Is Gulf Keystone Petroleum’s 20% yield worth chasing?

Gulf Keystone Petroleum (LSE: GKP) is one of the London market’s most infamous equities.

Shares in the oil producer were once highly sought after among retail investors. The promise of riches from its oil fields in Kurdistan sucked in punters, who were all too happy to ignore the challenges the group faced.

Gulf Keystone was founded by former CEO Todd Kozel, who is currently serving a five year prison sentence in the US for tax fraud.

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Kozel was a master of publicity. Thanks to his efforts, the firm managed to raise hundreds of millions of dollars to fund its ambitions. Despite the flood of cash, the challenges of doing business in one of the world’s most unstable regions proved too much.

The fledgling oil company was overwhelmed by its debts and forced into a reorganisation. Shareholders were almost wiped out in the following debt-for-equity swap. From a high of more than 40,000p, Gulf Keystone shares plunged below 100p.

Amazingly, unlike its CEO, Gulf Keystone has managed to wriggle out of its problems. After writing off its most expensive debts, the business was able to get its house in order, and today, the firm’s prospects are brighter than ever.

The Gulf Keystone share price rises from the ashes

I think it’s worth rewinding a few years to understand just how far the group has come since its restructuring in 2016. For the year ended 31 December 2015, Gulf Keystone recorded $540m in debts against $44m in cash. Losses totalled $134m in 2015 and $246m in 2014.

However, in the six months to the end of June the company earned $162m. At the end of the first half net cash was $132m.

Exploring and developing oil prospects is notoriously expensive and time consuming. It’s even more difficult in warzones. That’s the landscape the company faced at the time as Iraq and its allies tried to fight back the rise of Islamic State across the Middle East.

Kurdistan has some of the richest oil reserves in the world, (it’s said oil seeps through the sand in some places) but the region has its own unique challenges. The Kurdistan Regional Government is the official executive body of the autonomous Kurdistan Region, and it has been struggling for recognition virtually since its existence.

Gulf Keystone’s financial performance is bound-up with the ability of the KRG to make good on its licensing arrangements, which is far from certain. Over two-thirds of revenues from 2021 relate to receipts from the regional body, and it ended the year with tens of millions of arrears.

Patchy payment was one of the reasons why Gulf Keystone had to restructure in 2016 (although even if the KRG had settled its obligations in a timely manner the firm’s debts would have remained an issue).

While it might seem as if the two parties have reached some sort of happy middle ground, this risk is continuing to hang over the Gulf Keystone share price. Despite the company’s booming profits, the stock is trading at a forward price-to-earnings (p/e) of less than 3.

To some investors, this low ratio might look exciting, but I would exert caution here. The company, like others in the oil sector, is currently seeing windfall profits from high oil prices.

There’s no guarantee these high prices will last, a view that’s reflected in other listed oil producers' valuations. North Sea producer Harbour Energy (LSE: HBR) is trading at a forward p/e of 4 (even though the company operates in a much more stable region).

Profits have recovered but risks remain

There’s no denying the Gulf Keystone share price has plenty of attractive qualities. As well as its booming profits and valuation, the group is also throwing cash at investors.

In 2022 alone the firm has declared $215m of dividends, returning approximately 20% of its market value to investors. In some ways this is danger money. Investors should expect a premium return for owning a company with such a chequered past in one of the world’s most volatile regions.

If Gulf Keystone can keep this up, it might make a good investment. Unfortunately, the volatile nature of oil prices, and its relationship with the KRG suggests to me there’s no guarantee it can.