View from the top: Genel Energy interview

Vallares took the commodities sector by storm when it raised gross proceeds of $2.1 billion (£1.3 billion) after being admitted to the London Stock Exchange in June 2011 and swiftly reversed Turkish company Genel into the cash shell. Genel Energy then emerged with an enviable presence in Kurdistan and a bumper pile of cash to play with.Interactive Investor editor Sarah Modlock spoke to Genel Energy's chief financial offer, Julian Metherell about risk versus reward in Kurdistan, potential takeover targets and what the money will be spent on.Passionate and candid in equal measure, he is committed to furthering the firm's profile with private investors: "The questions from your users are absolutely the questions that shareholders should be asking and that we should be addressing."

What is planned for 2012?

There will be a significant ramp-up in production coming from our two big assets in Tawke and Taq Taq.

We produced 42,000 barrels per day (bpd) in 2011 and we hope to take that to 55,000-65,000 bpd this year. We are currently embarking on the most active exploration programme of any contractor in Kurdistan and will drill seven big wells this year, which are all very material, in a province that has historically delivered greater than 70% exploration success.

There is the opportunity, as we demonstrated last month with the well result on Tawke-16 with DNO, to significantly increase the reserve base through our exploration and appraisal programme.

We are also unusual as we have a Kurdistan business but we also have $1.9 billion (£1.2 billion) of cash sitting on the balance sheet and I think a big question that investors are asking is how are we going to deploy that? That is something that the team here is spending a lot of time on.

The cash today is earning 0.5% return in the bank and we need to find a way of putting that capital to work in the industry in high-quality assets in the Middle East and Africa to further deliver returns for shareholders.

We expect by the end of the second quarter to start laying the KICE pipeline that will go from the Taq Taq field up through Northern Kuridstan, joining the central Iraqi infrastructure at Fish Khabur, which will allow us to take the field from the capacity today of 90,000 bpd to 200,000 bpd by 2014.

At the moment, we have to truck all our crude from Taq Taq and there is a bottleneck because we cannot operate more trucks. We are sitting on two giant fields in Kurdistan and the pipeline project is critical.

We have the ability and ambition to do further deals in the sector to build Genel and we are also in a very constructive dialogue with the UKLA in seeking a premium listing. So it's going to be a very busy year with significant catalysts to move the share price forward.

We are thrilled with the quality of the business we have bought in Genel. It is the best portfolio of assets in Kurdistan. It's interesting that Mehmet Sepil, who founded Genel, went to Kurdistan in 2002, so he has real first-mover advantage. When Mehmet arrived there and raised money, because he was first there he was awarded the two biggest and most prolific producing assets.

Are you going for a high-risk/high-reward approach with Kurdistan?

Yes, absolutely. We could have gone for low political risk but a relatively low quality of assets, such as North Sea, but we said when we raised our cash shell that we were going to do something in emerging markets because that's where we saw the biggest opportunity.

The thing about Kurdistan is that it is one of the last great unexplored regions in the world. Had it not been for politics and wars, these assets would have been developed by the majors in the 1950s and we would be sitting here talking about the sunset years of the Kurdistan oil industry.

So it is very, very unique that we have been able to access assets such as this.

And yes, that comes with a higher political risk, but when you look at the extraordinary hydrocarbon potential and weigh up risks that we think are manageable, we think that offers a very exciting proposition to shareholders.

What is your approach to the politics there? What is your safety net?

When we looked at doing business there, we were looking for a partner and in Genel and Mehmet Sepil in particular we have found a business and an individual which have deeper, long-standing relationships and operating capability in the country than I think anybody else.

When you look at the success of Kurdistan today, 95% of its GDP comes from oil and it was Genel and Mehmet and his team that have played an important role in the growth of the country.

So in the team we have, the relationships are outstanding. The other very important thing to understand about Genel is the relationship between Turkey and Kurdistan. We unashamedly wear the Turkish flag; we are an Anglo-Turkish company.

When we think about how we mitigate the obvious risks there are in Kurdistan, our Turkish flag and the very strong relationship between Ankara and Erbil gave us further confidence in our ability to do business in the region.

It is now six months since the announcement of the deal - we are really seeing how powerful the Turkish provenance really is.

Do you see the limited sales there being increased further?

Yes we do.

If you were to go to Erbil today, you would compare it to Dubai 20 years ago. The extraordinary success of Kurdistan today is built on oil revenue and they know that. So they are looking to accelerate production as fast as they conceivably can.

Of course the minister has gone on record saying that he wants to reduce the number of players there from 40 to 20. And although the junior players there have played a fantastic role, he wants the likes of Exxon Mobil, Total, Genel and others because they are the companies with the capital and capability to take Kurdistan forward as a major producer.

Can you explain your rationale behind selling oil to the domestic market there?

In the first quarter of last year, Genel was exporting in full and paid in full. In the second quarter of last year it was paid $45 million and was owed about $90 million and then it has been paid nothing more.

When we took over the business on 25 November 2011, we sat down with our partners and the Kurdistan Regional Government (KRG) and agreed a domestic sales strategy.

So we went to see the KRG and we agreed that we would sell 50% of our production from Taq Taq and Tawke into the domestic market. The important thing is that out of those domestic sales, we take our full entitlement of cost and profit. So when people say "You're not being paid in Kurdistan", we are being paid our full entitlement but we are receiving $60 a barrel, which is the prevailing domestic price today, as opposed to world export prices.

What does that mean in terms of revenue? We will make between $250 million and $300 million in revenue this year, which more than covers our capital spend in the country.

So when you look at the ramp-up of Taq Taq and Tawke, and the seven-well exploration programme, we are doing that on a cash-flow-neutral basis. It's self-funded from Kurdistan and does not impact on our $1.9 billion.

Do you think investors are impressed that you have not spent the money in a hurry?

The worst thing we could do is a bad deal. We don't want to go off and be the Rambo of the oil industry. We're only nine months into this journey and we're thrilled with the Genel deal. We're spending a huge amount of time looking at 'what's next?' and we have just hired a new head of M&A - Charles Proctor, who had 22 years at BP - so there is a strong team of people looking ahead.

Putting that capital to work in a world class business is going to deliver very attractive returns.

The other thing we said on our capital markets day is that if we are unable to find a material opportunity to deploy that capital, we would potentially give that money back.

So for investors, if the market got very hot in this sector and we simply couldn't find quality opportunities - which I hasten to add I think is unlikely - we would consider a return of capital so investors would end up that on top of a world-class business in Kurdistan.

But that is unlikely, not least because the industry is still short of capital and that is creating an opportunity for us.

And you wouldn't want to get into bidding wars...

That's absolutely right. What we can't do is compete head-to-head with PTT or Shell for East African gas. Those are auctions where it's the winner's curse and we are never going to create attractive returns for our shareholders by competing against them. We need to find better ways of deploying our capital, rather as we did with Genel. There is room to do that again.

There are plenty of potential takeover targets operating in Kurdistan. Do Heritage Oil, Afren or Gulf Keystone Petroleum appeal?

We were pretty explicit at our capital markets day that in the current environment that we did not see a big acquisition to do in Kurdistan.

We were very fortunate to get into Kurdistan before Exxon. If we had waited another six weeks then we would have seen Exxon re-rate the region. I sit there and wonder if we would have been able to pull off our deal had we been six weeks later.

That doesn't mean that we don't see smaller opportunities there - we bought out Petoil and Longford and we are looking at other smaller opportunities there now. But as we sit here today, the next big deal is very likely to be in the Middle East or Africa. That also gives us the benefit of not having all our eggs in one basket.

Interactive Investor user question: We have seen, from some other Kurdistan oil explorers provide much more detailed "reporting" of the well-drilling operation - geological info regarding the various zones encountered by the drill, technical issues (swelling shales, hole stability, etc) as well as reports of oil shows as and when encountered, API grades encountered, as well as flow data, if available.

Does Genel intend to adopt this more informative and dynamic approach to reporting - or will it only provide one detailed report "when completed"?

There are two ways to test wells. Some people drill a section, then test and then drill on. That's a far more expensive approach than drilling, hitting total depth and then testing. So economics and efficient use of capital dictate that you drill it and then you test it.

The other fundamental issue in Kurdistan with deeply-fractured carbonate reservoirs is that you never really know what you've got until you've tested it.

There have been examples of companies which have made various comments as they drilled and got people very excited and then when they test it, there is nothing there.

So as much as people like regular updates, the danger is that you mislead and we absolutely don't want to do anything that is going to have risk misleading investors. We will do our utmost to update people on the operation progress of the wells but not at the risk of misleading.

Interactive Investor user question: The share price has suffered since launch - does the company view this as of no consequence? If not, what steps are being taken or considered to instill confidence among shareholders and support the price?

We are as frustrated as anybody. There is a big communication programme in place to inform people about the business and the outlook for it. This includes the media, sell-side analysts, current investors and new investors and there is a huge amount of energy going into that.

It's very encouraging that we've got five sell-side analysts writing on us and the average target price is £11.

We as a management team have to deliver on the programme we have set out and we have every confidence that this will be a good investment.

Interactive Investor user question: There have been reports of Genel people being interested in (and having been seen in) Libya, particularly eastern Libya, bordering on Egypt - can he please confirm the truth of this? If so, can he give us any sort of timescale for a possible Libyan involvement?

We see significant opportunity in Libya.

Going back to our Turkish provenance again, the relationship Turkey has with the new Libyan administration is very strong. It's an area we are following closely.

We perceive that we need to wait for [the] election in June before things will really start opening up, but it's a country that I think is very exciting from an oil perspective. There are a number of opportunities that are on our radar screen but don't expect anything imminently.

Interactive Investor user question: How positive has Tony Hayward's to contribution been to not only Genel but also when it came to raising a not-insubstantial sum of money for Vallares? Was his involvement key? Were there any negative connotations in the wake of the BP ecological disaster in the Gulf of Mexico?

One of the mains reasons we raised $2.1 billion last summer is because Tony has a huge following in the investor community. He is highly respected, has a significant fan club and he's a world-class chief executive.

Tony is completely focused on this opportunity and he is spending all his time as CEO on this business and like all of us, wants to make it a real success. We've left the past behind and we're not distracted by it. He and we are all very focused on Genel and making it a success.

We get on extremely well, it's a very happy team and the relationship with our partners is extremely strong.

With your background as head of UK Investment Banking at Goldman Sachs you must be used to more brickbats than bouquets. But is it this experience or your years as an army officer that come to the fore when you face challenges at Genel?

Ha! I haven't needed to use my military training in Kurdistan.

But seriously, I don't think there has been any call for any of that. We remain very upbeat and very optimistic about the outlook. The more we look at the business we bought and the opportunities in front of us, both in terms of Kurdistan and this unique position of having capital to deploy, we are very optimistic about our capabilities.

What attracted you to Vallares/Genel?

I could see the opportunity to deploy a lot of capital into this space. We have a London-listed vehicle with cash, with a high-quality board, a management team, a strong share register.

I could see multiple opportunities to deploy that vehicle and bring world-class assets to the London market in a way that simply cash wouldn't.

We couldn't have gone and bought Genel. Or if we had we would have been competing with the Chinese. And so I looked at this vehicle and was excited about the possibilities we could create.

This is only the end of the first chapter. Genel today is almost a Kurdistan business and a cash shell so we are on a journey and our potential has only partially been demonstrated.

How important is the role of the private investor in that journey?

We'd love to have more private investors on the register.

I think when you look at our quoted peers, all of them without exception - particularly the good companies - have attracted a lot of support from private investors. When we raised money, we raised it with the large institutions and so today we don't enjoy a following in the retail market and so would very much like to tell the story to retail investors and obviously they'd be very welcome to invest.

What what would you say to a private investor who is thinking of buying shares in Genel?

I think today is a fairly unique time to be investing in Genel.

Kurdistan is obviously capturing a very significant amount of interest - with good reason - amongst the investment community, particularly the retail community which is recognising the extraordinary quality of assets and the upside there.

We have a world-class portfolio, a lot of running room on the exploration upside, we're fully financed, we've got the team in place, there's the opportunity of finding the next Genel through the cash we still have.

And as you said earlier, the valuation today looks pretty anomalous when you compare it to our other quoted peers in the country. So it's a very interesting time for anyone to be coming into Genel today.