Bolstering production capacity
Since our last review in June (FAT39), Dragon Oil (DGO) has been quietly drilling and undertaking a well work-over programme in the Cheleken Contract Area in the Caspian Sea. The programme is part of a 38 well, field development plan, designed to tap into the company's relatively unexploited proven oil reserve base. We remain convinced that the wider development of these fields will underwrite DGO's long-term earnings growth.
| "From a medium to longer term perspective Dragon has impressive earnings growth potential, driven by an expected three-fold increase in oil production." |
DGO maintains that the full field development plan, encompassing new wells and well work-overs, will raise production to 40,000 barrels of oil per day (bopd) by 2008/2009. This represents a three-fold increase from 2003 production of 13,217 bopd (8,385 barrels attributable to DGO).
We consider the current work-over programme of the old wells in the LAM field as a relatively low cost way to boost oil production. Dragon is able to incrementally increase oil production from existing wells through the application of modern drilling techniques and technologies. To date DGO has tested five wells, adding 3,600 bopd to the field's 2005 production capacity. Three further wells are planned for the fourth quarter, potentially adding another 2,160 bopd to field production.
Dragon completed drilling on the third development well in July. The initial flow rate of 1,843 bopd was below the 3,000 bopd DGO expected for new wells in the area. Overall we have been disappointed with drilling results this year, with the previous well recording a flow rate of 2,035 bopd. Neverthless both wells are still commercial, and but a small part of an extensive 6 year drilling programme.
The past three months have seen DGO consolidate in a narrow range between 44p and 39p. In our view this is constructive and we now expect the shares to form a new base around current levels until further drilling results are announced. We believe the combination of successful drilling and the ongoing well work-over programme will drive the share price going forward.
Recoverable proven oil reserves in the Cheleken Contract Area were estimated at approximately 189 million barrels as at 31 December 2003. Dragon's entitlement under the production sharing agreement is 105 million barrels. At 2003 production levels, this equates to more than 34 years of oil production. This clearly highlights, in our opinion, Dragon's excellent reserve positioning and tremendous development potential.
In addition, Dragon has estimated gas reserves of 3.44 trillion cubic feet. This level of reserving is capable of sustaining gas production of 120 million cubic feet per day. Should a long-term gas sale contract be secured this would add significant value for shareholders.
We continue to regard DGO's current valuation as undemanding with the shares trading on an attractive historical price earnings ratio of less than 10 times. DGO does not pay a dividend, however we maintain shareholder interests are best served by cashflow being ploughed into oil field development. We remain unconcerned that the company's 2004 result will be affected by the suspension and spudding of LAM 21/106 in February. From a medium to longer term perspective Dragon has impressive earnings growth potential, driven by an expected three-fold increase in oil production.
From a technical perspective we believe further consolidation is possible in the near term, although downside appears limited. Once the present period of consolidation is complete, we expect DGO will regain upward momentum. A sustained break above 44p would be a positive signal and suggest that the upward trend was being re-established. In the meantime, we believe support between 40p and 39p should underpin the share price. Accordingly DGO will remain firmly held within the Fat Prophets Portfolio.
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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.