Seeking Alpha
Small-cap, macro
Profile| Send Message| ()  

It already had some of the cheapest gas in the world. Now they're embarking on a much cheaper, faster monetization route that leverages their low resource extraction cost and shifts much of the up-front capital cost to third parties. The market hasn't understood the the strategy, which provides an opportunity.

InterOil (IOC) surprised the market with an agreement for a near $1B 2M metric ton expandable 'modular' LNG plant with Energy World Corporation (OTCQX:EWCLY), to be build in nearby Gulf province (at 80km from their Elk/Antelope gasfields), rather than next to InterOil's refinery at Napa-Napa (340km).

Here's the deal:

EWC built the near $1B modular LNG plant in exchange for 14.5% gas royalties. InterOil has to build the infrastructure, a 80km pipeline from Elk/Antelope to the Gulf coast (rather than a 340km pipeline to Napa-Napa, first big saving), a jetty and a tidebreaker (if this is not the responsibility of EWI, per deal with the Gulf province). But this infrastructure is near free because of the synergies with another project, the condensate stripping plant (CSP) build by Mitsui (OTCPK:MITSY).

The financing of the CSP is the responsibility of Mitsui with InterOil having to put up the infrastructure, like the pipelines (30km) and the re-injecting wells. However, combining the two projects delivers great savings in the infrastructure spending:

  1. The pipeline to EWC's modular LNG plant passes Mitsui's CSP. For the first trajectory (30km until the CSP) they can be shared.
  2. The modular LNG plant provides an outlet for the dry (after condensate stripping) gas, obviating the need for re-injecting the dry gas
  3. This obviates the need for a return pipeline from the CSP.
  4. It obviates the need for drilling re-injecting wells.
  5. It obviates the need for big compressors to re-inject the dry gas.

The synergies can even be greater if some of the condensates will ship from the Gulf province, rather than being processed at InterOil's refinery (although the latter provides nice synergy between the CSP and the existing refinery, which has more than 10K bbs/d spare capacity or could even substitute the condensates for its regular crude feedstock which it gets from overseas).

Enter LNG Floating Production Storage and Offloading (FPSO)

Exactly the same infrastructure can be used for one or more floating LNG floating, production storage and offloading (FPSO) plant, which makes these plans that much more feasible. InterOil is in talks with no less than six consortia having such plans, InterOil's partner Petromin (OTC:PENMF), the energy arm of the PNG state and 20.5% owner of the Elk/Antelope fields, already has a preliminary agreement with DSME (subsidiary of Daewoo Shipbuilding and Marine Engineering) of South Korea and Höegh LNG of Norway.

Build Once, Profit Thrice

So, if all goes to plan, InterOil has to fund infrastructure once, which is the basis of:

  • The CSP, funded in full by Mitsui. InterOil could even own this CSP if Mitsui exercises an option to convert it into a 2.5% stake in Elk/Antelope.
  • The modular and expandable 2M metric ton LNG plant, funded in full by EWC.
  • A possible floating LNG plant.

None of these three plants require InterOil to put up capital, just the infrastructure will be provided by them. The infrastructure cost savings for the CSP as a result of the modular LNG plant pay for the extra pipeline required, so the additional infrastructure capital outlays are essentially free, and that same infrastructure support the FLNG.

Additional Benefits of This Faster Monetization Route

This is not all. Compared to the traditional plans for a traditional LNG plant further away at Napa-Napa (240km pipeline needed, versus 80km for the pipeline to the Gulf coast), next to the refinery, there are additional benefits:

  • Earlier monetization (the end of 2013) versus 2015-6 for the big (traditional) LNG plant at Napa-Napa.
  • Since the modular plant plus infrastructure is a $1.5B affair, rather than a $5-7B affair, and InterOil isn't responsible for a penny of the modular plant itself (while it would have to fund half the big plant in Napa-Napa and the pipeline to the modular plant is just 1/3 of the distance of that to the proposed big LNG plant at Napa-Napa) much less capital outlays and cash upfront needed, instead of billions, InterOil needs something like $500M for the infrastructure.
  • As a result, IOC will be able to keep a much bigger share of their resource. Instead of selling four 2.5% stakes an one 25% stake to a strategic, just a couple of 2.5% stakes could do (per Morgan Stanley)
  • With earlier monetization and containing reserves, not just resources (after FID on the CSP and/or modular LNG plant), the value the resource itself will increase
  • InterOil will have a greatly enhanced bargaining position vis-à-vis a strategic for the big LNG plant, or they could possibly even go it alone on that, or skip it and expand the much cheaper alternatives (the modular LNG plant and perhaps FLNG plant).

Very cheap gas (per Woodside McKenzie, see p.8) compounded with very cheap (and fast) monetization route (through CSP, modular LNG, FLNG) provide for really compelling project economics. This is why Morgan Stanley increased it's NAV substantially, from $151 to $225 per share (and also increased their price targed, albeit much less so, to $135 per share, because this is still in the design stage). This is how they summarized the deal:

We believe the new model for LNG development will generate higher returns for IOC than our prior assumptions, accelerate EBITDA generation by 3 years, and shift the financing obligation to a partner.

The skeleton of the financing is already visible for those who care to look:

Yes, one can say that individually, few of these are binding financing obligations (apart from Petronet's obligation to InterOil). But together and combined with the compelling project economics it's like a developing film coming into focus.

Remaining Doubts

The underwhelming reaction of the market is probably due to three remaining doubts (apart from an under-appreciation of the benefits):

  1. Is the modular LNG plant technology viable?
  2. Is the FPSO technology viable?
  3. Can EWI/EWC pull off the financing?

Is EWC's the Modular LNG Plant Technology Viable?

Well, we're no engineers, but more luminary people than us seem to have looked at this. According to EWC, they were looking for standardized parts but couldn't find these. So the likes of Siemens and Chart, big established players, helped here. Siemens (SI) was quick to see an opportunity. said Ralf Kannefass, Vice President Oil and Gas at Siemens AG, said:

With its unique portfolio and competences Siemens is the only company that can offer one-stop solutions from power to compression. As electric LNG applications become more and more attractive we are expecting a rapidly growing market for this innovative technology. With our standardized products for the mid-size LNG market we can also offer the most cost-efficient solutions to our customers.

The link above also shows as well that EWC already ordered a lot of equipment (here is the link from Chart). This was supposed to be used in a similar scheme for their Indonesian field. EWC was going to partner with no less than Tokyo Gas for exporting LNG from this modular plant, but these plans were cancelled by the Indonesians because they weren't consulted and want to keep gas for the domestic market.

Considering how Japanese companies work, we can't imagine the likes of Tokyo Gas not having done some serious due diligence on this project prior to that agreement (even if it's a preliminary one). We can't also belief EWC having ordered (and partly paid for) equipment if they weren't serious about this.

2) Is the Floating LNG Technology Viable?

Ok, granted none is operational yet but there are many well established and respected parties moving this technology. For instance, in the same Bloomberg article that described the Petromin, Höegh, DSME (Daewoo) deal, one can read stuff like:

  • Shell (RDS.A) is due to receive the first of as many as 10 floating LNG plants in 2016 for use off Australia.
  • “The Prelude floating LNG project is planned to be the first deployment of Shell’s floating LNG technology,” Claire Wilkinson, a Perth, Australia-based spokeswoman for Shell, wrote in e-mailed comments today. “The Prelude Project is currently in the engineering and design phase of development and is progressing well with a final investment Decision planned in 2011 and first gas planned for 2016.”
  • Woodside Petroleum Ltd. (OTCPK:WOPEY) and Petroleo Brasileiro SA (PBR) may also use similar technology at offshore fields as energy companies push further out to sea in search of new gas supplies to meet surging energy demand.
  • Samsung Heavy, based in Seoul, also has contracts to build four smaller floating LNG vessels for Flex LNG Ltd.
  • Using floating LNG technology will cut production costs for the venture by about 50 percent and avert the need to buy land from hundreds of owners for a 340-kilometer (211-mile) pipeline to an onshore facility, Kim said [with relation to the PNG plans]

And it seems to us that if it can be done at sea, it should be even easier on land, hence modular LNG does seem to make sense.

3) Can EWI/EWC Pull Off the Financing?

EWC owns and operates two gas fired power plants (one in Alice Springs, Australia, the other in Indonesia) and two gasfields (one in Queensland, Australia, the other in Sulawesi Indonesia) and some smaller energy properties.

Here is some stuff for you to ponder:

We'll leave you with a quote from Morgan Stanley:

Why we think EWC is a Credible Partner? We think EWC is able to meet a tighter time line for facility start-time in the IOC agreement because many facility materials were ordered and constructed in connection with the 2mtpa Sengkang, Indonesia LNG export project (due to start in 2011). Indonesia canceled the agreement with EWC in January 2009 due to concerns on its natural gas resources. Hence, IOC and EWC are able to cut the start time of the project to 2013.

And another one:

We believe catalysts remain. We look for other announcements in 4Q10 that: (1) strengthen the project’s credibility (off-take, FLNG, CSP FID and LNG FID); and (2) outline $500MM-$1.5Bn of potential capital in a upstream sell-down necessary for exploration and full development costs of Elk/Antelope.

So, one can profit from the market's skepticism, it won't last long.

Disclosure: Author long InterOil

Source: InterOil Leverages Cheap Gas With Cheap and Fast Monetization