Issue 862, 9 October 2009

Complex deals cast shadow over Kurdistan oil boom as spotlight falls on shareholders

Exploration successes by a number of small independent companies in Iraqi Kurdistan have inspired investor interest. But scrutiny of the regional government’s unorthodox financial arrangements with its partners shows that political risks remain high, even if the geological risks are lower than first supposed

The Kurdistan Regional Government (KRG) and Norway’s DNO have resolved the dispute which led to the temporary suspension of the Oslo-based company’s exploration and production rights in mid-September. DNO chairman Berge Gerdt Larsen wrote a letter jointly addressed to the main leaders of Iraqi Kurdistan and a second to Natural Resources Minister Ashti Hawrami expressing regret for the “harm and difficulties” caused to the KRG and to Hawrami by Oslo Børs’ publication of commercial correspondence about a share transaction. The KRG responded by lifting the six-week suspension on DNO’s Kurdistan operations after two weeks.

Until this crisis, DNO had been a symbol of the success of Kurdistan’s hydrocarbons sector development. It was one of the first to sign an agreement with the KRG and is the only producing company with infrastructure connected to the Iraqi export pipeline. So the resolution takes the heat out of a quarrel which had the potential to inflict serious political damage on the KRG and increase the risks for all international exploration companies in the northern Iraqi region. But it leaves many unanswered questions. Most crucially, why did Hawrami personally intervene in a share trade between two exploration companies with interests, including joint interests, in the Kurdistan region? “Is this the right thing for an oil minister to be doing?” asked one industry analyst.

Hawrami’s angry reaction to what he said was a “misleading and incomplete” description of his role in the share trade highlighted political vulnerabilities within the region. Many commentators believe the respected former federal deputy prime minister Barham Saleh, who recently became KRG prime minister, is likely to reappoint the hydrocarbons minister. His personal experience and expertise in managing the licensing process cannot easily be replaced. But his authority may be weakened. He has been summoned to answer questions in parliament about the DNO deal in mid-October. Officially an independent, he is believed to be an ally of the Erbil-based Barzani family group which runs the dominant Kurdistan Democratic Party (KDP). Saleh, by contrast, was nominated by the Patriotic Union of Kurdistan (PUK), which performed poorly in the July elections.

The region has drawn preponderant interest in financial markets in recent months thanks to a large number of financing deals at a time when there have been few other such deals. London stock exchange-listed Heritage Oil and Turkey’s Genel Enerji, both with large interests in the region, merged in June. China’s Sinopec acquired Addax Petroleum for $7.2bn at the end of August. Addax owns Taq Taq, one of Kurdistan’s few currently producing fields. AIM-listed Gulf Keystone Petroleum (GKP), with interests in four KRG blocks, raised $11.3m in a share placement in August and may soon have to go back to the market.

Canada’s Vast Exploration, which is quoted on the Toronto’s Venture exchange, is currently raising $15m-$25m from investors in an offering which was due to close just after GSN went to press. It raised $10m in a private placement in June to fund exploration in the Qara Dagh block. AIM-listed Sterling Energy announced plans to raise £13.5m ($24.4m) via a share placing to finance exploration in Kurdistan and elsewhere.

One London-based financial analyst described the region as being “geologically almost risk free” but the political risks are huge. The markets are assuming that almost every exploration licence will find hydrocarbons.

Additionally, investors have so far accepted the prediction that an agreement between Erbil and Baghdad allowing international holders of production-sharing contracts (PSCs) to be paid for exporting oil will be reached only in the second or third quarter of next year. “The assumption is that it is OK for them to spend tens of millions of dollars now because by the time they are spending hundreds of millions the issue will be resolved,” the analyst told GSN.

Lack of transparency

So far, the KRG has defied Baghdad’s refusal to recognise its PSCs with a process that appeared efficient and well-managed, and whose legal strength has been endorsed by international lawyers based in Erbil, and by a paper prepared by London-based law firm Clifford Chance. Dependent on international finance to keep its hydrocarbons development programme moving forward, the KRG cannot afford for international investors to lose confidence in this model. But the edifice no longer appears so solid. The facts uncovered in the DNO case have drawn attention to a lack of transparency. Dr Kamal Mirawdali, who was the main challenger to President Barzani in the June 2009 election, told GSN there had been no accountability in the licensing process.

The Oslo Børs stumbled into this sensitive area when it published correspondence relating to an investigation into DNO’s release of market sensitive announcements. It imposed sanctions on the company in June, but these were withdrawn on appeal in September. The exchange’s suspicions were first provoked by an email from DNO chief executive Helge Eide to Hawrami in October 2008, informing him that HSBC needed “to communicate with him on the transaction”. Hawrami then sent an email signed with his first name to a broker at HSBC discussing the purchase of DNO shares. Both the KRG and Hawrami denied gaining financially from the transaction in which 14.7m shares in DNO were bought by the KRG and ultimately ended up in the ownership of Genel Enerji, which has since merged with Heritage Oil to become the main exploration company in the Iraqi region.

DNO’s letter to the KRG leadership said it was now clear that “the KRG bought the DNO shares from DNO and this was done legally, officially and using the KRG’s funds directly”. It said the sale was approved by the DNO board. “The fact that this was done under a nominee account set up for the KRG by HSBC is a very standard practice,” it said, adding that the sale purchase was done to “facilitate funding” for its Dohuk work programme, and that “had it not been for this assistance from the KRG in the very difficult financial market at the time, we would not have been able to accomplish the important goal of commencing oil export from the region”. In late September, the KRG suggested that it had bought the shares to cover a financing gap. It explained its involvement in a statement, saying it had agreed a “prepayment/cash advance loan” to Genel and that it was “more convenient” to arrange direct payment “instead of first sending the money to Genel Enerji in another country”.

Other curiosities

The KRG has shown great willingness to take stakes in exploration companies which otherwise might struggle to finance operations. It has also become a direct shareholder in three other exploration companies in recent months. On 4 August, Heritage Oil announced that the KRG had acquired 96m ordinary shares in the company formed by its merger with Genel. The KRG took the shareholding in payment of a $1.1bn liability for infrastructure support owed by Genel, whose shareholders will receive a smaller share in the new entity as a result. Heritage said: “The KRG has confirmed that it intends to be a long-term shareholder and is therefore willing to enter into a lock-up agreement in respect of Heritage shares it will receive but with the ability to sell shares periodically to fund new infrastructure and local community support projects.”

On 31 August, Vancouver-based minnow Bayou Bend Petroleum (BBP) announced it had acquired majority working interests in the Pulkhana and Arbat blocks, of which it is now the operator, and has an option on a minority stake in Block 42, which Oil Search (Iraq) is currently exploring. It paid “capacity building bonuses” of $62.5m for the two PSCs, and also paid the KRG 100m shares. On 2 September, Calgary-based Vast Exploration acquired an additional 10% net working interest in the Qara Dagh PSC, increasing its stake to 37%. It paid a KRG social fund with 60m shares.

Growing scrutiny

As Kurdistan-focused exploration companies become increasingly successful, these sorts of arrangement will come under growing scrutiny. GKP’s shareholder structure has fallen under the spotlight recently after the company announced a number of discoveries at its Shaikan PSC. It made the latest find on 6 October. In August, executive chairman Todd Kozel said the company had made an “outstanding discovery” at Shaikan, indicating oil-in-place of 1.5bn-3bn bbls. Just weeks before this discovery, the company merged all its Kurdistan interests, including stakes in the Shaikan and MOL-operated Akri Bijeel blocks with those of a Middle East-based investment fund named Etamic in a subsidiary named Gulf Keystone Petroleum International (GKPI). It awarded Etamic a half share in the subsidiary in return for the fund’s 80% share of the Sheikh Adi PSC, which is adjacent to and on trend with the new Shaikan field, and a 40% share in the Ber Bahr PSC, which is operated by Genel. Etamic had secured rights in negotiations with the KRG, the details of which have not been made public. The introduction of this new stakeholder in what is potentially a substantial asset has provoked much market speculation. GKP finance director Ewen Ainsworth told GSN that Etamic was an energy-focused fund, but that its backers “have asked us not to say too much about them”.