Research Department UAE – Oil & Gas Dana Gas Company Report – Initiation of Coverage 13 January 2010 Dana Gas 1 Deep Rising Buy Kurdish operation is a key value driver with large reserve potential and good economics, but is significantly underpriced by market on political concerns. We believe the Egyptian operation could be partly or fully divested in the medium term to fund new upstream ventures. Alternatively, the company could implement a capacity increase, incentivizing bids for new concessions. We initiate coverage with a “Buy” rating and a price target of AED1.43/share (40% upside). Potential catalysts could add AED0.89/share to our valuation. We believe the Kurdish operation is a core value driver that is being heavily underpriced by the market mainly on political concerns. Pearl Petroleum, Dana Gas’s 40%-owned Kurdish subsidiary, has strong reserve potential and good economics, supported by the implied valuation from the acquisition of a 20% stake by MOL and OMV. An ease in political tensions between Kurds and Arabs in Baghdad (possible with impending elections in March) and the resumption of exports by foreign oilfield operators are the key drivers for the Kurdish operation. Imminent drivers would be the announcement of the result of field appraisals, the receipt of payment for already commenced condensate sales by Pearl Petroleum (around USD40 million currently) and securing sales to local users (Phase II). We conservatively value the Kurdish operation at a 20% discount to the OMV-MOL deal-implied valuation and a 40% discount to value potential, yielding AED0.69/share. Dana Gas Egypt is the company’s only relatively mature asset and could be considered for divestment in the medium-term to fund other ventures. Given recent successes on the exploration and production fronts, which the market has somewhat exaggeratedly reacted to, the company could get a decent price for its Egyptian operation to finance current and potential investments. Dana Gas is looking to expand and diversify its upstream assets, recently bidding (and losing) as part of consortium in Algeria’s recent oilfield rounds. We value the Egyptian operation using a combination of NAV and scenario-weighted DCF, yielding AED0.75/share. Valuing Dana Gas Egypt solely at NAV (which gauges divestment value) would add AED0.13/share to our valuation. We expect the UAE Gas Project will eventually come to fruition, despite numerous delays, since most CAPEX related to the project has been spent by both the UAE and Iranian sides. Dana Gas’s main shareholder Crescent Petroleum is in arbitration proceedings with the National Iranian Oil Company (NIOC), which could be a lengthy process. With limited visibility on a start date, we value the project at cost, yielding AED0.18/share. Assuming the project kicks off in 2011f, it would add AED0.22-AED0.30/share to our valuation. We initiate coverage on Dana Gas with a “Buy” recommendation and a sum-of- the-parts (SOTP) price target of AED1.43/share (40% upside). We valued key operations separately and assigned SG&A expenses, working capital investments, net debt and investments at the consolidated level. Current price levels value the company slightly below the Egyptian operation’s NAV plus investments, nearly ignoring all other ventures. Potential catalysts not reflected in our share price could add AED0.89/share to our valuation. These include: (i) the realization of the full value potential of Kurdistan (conditional upon successful reserve exploitation and an improved political climate), (ii) the commencement of the UAE Gas Project, and (iii) the possible divestment of or any other value-accretive development for the Egyptian operation (such as processing capacity expansion). Key Performance Indicators 2008a 2009e 2009c 2010f 2010c Net Revenue (USDm) 181 243 252 354 544 EBITDAX (USDm) 131 170 176 271 459 EBITDAX Margin 72.4% 69.8% 69.7% 76.4% 84.3% Net Income (USDm) 33 83 68 81 175 EPS (USD) 0.01 0.01 0.01 0.01 0.03 EPS Growth 10% 152% 106% -3% 158% P/E 50.53x 20.02x 24.59x 20.68x 9.52x EV/EBITDAX 17.55x 11.55x 12.63x 6.71x 4.43x Dividend Yield - - - - - P/BV 0.85x 0.77x - 0.73x - A = Actual; E/F = HC’s Estimates/Forecasts; C = Consensus Estimates Target Price (AED) 1.43 Market Price (AED) 1.02 Upside 40.2% Listed on ADX Bloomberg Code DANA UH RIC DANA.AD Enterprise Value (AEDm) 7,199 Net Debt (AEDm) 2,173 Market Cap. (AEDm) 6,120 Market Cap. (USDm) 1,668 Number of Shares (m) 6,000 Foreign Ownership Limit 49.0% Foreign Ownership Level 28.7% Daily Turnover (AEDm) 34.4 Daily Turnover (USDm) 9.4 Shareholding Structure Free Float 34.3% Crescent Petroleum 20.4% Other Investors 45.2% Price Performance Chart Hatem Alaa +202 33328 614 [email protected]Mai Nehad +202 33328 626 [email protected]* Disclaimer: See page 22 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 J F M A M J J A S O N D Dana Gas ADX
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Research Department UAE – Oil & Gas
Dana Gas Company Report – Initiation of Coverage 13 January 2010
Dana Gas 1
Deep Rising Buy
� Kurdish operation is a key value driver with large reserve potential and good economics, but is significantly underpriced by market on political concerns.
� We believe the Egyptian operation could be partly or fully divested in the medium term to fund new upstream ventures. Alternatively, the company could implement a capacity increase, incentivizing bids for new concessions.
� We initiate coverage with a “Buy” rating and a price target of AED1.43/share (40% upside). Potential catalysts could add AED0.89/share to our valuation.
We believe the Kurdish operation is a core value driver that is being heavily underpriced by the market mainly on political concerns. Pearl Petroleum, Dana Gas’s 40%-owned Kurdish subsidiary, has strong reserve potential and good economics, supported by the implied valuation from the acquisition of a 20% stake by MOL and OMV. An ease in political tensions between Kurds and Arabs in Baghdad (possible with impending elections in March) and the resumption of exports by foreign oilfield operators are the key drivers for the Kurdish operation. Imminent drivers would be the announcement of the result of field appraisals, the receipt of payment for already commenced condensate sales by Pearl Petroleum (around USD40 million currently) and securing sales to local users (Phase II). We conservatively value the Kurdish operation at a 20% discount to the OMV-MOL deal-implied valuation and a 40% discount to value potential, yielding AED0.69/share.
Dana Gas Egypt is the company’s only relatively mature asset and could be considered for divestment in the medium-term to fund other ventures. Given recent successes on the exploration and production fronts, which the market has somewhat exaggeratedly reacted to, the company could get a decent price for its Egyptian operation to finance current and potential investments. Dana Gas is looking to expand and diversify its upstream assets, recently bidding (and losing) as part of consortium in Algeria’s recent oilfield rounds. We value the Egyptian operation using a combination of NAV and scenario-weighted DCF, yielding AED0.75/share. Valuing Dana Gas Egypt solely at NAV (which gauges divestment value) would add AED0.13/share to our valuation.
We expect the UAE Gas Project will eventually come to fruition, despite numerous delays, since most CAPEX related to the project has been spent by both the UAE and Iranian sides. Dana Gas’s main shareholder Crescent Petroleum is in arbitration proceedings with the National Iranian Oil Company (NIOC), which could be a lengthy process. With limited visibility on a start date, we value the project at cost, yielding AED0.18/share. Assuming the project kicks off in 2011f, it would add AED0.22-AED0.30/share to our valuation.
We initiate coverage on Dana Gas with a “Buy” recommendation and a sum-of-the-parts (SOTP) price target of AED1.43/share (40% upside). We valued key operations separately and assigned SG&A expenses, working capital investments, net debt and investments at the consolidated level. Current price levels value the company slightly below the Egyptian operation’s NAV plus investments, nearly ignoring all other ventures. Potential catalysts not reflected in our share price could add AED0.89/share to our valuation. These include: (i) the realization of the full value potential of Kurdistan (conditional upon successful reserve exploitation and an improved political climate), (ii) the commencement of the UAE Gas Project, and (iii) the possible divestment of or any other value-accretive development for the Egyptian operation (such as processing capacity expansion).
Total Non-Current Assets 2,531 2,671 2,685 2,608 2,178 2,073
Total Assets 2,946 3,173 3,326 3,565 2,822 2,921
Trade Payables 53 70 93 127 153 175
Other Current Liabilities 56 64 73 87 98 107
Total Current Liabilities 109 134 166 213 251 282
Convertible Sukuk 856 867 867 867 - -
Other Non-Current Liabilities 10 10 10 10 10 10 Total Non-Current Liabilities 866 877 877 877 10 10 Total Shareholders' Equity 1,971 2,162 2,283 2,475 2,560 2,629
Cash Flow Statement
Net Income 33 83 81 192 233 69 Non-Cash Items 67 46 120 153 7 93
Net Change in Working Capital (67) (4) (1) (3) (3) (3) Operating Cash Flow 33 125 200 342 237 159 Net CAPEX (264) (190) (76) (45) (23) (16)
Other Investments 48 184 32 34 370 28
Investing Cash Flow (216) (6) (44) (11) 347 12
Financing Cash Flow (112) (61) (50) (65) (932) -
Change in Cash (295) 58 106 266 (348) 172 *Numbers presented only include: Egypt (assuming no capacity expansion), Kurdistan–Phase I and Ras Shukheir
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Dana Gas
Investment Case
� We initiate coverage on Dana Gas with a “Buy” rating as the stock is currently operation’s NAV plus investments nearly excluding other ventures. Market price offers a 40% upside to our price target with potential catalysts (not included in our valuation) to add AED0.89/share.
� Kurdish operation has large value potential that is unrecognized by the market. Easing political tensions and recognition of Kurdish oil contracts by Baghdad (leading to foreign operators in the Kurdish region receiving payment) could alleviate long-term concerns. Field appraisales are likely near-term catalysts.
� We believe there are three possible scenarios for the Egyptian operation: (i) maintaining status quo, (ii) boosting processing capacity through pumping around USD100 million, which could entice bidding for new concessions, and (iii) fully or partly divesting the operation most likely at a premium to NAV. We believe the UAE Gas Project is bound to materialize, but could still take some time.
Current price levels nearly discount operations ex
We initiate coverage on Dana Gas with a “Buyupside). Current price levels value the company slightly belowMOL), almost ignoring other operations mainly on concerns related to: 40%-owned Pearl Petroleum, which we believe is an unexploited and unrecognized value drivergas supplies from Iran as per the UAE Gas Project. somewhat exaggerated manner (see Chart 1 below)
Chart 1: Dana Gas’s Share Price Performance
Source: Dana Gas, Reuters, HC Brokerage
Potential catalysts to add AED0.89/share to our valuation
Our price target does not include the following potential catalysts, which would add potential of the Kurdish operation, conditional upon the exploitation oof the UAE Gas Project and the implementation of a valuedivestment value of the Egyptian operation (as measured by NAV), which is likely in the mediumless mature and more promising exploration and production prospectsSharjah Western Offshore Concession, and assets in Nigeria and Tunisiainformation).
We initiate coverage on Dana Gas with a “Buy” rating as the stock is currently trading slightly below the Egyptian operation’s NAV plus investments nearly excluding other ventures. Market price offers a 40% upside to our price target with potential catalysts (not included in our valuation) to add AED0.89/share.
large value potential that is unrecognized by the market. Easing political tensions and recognition of Kurdish oil contracts by Baghdad (leading to foreign operators in the Kurdish region receiving payment)
term concerns. Field appraisal results, receipt of condensate sales payments, and securing local
We believe there are three possible scenarios for the Egyptian operation: (i) maintaining status quo, (ii) boosting ping around USD100 million, which could entice bidding for new concessions, and (iii)
fully or partly divesting the operation most likely at a premium to NAV. We believe the UAE Gas Project is bound to materialize, but could still take some time.
price levels nearly discount operations ex-Egypt
Buy” recommendation and a sum-of-the-parts price target of AEDslightly below the NAV of Dana Gas Egypt plus investments (mainly a 3% stake in Hungary’s
mainly on concerns related to: (i) escalating political tensions in Kurdistanis an unexploited and unrecognized value driver, and (
gas supplies from Iran as per the UAE Gas Project. Share price performance has recently been mainly triggered by Egyptian discoveries in a anner (see Chart 1 below)
Dana Gas’s Share Price Performance
Potential catalysts to add AED0.89/share to our valuation
potential catalysts, which would add AED0.89/share to our valuationconditional upon the exploitation of reserves and securing local and export sales
and the implementation of a value-accretive capacity expansion subsequent to the start of gas deliverydivestment value of the Egyptian operation (as measured by NAV), which is likely in the medium term should the company opt to invest in less mature and more promising exploration and production prospects, and iv) other ventures with limited visibility including Gas Cities, the
assets in Nigeria and Tunisia (we have no assigned values for these ventu
3
trading slightly below the Egyptian operation’s NAV plus investments nearly excluding other ventures. Market price offers a 40% upside to our price target
large value potential that is unrecognized by the market. Easing political tensions and recognition of Kurdish oil contracts by Baghdad (leading to foreign operators in the Kurdish region receiving payment)
sal results, receipt of condensate sales payments, and securing local
We believe there are three possible scenarios for the Egyptian operation: (i) maintaining status quo, (ii) boosting ping around USD100 million, which could entice bidding for new concessions, and (iii)
fully or partly divesting the operation most likely at a premium to NAV. We believe the UAE Gas Project is bound to
price target of AED1.43/share (40% the NAV of Dana Gas Egypt plus investments (mainly a 3% stake in Hungary’s
i) escalating political tensions in Kurdistan, home to Dana Gas’s ii) incessant delays in the delivery of
Share price performance has recently been mainly triggered by Egyptian discoveries in a
to our valuation: (i) the full valuation f reserves and securing local and export sales, (ii) the commencement
accretive capacity expansion subsequent to the start of gas delivery, (iii) the full term should the company opt to invest in
and iv) other ventures with limited visibility including Gas Cities, the (we have no assigned values for these ventures due to limited
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Chart 2: Dana Gas’s Price Target Breakdown and Potential Catalysts
Source: HC Brokerage
Pearl Petroleum (Kurdistan)–Possesses strong value potential that is unrecognized by the market
We believe the Kurdish operation is Dana Gas’s value driver in the medium to long term, with large unexploited reserves and a production potential of 3 Bcf/day. The Kurdish assets’ valuation prospects were validated by the acquisition of a 20% stake in Pearl Petroleum by OMV and MOL last May in a deal that valued the company at USD3.5 billion. We conservatively value Pearl Petroleum at a 20% discount to the OMV-MOL deal-implied valuation, yielding AED0.69/share. We believe Dana Gas’s Kurdish assets have a potential value of AED1.14/share, conditional upon the successful exploration of Khor Mor and Chemchemal wells and the successful commencement of Phases II and III that entail gas and byproduct sales to local industries and domestic users as well as exports.
Key near-term catalysts are the announcement of field appraisal results, the receipt of payments by Pearl Petroleum related to commenced condensate sales (the first stage of Phase I) that currently stand at around USD40 million, and securing local sales contracts, which we see limited risk for given growing demand for energy in the country. The operation is being heavily underpriced by the market mainly on political concerns related to growing tensions between the Kurdistan Regional Government and the Iraqi Central Government that are raising questions on whether exports out from Dana Gas’s Kurdish assets (Phase III) will materialize. Export concerns could be alleviated with a possible improvement in political climate following next March’s elections and the receipt of oil export payments by foreign operators in the Kurdish region (Norway’s DNO and Turkey’s Genel Enerji).
Dana Gas Egypt–Priced-in but is divestment likely in the medium-term?
The market has recently been reacting almost solely (and somewhat exaggeratedly) to discovery announcements related to Dana Gas’s Egyptian operation, which is the company’s only fully up-and-running operation. Given limited risks and an established presence in the country, we believe the Egyptian operation is fully priced into Dana Gas’s share price by the market. We expect the share price to continue to react in an inflated manner to further exploration results in Egypt in the near term.
What is in the cards for Egypt? Three possible scenarios in our view…
Scenario 1: Remaining as is
Dana Gas could remain in Egypt and maintain its status quo, operating at a maximum production of around 42,000 BOE/day (compared to 40,000 BOE/day currently). We value this scenario at AED0.60/share and assign it a 25% probability.
Scenario 2: Expanding processing capacity
With production nearing a bottleneck, we believe capacity expansion is imminent. The company is currently studying the construction of a gas processing plant, reminiscent of its existing Wastani facility, which could add a processing capacity of around 27,000 BOE/day at a cost of around USD100 million. The possible capacity boost would increase the likelihood of bidding for more concessions in the country. We valued this scenario at AED0.65/share and also assign it a 25% probability.
Scenario 3: Divestment
We believe Dana Gas could opt for a partial or full divestment of its Egyptian assets in the medium-term to fund investments in more promising upstream ventures especially given the relatively mature nature of the operation. Another likely incentive is the near-term expiration of Dana Gas’s umbrella agreement with Crescent Petroleum that mandated granting Crescent Petroleum the option to take part in all available investment opportunities on an equal basis. Dana Gas recently bid as part of a consortium but failed in Algeria’s latest bidding rounds, signaling that Dana Gas is seeking to diversify its upstream assets. We believe a likely divestment would be at a premium to NAV
1.681.43
2.32
0.69
0.75 0.18
0.06
(0.16) (0.30)
0.21
0.17 0.29
0.22 0.08
0.13
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
Kurdistan (20%
Discount to OMV-MOL
Deal)
Egypt UAE Gas Project @
Cost
Ras-Shukair Enterprise Value
SG&A and Working Capital
Net Debt Investments Price Target OMV-MOL Deal
Discount
Kurdistan's Remaining Value
Potential
Start of UAE Gas Project in 2011
UAE Gas Project
Increases Capacity
Remaining Portion of
Egypt's NAV
Potential Value
Potential Catalysts
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Dana Gas 5
(based on recoverable reserves) to reflect the value of processing facilities and other assets. We conservatively value this scenario at NAV based on 2009e 2P reserves, yielding AED0.88/share, and assign it a 50% probability.
UAE Gas Project–Gas delivery will happen in our view but could take more time
The UAE Gas Project, which was the driver behind Dana Gas’s inception, has been plagued by an endless string of delays. We believe gas delivery out of Iran’s Salman field will eventually take place, especially given the large CAPEX already spent by both the Iranian and UAE sides. However, the process could prove still lengthy especially with Dana Gas’s largest shareholder Crescent Petroleum, the company that forged the deal with the Iranian side, currently involved in arbitration with the National Iranian Oil Company (NIOC). We thus do not expect a positive development on the issue in the short term. We value the project at cost for Dana Gas at AED0.18/share. Project commencement could add AED0.22-AED0.30/share to our valuation. The upper bound of the range reflects the implementation of a USD50 million capacity increase to handle 800 MMscf/day, compared to the design capacity of 600 MMscf/day.
Downside risks
Downside risks to our valuation include:
(i) Severe delays in the receipt of payments by Pearl Petroleum related to Phase I sales of condensate and LPG;
(ii) A worsened political situation in Kurdistan that could increase skepticism over the implementation of Phases II and III;
(iii) Disappointing results of the ongoing appraisal of the Khor Mor and Chemchemal fields in Kurdistan;
(iv) A prolonged deterioration in oil prices below our long-term assumed price of USD75/bbl. This would lower our valuation of Dana Gas Egypt since oil-linked byproducts represent 20-25% of the operation's output;
(v) The inability to find new upstream investment opportunities or the lack of new concessions in Egypt, which could be problematic in the long run as reserves from existing concessions and assets are depleted;
(vi) Disappointing results of the remainder of the exploration program in Egypt that is expected to continue until 2012f;
(vii) Delays in the construction of the Ras Shukhair liquids extraction plan.
Although more delays in the UAE Gas Project would hamper share price performance, we do not believe this is a major risk to our valuation as we value the project at cost for Dana Gas. In the worst of cases, Dana Gas could sell the project's infrastructure to recoup its costs.
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Valuation
� Our SOTP valuation for Dana Gas yields a value of AED1.43/share (40% upside). Potential catalysts could add AED0.89/share to our valuation.
� No sensitivity to gas prices in the near term due to fixed price in Egypt. Sensitivity to oil prices is currently limited as oil-linked byproducts are only 20-25% of Egypt’s production.
� Repayment concerns related to convertible sukuk maturing in 2012f are not an issue even if UAE Gas Project and latter phases of Kurdistan don’t start. Dilution is also not a concern as the conversion option is currently deep out-of-the-money.
A well-integrated player – We start coverage with a “Buy”
Headquartered in Sharjah, Dana Gas is the first and largest private sector natural gas company in the Middle East. It operates in the Middle East, North Africa, and South Asia (MENASA) across the entire natural gas value chain through a number of subsidiaries.
Chart 3: Dana Gas’s Subsidiaries and Affiliates
Source: Dana Gas, HC Brokerage
We initiate on Dana Gas with a “Buy” recommendation and a sum-of-the-parts (SOTP) price target of AED1.43/share (40% upside to the current market price). We assigned a value to each key operation—Egypt, Kurdistan, UAE Gas Project, and Ras Shukheir—and attributed the following at the consolidated level: (i) selling, general, and administrative expenses, (ii) working capital investments, (iii) net debt, and (iv) the market value of investments (mainly a 3% stake in Hungary’s MOL). We have excluded other ventures (Gas Cities, Sharjah Offshore Concession, and Nigerian and Tunisian assets) from our valuation due to limited information and visibility. We assume a sustainable price for oil of USD75/barrel and for gas of USD4.5/MMBTU, and priced byproducts (mainly condensate and LPG) as a multiple of our long-term oil price.
Current share price levels value the company at slightly less than the Egyptian operation’s NAV (AED0.88/share based on our numbers) plus investments (AED0.21/share), nearly ignoring the Kurdish operation (which we believe is a core value driver), the UAE Gas Project, and other ventures. Projects and potential catalysts not included in our numbers, which are detailed in each section below, could collectively add AED0.89/share to our valuation.
Upstream
Dana Gas Egypt (Centurion)
Exploration & Production
Pearl Petroleum Co. Ltd. (PPCL) [Kurdistan, Iraq] Exploration & Production
100%
40%
Midstream
Egyptian Bahraini Gas Derivative Co. (EBGDCO)
[Egypt] Gas Processing
40%
100% United Gas Transmission Co. Ltd. (UGTCL) [Sharjah, UAE]
Gas Transmission
100% Sajaa Gas (SajGas) [Sharjah, UAE] Gas Sweetening
Dana Gas
66% DanaGaz Bahrain WLL [Bahrain]
Gas Processing
Downstream
50%
35% Crescent National Gas Co. Ltd. (CNGCL) (Sharjah, UAE)
Gas Marketing
Gas Cities Ltd. [MENASA]
Gas Marketing
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Table 1: Dana Gas Valuation Summary
Operation Valuation Methodology Value/Dana Gas Share (AED)
Contribution to EV/Share
Dana Gas Egypt 50% NAV & 50% Scenario-Weighted DCF 0.75 45% Pearl Petroleum – Kurdistan 20% Discount to OMV-MOL Deal-Implied Valuation 0.69 41% UAE Gas Project Cost 0.18 11% Ras Shukhair DCF 0.06 3% Enterprise Value 1.68 100% SG&A and Working Capital Investments DCF (0.16)
Investments* Market Value on 8 January 2010 0.21 Net Debt Cost (0.30)
Equity Value 1.43
Market Price 1.02 Upside 40.2%
*Mainly a 3% Stake in Hungary’s MOL Source: HC Brokerage
No near-term sensitivity to gas prices; oil prices have some impact
Dana Gas is not impacted by fluctuations in natural gas prices given that: (i) in Egypt, the company sells at a fixed price of USD2.65/MMBTU, (ii) Kurdish gas sales will only commence once the latter phases are up and running (our valuation for the Kurdish operation is deal-implied from OMV-MOL acquisition), and (iii) gas sold by Dana Gas as part of the UAE Gas Project (which we value at cost) will likely be at thin margins and therefore has a limited valuation impact.
As indicated by Table 2 below, the sensitivity of our valuation to fluctuations in oil prices is not very significant. Byproducts (mainly condensate and LPG), which the company sells in all of its operations at international prices, are typically priced as a multiple of oil and thus the company’s numbers are typically affected by oil price fluctuations. However, only 20-25% of the sales volumes of Dana Gas Egypt, which is the only real contributor to consolidated numbers at the moment, are in byproducts and the impact on numbers is thus moderate.
Table 2: Sensitivity of Dana Gas’s Valuation to Oil Price Assumptions
Oil Price (USD/bbl) Dana Gas Price Target (AED/Share) Deviation from Base Case
Sukuk repayment and potential dilution should not be a concern
Dana Gas issued in October 2007 convertible sukuk worth USD1 billion that mature in 2012f and pay a fixed interest rate of 7.5%. The company did this mainly to partly finance the Centurion (the Egyptian operation) acquisition earlier in the year. We are not worried about the repayment of the sukuk even if a worst-case scenario emerges where both the UAE Gas Project and the latter phases of the Kurdish operation do not commence. We believe repayment will be financed through a number of sources including: (i) full cost recovery from the Kurdish operation as we expect the company to recoup its Phase I CAPEX (in excess USD300 million) over 2010-2012f, (ii) ongoing cash flows generated from the Egyptian operation, and (iii) the company’s investments (mainly their 3% stake in MOL), which currently have a market value of around USD330 million. Dilution concerns, should conversion take place, are also far-fetched at current price levels given that the conversion option is currently deep out-of-the-money since the conversion price is AED2.12/share (nearly double the current market price).
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Dana Gas 8
Pearl Petroleum–Kurdistan Region of Iraq (KRI)
� Pearl Petroleum, Dana Gas’s 40%-owned Kurdish asset, has significant hidden value in our view with a production potential of 3 Bcf/day. Key drivers at this stage are field appraisal results, receipt of payments for commenced condensate sales by Pearl Petroleum and securing local gas sales.
� Despite a strong vote of confidence by acquisition into Pearl Petroleum by Nabucco pipeline architects OMV and MOL, exports remain the primary overhang for the Kurdish operation. Possible changes in the political climate after next March’s election and the receipt of export payments by other operators in Kurdistan could ease concerns.
� We value Dana Gas’s Kurdish operation at a 20% discount to implied valuation by OMV-MOL deal (and a 40% discount to value potential based on our numbers) yielding USD1.12 billion (0.69/share).
The venture into Kurdistan
In April 2007, a 50:50 joint venture between Dana Gas and Crescent Petroleum (later named Pearl Petroleum), signed a Strategic Alliance Protocol with the Kurdistan Regional Government (KRG) of Iraq, granting the company a 25-year service contract to develop, process, and transport natural gas on a fast-track basis from the Khor Mor gas field and to evaluate the potential of the Chemchemal gas field. The two fields are preliminarily estimated to have gas reserves of 4-5 Tcf, around 3% of Iraq's 112 Tcf of reserves (based on latest available figures from the Iraqi government), but it is highly likely that actual reserves are much higher with affirmation provided upon the conclusion of field appraisal.
The 25-year service contract allows for 100% cost recovery of both CAPEX and OPEX in addition to receiving an undisclosed share of revenue, which we believe to be in the range of 12% based on the presentation of the now scrapped merger between UK-based Heritage Oil and Turkey’s Genel Enerji. Dana Gas’s Kudistan project involves three phases (detailed below) with the first stage of Phase I already up and running.
Chart 4: Map of Iraq’s Oil and Gas Fields
Source: Energy Information Administration (EIA)
Phase I: Khor Mor Gas Field Development
The initial focus of the project is to develop the Khor Mor field to provide steady natural gas supplies to fuel domestic electric power generation plants in the cities of Erbil and Chemchemal (in the province of Sulaymaniyah). Generation capacity in Erbil will be 500 MW and 750 MW in Chemchemal, supplying electricity to over 4 million Iraqis and saving the government around USD2.5 billion a year in liquid fuel import costs. The total investment cost for Phase I is estimated at USD650 million.
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Stage 1: Pre-LPG Plant
Production from the Khor Mor gas field started in October 2008 through early production facilities producing 85-100 MMscf/day of gas, which are transported free of charge to the power stations through a 180 km pipeline, and 4,300 barrels/day of condensate sold to end-users at international prices. It is worth noting that Pearl Petroleum has not yet received any payments from the government for its condensate sales, which currently stand at around USD40 million.
Stage 2: Post-LPG Plant
(i) The second stage of Phase I involves the upstream development of a two-train LPG plant, which is set for completion in early 2010. Once the plant is complete, production is expected to increase to: 300 MMscf/day of gas, 940 tons/day of LPG, and 14,000 barrels/day of condensate. Like the first stage, natural gas is provided free of charge while byproducts are sold at international prices.
(ii) The post-LPG plant stage also includes the continuation of field appraisal, tapping into the area’s huge reserves. The company is currently extracting gas from only five wells in Khor Mor, and thus there is still substantial extraction potential in Khor Mor as well as the unexploited Chemchemal field, which is believed to have significant reserves. Should full exploitation of the Khor Mor field and the development of Chemchemal go through, the area can produce over 3 Bcf/day of gas in addition to substantial volumes of associated liquids.
We valued Phase I at USD319 million (AED0.20/ share) by forecasting free cash flows over a 25-year horizon and applied a WACC of 15.3%. Our valuation is strictly based on the sale of byproducts and does not incorporate the possibility of sale of excess gas that is not utilized by the power stations, which is likely to happen once the LPG plant is fully up and running.
Table 3: Valuation of Phase I of Dana Gas’s KRI Project
The second phase of the Kurdistan project involves supplying gas and byproducts to a number of users within the Kurdish region including:
(i) cement power plants and other industrial users,
(ii) the Kurdistan Gas City, which is a gas-utilization industrial complex to promote private-sector investments in a variety of gas-related industries thus ensuring optimal use of the region's natural gas resources (see the Other Projects section for more details). Land has already been allotted and advanced negotiations are currently in place with potential anchor tenants, and
(iii) the domestic sector for residential usage and as compressed natural gas (CNG).
Phase 3: Gas exports—the driver behind the recent partnership with OMV and MOL
The third phase of the Kurdistan project will involve the eventual export of some of the fields’ reserves to Europe and the Middle East. This phase was the key driver behind with the recent partnership with OMV Upstream International GmbH (OMV), Austria’s largest listed industrial company and a leading Central European integrated oil and gas group, and MOL Hungarian Oil and Gas Public Limited Company (MOL), Hungary’s largest listed company and also a leading Central European integrated oil and gas group.
Dana Gas and Crescent Petroleum signed in May 2009 an agreement with both MOL and OMV to acquire a 10% stake each in Pearl Petroleum, which valued the Kurdish operation at USD3.5 billion (USD1.4 billion or AED0.86/share for Dana Gas’s stake). In return, OMV paid USD350 million, which will be reinvested in the Kurdish region’s resource development, and MOL swapped shares with the original partners, granting both Dana Gas and Crescent Petroleum a 3% stake each in MOL. We believe this will generate dividend income of roughly USD6 million per annum for Dana Gas. The project partners will now push forward substantial investments in the Kurdish region, which are estimated at USD8 billion, to realize the fields’ full production potential of 3 Bcf/day.
UAE – Oil & Gas
Dana Gas
Chart 5: Pearl Petroleum’s Shareholding Structure Post the May 2009 Deal
Source: Dana Gas, HC Brokerage
Partnership is a vote of confidence by OMV and MOL
We believe OMV and MOL’s partnership in Pearl Petroleum is a clear attempt to secure further gas supplies (in addition to
pledges from Azerbaijan, Turkmenistan, Egypt, Iraqpart that gas from the two Kurdish fields will eventually be exported.
original architects of the project. The Nabucco project is will link the Middle East and Caspian regions via Turkey, Bulgaria, Romania
Western Europe. The key motivation behind the project is to reduce Europe’s dependence on R
the continent’s requirements. Construction of the pipeline is that will be fully up-and-running at least by the end of 2015f. The pipeline’s first construction phase is expected to be completed by 2014f
with an initial capacity of around 0.8 Bcf/day.
Chart 6: The Nabucco Gas Pipeline Route
Source: The Nabucco Gas Pipeline
Ongoing conflict between Kurds and Arabs in
The Iraqi Central Government does not seem supportive ofand Chemchemal upon their full development, pa
estimates range from 4.5 to 7.0 Tcf), in addition to
The Central Government and the KRG have been in a dispute
which Kurds consider their ancestral homeland). exploration and production sharing agreements with a number of
Heritage Oil, and Genel Enerji. The central government deemed
Kurdistan has been the fastest region in exploiting its hydrocarbon assets andexports via its national pipeline that connects to Turkey with first exports on
Taq Taq oil field run by Genel Enerji and Canada’swere a good signal for Dana Gas’s potential for export from its Kur
receiving payment from Baghdad in return for their exports. among its different regions by the central treasury, and
Petroleum,
OMV,
Shareholding Structure Post the May 2009 Deal
by OMV and MOL that exports will eventually happen
We believe OMV and MOL’s partnership in Pearl Petroleum is a clear attempt to secure further gas supplies (in addition to
, Egypt, Iraq, and Syria) to the Nabucco gas pipeline and is thus a strong vote of cofields will eventually be exported. OMV and MOL own a 16.7% stake
. The Nabucco project is a 3,300 km gas pipeline with an estimated investmeregions via Turkey, Bulgaria, Romania, and Hungary with Austria and further on with Central and
The key motivation behind the project is to reduce Europe’s dependence on Russian gas
of the pipeline is set to begin in 2011f, and the pipeline will have a the end of 2015f. The pipeline’s first construction phase is expected to be completed by 2014f
Arabs in Baghdad overshadows export potential
Iraqi Central Government does not seem supportive of the proposed Kurdish-Nabucco link, which partly because Baghdad hopes to supply gas to Europe from the Akkas
Tcf), in addition to the ongoing apprehension that Kurdistan achieves full
overnment and the KRG have been in a dispute since 2004 over Iraq’s land and hydrocarbon
. Upon failure to pass a hydrocarbon law, the KRG greements with a number of relatively small international energy firms
central government deemed these agreements illegal.
gion in exploiting its hydrocarbon assets and, accordingly, the Iraqi government permitted Kurdish via its national pipeline that connects to Turkey with first exports on 1 June 2009 of around 100,000 barrels/day mainly from the
and Canada’s Addax Petroleum, and the DNO-operated Tawke fieldpotential for export from its Kurdish resources, the positivity was muted by
in return for their exports. Iraqi constitution stipulates a formula for distributing hydrocarbon revenue among its different regions by the central treasury, and, accordingly, Kurdistan is entitled to a 17% revenue shar
Dana Gas, 40%
Crescent
Petroleum, 40%
OMV, 10%
MOL, 10%
10
We believe OMV and MOL’s partnership in Pearl Petroleum is a clear attempt to secure further gas supplies (in addition to willingness
to the Nabucco gas pipeline and is thus a strong vote of confidence on their 7% stake each in Nabucco and are the
with an estimated investment cost of EUR7.9 billion that and Hungary with Austria and further on with Central and
ussian gas, which caters to roughly 40% of
pipeline will have a design capacity of 3 Bcf/day the end of 2015f. The pipeline’s first construction phase is expected to be completed by 2014f
, which will help secure sales from Khor Mor hopes to supply gas to Europe from the Akkas gas field (reserve
full autonomy.
land and hydrocarbon resources (especially over Kirkuk,
started in 2007 to unilaterally sign international energy firms, including Norway’s DNO,
y, the Iraqi government permitted Kurdish oil of around 100,000 barrels/day mainly from the
Tawke field. Although the initiation of exports dish resources, the positivity was muted by international companies not
Iraqi constitution stipulates a formula for distributing hydrocarbon revenue accordingly, Kurdistan is entitled to a 17% revenue share.
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Dana Gas 11
DNO halted its exports in September 2009 and ceased drilling in December 2009, focusing instead on sales to the local market until a clear payment mechanism for exports is in place. Output from the Taq Taq field has also been diverted to the local market. Additionally, the proposed Heritage Oil-Genel Enerji merger that partly aimed to consolidate their Kurdish assets was cancelled.
Implications of the Iraqi bidding rounds The relative success of Iraq’s second bidding rounds that took place in December 2009 raised questions on whether Kurdish exports will be allowed as skeptics believe that Iraq could now be more reluctant to reach a resolution with the Kurds as it finds itself with sufficient oil revenue. We believe that with an ability to export 250,000 barrels/day, which the central government is bound to benefit from, the Kurdish situation is unlikely to be neglected, especially since the newly-awarded fields will likely take a couple of years at least to start production. Also, the success of the bidding rounds affirms foreign interest in the country and signals that Iraq is becoming more and more conducive to foreign investments.
Iraq held in June 2009 its first bidding round since the 2003 US-led invasion, offering 20-year service contracts for a number of oilfields. The bidding process was a failure as companies demanded higher remuneration fees than the average of USD2/bbl offered by the government, which retains ownership in all fields. Out of eight projects, only one was awarded to British Petroleum and China National Petroleum Corp., in addition to two that were awarded in preliminary deals subsequent to the failed auction. The second bidding round in December 2009 was more successful, with seven oilfields awarded. The contracts from the two auctions are expected to quadruple the country’s oil production to around 12 million barrels/day, generating additional revenue of USD200 billion per year in six years, according to Iraq’s Oil Minister.
Table 4: Results of Iraq’s 2009 Oil Field Bidding Rounds
Contract Area Awarded Companies/ Consortia Plateau Production Target (bbl/day)
Remuneration Fee (USD/BOE)*
First Bidding Round (June 2009)
Rumaila BP (Operator)/China National Petroleum Corp. 2,850,000 N/A West Qurna (Phase I) Exxon Mobil/Royal Dutch Shell N/A N/A Zubair Eni SpA N/A N/A Kirkuk No Bid N/A N/A Bai Hassan No Bid N/A N/A Akkas No Bid N/A N/A Mansuriyah No Bid N/A N/A
Second Bidding Round (December 2009) Majnoon Shell (Operator)/Petronas 1,800,000 1.39 Halfaya CNPC (Operator)/Petronas / Total 535,000 1.40 East Baghdad (Central and North) No Bid N/A N/A Eastern Fields (Gilabat, Khashem Al-Ahmar, Nau Doman, Qumar)
*Represents the maximum fee set by PCLD and accepted by the winner; the original bid is shown alongside in parentheses where available Source: Iraq Ministry of Petroleum Contracts and Licensing Directorate (PCLD), Reuters, HC Brokerage
Limited risk for local sales–What else to keep an eye out for? Despite the multitude of issues plaguing the Kurdish operation, we are strong believers in the region’s prospects, and feel it serves as a strong value driver for Dana Gas. We also believe that after the full execution of Phase I, there is little risk for sourcing local industries and domestic users (Phase II), especially given the country’s dire need for energy and dependence on hydrocarbon revenue (around 90% of the Iraqi government’s revenue). Phase II will serve as a buffer should exports (Phase III) fail—something that we see as highly unlikely in the long run.
We thus believe the key things to keep an eye out for at this stage for Dana Gas’s Kurdish operation are: (i) results of field appraisals expected in 2010f that would earmark the true production potential of Khor Mor and Chemchemal, (ii) the receipt of payments by Pearl Petroleum for already-commenced sales as part of the first stage of Phase I, and (iii) securing local sales contracts with favorable terms, which is likely to be dependent on developments relating to the Kurdistan Gas City. Despite the limited likelihood of exports starting anytime before 2014f, when development efforts bear fruit and the Nabucco pipeline is operational, the exports issue remains the primary overhang on Dana Gas’s Kurdish operation. The two likely positive signals for exports to watch out for are: (i) the verdict of the Iraqi elections to be held in March 2010, which could eventually lead to a more conducive political climate to the resolution of the Kurdish situation, and (ii) the receipt of export payments by the likes of DNO, which will in turn lead to resumption of drilling activity and exports.
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Dana Gas 12
We value Pearl Petroleum at a 20% discount to the OMV-MOL deal valuation; 40% below value potential
Given limited visibility on how the Kurdish operation will turn out and the lack of accurate reserve estimates, we believe the best value indicator for Pearl Petroleum at this stage is the valuation implied by the OMV-MOL deal, which valued the company at USD3.5 billion and, accordingly, Dana Gas’s stake at USD1.4 billion. To be conservative, we applied a 20% discount to the deal-implied valuation, thus valuing Dana Gas’s Kurdish interests at USD1.12 billion (AED0.69/share).
To gauge the value potential of the Kurdish operation, we conducted a rough valuation exercise to assign value to Phases II and III of the KRI project. We assumed that Pearl Petroleum shareholders will pour investments of USD8 billion (USD3.2 billion by Dana Gas alone) to fully exploit Khor Mor and Chemchemal reserves over 2010-2015f and thus produce an additional 2.7 Bcf/day of gas plus associated byproducts by 2015f that will all be sold at international prices locally and/or in export markets. The valuation does not account for reserve depletion given the absence of accurate reserve estimates. We applied a WACC of 15.3% over a 25-year horizon. This yielded a value for Dana Gas’s stake of USD1.55 billion (AED0.95/share). Adding to that our valuation for Phase I, the potential value for Dana Gas’s Kurdish operations stands at USD1.87 billion (AED1.14/share).
Table 5: Gauging the Value Potential of Dana Gas’s Kurdish Interests
Gas (MMscf/day) - 500 1,000 1,500 2,000 2,700 2,700 Gas Sales* - 822 1,643 2,465 3,287 4,437 4,437 Condensate (bbl/day) - 23,333 46,667 70,000 93,333 126,000 126,000 Condensate Sales - 605 1,211 1,816 2,422 3,269 3,269 LPG (tons/day) - 1,567 3,133 4,700 6,267 8,460 8,460 LPG Sales - 330 660 991 1,321 1,783 1,783 Total Revenue from Fields - 1,757 3,515 5,272 7,029 9,490 9,490 Dana Gas’s Share - 775 861 946 854 974 529 EBITDA (Ex-SG&A Expenses) - 726 810 894 800 918 454 CAPEX (533) (533) (533) (533) (533) (533) (8) Free Cash Flows (533) 192 276 361 267 385 446 Phases II & III Valuation 1,549 Value/Share (AED) 0.95 Phase I Valuation 319 Value/Share (AED) 0.20 Value Potential of Pearl Petroleum 1,868 Value/Share (AED) 1.14 Discount 40% Pearl Petroleum’s Assigned Value/Share (AED) 0.69 Implied OMV-MOL Deal Valuation 1,400 Value/Share (AED) 0.86 Discount 20% Pearl Petroleum’s Assigned Value/Share (AED) 0.69 *Based on a long-term gas price of USD4.5/MMBTU Source: HC Brokerage
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Dana Gas 13
Dana Gas Egypt
� Since its acquisition of Egyptian assets in 2007, Dana Gas made major discoveries and boosted production by around 40%.
� A likely scenario could be a full/partial exit from Egypt in the medium term to fund new ventures. Dana Gas Egypt could also increase its processing capacity and then possibly bid for new concessions.
� We value Dana Gas Egypt at USD1.23 billion (AED0.75/share) using a combination of NAV and DCF based on two likely scenarios (maintaining status quo and increasing current processing capacity).
The Centurion acquisition
Dana Gas acquired in January 2007 100% of Centurion Energy International (later renamed Dana Gas Egypt), which had previously been listed on the Toronto Stock Exchange and the London AIM, in a deal worth USD1.12 billion. The acquisition was funded from the company’s cash resources and an Islamic Shariah-compliant facility from Citibank worth USD470 million, which was fully repaid on 31 October 2007 out of proceeds from the company’s USD1 billion convertible sukuk. Dana Gas Egypt, which is currently the country’s sixth largest natural gas producer, has a number of concessions and development leases in Egypt detailed in Table 6 below. Revenue is received based on a production sharing agreement (see Chart 7 below) that allows Dana Gas to recoup CAPEX and OPEX as well as earn a profit. Under the agreement, Dana Gas Egypt receives a maximum of 47.5% of the revenue pool in any year.
Table 6: Dana Gas Egypt’s Concessions
Concessions Working Interest % of Production* Acreage Location Comments
El Wastani 100% 59.0% 13,017 Nile Delta - South El Manzala 100% Non-Producing 16,055 Nile Delta - West El Manzala 100% 40.6% 476,216 Nile Delta Concession expires and non-productive land to
be relinquished on 30 June 2012. Four development leases created to date.
West El Qantara 100% Non-Producing 319,618 Nile Delta Concession expires and non-productive land to be relinquished on 30 June 2012. Three discoveries made over the past nine months.
Kom Ombo 50% 0.4% 5,654,727 Upper Egypt Farm-out agreement with Kuwait International Oil & Environmental Co. (KIOEC). Dana Gas is the operator. Produces only oil. Oil transported via land trucks to Assuit refinery then sold out.
*As of 30 September 2009 Source: Dana Gas, HC Brokerage
Chart 7: The Production Sharing Agreement
Source: Dana Gas, HC Brokerage
Impressive Achievements Since the Acquisition
Dana Gas announced in March 2008 the execution of an aggressive USD170 million drilling and development program that involved drilling 19 wells (15 exploration prospects and four development wells) with five drilling rigs acquired for the program. The program has managed to increase the Egyptian operation’s 2P reserves by over 40% in 2008 and boosted production to around 40,000 BOE/day currently from 28,600 BOE/day at the time of acquisition. The company’s exploration program is set to continue until 2012f when most of the existing exploration rights expire. We forecast CAPEX in excess of USD120 million over the next three years on further exploration efforts.
Natural Gas Sold at a fixed price of USD2.65/MMBTU
(75-80% of Output)
Byproducts (Condensate & LPG) Sold at international prices
(20-25% of Output)
Revenue Pool
Cost Recovery Pool
30% 70%
Profit Pool
Egyptian government
Dana Gas Egypt 25%
75% A maximum of 30% of revenue pool covers Dana Gas’s CAPEX and OPEX. Uncovered costs (around USD200m currently) are carried forward to subsequent years.
UAE – Oil & Gas
Dana Gas 14
Table 7: Discoveries Since Centurion Acquisition (2007-Present)
Well Concession Results Estimated Reserves
Jun. 07 El Wastani West-2 El Wastani 9.5 MMscf/day (gas); >1,000 bbl/day (condensate) N/A Aug.07 Dabayaa-1 West Manzala 16.5 MMscf/day (gas); 330 bbl/day (condensate) N/A
Sep. 07 Al Baraka-1 Komombo First commercial oil discovery in Upper Egypt –
Jun. 08 Al Baraka-2 Komombo N/A N/A Oct. 08 El Basant-1 (El Tawil-1) West Manzala 23.5 MMscf/day (gas); 1,027 bb/day (condensate) 90 Bcf (gas); 4 MMBOE (condensate) Dec. 08 El Basant-2 West Manzala 10.5 MMscf/day (gas); 50 bbl/day (condensate) >130 Bcf Dec. 08 Salma-1 West Qantara 17.2 MMscf/day (gas); 415 bbl/day (condensate) >150 Bcf Feb. 09 Sondos-2 (West Manazla-2) West Manzala 11 MMscf/day (dry gas) 20 Bcf Feb. 09 Azhar-1 West Manzala 15.1 MMscf/day (gas); 444 bbl/day (condensate) 100-150 Bcf May. 09 Tulip-1 West Qanatara 10.6 MMscf/day (gas); 252 bbl/day (condensate) 27 Bcf Aug. 09 Sharabas-1 West Manzala 7 MMscf/day (gas); 198 bbl/day (condensate) 28 Bcf
Aug. 09 Sama-1 West Qantara 13 MMscf/day (gas) & potential to reach 20
MMscf/day 48 Bcf Aug. 09 Salma Delta-2 West Qantara 12.5 MMscf/day (gas); 352 bbl/day (condensate) >200 Bcf Oct. 09 Faraskur-1 West Manzala 12.2 MMscf/day (gas); 243 bbl/day (condensate) >73 Bcf Oct. 09 Marzouk-2 West Manzala 10 MMscf/day (gas) 13.4 Bcf Dec. 09 Orchid-1 West Manzala 12.6 MMscf/day (dry gas) 10-50 Bcf Jan. 10 Baraka-4 Komombo 220 bbl/day (oil) with a maximum of 1,300 bbl/day N/A
Source: Dana Gas, HC Brokerage
A possible processing capacity expansion on the horizon
Dana Gas Egypt currently has two processing facilities with a potential third under study.
El Wastani Gas Processing and Liquid Extraction Facility
Located to the West of the Nile, the plant has a capacity of 160 MMscf/day of gas and 7,500 bbl/day of condensate and LPG. It handles production from El Wastani, El Wastani East, Luzi, and Dabayaa Development Leases. Some of the discoveries from West El Manzala are tied to the plant. El Basant discovery, 17 kilometers away, is tied to the plant through a 12-inch gas pipeline and 6-inch condensate line. Azhar discovery will also be tied into this line. Accordingly, the plant is expected to operate above its capacity for a number of years. The company is studying whether to debottleneck the plant or expand its capacity (to around 200 MMscf/day), which is dependent on whether more gas reserves will be discovered around the area.
South El Manzala Gas Processing Facility
Located to the East of the Nile, the facility only handles dry gas. It generates production from the Sondos discovery, which lies on the pipeline route leading to this plant and started to contribute to production in mid-2009.
Salma Discovery Could Lead to a Third Plant
Located to the East of the Nile, the Salma field discovery, which is the largest single discovery since the beginning of the company’s exploration program, is undergoing further exploration works to determine whether a new gas processing plant, presumably with LPG extraction facilities, can be built. This would replicate the El Wastani plant, and would cost around USD100 million.
Valuing Dana Gas Egypt
We value Dana Gas Egypt at USD1.23 billion (AED0.75/ share) using a combination of net asset value (NAV) and DCF (based on two scenarios). For our two DCF valuations, we applied a WACC of 14.3% and calculated a terminal value assuming that the company will be sold five years from now at a price tag based on the remaining 2P reserves.
Table 8: Valuation Scenarios for Dana Gas Egypt
Methodology
Description
Weight Valuation (AEDm)
Value/ Share (AED)
Prob.-Weighted Value/Share (AED)
DCF Status Quo 25% 13,221 0.60 0.15 DCF Establishing New Plant 25% 14,390 0.65 0.16 NAV Divestment Value 50% 19,353 0.88 0.44 Prob.-Weighted Valuation 16,579 0.75
Source: HC Brokerage
DCF Scenario 1: Status Quo
The company could opt to continue with its exploration program and not invest to establish a new processing plant. Accordingly, the company will operate at a maximum processing capacity of 42,000 BOE/day for three years until 2012f, after which production will drop by an average of 12% per annum. Under this scenario, we assume the company will add 42 MMBOE in 2P reserves over the next three years. This scenario (25% weight) yielded a value of USD982 million (AED0.60/share) for Dana Gas Egypt.
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Dana Gas 15
Table 9: Dana Gas Egypt’s Status Quo Scenario Forecasts and Valuation
Value of Dana Gas Egypt 982 Value/Share (AED) 0.60
Source: HC Brokerage
DCF Scenario 2: Establishing a New Processing Plant to Boost Capacity
Given that production is nearing a bottleneck, it is highly likely that Dana Gas expands its processing capacity through adding capacity at El Wastani and/or building a plant similar to El Wastani. The company will have to invest around USD100 million on top of planned exploration and development, spending over two years boosting production to around 69,000 BOE/day by 2014f. Under this scenario, we assume the company will add 75 MMBOE in 2P reserves over the next three years as we believe the company is not likely commit to such an investment without reasonable reserve additions. Such capacity expansion would entice the company to bid for more concessions in the country. This scenario (25% weight) yielded a value of USD1.07 billion (AED0.65/share) for Dana Gas Egypt.
Table 10: Dana Gas Egypt’s Capacity Expansion Scenario Forecasts and Valuation
Value of Dana Gas Egypt 1,068 Value/ Share (AED) 0.65
Source: HC Brokerage
Net Asset Value (NAV): A Possible Divestment Value
Our NAV for Dana Gas Egypt yielded a value of USD1.44 billion (AED0.88/share). It is based on estimated 2P reserves at the end of 2009 of 116 MMBOE net of liabilities directly attributable to the Egyptian operation. We believe our NAV valuation for Dana Gas Egypt is conservative as it does not assign value to existing processing facilities and other assets. Should Dana Gas opt to divest part or all of its Egyptian operation, it will likely sell it a premium to NAV. We do not view the divestment scenario as far-fetched in the medium term, and we accordingly assign a 50% weight to NAV in our valuation.
Price/ton (USD) 578 2009e Reserves (MMBOE) 116 Dana Gas-Attributable Sale Value of Reserves*(USDm) 1,487 Liabilities (USDm) (50)
Value of Dana Gas Egypt (USD) 1,437 Value /Share (AED) 0.88
*47.5% of total potential revenue pool Source: HC Brokerage
Why we think full or partial divestment of Dana Gas Egypt is not far fetched
We believe Dana Gas could fully or partially get out of Egypt in the medium term and yield a decent price tag, especially with recent successes in both exploration and production. The divestment option could be even more likely if the company is not awarded new concessions in Egypt. The key reasons for a potential divestment of Dana Gas Egypt in our view would be:
(i) To invest in promising exploration and production assets in other countries. The company recently bid (and lost) with Algeria’s Oil and Natural Gas Corporation and Turkish Petroleum Corporation for the Hassi Bir Rekaiz acreage in Algeria’s latest licensing rounds.
(ii) Not-so-favorable economics of Egypt, especially given a fixed gas price that is below current market prices. Like many of its peers, the company is negotiatng with the Egyptian government to discuss the possibility of marketing natural gas to end-users at international prices, but we see limited visibility for that outcome for Dana Gas at this stage. If approved, we believe it will most likely be applied only to undeveloped assets and/or new field auctions by the government, and not existing operating assets.
(iii) Large investments likely to be incurred if the company remains in Egypt. We believe further investments (of at least USD100 million as mentioned earlier) will have to be incurred to increase capacity and tie in distant fields with strong reserves like Salma.
(iii) The expiration of existing concessions’ development rights by 2012f. The company, however, could opt to bid for new concessions in the country, but we see this as unlikely unless they increase processing capacity;
(iv) The expiration of Dana Gas’s five-year umbrella agreement with Crescent Petroleum signed back in 2005. The agreement has two components: (i) a management services agreement that involves sharing technical and managerial expertise, and (ii) a non-compete agreement that requires Dana Gas to grant Crescent Petroleum the option to share in all available investment opportunities on a 50:50 basis.
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Dana Gas 17
The UAE Gas Project
� The UAE Gas Project, an agreement signed back in 2001 between Crescent Petroleum and the National Iranian Oil Company (NIOC), was compelled by a growing gas shortage in the country that is estimated at 1 Bcf/day currently. Dana Gas is involved in the transportation, processing, and marketing of Iranian gas in the UAE.
� We believe gas delivery will eventually take place despite delays driven by a long-standing dispute, especially given that the majority of the CAPEX has been spent by both the UAE and Iranian sides.
� Given limited visibility on a start date for gas delivery, we value the project at a cost of around USD300 million (AED0.18/ share). If it starts operations, the project could add AED0.22-0.30/share to our valuation.
The UAE natural gas problem
The UAE has estimated natural gas reserves of 227 Tcf, making it the world’s seventh and the MENA region’s fourth largest country in terms of natural gas reserves. Despite its huge reserves, the UAE suffers from extreme shortages since: (i) most of its reserves are in associated gas (found with crude oil) with costly extraction, and (ii) a chunk of the associated gas is reinjected to boost reservoir pressure of the country’s major oil fields, without which oil extraction would stagnate. An estimated 93% of the UAE’s total gas reserves (almost all of Abu Dhabi’s gas reserves) are directed towards reinjection.
Population growth and a surge in domestic consumption (mainly for electricity and desalination) from both industrial and residential users, has stretched the country’s natural gas shortage, especially in the Northern Emirates. Gas demand in the Northern Emirates leaped from around 600 MMscf/day in 2005 to nearly 1.1 Bcf/day in 2008 and is projected to hit 2 Bcf/day by 2015f.
The gas shortage in the UAE at large is currently estimated at 1 Bcf/day. Accordingly, the country is the Middle East’s largest natural gas importer and the world’s tenth largest. The UAE purchases around 2 Bcf/day of gas from Qatar, transported through the Dolphin Subsea Pipeline, the first cross-border energy deal between Gulf countries, which serves around 60% of the country’s power generation needs. The dire need for gas to fuel local consumption was also the initiative behind the UAE Gas Project to import gas from Iran.
Chart 8: Growth in the UAE’s Natural Gas Production and Consumption (1982-2008)
Source: BP Statistical Review, HC Brokerage
Chart 9: UAE is Among the World’s Top Importers and Consumers of Natural Gas
World’s Top 10 Natural Gas Importers (2008) World’s Top 20 Natural Gas Consumers (2008)
Source: BP Statistical Review (June 2009), HC Brokerage
Natural Gas Production Growth Natural Gas Consumption Growth
3,687
3,076
2,660
1,295 1,251 1,141
644 636 562 544
0
500
1000
1500
2000
2500
3000
3500
4000 Total Imports (Bcf)
63.4
40.5
11.3
9.7
9.1
9.0
7.9
7.8
7.5
7.5
6.5
5.8
5.6
4.7
4.3
4.3
4.0
3.9
3.8
3.8
0
10
20
30
40
50
60
70 Natural Gas Consumption (Bcf/day)
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Dana Gas 18
The UAE Gas Project–Understanding the Dispute
Dana Gas’s largest shareholder Crescent Petroleum signed in 2001 a 25-year deal with the National Iranian Oil Company (NIOC) to import around 600 MMscf/day of Iranian gas from the offshore Salman field in the Persian Gulf. The gas will be pumped to Sirri Island, from where Crescent Petroleum was to supply 350 MMscf/day to Dubai and pump the remaining 250 MMscf/day to its own Mubarak field for consumption in Sharjah. Crescent Petroleum and Dana Gas (which will be involved in the transportation, processing, and marketing of the Iranian gas within the UAE) have both completed the infrastructure necessary for the project. NIOC reportedly completed most of the major development work at the Salman Field in 2008. However, no gas has been delivered yet due a long-standing dispute on the project between Iran and the UAE. Press reports have been varied regarding the reasons behind the dispute, citing a number of reasons including:
(i) A “fair gas price”: This is the commonly cited reason by the Iranian side. First gas delivery was expected back in the summer of 2006 based on a crude oil price of USD18/bbl, but in May 2006, the Iranian Oil Minister deemed the initial contract terms unattractive given that the gas export price then was USD64/bbl. Iranian officials said that the country would lose around USD21 billion over the contract’s duration if pricing was not revised.
(ii) Other deal terms: Iranian officials had expressed the need to renegotiate other terms of the deal including the manner of export, sale, and delivery.
(iii) Infrastructure delays from the Iranian side: Crescent Petroleum cites this as the main reason behind the dispute. As mentioned earlier, Iran only completed the majority of the infrastructure necessary for the project in 2008. It is also reported that some minor yet significant development work needs to be completed to allow the delivery of gas. We believe such delays are the main issue underpinning the dispute.
The issue has been continuously exacerbating over time with ongoing threats from Iranian officials to withhold exports and use the gas domestically while Crescent Petroleum consistently asserts that the agreement is internationally binding and legally sound. Crescent Petroleum resorted in July 2009 to arbitration at the International Chamber of Commerce (ICC) against NIOC to oblige the latter to start delivering the gas. Later in August 2009, an official at NIOC’s subsidiary National Iranian Gas Export Company (NIGEC), which will responsible for the issue, said that Iran would not deliver any gas unless both sides reach an agreement on price and new delivery points. Worth noting is that Iran had faced arbitration in February 2009 on a gas deal with Turkey’s state-owned pipeline operator Botas where the latter won compensation of USD750 million.
Why we think gas delivery will take place
Although the project is long overdue, we believe gas delivery will eventually take place, but only once the arbitration process, which can be a bit lengthy, is concluded given that:
(i) the majority of the CAPEX has already been spent by both the Iranian and UAE sides,
(ii) Iran will substantially benefit from developing the Salman field especially as it will reportedly also allow them to sell around 500,000 bbl/day of oil, and
(iii) although not formally disclosed by either party, we believe the gas export price is not based on a fixed pricing formula and that a big part of the issue has been related to delays from the Iranian side in the project’s infrastructure development, which is supposedly mostly over. What’s in it for Dana Gas?
Dana Gas’s involvement in the UAE gas project is through three of its subsidiary companies:
Crescent National Gas Corporation Limited (CNGCL) (35%-owned by Dana Gas): A marketing company with access to local gas supply in the UAE from Crescent Petroleum as well as supply of gas received as per the agreement between Crescent Petroleum and NIOC. It has long-term secured contracts in the UAE with the likes of Sharjah Electricity and Water Authority (SEWA), Federal Electricity and Water Authority (FEWA), Dubai National Gas Company (DUGAS), and a large industrial enterprise in the Hamriyah Free Zone in Sharjah.
Sajaa Gas Private Limited Company (SajGas) (100%-owned by Dana Gas): Owns and operates gas sweetening and sulfur recovery facilities with an initial design capacity of 600 MMscf/day of gas with the expansion capability to process up to 800 MMscf/day of gas. SajGas has a long-term agreement with CNGCL for gas sweetening.
United Gas Transmissions Company Limited (UGTCL) (100%-owned by Dana Gas): Owns and operates gas transmission facilities in Sharjah that are comprised of: (i) a new gas receiving platform bridge linked to Crescent Petroleum’s existing facilities offshore Sharjah, and (ii) a 30-inch, 80-kilometer pipeline between the offshore receiving platform and the SajGas plant. As part of a long-term agreement, UGTCL will transport gas supplied by CNGCL to SajGas for sweetening. As part of a 50:50 JV, UGTCL owns and operates a 48-inch, 32-kilometer gas pipeline extending from Sajaa in Sharjah to the Hamriyah Free Zone with a capacity of up to 1 Bcf/day (see Other Projects section for details).
CNGCL will first buy the gas from Crescent Petroleum and then transport it through UGTCL’s pipeline to SajGas’s processing facilities. In the process, UGTCL and SajGas will earn transportation and processing fees, which we assumed at USD600/MMscf collectively. Then CNGCL will sell the processed gas to end users (FEWA, SEWA, etc.) also relying on UGTCL’s pipeline for transportation. CNGCL will also sell the processing byproducts at international prices.
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Chart 10: Involvement of Dana Gas’s Subsidiaries in the UAE Gas Project
Source: Dana Gas, HC Brokerage
We value the UAE Gas Project at cost given limited visibility on a start date
Given that there is limited visibility on when gas will be pumped from Iran, especially with the ongoing arbitration that could take some time, we opt to value the UAE Gas Project at cost for Dana Gas (based on completed infrastructure spending to fulfill its part in the project), which we estimate at USD300 million (AED0.18/share). We believe this is a conservative assumption as at worst Dana Gas would sell the project’s infrastructure recouping at least tangible costs. We believe the UAE gas project will begin contributing to Dana Gas’s top line by 2011f at best.
Should gas delivery take place, the project could add USD360-493 million (AED0.22-0.30/share) to our valuation based on two possible scenarios that assume a 2011f start for the project, a 25-year project horizon, and a WACC of 12.4%. According to management, the transportation and processing fees and the gas sale revenue will offset the costs of the project. Thus, EBITDA generation will be mostly from the sale of byproducts.
Scenario 1 (AED0.40/share): assumes constant throughput of 600 MMscf/day.
Scenario 2 (AED0.48/share): assumes throughput increasing to 800 MMscf/day by 2013f after Dana Gas spends around USD50 million to increase capacity.
Table 12: Dana Gas’s UAE Gas Project Forecasts and Valuation Under Different Scenarios
*2013f numbers after spending around USD50 million to boost capacity **Proportional to 35% stake in CNGCL and based on an oil price of USD75/bbl and a gas price of USD4.5/MMBTU Source: Dana Gas, HC Brokerage
Transported by UGTCL
Transported by UGTCL Gas from NIOC Pipeline
UGTCL Receiving Platform
CNGCL SajGas Sweetening Plant
Sold to End Users (FEWA, SEWA, etc.)
Byproducts
Sold at Intl. Prices
Gas
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Other Projects � Gas Cities LLC aims to establish gas-intensive industrial clusters in a number of countries, providing Dana Gas with a potential gas market. We exclude it from our numbers and valuation at this stage but view it as a long-term value driver.
� Dana Gas has a 26.4% net working interest in a gas liquids extraction plant in Ras Shukheir, Egypt that will produce and sell 120,000 tons/annum of liquids starting 2011f. We value the project at USD95 million (AED0.06/share).
� Other ventures (excluded from our valuation) include: a 50% working interest in the Sharjah Offshore Concession (expected production of 55 MMscf/day by 2011f), a 50% stake in the now-operating JV to manage and operate the UAE’s Hamriyah gas pipeline (included as part of the UAE Gas Project), and small assets in Nigeria and Tunisia.
Gas Cities: A sound and popular concept
Gas Cities LLC, established in 2008, is a 50:50 joint venture between Dana Gas and Crescent Petroleum that is built on the concept of clustering different gas-intensive industries in an integrated, self-sustaining industrial zone with the company acting as master developer. The company will procure, process, and distribute gas while providing amenities and benefits to gas-intensive industrial users in the Middle East. Benefits of the concept include bringing industrial users to the energy supply, enhancing economic growth through increasing local and foreign direct investments (FDI), optimizing natural gas utilization, and creating employment opportunities. The cities will include processing areas (for heavy industries such as cement, petrochemicals, and steel), industrial parks (for medium- and small-scale industries such as electronics, food and beverages, and automotive assembly and components), and residential zones.
Dana Gas and Crescent Petroleum plan to build at least four “gas cities” in the MENASA region. Land has already been allotted for a gas city in Kurdistan and there are two MoUs signed with the Egyptian and Yemeni governments. There are reports that some Gulf states have approached the two companies to establish gas cities on their land.
Despite heavy investments of roughly over USD3 billion per gas city, we expect each city to be self-financed with the proceeds from tenants used to finance construction. We exclude Gas Cities from our numbers and valuation at this stage given limited information and its long-term nature but we believe it could be a strong long-term value driver that will provide a potential gas market for Dana Gas.
Table 13: Details of Some Current ‘Gas Cities’
Kurdistan Region of Iraq The gas-utilization industrial complex, which was launched in July 2008, will be built over a 40 square-kilometers free-zone officially assigned by the KRG. Expected initial investments in basic infrastructure works are estimated at USD3 billion. The project is expected to bring in investments of over USD40 billion and create over 200,000 jobs for Iraqis directly and indirectly. Discussions are currently underway with international and regional energy and petrochemical companies as prospective tenants. The city is expected to receive feedstock from Pearl Petroleum’s Khor Mor and Chemchemal fields as part of Phase II of the Kurdistan project (see section on Kurdistan above).
Yemen Dana Gas and Crescent Petroleum signed in September 2009 a MoU with the Yemeni government to establish a gas city in the country. The project could bring in around USD15-20 billion in investments over 25-30 years—doubling Yemen’s FDI—as well as around 90,000 jobs directly and indirectly. The project is still in an early stage, which entails developing a viable feedstock profile and finalizing the city’s location.
Source: Dana Gas, HC Brokerage
Gulf of Suez Gas Liquids Extraction Plant (Ras Shukheir)
Dana Gas, through its 66%-owned subsidiary DANAGAZ Bahrain, entered into a joint venture in June 2007 to form the Egyptian Bahraini Gas Derivative Company (EBGDCO). DANAGAZ Bahrain has a 40% stake (and thus Dana Gas has an effective interest of 26.4%) in the JV, with the Egyptian Natural Gas Holding Company (EGAS) holding 40% and Arabian Petroleum Investment Corporation (APICORP) owning the remaining 20%.
EBDGCO will build, own, and operate a USD83 million natural gas liquids extraction plant near Ras Shukheir on the western shore of the Gulf of Suez in Egypt, as well as undertake the export marketing of liquid products from the plant. The plant will straddle the existing natural gas pipeline grid in Ras Shukheir and extract propane and butane from the neighboring wet gas fields. The contract for the LPG plant’s construction was awarded in June 2009, with construction to take up to 18 months. The project is thus expected to contribute to Dana Gas’s numbers by 2011f.
The plant’s natural gas processing capacity will stand at 150 MMscf/day yielding 120,000 tons/annum of propane that will be exported by sea primarily to European markets, and 12,000 tons/annum of butane that will be sold under long-term contracts to local facilities owned Egyptian General Petroleum Corporation (EGPC). Residual gas (around 143 MMscf/day) will be returned to the pipeline. The government is seeking to replicate the concept at other points of the national gas grid.
We value Dana Gas’s effective stake in the project at USD95 million (AED0.06/share) based on sales of 120,000 tons/year of LPG. We applied a WACC of 14.3% and a perpetual growth rate of 3%.
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Table 14: Forecasts and Valuation of Dana Gas’s Ras Shukheir Project
Sharjah Western Offshore Concession–Zora Gas Field Development
Dana Gas signed in March 2008 a 25-year agreement with the government of Sharjah to explore and develop a western offshore concession in Sharjah, giving the firm a 50% working interest in the project (with the rest belonging to the Ajman government). The agreement covers an offshore area of 1,000 square kilometers and includes development of the Zora gas field discovered in 1979. Under the agreement, Dana Gas is required to: (i) resume and complete horizontal drilling of two wells originally drilled by Crescent Petroleum, (ii) install offshore platforms for immediate processing and production, and (iii) transport the processed gas via a 25 kilometer offshore pipeline to be installed by Dana Gas. The agreement also allows Dana Gas to conduct exploration work within the concession area. The field’s total reserves are estimated to be around 100-300 Bcf, and production is set to start in 2011f at around 55 MMscf/day, supplying much-needed gas to the UAE domestic market. Total exploration and development costs for the Zora field are around USD100 million. The concession’s economics are not very lucrative and Dana Gas could thus bring in another partner through a partial stake sale. We exclude the concession from our numbers and valuation due to insufficient information.
The Hamriyah Gas Pipeline
United Gas Transmissions Company Limited (UGTCL), which is fully-owned by Dana Gas, has a 50:50 joint venture project with Emarat to construct, own, manage and operate the Hamriyah Gas Pipeline, the Middle East's first common user gas pipeline. The 32-kilometer, 48 inch pipeline, which was completed in June 2008, has a capacity of 1 Bcf/day. It extends from the Sharjah gas hub at Sajaa to the Hamriyah Free Zone, a fast growing industrial area, to serve three users – FEWA, SEWA, and CNGCL – under a 25-year contract. UGTCL earns a fee on the transportation of the natural gas through the pipeline. The project is currently very small, contributing around USD4 million to Dana Gas’s annual revenue, and we have included it as part of the UAE Gas Project’s valuation.
Dana Gas received interests in assets in Nigeria and Tunisia as part of its acquisition of Centurion Energy. Dana Gas holds a 9.5% non-operated interest in the offshore oil Block 4 of the Nigeria-São Tomé Joint Development Zone. Block 4 is operated by Canada’s Addax Petroleum, which already started to drill the Kina-1 exploration well in July 2009. Estimated reserves at Kina-1 are 300 million barrels and 150 million barrels at Melanza-1. Total development cost is estimated at USD100 million. Dana Gas also has an exploration lease in Tunisia granting it the option to have a non-operated interest of up to 50% in deeper prospective horizons that potentially have significant oil and gas reserves. Drilling has not begun yet in Tunisia to allow Dana Gas to exercise such an option. Both the Nigerian and Tunisian assets are excluded from our numbers due to limited information and visibility.
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Rating Scale
Recommendation Upside
Buy Greater than 20% Hold -5% to 20% Sell Less than -5%
Disclaimer This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to be reliable and from information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the information mentioned in this memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed and decisions made based on information presented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinion or information. HC Brokerage and its affiliates and/or its directors and employees may own or have positions in, and effect transactions of companies mentioned in this memorandum. HC Brokerage and its affiliates may also seek to perform or have performed investment-banking services for companies mentioned in this memorandum.
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