Dragon Oil - Why the drag on share price? Trying to pick the timing of pullbacks in the oil price is of course difficult, if not impossible. In our opinion, investors in the sector however should take some comfort that the uptrend will ultimately resume as the underpinning fundamentals remain place. In the meantime, it is no surprise that the share prices of oil juniors such as Caspian Sea based Dragon Oil (LSE: DGO) have softened considerably in tandem with oil price weakness. We believe these downward re-ratings should prove temporary for oil producers that are ramping up output and reserves. Such is certainly the case for Dragon. Demand for oil is still strong. Earlier this month the IEA not only raised the world oil demand growth forecast for this year, but also stated that demand for 2009 is expected to grow by 1.1 percent to 87.7 million barrels of oil per day (bopd). The message this forecast makes clear to us is: although high oil prices will contribute to a contraction in demand in the West (i.e the US), this will be more than offset by robust growth in developing economies (i.e ‘Chindia’).  Adding further fuel to the fire is a lack of fiscal restraint, loose monetary (interest rate) policy, ongoing trade deficits and a ballooning national debt in the US that has caused an increase in the supply of dollars now circulating through the global economy. As the US dollar continues to decline in value, over the medium term, we continue to believe that energy and commodity prices, which are priced in dollars, will continue to inflate. And that is without mentioning the escalating tensions between Israel and Iran. In stark contrast to share price performance, production at Dragon for 2008 has flown out of the traps as average production for the first half of this year climbed an impressive 37 percent to 38,482 barrels of oil per day. Dragon owes its success in large part to increased activity with the drill bit and the four development wells completed during the first half of 2008. And looking ahead, in our view the outlook for Dragon’s bottom line remains positive. Despite negative results on the exploration front in Yemen, we remain staunch supporters of Dragon’s geographic expansion efforts and see such setbacks as a normal part of the exploration process. Given time, we fully expect the company’s excellence in exploration, production and commercialisation to be translated successfully into other geographic areas. With healthy cash balance of US$654 million and no debt, the company is well positioned to capitalise on bolt-on acquisitions should they arise. The company’s pursuit of increased production is relentless and could not be better timed. Current cash cows continue to produce, while management remain resolute in their quest for greater geographic diversity. The company continues an astute investment strategy and can, in the longer term, look forward to the commercialisation of the vast gas reserves.
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