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We’ve been following Gulf Keystone Petroleum (LSE:GKP) on a regular basis for some time now, believing that its potential reward for long-term investors could be substantial. Oil and gas sector stocks are not for the faint of heart, for sure, but we believe that it’s not the risk that is the important factor, it’s the risk compared to the potential reward and the potential for achieving the reward. It has been four years since GKP began drilling in Kurdistan where the potential for great rewards has nearly always been substantial.
Today, in GKP’s first half operational report, the company announced that it had begun commercial production in mid July in the oil rich Shaikan field. This is the day that begins the reversal of fortunes for committed investors. It’s no secret that oil and gas, and mining, are front-end loaded with expenses that cannot be recuperated just because operations are underway. In fact, the commencement of operations generates expenses. Without extraction of material and commercialization there is no recovery, let alone return, on the investment.
CEO Todd Kozel described the achievement: “We are delighted to have entered the first phase of commercial production, which was eagerly awaited by the Company’s shareholders. It is an important milestone and another highlight of the four years of hard work since striking oil in August 2009. We are working hard to deliver on all of our stated objectives and are very pleased to have appointed Deutsche Bank to advise the Company on achieving our goal to move to the Main Market by the end of 2013.”
So, how has GKP’s share price responded today? It has plunged 5.5% to 205.75. You’ve got to be kidding! It must be something in the financials.
- After tax loss for the first half dropped from $31.4 million to $26.4 million year-on-year – and commercialization had not even begun at 30 June!
- Loss per share dropped from $0.04 to $0.03.
- Cash and cash equivalents rose from $130.4 million to $141.2 million.
If you were strictly a numbers person, that would make no sense at all. So what caused this sudden drop? I considered Ben Bernanke, but that made no sense. Perhaps it is the situation still brewing in nearby Syria. That didn’t make sense either, so I went back to the report. I think I may have found it.
Methinks that some “long-term” investors have been viewing the production of oil at Shaikan PF-1 as the overall objective, thinking that “once they get that project into production, massive returns will be flowing our way.” The correct perspective is that once production and commercialization are underway, the company will be able to use the money to grow the business. That is exactly what the company is going to do. As Shaikan PF-1 continues to ramp up to 20,000 bopd (it had reached 12,400 by 01 September), enough oil and cash will be flowing to focus on the development of PF-2 (which should produce another 20,000 bopd), the development of Shaikan-7 (which has the potential to produce up to five billion barrels of gross oil-in-place), other projects in the region, and capex needed to develop, improve, and maintain each production facility. It’s called operating capital.
It’s going to take a continued stiff upper lip to keep holding that investment in GKP, but the longer investors can hold on, the greater the payout will be. It is my opinion – please remember that I am a columnist, not a financial adviser – that, pound-for-pound, Gulf Keystone might have the most solid potential for great future rewards than any other stock on the London Exchange.
The commercialization of Shaikan 1 is the end of the beginning for GKP, and the beginning of a story that our children may marvel at and thank us for being a part of it.
