Power of two: Bijan Mossavar-Rahmani interview

Whilst on a national level the supermajors, which have minority stakeholdings in the behemoth Abu Dhabi national oil companies, and the Emirate-owned energy producers dominate the industry consciousness, it has fallen to private companies to take UAE oil and gas entrepreneurship and accomplishment to replicate that reputation abroad.

Sharjah’s Crescent Petroleum and its subsidiary Dana Gas have delivered tremendous results for the local population in Iraq’s Kurdistan and have struck upon success after expectation beating success in its exploration efforts in Egypt.

Dubai’s Dragon Oil has shown local businesses are up to the challenge and can overcome the hurdles of prospecting, producing and profitably selling oil from Turkmenistan. Now you can confidently add to that portfolio Ras Al Khaimah’s homegrown RAK Petroleum.

A relative newcomer in the Middle Eastern oil and gas business, the company, only founded in 2005, today holds an interest in and is operator of, four concessions in the Sultanate of Oman and three on home turf in the Emirate of Ras Al Khaimah. The company has an extensive and active work programme covering exploration, appraisal, development and producing operations.

RAK Petroleum also holds a non-operated interest in the Hammamet Offshore licence, Tunisia.

In Oman, its production from the offshore West Bukha oil and gas field currently averages 9,000 barrels per day of oil and associated liquids and 27 million cubic feet per day of dry gas.

The nearby gas and condensate field, Bukha, produces another 10 million cubic feet per day of gas and 800 barrels per day of associated liquids. Both fields are located in Oman Block 8 and are operated by RAK Petroleum with a 50 percent participating interest.

In its consolidated results for last year, the company recorded a net profit from operations of US$26.4 million (year ended 31 December 2010), its first back-to-back profitable year since its founding in 2005.

Good results undoubtedly, but what has propelled the company to international fame in 2011 is its growing stake in, and soon-to-be-completed merger with Norwegian upstream operator DNO.

As of the second quarter 2010 RAK Petroleum’s shareholding in DNO International ASA reached 30 percent, and the UAE company now has two management members on the DNO Board after the Chairman of the Board and Chief Executive Officer Bijan Mossavar-Rahmani was elected by DNO shareholders in March 2011.

The merger proposition has raised eyebrows in both companies’ home turf, as well as garnering attention from some of the biggest names in the oil business in London.

Pitched as an opportunity for DNO to broaden its footprint in a prolific hydrocarbon area, and for RAK Petroleum to bring its local knowledge, assets and skills to DNO’s exciting prospects in the Kurdistan Region of Iraq, the deal has been met with almost unanimous enthusiasm by directors, shareholders and analysts across the board.

Oil & Gas Middle East met with CEO Mossavar-Rahmani in Dubai to discuss the upcoming merger, and uncover why, in his word’s, the deal really is a win-win proposition.

He says that for DNO, the local knowledge and understanding of regional risk, in addition to RAK’s assets, brings tremendous value, and for RAK stakeholders, the tantalizing prospect of the Kurdistan concessions under DNO’s belt provides an opportunity too irresistible to miss.

“As a joint entity the merger works on a number of levels. There is a familiarity and comfort that comes with having a substantial element of local content and local contact on the ground in these regions,” he says.

“I happen to have some Kurdish ancestry and I’m very comfortable in Kurdistan, I have a knowledge of their history, of the mindset, and they understand how I think and work.

In a sense that familiarity, shared culture, language and ethnicity can all be very helpful in understanding how one conducts oneself in business in these regions – that’s part of it.”

Mossavar-Rahmani explains that the way in which someone from the UAE views political and contract risk within the Middle East is different to what an investor in Scandinavia might think.

“Familiarity breeds a level of comfort and understanding of risk, and knowing how to mitigate it perhaps more than a western investor. Western investors are most comfortable investing in western companies, whereas for people from this region investing in the US comes with a set of risks, such as visas, and access.”

It follows that local advantages can be reaped beyond the business and socio-political spheres. “Even from a geology and geophysics point of view, working in a particular region means a better understanding of what you are dealing with, which equates to a competitive and comparative advantage, and local content is the first step to ultimately achieving more with less,” enthuses Mossavar-Rahmani.

Enthusiasm for all things Kurdistan has dominated the regional upstream news agenda throughout 2011. Longstanding concerns surrounding the contractual legality of operating in the semi-autonomous northern region, in a country still wanting a decisive Oil Law kept potential investors at bay, but the tide appears to have turned.

Indeed, spotting an opportunity and being willing to take the risks associated with being a prime-mover, DNO was actually the first international oil and gas upstream player to sign a production sharing contract signed with the regional government in 2004.

That boldness has set the company apart from its peers who are now perceived to have largely missed the boat with regards to getting in on an unprecedented slice of oil and gas real estate.

“We understand that there are issues surrounding the sanctity of contracts in the Kurdistan Region of Iraq with respect to Baghdad and their sensitivities. The issues are complex and complicated and need to be addressed. However, we felt comfortable that we understood the larger context and that we could also be helpful in the discussions that could lead up to the resolutions,” explains Mossavar-Rahmani.

“The approach of ‘wait and see’ quickly transitions to ‘wait and lose out’. Those who have sat on the sidelines waiting have seen opportunities grabbed by others prepared to take risk. Whereas those that have gone in have been tremendously successful,” he says.

What has set the Kurdistan Region apart from the southern Iraq experience is its openness to doing business with companies large and small. Whilst the supermajors have concentrated on chasing the giant technical services contracts in the South, the production sharing action in the North has gone to more agile players such as DNO.

“I see Kurdistan as a launch pad for growth, and it is on a rapid trajectory. The speed and success Kurdistan has had in opening up and attracting companies is really unprecedented in the modern period.

“They have been tremendously successful in attracting small companies first, which has been followed by larger companies coming in to drill, find, produce and bring their oil to market. It’s actually something of a phenomenon.”

This is not untypical – very large companies to tend to be more lumbering and slower to act when it comes to frontier areas. Smaller companies tend to go in, prove it can be done, and then sell to larger players.

“In Kurdistan, companies with quite limited presence in the rest of the world have been successful. Smaller companies eventually get swallowed by larger ones until you reach a supermajor who can manage the lot,” he says.

“I think the trend towards larger players coming in with deeper pockets is somewhat inevitable in Kurdistan. There have been many discoveries which will require larger players with the wherewithal to develop them. Taking the region to the next level will require companies with the necessary financial backing.”

Contractual Issues
There is a huge degree of contractual variation in Iraq, and companies which signed deals amidst much hype and fanfare in the last two years are now returning to the table looking to renegotiate those terms.

Kurdistan was more of a clean sheet and the contracts are quite transparent, says Mossavar-Rahmani.

“There was perhaps a perception that one of the challenges to the Kurdistan business model was a lack of transparency, which has been addressed by the Kurdistan Regional Government by taking the unprecedented step of making the contracts publically available by publishing them online. That is an unheard of not just in Iraq or Kurdistan but pretty much region-wide,” he says.

DNO has a Kurdish operating capacity of 65,000 – 75,000 barrels per day (bpd), and is currently producing 32,334 bpd while reservoir monitoring work is underway in production.

The company is producing at those rates today. “That production capacity can be increased with some modest investment to around 100,000 barrels per day, and potentially even further.”

The issue for DNO is how to manage its investments to aximise revenue from a difficult market mix (‘Revenue Wrangling’ opposite).

MENA LEADER
Kurdistan aside, one of the primary reasons Mossavar-Rahmani is excited by the merger is the opportunity it creates to emerge as a unified Middle East and North Africa focused company, with a portfolio spanning reliable and exciting hydrocarbon markets.

“The RAK Petroleum assets would help DNO corporately become a stronger company, not just because of the value of bringing our experience to the Iraq operations. By contributing our blocks in the UAE, Oman and Tunisia we will transform DNO from a two MENA-country company into a five country MENA presence,” he says.

The Middle East and North African opportunity landscape is, he says, ripe for an ambitious company.

“Clearly some of the best oil and gas real estate on earth is concentrated in this region. We are pursuing a couple of redevelopments in the Northern Emirates, offshore Ras Al Khamiah, and DNO is active in Yemen, and I’d like to build on that opportunity.
Yemen is not the easiest place to operate right now due to civil strife, but where that poses one set of challenges, we also feel there are opportunities.”

Mossavar-Rahmani says that the share prices of companies exposed to countries at the centre of the Arab Spring have been hit, and where others may fear to tread, he sees lands of opportunity. “Yemen and Egypt may also be viewed as distressed states by the investment community and companies with a lower risk appetite may be looking to exit, whereas I think they may pose important opportunities in the future.”

“If we have a greater appetite for regional risk, because we see it differently, then investing in assets across the region would be appealing to us, in the same way that some operators may prefer to cash in their value and move into territories or environments closer to their own comfort level.”

“DNO has stated it wants to do more in Tunisia and Yemen. Now, obviously, they are not Iraq and Libya – the size of the fields is different – but a cluster of smaller operations can combine to a significant business opportunity. It’s not always about the size of the reserve under the ground, rather what you do with what you’ve got and how well you can manage those assets,” he adds.

Looking further ahead, future footprint expansions in North Africa could also be on the cards.

“We would absolutely look at Libya as an opportunity in the future. As it opens up I think it will definitely be a market that’s going to be exciting. It’s a little bit early for us now, and we are in the middle of a merger, but I would be very excited in 2012 to look at the opportunities which are there,” he says.

“South Sudan is another area where companies will look and we hope to look in there in time. In a political sense, both Libya and South Sudan are clean slates and the potential to build exciting developments in their upstream industries is certainly appealing.”

Money Talks
Once the merger goes ahead, which looks ever more likely now that minority shareholders initially reticent are now on board, the company will look to international investors to finance its growth ambitions.

“Once the merger is complete we will look to a London listing, because there will be stronger investment appetite and larger investment pools chasing the sort of opportunity we represent. Having access to that means we could place more shares in London and raise capital that way, and the capital value of existing shares will increase,” he outlines.

“London will give us access to higher multiples, more shareholders, and shareholders with deeper pockets. Also importantly, what London does is give us shares in a currency we can use to do other mergers with.”

Initial meetings with potential investors have been positive, he says, but local investment would be advantageous too. “One of the largest investor pools really should be local. RAK Petroleum is a locally formed and locally funded company with key investors from the UAE and Saudi Arabia. There is a large investor pool here we can tap into here too, which I hope we can tap into,” he concludes.

Acquisition fever
The banner development for DNO this year has been its acquisition of RAK Petroleum’s oil and gas assets in the Middle East and North Africa for $250 million in shares. The transaction values DNO at $1.64 billion, or 9.50 kroner a share, and RAK’s operating subsidiaries at $250 million, with the enlarged DNO group having interests in the Kurdistan region of Iraq, Yemen, the United Arab Emirates, Tunisia and Oman.

The company has firmly nailed its colors to the mast, setting out a plan to expand through mergers and acquisitions. However, other major players in the region have designs of their own.

Tony Hayward, who will shortly become CEO of Genel Energy after Vallares agreed the purchase of the company through a reverse takeover earlier this year, told the Norwegian newspaper Finansavisen “DNO International could be interesting to us eventually.”

Vallares acquired Genel in a deal valued at $2.1 billion, and having declared an acquisition range of up to $8 billion in June, has a mandate to either leverage investors’ capital for a further purchase to tap up equity markets if it achieves the premium London Stock Exchange listing it expects in early 2012.

Genel’s current operations leave the company with net cashflow of 8% of revenues, which Hayward says gives Genel room to “to participate aggressively in the significant consolidation we expect to see in the region.”

Revenue wrangling
DNO, like Genel, is owed between$200-350 million dollars by the Kurdish Regional Government, a situation which stems from the lack of a settled oil law to regulate the relationship between the KRG and Iraqi government on contract management and oil revenues.

Currently, the region’s oil for export is pumped via Kirkuk to Turkey through the ageing Ceyhan pipeline, and revenues are paid to Baghdad. The capital has been withholding the contractually-mandated profit oil revenues from DNO’s exports because it says that the PSCs under which DNO operates are unconstitutional, a position the KRG firmly opposes.

DNO pumped the region’s first export oil to great fanfare in 2009, but exports ceased after just four months when Baghdad refused to pay the KRG out as the oil came via the PSC it had signed with DNO in 2004.

As a result of the legal limbo, DNO has been paid only $163.7 million for exports to date, ostensibly on account of exploration and production costs, for the period of when it has been able to export Kurdish oil. Payments were made by the KRG in June and September this year after it received cash from Baghdad.

From the export halt in October 2009 until February 2011, the Norwegian firm sold its oil domestically at knock-down rates of around $25 per barrel, against prevailing average rates for Iraqi combined export crude of $104.

After a temporary deal struck between Erbil and Baghdad in January 2011, DNO began exporting oil again, which led to pumper profit and operating revenues of NOK 355 million ($63 million) and NOK 732 million ($130 million) respectively in the second quarter this year.

However, continuing payment problems, a higher domestic market price and technical issues with export infrastructure has pushed DNO back to the regional market.

On 17 October the company announced the diversion of a third of its production back to the domestic market to improve “the stability of its revenue stream.” 10,000 bpd are reaching the local market at prices of $50-55 for which DNO gets paid immediately, with a total of 675,000 barrels slated for domestic sale.

In other words, DNO would rather sell cheaply-produced oil within the region for sub-optimal rates than have to rely on both the creaking export infrastructure and fractious political relations between Erbil and Baghdad that are running up a huge amount of oil that has been ‘bought’ from DNO by the Iraqi government but has not been paid for.

Meanwhile, the firm’s exports – which are essentially delivered on credit – currently average 25,000 bpd from the company’s total production capacity in-country of 70,000 bpd.

Analyst Insight
Since the RAK/DNO merger prospectus was made available, investment analysts following DNO have reviewed the proposal. Each has endorsed the transaction and produced a Buy
recommendation for DNO shares.

Here’s what the analysts say: First Securities, October 26, 2011: “There are two main reasons why we think investors should support the merger: Firstly, a merger will create a wider portfolio with lower political risk and better geographical diversification.

Secondly, a merged asset base will most likely provide a more stable operational cash flow as the company’s operational cash flows have been volatile in periods with exports from Kurdistan.”

ABG Sundal Collier, October 11, 2011: “On the back of the release of the DNO/RAK Petroleum merger prospectus we raise our recommendation to BUY (from SELL). We believe the merger will offer substantial downside protection and view the enlarged regional footprint following the merger as adding value.”

Arctic Securities ASA, October 21, 2011: “DNO/RAK merger creates significant MENA E&P Player. The merger is in line with DNO’s strategy to grow assets and production in the Middle East and North Africa, while providing diversification regarding political and technical risk.