Gulf Keystone Petroleum Limited (GKP) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Welcome to the Gulf Keystone Petroleum Limited Half Year Results Investor Presentation. [Operator Instructions] Before we begin, as usual, we would decide to submit the following poll. And if you'd give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand you over to CEO, Jon Harris. Jon, good afternoon sir.

Yes. Thanks, Jake. Welcome to Gulf Keystone's 2024 Half Year Results. My name is Jon Harris, and I'm the CEO. I'm joined by Gabriel Papineau-Legris, our Chief Financial Officer, who will be taking you through our financial performance shortly. We're pleased to be able to speak directly to our retail shareholders, who account for an important part of our share register. We are continually looking for opportunities to engage with and receive feedback from all our investors, and we are pleased that you have joined us today. After the presentation, we will be happy to take your questions. Next slide, please. This is our regular legal disclaimer, and I'll leave you to review it at your leisure. And I'd like to remind you that the presentation slides are also available on our website. Next slide, please. We delivered a solid operational and financial performance in the first half of 2024, facilitated by our continued focus on safe operations with no lost time incidents for over -- for over 590 days. Robust local sales volumes with gross average production of over 41,000 barrels of oil per day in 2024 to date, combined with sustained capital and cost discipline, enabled us to return to profitability and free cash flow generation following a challenging year, impacted by the suspension of Kurdistan exports. Cash flow has enabled us to both strengthen our balance sheet and restart shareholder distributions with $25 million returned to shareholders via dividends and buybacks year-to-date. Looking ahead, we are focused on maximizing shareholder value on the local sales market. We also continue to engage with government stakeholders regarding the ongoing shutting of the Iraq-Turkey pipeline, which I'll update you on shortly. Next slide, please. We've seen robust local sales in the year-to-date, with gross average production of around 41,400 barrels of oil per day as of the 27th of August. We started the year with weaker volumes in January, caused primarily by seasonal effects and excess supply in the market from competitors. From February, we saw demand pick up for crude to be refined locally into products. Since then, we've seen consistent local sales volumes, aside from some minor fluctuations in April and June when the Eid holidays reduced truck availability. Prices have also remained reasonably stable. While they continue to be a significant discount to the international prices, we have sold crude in the range of between $25 to $28 a barrel so far this year, and we're currently selling at around $27 a barrel. July and August have been particularly strong months for sales. And looking ahead, we see the same strong outlook in the near term. Longer term, the market remains unpredictable, with volumes and prices driven by local supply and demand dynamics. Contracts are currently renewed on a month-by-month basis. Looking at production. We've been really pleased with the performance of the reservoir and trucking operations, which have responded well to the ramp-up in market demand. The Shaikan Field is now producing close to its maximum capacity, which is based on our prudent view of our oil and gas capacity in the current constrained investment environment. To continue capitalizing on strong local sales demand, we are focusing on 2 areas. Firstly, we have been able to identify a number of low-cost quick payback opportunities to optimize production this year, and we see more of those initiatives in the second half of the year. Secondly, we also see some additional opportunities to increase process safety and reliability. That means a slight increase in our average monthly run rate for the full year, which Gabriel will talk about in his section. We don't have production guidance, but we have flagged previously that we are temporarily shutting in PF-1, which is now scheduled to take place in November. During the shutdown, we will execute the safety opportunities I've just talked about. We still expect the shut-in to impact production by around 26,000 barrels of oil per day for around 3 weeks, equating to just over $5 million of sales revenue based on current realized prices. Moving on to Slide 6. I'd like to give you a short summary of where we are and remind you of the fantastic potential opportunity that we have ahead of us from achieving a solution. As you all know, the Iraq-Turkey pipeline remains closed and has been shut-in for over 17 months now. Turkish regional government continues to publicly state they want the pipeline open. Turkey have also publicly stated that they are happy for the Turkish side of the ITP to open. I believe the sticking points appear to me to be reconciling the payment mechanism to the international oil companies from [ SOMO ] selling the oil under our existing economic commercial contracts and settling the arbitration award between Turkey and Iraq. We continue to believe that there is a significant economic value to unlock for Kurdistan and Iraq. The main benefit would be bringing back around 400,000 barrels of oil per day to the international market, which could then be sold at international prices to fund Kurdistan's allocation from the Federal Iraqi budget. The Kurdistan Regional Government have been receiving their allocation from Federal Iraq, but it's being piecemeal. And at the moment, it has to be funded by all revenues from the rest of Iraq. That's less than optimal when Kurdistan is sitting on millions of barrels of reserves, not least in the Shaikan Field and which has excellent growth potential. We're really hopeful therefore that a solution can be found, and we continue to engage with all stakeholders to this effect with tripartite meetings held between the Kurdistan Regional Government, the Federal Government of Iraq and the international oil companies. We remain ready to restart exports, but we need to clarify on how we will be paid for future exports and past receivables. And we need to see the current economics in our contracts preserve. As we've outlined before, the price is large for Gulf Keystone. We could see our current realized prices double as we move back to selling at international prices. And we could unlock further significant upside from the repayment of outstanding export sales receivables, which total over $150 million net to Gulf Keystone. Our cash flow will continue to be supported by the recovery of past costs and a continued commitment to capital and cost discipline. We would also be able to reinstate the distributions policy to provide shareholders with greater clarity on returns. With that, I'll now hand over to Gabriel for the financial review.

That's great. Thank you, Jon. I'm pleased to present my first set of Gulf Keystone numbers to you today as CFO. Looking at the charts on the slide, you can see that the company is in a fundamentally better position and more positive one than it was a year ago. As Jon outlined, we have had great production and local sales performance so far this year, and we've maintained a high level of discipline on CapEx and costs. This has enabled us to return to profitability and free cash flow generation in the first half. Given our limited capital program, which you can see from the top right chart, we've been able to return a lot of the cash flow generated from local sales back to our shareholders with $25 million distributed so far this year, which I will talk a little bit more on distribution shortly. Next slide, please. Adjusted EBITDA increased 6% to $36 million in the first half of the year. The improvement was mainly driven by strong production of over 39,000 barrels a day in the first half as well as cost control and other G&A and share option expense reduced more than offsetting the higher operating costs primarily related to the increased production. We also saw a $5 million benefit from the absence of one-off costs incurred in the first half of 2023 related to wind down of activity. Higher volumes and lower costs were partially offset by the 49% reduction in realized price associated with the transition from export to discounted local sales, which achieved an average realized price of around $26 per barrel in the period, which represents almost a $60 discount to Brent. Local sales are not linked to Brent and continue to be determined by supply and demand dynamics in the local market as well as the crude quality of the Shaikan crude. Next slide, please. On cash flow, stronger adjusted EBITDA and sharply lower net CapEx enable us to generate $27 million of free cash flow in the first half of the year. Net CapEx reduced 83% from $47 million to just under $8 million in the first half of 2024, reflecting our lean work program compared to the busy expansion program that was in progress prior to the Iraq-Turkey Pipeline closure in March 2023. Free cash flow generation has strengthened our balance sheet, increasing our cash balance from $82 million at the end of last year to $102 million at the end of June has been used to fund shareholder distributions. Our cash balance as of yesterday was $98 million. Next slide, please. Looking at our costs, we have continued to exercise tight control over our OpEx and G&A, while maintaining full production capacity. This has enabled us to respond to local sales demand and the potential restart for exports. Gross OpEx per barrel reduced by 25% year-on-year to $4.2, primarily reflecting higher production in the first half of the year. Other G&A reduced to $5.4 million. The reduction included the absence of $2.1 million of nonrecurring corporate costs from last year and some cost reductions. Putting OpEx and G&A together with our capital expenditure, our average run rate for the first half of the year was [ $4.2 ] million per month in line with the original guidance, at $6.2 million. As Jon mentioned, we are now planning to extend a little bit more on production optimization and process safety and reliability, so we can continue to capitalize on the strong market sales demand that we're seeing at the moment. That will mean that our average run rate for the full year is now expected to be around $7 million per month. This implies an elevated run rate for the second half of the year. That's due to both the incremental spending and the phasing of CapEx and OpEx in the second half of the year, which is linked to the implementation of the safety upgrades and maintenance during the PF-1 shutdown in November. Our estimated net CapEx for 2024 remains at around $20 million as guided previously. Before I move on, I would like to emphasize that while we see good local sales demand in the near term, we retain flexibility to rapidly and significantly reduce our capital expenditures and costs in a downside scenario. The $7 million run rate per month implies free cash flow breakeven at around 24,000 barrels of production, which is about half of the current production levels. We have identified actions to sharply reduce the run rate if required, although we would have to balance them against potentially delaying a restart to full production capacity. Next slide, please. Our shareholder, as you are, will be well aware that by now we have a strong commitment to returning excess cash, provided if we have sufficient cash available to manage the operating environment and the liquidity needs of the business. That's evident from our track record over the years, as you can see from the chart that we've distributed over $460 million since 2019. Throughout, we have balanced shareholders' return with investment in profitable production growth and maintaining an appropriate balance sheet to navigate the operating environment in Kurdistan as well as the commodity cycle. This year, we're really pleased to restart shareholder distribution following the decision in 2023 to suspend our ordinary dividend policy to respond to the closure of the Iraq-Turkey Pipeline. To date, in 2024, we have already completed 20 -- sorry, $10 million share buyback, which was an effective way to capitalize on the attractive valuation of our shares, while reducing our share capital with surplus cash. We have also paid an interim dividend of $15 million earlier this year last month. Looking ahead, we are continuing to keep a very close eye on our liquidity level and our capacity to return further cash to our shareholders either via dividend or further share buybacks. With the improvement of the Indian operating environment, it is our ambition to reinstate an appropriate distribution policy to provide shareholders with greater clarity on future returns, both in terms of timing and quantum. With that, I will now hand the over back to Jon to wrap up.

Okay. Last slide, please. Thanks, Gabriel. To summarize, we are pleased with our performance in the first half of 2024. Looking ahead to the remainder of the year, we have 2 priorities. First, we are focused on maximizing shareholder value from local sales. This means balancing a focus on capital and cost discipline with incremental expenditures on production optimization and process safety and reliability, so we can continue to meet the strong local sales demand we are seeing in the near term. As we generate cash flow, we will continue to review the company's capacity for additional shareholder returns via dividends or buybacks. Secondly, we are continuing to work towards unlocking significant potential upside from the restart of exports and repayment of receivables. While there remains no time line, we have seen some traction this year through tripartite and other discussions, and we are hoping for a conclusion. With that, I will now hand over to Aaron to take your questions. Aaron?

Thanks very much, Jon. We've got lots of great questions in the chat, and thanks to everyone for submitting questions before the call. So I'm just going to organize them thematically. I think let's start with exports and the pipeline. First of all, Jon, when do we expect to get repaid the receivables that were currently owed by the KRG?

I think the recovery of receivables is really -- past receivables is really a function of the export pipeline opening. So we're going to have to see that happening, I believe. And what I'm hoping is that obviously, we would hope to get paid back as quickly as possible. Previously when we were over 4 months of receivables back in the back of '19-'20 -- beginning of '20, we -- when we did start to get to export -- we continue to export oil and the oil price recovered, we saw -- it took some 15, 16 months to recover those -- for those 4 months. So I would expect us to -- a mechanism to be put in place for us to get that, but it does -- it is dependent on export sales being reestablished.

Okay. Great. Just another one here on how government stakeholders are helping to put pressure to get this pipeline reopened. I mean are we seeing any support from Western countries in the discussions with the KRG in Iraq?

Yes, I think what we're seeing is we received support from the U.S. and also European countries on the opening of the pipeline.

Okay. Great. A question on the recent media reports around BP and the Kirkuk news flow that we saw, I think, earlier this month. And someone just making a point around the profit sharing model and whether that would be an option for GKP? If so, would it be better or worse than existing contracts?

Okay. Well, we haven't seen the exact mechanism that bp and Iraq government are going to agree. I mean at the moment, it's just in the heads of terms stage. So that will obviously be refined once they get into the detailed negotiations around that. And I did notice they're expecting to close that next year. So it's not -- there's quite a lot of -- quite a lot more work to be done on that. I think also, we've obviously looked at the fifth plus and sixth licensing rounds, which also have adopted a profit-sharing mechanism. And I actually feel that could we transpose to a profit-sharing mechanism? I think we have looked at it, and it will be quite possible for us to transfer to a profit from a production sharing to a profit sharing and have terms within that profit sharing that basically maintain our current economic position. So we have looked at that. And if that was adopted, then I think our economics and commercial position would remain the same. So I think that's a yes. It's a broad yes, but obviously, devil's in the detail.

Okay. Very good. Just a question on the OPEC quota. What do we understand about that? Do we think that Kurdistan production is included in OPEC's quota? Is the OPEC quota an obstacle to exports restarting?

Okay. I don't believe that the export -- that the OPEC quota is a barrier to exports restarting. That's been stated. I think, by OPEC, OPEC are encouraging. Recently, we're encouraging with Kurdistan exports to be -- to restart. But of course, we haven't -- we're not party to those conversations between Iraq and OPEC. And therefore -- and we've not been told anything that's been going on between Iraq and OPEC, other than what we read in the news like everybody else. So I don't really feel that I can comment on, is it a barrier other than OPEC themselves are encouraging the restart.

Very good. Okay. Let's move on to local sales. So very simple question here on who are the end consumers of local sales? I guess who are we selling to in the local market?

Gab, do you want to take that?

Yes, I'll take that, Aaron. Thanks. So the crude is sold locally to trading companies, and it's typically refined locally. There's a large network of small topping plants and some bigger refineries. So essentially, the crude is trucked and goes in the region of the [ Huk ] in Erbil, goes to those small refineries and product is largely consumed locally. So that's pretty much it at the moment.

Okay. Very good. And a question here on would we consider continuing to sell in the local market, even with exports up and running? Maybe Jon or Gabriel?

Yes. No, that's a very good question because there's obviously balancing the appeal of getting a much higher realized price, but also the payment side of it is also very, very important for us to consider. So obviously, closer to the events, we would really balance both options partially or likes. But there's no real requirement for us to fulfill long-term volumes, the local markets or the local sales are renewed on a month basis. But there are some benefits, especially if you're considering making some investments, having that cash flow coming in for a portion of the production. And the other element is also that we have a proven track record that there is definitely some demand for Shaikan crude locally. So yes, so it's definitely a valid question that we keep on top of our mind.

Great. Okay, Gabriel, let's stay with you for the next 2. So moving on to the financials. So just looking at the cost run rate, there's a question here on whether we expect the run rate to be around $8 million, let's say, in the second half? And can we just explain why, why we would be seeing that kind of increase in the second half of this year?

Yes. No, that's good. So there's a phasing element to it. As we mentioned, we're going to carry actually the bulk, the majority of our CapEx program in the second half, particularly with the shutdown of PF-1 in November. So that is -- that's why you see your math is right. It's the second half you will see some months at the $8 million per month. But on an average for the year, once you normalize for the start of the year towards through the year, we're at $7 million. And the other element that's driving a little bit of the increase, it's really benefiting from the strong production that we've seen. And we've tackled a little bit of activities to improve some of the wells delivery, trying to bring 1 or 2 -- so it's a minor work, but it starts hiding up and as you can see from the production, it's been at very high levels. So we're quite pleased to spend a little bit more to benefit and make sure that the production stays strong.

Great. The next one is more of a modeling question. So in terms of GKP's entitlement, which we said today is around 36%. How stable is that 36%? And what factors could affect that percentage going forward?

Yes. I think the main driver that will affect that percentage is really going to be the cost recovery pool. As you've seen, we just have under [ $190 ] million of cost oil on a gross basis between GKP and our partner MOL. And that's quite a big chunk of the entitlement that we received every month. So over time, we have -- if we stay in the local market environment, we have still a number of years with that level of entitlement. But obviously, as we get back to the exports, where we're doubling our entitlement, let's say, through the better realized price. And on top of that, we have the recovery of the past 3 years, you could see a scenario where our entitlement will decrease. But just bear in mind that when the cash balance or the cost will become 0, then after that, every single investment decision becomes much quicker in terms of the recovery. So you almost invest dollar and you recover dollar very shortly thereafter, which made the investment decision actually quite efficient and effective and de-risk the business along the way. So simply think about 36% as a status quo largely for the foreseeable future and the local sales. But as we expand, we return back to exports, you could see over time a reduction, but we will communicate to the market, obviously, over time. So there's no surprises.

I think also in the slides -- in the appendix to the slides, there's our cash flow waterfall and how that's calculated. And within the RNS, there's a section, which talks about our cost oil, which is I think is $180 million plus at the moment. And also the R-factor, which is how the profit oil is apportioned between the contractor and the government and how that's calculated and what that percentage then equates to. So that's in the RNS. There's a detailed breakdown. The R-factor at the moment is 1.21, and the cost oil is $180 million. So I think you can build that into your models, if you want to understand the future cash flows.

Great. Thank you, Jon and Gabriel. So quite a few questions on distributions. Let's start with this one. Why did we decide to make a distribution today, given our cash balances at similar levels as it was prior to announcing the buyback and the interim dividend earlier in the year? Maybe Gabriel, you can answer that one.

Yes. No, that's a good question. So -- as we mentioned in the past, we really want to strike to write balance with the distribution and the activity on field. We -- you'll recall that we paid a little bit more than a year -- than a month ago, already a distribution where we'd like to move it, providing some more guidance to investors on something a little bit more, I'd say, clearer for you to compute in the future, both from a quantum as well as timing rather than whenever there's a little bit of money without prediction and the like. So we're working with the Board, looking at different scenarios. We also have our budget process cycle into next year, some opportunities that we're seeing, but that's a little bit too early for that. But I can reassure you that the returning excess capital to shareholders is definitely on top of our mind.

Great. And just to build on that, I mean, how does the company decide between buybacks or dividends?

Yes. So this is -- I think, first of all, we continue to have a very active dialogue with as many shareholders as we can to have a good feel of preference. There's -- as you know, there will be different preferences, different circumstances. But what we try to do is striking the right balance between cash coming back to the shareholders themselves via the dividend, but also when we see the valuation being at opportunistic level, buybacks could become also appealing for the longer term. So it's -- that's definitely part of our thought process as well, and we want to make sure that all shareholders, we can strike as much common ground as possible.

Okay. Great. And just to round up capital allocation more broadly. A question here on CapEx and whether clearly, reducing CapEx in the short term has the benefit of increasing free cash flow, but does that risk under investment in the future when hopefully, the pipeline is open. So maybe Jon, how are we thinking around investment in the field?

Yes. Obviously, at the moment, we're investing a small amount of capital and also some operating costs in getting -- maintaining our production levels and also hopefully trying to increase them slightly going forward. Some of the capital is being used for process safety upgrades, which will -- which will give us a small -- which will increase our gas handling capacity and oil as well as part of doing that in PF-1. In terms of longevity, does it affect it? Not really. I think in order to do -- to what we're doing -- we're hoping to do with the current expenditures is to kind of maintain the current level of production for as long as possible. We already have a message that over -- producing at these levels, there will be somewhere between a 6% and 10% rate of decline in the overall production levels. So fine, that that's year-on-year. In order to kind of invest significantly in terms of the field development, we would really, in my mind, need to see a return to exports and the sort of revenue generation -- the increasing revenue generation that, that brings. And we also -- I think -- and hopefully, the past receivables that are owed to us, again, would certainly enable us to recommend the field development and a longer -- and a prolonged drilling campaign to get our production levels up to the sort of numbers that we were talking about before, the 80,000-plus barrels of oil a day.

And maybe just the other point I would add to this is that obviously, when we stopped in March last year, we were right into the middle of an expansion program. We put things on hold, certain elements of the facilities, but also in terms of some of the inventory that we have for the drilling. So the point is that in terms of hard cash to return some of the activity will actually be lower than what we were seeing before because we've already kind of preset the -- some of the pre-spend and have the equipment in inventory to at least get us going from the beginning. So I think that that's quite also appealing that it reduces the risk when you're ready to commit a little bit more the actual cash upfront is a little bit lower. And also from a supply chain perspective, you can be a little bit more effective and nimble to go after it.

Great. Okay. So just coming to the last couple of questions. So in terms of our balance sheet, what do we consider as an appropriate level of cash to mitigate risk in the current environment?

Yes. So that's a good question, and it ties back also obviously sometimes to distribution and capital allocation. So the way, from a rough perspective, is to think about kind of 1 year of runway. We want to make sure that as we want to spend and run the business, that we don't have unforeseen events as seeing the local sales reducing or other constraints that we see. So think about it that you have -- we talked about the $7 million kind of run rate on average for a year, per month, 12 months, gets you kind of almost [ $80 ] million. And so I would kind of use this as a starting point. Obviously, over time, that may change. But for the time being, I think that's quite a fair level to be thinking.

Okay. Great. Last question. And really, this is in response to actually a few questions we've had around rumors of a takeover of GKP. And I think it's only fair that we answer that -- try and answer that question. So Jon, maybe you could comment on that.

Yes, sure. I mean we're very focused on maximizing shareholder value. At the moment, that's from -- clearly from local sales. To do that, we have to have a very -- we're balancing the focus on capital and cost discipline. And we're spending a little bit, as we said, on optimizing, keeping production up as much as possible, maintaining our process safety and improving our process safety and reliability so that we can continue strong local sales into the near term, certainly. And obviously, from a shareholder perspective, the company's capacity for additional shareholder returns by dividends or buybacks, which Gabriel just talked about. I mean, secondly, as well, we're very focused on the real value is unlocking exports again and seeing a return to higher -- much higher netbacks that we've received from export sales, which would then allow further to field development and higher returns and higher valuation for the company. We're very -- we always remind ourselves of our fiduciary duties to maximize shareholder value and to look after that. Gabriel, you got anything to add?

No, I'd say we're not really commenting on any specific M&A rumors. But as Jon said, there is a fair understanding of this fiduciary duties of the company and the Board to maximize shareholder value, whether that comes through the business or through a third-party coming in to put a value on the table to shareholders. So yes, I think it's good.

Very good. Thank you very much. I think with that, I'd like to close the call and hand back to Jake.

Perfect. Aaron, Jon, Gabriel that's great. Thank you once again for updating investors this afternoon. Could I please ask investors not to close this session, as you will now be automatically redirected for the opportunity to provide your feedback in order that the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure it'll be greatly valued by the company. On behalf of the management team of Gulf Keystone Petroleum Limited, we would like to thank you for attending today's presentation. That now concludes today's session. So good afternoon to you all.