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.

Reserves

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.

Valuation

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.

Risk

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?

Summary

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.