Things are heating up again at InterOil (IOC), after we (correctly) predicted some consolidation. InterOil is the company that made a big gas discovery at Elk/Antelope and proposes to monetize in a novel way, not using a traditional LNG plant. Instead, it is planning to go with a floating LNG (FLNG) plant provided by Flex of Norway and Samsung of Korea, and a modular LNG plant build by Energy World Corporation (EWC) of Australia.
Financing these plants was also innovative, as that burden falls on Flex and EWC in exchange for 14.5% of LNG sales. Apart from the considerable time savings (plants are not built on site, a logistical nightmare), this saves hosts of up-front capital needed.
However, these plans ran into some headwind when some parts of the Papua New Guinea (PNG) government, which was solidly behind these plans before, seemed to develop second thoughts. Unfortunately, the original agreement between InterOil and the PNG government, signed in December 2009, doesn't reflect the new plans.
So InterOil was asked to look for a 'world-class operator' and partner (not necessarily the same player), and it is in the process of doing that. And it's here where the first news is venturing out. The Wall Street Journal noted a (combined) interest from Kogas (the world's largest LNG importer) of Korea and Japex and Mitsui of Japan.
Is the interest surprising? No, not really. Consider the following facts:
- InterOil's Elk/Antelope resource has been vetted three years running by GLJ of Canada and contains 8.59Tcf of recoverable gas and 129MMbbls of condensate. Recoverability is likely to be very good, with wells having 1175 and 2279ft of net payzones with 14% and 8.8% average porosity. Antelope partly consists of dolomite reef, prime quality source rock.
- InterOil is now well on its way drilling Triceratops. This is a resource with known gas (per 1959 well), and seismics also spotted a reef and indicated the field could be substantially larger even than Antelope
- Apart from these two reefs, InterOil has 10 more reefs on some 54 leads and prospects. These are top quality exploration licenses for which high interest is to be expected.
Mitsui is already involved as it is the company that is going to build (and pre-finance) the condensate stripping plant together with InterOil. Having the FLNG and modular LNG plants negates the need for re-injecting the dry gas, as these plants can be built years quicker than a traditional LNG plant (which is part of the attraction of the new plan).
Now, there are 8.87M shares short. We really do not understand why.
Elk/Antelope is a prime field on the doorstep of Asia's booming LNG market. Russian gas deliveries are unreliable, as Europeans found out once again in the present cold spell. Qatar has a moratorium on expansion and is totally dependent on the Street of Hormuz being open. Indonesia, Asia's prime LNG exporter, is exporting less as its prime gas field (the Arun field) is drying up and it needs more gas for domestic consumption and fertilizer plants. Australia gas is much more expensive (and partly sold out).
To assume that there wouldn't be interest in InterOil's prime assets, we have yet to see any even half convincing argument. Some of the shorts, like Whitney Tilson, argue that they have strong doubts whether the gas is actually there:
so even if InterOil has discovered a major natural gas field (which we highly doubt)
We're at a complete loss to explain that view since Tilson doesn't provide even a single datapoint, argument, or other form of substantiation in support. The first (of three yearly) GLJ reports is actually on-line in its entirety. It also sits oddly with his other arguments:
The government of Papua New Guinea appears to finally be waking up to this gigantic promotion because it's demanded that InterOil find an "internationally-recognized LNG [liquefied natural gas] operating partner," which is highly unlikely ever to occur
Well, for starters, if InterOil hadn't discovered a major natural gas field, then exactly why would the PNG government demand that it find an internationally recognized LNG partner? We could go on with Tilson's unsubstantiated blabble, but we've done so before.
Shorting an execution risk
It can even get worse (apart from Barry Minkow and crew). Just the other day, Investment Underground suggested a short in InterOil on earnings and something (we're not sure what) to do with Libya. Perhaps these Investors have stayed underground for too long, because InterOil has absolutely nothing to do with Libya.
With the short arguments this weak, they're basically shorting an execution risk. Yes, it's difficult to get this project off the ground, but it has been done before, in more difficult circumstances. So we can't see how the execution risk can be substantially more than something in the order of 10%.
It does need capital, but the quality of the resource, the probabilities of other substantial finds, and the booming Asian LNG markets are too good a backdrop for it to be hobbled by a lack of backers. In Australia, LNG projects costing several tens of billions of dollars are planned and built, serving the same markets. These mostly are unconventional gas resources (offshore or coal seam gas). Compared with those, Elk/Antelope and InterOil's monetization plans are simply an order of magnitude cheaper.
Well, it increasingly looks that the shorts are in a spot of bother here. InterOil's shares trade at roughly 60cents per Mcf while deals of comparable resources traded for $2 per Mcf upward. And we have to stress, this doesn't count anything for any of the other leads, one of these is being drilled right now (Triceratops) and we know it contains gas (per a well in 1959).
Also ominous is that the big institutional holders (Soros, Cap Re, Wells Fargo and a few others) have mostly increased, even during the political spat with the PNG government. At roughly $72 per shares now, we're not even at the $75 of the offering last year, in which management participated for a little over $40M.
Most of all, the price has kept on rising from $31 in October even in the face of a rising short count. This isn't exactly a very liquid stock, so any positive news is likely to cause further mayhem for the shorts. And there are quite a few possibilities:
- Triceratops drilling. We don't have to go all the way to the bottom of the well. The issue is whether there is a reef on top (seismics says there is), and whether that reef is a dolomite reef. If so, the field is likely to be a whopper and could even rival Antelope. Remember, this is an appraisal well, there is gas there. The question is how much.
- Any positive drilling news, which could come as early as next month, will greatly enhance InterOil's leverage and possibilities in negotiating deals with prospective partners. They could even sell off much of Elk/Antelope, pay a super dividend, and start over again with Triceratops and exploring the other possible reefs the seismics has indicated.
- Any official government sanctioning of the project will relieve any remaining lingering doubts about whether the PNG government is fully behind the project.
With the first tangible, albeit not surprising evidence of wider interest, there is one more risk that seems a lot less threatening (if it ever was serious in the first place). That is the risk that Shell (RDS.A), which struck a deal with PNG state-owned resource company Petromin (20.5% owner of Elk/Antelope) on last August 18, and is for some the preferred partner (probably as a result of that deal with Petromin), would enjoy a favorable negotiating position.
The PNG government cannot be seen to favor Shell over the Korean and Japanese companies since that is likely to create a considerable backlash for the government. So the more we hear about participation of other companies, the more open and level the playing field is likely to be. Which is terrific news for IOC shareholders.