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If you're looking to get a little off the beaten path, away from exposure to eurozone troubles or 'super' committees, investing in hard assets in emerging markets might be a good idea. You'll be in the good company of George Soros and Capital Re, who keep on adding.

Here is an emerging market stock, InterOil (IOC) with operations based in Papua New Guinea (PNG). We've written quite a bit about this company but have never really done a full write-up, and the stock is on fire at the moment, with exciting possibilities right in front of it, so it seems about the last chance to do it.

InterOil has a monopoly refinery business and a near monopoly distribution business. Much more importantly, it has the Elk/Antelope resource and 4 million acres of promising exploration licenses. The company has exposure to the booming Asian LNG market where prices ($16 per Mcf) are a multiple (4-5x) of those in the US.

The refinery and distribution businesses post a modest profit and have upside due to the low capacity utilization and the strong (resource and mining driven) growth of PNG.

World-class resource

However, the crown jewels are the Elk/Antelope resources, which have 8.59Tcf of gas and 129MMbls of condensate, per GLJ (see here for the full 2009 report). The well data from Antelope are very impressive, with consecutive world record flow rates (382 and 705Mmcf/d), average porosity of 8.8% and 14%, and net payzones of 2277ft and 1175ft. Pressure rebuild was near instant.

The field can be developed by 6-10 wells, producing at up to 200mmcf/d each. The gas is of high quality (low CO2, minimal pre-LNG processing required, apart from profitable condensate stripping, see p12 of here).

An indication of the quality of the resource and project economics can be gauged from the figure below.

World-class exploration acreage

The next well the company will to drill (start before year-end) is Triceratops, a resource which we already know contains gas, from the Bwata-1 well.

Seismics had shown several reef structures in these fields (reef is very porous, it's what's making the Antelope field so productive). On the basis of that, Knowledge Reservoir (pdf) made an initial estimate of the field of 4.6Tcf (see p25 of Aug. presentation to the Oil And Gas Conference - pdf).

The latest Conference Call was even more bullish on its prospects. Of course, we'll have to wait until the company confirms the reefs by drilling, but we'll soon find out. On top of that, there are 56 prospects with 12 possible reefs identified. Money from the sell-down of the strategic partner they're getting on board will probably provide ample funds to drill these.

The business model is very profitable

InterOil is planning to monetize the Elk/Antelope resource with the help of a (3mtpa) modular plant build by EWC of Australia, a (1.8-2mtpa) floating LNG (FLNG) plant by Flex of Norway, build by Samsung Heavy Industries and a condensate stripping plant (CSP) build by Mitsui of Japan.

The cost of the plants fall on the other parties in exchange for 14.5% of LNG sales to EWC and Flex. Mitsui and InterOil are sharing the CSP but Mitsui is pre-financing InterOil's part as well. It has 2.5% buy-in options for Elk/Antelope). InterOil is only liable for the infrastructure (pipelines, jetty, field development).

InterOil went to market (at $75) last year (much of management participated to the tune of $44M) and has a considerable amount of the funds for the infrastructure in place.

The sharing of infrastructure, early monetization and synchronized final investment decisions (FIDs) mean that no re-injection of dry gas is required. That saves a lot on return pipelines and compressors.

The project is also scalable by adding modules and could ultimately ramp up to 20-30mtpa (see slide 18 of this). These modules are, just like the FLNG, not constructed on site but under controlled circumstances (like the Samsung wharf), greatly simplifying the process.

Cash flow at first full year after start-up (2014) is in the order of $1B ($90 oil and 0.1485 slope) (see p15-6 of here). With fully planned expansion (paid out of cash-flow, adding LNG modules) it will be $2.5-2.9B.

Petromin owes $120M for their 22.5% participation (including 2% for landholders) in Elk/Antelope and these could be paid anytime soon as a result of Shell's (RDS.A) deal with Petromin:

Papua New Guinea energy company Petromin has signed a joint oil and gas exploration deal with energy giant, Shell. Under the agreement, Shell will finance all joint exploration and development of new oil and gas projects, as well as other projects that Petromin already has.


Of course, Shell was the company that tried to muscle in through the back door, which led InterOil to hire three investment banks which will add a big partner to the project. It could still be Shell, but IOC has been given assurances of PNG authorities that they will not force them into an unfavorable negotiating position with a single company. (see slide 26 from the recent CC presentation).

After some considerable uncertainty, it emerged that the present project will go ahead more or less as planned with the addition of a big partner as operator of the plants and that partner will also take a stake in the project. Liquefaction capacity will also be accelerated to over 7.6mtpa.

Marubeni paid $298M for an 21% stake in Merlin Petroleum's stake of the rival Exxon (XOM)/OilSearch project. That's about a 1% stake, to which some 9.5Tcf of gas is dedicated, or roughly $3.18 per Mcf. For good measurement, InterOil trades at roughly 50 cents per Mcf with their project better in every aspect bar having a big partner. But the latter is being added in the process, so we don't see much reason for a significant price deviation, but we'll have to wait and see.

In the meantime, the market is finally realizing that InterOil is very undervalued and that it is very unlikely that the project is cancelled or even significantly delayed.

Price movement

In two days, the stock price moved from the high 40s to the low 60s, on high volume, crossing through the 200-day moving average and the upper band of the downward trend. In all the years we have watched this stock, we've never seen such a move without there being some kind of fundamental development. There are quite a few possibilities.

Before the end of the year

During the last Conference Call, InterOil argued that some stuff is still scheduled before year-end. We get FID's from partners Mitsui, EWC and Flex/Samsung. The spudding of Triceratops, one or two offtake deals (one possibly getting a $5-7 per Mcf forward sale price).


We're also encouraged by the rather bullish option activity for December and January, which saw very strong volumes in calls. The 7.88m shares short could add significantly to the rally now that InterOil is on the edge of achieving a stable future, especially now that big funds, like Soros and Capital Re have bought right through all the political uncertainty (see here and here) and the float is drying up and shares are difficult to borrow.

We're also quite reassured by the very lame quality (or lack thereof) of writers from the short side and having very bullish analysts with price targets way higher than the $61 the shares closed on Tuesday:

  • Morgan Stanley (MS) has a NAV of and a target price of $135, but this assumes only $2 per Mcf in a sell-down of Elk/Antelope and nothing for Bwata/Triceratops while they acknowledge that the new seismics "provides clear upside to the P-50 pre-drill estimate of 4.6Ttcfe of the T-2 well that will likely TD before year-end."
  • Macquarie has a price target of $120
  • Raymond James (RJF) has a $60 price target but this is a 40% discount of NAV of $109 P1 ("proven") resource numbers. It doesn't include anything for the other fields and it acknowledges that the shares trade at 50 cents per Mcf with comparable deals in the region a multiple of that.
  • BNP Paribas have a $90 target

Macquarie and Morgan Stanley have recently been included as investment bankers for acquiring a strategic partner, but these reports pre-date that.

There are risks. The main one is political. PNG is in a bit of political turmoil after long-standing PNG PM Somare was struck down by ill health. However, after some turbulence which were widely misrepresented, we think that relationships are good and PNG depends on prospective tax revenues, via Petromin it is a partner in the project, and the country is quite dependent on foreign investment and expertise.

The world economy is another risk, but we think there is quite a bit of momentum behind the Asian LNG market, especially after the Japanese tsunami.

Source: InterOil: Undervalued With Exciting Possibilities Ahead