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Thinking of buying the UKOG share price? Read this first

UK Oil & Gas (LSE: UKOG) believes that it’s sitting on what could be one of the most significant onshore oil finds in the United Kingdom. The company hit the headlines in 2016 when initial flow tests hinted at the size of the Horse Hill well, and investors flocked to UKOG due to its licence interests in the Weald basin region.

However, if you are thinking of buying the shares because they look cheap, there are several issues you need to consider first.

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Black box

The first issue is the company’s valuation. Placing a value on undeveloped oil assets is notoriously tricky. Even though these assets may eventually produce oil, in reality they’re only worth as much as other parties are willing to pay for them. UKOG’s Horse Hill-1 well was tested at 1,688 barrels per day (bbl/d), the highest initial production rate of any UK onshore discovery well, but other company assets have struggled to produce a similar positive result. 

Despite spending months (and a small fortune) trying to get oil from Broadford Bridge’s six Kimmeridge horizons, there’s been no sign of black gold in this region.

With so much uncertainty hanging over the company and its prospects, it’s almost impossible to try and value the business and its current state, which means it’s difficult to tell if the current price is attractive.

Money, money, money

The second issue to consider is UKOG’s funding. The company is generating virtually no revenue and, therefore, almost no cash to fund development costs (although analysts are expecting the firm to generate revenues of £6.3m for 2018).

The majority of development work and acquisitions have been funded by the issue of new shares. The latest deal involves the issuance of nearly 250m new shares to increase UKOG’s stake in Horse Hill Developments Ltd.

Tapping investors to keep the lights on is nothing new — it’s an easy way to access cheap financing. However, this method of fundraising also has a dark side.

Dilution

Over the past five years, UKOG’s number of shares outstanding has increased from 83m to somewhere in the region of 4bn, according to my figures. By issuing shares, the company has been able to remain afloat, although it has diluted existing shareholders. 

Put simply, by issuing so many new shares, UKOG has been able to transfer tens of millions of pounds in wealth from shareholders’ pockets to itself. The dilution means each shareholder is likely to get back significantly less than they’ve invested, even if the company does strike black gold.

Conclusion

Considering all of the above, UKOG’s outlook is uncertain. The company may be sitting on one of the UK’s largest onshore oil and gas deposits but, so far, drilling results have failed to turn up any concrete evidence of this.

Personally, I’d like to see some real progress before investing, but other investors might be more comfortable with taking on the uncertainty.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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