In the present rough market climate, InterOil (IOC) should offer a nice upside (or better) for those that want to hide from the market mayhem elsewhere. While hardly immune to volatility itself, things are finally coming together for the company.
The company had drilling success, confirming a new big recourse (Bwata-Triceratops or BT). It immediately concluded a rather lucrative farm-out deal with Pacific Rubiales (PRE), and, most important of all, the tension with (part of) the government seems to be waning as three different investment banks are busy clobbering a deal together that monetizes the gas. That process is nearing completion.
Booming Asian LNG market
While the American natural gas market is plagued by oversupply and historically low prices, the gas, or rather, LNG market in Asia is booming. This is the result of various trends, like:
- Strong economic growth
- Reduction of greenhouse gases
- Pollution in cities and the need to shift away from coal
- The Japanese nuclear disaster (at present, all 54 Japanese reactors are decommissioned).
This has resulted in LNG spot prices of a whopping $18 per mcf (thousand cubic feet, or mmbtu which is roughly the same), a our year high. Compare that with American Henry Hub gas prices of less than $3/mcf. It's no wonder that:
Japanese companies are buying natural gas assets and fields around the world, setting the nation on course to be the first of the 10 largest energy users to bet its future on a less-polluting fuel than oil or coal. [Yahoo]
This booming LNG market is a nice backdrop for IOC to conclude deals.
The T2 well confirmed a large (1800ft) gas and liquids column with 5.2% average porosity and the field is large (up to 40,000 acres). The preliminary well data (and the data from the two existing wells and the seismic data) was good enough for Pacific Rubiales Energy to take a 10% stake in the PPL237, where the resource is located for a total of $345M. The final resource payment is based on $3.85mmbtu for proven resources and $2.85/mmbtu for probable resources.
While these numbers have to be discounted into the future (to something like $2.35 for the 2P numbers), they are a multiple for what the market values IOC shares at the moment (which is about 50 cents per mmbtu). We also bring to your attention that none of the analyst covering InterOil has even ascribed any value for the Triceratops/Bwata resource, and while good, the initial well data isn't in the same category as that of the Antelope wells.
In previous articles, we've tried to figure out what exactly the objections of the Minister of Energy to the Gulf project were. To fresh up your memory, InterOil planned a traditional LNG plant at Napa Napa, and had an agreement with the government in December 2009 for that.
However, InterOil subsequently changed these plans and intended to go with a modular LNG plant from EWC of Australia and a floating LNG (FLNG) plant from Flex of Norway, to be build by Samsung Heavy Industries (SSNLF.PK) of Korea. At first, the Government was on board with that, since the new plan has numerous advantages:
- Much less total capital as well as up-front capital is needed
- Expandable (modules) and largely off the shelf technology produced by Siemens (SI) and Chart Industries (GTLS)
- Both the modular as well as the FLNG are not build on-site, greatly reducing logistical complexity and the risk of cost and time overruns (one might want to check out the Australian LNG project to assess these risks..)
- Much quicker build, so no re-injection of gas after stripping the condensates by Mitsui (MITSY.PK) of Japan
- Much shorter pipeline (the Gulf is 1/3 of the distance from Elk/Antelope resource compared to Napa Napa).
We thought that the initial start-up capacity of 5mtpa, as well as the lack of a 'world-class' operator were the sticking points for the Minister of Energy (whose objections materialized only in the spring of last year). Which is why we expected the Gulf project more or less in its proposed form to go ahead. However, there are other interpretations possible so we're not at all sure of that anymore.
It could very well be that the companies IOC and the investment banks is negotiating with would prefer their own technology, which could result in a traditional LNG plant build in the Gulf. It isn't inconceivable that two types of plants will be build if IOC sells a big stake in Elk/Antelope (or even all of it) and, brimming with funds, goes on a drilling spree and discovers more resources.
These aren't even necessary as Bwata/Triceratops could very well be monetized with a modular and/or FLNG plant and the funds from any Elk/Antelope deal will likely go a long way to de-risk such project, should InterOil chose it (rather than sell the gas to the new operator for Elk/Antelope).
We know that a consortium consisting of Japex and Mitsui of Japan and Kogas of Korea have a strong interest in joining with InterOil:
Korea Gas, known as Kogas, is stitching together a consortium involving Mitsui and Japan Petroleum Exploration that aims to join InterOil's proposed gas-export project in Papua New Guinea as a strategic partner, a person familiar with the matter told Deal Journal Australia. [WSJ]
Perhaps one should pause a moment here and reflect on the following facts:
- Japan and Korea are the top two LNG importers in the world
- Kogas is Korea's sole LNG importer
- Mitsui is already involved in the project as it's going to build and finance a condensate stripping facility CPS
It's difficult to imagine that when rival regional powers and LNG heavyweights Japan and Korea join forces to participate in the project PNG politicians would want to snuff them all to openly.
There are even more possibilities as Exxon is building a big LNG plant and pipeline, IOC could sell its gas to Exxon as well. We're pretty sure at least some of these possibilities are discussed and are in an advanced stage. There are rumors galore on the message boards (of course, much of these should be taken with a pinch of salt) and the stock price, and especially the option market have rallied strongly. The amount of out of the money June calls is truly staggering.
After what seemed a last ditch effort from parts of the DPE (which seem to favor a participation by Shell), the department for energy, to cancel the project agreement (and call for 6 months of talks), politics has taken a more moderate tone. PM O'Neill, denied that the DPE has cancelled the project:
O'NEILL: The Department of Petroleum and Energy is continuing to monitor the gas agreement that the developer has signed with the government and of course, some aspects of that agreement is yet to be fulfilled by the developer. But the decision to either terminate that agreement or not is up to Cabinet after Cabinet deliberates on that matter. But I can assure you that it is in our interests and our country's interests that while we are moving towards the end of the construction of the first LNG, that it's very important that we maintain the growth of our economy. First LNG contributes about three percent of GDP to the growth of our economy. We must sustain that by making sure we allow the second LNG to progress to the development stage. So we are working closely with both the developer and the other stakeholders in that project and the NSC will be reviewing what has been proposed by the department. [Radio Australia]
InterOil took the unusual step of announcing it had received evidence from an "unofficial channel" that the Department of Petroleum and Energy aimed to cancel the government agreement with it over the project. Duma since denied that was the case but more importantly, Prime Minister Peter O'Neill went on the record saying any such decision would need to be a National Executive Council decision (involving key cabinet ministers). [PNG Indusstry News]
And he seems to think an agreement is basically a done deal:
I was faithful in my portfolio as the Minister for Petroleum and Energy and delivered to this nation the much talked LNG project and second LNG in Gulf," he said. [Postcourrier]
Now, of course this is electoral posting, but it was quite a notable remark nevertheless. We are not blind to the political risks, especially since PNG elections will be held in June. However, it's in the interests of all that the project gets underway and as long as InterOil manages to deliver a project that abides by the terms of the 2009 agreement with the PNG government, there is little reason for them to cancel it.
Consider the following facts:
- InterOil's shares, even after the rally in the last two weeks, are still noted at 50 cents per mcf
- This excludes any gas from Bwata/Triceratops (BT), for which PRE payed $345M for a 10% stake
- BT is, so far, of a lesser quality (although not necessarily of a lesser quantity, as it is geographically larger) compared to the resource of which parts (or even all) is on offer, Elk/Antelope (EA). If the lesser quality resource fetches $2/mmbtu+ (fully discounted), it sets a benchmark for the better quality resource. That's at least four times the present stock valuation.
So why is the stock valuation so low? Because of the perceived risk, but that would largely be eliminated with a deal as well, setting the stage for much higher valuations. Even a lower priced deal for part, or even all of EA would produce a substantial rally. InterOil will suddenly be awash in cash and have plenty of funds for doing what it does best, exploration of its prime portfolio of 4 million acres with 54 leads and prospects, 12 of which are possible reefs (resource rock with very high porosity, which makes the Antelope wells flow at world records).
InterOil could still go ahead with 'it's own LNG project' on the basis of gas and liquids from BT (and possible additional finds). The cheap expandable modular LNG concept is ideally suited for that.
Add in the mix the 9M+ shares short, whose only remaining gambit can only be the political uncertainty in PNG and the stage is set for a rather big rally. This situation hasn't escaped some of the biggest investors around, like billionaire Richard Chandler, who buys big chunks of IOC shares on a daily basis. His position now well over 10%, drying up the float.
We can't predict which bidding party will win, the Japanese-Korean consortium, Shell, Exxon, or a yet unidentified bidder are all possibilities. What we do know is that the process is coming to an end, that the bidders are of more than sufficient weight for PNG not to spoil the party (why would they?), and that the price is almost certainly be a whole lot more than the 50 cents per mcf that IOC shares fetch on the market today.
Disclosure: I am long IOC.