In September 2011 InterOil Corporation (NYSE: IOC) hired three world-class Investment banks - Morgan Stanley & Co LLC (NYSE:MS) in the US, UBS AG in Europe (NYSE:UBS), and Macquarie Capital in Asia - to lead the bid process to select an internationally recognized LNG operator to join the Gulf LNG project in Papua New Guinea. After a long series of delays in the process (due to PNG political uncertainty in late 2011 and new PNG elections through 3Q 2012), InterOil announced on January 24, 2013 that formal bidding instructions were sent out to all potential bidders by the investment banks with a firm deadline for bids of February 28, 2013.
Phil Mulacek, IOC's CEO, said "We understand the PNG Government's desire to have an internationally recognized LNG operator join the project and we trust that our LNG bid process will fully satisfy that requirement. We welcome the continued support of both the Prime Minister and the Minister for Petroleum who endorse an LNG project in the Gulf which complies with the LNG Project Agreement." InterOil has been working extremely closely with Prime Minister Peter O'Neill and the Minister of Petroleum and Exploration, William Duma, to ensure the partners, deal structure and bidding process is acceptable to the PNG government.
Let's examine exactly what is the gas and condensate resource that is involved in the Gulf LNG project, who might the potential LNG operators be, and why would those companies be interested in partnering in the first place?
The Elk/Antelope Resource
GLJ Petroleum Consultants Ltd. (GLJ) has been commissioned by IOC annually to prepare an independent resource assessment of the Elk/Antelope Gas Field which is located in Petroleum Prospecting License 238 in Papua New Guinea. IOC will hold a roughly 58.6% participating interest in the asset assuming all investors and the Papua New Guinea Government elect to fully participate after a Production Development License has been granted.
The structure was discovered with the drilling of the well Elk-1 which tested gas at 21.7 MMCFD (million cubic feet per day) from drill stem test #2 (DST#2) in 2006. The reservoir of the Elk/Antelope structure is contained within fractured limestones of the Puri and Mendi Formations. The well Antelope-1 was rig released in 2009 and discovered a dolomitized reef facies. The dolomitized reef was further delineated by the well Antelope-2.
World-class oil service companies performed the drilling, took core samples and generated all of the drilling log data used by the reservoir engineers for their analysis. The electric log data on Elk/Antelope was done by Schlumberger (NYSE:SLB), the flow rates were measured by Weatherford (NYSE:WFT) and the analysis of the composition of the gas and condensate liquids was done by SGS. In addition, seismic, geological and well information was used in the reservoir analysis.
The estimate of resources of 9.4 trillion cubic feet equivalent (tcfe) ("best estimate" of gross contingent resources) and 5.6 tcfe ("best estimate" of net contingent resources) is based on the independent resources report prepared by GLJ dated March 7, 2012 with an effective date of December 31, 2011 setting forth certain information regarding contingent resources of InterOil's interests in the Elk and Antelope fields in PNG. As a reminder, when calculating tcfe, it reflects the combination of the gas + condensate liquids.
As at December 31, 2011
Initial Gas in Place (Tcf)
Initial Recoverable Sales Gas (Tcf)
Initial Recoverable Condensate (million barrels)
Initial Recoverable MMBOE
On November 15, 2012 Prime Minister, the Honorable Peter O'Neill, announced PNG Government approval of the project, clearing the way for the Gulf LNG plant with initial output of 3.8 million tons of LNG per year.
The Sell Down Potential Bidders
InterOil's CFO, Collin Vissagio, stated on November 9, 2012 that initial bids were in-hand from National Oil Companies (NOCs such as PTT and Petronas), utilities (Japex/ Kogas/ Mitsui Consortium referred to as JKM), and Super Majors (SMs) - the former seven sisters meaning an Exxon (NYSE:XOM)/ Total (NYSE:TOT)/ Chevron (NYSE:CVX)/ BP (NYSE:BP)/ Shell (NYSE:RDS.A) type company. Those companies need what IOC is offering, i.e., a concentrated asset, already certified by more than one reservoir engineering firm and a geographical location near the largest LNG markets of Japan, South Korea and China. With PNG government approval now secured, all that's required is a BUY IN or BUY OUT of the entire company of InterOil.
On January 24, 2013 IOC announced that it has completed the logging program at the Antelope-3 well. As in the previous wells, conventional wireline logs (porosity, resistivity and sonic) were acquired in addition to formation imaging (FMI), vertical well bore seismic (VSP) and rotary sidewall coring conducted while under pressure. The formation evaluation by Schlumberger indicates an average porosity in the pay interval of 10.2 percent and a net to gross ratio of 66 percent. This compares favorably with the results from the Antelope-1 and Antelope-2 wells with average porosities of 8.8 and 13.1 percent respectively (see the table below).
InterOil summarized the results in the below exhibit stating, "We believe these results indicate that the reservoir quality at the Antelope-3 location is of similar quality to the Antelope-1 and -2 wells, and fully support our reservoir model." This is a key factor in the sell down process because it confirms to the bidders that the Elk/ Antelope structure is completely contiguous; all parties now have sufficient information to make informed decisions.
The next step is for the bids to be finalized and approved by their respective Board of Directors. As mentioned, final bids from all of the bidders must be back to IOC no later than February 28, 2013; then IOC will make its final decision on partner selection immediately after they are shown the bid comparisons by the three IBs.
According to Pavel Molchanov, Sr VP and Equity Research Analyst of Raymond James & Associates (RJF), in his latest IOC update,
the fact that the company feels confident enough to self-impose a deadline for concluding the negotiations is encouraging, because it signifies that management is comfortable with what's already on the table. There obviously remains plenty of market skepticism that the company will deliver a deal. Given this skepticism, short interest has ramped up, and we think the stock is setting up for a short squeeze once the partnership announcement comes out.
Part of the Due Diligence of the three Investment Banks when they present the bids to IOC on/around March 1 is to list the pros and cons of each bidder. IOC must have a favored bidder by now. The highest bidder may not be the winner; instead, the best fit (financially, skills, resources, depth, relationships, level of vertical integration, etc.) will be the selected winner. The IOC Board of Directors, led by Gaylen Byker, will pick the winner. Most would say there's not a mistake to be made since all of the bidders would do well.
The better question is what will the losers do in three weeks' time on/after March 4th? After IOC makes its partner decision is when things may very well heat up to a boil. The Confidentiality Agreements between InterOil and the bidders will expire on the announcement of the "winner." Recall that the Confidentiality Agreements contain a standstill clause preventing the bidder from buying InterOil's stock in the public market. With the expiration of the Confidential Agreements and the termination of the standstill provisions, we may see takeover bids for 100% of InterOil from the losing bidders. JKM can't afford to lose this bidding process, as both Japan and South Korea desperately need new Asian/Pacific supplies of LNG. Shell may attempt a hostile takeover. Exxon wants to leverage their current $16 billion LNG plant in PNG and retain the 8,000 workers that are wrapping up construction work on the PNG LNG plant, etc.
Will such a takeover bid be high enough for the top ten IOC shareholders who collectively hold well over 70% of the voting shares to compel them to sell the entire company? What price per share would be fair? Is the Mitsui deal option-price-equivalent of $22 billion (Over $450 per share) the right value takeout value of IOC?
What Is the Right Price for a Buyout?
A lot of majors seem to be coming up with Dry Holes around the world, resulting in a net decline of reserves on their books ... volume out the back door is greater than in through the front door!
Examples of dry holes include Lundin/ Petronas Carigali in off-shore east coast Malaysia, Chevron in Orphan Basin off the east coast of Canada, and Santos tasted dust when they recently plugged and abandoned the Hurricane-3 gas appraisal well off Western Australia as a dry well.
The majors are once again faced with the reality that small/ efficient exploration companies such as IOC are more adept at finding oil, condensate and gas reserves than their own crackpot teams.
With five majors (Chevron, Shell, ExxonMobil, BP and Total) plus several Asian National Oil Companies and Utilities (PTT Thailand, PETRONAS Malaysia, PetroChina et al, JKM) seemingly all circling IOC, it's likely that at least one of them has already made a non-conforming "bid" for 100% of IOC. I would hazard a guess that a low-ball offer in the $6-$9 billion range is already on the table. Even though today's market cap is just $3 billion, in my opinion, a low-ball bid of $6-$9 billion for 100% of IOC will not be accepted by the board of directors.
Now let's take a step back and look at Anadarko Petroleum (NYSE: APC) in the US.
Anadarko is the second-largest U.S. independent oil and natural gas producer and has been mentioned on several occasions as a possible target for ExxonMobil. One analyst speculated the takeover price for Anadarko could be as high as $52 billion.
Recently, Bloomberg reported Anadarko's reserve replacement ratio last year was 148 percent compared to just 107 percent for ExxonMobil. Anadarko had total reserves of 2.5 billion barrels at the end of 2011 and is targeting 3 billion by the end of 2014.
Back to IOC.. the GLJ best estimate of recoverable gas plus condensate in Elk/ Antelope is equivalent to 1.56 billion barrels of recoverable oil equivalent. IOC currently controls 80% of that amount, with 20% in the hands of partners that can be clawed back at some price. After the PNG government takes their 22.5%, IOC is left with 58.6%.
If we take 58.6% of 1.56 billion barrels, that comes to 0.91 billion barrels of oil equivalent in E/A being controlled by IOC.
Now suppose that the already-explored Triceratops asset has roughly the same amount of gas and condensate as E/A; this is not a stretch by any means, and numerous observers and petro-geologists believe the Triceratops resource contains more recoverable gas and condensates than E/A.
Elk/ Antelope + Triceratops total recoverable hydrocarbons approaches 2 billion BOE owned by InterOil.
InterOil has over 40 other prospects in its acreage. Assume the other IOC acreage in PNG has another 1 billion BOE in total (likely a very conservative estimate) controlled by IOC.
Now we're up to nearly 3 billion barrels of oil equivalent that same as Andarko will have by the end of 2014. That begs the question: "Is IOC a potential takeover candidate at $52 billion?" The answer is surely NO.
QUESTION: So what is the logical amount that a winner would pay to acquire IOC in a takeover bidding war?
ANSWER: At least $22 billion (the Mitsui-implied value). That comes to about $7 per barrel of oil equivalent. That's a steal since the three-year average cost per barrel of oil equivalent, excluding acquisitions of proved reserves, has been $27.22.
InterOil's exploration and development costs are estimated to be far lower than those of most other world-class LNG projects. The Elk/Antelope resource will require at most 10 wells in total as a result of its high porosity and huge hydrocarbon column. The on-land dry gas pipeline length of only ~120km from the field to the coast pales against those for offshore Australia projects. The operating costs for the liquefaction plant are expected to be only $0.40 per mcf, substantially lower than those of virtually any other LNG project in the world. The anticipated capital cost is only $1.20 billion per Mtpa while those of Exxon's neighboring PNG LNG Project, for example, are approaching $2.5 billion per Mtpa.
With 48.6 million IOC shares outstanding, that comes to $452.77 per share of IOC stock (over 600% higher than current prices around $63). Chevron's stock price closed on Friday February 8 at $115.64.
In an all-stock takeover at $22 billion, we would see CVX offer 3.92 shares of stock per share of IOC. Let's round that up to 4 and be done.