Saturday, February 28, 2015

Dragon Oil (LSE:DGO)

Dragon Oil is the largest oil producer in Turkmenistan. All their commercial production is from their Cheleken Contract Area in the Caspian Sea, consisting of the Zhdanov and Lam fields.  The contract lasts until 2025, with rights to negotiate a ten year extension.

In December 2014, oil was found in Iraq; expected to take 2 or 3 years to determine if commercially viable.

They are also performing exploration in Algeria and Egypt.

Revenue (Production Service Agreement)

Their Cheleken PSA entitles Dragon to 50% of the oil found over the life of the contract.  In the short term, that percentage varies depending on opex and oil prices.  Entitlement in 2013 was 44%, 2014 was 56%, and 2015 is expected to be 65%.  Dragon also has to pay some taxes on profit as part of the PSA.

I could not find any other details or a copy of the PSA.

The PSA seems to be frequently amended.  In December 2014, after the oil price fell steeply, taxes were reduced from 25% to 20%, to be replaced by an additional flat $10m to be spent on social and training projects.


The company only gives 2P reserves (50% confidence level of recovery).  Dragon Oil concentrates more on production than exploration - Over they long term reserves are flat:

But they have been decreasing in the two years: 93% replacement in 2013, and 60% replacement in 2014.  Their reserves may be fluctuating based o oil prices (?)

Costs and Breakeven

Look at their break-even costs per barrel.  Use all costs on the income statement, except for taxes (not required if making a loss):

In 2009, management stated (p11) they has break-even costs of between $25-30/bbl.  Cash costs consist of in-country operating costs of $4-5/bbl, G&A costs of $2-3/bbl, and marketing/transport at $2/bbl.  Add depreciation of $16-17/bbl.  The resulting $25-30/bbl cost is close to my numbers.

They sell at a discount to Brent, on an FOB basis.  In previous years the discount was typically 14-18% of the price.   In 2015, the discount negotiated is a flat $14/bbl.  So the final 'all-in' break even price, conservatively, is $44 Brent.

Balance sheet

At end 2014, net cash is use 1.9bn, or USD 3.93 per share (roughly 255p).

Management stated they hope to make acquisitions in 2015.  No special dividend is planned.


Assuming Brent $70 with some reasonable assumptions, I get a PE of 12:

Due to majority ownership by ENOC, this firm cannot be a takeover target.

Trailing dividend yield is 36c, or 23p, or about 4% at a share price of 550p.


Turkmenistan is a dictatorship and one of the worlds most repressive countries, with leaders that have built cults of personality around themselves.  Do you really want to invest money in a country that erected gold plated statues to Glorious Dear Leader?


Excellent numbers from a company generating free cash-flow from a low cost resource base.  Good valuation.  Limit any investment to 2% due to the geopolitical risk.

Wednesday, February 4, 2015

Bought IEO

Bought 300 shares of IEO, at $74.19 each this morning.  Total cost USD 22,311.

WTI was ~ $53 when I bought.  I guess its long term sustainable price to be $70 - seems to be the consensus view too.

Its 1/3rd of my intended position. In case this week's breakout was real.  I'm always uneasy buying on breakout, because it comes from fear.  Fear of missing out.  My old broker used to say "Never chase".

If this breakout is fake, and oil goes down to the forties again, then I hope to accumulate at better values.  If not, today's trade may give me a consolation prize.

Sunday, February 1, 2015

Oil ETFs

I believe oil is priced below its sustainable price.  Beyond buying a few barrels to store in my flat, how can I invest in it?  All the individual companies I've looked at are not at low enough valuations for me catch a falling knife.  What about ETFs?

Oil commodity tracker ETFs, such as USO, are synthetic, since its hard to physically store  oil.  They suffer from large tracking error when the market is in contago, as they have to regularly roll over their (cheaper) expiring near term futures into longer term (expensive) ones:

(Source - - Seeking Exposure to Oil and Gas prices?  Here is what you should not do.)

ETF tracking Oil companies are better.  But most common ones, XLE or VDE, are heavily weighted towards large caps (with 22% ExxonMobil 22%, and 12% Chevron).  Looking at Jim Chanos' recent short position in XOM, I'm hesitant to bet against him.

XOP, tracking the "SPDR S&P 500 Oil and Gas exploration & production index" may be a better choice to track the WTI.   It is split by equal weightings into 80 companies, each less than 2%.  Holdings are 100% US based, around 77% are E&P.  They are all small E&P companies such as Laredo Petroleum or Parsely.  The top ten holdings make up 15%.  The risk here is that a large number of these companies go belly up -  based on 1-2m bbl/d oversupply on the global markets, US shale production needs to drop by 10-20%.

IEO, the "iShares U.S. Oil & Gas Exploration & Production ETF" is another option, which holds mostly mid-sized companies such as EOG or Andarko, with 73% E&P, also 100% US based.  The top ten holdings make up 60%.  IEO behaves as a lower beta version of XOP - they both track WTI, but IEO rises and falls less.

I'm thinking of taking a third of my planned position by buying IEO at the WTI support of $44 - too bad I missed Friday night (morning in US). Later buy another third if WTI drops below $40 - hopefully by then, valuations are down enough for me to buy individual stocks.  And then I may swap my initial IEO position into a higher risk XOP one.

Sunday, January 18, 2015

The Oil Majors

Since I'm looking for a way to place bets on a rising oil price sometime in the future, take a look at the large Integrated Oil Companies.

There have been many articles over the past few years saying that the IOCs are losing out to the National Oil Companies, as cheaply accessible oil is getting harder to find.  To check this, look at these these numbers over the past 10+ years:
  • Volume of oil produced.  Don't look at revenue, which depends on a fluctuating oil prices.  And don't use BOE, which mixes oil and gas but disregards their differing values (similar to comparing a kilo of gold with a kilo of silver).
  • Proven reserves.  Again look for barrels of oil, not BOE.
  • Cash Flow from Investment (CFI).  Capex (cash spent to find/produce future oil), plus anything gained/lost from buying/selling their reserves.
One company at a time.

Exxon Mobil

Hard to tell if its an oil or gas company?  In 2013, 34% of production was oil and liquids, as measured by BOE, and 66% gas.

Oil and Gas production as (measured as BOE) has remained steady:
But after removing gas, liquids production (mostly oil) has fallen in the past 5 years:

Proven oil reserves (again, excluding gas) have fallen.

But CFI has risen steadily.

The end result is steadily increasing capex, for decreasing oil production and reserves.  Jim Chanos gave an interview last month (second video) stating that he is short XOM/long oil, as they cannot keep their dividend up if the price of oil remains low, and their BOE reserves may be overstated by the XTO acquisition (p12).  Chanos has previously been right about China, IBM and Petrobas, I'm not going to bet against him.


They are primarily an oil company - in 2013, 88% of their production (measured by BOE) was oil.

Oil and NGL production is trending down:

Shell restarted their reserves in 2014, so numbers before 2002 are meaningless.  Proven Oil and NGL reserves fell from 2012 to 2007, but have stopped falling since then:

CFI seems to be rising (though not as clearly as XOM):


1/3rd of their 2013 production (measured by BOE) was gas - so its still mostly an oil company.

Oil production may or may not be declining:

Proven Oil reserves are clearly trending down, being replaced by gas.  Could not find figures for developed/undeveloped oil reserves:

Gas is generally cheaper than oil, though it depends on location since transportation is difficult.  For example, it costs around $3 per BTU in the Marcellus, but may be over $10 in Tokyo - after expensive liquefaction, transport and gasification.  So its a lot harder to determine profitability for a gas company than an oil company.

Again, CFI trending up:


39% of their 2013 production was gas, 61% liquids, as measured by BOE.

Oil production has dropped off slightly in the past 5 years:

But Oil reserves are not going down!

CFI may be trending up, but not so clearly:

BP looks the best out of the majors.  Most of this is due to its investment in Russia: originally the joint venture TNK-BP, now converted to a 20% stake in Rosneft.   If we exclude Russia, the numbers look similar to the other companies:

So a bet on BP is a bet on Rosneft.

In terms of long-term value creation, BP is probably the best (or least worst) of the major oil companies.

[Update 30/Jan/2015: Spent three nights working with BP's figures trying to figure out how much it costs them to produce one barrel of oil, and their sensitivity to oil prices.  Couldn't make out anything.  Shit!  May just buy XLE or VDE instead.]

Saturday, January 10, 2015

Gran Tierra Energy (Nasdaq:GTE)

Gran Tierra Energy is a conventional oil producer, primarily in Columbia.  97% of their 2013 was liquids, very little gas.  In Columbia, they have interests in 22 blocks, 5 of which are producing.  75% of their 2013 production came from the single Chaza block, in which they have 100% interest.  Their production contracts for Chaza expire after 2034.


GTE pays royalties, as a percentage of oil produced on a sliding scale according to production volume. The royalty levels are a bit complex (p12), and are different for different fields on each block.  Roughly 25% in 213.  Revenue stated is NAR (Net After Royalties).  Since there's no complex PSC, it is easier to estimate their sensitivity to oil prices - production retained (after royalties) will be the same each year assuming constant production levels.

On average, their oil is sold at a discount to WTI, due to transport costs.


Have risen steadily over the years:

Production Costs

Depreciation, Depletion & Armortisation (DDA) forms a high proportion of their costs.  Probably because they use the full cost method to account for exploration costs, where failed exploration efforts are capitalized, then later amortized during production.

In 2013, 49% of oil was sold to a customer requiring trucking 15,000 km away.  The trucking costs were deducted from revenue in 2013, but in previous years were recorded as revenue and expenses (increasing revenue but decreasing margin).

For the spike in 2012 operating expense: $29.3m of it was due to to new pipeline transportation costs of $3.77/BOE and the above mentioned trucking costs.

Other Financials

At the end of 3Q2014, they had $360m cash with no debt.

Planned capex for Q42014 is $220m, and 2015 is $315m.

Management stated they have not taken out any credit lines for contingencies.

Could they survive if oil fell to $40?
  • Its reasonable to remove Depreciation, Depletion & Armortisation from the costs to get 'cash costs':  "The cost of repairs and maintenance is charged to expense as incurred.".  So most capex in CFI should be for new exploration or production, not maintenance.  
  • They sell at a discount to WTI.  Due to a regional differential, and trucking.  In 2013 the average price received was $90.61 versus $97.97 WTI.  In the first 9 months of 2014, the average price received was $89.41 vs $99.61 WTI.  Lets say an discount to WTI of $7-10.
  • So with cash costs between $20 and $26 in the past 5 years, they would generate $4 to $10 cash per barrel for WTI $40.  While making losses on the income statement.
What would its PE be at $60-70 WTI?
  • Extrapolating production for the first 9 months of 2014, with WTI $70, and selling oil at a discount of $9, I get EPS of 12c. 
  • We should probably factor in some growth, as production has risen 30% in the 4 years from 2010 to 2014 (CAGR of 7%), and reserves have risen  steadily over the past 6 years.


Low cost of production and excellent financials make this a good play for an oil price turnaround.  But the nature of their industry and where they operate makes this a speculative stock.  No more than 2% of my portfolio if I buy.  Still too expensive right now.

Wednesday, January 7, 2015

Genel Energy (LSE:GENL)

Genel is a low cost oil producer in Kurdistan, one of the last places in the world with cheaply accessible oil.  They have minority stakes in 2 producing oilfields:
  • Taq Taq (44% interest), produced 42680 bopd for Genel in the 9 months to Sept.
  • Tawke (25% interest), produced 21000 bopd for Genel in the 9 months to Sept.
The Kurdish Regional Government (KRG) has completed a pipeline (in green) through their territory, linking to Turkey's pipes through to the port of Ceyhan, allowing exports.  Genel expects all their oil to be sold at higher export prices in 2015 (p29).

Genel has recently signed a deal to develop 2 gas fields, Miram and Bina Bawi, for export to Turkey.  Production is expected to start in 2016.
They are also exploring in Morocoo, Ethopia, Côte d'Ivoire  and Malta.  Exploration is a hit-or-miss affair, mostly the latter.

I'm looking at the 2 producing oilfields only.

Production Costs

Extremely low costs.  I use net production, divided by all costs on the income statement:


Offsetting its low production costs, Genel sells its oil at far below market rate as agreed in the Production Service Contract (PSC) with the KRG.

Generally, a PSC breaks down the revenue received into 3 parts: the contractors costs, government royalty, and the profit.  The first is given to the contractor, the second to the government, and the third is split:
(Source - p26)

For Genel, to calculate their share of oil produced:
  • Subtract royalties of 10%
  • Genel gets to keep costs.  Specifically: production costs, exploration costs, gas marketing, development and decommissioning.  Up to 40% of the oil (excl. royalties).
  • The remainder is profit oil, to be shared between Genel and KRG.  Generally, 15-16% of this goes to Genel.  The amount depends on the projects profitability, or R-Factor (accumulated revenue over accumulated costs throughout project lifetime).
  • However, we have to halve Genel's share of the Profit Oil, due to KRG's 20% carried interest, as well as a 30% 'infrastructure/capacity fee'.
A summary of the PSC is on p30.  PSC details are here, with the 2010 amendment for the 30% capacity fee here.  Genel provided an example, assuming $90/barrel:

(Source - 2011 Company Presentation - p19)

I was not able to reconcile the formula with the prices and volumes given in their results.  Without knowing which costs were claimable and what the R-factor is.  The best I can say is that this is a 'cost plus' model, which gives Genel some protection from falling oil prices.  They mentioned in November that a 10% fall in oil prices would lead to a 6% fall in revenue (p12).

Averaging out over their net oil production, they were getting around $20/bbl.  For the actual barrels sold in 1H14 (before the cost of the PSC is accounted for): they said they sold most of it in Kurdistan for $60-70, and trucked the remainder to export markets for $80.

Other Financials

After the first line on the income statement, the other numbers in the financial statements are simple.

Cash at hand was 973m at 1H14, after issuing US 500m bonds, which pay 7.5% and are due in 2019. 

Capex is estimated at 300-250m in 2015.  None given afterwards.

Could they survive if oil fell to $40?  I'm estimating yes, conservatively using 1H14 figures, whey would still roughly break even on the income statement.  They still would be generating cashflow from operations, and it would cover their capex in 2015, leaving zero cash on hand.  They'd still survive, but would have to cut capex afterwards.  This does not account for increases in production, or for the PSC decreasing sensitivity to oil prices.  Check again when we get the 2014 results.


Reserves for their 2 producing oilfields are slowly decreasing:

See if they are increased in future Annual Reports.  Look at oil only, as gas confuses things.


I would value an oil company on a sustainable oil price.  Probably $60-70.  Can't estimate their revenue/earnings at this price because I don't understand their PSC.  Theres also too many other moving parts: production increases, reduced transportation costs due to the pipeline, and the two new gas fields.

So a rough guess first.  Since they say they sold their oil for in 1H2014 mostly at $60-70, based on the earnings in that period, their PE at a share price of 700p is around 21.  Too expensive.  


I think Kurdistan is not as dangerous as most people think; the main risks for this company are political:
  • Dependent on the Iraqi Government to recognize the oil exports (recently done), and the Turkish Government to continue to accept gas imports and transport oil over their pipelines.  Although the current Turkish government seems to be friendly to the Kurds, they have a long history of conflict.
  • The KRG may renegotiate the PSC, as in 2010.  Genel gained from being one of the first to move into the region, but now that larger companies are moving in, it may be more competitive.


I don't fully understand the company, especially its revenue.  It seems OK, with a good chance of surviving low oil prices.

Oil is a risky business.  All the E&P companies I've looked at from the majors down to the independents have a lot of risk.  None have sustainable competitive advantages.  I'll aim to buy 'a basket' of oil stocks - allocate 2% each - to try to spread the risk.  Pick ones with good finances and low production costs, that give them a reasonable chance of surviving. These aren't stocks to hold forever, just buy to take advantage of the low oil price till it recovers to a sustainable $60-70 level.

Later on, I'll check Genel's 2014 results, for their cashflows, ability-to-survive, and see if we get a better revenue estimate based on lower oil price.  Also valuations.

Tuesday, December 30, 2014

Oil - part 1

Oil has dropped nearly 50% in the past 6 months, due to an estimated  1m bpd excess, over 92m bpd usage.  Oil prices swing wildly with small changes in supply or demand, as it can't be stored cheaply or safely.

In theory, a commodity glut ends when the price falls below the cash cost of marginal producers, eventually pushing them out:

(Source - Business Insider)

I believe US tight oil (shale) producers are the marginal producers. They are high on the cost curve.  And individual shale oil wells have a very rapid decline in production:

This means they need to constantly drill new wells every year to maintain current production levels.  For the successful ones, their business model is to have the initial production spurt in the first few years pay off the well (usually at hedged prices), after which the the remaining tail end of production (even if only hundreds or tens of barrels per day) is mostly profit.  For the weaker ones, with bad acreage or too much debt, the constant need for capex to re-drill will kill them.

No one knows what the real tight oil production costs are:

  • Costs are always falling, due to new techniques such as horizontal drilling, multi-well pads, and  wide short fracks.
  • There is no single cost number we can use: every single well must be evaluated individually, due to differing location, technology and fracking techniques used.
  • I could not approximate EOG's past few year's production volumes with the above decline curve, they're far higher than it suggests they should be.
For now, lower prices mean that everybody drills more.  Individual US companies drill to pay off debt and keep their leases.  The poor shitty countries that depend on oil revenue will produce more of the stuff to try to pay their bills.  We won't know when it ends, or at what price US production numbers drop, until after it happens.

In the long term:
  • Supply is controlled by the Saudis. Even with the cheapest production costs, they have a large welfare payments to make. Their projected 2015 budget has a shortfall of nearly USD 40bn at an estimated oil price of $55-60 per barrel.  They have about $750bn reserves.  They can't do this forever - maybe 5 years at $40 oil.  They reportedly did want to initially cut production, but increased it instead after they could not agree with Russia.
  • I think the future oil price will be capped at $70-80.  Even after US tight oil companies go bust, production can start up again in a matter of weeks or months if prices rise.
  • This means fewer new deep water projects.  It makes no sense risking hundreds of millions upfront to explore and produce, when you know where the oil is in the continental US and land rigs can be deployed for less than 10m each.
So I believe that oil will recover to a sustainable cost ($60-$70) in 1-4 years.  Unless we get a US recession - the current upswing is now 5 years old - or a hard landing in China - about a 1/3rd chance - in which case prices remain low longer.

At some point, the price falls far enough to say an asset undervalued.  For a commodity its based on marginal production costs.  I'm going to pick WTI $40.  No guarantee it will reach there, but if it does, production costs mean it must increase eventually.  Around that point, I'd look to buy strong companies that can survive the downturn.