Ivanhoe Energy Story Is Getting Even Better

Jan. 5.12 | About: Ivanhoe Energy, (IVAN)

Ivanhoe Energy Shares pop on big volume. One wonders “again”: What’s up?

Ivanhoe Energy (NASDAQ:IVAN) Nasdaq - Market cap is $317 million.

Thoughts:

I continue to find the Ivanhoe Energy story irresistible, but over the last year there’s been little of "meat on the bone" news released and the shares have ratcheted down and had the believers squirming, to put it mildly. Obviously, the big break in the price of crude that fell from $120 a barrel in April to $75 a barrel in October didn’t help, and the stock market / Euroland mess was also contributory to the selloff as many sellers lightened the ship, then the tax selling hit and it’s been a nightmare anyway you look at it. Nevertheless, the IVAN story remains intact ― in fact, it’s getting even better.

Certainly, this is a story that has worn out and hurt investors and been a huge disappointment. But the relentless selling of the shares has created extraordinary value as the price of IVAN has gotten incredibly cheap (again!). Moreover, the stock market backdrop and the escalating price of crude have now vastly improved. For perspective, a look at the Amex Oil Index (XOI), which includes the leading oil stocks, shows a fall from 1409 to 958 during the same period when IVAN had the dramatic sell-off.

There is a short position of 9.1 million shares and those short the stock have profited to a large degree. Their thesis has been: little revenue ($34 million), there are no earnings and they will need to do a financing and dilute the shares as the company can’t go another year without more cash. While the potential US recession never developed, crude oil sold off dramatically and the Euro debt crisis had investors bailing out of whatever they could sell. And let’s not forget the year end tax selling to compound the perfect storm of reasons to sell.

Now, of course with the New Year recently arrived and the market at cycle highs, these last considerations are moot and as I mentioned I believe that value is there. Moreover, the shares are now advancing and have moved off their lows of $0.72 to tick $1.20 on 12/30/2011.

So where are we with the long side hypothesis?

· IVAN’s Canadian Tamarack resource was significantly upgraded (2/7/2011) and is expected to produce at approximately 40,000 barrels per day for at least 30 years. ($43 billion with crude at $100 a barrel.) There are 176 million barrels of probable reserves at Tamarack, plus a best estimate contingent resource that rose 18% compared to a previous report. Management is plowing away at a stack of engineering, financing, regulatory and environmental labors and has targeted oil production for 2014.

It will cost about $1.4 billion in CapeX to get the first 20,000 bbd up and running. Valuation on their Canadian operations of proven and probable [2P] reserves is $925 million; add in the present value of estimated future oil and gas revenues, net of estimated direct expenses, discounted at an annual discount rate of 10% [PV10] and it’s $2 billion. On Canada / Tamarack alone IVAN’s a hell of a deal.

IVAN believes that Tamarack’s reservoir characteristics are very similar to Suncor’s (NYSE:SU) operational 30,000 barrel-per-day MacKay River oil sands facility—one of the largest commercial operations of its kind in Canada and located only 12 miles away from Ivanhoe’s asset.

· HTL: IVAN’s highly market disruptive heavy oil to light oil [HTL] technology converts—for the first time ever—heavy oil to lighter, more valuable oil and does so effectively, efficiently, inexpensively, and in volume. The 100% untapped market to develop stranded heavy crude oil assets is gargantuan. Importantly, there are 3 barrels of heavy oil for every 1 barrel of light oil on the planet. A HTL plant is much more capital efficient (e.g. $15,000/ bbl USGC or HTL vs. $40,000 / bbl USGC for conventional) and it takes up much less plot space than a conventional upgrader. This stunning technology alone, once implemented, makes IVAN an energy stock for the decade.

The short version of how the conversion technology works is this: 100% heavy oil goes in one end and 90% light oil comes out the other. Significantly, the process is self sustaining as the remaining 10% in the form of coke and gas by-products “resid” fuels “the process” with some ‘energy’ left over. The processing of the resid creates steam – that is, power – as a byproduct; it takes three barrels of steam to extract one barrel of heavy crude. HTL facilities can be economically applied in scales as low as 10,000 to 20,000 barrels per day.

Well, how come they haven’t done some kind of deal with someone by now? A good question. And we have heard the reply: “Ivanhoe is currently in discussions with several international governments to contract its HTL process to enhance the value associated with existing, producing heavy oil fields.” Yeah, but how come it takes so long?

The nature, size and scope of IVAN’s disruptive heavy oil to light oil [HTL] technology and the applicable projects lend themselves to government or quasi-government entities for the most part and it takes about a half a $ billion downstroke to get operational. That being the case, one can imagine the necessary “ducks” needed to line up in a row to complete an agreement of this size with for example some South American country. Think multiple layers of government entities and the signatures necessary from their highest supervisory levels.

When you consider the administrative divisions and bureaucracy agencies (environmental, indigenous peoples, transport, storage, pipeline, etc. etc.) that would need to be signing off on such an agreement, you can get an idea of the hang up. IVAN is allegedly dealing with the most senior oil controlling levels of some government... think Pemex in Mexico as a possible example. The old Peggy Lee song Manana (Is Soon Enough for Me) comes to mind.

Newly appointed Executive Co-Chairman Mr.Carlos Cabrera said that IVAN’s “HTL upgrading technology is uniquely positioned to help satisfy the global energy industry’s increasing dependence on known reserves of heavier oil.” “In addition to enabling the economic production of previously unexploited heavy oils, HTL has shown that it can extend the life of large oil fields that are increasingly producing heavier crude oils that are more difficult to transport to markets.”

Also of Note: since 2000, Cabrera has served as President and CEO of China's National Institute of Low Carbon and Clean Energy [NICE], based in Beijing.

Robert Friedland, IVAN’s Executive Co-Chairman said on 12/14/2011:

In addition to our Pungarayacu Project in Ecuador, we also see significant opportunities in Latin America, North America, the Middle East and Asia for our proprietary Heavy-to-Light upgrading process that we will be pursuing with the added benefits of his (Cabrera’s) leadership and the professional recognition he has earned in his long career in the energy industry.

· Regarding IVAN’s enormous Ecuadorian Pungarayacu field (426-square-mile block, about 40 miles long and 10 miles wide), independent third party engineering analysis shows “up to between 4.3 and 12.1 billion barrels” of oil in place. By any standard, anywhere, this is a huge hydrocarbon deposit. Importantly, the resource may be even bigger than first thought: “Additionally, initial internal interpretations may also suggest an extension of the field beyond what was originally estimated.” According to a 11/9/2011 press release, IVAN is proceeding with one exploration well into the deeper Hollin and pre-cretaceous horizons in the southern part of the Pungarayacu Block. The first phase of this program is now complete and analysis is still underway. Early interpretation is encouraging as it indicates deeper faulting, with the potential to trap lighter oil resources, which could prove beneficial for blending purposes and overall project economics. Drilling results are anticipated within the first quarter of 2012.

· Next, recall IVAN’s huge multi TCF (trillion cubic feet) gas find in China. From what I hear the gas is there, and there’s lots of it, but it’s deep, difficult, and expensive to get. It looks like they will be going horizontal to harvest the gas.

Both the Yixin 2 and Zitong 1 wells have completed their respective long-term built up tests and the down hole recorders have been recovered and the wells shut-in and secured. Data collected from these recorders has been delivered to contracted third-party “tight gas” experts to conduct detailed analysis and modeling of reservoir parameters and potential completion and stimulation techniques to assist the company in developing exploitation programs on the Zitong Block. There are also multiple layers of gas there. Gas produced in the 1,031 square miles Zitong would be fed directly into an existing regional gathering and sales distribution system.

Because of China’s natural gas shortage, Petro China pays a significant premium for gas over the world price. Ivanhoe management reached agreement with PetroChina and will be signing a Supplemental Agreement to complete an appraisal program by the end of June 2014. The work program consists of 160 sq. km of 3D seismic, and drilling and completing three horizontal wells on the Guan and Wen structures. The seismic work will be completed in the first half of 2012.

· Finally, consider a mammoth parcel of “oil on the surface” in Mongolia. “Block XVI” is a 12,679-square-kilometre area that encompasses the Nyalga Basin and is adjacent to the north-south Trans-Mongolian Railway. Management believes that the Mongolian concession could be one the richest oil zones outside of the Middle East Gulf states. On October 27 the company announced the successful drilling of its second exploration well on the Nyalga block in east-central Mongolia, on schedule and on budget. Oil staining, fluorescence and increases in background gas were observed in several sand sections, which are positive indicators of the presence of oil. The logs are currently being reviewed, with results expected before the end of 2011. The well will be tested in the first half of 2012.

Despite months and months of what appears to be a void of news concerning new deals, major institutions continue to invest in IVAN. Obviously they have confidence in senior management, in the size and breadth of the resources, and in what they see on the horizon, as well as in the breakthrough HTL technology. 56 institutional holders hold 25% or 88,516,546 shares of IVAN. Of Note: Fidelity has instituted a “new position” holding 4,875,000 shares.

Disclosure: I am long IVAN.

Additional disclosure: I'm an investor in Ivanhoe Energy and have bought shares on the open market and have no affiliation with the company other than as a shareholder.