The last time I covered UK Oil & Gas (LSE: UKOG), I concluded the company’s future success depends on its ability to make good on management’s 2019–2020 drilling and production plans. It looks as if it’s doing just that.
Growing production
Today, the group published a trading update informing investors that so-called dry oil production, which is oil produced without water, from the Portland reservoir at the Horse Hill oil field has now exceeded 15,000 barrels of oil (bbl). The well has been producing at a “stable rate of over 220 barrels of oil per day (bopd)” for the past few months, and production “continues to be maintained below the previously reported 362 bopd calculated optimised sustainable rate” for “prudent Portland reservoir management purposes.”
After several months of steady production, management believes the “Portland and Kimmeridge extended test programme has now produced a significant aggregate volume in excess of 40,000 bbl.“
In my opinion, this is a significant step for the business. Owning UKOG shares has always come with a lot of risk because oil exploration and production is a hit-and-miss industry. Even if a company believes it has stumbled across one of the world’s largest oil reservoirs, there’s never any guarantee the business will be able to start production successfully.
Now that UKOG has moved from the exploration stage to the production stage and is producing revenues, the risk of owning the stock is greatly reduced, in my view.
To borrow CEO’s Stephen Sanderson’s words: “The Portland’s proven ability to sustain a stable dry oil production rate of over 220 bopd for two months provides a further landmark that solidly underpins the validity of the company’s planned field development.“
The firm and its partners are planning to drill further wells over the next few months, which should help UKOG meet its 720–1080 bopd production target.
Dilution risk
Further progress towards this target will boost the company’s investment case, in my view, but it won’t eliminate all of the risks.
As I’ve mentioned several times, until UKOG becomes self-funding, shareholder dilution will remain a risk.
The company has a long track record of issuing shares to fund its operations and keep the lights on, diluting existing shareholders. For example, at the end of March, UKOG raised £3.5m through a placing of 333,333,330 new ordinary shares at a 12.5% discount to the prevailing share price at the time. This is earmarked to fund the drilling programme over the next few months.
Raising funds this way is an attractive alternative to borrowing money but, as noted above, it does mean existing shareholders get diluted and will have to invest more to maintain their share in the business.
The bottom line
Overall, the next six months will be crucial for the UKOG share price. If the company continues to proceed with its well development plan, and it successfully achieves the stated production goal, I think the shares could rise substantially from current levels.
However, the firm still has plenty of work to do before it reaches this point. So even though current production might have de-risked the investment case, the UKOG remains a speculative investment, in my opinion.
