Interoil Corp.: Massive Drop Presents Huge Buying Opporunity

Jul. 2.07 | About: InterOil Corporation (IOC)

Enough Is Enough Watch: Interoil Corp. (NYSE:IOC) -- is this the end? Early well results trip up stock. In a nutshell this is an over-reaction.

IOC is down from $44 to $19 in four days -- a 58% plunge since Tuesday. The fall started the day after the company's annual meeting and a day before they announced preliminary drilling results at their Elk-2 appraisal well in Papua New Guinea. Rumors have been that the well is dry, casting doubt on the ability of the Elk structure to support a proposed LNG facility.

IOC chart 02 07 2007

IOC has two main areas of operation: 1) a small 38,500 bpd refinery which accounts for the vast majority of the company's revenues. And 2) an exploration arm that has had some notable successes. A LNG project is expected to be underpinned by one of these, Elk, discovered in November 2006. At present revenues and cash flow are derived almost entirely from the company's midstream assets. But the snap to the story is the potential for the LNG project.

In its well report last Wednesday, the company failed to report test volumes for the still drilling Elk 2 well, a 5 kilometer downdip stepout designed to help delineate the size of the initial discovery, which is estimated to contain several Tcf of gas, enough to support the development of an LNG facility.

While initial results do not confirm a commercial gas discovery, the well is not yet at total depth. At 5,920 (?) the ELK2 was said to be near its target objective, the Puri limestone. At 8,684 (?) the well was 1200 feet into the formation and was still not deemed commercial. However, drilling results are required on a weekly basis for Australian firms and for many exploration wells drilled in this part of the world, and in this case I think investors are jumping the gun. In the U.S.,these results would not have been released and this opportunity to scoop up cheap shares would not have arisen.

Balance sheet: Solid. Lowish debt to equity for an E&P of this size with a respectable cash position.

Most importantly, yesterday IOC announced it had reached a deal to continue the preferential interest rate of 4% on a $130 million secured credit facility through May 2008 underwritten by Merrill and Clarion Finanz AG. All parties say they are now "encouraged with the interim results of the Elk-2, and the overall resource potential in the structure which can underpin the joint LNG project."

In yesterday's press release, the company reiterated a few points that seem to have been ignored by the Street about the Elk-2 well:

  • gas was produced to the surface (though how much is in still in question),
  • logs show heavy gas and gas liquid compositions,
  • downhole pressures of 3,800 psi are very good (higher than in the discovery well),
  • gas concentration is increasing with depth,
  • to date, the gas water contact has not been reached nor has a targeted oil leg,
  • so far, a 2,300+ foot gas column has been encountered!

Summary: This almost certainly gaps up in the morning, and I'll take a few calls at the open if reasonable, but also after the stock takes a breather and the quick buck artists hit the exits. I'm looking very a very significant bounce here folks.

IOC 02 07 2007