Interoil's Elk Project: Third Time a Charm?

This is a bet. A bet that the third time is a charm. Interoil (IOC) has found gas, a lot of gas, in Papua New Guinea. The question is, is it enough gas (multiple TCF) to justify an LNG facility. The company thinks so. As does their banker Merrill Lynch and an analyst at Piper who has a $65 price target. A third well on the ELK structure is currently turning to the right in an effort to answer that question. The well definitely has make or break potential for the stock. A stud gives you a quick trip to $30; a dud an ugly fall to $10.

A little history is in order:

The ELK area contains multiple high porosity limestones with an excellent shale seal. The map below shows their activity to date in this relatively undrilled region.

The Discovery Well, ELK 1:

Initial results announced: October 2006

This was 6,500 foot test that encountered a 4,000- foot hydrocarbon column in the Mendi and Puri fractured limestones.

• Had some down hole issues (swelling and sloughing) early on which probably explains the heavy duty casing program on the current well, the Elk 4.
• Encountered very high pressure gas below 5,000 feet.
• Production test: 7" pipe flowed at 50 MMcfgpd with 2,000 psi. Calculated actual open flow rate was 150 MMcfgpd.

ELK 2 - The first appraisal well - October 2, 2007.

• A quote from the company:

The Elk 2 appraisal well has confirmed conductive fractures, porosity and deliverability and a larger rock volume and better than anticipated reservoir quality , which indicated increased potential gas resource in the Elk structure.

• They logged 663 net feet of pay with an average porosity of 4.5%

• Drill stem test (DST) indicated high permeability in two limestone: the Mendi and the Puri.

• These are the kinds of words and figures you would want to hear about an appraisal well.

Then they said this: The well was drilled to a TD (total depth) of 10,922 feet. The gas water contact may be at 7,596 feet but highest known water recovered in the well was at 8,777 feet and that everything above that level was tight with only small amounts of gas produced and no liquids.

And they did not production test the well from the deeper, high porosity limestones.

They then said they were suspending the well for possible future re-entry and moving the rig to the Elk 4 location. Shares immediately fell 24%.

The Stock's Reaction Wasn't Pretty

click to expand.

ELK 4: The Next Big Event:

As Elk 4 is much closer to the discovery well than Elk 2 and has been drilling for several weeks now we should expect the well to encounter pay zones much earlier than in the Elk 2. Preliminary results on their Elk 4 well should be out around month end. These results could and include length of hydrocarbon column and log data (gas saturation, and potentially porosity and permeability depending on what kind of logs they run).

Major Holders: Institutional owners hold 47% of the company. The top 5 hold 25%.

Note the fourth name down on the list is BP Capital, T Boone Pickens' outfit. They took their position in August after seeing the results of the Elk 2 well. T Boone also owns about two million shares personally.

High Squeeze Potential: 11 million shares short out of 30 million outstanding. That's over 1/3 short and would take 18 days to cover given IOC's average volume.