Since the last time we wrote here about IOC a month ago (May 5), a lot has happened - apart from the share price rallying 30+%. A revisit is warranted. I think that a lot of uncertainty is being taken out as we speak, and the upside is now very, very significant.
Refinanced
The outstanding loan to Merrill Lynch and Clarion Finanz ($130M) was settled by two deals. Clarion agreed to a straight debt for equity swap of their part of the loan ($60M). InterOil issued 2.7M shares at $22.65 (which was about a dollar higher than the market price when the deal was announced, and probably quite a bit more when it was negotiated).
The remaining $70M was owed to Merrill Lynch. They apparently did not like the conditions Merrill Lynch were setting, so they went around with their hat, and hey presto, ended up with $95M in it. This is a pretty bullish sign to get that much at such short notice at these conditions, and the market took it as such.
Elk4 DST #1 and 2
We now had two DST tests, you can read the full results in the pr’s, PR1 and PR2. There are a couple of noteworthy points.
1) Flow rates increased with depth, from 8.3MMcf/d to 14.1MMcf/d
2) Flow rates have been negatively impacted by heavy skin damage resulting from:
“kill operations using heavy mud and lost circulation material. The calculated stabilized flow is the rate expected at the sandface of the reservoir if all the skin damage is cleaned up, which is a relatively simple operation in limestone reservoirs.” (PR1)
Although the calculated flow rate with zero skin damage (+/- 500MMcf/d!) is a little bit of a gimmick, they are right that heavy skin damage will severely reduce gas flows and that skin damage can be cleaned up relatively easily.
3) Apart from heavy skin damage, flow rates in the second DST test were also limited by “the capacity of the Drill Stem Testing equipment at surface” and “tubular constraints” (which suggest they’re using a very small pipe, using a bigger pipe would significantly increase flow rates).
Matrix porosity?
The heavy skin damage also indicates the existence of matrix porosity. In the words of Wayne Andrews (analyst at Raymond James, in an update May 14):
First, the company described pumping heavy mud with Lost Circulation Material [LCM], to stop the flow of gas and liquids into the well bore. The LCM works to seal porous formation, but depending on the type of material may not be as effective on fractures. The fact that the LCM was effective is a potential indicator of real matrix porosity, a very positive sign for reserve potential. However, and more importantly, the heavy mud probably caused near well-bore formation damage which may have hampered the flow rate of the well in addition to the drilling fluids that were being recovered during the test. Both of these give us confidence that the well will be capable of flowing at substantially higher rates.
It’s not the only indicator, as he argues elsewhere in the same update:
the visible matrix (vugs, chalky limestone) and fracture (visible micro-fractures) porosity along with shallow marine fossil evidence observed in cuttings from the well within the recently tested limestone reservoir.
Now, Wayne Andrews argued previously (RJ 11/04/07 p3), when discussing the Elk resource estimate (3.1-15.7Tcf at that time, increasing to 3.5-18.8 after Elk2):
The low end of the range assumes only fracture porosity contribution to reserves and excludes matrix porosity. The high end als includes matrix porosity.
So, if these multiple signs of matrix porosity play out, expect a big increase in the resource estimates.
Resource thickness keeps increasing
One has to remember that Elk1 (the discovery well) was not drilled to a finish, as the ELK1 did not drill the entire ELK formation as the well was not initially designed for drilling a very permeable high pressure gas formation. Elk1 was drilled to 1983m (6506ft), with a pay zone of about 1100 feet thick.
In a recent update (June 11 2008) after the second DST at Elk4, Wayne Andrews said:
This latest test has established a new Lowest Known Gas [LKG] level at 7,586 feet, confirming a substantial gas column height of 1,948 feet.
And:
Given our belief that both Elk and Antelope are part of the same structural complex, further testing and the confirmation of hydrocarbons at this level and deeper should result in a meaningful increase in the lower-end estimate of the resource in place and provide confidence to move ahead with LNG plans.
This is saying the pay zone of Elk has been increased from about 1100 feet thick to about 1900 feet thick. And since InterOil has already cored until 7815ft and still hasn’t encountered the water contact (they are executing DST #3 these days), it keeps getting bigger. This is another reason we can expect a big increase in the resource estimate.
Condensates
According to Wayne Andrews (June 11 update):
the condensate to gas ratio continues to rise - coming in at 12.4 Bbls/MMcf in this second Elk-4 DST, up from 11.2 Bbls/MMcf in the first Elk-4 DST and 5 Bbls/MMcf in the first Elk-1 DST. This higher liquid content suggests increasing condensate with depth, consistent with findings in gas caps on oil reservoirs and increasing the probability of encountering an oil leg with further drilling.
And indeed, in the second Elk4 DST, the condensates level increased further from 82 to 175 barrels a day. After the first DST test, Wayne already allowed for condensates to be included in his valuation of IOC:
Based on the estimated liquids content given the initial Elk-4 results, we are adding incremental value for liquid resource potential (69 MMBbls at $15.00/Bbl, risked at 50%) into our risked NAV, which essentially offsets the increased share count from the recent equity offerings.
These condensates can be used directly in InterOil’s refinery, providing instant cash-flow.
Oil?
As we have seen above, the increasing condensate level with depth (not only increasing depth within Elk4, but one also has to realize the payzone at Elk4 is a lot deeper than at Elk1) certainly point to the possibility of an oil leg.
Further, lab analysis of the specific gravity of the condensate, at room temperature rather than the heated temperature from the well bore, indicated 48 degree API, very close to crude oil. The fact that the specific gravity of the condensate is increasing with depth increases the probability of encountering an oil leg as the company deepens the well.
Valuation
Wayne Andrews first calculated the value of Elk by taking:
- 6.9Tcf, the midpoint of the then reigning recoverable resource estimate
- Value it at 75 cents per Mcf and risk it at 50%, effectively valuing it at 37.5 cents per Mcf
- Deducting third parties’ stake and applying 10% discount factor for cashflow.
Now, consider the following:
1) At the time of that valuation, gas was trading at $4, now, in Asia, it trades at close to $20
2) The 37.5 cent per Mcf valuation will have to increase as a result of a quadrupling in gas prices. But not only that, risk will also be removed when Elk4 completes and an independent third party assessment of the Elk/Antelope resource comes out.
3) From a story by Bloomberg: Petronas yesterday agreed to pay A$4.91 a gigajoule for proven and probable coal seam gas reserves from Adelaide-based Santos, which Santos Acting Chief Executive David Knox said sets “a new benchmark” for reserves valuations.
Calculating it back to US$ and Mcf, that’s a valuation of US$4.75 per Mcf. That’s 13 times the valuation Wayne attached to InterOil’s resource. Now, before we get too excited:
- These Santos reserves are proven and probable reserves. InterOil isn’t as far so a difference in valuation is warranted at the moment. However, they will be a lot closer with Netherland Sewell report and Elk4 concluded, which will move a lot of risk, and thereby reduce the risk factor and hence increase the resource valuation
- On the other hand, coal seam gas is more difficult and costly to extract (which is why, until recently, there wasn’t a lot of interest in doing it)
- The fact is, Santos also needs to build an LNG facility, they’re planning one. The first gas is expected to be delivered in 2014 (PR p15). So this is not unlike InterOil’s situation.
3) That valuation did not contain ANY provisions for oil, or any of the other 40 drilling prospects on 8.8M acres IOC has licensed in PNG. In a the latest update, some provision is being made for the liquids, but this is crossed out by the increasing share count as a result of the financing, leaving the NAV estimate essentially unchanged.
Shares short
InterOil historically has had a very high short count. The shorts have been there way before the Elk/Antelope discovery, and that is somewhat understandable. Exotic country, unknown company, lossmaking refinery. However, not only is the refinery slowly improving, the company has changed with the discovery of Elk/Antelope.
We’re now close to proving a resource. The shorts are still there because they didn’t believe this would be possible and it’s very difficult for them to get out without inflicting heavy losses on themselves. IOC has also been for 448 consecutive days on the naked short list, which is all but proof of foul play.
Other possible catalysts
The following items are set to propel the share price higher pretty soon after Elk4 has been completed:
- Netherland Sewell, a world-class engineering firm, will perform an independent audit of the Elk property
- An agreement with the PNG government about the LNG facility, giving Liquid Niugini (of which IOC holds a third) an almost unassailable lead over competing LNG projects
- An agreement with outside (Japanese, Korean) investors for a participation in the LNG facility
- The active negotiation with a strategic partner for the sale of a 10% interest in Elk, which has the potential to create an implied “industry” valuation several-fold higher than the market’s current valuation
- The possibility of farm-out opportunities to industry partners, which could further accelerate the exploration of the company’s extensive acreage position.
This article has 26 comments:
Altendorf
unite
Formal assessment has been done by Raymond James. Netherland Sewell is doing one as well, and they're at the well.
unite
We think a short squeeze will be highly likely once the well is finished and third party report is out. The well already had two good DST's, and they keep getting deeper so the resource is getting bigger.
Other funds will probably recognize the vulnerable positions of the shorts and turn on the screws, it's a pretty risk free strategy, especially when third party report is out.
Altendorf
unite
Perhaps you could explain why you called the company a scam even before your formal assessment? Could you substantiate that rather bold claim in any way?
By the way, Stocklemon hasn't writen any on IOC in 15 months or so, it sure looks like they're not following the story anymore (and in fact, they made statements to that effect). Most of what they had to say came down to "stranded gas" and financing problems. Perhaps, with four IOC financing deals in the last half year, skyrocketing LNG prices in Asia and three plans for LNG facilities in PNG, they might have realized 2008 is not 2006 (the year when they were actively following the story)...
Altendorf
www.nytimes.com/2007/0...
unite
And when you read this article, you just happened to immediately remember a newspaper article that appeared one and a half years ago, right?
And what does that newspaper article say is the relation between Enron and InterOil??
“Enron Survivor”, the article even puts this in the title. This guilt by association tactics turn out to be very thin indeed. Such a title would one lead to expect Mulacek to have had a career at Enron, and even having served prison time for wrongdoings there, something like that. In fact, it’s not anything like that. In 1997 one (of thousands) of Enron’s investment vehicles bought a small part in one of the predecessor companies, together with another company (Titan). Mulacek needed money for relocating the refinery, they invested. But this investment was soon superseded by the much larger OPIC loan, so it’s relation to Enron, which the writer of the article deemed important enough to mention in the title of the article, turn out to be nothing more than one of thousands of Enron’s investment vehicles at one part, more than 10 years ago, bought some stake in the predecessor of Interoil. Any evidence (or indications) of any wrongdoing here?? Nope. What you see though, is an effort to taint IOC with Enron.
If we use these kind of tactics, anything ever touched by any remote part of Enron would be tainted, including at least half the American government, including probably most of US energy companies, should I go on...
messages.finance.yahoo...
unite
unite
Who argued that short 'argument'?? It's complete baloney.
T Boone Pickens has 3M shares in this (apart from a masters in geology), don't you think that it would be the first thing he would wonder about?
unite
- the short argument is rather simple
- yet the geology is beyond you
- notwithstanding the fact that you claim to have a degree in geology.
This trio bites one another. Perhaps you could give any reference (textbook, or otherwise) that that short argument makes sense even in a theoretical fashion.
If that short argument would have any merit it would have been taken seriously by someone, especially because it is "rather simple". It would have been something Boone, or Wayne Andrews, or any serious investor would have taken it up.
I have read that article by some guy writing on value investors club. He has obviously no background in geology, nor geological knowledge, he doesn't use a single geological source (hardly any other), he wrote two-three years ago, only a handful of items since, the board has only a handful of participants, who didn't pose even a single critical question..
Anyway, the truth will be out shortly, by Elk4 and Netherland Sewell.
A word to the wise in investing, pay more attention to those that oppose your viewpoint rather than making personal attracts on them. An investment in any company should be dispassionate.
unite
2) I asked you for some textbook case of the short argument, as you claim to be a geologist. If their argument is that simple, it should not be hard to find...
3) Binary investment are risky only if you attach equal weight to the probabilities of the outcome. The whole article is actually arguing that one outcome is now overwhelmingly more likely. I did an earlier article, you will notice that I wasn't so optimistic then, but that was before two successful DST tests in their latest well.
4) The short argument is expounded three years ago on some hardly visited message board by some guy who doesn't use a single geological source and didn't had to field a single critical question. How credible is that?
5) A word to the wise in investing. Pay no attention to those that cannot substantiate their claims.
Ronnie
On Jun 19 04:59 PM mus wrote:
> Could today 's trading be a strategy from a short so the stock opens
> tomorrow down 30% and scare everybody....? I heard it was a mistake
> from a trader , whatever it is , people are getting REALLY nervous.
> Anybody?
Altendorf
ftalphaville.ft.com/bl.../
unite
Ronnie
On Aug 13 02:59 PM shareholders unite wrote:
> Many people have argued lots of nonsense about this company, including
> a UCLA lecturer (all meticulously documented on our website). Was
> anyone sued for that, Alan?? If you thought you had a case (which
> seemed the case, even before doing that "formal analysis" you promised
> "over the weekend"), why wouldn't you make it? Perhaps you can't
> argue with a 63MMcf/d DST test?
They go on to say that this is a vast criminal consipracy where the shorts are naked shorting and paying Interoil's adversaries to post on message boards. All in the name of trying to keep Interoil's shares down as opposed to covering.
He goes on to argue that the short sellers are engaged in a vast criminal conspriacy involving naked shorting and paying people to lie on message boards to keep the stock price down.
He does not believe that the stock is a binary outcome as he believes that its a sure thing that Interoil has found and will monetize its estimated natural gas find.
Further, he believes that the refinery itself is worth the current stock price.
unite
1) The three analyst covering it are all bullish to very bullish (Raymond James ($65), Nataxis Bleichroeder ($45) and Monness Crespi Hardt & Co. Inc (no price target, but you should read their reports...)
2) IOC has been on the regSHO list for almost 500 consecutive days, clearly this is not your garden variety delivery problem..
3) What do you think would happen to the stock price if 11M shares had to cover (it's roughly half the float)? Add to that a little extra squeeze from other funds and traders jumping on the bandwagon... That's all I argued. Covering is very expensive. Until all doubt is removed, they hang on.
4) They have two big gas/liquids finds in less than 2 years, even if not enough for LNG facility (which doesn't look the case anyway), there is another one in the making on PNG and a liquids stripping plant is a lot cheaper and faster to build..
5) The refinery is now profitable (at just over half capacity, show me another one that does this), the balance sheet cleaned up, there might be a downside, but it can't be a whole lot.