InterOil vs. OilSearch: LNG Projects on Papua New Guinea

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 |  Includes: IOC, NPOIY, STOSY, XOM
by: Shareholders Unite

Comparing the two projects that are scheduled to deliver LNG for the lucartive Asian market from 2014 onwards, we arrive at the conclusion that InterOil's (NYSE:IOC) project has significantly more upside.

Reserves/Resources

  • OilSearch [ASX: OSH] has 66.9 BOE of P2 reserves, InterOil has zero reserves, because it doesn't yet produce oil or gas, and it hasn't taken a final investment decision to do so yet.
  • When a final investment decision is taken, OilSearch will move approximately 580 million BOE from reserves to resources (P2). Something similar will happen to InterOil when such a decision is taken
  • OilSearch has 952,8 million BOE of P2 resources (including the 66.9 million BOE of P2 reserves), comprising of 157.1 milliion BOE of oil and 4,774.1Tcf of natural gas. InterOil has 6.7Tcf of P2 gas resource (new Knowledge reservoir report) and 20-49 million barrels of condensates (older GLJ Petroleum Consultants report, not including Antelope1 condensate figures of 5000bbs/d), for a total of 650 million BOE, 2/3 of OilSearch.
  • Although somewhat speculative, it's fair to argue that since OilSearch fields are much more advanced in the appraisal process, the upside is far larger for InterOil. Even its prime reefal field at Antelope has to date only two wells drilled, while seismics indicate it's a lot larger still.

The Economics of the Project

  • OilSearch project is budgeted at $12.5 billion, InterOil's at $5-7 billion, some of that cost difference can be explained by:
  • OilSearch wells cost $75-$100 million to drill, InterOil's wells 1/3 of that ($25-40 million)
  • OilSearch wells flow at rates of 8-15MMcf/d, InterOil's wells 20 times that, at 100-400MMcf/d
  • So Elk/Antelope is 20 times more productive at 1/3 of the cost per well.
  • OilSearch LNG projects is supported by 6 fields scattered in the highlands, compared to one field (Elk/Antelope) in the lowlands for InterOil. Therefore, OilSearch does need 3 times the pipeline length..
  • InterOil has certain other advantages, like landowner agreements, a deep harbour, a jetty system the location of the LNG facility next to the refinery
  • OilSearch has an advantage in having a partner with deep pockets, like Exxon (but a significant part of the LNG project will be financed by debt and equity anyway).
  • OilSearch has a 34% stake in its LNG facility (others are Exxon (NYSE:XOM) 41.5%, Santos (STOSY) 17.7, and Nippon Oil (OTC:NPOIY) 3.6%), InterOil has a 50% stake in its LNG facility.
  • In December 2008, Nippon Oil paid almost $400 million for a 3.6% stake in OilSearch LNG facility.
  • Nippon Oil also paid over $400 million for a 3.6% stake in the relevant 6 gas fields relating to the LNG project, this amounts to approximately $1 per Mcf, at a time when energy prices where at their lowest in years.
  • OilSearch LNG facility has already been sold out even befor the final investment decision has been made. Two Japanese and one Chinese customers contracted for all its LNG already, leaving others (like Korea Gas) in the dust.
  • The long-term contract price for OilSearch LNG is estimated at $12 per Mcf, its cost at $3 per Mcf.
  • From the above, it will be clear that with wells costing 1/3 and being 20 times more productive, having a single resource and favourable location, it's hardly a great leap of faith to argue that InterOil's gas will be significantly cheaper still, which will put those Nippon Oil deal numbers in a very favourable light.

Other Metrics

  • OilSearch is far more profitable, with $240 million in net profits (excluding a one time gain from the sale of gasfields) on a revenue of $814 million. Its market cap is $5 billion, giving it a p/e of approximately 17. Way too low, according to Neil Beveridge from Bernstein.
  • However, InterOil's performance has been structurally increasing (loss narrowed from $46M in 2006 to $29M in 2007 to $11M in 2008 on a revenue of $915M), and its refinery is operating under 2/3 of capacity.
  • The refinery profitability especially could receive a big boost from the start of construction of the LNG projects (or even a single one of them, don't forget these are projects of the size that double the PNG economy over six years) and especially if InterOil can produce its gas liquids and/or oil. Then it will be able to substitute much (if not all) crude imports, which will give a big boost to profitability.

Conclusion

  • Although OilSearch is, at present, much more profitable and has a strong partner in Exxon, and its LNG project has already been sold out, InterOil's project has important cost advantages that could become especially manifest if it manages to produce liquids and/or oil, which will turn the refinery into a money spinner.
  • And with exploration companies mostly valued on the basis of what's in the ground, OilSearch only has about 1/3 more, and InterOil's upside is arguably much more substantive.
  • We find the 5:1 market cap advantage for OilSearch a bit rich and expect that to come down in time.