net debt cannot fund this, it 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 enviroment. This goes someway to explaining why OMV flogged their 36% share of the 7.1 tcf Bina Bawi asset for just $5m upfront, so if we take this as fair value then the figure 3 valuation is materially unchanged. It is worth noting there is up to $145m of deferred consideration to pay if Genel ever get this asset producing, but I doubt OMV are recognising this as an asset in their books!

Summary
HOLD – potential buying opportunity around 80-83p where discount to NPV looks apealing, all other things being equal.

I wouldn’t be rushing to sell at the 91p level but I wouldn’t be buying further either. There is a lot of potential upside here, but until the KRG repays all past debts and ensures that IOCs are paid reliably then the KRI simply does not represent an environment for investment for me and hence I can’t assign much value to the gas projects or the additional KRI exploration/prospective resources at Taq Taq and Tawke. If you are already invested my advice would be to hold and see how the KRG situation unfolds, oil above $55 for a period of time would help too!

Disclaimer – I have a long position equal to 2% of my net assets in Genel bought in at 105p. I have no further positions in any of the other stocks mentioned and to my knowledge nor do any close family, friends nor associates.

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.

Screening Oil Companies Resources vs. their Enterprise Value

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


The average private investor can find it most confusing trying to assess a company’s share price when looking at its resource base. This isn’t helped by wild claims by some junior resource stocks (which I won’t name) on billion barrel discoveries. So I’ll briefly explain each of the internationally approved reserve classifications to assist understanding.

We can also look at some of the more popular oil company’s enterprise values versus their resource base to illustrate how you can start playing with figures and building this into your appraisal of stocks.

The below summarises the Petroleum Resources Management System, and the different classifications of reserves:

reserve classes

Reserves

Hydrocarbons that are either already on production, approved for development or justified for development, i.e. commercial reserves. The most common way of assessing a company’s resources is using 2P reserves, i.e. reserves that are already on production and those reserves where a board FID case has been passed. As the reserves should be commercial in order to be recognised then this gives the investor some confidence of a viable production business. Note – commercial is a broad term though, Afren went into administration with 200mm Boe of 2P reserves!

Contingent Resources

These are resources that are discoveries, but development potential is on hold. This could because of sub commerciality or it could be the project is viable but further work is needed to get this to a FID. i.e. there are contingencies which need to be solved before they can be booked as reserves.

Prospective Resources

Exploration Plays, Prospects or Leads. Typically undrilled or not sufficiently appraised to move to contingent resources.

How are companies able to book reserves?

To stop companies quoting utter codswallop in their reserves, a Competent Person Report is required (CPR) before a company can recognise these reserves in its financial reports.

So let’s take a look at the bulletin boards favourite companies…

I’ve looked at Gulf Keystone, Genel Energy, UK Oil and Gas, 88 Energy and Sound Energy. I’m not going to analyse these companies in detail but just make brief comments about what the results show us.

2p reserve vs ev

Genel
Very low value assigned to each barrel. The overall OPEX Boe is low, however all contracts relate to Production Share Agreements which are less lucrative. That said this is potentially an attractive valuation and could be a buy signal.

Gulf Keystone
Very low value assigned to each barrel. The overall OPEX Boe is higher than Genel as its transport is through trucking rather than pipeline. Significant CAPEX also likely required to maintain production and access these reserves.

BP
Included as Benchmark, it is hard to value BP on this basis as it only publishes a 1P figure, it also as downstream and trading operations so the figure is likely lower than illustrated above when these factors are adjusted for.

UKOG
The favourite stock of the Bulletin Board. Based on its 2P reserves UK Oil and Gas appears hugely overvalued, with its 2P reserves valued at $60 a barrel this is well in excess of current oil price and thus the current valuation must be expecting material upgrades to reserves from its exploration plays. Let’s look at that next…

resources vs ev

The above chart combines reserves, contingent resources and prospective resources so low valuations here could indicate a buy signal and represent significant growth upside.

Genel and GKP
Both have lots of potential resource which could make them good longer term growth plays. Both operate in low CAPEX/OPEX environments, any oil price rise and the KRG payment situation sorted could help significantly. However, high risk too given where they operate. However, here is where you need to be cautious, I would though not buy GKP due to the distressed financial situation it finds itself in (I wrote about this here), this highlights the importance of using analysis like this as part of your research, not basing investment decisions solely on this analysis.

88E
A one trick pony company but with some promise. A recent CPR estimates 768m barrels net. It is also looking at conventional prospects expecting results of seismic soon, this could upgrade its resource bookings further. Again a good speculative play, close to infrastructure and planning permission unlikely to be an issue unlike UK Oil and Gas.

UKOG
Despite lots of media attention with its ‘Gatwick Gusher’ UKOG is unattractive to me. The Gatwick Gusher aka Horse Hill lead is not included in the reserves or resources classifications as it is too immature, and this is confirmed by its own RNS.

hh rns

UKOG does talk about 3.6bn barrels of OIP, however this is total oil in place and with today’s technology only a fraction will be recoverable. Taking a conservative recovery factor of 20% this gives 730m barrels, which granted if were to be included as prospective resources then it’s $ per Boe would be below that of Genel Energy, which I believe is a value stock. It is not clear to me when UK Oil and Gas will be able to firm up this lead to prospective resources and have a CPR on the figures though so I am very cautious.

Ultimately, for me I would not be considering an investment here until I see a clear timeline towards a booking resources or reserves on Horse Hill. To me one major bottleneck will be building the onshore facilities needed to extract the oil, this discovery with where it is located I cannot see extensive facilities gaining planning permission, at least without a lengthy process. Just look at how close we are at getting a third runway in the south east, extracting 700m barrels of oil in Sussex will be equally as protracted in my opinion.

Sound Energy
I have not included this company on the chart above as it is so far off the chart, its current resources are priced in at $586 per Boe! However, none of its recent discovery in Morocco is included in prospective resources or contingent resources, again I would be looking to understand when work can be done to move this discovery into these categories before jumping in here. Watch closely but not a BUY in my opinion.

Summary

You should never only look at Enterprise Value vs Reserves & Resources when making investing decisions but this screening method can identify over and undervalued companies, as long as you are prepared to understand what additional factors which may be behind valuations.

Disclaimer – I have a position equal to 2% of my net assets in Genel Energy. I have no further positions in any of the other stocks mentioned and to my knowledge nor do any close family, friends nor associates.

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.