InterOil: Introducing the Biggest Natural Gas Well in the World

InterOil (IOC) is a Canadian integrated (exploration assets, refinery, near distribution monopoly) located in Papua New Guinea [PNG]. After having struck two earlier profusely flowing natural gas and liquids wells (flowing at 102 and 105MMcf/d respectively), they hit an absolute killer with Antelope1, which flowed at a whopping 382MMcf/d.

Record well
Summing up a few findings:

• 382MMcf/d with the pipe only 30% open for safety reasons, and the log indicated that the permeability at the top did not allow the lower section of the reservoir to contribute to the flow test. That is, all the gas just came from the top 12% of the reservoir
• 5000bb/d in condensates
• 792 meters (2300ft) of net pay zone, which is more than three times the size of the biggest American well (650ft), and the gas / water contact has not even been determined yet
• The largest calculated absolute open flow [CAOF] at 17.7 Billion cubic feet of natural gas per day
• 8.4% average porosity
• From the seismics, the Antelope field is 14 x 7 kilometres

Let’s put that in perspective
Just three wells flow 600MMcf/d, more than enough to supply the daily needs of an LNG facility. This is roughly equivalent to the daily productivity of Southwestern Energy (SWN), enterprise value of 10.5 billion. It is larger than the daily production of Ultra Petroleum (UPL), enterprise value of roughly $6 billion. The record-breaking well by itself has larger daily production than the entire corporation of Range Resources, enterprise value $7.3 billion.

And all that with just three wells, with seismics indicating plenty of potential left for more. This leads to another important point, how InterOil’s location and quality of its resource provides it with a large cost advantage over most competitors for the most lucrative LNG market in the world, Asia Pacific.

Even long-time skeptic Ross Smith Energy Group turned around even before the record setting flow test.

Cost advantages
PNG is located next to the world’s most lucrative LNG market, Asia Pacific. PNG is a very low cost location, and has a rather business friendly regulation, which put resources located here at a considerable advantage.

Australia has emerged as the next big LNG play for Asia Pacific, but its labour, tax, and regulation costs are a multiple of those in PNG, yet tens of billions of dollars are going into these Australian coal seam projects even in today’s low energy and credit constrained environment.

And where InterOil can supply a LNG facility from just three wells, coal seam gas projects need to drill, treat, and man literally thousands of wells.

InterOil’s planned LNG facility is estimated at just $5-7 billion, low for international standards. Even a rival comparable project on the same cheap PNG location, led by OilSearch and Exxon (XOM) is budgeted at $11-12 billion for a 6.3 million tonne per annum facility. (InterOil’s facility will have a capacity of 6-9M tonne).

The InterOil project is cheaper because the gas comes from a single resouce and, unlike OilSearch, important infrastructure is already in place. InterOil does not have to build a harbor, housing, power facilities, water facilities, deep water jetty system, InterOil already has land rights, and their pipeline is less than half the distance and is not in the mountainous terrain of the highlands (like Exxon / OilSearch’s).

What will happen next?

1) Determining the condensate ratio at depth and looking for oil
This will be done by side-tracking Antelope1 and proceed with three DST tests for the condensates, which increase with depths, and oil, within the next 30 days.

The first three DST tests will not deliver a ‘wow’ factor, their aim is to find out the gas / condensate ratio at different depths. This is a necessary task for getting a grip on designing the best way to produce these condensates.

A wow factor might come from the last DST test, specifically to test an interval where there might be oil. CSIRO, the famed Australian engineering bureau, has commented that the gas is likely to come from an oil system, so there is a reasonable chance there is oil somewhere in Antelope.

However, oil has a habit of migrating to unexpected places, so actually locating it might be problematic.

2) Reserve reports
These might not provide much ‘wow’ factor either, as these reports tend to concentrate on what can be proven now, not on how much more there might very well be (according to seismics), so they have a conservative bias and are unlikely to come close to the numbers going around on the boards (6-12Tcf) or InterOil (11Tcf).

Getting reserves on the books is significant, InterOil doesn’t have any now and exploration companies are mostly valued on their reserves. Also, any reasonable doubt about whether InterOil has enough gas to support an LNG facility will disappear.

3) Selling up to a 25% stake
After preliminary discussions with major oil companies, national oil companies and international natural gas utilities, Interoil and its advisors will determine the most suitable industry farm-in to acquire up to 25% interest in its LNG assets. InterOil has retained the services of BNP Paribas (BNPQY.PK) and ABN Ambro (ABN) as advisors.

There is no shortage in potential partners, two categories are most likely, Asian utilities and big oil companies. The latter are looking to add reserves in a world where more and more resources are nationalized, the former are trying to secure long-term energy supplies as a matter of national security.

Both parties have long-term horizons and deep pockets and the extraordinary economics of their Elk / Antelope discovery ensure that it’s one of the most competitive natural gas resources to develop. Getting the gas condensates out would improve the economics even more, as it provides early cash-flow, further derisking the project.

Valuation
Raymond James in a recent research report used two valuation methods, a net asset valuation [NAV], and comparing it with similar deals.

For the NAV exercise, they used the following assumptions: 6.9Tcf of gas , 60% working interest, 50% risk factor, $0.75/Mcf multiple, very conservative in the light of “Asia’s premium priced (typically $10+/Mcf) LNG market and valuations in the depressed U.S. gas market (typically $1.50 to $2/Mcf) and 69MMBbls of condensates at $10 per barrel and risked the same way.

They arrive at a NAV of $55.52 per share, roughly 2.5 times current prices, with substantial upside to both the amount of gas, its valuation, and reducing the risk factor (with independent reserve reports).

Perhaps even more interesting was Raymond James comparing a possible InterOil deal with Nippon Oil buying AGL’s 3.6% stake in the PNG exploration interest and LNG facility planned by OilSearch and Exxon, for $800 million last December.

Arguing InterOil’s assets are comparable to those for sale in the above transaction, a 25% stake would fetch $5+ billion and put the enterprise value at a whopping $22 billion. All this suggests that, longer-term, this stock can only move in one way, and that is up.

Disclosure: None

Comments

[erniem:]

Up provided a healthy market for LNG remains steady, as it costs a lot to deliver.

Mar 24 11:08 AM

[Martin Soko...:]

And why does InterOil think they can build their FIRST LNG plant for half the cost of that of very experienced XOM? LNG plants are very complicated and costly and need very experienced teams of engineers to successfully design and execute these projects.

Don't forget the cost of the pipelines to bring the gas to the LNG site, the gas treatment facilites to condition the gas for the LNG and the infrastructure to support the plant. (Not to mention negotiating LNG contracts and costs for dedicated LNG tankers). Several small/ mid-sized oil and gas companies had big problems with their LNG projects and budgets usually doubled or more from inital estimates. Which raises the point, how good is the InterOil cost estimate?

Mar 24 12:49 PM

[Shareholder...:]

The design is already done. The rest of cost advantages are described above, like InterOil needs less than half the pipeline compared to the Exxon project and they have one resource in the lowlands, versus multiple resources in the highlands, etc. etc. see map on the link:
messages.finance.yahoo...

Mar 24 07:12 PM

[E.D. Hart:]

Sooooooo, why aren't you long? Just wondering...

Mar 24 07:38 PM

[Mad Hedge F...:]

At least someone in this space is doing well. Natural gas ($NATGAS), which peaked at $13.50/btu last year, has been one of the most severely punished energy contract in this recession, plunging 72% to a low of $3.75. The credit crisis has forced US companies like Chesapeake Energy (CHK) and Devon Energy (DVN) to scale back exploration, so the US rig count had dropped by 50%. The price collapse is welcome news for consumers, as NG is an essential raw material for making naphtha, fertilizer, and plastics and accounts for 20% of US electric power generation. It also is a favored fuel of the green crowd, as the only products of its combustion are carbon dioxide and water. The industry was making the leap from a domestic industry to a global one just as the bottom fell out of the market. The completion of six liquefaction plans in Qatar, Russia, Indonesia, and Yemen costing $48 billion is expected to boost global production by 25% this year, and more big plants are coming on stream in the near future.

Mar 24 08:05 PM

[Shareholder...:]

US market has little to do with Asia, prices are MUCH higher there and haven't fallen by nearly as much.
That 25% supply increase this year, you got a source for that? Don't you mean over the next four years? Before the crisis, demand for nat gas was rising at 7.5% a year and construction of LNG import terminals is outstripping supply.
"Beyond 2009, the outlook over the next decade and a half appears to be of an increasingly tight global LNG market," Bernstein said, according to Reuters.
www.lloydslist.com/ll/...;jsessionid=38329B0D53...

Mar 24 09:37 PM

[376602:]

interoil.com 3 photos show fire and a nonflammable fountain of water. BP capital filed SEC notice in 2/9/2009 after sale.

Mar 25 01:26 AM

[manulad:]

Another O&G operator in PNG worth looking at is RIFT Oil, who have discovered around 2 trillion cubic feet of gas in the western highlands region of PNG. Rift Oil who trade on the London AIM market currently have a market capitalisation of £43 million and are in advanced discussions with an unidentified potential farm-in partner.

Mar 25 04:21 PM

[Alan von Al...:]

On advice of counsel, can't comment.

Mar 27 08:00 AM

[Shareholder...:]

Were is that formal assessment you promised after an earlier article, Alan? More importantly, you never answered questions regarding to why and how (considering you're limited access to data) you would do that, and who would pay you for your time.

If you don't want to comment, then don't, but don't give us this bs, again..

Mar 27 01:26 PM

[mxd06:]

The increased availability of US natural gas supplies are a result of the increased production in the Barnett shales, the new play in La, the shale play in the Dakotas, the marcellus shale play in NY,Pa, WVa, and the potential play in the Utica shales

Mar 28 09:52 AM

[Shareholder...:]

All that shale gas is quite expensive, most of it cannot even be produced at a profit at today's US prices (they need $6-8 per Mcf), and export capabilities are VERY limited:
www.bloomberg.com/apps...

Mar 29 10:45 PM

[manulad:]

March 31 (Reuters) - British oil and gas explorer Rift Oil Plc (RIFT.L) said on Tuesday test results from its Puk-Puk project in Papua New Guinea showed high-quality reservoirs, fully charged with gas

www.reuters.com/articl...

Mar 31 02:12 PM

[User 296010:]

simpkins comments:

The biggest indictment of this Blog is the Author's failure
to back up his opinions with any ownership of IOC. Put his money
where his Mouth is????

Why Not???

Apr 04 11:17 AM

[adamnb:]

agreed. add to that high depletion rates.


On Mar 29 10:45 PM Shareholders Unite wrote:

> All that shale gas is quite expensive, most of it cannot even be
> produced at a profit at today's US prices (they need $6-8 per Mcf),
> and export capabilities are VERY limited:
> www.bloomberg.com/apps...;sid=aP7N7ZkaXSAw&...

Apr 08 06:11 PM

[adamnb:]

In a former article by this author (10/08) the author disclosed he held a long position on IOC.



On Apr 04 11:17 AM User 296010 wrote:

> simpkins comments:
>
> The biggest indictment of this Blog is the Author's failure
> to back up his opinions with any ownership of IOC. Put his money
>
> where his Mouth is????
>
> Why Not???

Apr 08 06:37 PM

[Walawala:]

Can 2 LNG Projects coexist comfortably in PNG?

Apr 13 07:17 AM

[manulad:]

April 15 (Reuters) - Rift Oil Plc (RIFT.L) said on Wednesday it expected capital costs of $678 million to $968 million on the Papua New Guinea (PNG) gas pipeline, for which it did not find any technical glitches.

The oil and gas company said it completed a final feasibility study along with Flex LNG FLNG.NFF for the construction of the pipeline export gas from its PNG licences

uk.reuters.com/article...

Apr 15 06:28 AM