Dragon Oil’s Interim Management Statement leaves investors wondering

Dragon Oil (LON:DGO), the Turkmenistan based oil and gas production and exploration company, recently released their interim management statement. This statement, it has to be said, was a little lacking on the information side, though it did in a way bring to an end a few factors that had been worrying investors recently. To go through the statement:

The key highlights were stated as:

The first statement strikes me as a little bit misleading really. As they do not elaborate in the report anywhere, I feel I need to highlight that, although production is up on the comparable period last year, it is actually down a little from the last period. Of course this was expected due to well flows on certain fields reducing, thus it seems to be nothing to worry about, but it would have been better for them to mention this. The next statement seems like very good news for Dragon as it shows that their infrastructure and drilling spend (mentioned in the next statement) has been used well. The final statement is, as expected, a mention of their exceptionally good balance sheet position.

Moving onto the actual details of the report, first they give some information on production:

‘The gross production for Q1 2010 averaged 47,654bopd. This represents a 9% increase over the comparable period in 2009 when the average daily production rate was 43,787bopd. The entitlement production for Q1 2010 was approximately 50% of the gross production compared to 65% for the comparable period in 2009. The entitlement barrels are dependant amongst other factors on operating and development expenditure in the period and the realised crude oil price. In Q1 2010, higher oil prices and lower capital expenditure than in the comparable period in 2009 resulted in lower entitlement barrels. The entitlement is expected to increase as the expenditure on infrastructure is weighted towards the second half of the year.’

The above may disappoint some investors as it shows that net entitlement has dropped quite significantly to 50%. But, in reality, it is not that bad as it appears as though it means that actual net production for Q1 2010 was only 23,287 bopd versus Q1 last year’s 28,461 bopd, meaning that their actual production has fallen. The reason the Q1 2009 net entitlement was so much higher was simply because the oil price was so much lower, hence the apparent massive fall is actually artificial meaning that Q1 2010 financial performance should be better than Q1 2009.

If you are confused how the entitlement deal actually works, do not worry as nearly all of Dragons investors are as they have never really explained in any detail how it works. Here is a simple way to look at it: if oil rises, the net entitlement falls; if oil falls, it rises; if operating and capital expenditure rises, the entitlement rises; if operating and capital expenditure falls, the entitlement levels falls.

Next they give out some interesting information on the marketing of their oil:

‘Dragon Oil sold 2 million barrels of crude oil in Q1 2010, which is 20% lower than the volume sold during the corresponding period last year (Q1 2009: 2.5 million barrels). During Q1 2010, 86% of crude oil was exported via Neka, Iran. Since the commencement of the PSA, Dragon Oil has been marketing the majority of its entitlement barrels through a crude oil swap agreement with a subsidiary of the National Iranian Oil Company, Naftiran Company (NICO) Limited. The term of the swap agreement was for 10 years and that expired on March 31, 2010. Whilst Dragon Oil is currently in the process of negotiating a new long term swap agreement, the Group has concluded an agreement for a short term on a rollover basis on revised terms.

Exports through the western route will increase in volume until more favourable long term swap agreement terms are negotiated. Dragon Oil is satisfied that there is sufficient capacity in existing marketing routes to satisfy current production. The realised prices are expected to be impacted by the change in the marketing arrangements. Dragon Oil continues to assess additional routes to market its crude oil.’

What is the most interesting about this statement is that it shows that they have agreed a new short term deal on revised terms yet make no actual mention, or even hint, as to what the revised terms are. It has to be said that it is not exactly shareholder friendly to say that realised prices will be impacted, but then not to hint at by how much. Even though Dragon's investors have complained about this, the truth be told it is not uncommon practice for companies to make statements like this. Just a note also, they do have other options out there to sell their oil to the likes of Baku which, although they offer poorer terms, means that they have a better negotiating position (i.e. the revised terms should hopefully be no worse than the Baku terms).

To round up the remaining interesting factors to be taken from Dragons accounts: first, as the average price attained per barrel of oil was $75 and they sold 2m barrels in the period, this means that turnover should be approx $150m for the period, $40m more than what was achieved in Q1 2009 (further proving my earlier statement that on the effects on the net entitlement agreement not being as bad as it appears). Secondly, the CEO commented that ‘We continue to drive our gas monetization and diversification strategies’. Although it is unlikely that this comment will mean much to investors who have heard it all before many times, it is still a bullish statement to make, and this should not be ignored.

To conclude, yes the statement did not contain as much information as investors would like, but if you are invested in Dragon then you will be used to this. Also obviously investing in Dragon oil is not without its risks. For a start, they operate in a high political risk region, and as everyone knows the ENOC holding has not exactly been good for investors. But they still warrant a place in the growth section of ‘Grays Stocks to Watch’ because i) Dragon have near $1bn in free cash, ii) they plan to achieve annual production growth of between 10-15% a year via a big capital spend over the next three years (though this spend should not dent the cash position as it should be covered easily by cash flow if the oil price stays at its current levels) and iii) at their current market cap, they are only on a 2009 P/E ratio of 16.

Disclosure of interest: The Author has no interest in Dragon Oil