Kate Mackenzie Heritage: In for a penny, in for a pound in Kurdistan

London-listed small oil company Heritage and Turkey’s Genel, in attempting to consummate their merger, had to deal with the pesky problem of a $1.1bn of liabilities owed by Genel to the Kurdistan Regional Government.

Under the arrangement with the KRG, Genel’s parent company Cukurova was to pay $605m of the liability, while the remaining $495m became a long-term liability of the new merged company. Instead, Heritage and Genel are proposing to pay it off all at once by issuing equity to the regional authority.

This was hinted at by Heritage’s chief financial officer Paul Atherton last month when he mentioned an ‘equity consideration’ could be part of the settlement. Today Heritage announced that the entire liability would be paid for in equity, with KRG to  be issued 96m shares in the new company. This a stake of about 17 per cent in the merged company, with about 33 per cent going to Genel and 50 per cent to Heritage. Furthermore, Heritage said the KRG has agreed to hold on to that stake for some time:

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, indicating its support of the post merger entity and the growth prospects it believes exist for the Enlarged Group.

Investors seem to be happy with the certainty the arrangement provides for the merger itself, pushing the shares slightly higher today, even though Oriel Securities noted it would be more dilutive for existing shareholders:

This announcement looks positive for Heritage and suggests that the deal is progressing as expected and clarifies how the US$1.1bn liability will be settled. However the larger consideration dilutes existing Heritage shareholders by 9%, bringing our risked NAV + EMV to 634p/sh (from 663p/sh)

So what will it mean for a state entity (of sorts – the KRG’s authority is somewhat fuzzy) meant to have a decent-sized stake in HeritaGE?

For one thing, Heritage is already heavily involved in Kurdistan, with all the drama that that entails. Kurdistan’s decision to go ahead and grant oil licences without central government approval has caused tension with Baghdad, and oil companies active in Kurdistan tend to be blacklisted from other parts of Iraq. The company said in May its Miran West field in the oil rich region might hold more than 2bn barrels of recoverable oil, making Kurdistan the most important source of Heritage’s assets (it also has stakes in Uganda). All of which means it won’t be going in any Iraq oil auctions soon.

In the short term, it might not be a bad thing to have the government of the day being involved: at least it could be a disincentive to obstructing the company, for example by changing the financial terms of contracts, which is not unheard of in the region.

Having had an election just last month, there are no obvious big surprises looming in Kurdistan in the short term. In the longer term, it’s far from clear. But as we’ve seen, the KRG’s efforts to honour the contracts it has signed with oil companies, despite Baghdad’s opposition, and turn on the taps of producing fields in June has boosted confidence in the the authority. And in oil these days, exposing oneself to some political risk is just about the only way to get into big new supplies of conventional oil

Related links:

Kurdistan oil lures yet more investment (FT Energy Source, 20/07/09)
Heritage and Genel unveil $6bn merger (FT, 09/06/09)