InterOil's Exciting Quarter Revisited

| About: InterOil Corporation (IOC)

InterOil had a rather bullish conference call on Tuesday morning (see the presentation here). During the conference call, InterOil confirmed that:

  • The project, with an addition of a "world-class" LNG operator and partner to accelerate the LNG capacity to over 7.6mtpa, has the backing of the PNG government (see slide 26 from the presentation).
  • The government won't force InterOil into an unfavorable negotiating position with a single company (slide 26).
  • The final investment decisions (FIDs) on the project with partners Mitsui (condensate stripping facility, CSP), Flex and Samsung (floating LNG plant, FLNG) and EWC of Australia (modular LNG plant) are still on track before the end of this year.
  • They're expecting one or two off-take deals for LNG to be finalized before the end of the year, one could have a forward sale in the range of $5-7 per Mcf
  • Spudding of Triceratops is still planned before the end of the year. We might refresh memories here and remind people that the Triceratops field has been proven to contain gas (per a well drilled in 1959), and recent seismics work have identified some reefs (the type of rock that makes the Antelope resource so productive). The latter will have to be confirmed by the drill-bit, of course.
  • InterOil is considering a stock buy-back program.

This is all rather remarkable and exceeding our expectations, to be honest. We were sort of resigned to at least some delay over the final investment decisions, as negotiating with and accommodating a new partner within the existing framework is a rather complex process that shouldn't be underestimated.

After all the fuss that was created over the status of the project after the PNG Energy Minister demanded a world-class operator be added, things seem to be progressing rather smoothly, and none of the doom scenarios (cancelled project, cancelled agreements with partners, years of delay, etc.) seem to materialize.

One give-away is the significant addition of shares in the third quarter (see here and here), despite all the controversy about the status of the project after some unhelpful comments from the PNG Energy Minister. (For a take-down at that controversy, see here).

So we can expect the inclusion of a new partner providing operational expertise and taking a stake in the whole project any time soon. It is noteworthy that there was a transaction in another LNG project on Papua New Guinea led by Exxon (NYSE:XOM) and OilSearch.

Marubeni paid $298M for an 21% stake in Merlin Petroleum's stake of the Exxon/OilSearch project (estimated at $15B). That roughly amounts to a 1% stake in the project, to which some 9.5Tcf of gas is dedicated, or roughly $3.18 per Mcf.

The economics of InterOil's project are probably considerably better, (it's much more favorably located, and the Antelope wells are much bigger, for instance) so there isn't any reason not to take this as a benchmark for an InterOil stake, especially since the major will give added credibility to the project.

InterOil's shares are changing hands at considerably less than 50 cents per Mcf, so $3 per Mcf (six times the current market price) would be something of a bonanza. We'll have to see what materializes, but that there is significant upside to the present share price seems almost certain.

Not everybody sees it that way, however. In quick succession, Adam Gefvert produced two very dubious articles on InterOil (here and here). While it's neither necessary or worthwhile to go through all of Gefvert's claims (any perfunctory due diligence will immediately refute most), there are a few points worth picking up.

His whole thesis of the last article rests on the comments of a certain "eoneil" (comments made at the bottom of articles about InterOil on Seeking Alpha). This eoneil claims to be Edgar O'Neil, the author of a book on doing business in PNG. Gefvart takes that completely at face value. here is a selection:

NO - Interoil does NOT control a valuable gas resource

Senior DPE (Dept of Petroleum and Energy) officials I spoke to could not understand why InterOil wanted the LNG project agreement signed with the government before any PDL was awarded.

I think Shareholders Unite may be part of the InterOil PR juggernaut that have been hyping the stock for some years

I find it hard to believe that Shell would be interested in becoming involved in this project.

I am also aware of a number of senior InterOil employed geologists who paint a completely different picture of how big InterOil's resource at Elk/Antelope really is.

This refinery does not add value because it simply blends already refined oil.

Don't you know that the reserves they are claiming have only been certified by an obscure Canadian company

Why does InterOil use a relatively obscure Canadian company - GLT Petroleum Consultants - to certify the huge resource they are claiming

Its ironic your reference to politicians taking bribes, considering that's been InterOil's area of expertise up to now.

To take any of this at face value is quite laughable, but to build one's short thesis on this single unverified commentator without verifying his identity or his rather bizarre statements is, well, just silly. Or worse.

Even the most minimal due diligence would have revealed large cracks in these statements. For instance, GLJ is anything but an "obscure Canadian company."

The main point of the thesis is that InterOil doesn't have a PDL license (yet), and according to this eoneil, this is supposed to be a sign that the resource isn't what GLJ says it is. There are numerous easy retorts. For starters, InterOil has always gotten the licenses it applied for, sooner or later.

Rather than rely on an anonymous commentator, Adam Gefvert could have taken the trouble to look things up in PNG's Oil & Gas Act (section 25):

"A petroleum prospecting licence, while it remains in force, confers on the licensee, subject to this Act, and to the conditions specified in the licence, the exclusive right to explore for petroleum, and to carry out appraisal of a petroleum discovery, and to carry on such operations and execute such works as are necessary for those purposes, in the licence area, including the construction and operation of water lines, and, if authorized by the Director, the completion of wells, the conduct of drill stem or extended production tests for appraisal of a petroleum pool (including the construction in accordance with the authorization and the operation of pipes and facilities to gather and transport petroleum to a point of testing or treatment or disposal), and the recovery and sale or other disposal of all petroleum so produced."

The law is describing a PPL, a petroleum prospecting license, not the PDL Gefvert claims they absolutely need, and the absence of which spells disaster. It turns out one can produce with a PPL (the least onerous of licenses), which InterOil has. In fact, they have a PRL license for the property.

Gefvert could also have listened in on the conference call today, where Calio from Morgan Stanley asked a question about the licenses. That provided the following exchange about this topic:

A - Phil E. Mulacek: We have a retention license and a lot of - or even Chevron went into production with a PRL and the PDL allows you to do the social mapping for landowners, complete the landowner forms and then you get a PDL. And that's - can happen post-production or prior. For us because of the LNG project, it'll be - we'll get it pre-production because of the timing; we'll have [ph] then (52:34) significant time. But the final approvals by the minister and the government is - were submitted documents and that process is underway. So it's not a fixed milestone that you have to have before the next step. It's something that you do in parallel sort of like our Refinery Facilities License actually was granted post-commercial operations. They wanted to make sure that it was reliable, safe, and the same processes happen in Papua New Guinea. So each individual company can put - set their own expectations on the licensing process. But we don't have a lot of landowners, specifically; population density for the upstream pipeline area as 2,000 to 3,000. The specific landowners on the field itself is under 1,000. So the [ph] forward (53:43) process for the landowners should be fairly straightforward, as Allan mentioned earlier. Hopefully that's helpful. I mean [indiscernible] (53:50) Ministry for Petroleum. Anything else that you can add?

A - Sir Rabbie Namaliu: I think that's basically the processes [ph] that you've outlined (53:59).

A - Phil E. Mulacek: Yes.

A - Sir Rabbie Namaliu: So social mapping is an extremely important part of this exercise. And as Phil said, that can be done before or after, but it's a condition that has to be fulfilled.

A - Phil E. Mulacek: Yes. It's where the 2% royalty goes and to make sure that the proper representation and all the stakeholders are properly compensated. And it is a material for that province for tax base and not just the landowners, but the provincial and regional base.

Q - Evan Calio: Is it a pre-FID or a post-FID event, getting the PDL, Phil?

A - Phil E. Mulacek: Post.

For clarification, Sir Rabbie Namaliu is a former PNG Prime Minister and is now a member of InterOil's Advisory Board. There doesn't seem to be any reason for concern, and it's certainly wafer-thin to build a short thesis on. But then again, we've seen it all.

Disclosure: I am long IOC.