Earnings Transcript for GKP.L - Q2 Fiscal Year 2023

Jon Harris: Hopefully, good morning, again. Apologies for that – this delay. In starting, we have a unscheduled fire alarm and had to evacuate. We are now back in the building. So thank you, for joining Gulf Keystone Petroleum’s 2023 Half Year Results. I'm Jon Harris, and I am Gulf Keystone Petroleum’s Chief Executive Officer. I am joined today by Ian Weatherdon, Chief Financial Officer, who will be talking you through our financial performance. I'm also joined by John Hulme, COO; Gabriel Papineau-Legris, Chief Commercial Officer; Alasdair Robinson, Chief Legal Officer; and Aaron Clark, Head of Investor Relations and Corporate Communications. Over the next few slides, we will run through our operational and financial performance in the half-year and year-to-date, talk about the current situation on the ground in Kurdistan and Iraq, and explore the outlook for Gulf Keystone Petroleum in the second half. Following that, we will open the line up for your questions. Slide 2, Disclaimer. I would like to remind you that the presentation slides are available to view on our website. I will leave you to review the legal disclaimer in your own time. Next slide, please. Highlights. We entered 2023 following a year of record profitability, cash generation, and shareholder returns and with strong momentum in the Shaikan Field, driving increases in profitable production growth. On March the 25th, the world changed. With the closure of the Iraq-Turkey Pipeline and the suspension of the Kurdistan crude exports, our operational and financial performance was materially impacted with reduced profitability and cash generation in the first half of the year, driven by the suspension of oil sales and continued delays in the Kurdistan Regional Government payments. In response, we moved quickly to preserve liquidity, suspending oil expansion activity, reducing the organization and canceling the 2022 final dividend. Decisive action has placed us in a much better position to manage the current situation. Deep cost cuts have reduced our average monthly run rate of net CapEx, operating costs and other G&A to around $6 million in the second half of the year. We have also started and increased local sales to around 23,000 barrels of oil per day towards the end of this month, selling over half a million barrels of crude to local buyers since 19th of July. At current volumes and realized prices, we are able to cover our monthly costs and manage our accounts payable with greater flexibility. The economic and political environment on the ground remains complex and continues to evolve. However, we have seen steps in the right direction. Slide 5, please. Overview of current operating environment. Crude exports from Kurdistan have been suspended for over five months following the closure of the Iraq-Turkey Pipeline on the 25th of March. The pipeline was shut-in by Turkey following the award to Iraq of its longstanding arbitration against Turkey at the International Chamber of Commerce in Paris, which states back to 2014. While no official timeline has been announced for the reopening of the pipeline, negotiations remain active between the Kurdistan Regional Government, Iraq and Turkey. Recently, meetings with senior officials from all three governments have taken place in Erbil, Baghdad and Ankara with supportive statements made regarding the need to resume exports as soon as possible. The prolonged suspension of exports has in turn put pressure on the Kurdistan Regional Government's finances and extended delays to international oil company payments. Overdue receivables to Gulf Keystone Petroleum amount to $151 million net based on the KBT pricing mechanism with the last door sales payments received in March 2023 for the month of September 2022. The approval of the 2023-2025 Iraqi budget marks significant political progress in creating a framework for the exchange of Kurdistan production for budget transfers potentially paving the way for the Kurdistan Regional Government to broadly cover its monthly expenses, including ongoing international oil company receivables. However, negotiations are ongoing between Kurdistan and Iraq regarding its final implementation, as well as regarding the creation of a new Iraqi Oil & Gas Law. As the situation continues to evolve, we have responded in three ways, focusing on what we can control. Firstly, we have moved aggressively to preserve liquidity, which I will talk about on the next slide. Secondly, we have commenced local sales with domestic demand for Shaikan crude from local buyers emerging in July. While the market remains unpredictable, there are signs demand is increasing in the continued absence of export availability. Realized prices for Shaikan crude to date have averaged around $30 a barrel, which is in line with what we are currently seeing in the local market considering different crude qualities, payments are made in advance, eliminating payment risk, and GKP keeps its entitlement share currently around 36%. Thirdly, Gulf Keystone Petroleum and other international oil companies are making our collective voice heard with the Kurdistan Regional Government and other key stakeholders through The Association of the Petroleum Industry of Kurdistan or APIKUR. APIKUR was established at the beginning of this year with Gulf Keystone Petroleum as one of its founding members. The association advocates for the common interest of its members towards all stakeholders and provide a forum to share industry information and best practice. Regarding the current situation, APIKUR is emphasizing the importance of restarting pipeline exports, resuming timely oil sales payments, and in general, protecting the contractual rights embedded in our Production Sharing Contracts, which are governed by English Law. We continue to be encouraged by the assurances from the Kurdistan Regional Government, the Production Sharing Contracts have sanctity in line with the Kurdistan Regional Government historic track record. Next slide, please. Operational activity. Gulf Keystone Petroleum's operational activity in 2023 has shifted rapidly from a focus of driving profitable production growth with record production levels achieved in March to a focus on liquidity preservation following the suspension of exports. Following the ITP closure, production was curtailed and diverted into storage with the Shaikan Field shutting in on the 13th of April when storage was full. We also suspended expansion activity including drilling, well workovers, facilities expansion and well pad preparation, and regrettably reducing the organization including a 55% reduction in our expat workforce and a reduction in working hours for our local workforce. While our focus has been aggressively reducing CapEx and costs, we have maintained sufficient operational capability to both quickly resume exports and to restart more labor intensive trucking operations for local sales. On July 19th, we commenced local sales from PF-1 with sales starting at PF-2 in August. We have sold crude from storage whilst restarting a number of PF-1 and PF-2 wells. To date, we have seen no degradation in well performance from the extended shut-in, but continue to ramp up production gradually to limit drawdown on the reservoir. Since we started, we have steadily increased volumes with gross average sales of around 23,000 barrels of oil per day between the 19th and the 29th of August. We are focused now on increasing sales and there appears to be significant demand for Shaikan crude. Nonetheless, volumes and pricing remain difficult to predict, and we continue to retain significant flexibility to dial operational activity up or down. If we are unable to maintain sustainable local sales, we have identified options to reduce monthly costs by up to $2 million. However, these could potentially delay a timely return to full production. Next slide, please. Local sales. It's excellent to be producing and selling crude again, and the teams at PF-1 and PF-2 have done a fantastic job in a challenging operating environment to transition smoothly and safely from pipeline operations to trucking operations, which were last implemented in 2019. We are currently loading over 120 trucks per day and looking to move to 24/7 operations when local sales increase. Throughout the period, we have maintained a rigorous focus on safety even in the face of new operational challenges presented by trucking operations and temperatures on the ground that have approached 50 degree Celsius. Next slide, please. GKP and the Shaikan Field. Given the challenging operating environment at the moment in Kurdistan, it is easy to forget the price we have in front of us once the situation stabilizes. Looking back, we have overcome several challenges to generate profitable growth from the Shaikan Field substantial reserve base and significant shareholder value. Despite the current situation, there remain a number of attractive fundamentals to know about the Shaikan Field and GKP’s track record. First, we continue to operate a large long-life with over 800 million barrels of gross 2P reserves and 2C resources confirmed by the 2022 Competent Person's Report and external third-party audit. Second, production is low cost and Gulf Keystone Petroleum has consistently had one of the lowest operating costs and G&A per barrel among Kurdistan and international peers. Third, we have a strong track record of profitable production growth with over 117 million barrels produced to-date and 40% production growth between 2018 and 2022. Fourth, we have demonstrated a commitment to shareholder distributions with 440 million distributed in dividends and buybacks since 2019. This adds up to considerable upside potential should the operating environment improve. With that, I'll now hand over to Ian for the financial review. Ian?

Ian Weatherdon: Thanks very much, Jon, and good day, everyone. Now moving to Slide 10, please. Building on our strong financial performance in 2022 in which we generated record profitability and cash flow, distributed $215 million of dividends to shareholders and repaid a $100 million bond, we were on track for another strong year in 2023 until closure of the Iraq-Turkey Pipeline. As Jon mentioned, the suspension of exports and continued delays to KRG payments materially impacted our financial performance in the first half of the year, reducing profitability and cash generation. In response, we move quickly to preserve liquidity, aggressively reducing our costs with a significant step down in activity from Q1 to Q2, which is evident in the bottom right net CapEx chart. Today, increasing local sales are enabling us to cover our estimated monthly expenditures, which I'll talk more about shortly. Next slide, please. Adjusted EBITDA in the first half of the year decreased from just over $200 million in the first half of 2022 to $34 million, primarily reflecting the suspension of exports and lower realized prices in the first quarter. While we enjoyed record production levels in the first quarter, gross average sales in the first six months of the year, almost half relative to 2022 to 23,256 barrels of oil per day with no revenue from the 25th of March. Dated Brent prices decreased from $108 per barrel in the first half of 2022 to $80 per barrel in the first quarter of 2023. The Brent price impact was compounded by the KRG unilaterally changing the reference price from Dated Brent to Kurdistan Blend resulting an increase in the discount per barrel of about $6. Combining these impacts, our realized price was down $33 per barrel from the first half of 2022 to $51 a barrel in the first quarter of 2023. Next slide, please. The impact of lower adjusted EBITDA and increasing delays to KRG payments drove a significant reduction in free cash flow from $177 million in the first half of 2022 to a cash outflow of $10 million in the first half of 2023. The closure of the pipeline towards the end of March has resulted in only two KRG payment receipts this year with the last payment being received in March for September 2022 sales. Accounts receivable totaling $151 million net to Gulf Keystone. For October 2022 to March 2023 oil sales are now all overdue. The resumption of pipeline exports and consistent budget transfers from Iraq to Kurdistan are likely required before we see a return to more normalized KRG payments and the KRG providing international oil companies a plan to address the outstanding arrears. Net capital expenditures were $47 million in the first half. Capitalizing on the momentum from 2022, we had a very active drilling and facilities expansion program in the first quarter. With delays in the reopening of the pipeline, we quickly reduced expenditures to preserve liquidity, resulting in a two-thirds reduction in net CapEx from $35 million in 1Q to $12 million in 2Q. Following the payments of a $25 million interim dividend in March, we canceled the payment of the 2022 final dividend to preserve liquidity. We continue to believe dividends are important to reward shareholders and will review reinstating the dividend when the environment and our liquidity position improve. In July, we started local sales, which along with cost reductions and managing accounts payable have supported our liquidity position. Our cash balance as of yesterday was $82 million. To manage credit risks, buyers are required to prepay for all local crude purchases. Gulf Keystone as operator has collected sales proceeds on behalf of MOL and the KRG. Prepayments for crude not yet lifted and amounts due to MOL and the KRG totaling $8 million are included in our current cash balance. Next slide, please. Gulf Keystone has consistently maintained strict control of its costs and as one of the lowest operating costs in G&A per barrel among Kurdistan and international peers. While costs have been increasing in the first quarter of the year, reflecting increased operational activity and investment in the Shaikan Field, following the suspension of exports, we move quickly to reduce our costs to preserve liquidity. Operating costs in the first half of the year were flat relative to the prior period, reflect an increased cost in 1Q related to higher production offset by a 36% decrease in 2Q as production was shut-in and non-essential maintenance deferred. After adjusting for non-recurring corporate costs of $2 million and an increase in non-cash depreciation of $1 million, other G&A expenses were flat from the first half of 2022. We continue to review our cost structure and look for further reduction opportunities. Next slide, please. Deep cost cuts have been key to preserving liquidity. Our current estimated aggregate net CapEx, operating costs and other G&A monthly run rate of around $6 million in the second half of 2023 is down two-thirds from the first quarter of the year. The declining run rate reflects a steep production in CapEx guidance from $160 million to $175 million to the current $60 million to $65 million. Current guidance reflects $10 million of cost savings realized in June. We now forecast less than $15 million of net capital expenditures in the second half of the year. Assuming a continuation of gross average sales of around 23,000 barrels of oil per day, an average realized prices of around $30 per barrel, our entitlement share of 36% covers our estimated monthly run rate of around $6 million net, and provides us with increased flexibility to manage the timing of payment of our accounts payable. While the demand for Shaikan crude is promising and we are targeting further increases, sale volumes and prices remain unpredictable. As a result, if sustainable local sales do not materialize, we would consider taking additional liquidity actions. This includes identified options to reduce our monthly expenditures by up to $2 million. We would take this decision carefully as it could potentially impact our operating capacity and delay the time it takes to return to full production when conditions improve. While good progress has been made, we continue to further – pursue further cost reductions in inventory sales and will consider further sources of liquidity as necessary. With that, I'd like to now hand it back to you, Jon.

Jon Harris: Thanks, Ian. Final slide, outlook. To summarize the suspension of exports and continued delays to the Kurdistan Regional Governments payments have had a material impact on our performance in the first half of the year. In response, we've taken rapid and aggressive action to preserve liquidity, enabling us to reduce our average monthly CapEx costs to around $6 million in the second half of the year. With current local sales and prices, we are generating enough cash to cover our monthly costs and increase our flexibility to manage our accounts payable. Nonetheless, more demand for Shaikan crude appears significant, the market remains unpredictable, and we would take further actions without sustainable sales as we remain relentlessly focused on cost reductions and preserving liquidity. Looking at the bigger picture, we continue to believe the suspension of exports will be temporary and the Kurdistan Regional Government's payments will normalize in due course. As an industry, we are continuing to engage with the Kurdistan Regional Government and other key stakeholders to make our voices heard with the objective of protecting the interest of all our stakeholders and returning our industry to its role of generating significant economic value for Kurdistan, Iraq and our shareholders. When conditions improve, we look forward to returning to a balance of growth and returns. With that, I'd like to thank everyone for joining. I apologize for the late start due to our fire alarm. Hope you found it informative, and I'll now hand it back to the operator for questions. Thank you.

Operator: Thank you very much, Mr. Harris. [Operator Instructions] Our first question is coming from David Round of Stifel. Please go ahead, sir. Your line is open.

David Round: Thank you, and hi, guys. Sorry, I've [indiscernible] few down here. So let me just pick out the ones I'm most interested in. I suppose, firstly, just thinking about OpEx going forward, I think we've seen some costs come out in H1, but interested how you're thinking about OpEx for the rest of the year, and also whether that changes materially once you've sold all your barrels out of storage? Do you then have to scale up your operations again in order to continue domestic sales? Can I just ask you the level of domestic sales you need to get to a more comfortable financial position? And with that, I'm sort of – I'm also very interested in the payables online. And finally, I mean, just on the [indiscernible] percentage, you mentioned 36%. I felt that was a bit light versus what I had. Have you recovered all your [indiscernible] 40%? Thank you.

Jon Harris: Yes. Thank you, David. You're a bit crackly there, but I think we got all the questions. So I'll repeat the question. If you please just jump in if it's not what you want or looking for. I think you were saying that will the $6 million change going forward once we've recovered all our – once we've produced all our production from storage or our storage volume, and then have to ramp up the well, that that number $6 million includes full production, essentially full production cost. I think we've mentioned in the presentation that if we had lower volumes, then we could potentially take $2 million out of those operating costs going forward, but that would be because we've got lower. It is not a full production scenario. I think you said also then it was the – what's the level of production to get comfortable. Ian, perhaps you want to answer that one.

Ian Weatherdon: Thank you very much, David. In terms of the level of domestic sales to be comfortable, what I would firstly like to emphasize is the very positive progress that we've made to date. Starting mid – just after the middle of July, averaging about 5,000 barrels a day, stepping up in the first half of August to 12,100, and then finally toward in the second half, roughly to around 23,000 barrels a day. And as we signaled the intent, there is indications of strong market demand. We are, of course, focused on driving production upwards. In terms of where we currently sit today, we've referenced the 23,100 barrels per day. We've noted that that covers our ongoing run rate of $6 million for CapEx, OpEx, and G&A. So I'd say that that's an important first step to basically be cash flow neutral on a month-over-month basis. And then on top of that, there's some incremental cash flow that gives us some flexibility in managing the accounts payable. So good progress so far. We continue to drive increased sales.

Jon Harris: I think your last question around entitlement at 36%. I think the – essentially our recovery is very similar, if not identical to the last six months. For the next six months, our cost pool is – where you asked the question about cost pool, the cost pool to over $220 million, which is ever so slightly up on where it was at the end of 2022. And the R-factor is virtually unchanged. So you should have 36% in this or around 36% for the first half and for the second half of 2023.

Ian Weatherdon: And David, on that, I think it is important from your question, and also more broadly thinking about everybody when you look at the run rate this entitlement percentage, of course, is a very important number indicating what our take is of gross sales. So what we've included in the Investor Presentation on Page 19 is actually the waterfall that shows the details from gross revenue down to Gulf Keystone's take. And by all means, if you would – if you have any further questions, we're happy to take that offline and talk about it. The other thing that you talked about is on the accounts payable side of things, just to give you a feel for that. The first thing that I would note is that we have a disclosure in note 13 to our financial statements around accounts payable. So the first thing that's very key is the headline number, in our financial statements for accounts payable is very high. It's $131 million. And it's important to look at that disclosure because a large proportion of this, we actually don't believe that we will ultimately settle in cash. And this has a lot to do with ongoing prior discussions with the KRG, and that would be netted out. So when you focus down onto accounts payable, what is really important from a cash standpoint in the first instance, you'll see also in the note the trade payables. And our trade payables are currently about $24 million. We have a very active dialogue with each of our suppliers. As you can imagine, they're in this with us as other IOCs are also speaking to their suppliers. So through this very active dialogue, we've looked to defer and push out the accounts payable. And we will continue that dialogue with our suppliers, and as the situation evolves, we will adjust. And we've been very, very clear to that. So those are – I think that covers off your points. As Jon mentioned, you were a bit crackly. David, is there anything that we missed or you'd like us to expand on?

David Round: No. That is perfect. Thanks, guys. Apologies for the line.

Jon Harris: No. That's good. Thank you.

Operator: Thank you, Mr. Round. We'll now go to Mr. Charlie Sharp of Canaccord. Please go ahead, sir.

Charlie Sharp: Yes. Good morning, gentlemen. Thank you very much for taking my questions. I think I have three, and I won't go over those. Just to follow-up on those comments about note 13 and you mentioned that the trade payables and the sort of working with those entities. You also have accrued expenditures of about $24 million. Is that a similar sort of situation in terms of the payments? Are they working with you and how much pressure is there on you to pay those? That's one question. Second question is the domestic oil prices you are receiving, which I think are pretty good for your crude. Is there some sort of discussion that goes on that sets that price? Can you give a bit more flavor on where that $30 or so number comes from? And then finally, you've indicated that KRG has confirmed commitment to contract [indiscernible]. Have you had any similar commitment out of Baghdad?

Ian Weatherdon: Okay. Very good. All right. On the accruals first – thank you for that question. So the key difference between trade payables and accrued expenditures. In the first instance, trade payables are invoices that have been received and we've actually booked them and that's what that recognizes. Accrued expenditures relate to works completed or goods received, but the suppliers have not yet invoiced us. So we would expect likely over the next several months to receive invoices and then there's payment terms around that. Again, Charlie, as I mentioned, we've been very proactive speaking to our vendors, and we've already had discussions with the vendors pre-positioning them. And we will, as I noted, carry on with those discussions. The second question you had around domestic oil prices and discussions in the market and the like, you would've seen – there's a few data points here. First off, you would've seen disclosures from some of our peers in the market around this. And we have done some benchmarking relative to our peer disclosures relative to our crude and recognizing the prices are a bit different because of the crude quality. We have a heavier, a more [indiscernible] crude. But when you do that relative benchmarking, actually Shaikan stacks up very well from a relative standpoint relative to our peers. The second point that I would note, we have talked about strong indications of demand. So actually there are a number of different buyers that are interested in Shaikan crude. So the great thing for us is that through that process and having a number of buyers interested is we are able to conduct price discovery in the market and get comfortable with the crude price. Generally the local crude prices, they're not as transparent, they're sticky, so they may not move in line with Brent. There maybe quite a lag. But it's something that we are working very hard on to make sure that we maintain visibility into the market and we continue to realize a fair price. Yes, I think that in summary, if you think about benchmarking to our peers, which you can see in public disclosures, and the fact that we have multiple buyers, which creates some competition for our crude, that's how we get comfortable with the crude price. Maybe on the third question regarding contract sanctity interactions with Baghdad, I'll hand that to you, Jon.

Jon Harris: Yes. Certainly. So our conversations with Masrour Barzani, the Prime Minister of Kurdistan, [indiscernible] President of the Parliament, and also Kamal Al-Atroshi, the acting Minister of Natural Resources, they all continue to stress the contract sanctity. And they've done that on numerous occasions over the last three or four months in fact. I think you'll recognize that our contracts are with the Kurdistan government and not with the Baghdad, Iraqi government. That said, through APIKUR, we have been lobbying with regards to our situation. And I think what we hear very strongly is the new Prime Minister of Iraq, Sudani, really is very keen to maintain or increase I should say the investment environment in Iraq. And therefore, I believe he'll be keen to represent the contracts have sanctity going forward. So I think that's the answer for the last question. Is that all right, Charlie?

Charlie Sharp: That's very helpful on all fronts. Thank you.

Operator: Thank you, Mr. Sharp. We do not appear to have any further questions. I turn the call back over to you, Mr. Harris, for any additional or closing remarks. Thank you.

Jon Harris: Yes. Thank you. Thank you very much to everyone who is on the line. I really appreciate your perseverance with us. Sorry about the fire alarm. It wasn't – obviously it was completely unscheduled and we had to evacuate the building. And so thanks for coming back on and thanks for taking the time this morning to listen. I hope you found it informative and look forward to your continuing support. Thank you.

Operator: Thank you, sir. Ladies and gentlemen, that will conclude today's presentation. Thank you for your attendance. You may now disconnect.