Gulf Keystone a triple play

Shares in Gulf Keystone Petroleum have lots going for them. The company has just made its third oil discovery in the Kurdistan region of northern Iraq; its oil sales could reach substantial volumes next year; its largest exploration prospect could start drilling before the year end and the size of its discoveries makes it a likely takeover target.

Kurdistan was lightly explored while Saddam Hussein controlled Iraq, but lies on the same prolific hydrocarbon trend as Saudi Arabia, Kuwait, Iraq and Syria. The geology is simple and characterised by large structures that are often visible on the surface. Extensive seepage of oil to surface rocks further indicates the abundance of hydrocarbons. Industry sources suggest Kurdistan could hold 40bn to 70bn barrels of oil, which compares with Iraq's proved reserves of 115bn barrels.

Shaikan, Gulf Keystone's first Kurdistan discovery in 2009, was one of the most significant exploration successes anywhere in recent years. The latest independent estimate of oil in place is between 4.9bn and 10.8bn barrels, which could rise with more drilling.

The second exploration success came at Akri Bijeel, where reserves are estimated at 2.4bn barrels. The company has just announced a third discovery at Sheikh Adi, where reserves are estimated at between 1bn and 3bn barrels. Yet Gulf Keystone's fourth Kurdistan asset, the Ber Bahr joint venture with Turkey's Genel, could prove the largest. True, the project won't be easy to explore because it's close to a town. That said, drilling could start in the autumn, which should inject excitement into the share price.

Kurdistan has a history of political instability, but its economy is improving and Norway's DNO became the first foreign oil firm to be paid for exports when it received $104m (£64m) in June from the Kurdistan Regional Government (KRG) for sales made in February and March.

However, future payments remain in doubt. That's because the KRG has an oil and gas law, but the corresponding statute in southern Iraq is still to be approved by the national parliament. So it's still possible that central government may not recognise production-sharing contracts awarded by the KRG to firms such as Gulf Keystone.

Furthermore, the agreement between central government and the KRG over how to split oil revenues is only in draft form. The draft awards 17 per cent of net oil revenues from all regions of Iraq to Kurdistan, although the security of payments to oil firms requires this agreement to be ratified in law.

Nevertheless, encouraged by DNO's receipt, Gulf Keystone is rapidly developing its own oil sales from Shaikan. Two completed wells at Shaikan combined can produce 20,000 barrels of oil per day (bopd) although current facilities can only handle 15,000 barrels. The company will initially truck about 5,000 barrels to DNO's Tawke facility, but management aims to have the facilities to handle up to 40,000 barrels daily by the end of 2012 and, longer term, to build a pipeline.

However, realising the potential of oil fields the size of Gulf Keystone's discoveries is the preserve of oil majors. Shaikan alone could produce several hundred thousand barrels of oil per day, and might require hundreds of wells to flow at its peak. That would require more capital spending than Gulf Keystone could contemplate, which makes the company a likely takeover target. So the challenge for Gulf Keystone's bosses is to drill enough wells to prove up sufficient reserves to ensure that a takeover price fairly reflects the likely value in the ground..