Gulf Keystone

8/8/2019 Gulf Keystone

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The Great Race

By virtue of its astonishing reserve

potential, Gulf Keystone is likely to

become a takeover target

Investment Case

Shaikan has Pmean resources of 4.2bnbbl. Anoil/water contact at 2,230m could indicateresources of >18bnbbl on just one of its fourblocks

To maximise shareholder value before theybecome a bid target, Gulf Keystone shouldprove up the resources of its other blocksthrough drilling and seismic

Getting more rigs ameliorates earlier delaysand their return potential far outweighs thecosts and balance sheet impact

This is a race against time

31 August 2010

update

Gulf KeystonePetroleum LtdOil & Gas Exploration and ProductionGKP (FTSE AIM UK 50)

BuyUpside

34.8%

Richard Nolan - Equity Analyst +44 (0)20 7776 6935 [email protected] Team +44 (0)20 7776 6931 [email protected]

Price 111pTarget Price 150p

60

70

80

90

100

110

120

130

A ug S ep Oc t No v D ec J an Fe b M ar A pr May J un J ul

Price FTALLSH re la tive to Pr ice

Source: Proquote

Shares in issue 676.2m

Net Debt/(Cash) (12.0)m

Market Cap 752.3m

Enterp. Value 740.3m

NAV/Share 8.8p

Next Event Interims 30 September 2010Net Debt is current year estimated

Forecasts ($m) 12/08A 12/09A 12/10E

Turnover 1.0 0.0 26.9

EBITDA (58.9) (95.1) 7.3

PBT 0.0 0.0 0.0

Tax (%) 0 100 200

EPS (p) (0.2) (0.1) 0.0

DPS (p) n/a n/a n/a

Ratios (x) 12/08A 12/09A 12/10E

P/E n/a n/a n/a

EV/DACF 0.0 0.0 0.0

Yield (%) n/a n/a n/a

Price/NAV 5.5 12.6 3.2

Data is adjusted

Company Description

Gulf Keystone Petroleum is an independent E&P

company which explores develops and producesoil and gas in the Kurdistan region of NorthernIraq. It has licenses on four blocks at varyingstages of development.http://www.gulfkeystone.com/


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02 Gulf Keystone Petroleum Ltd | Oil & Gas Exploration and Production | 31 August 2010

Accelerate drilling before a bid

We released a brief teaser immediately upon returning from the Gulf Keystone fieldtrip in Kurdistan. The headline was to report its impressive assets and how bullishwe are. Here we provide significantly more detail and analysis of the investmentopportunity in a significant discovery, and in our opinion, a likely takeover target..

Volumes in place and recovery rates

Volumes for Shaikan have been a well known theme since the first reporteddiscoveries and the January 2010 report by Dynamic Global Advisers which

summarised volumes as follows: P90 1.9bnbbl, P10 7.4bnbbl and Pmean 4.2bn bbl. Notincluded in these figures are the two shallow zones that are the target of Shaikan-3which could add 500mmbbl or more. These days a discovery of 500mmbbl is worthyof headlines, yet at Shaikan this is a mere addition and goes to show the sheerscale of the find.

Having said that, what has not yet occurred at any of the blocks is the determinationof the oil/water contact point. Shaikan-1 had to stop due to an unanticipated gas kickand did not encounter water. Comparing pressure gradient data from GulfKeystones drill stem tests (DST) and those from other wells such as the Jebel Kand-1, suggests that the oil-water contact may be as low as 2,230mTVDSS. Should thisin fact be the case, resource volumes at Shaikan would be in the 18bnbbl to 20bnbblrange. A similar analysis across all of the blocks could see resources of 60bnbbl ormore and with a recovery rate of about 30% Gulf Keystone could be sitting on a gianton an equal footing to the Kirkuk field which has been producing for more thanseventy years and still flows at 400,000 - 500,000b/d. This part of the investmentthesis will have more clarity once Shaikan-2 discovers the oil-water contact pointwhich would be in Q1 2011 by our estimate.

Acquisition radar and reserve replacement ratios

At present there are three rigs working across Gulf Keystones blocks. Managementis discussing weather or not to get another one via tender. Our belief is that theyshould and will do so as soon as possible. While there will be an impact on thebalance sheet we believe that proving resources is of greater importance. Thereason is simple, reserves and reserve replacement ratios. Many of the major IOCs,not to mention the NOCs, have had reserve replacement issues for several years.The IOCs in particular are having an increasingly difficult time gaining access to newreserves and exploration areas. Simultaneously, NOCs are operating in amercantilist way buying whole companies to help satisfy their governments energyand domestic social policies. Any company with Gulf Keystones size of potentialreserves will surely appear on the acquisition radar of many NOCs and IOCs.

At present Gulf Keystone has good information on Shaikan. They could make acompelling argument to any prospective buyer to pay for those assets. It would be amore difficult discussion for the other blocks. Assuming Gulf Keystone ultimatelybecomes an acquisition target, the best things they can do is drill and shoot seismicto one end to prove their resource.

Rigs, drilling and more drilling

At the moment there is no direct evidence of an approach but, as we said, the size ofthe resource is exceptionally tempting. One thing we discovered is that if GulfKeystone did secure another rig it would be of a short duration, perhaps just one yearwith a one year option. Taking on a rig with short contract is more expensive than


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Gulf Keystone Petroleum Ltd | Oil & Gas Exploration and Production | 31 August 2010 03

longer contracts and does not make sense for a company at this level ofdevelopment and with about $100m

1on it balance sheet. (To illustrate the point, the

day rate for the AOS Discoverer which had a five-year contract is about $35,000/d.Add crew and other costs the total day rate close to $130,000 $140,000/d;annualized this is about $50m. A rig on a one year contract would likely cost evenmore.) True, a good portion of this cost would be offset by production, but why ashort term contract? If our thesis that Gulf Keystone becomes a target is correct,then they should be doing as much as possible to prove their resources, especiallydrilling. In this case rigs on short term contracts may make more sense and beeasier to secure them. Any new rig in this scenario would be working flat out. Thereturn on investment for drilling would be well worth it especially if they have anotherbig find at Ber Behr.

Management thinking: a race against time

Indications that management is thinking along these lines would be either the

announcement of a new rig or getting becoming the exploration operator at Ber Bahr.We think its a high probability that they go for the new rig. Drilling on Shaikan tooklonger than expected; Bijeel is also taking much longer, the date of first oil hasslipped. Delays have occurred for various reasons including several well beyond thecontrol or even influence of Gulf Keystone. To make up for lost time and to increasevalue, getting the rig now makes a lot of sense else Gulf Keystone runs the risk ofleaving a lot of value on the table. This is a race against time so drill, baby, drill!

Shaikan Production Facility

Qualitas International, a Canadian company, is the provider of a majority of theproduction facility at Shaikan. Work on the facility including a 22,000bbl storage tank,a twin truck-loading tower and scales was nearly complete at the time of our site visit.Additional equipment (heater and separator) needs to be delivered and some final

onsite welding and assembly remain before completion of the facility which will thenhandle production volumes from the extended well test of 8,000 10,000b/d.

22,000 bbl storage tank at Shaikan

Source: Daniel Stewart

1 As of June 10th GKP had $156.4m on its balance sheet less the August 9 thannouncement that it had to pay $52m to the KRG leaves about $100m


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Twin Loading tower


The completed production facility will have storage for just over two days ofproduction from Shaikan. Presently the site is operationally designed for up to18,000b/d limited by the requirement to have produced oil trucked out, just like otheroperators in Kurdistan. The area immediately around the storage tank has sufficientarea to accommodate another similar sized tank and a third tank of a slightly smallersize. One implication from having the opportunity to more than double storagecapacity is that management believes that Shaikan will have a higher production ratein the future. Another possibility is that, in the short term, additional storage capacitycan act as a buffer should there be any delays in trucking the already produced oilout. Both cases are positive: the first shows the potential of Shaikan and the secondthe foresight and skill of management.

Shaikan-1

Completion of Shaikan-1 is being carried out by a work-over rig from the Turkishcompany, ARAR. Once work on Shaikan-1 is finished the well will be placed on anextended well test which should start in September. Test volumes should bebetween 8,000b/d 10,000b/d. We believe that, allowing for thepossibility of delay,it may in fact deliver first oil in late September or early October.

Further production preparation took the shape of several five litre canisters of sampleoil that are being sent to local refineries so that they can prepare for imminentdeliveries.


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ARAR Work-over rig at Shaikan-1


Shaikan-2

Shaikan-2 is a step-out well situated nine kilometres from Shaikan-1. The spud dateis now expected to be in October using the same Weatherford 842 rig that drilledShaikan-1 which is currently drilling at the Kallegran operated Bijeel-1 location. Thisappraisal well is designed to test the Cretaceous, Jurassic, Triassic and upperPermian. The casing for Shaikan-2 has been designed to cope with the highpressure in the Permian which forced Shaikan-1 to stop short of its intended targetdepth. One of the more important objectives for Shaikan-2 will be to determine thedepth of the oil-water contact which will have a material impact on potential

resources.

Shaikan-3

Shaikan-3 is adjacent to Shaikan-1 and will be spuded by the ARAR work-over rigonce it is finished on Shaikan-1. Shaikan-3 will be a shallow well drilling to about300m TVDSS which corresponds to 1,200m. The Shaikan-3 drilling programme willtest the Sarmord and Garagu formations which could not be tested at Shikan-1.Management estimate that these two formations could contain between 500mmbbl to1bnbbl of recoverable oil. These figures are not included in the resource volumecalculations that were completed in January 2010 by Dynamic Global Advisers.

Shaikan-4

Shaikan-4 is expected to spud in early 2011. It is located approximately 6km west ofShaikan-1 and will appraise all zones down to and including the upper Permian. Thelocation for the staff camp and the drilling pad are being prepared and are nearlycompleted.


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Future site of Shaikan-4 drill pad and camp


Sheikh Adi

Sheikh Adi-1 spudded August 6th

and two and a half weeks later its depth was about300m. Even at these depths the well has encountered hydrocarbons, albeit close totar, but a positive indication none the less. The first objective for Sheik Adi-1 is atabout 700m and should eventually explore all zones down to and including the upperPermian. Preliminary management estimates are for the resources to have a Pmeanof about 2bnbbl or just under 50% of Shaikan.

AOS Discoverer 1 at Sheikh Adi


Akri Bijeel

Progress on Bijeel-1, operated by MOLs 100% owned subsidiary Kalegran, has beenmuch slower then when Shaikan-1 was initially drilled and there has been somedifficulty with testing. Originally it was expected to take four to five months tocomplete from its December 11th 2009 spud date. The latest estimate is for Bijeel-1to complete towards the end of September but we would not be surprised if this date

Camp

Drill pad


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slipped in to October. Any delay will have a corresponding delay on the spud datefor Shaikan-2.

Weatherford 842 rig at Bijeel-1


Within the Akri Bijeel block, Bijeel is the smallest of three structures the other two,

much larger structures are Bekamee and Bakrman. Resource estimates for theBijeel structure are in the range of 500mmbbl to 1bnbbl. Bijeel-1 was chosen as thefirst location because it had no surface seeps and was therefore thought of as alower risk prospect with an intact seal. The experience at Shaikan-1, which hadseeps, indicate that the residue formed an effective seal and in that respect reducedthat element of risk. Bekamee and Bakrman. These could be drilled in Q4 2010 andearly 2011 respectively once new rigs arrive.

Akri Bijeel Block and Structures

Source: Daniel Stewart, Gulf Keystone

Bekamee

Bakrmana


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Ber Bahr

While Ber Bahr may not be the largest block in the Gulf Keystone portfolio at 208 km2

compared to Shaikans 283 km2 and Akri Bijeels 889 km2, the sub surface structureis bigger than Shaikans covering >50% of the block. Genel, the operator, anticipatesan exploration well in early 2011.

Top Jurassic P1, ~2,230m

Source: Daniel Stewart, Gulf Keystone

We understand that Gulf Keystone has initiated conversations with Genel to see ifthey can assume operatorship during the exploration phase. Should Gulf Keystonebecome the operator this would be a very positive development as we suspect theywould accelerate drilling the structure.

Other Gases

It is worth making a brief comment on the presence of H2S and CO2. H2S is presentin concentrations up to 20%. The presence of both gasses is primarily a resolvableengineering challenge that increases costs and reduces the total natural gas that isproduced. As we have not given any value to the natural gas there would a slightimpact on cash flow. On the whole this does not affect our rating on the company orits share price - especially in light of our main thesis of it being a take over target.

Politics

It is worth mentioning the political context of Kurdistan and the relationship betweenErbil and Baghdad. All the interests of Baghdad, Erbil and the US are aligned to seeeach region start to generate oil revenue; to rebuild one city and the continue thedevelopment of the other and assist in the exit of the US from the country. Webelieve that these issues will be resolved in a matter of months.


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Disclosure Checklist

Company Code Disclosure

Gulf Keystone Petroleum Ltd GKP 1,2,3,10


1. Within the past twelve months Daniel Stewart & Co plc and/or its affiliates has managed or co-managed a public offering for this Company, for which itreceived fees or the promise of fees

2. Daniel Stewart & Co plc and/or its affiliates act as corporate broker or nominated advisor to this Company

3. Daniel Stewart & Co plc and/or its affiliates regularly hold/may hold in future trading positions (which may include options) in this Company

4. Daniel Stewart & Co plc and/or its affiliates holds more than 5% of the securities of this Company

5. The Company holds more than 5% of the securities of Daniel Stewart & Co plc and/or its affiliates

6. Daniel Stewart & Co plc and/or its affiliates may currently be providing, expects to provide within the next three months or may have provided within the

previous twelve months, investment banking services to this Company, which have given rise to payment or the promise of payment

7. The author and/or an individual responsible for production of this report has direct ownership of stock in this Company

8. The author responsible for the production of this report received or purchased shares in the issuer, prior to a public offering of the shares.

9. Daniel Stewart and Company is party to an agreement with this company for the publication of research on it

10.This research note has been disclosed to the Company, with resulting amendments, prior to its dissemination

11.Daniel Stewart & Co and/or its affiliates act as financial advisor to this company

The Daniel Stewart recommendation structure is based on relative

upside/downside to target price. The target price is set on a rolling 12 month

view. Upside or downside of 10% or more is categorised as Buy or Sell

respectively, and less than 10% a Hold. Our Distribution of Recommendation

statistics table can be viewed at www.danielstewart.co.uk/research/legal.asp

We aim to cover companys results or major events, but we do not guarantee todo so and coverage may cease at any time.

Although reasonable care has been taken by Daniel Stewart & Co plc to ensure

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Authorised and Regulated by the Financial Services Authority. Apr 10Recommendation History

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Buy

Share Price Target Price



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31 August 2010

Gulf Keystone PetroleumLtdupdate

Key Assumptions

EWT beginning in September

$70/b flat oil

Income ($m) 12/08A 12/09A 12/10E

Turnover 1.0 0.0 26.9Gross Profit 0.0 0.0 0.0EBITDA (58.9) (95.1) 7.3EBIT (61.1) (95.1) 0.6PBT 0.0 0.0 0.0EPS (Adj.) (p) (0.2) (0.1) 0.0

EPS (p) (0.2) (0.0) (0.0)DPS (p) n/a n/a n/a

Ratios (x) 12/08A 12/09A 12/10E

P/E n/a n/a n/aEV/DACF 0.0 0.0 0.0Div. Yield (%) n/a n/a n/aP/NAV 5.5 12.6 3.2EV/Gross profit n/a n/a n/aEV/EBIT n/a n/a 1,955.8P/FCF n/a n/a n/aFCF Yield (%) (0.3) (0.1) (0.1)NAV (p) 20.1 8.8 34.5EV($)/ 2P bbl 0.0 0.0 0.0

Cash Flows ($m) 12/08A 12/09A 12/10E

Op.CF (11.0) (1.3) 7.3FCF (143.9) (125.7) (130.7)FCFPS (p) (0.5) (0.2) (0.2)

Balance Sheet ($m) 12/08A 12/09A 12/10E

Fixed Assets 111.2 94.9 226.2Current Assets 13.8 3.4 3.4Current Liabilities 0.0 1.0 2.0Capital Employed 0.1 0.1 0.2Long-term Liabilities 0.0 0.0 0.0Net Assets 122.4 69.1 286.0Net Debt/(Cash) (33.6) (19.2) (104.8)

Data is adjustedDSC EPS is fully diluted

Recent News / Events

11 August increased flow rate from theMus formation on Shaikan-19 August reorganisation of interests inKurdistan complete5 August Butmah formation re-test flowrate of 4,650b/d

Management Team

Todd Kozel Executive Chairman , CEO,co-founderJohn Gerstenlauer COOEwen Ainsworth CFOAli Al-Qabandi Business developmentdirector & co-founderChris Garrett VP OperationsAdnan Samarrai Country Manager,KurdistanTony Peart Legal & Commercial Director

Major Shareholders %

Capital 7.69Management 7.49TD Waterhouse 6.51M&G Investments 6.01Barclays Stockbrokers 5.48Halifax 4.94Gokana Trust 4.49Blakeney 4.36Selftrade 3.34Hargreaves London 2.56Oppenheimer 2.37

Consensus and DSC Estimates

12/09E

PBT($m)DSCe 0.0EPS (p)DSCe (0.1)DPS (p)DSCe n/a

Source: Fidessa

Gulf Keystone

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