In a move that could have profound implications for a handful of UK oil and gas explorers, the Kurdistan Regional Government (KRG) has revealed a plan to construct an oil pipeline to Turkey with a projected volume of 1m barrels per day. The news prompted a positive response from Paul Atherton, finance chief of Heritage Resources, a company that is looking at ways of commercialising one of the largest natural gas finds in recent years: "This is an excellent opportunity for Heritage to fast-track exports, and therefore monetise its gas from the Miran field."
The proposal could certainly accelerate the monetisation process for the region's hydrocarbon assets – estimated at 3-6 trillion cubic metres of natural gas and 45bn barrels of oil – and it could also have implications for Iraqi-Kurdistan relations. The ongoing spat between Baghdad and the KRG over who controls energy licences within Iraqi Kurdistan has frustrated the ambitions of oil and gas explorers in the region, but the pipeline deal could conceivably prompt Baghdad to take a more conciliatory line over this issue, while "the KRG is unlikely to go it alone, as it's still the beneficiary of 17 per cent of Iraq's annual oil and gas receipts", according to Tim Hurst-Brown, energy research analyst at Mirabaud Securities.
Turkey and Kurdistan – a strategic fit
It's not difficult to appreciate why the KRG would be keen to cement commercial ties with their northern neighbours, especially when you contrast Turkey's economic outlook with that of Iraq's, or even member states of the European Union (EU) for that matter. At a time when many European economies have been flat-lining (at best), Turkey has been surging ahead, as evidenced by a comparatively low rate of youth unemployment and gross domestic product that averaged 8.7 per cent over the past two years. Although this rate of growth will undoubtedly be pared back by macro effects in the current year, it must be particularly galling for the Greeks when they view the progress Turkey has made outside the EU.
However, Ankara is often forced to run a high current account deficit because of the economy's dependency on energy imports, which renders it vulnerable to oil price spikes. There's a political dimension to consider as well, given that the Turks haven't always enjoyed amicable relations with some members of OPEC, so it's hardly surprising that they might want to secure a portion of their energy needs through bilateral arrangements with the KRG, although the proposed pipeline will also allow Kurdish production to make its way onto international markets. It's thought that closer economic ties could also improve the often fractious relationship between Ankara and Turkey's ethnic Kurdish minority.
Energy concessions – a stumbling block
Predictably, the central Iraqi government in Baghdad has asserted that the proposed pipeline will be illegal, but Turkey's Energy Minister Taner Yildiz is pushing the idea at the top level. The KRG countered Baghdad's position by claiming that international law supports the view that Kurdish regional oil and gas law holds sway in the matter of new energy concessions. As mentioned, Baghdad also claims that dozens of production sharing contracts (PSC) awarded by the KRG to foreign oil and gas companies are illegal because they were initiated without central Iraqi government approval. Last October, for example, Baghdad threatened to suspend the Iraqi operations of ExxonMobil after the US energy giant was granted a Kurdish PSC, but Iraqi officials quickly relented. In fact, Exxon has just signed a $100m (£62.9m) 20-well contract with the state-owned Iraq Drilling Company as part of its development of the massive West Qurna field in Iraq, where Exxon has already brought daily oil production up to 400,000 barrels, en route to 2.83m by 2017.
Gulf Keystone provides a catalyst
While ExxonMobil was the first major to stake a claim in the Kurdish oil and gas fields, IC readers will be well aware that a number of London-listed explorers have been active in the region for some time. Two of our favourite drillers - Gulf Keystone Petroleum and Afren - hit the headlines recently, but for very different reasons.
Gulf Keystone was forced to scotch rumours that it was planning a heavily discounted cash call. Shares in the company have been prone to volatility, but bulletin board speculation had directly undermined the share price. Of greater interest is the work under way at the Shaikan-6 well, where drilling has already encountered good quality oil deposits well below the estimated maximum depth. This could be an indication - although it's by no means certain - that the Shaikan field contains much larger oil-bearing structures than originally thought. By the end of the appraisal work, we will have a clearer idea if there will be a substantial upgrade to the current estimated mean resource of 10.5bn barrels.
Analysts produced a wholly upbeat assessment of latest drilling from the Simrit-2 discovery well, in which Afren holds a 20 per cent stake as part of the Ain Sifni PSC in Kurdistan. Drilling to 3,700 metres encountered a 409 metre hydrocarbon interval, including 312 metres of what is thought to be light oil. Afren currently has interests in a dozen countries, but the size of the discovery within the Simrit structure, together with surrounding prospects on the Ain Sifni PSC, are potentially "transformational" for the business, according to chief executive Osman Shahenshah. The scale of the find can be gauged by the fact that it prompted JPMorgan Cazenove to increase its gross resource estimate by 66 per cent, while FirstEnergy Capital estimates Afren's total exploration suite at 21p risked and 223p unrisked per share.
The success of Gulf Keystone has acted as a catalyst for other explorers to enter the region. It may have prompted Dublin-based Petroceltic - whose chief executive is 25-year industry veteran Brian O'Cathain - to expand its operational focus beyond its core Algerian assets, in favour of new prospects. The company entered the fray last year when it secured a 16 per cent stake in two licences in Kurdistan operated by US integrated major Hess Corp. While it's still early days, the companies have already initiated an 850km seismic survey that should be acquired by Christmas. If all goes to plan, it's anticipated that at least one exploration well will be drilled in each licence area during 2013.
Mr O'Cathain said: "Petroceltic is delighted with the agreement between Kurdistan's Ministry of Natural Resources and the Turkish Energy Ministry to build an oil and gas pipeline taking oil from Kurdistan to Ceyhan on Turkey's Mediterranean coast. This is a positive step towards the commercialisation of oil reserves in the region and will help monetise any successful discoveries made by our exploration drilling programme in 2013."
One person who will certainly be keeping a close eye on developments is Tony Hayward. The ex-chief of BP is now heading Genel Energy, which was formed last September when the Rothschild investment vehicle Vallares merged with Ankara-based Genel Enerji via a $2.1bn all-scrip reverse takeover. Through its six PSCs in Iraqi Kurdistan, Genel is both the largest holder of reserves and the top oil producer in the region, but the pipeline proposal must hold specific benefits for the newly formed entity given its commercial ties with Turkey.
The pipeline proposal provides a positive beat for explorers in the region. Until now, companies such as Heritage Resources have been stymied in their attempts to develop ways to monetise their assets because of the continued impasse over PSCs. The dispute also acted as a disincentive for oil majors to enter the region. If Iraqi authorities are sufficiently alarmed by the prospect of the KRG forming closer links with Ankara, they might be inclined to compromise over the disputed issue of the PSCs. If this came to pass, it might precipitate a spate of assets sales within the region, as big industry players, who hitherto had been reluctant to commit to Kurdistan because of their interests in Iraq, would be free to buy a stake in the region. One of the more likely targets is Gulf Keystone - a speculative 'buy' (138p, 19 August 2011) – that has previously been touted as a possible strategic target for China's state-owned Sinopec. Gulf Keystone is trading 43 per cent in advance of our advice, but if the aforementioned PSC squabble is resolved and there's another resource upgrade on the back of the Shaikan appraisal, then suitors are likely to come calling.
