Enter the lair
Dragon (DGO) is an independent oil and gas company with exploration and production operations in the Caspian Sea, off Turkmenistan. We consider Dragon to represent an inexpensively priced exposure to rising energy prices. Dragon has an excellent exploration record, and we expect to witness further reserves and earnings upgrades in the coming months as DGO presses ahead with new drilling.
| "Development scenarios indicate that a full field development programme could build oil production towards 60,000 boepd within a five-year period" |
Dragon is currently involved in the redevelopment of two producing oil and gas fields, LAM and Zhdanov, in the Cheleken Contract Area. DGO's interest arises out of a 25-year Production Sharing Agreement (PSA) management negotiated with the Turkmenistan government in 2000. The fields covering some 950 square kilometres, were discovered during the Soviet era in Turkmenistan and were partially developed with Soviet technology until the late 1980's. The area is highly prospective with studies indicating that only around 6 percent of the proven and probable reserves at the fields have been recovered to date.
Changes in the company's share register in the last five years have allowed Dragon to make great strides in a bid to establish a production and exploration foothold in the region. In 1999, the Emirates National Oil Company (ENOC) became the major shareholder in Dragon, and currently holds around 60 percent of the shares. The backing of a Middle East National Oil Company with strong commercial and political relationships has proven a significant factor in the progress made by DGO in recent years. ENOC was influential in securing the PSA agreement with local government, and in the award of a swap agreement with Iran, which enables Dragon's Caspian production to be delivered into the Persian Gulf.
Although the company's prospects have turned around in recent times, things were not always so rosy. In common with many other companies in the oil sector, DGO's shares experienced a severe bear market in the late 1990's, which in DGO's case resulted in the shares tumbling by more than 90 percent. Following the sell-off, DGO traded sideways with little activity for more than four years. However over the past twelve months prices have turned higher and we believe that a lasting recovery is now underway as the company begins to ramp up production and exploration.
We are particularly impressed by Dragon's recently released full year results (to 31 December 2003) which were the company's best on record. Profit after tax increased 85 percent to US$28.8 million due to increased production, improved oil prices and prudent cost control. Turnover increased 62 percent to US$82 million, as total field production for 2003 climbed to 4.82 million barrels. Average gross production from the Cheleken Contract Area increased 27 percent to 13,217 boepd (barrels of oil equivalent production per day), with 8,385 boepd being attributable to DGO.
Cash generation for the year was exceptionally strong as a result of a stellar operating performance, a $US18 million equity placing last December, and lower capital expenditure requirements. DGO achieved net operating cashflows of US$55.4 million which has allowed the company's balance sheet strength to improve markedly during the year. At year-end DGO had cash balances of US$52.2 million, and total borrowings of US$75.2 million compared with US$18.1 million and US$88.3 million respectively at the end of 2002. Current gearing is fairly conservative at around 9 percent with a further £1.7 million of debt principal payments made subsequent to year-end.
Given Dragon's sound financial shape, we believe the company is in an excellent position financially to pursue future growth. The assistance of majority shareholder ENOC should also enhance Dragon's ability to grow the resource base further by capitalising on opportunities within the Middle East and Caspian region.
We consider the production and earnings outlook for Dragon's existing fields to be particularly strong. The latest independent assessment puts the total remaining recoverable proven and probable reserves in the Cheleken Contract Area as of 31 December 2003, at 641 million barrels of oil. Dragon's entitlement barrels under the Production Sharing Agreement amounts to 356 million barrels of oil. In addition, the best estimate for gross gas resources is around 3.44 trillion cubic feet.
Development scenarios indicate that a full field development programme could build oil production towards 60,000 boepd within a five-year period. In addition, the associated and free gas resources are thought to be capable of sustaining a production level of 300 million cubic feet per day.
Dragon has a proven exploration track record in the region with successes achieved at each of the first five development wells drilled at the LAM22 platform in 2001/2002. We are optimistic of further successes in the months ahead as Dragon continues with an aggressive drilling programme. Although the first of four planned wells was temporarily suspended due to technical reasons, Dragon is aiming to drill a further 3 wells from the LAM 21 platform by June. We expect further targets to be identified in the next 12 months following the commissioning of a marine 3D seismic survey this quarter.
| "With current global consumption approaching 80 million barrels a day, rising political tension, and natural oilfield declines, we believe the price of oil will continue to climb from current levels. " |
In order for Dragon to achieve its goal of raising daily ouput fivefold by 2010, the company will need to make significant improvements to existing field infrastructure. Dragon's focus this year will be to explore various financing options to fund the long term development plans for the Cheleken Contract Area. However, the potential of the area is massive and we expect further financing progress to be made once results of the current seismic studies are announced. We expect the wider development of these fields to underwrite DGO's long-term future earnings growth. In the meantime we believe near-term earnings growth to be driven by ongoing successes from the current drilling programme.
Fat Prophets retain a bullish view on the price of oil, and we expect the earnings of proven producers such as Dragon to benefit significantly in the years ahead. With current global consumption approaching 80 million barrels a day, rising political tension, and natural oilfield declines, we believe the price of oil will continue to climb from current levels. We believe this will inevitably translate into higher valuations for quality oil companies.
Currently Dragon is on a prospective price earnings ratio for 2004 of around 10 times, however this could prove conservative if current drilling is successful. Although prices are currently trading near six year highs, DGO remains a long way below levels seen at their peak in the 1990's. With an upward trend now in place, we believe that DGO provides sound longer term potential. Accordingly Fat Prophets recommend DGO as a buy up to 43p.
DISCLAIMER
Fat Prophets has made every effort to ensure the reliability of the views and recommendations expressed in the reports published on its websites. Fat Prophets research is based upon information known to us or which was obtained from sources which we believed to be reliable and accurate at time of publication. However, like the markets, we are not perfect.
This report is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore discuss, with their financial planner or advisor, the merits of each recommendation for their own specific circumstances and realise that not all investments will be appropriate for all subscribers.
To the extent permitted by law, Fat Prophets and its employees, agents and authorised representatives exclude all liability for any loss or damage (including indirect, special or consequential loss or damage) arising from the use of, or reliance on, any information within the report whether or not caused by any negligent act or omission. If the law prohibits the exclusion of such liability, Fat Prophets hereby limits its liability, to the extent permitted by law, to the resupply of the said information or the cost of the said resupply.
As at the date at the top of this page, Directors and/or associates of the Fat Prophets Group of Companies currently hold positions in Avexa (AVX), Evolution (EVN), Cerro Resources (CJO), Energy Action (EAX), Mt Isa Metals (MET), Telstra (TLS), Woodside Petroleum (WPL), ANZ (ANZ), Austar (AUN), Carsales.com (CRZ), Gold Road (GOR), IOOF Holdings (IFL), Magellan Financial group (MFG), Paladin Energy (PDN), QBE Insurance (QBE), Platinum Australia (PLA), Datasquirt (DSQ), Hodges Resources (HDG), Newcrest Mining (NCM), Oil Search (OSH), Zambezi Resources (ZRL), Auroa Minerals (ARM), Billabong (BBG), Pioneer Resources (PIO), Runge (RUL), Westpac (WBC). These may change without notice and should not be taken as recommendations.