For over a decade, InterOil (IOC) has been exploring oil and gas wells in Papua New Guinea. Most of its early test sites flamed out, but then it came upon a discovery of gas in test sites called "Elk" and "Antelope". Eventually In December 2009, InterOil made an agreement with the Papa New Guinea (PNG) Government on a plan to monetize InterOil's Elk and Antelope gas wells.
The investor debate has raged on for years: is InterOil sitting on a perpetual cash cow, or is it all a bunch of "hot air"? This debate will soon likely be coming to a close because of InterOil's slow pace and constant extending of target dates. The PNG government has now reached its last strand of patience.
The reason why speed is important, is because a slow development is directly hurting future profits. As slow as InterOil is moving, by the time they're finally ready to ship the gas, if the agreement doesn't get cancelled, it will at the earliest be between 2018-2020. That's very late to the natural gas export game and by 2020 and beyond the arbitrage differential between the price of natural gas in Asia compared to elsewhere in the world will have gone down a lot. One energy specialist portfolio manager suggested Asian natural gas prices will quickly go from the $18 MMbtu price it's at today, to around $11 MMbtu or lower. This is because there currently is a frenzy of natural gas export projects going on all over the world, lead by Australia. Eventually, the only difference between natural gas prices in Asia and elsewhere will be the shipping costs and the liquefaction/regasification costs. Australia, currently the "world's LNG supermarket", has over 15 natural gas export projects in development and its natural gas production is expected to triple in the next 10 years.
Judgement Day Approaching
In 157 days, either InterOil won't find a partner and the project agreement will either be terminated or in serious jeopardy, or they will find a partner and the stock will go up. It's just a waiting game now for the shareholders and the short sellers with a clear upcoming catalyst. Without the expected gas earnings, InterOil's other projects and current earnings make the stock worth at best $15.
On May 14th, 2012, InterOil revealed a news release that that I interpret to say:
The Government is upset that we are moving too slowly with the agreements we made three years ago with them in developing the wells and finding a major partner. They say they'll terminate our agreements in 180 days if we don't find a major partner. However, our lawyers say if push comes to shove, we'd win a legal battle. They have also given us six months to sweet talk them and make them feel more comfortable.
The PNG Government is very worried, and rightfully so. They are in a race against time since, as stated above, the longer it takes, the less of an arbitrage opportunity there will be with exporting natural gas. They don't want InterOil messing things up what could be a great resource for their country. That is, if it does turn out to be a great resource like InterOil says it is. InterOil is a small oil company, in talks with all kinds of small partners to each take a piece of this huge endeavor, but none of these partners are committing any capital unless InterOil passes certain milestones. This includes the blessing of the Papua New Guinea government. The government has a responsibility to its people. If InterOil is moving slower than what was decided upon in the agreement, or doesn't secure a major partner, then PNG has every right to break the agreement. An article just came out in The National stating that InterOil's latest talks with the government have begun to break down.
No Signs On Getting A Major Partner
From my research, I find it very unlikely that InterOil will find a major partner in the next six months. As slow as InterOil goes, six months will pass like the blink of an eye. In October of 2011, the Company hired not one, not two, but three major investment banks to help them find a major partner. Today, seven months later, there has been no sign that the major partners like Shell, BP or Chevron have any interest. It's clear that the majors aren't falling over themselves trying to secure a deal. There hasn't even been any reports of them inspecting the wells.
InterOil claimed to be in talks with Chevron to fulfill this operator role, although Chevron had yet to make a formal statement on the matter. It was reported that Chevron representatives met with PNG treasurer Don Poyle. PNG Energy Minister William Duma said that he never spoke with Chevron, and only knows that Mr. Poyle encouraged Chevron to invest in the country. "Poyle did not encourage Chevron (CVX) to work with InterOil", said Mr. Duma. What this sounds like to me, is that the PNG government is on their hands and knees begging a major oil and gas company to take over the projects in PNG. They could care less if InterOil is a part of it or not, as long as the resources are extracted.
Some investors are getting fed up with InterOil's delays and broken promises. Investordave59 on IOC's message board on June 6th posted:
After holding IOC for over 4 years, I sold my entire position today after receiving the annual report yesterday. If you read between the lines in the annual report, it is obvious that Phil is extending his target dates yet again. He now states "soon" for target dates on FEED, FID, and operator partnership. I guess Q2, 2012 is now just a dream. The fine print also mentions that several of the parcel licenses expire on MARCH 2013!!!!! I was unaware of this until I read the annual.
The PNG government should void all IOC licenses and find a major that can actually monetize the resources of the country.
Phil has failed IOC shareholders.
A couple days ago I published a bullish article applauding Cheniere Energy's (CQP) progress to becoming the first natural gas exporter in the United States. The bearish argument is that the $10 billion that Cheniere needs to build its liquefaction trains is too much for the company to handle for future revenues. Compared to InterOil, however, Cheniere's problems are peanuts.
All Cheniere needs to focus on is building a Liquefaction plant, for which they have started and now have a clear trajectory to begin shipping the gas by 2015 or 2016. InterOil, like Cheniere, also needs to build a liquefaction plant, but they are nowhere near starting it. They aren't even sure yet whether it will be on land or in the water. They also need to finish getting seismic data and spudding the gas wells. Then they need to case the wells and drill deeper. Then they'll need to build the pump and pipeline to the liquefaction plant. Given that Cheniere's liquefaction plant alone will cost $10 billion, InterOil's project costs are probably in the range of $20-$30 billion!
Getting back to basics, InterOil hasn't even proven the gas reserves yet. They only have gotten estimates from third party consultants and geologists. Upon speaking to an energy analyst, not proving the reserves yet is a big red flag. "Prove your reserves already!" he said.
"InterOil Corporation today announced receipt through an unofficial channel, from the Department of Petroleum and Energy (DPE), of a copy of a notice of intention to cancel the 2009 LNG Project Agreement between Liquid Niugini Gas Limited and the Independent State of Papua New Guinea. Having considered the issue carefully with our external advisers, we are strongly of the view that the State has no right at present to terminate the Project Agreement. The notice does activate a six month consultation period during which the parties are to explore steps to deal with or remedy the DPE's concerns."
This is my translation of InterOil's news release.
Disclosure: I am short IOC.