Business Review

THE MACRO ENVIRONMENT/BUSINESS BACKGROUND
Relative to historic norms, the Brent oil price environment remained strong during 2006, sustained by continuing geo-political unrest in the Middle East, Nigeria and South America. Prices climbed from approximately $59 per barrel at the start of the year to a peak of around $78 per barrel in August 2006 due to heightening tension in the Lebanon, before cooling through the fourth quarter to end the year at just under $61 per barrel. Overall the average Brent oil price for 2006 was approximately $65 per barrel, compared to approximately $55 per barrel in 2005. Prices dropped sharply in the first couple of months of 2007, but have since recovered, and at the time of writing remain around the 2006 Brent average.

UK gas prices on the other hand have been on a steeply declining trend since fourth quarter 2006 following the introduction of new supply, principally from Norway. This was also further exacerbated by the exceptionally mild winter weather, creating unseasonably low demand. As a result, the average gas price for January 2007 was approximately 43p per therm lower than the same period 12 months previously. Prices have since fallen below 20p per therm though the forward curve for winter 2007 remains above 40p per therm, with most commentators supporting a rising forward market.

The increasing investment activity levels spurred by the strength of commodity prices over the last two years has created significant competition for the resources necessary to support that activity, with particular reference to people, drilling rigs and equipment. This inevitably has created significant upward pressure on the industry cost base, and this shows no signs of abating in the short term.

Increasing competition for opportunities is also the order of the day in the upstream acquisition and divestment market, as relatively easy access to capital, allied to strong industry free cash flows, has significantly increased the number of potential buyers; and hence the premiums required to secure new opportunities. In addition there is also an increasing trend for national oil companies to be competing aggressively on the wider international market and to be demanding an increased influence and greater share of their domestic market.

On a world level, the Oil and Gas industry is being challenged by fiscal instability as host governments seek an increased share of the rising revenues either via a form of nationalisation in certain parts of the world, but more generally from changes to the underlying fiscal regimes, thus adding to the economic uncertainty of investment decisions in the industry.

PRINCIPAL BUSINESS RISKS FACING THE COMPANY
As a participant in the Upstream Oil & Gas industry, Dana encounters to varying degrees, the macro risk factors noted above. In addition, the Board conducts an annual review of the Company’s system of risk assessment at the micro level for the specific risks faced by the Company.

These risks are considered typical for an upstream company of Dana’s size, as can be illustrated from the following extract from the most recent Board review in December 2006.

 

2006 BUSINESS PRIORITIES
The following general and specific indicators were considered key to assessing the Company’s performance and progress during 2006:

• Production growth
• Reserves replacement
• Completion of the Gaz de France Exchange Agreement
• Execution of the planned Exploration drilling programme
• Delivery of Development projects
• Delivering new commercial transactions
• Safety performance
• Financial performance

A review of each of these areas now follows.

PRODUCTION GROWTH
2006 was another year of record oil and gas production. Annualised average production for the year was 22,285 boepd (2005: 19,683 boepd), with 93% delivered from the UKCS (2005: 91%). Oil continued to account for 84% of production.

A regional analysis of the source of production is provided in the graphic below.

 

In the Northern North Sea, Hudson field production (Dana 47.5%) was impacted by a fire on the Shell operated host Tern platform, which required the replacement of a damaged compressor and resulted in a reduction in gas lift volumes available to Hudson. The new compressor was installed and commissioned early in fourth quarter 2006. Notwithstanding the negative impact on 2006 production; reservoir performance has been encouraging, where Dana, as operator, has driven forward a programme of improvements to optimise production performance. As a result production capacity from the field is now at levels significantly above those when Dana increased its interest and took over operatorship in 2005. Otter field production (Dana 19.5%) was also affected by the need to replace subsurface electrical submersible pumps, a situation since remedied by the operator.

In the Central North Sea, GKA (Dana 50%) continues to be a key area of investment and return for Dana. The highlight of the year was the Goosander field coming on-stream in August 2006, ahead of schedule, at stabilised rates of approximately 16,000 boepd, well ahead of prognosis. This compensated for problems in the first half of 2006, when production from GKA was significantly affected by a rig anchor handling incident in February, which severely disrupted Mallard and Gadwall production during the period. Once these fields re-started, and together with Goosander, this resulted in GKA peak production rates reaching record levels of 32,000 boepd in the second half of the year.

In the Southern sector, production was enhanced from the fourth quarter of 2006 by the acquisition of a 25% interest in the Anglia gas field, and an additional 22.11% in the Johnston gas field, as part of the Gaz de France Exchange agreement. In addition, 2006 saw the first full year of production from the F16-E gas field in the Netherlands. Gas production from the Victor field (Dana 10%) was also maintained over the summer months, following renegotiation of the gas sales contract with the gas buyer.

RESERVES REPLACEMENT
2006 was a successful year for Dana in terms of reserves replacement, with an increase in proven and probable reserves of 19.0 mmboe to a record high of 130.6 mmboe at the end of 2006. This represents an increase of 17% in reserves, or a replacement ratio of 336% (based on annual production of 8.1 mmboe).

Reserve changes arose in three areas. Firstly, there were a number of upward revisions in producing fields, principally in GKA. Secondly, there were additions due to acquisitions, related principally to the Gaz de France transaction, and the acquisition of the Christian discovery in the GKA. Thirdly, the discovery of additional oil in the Causeway well and gas in the Babbage well together added 7.5mmboe of reserves. Further reserves growth through drilling is being targeted from the 32 well drilling programme to end 2008.

Contingent resources decreased from 124.3 mmboe to 101.7 mmboe with the key changes being a reduction of 48.1 mmboe due to the Gaz de France asset exchange, whilst there was an addition of 19.8 mmboe due to the Aigrette discovery in Block 7 Mauritania.

Overall, the total resources decreased by 3.5 mmboe, but this reduction is balanced by the significant acceleration of value to currently producing fields. This is entirely in line with Dana’s strategy of accelerating value by leveraging exploration, in this case in Mauritania, for existing production and near term development.

COMPLETION OF GAZ DE FRANCE EXCHANGE AGREEMENT
The transaction with Gaz de France is the most ambitious transaction completed by Dana to date.

The initial agreement, signed in November 2005, consisted of a swap of 17.5% interest in Block 8 Mauritania, 27.85% in Block 7 Mauritania and 24% in Block 1 Mauritania for 25% in the producing Anglia field and 22.11% in the producing Johnston field, both in the UK southern North Sea, 30% in the West El Burullus licence, offshore Nile Delta, Egypt and a $27 million well carry on three wells in Mauritania. Taken together this represented a swap of around 40% of Dana’s Mauritania position for $27 million of costs, production of approximately 2,100 boepd, additional North Sea reserves of 3.2 mmboe and additional exploration in Egypt. This transaction delivered on the strategic driver of using exploration as leverage to accelerate growth by essentially exchanging exploration assets for producing fields and fields under development. In addition, the transaction balanced the Company’s investment to a wider range of opportunities whilst maximising the probability of success by providing more exploration in the portfolio while retaining significant access to the upside potential in Mauritania.

Inevitably in such a complex cross-border transaction across 4 countries, completion of the transaction takes a significant period of time, and the final elements of the transaction were only completed in September 2006. However, this clearly demonstrates the ability of the Dana team to deliver on complex transactions.

EXECUTION OF PLANNED EXPLORATION PROGRAMME
Going into 2006, the Company was planning on drilling a total of 11 exploration and appraisal wells, comprising 6 wells in the UK, 3 operated wells in Mauritania and 2 non-operated wells in Kenya, plus exposure to one Faroe Petroleum well. A total of 8 wells were actually drilled. One of the planned Kenya wells was drilled early in 2007, a decision has been made to progress the Barbara development without further appraisal, and a third well was deferred due to rig availability.

Dana drilled two operated wells in Mauritania in 2006. These operations relied on the Company’s close relationship with Peak Well Management, our drilling management contractor. Dana will continue to work with Peak for the drilling of future wells internationally and in the UK.

Dana has been successful in delivering its drilling programme by working with larger operators, who have long term rig contracts, and by securing rig slots as part of rig sharing ‘clubs’. The Company will continue this strategy going forward. For the period mid 2007 to mid 2008, 4 rig slots on the Sedco-704 semi-submersible rig and 2 rig slots on the Ensco-100 jack-up rig have been secured. These rigs will be used for UK North Sea drilling. Along with rigs from other operators and ongoing tendering exercises, Dana is confident of delivering its planned 32 well exploration and appraisal programme in 2007 and 2008.

Commentary on the results of individual wells has been included in the Chairman & Chief Executive’s Review.

As part of Dana’s commitment to Mauritania, the Company has become more actively involved in the local community. Dana has two Mauritanian staff in country who undertake the day-to-day activities for the Company, and have close working relationships with the relevant government departments. In addition, Dana has distributed sports equipment to local schools and sponsored an ambulance for distributing health care.

DELIVERY OF DEVELOPMENT PROJECTS
Dana has historically had minimal involvement in the development phase of the lifecycle, but progressing assets through this phase will become increasingly important as the Company continues to grow and develop. In August 2006, the Venture operated Goosander field which is located in GKA, was brought onstream approximately 2 weeks ahead of schedule. The field has already performed significantly above expectations.

During the year, Development work progressed on the RWE-operated Cavendish gas field, with the installation of the platform and the laying of pipelines during 2006, and the drilling of the wells and host platform modifications in early 2007. Dana now holds a 50% interest in the field which will add approximately 8,500 boepd to the Company’s production when the field reaches maximum capacity by the winter of 2007/8. First gas is planned for second quarter 2007. Development work also progressed on the Enoch oil field in the UK Central North Sea during the year with first production also expected in second quarter 2007.

Development planning is progressing on the Barbara discovery in the UK Central North Sea, with first gas targeted for 2009. It is likely that Barbara will be a joint development with the neighbouring Phyllis development. This project represents the most important development in Dana’s portfolio. The Eon-Ruhrgas operated Babbage development is also progressing, with first gas again planned for 2009. These two developments rank as two of the largest undeveloped gas discoveries in the UK, and will add significantly to Dana’s growth in the medium term.

NEW COMMERCIAL TRANSACTIONS
Dana’s commercial team was extremely active during the year. In 2006 the following deals were either completed or close to being completed by the end of the year:

• acquisition of 50% interest in 21/20b (including Christian discovery) and 25% interest in 21/20a (including Bligh discovery) from Venture Production, as part of a back-to-back deal following Venture’s acquisition of the assets from ExxonMobil and Hess;
• in addition to the Gaz de France Exchange Agreement, Gaz de France had also agreed to sell Dana a 15% interest in Algerian assets. As this transaction was subsequently not approved by the Algerian authorities, Dana secured the following additional assets, namely (i) additional 20% interest in West El Burullus block, offshore Nile Delta, Egypt which is currently awaiting final government consent; (ii) 25% interest in Cavendish gas development, UK Southern North Sea which completed in March 2007, (iii) 20% interest in PL.311 and PL.311B, Norway, and (iv) 10% interest in PL.329, Norway. Both Norwegian transactions are progressing to completion;
• acquisition of 25% interest in North Ghara block, Gulf of Suez, Egypt from BP;
• acquisition of 15% interest in South Feiran block, Gulf of Suez, Egypt from CEPSA;
• agreement to enter Exploration Licence in Bouanane block, onshore Morocco at 50% equity and as operator;
• acquisition of additional 5%
• exchange of 3% interest in Blocks L5 and L7, offshore Kenya for 15% interest in Tanger-Larache Block, offshore Morocco with Repsol;
• acquisition of Devon Energy’s entire interests in Egypt through a Sale and Purchase Agreement of eight Devon corporate entities. This agreement was signed in April 2007 and is subject to standard government and third party approvals and preferential rights.

SAFETY PERFORMANCE
As outlined in the Report of the Directors, the Board considers safety to be an integral part of its business. Safety performance on Dana’s operated activities is the direct responsibility of the Technical & Commercial Director. The Company has a Health, Safety and Environment System which complies with UK legal requirements. This System is also applied during drilling activities overseas.

In 2006, there were no safety incidents in Dana’s operated UK assets, namely the Hudson field, due to the planning, preparation and cross-functional workshops undertaken before significant offshore work campaigns. Unfortunately, there were two Lost Time Incidents during the Mauritanian drilling campaign. Both incidents were in the early stages of drilling of the first well in the programme, and investigations were subsequently promptly undertaken and the report recommendations implemented for the remainder of the programme.

Where Dana’s role is in a non-operated capacity, the Company’s role is to influence the Operator to demonstrate capability and leadership in safety and to promote the highest standards of safety in their operations.