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Barry Minkow from the FDI claims IOC is a "great Ponzi scheme". He commissioned a geologist, Bertoni, to proof these claims. Did he? Uhhh, not really...
This article appeared earlier as Daily Distortions 31, the shorts attack InterOil again 

While drilling proceeds smoothly at Antelope2, the following story came out. Barry Minkow, who we featured before and whose business model is to short stocks, write reports accusing the company in question of some misdeeds (at least on one occasion financed by a hedgefund) and cash in. He (and understudies Howard Sirota and Sam Antar) did that with Herba Life and USANA Health.

Not always successful, but it depends what you mean by success. Today's world is ruled by perception, and if you can create the perception that something is wrong, that's often enough to produce a desired effect. Authorities have found no wrongdoing at USANA and Minkew even had to retract all his accusations against Herba Life.

This time, Barry has hired a geologist by the name of Renato Bertani. He will, according to the newsstory out today, put a lot of question marks over InterOil's resources. How exactly he's going to do that from the comfort of his desk is quite another matter, but let us put some rather large question marks over that newsstory out today.

• For years, the energy company has made encouraging announcements about its progress in finding natural gas at its key Papua New Guinea drilling project - talking of a "world class" find, or a "world record" flow of gas, or a flow so strong that stemming it was like "trying to stop the Mississippi."

Note how the impression is created that IOC has claimed they have big things for years, while in fact they've drilled only four wells in the Elk/Antelope structure. Indeed, InterOil argued, with the help of seismics and information from the earlier wells, that the structure is large, based on their geological interpretation of Elk/Antelope.

Fact is, the more they've drilled, the more their geological model proves to be right, even old foe Ross Smith Energy Consultancy, in a rather embarrassing about-face, had to admit as much.

Note also the quote from InterOil's CEO Phil Mulacek, about "stemming the tide of the Mississippi". This actually refers to the problems they had in controlling the gasflow at Elk1, the first discovery well drilled in 2006, read Mulacek's the quote in full:

• The size of the discovery was so large, Phil E. Mulacek, InterOil's chairman and chief executive, informed an analyst, that simply controlling its output "was sort of like trying to stop the Mississippi." [NYT]

They had such problems in controlling the gasflows that they had drilling mishap which we believe was covered by an insurance company. After a few earlier disappointing discovery wells they were ill prepared for 100MMcf/d gasflows.

We also wonder what else one could call a 2000 ft net payzone with 8.4% average porosity and a 382MMcf/d flowrate with only 1/3 of the pipe open anything else than 'world-class?' In fact, it was recognized as such as Antelope1 (from which these metrics come from) made the cover of World Oil Magazine in May this year.

The newsstory announcing Barry Minkow hiring a geologist continues with:

• Yet, despite InterOil's optimistic statements, it's never been able to report any proven, viable gas reserves under regulators' standards.

This is such a clear indication of a negative bias. For starters, only recently has InterOil received an independent resource assessment from Canada's premier outfit GLJ Petroleum Consultants. They put the resource at 3.4Tcf (P50), but it's important to realize that this figure only included data up to 31 December last year.

That means that almost all data from Antelope1 (the record vertical payzone, record flowrate, porosity) wasn't included. Antelope1 is by far the best well, so that number can only rise significantly with the inclusion of Antelope1 data. And indeed, there is a newer independent resource report from Knowledge Reservoir that put the P50 number at 6.7Tcf.

To argue that IOC has never been able to prove reserves when they don't (yet) produce any carbohydrates and have only just been evaluated by third parties is a bit of a hoax. We have written about the resource/reserve distinction before, but ponder over the following statement from the OilSearch yearend report:

• When a final investment decision is taken, OilSearch will move approximately 580 million BOE from reserves to resources (P2).

A final investment decision will do something similar for InterOil. So basically, the argument from the shorts is circular. They won't build an LNG facility because they don't have reserves. But the truth is, if they decide to build the LNG facility, most of their resources will be instantly classified as reserves.

For amusement purposes we'll give you a taste of what some people write on the message boards about this:

• "Does labelling gas in the ground resource, rather than reserve change, in any way, the assessment of the QUANTITY that's in the ground??" Yes it does. It makes it much more likely that the quantity is ZERO. [Bostonkenmore]

This is the same character that was featured in the first ten episodes of this 'Daily Distortion' series, but he seems to have moved up in his world, as it looks like he had early knowledge of this "news" coming out (see here and here). It certainly looks like he didn't want to provide a link to the story (links are not his forte anyway) as the story only came out later that day (August 11):

• A yahooo message board is not the place to present evidence of fraud. Evidence of fraud is for securities regulators. Not a yahoo message board controlled by Interoil insiders. [Bostonkenmore]

We go back to the newsstory:

• Now, two of the company's biggest critics contend that some of InterOil's rosy statements have violated securities regulations. And these critics speak from experience: They're both reformed financial criminals.

Is that experience relevant? Hardly:

• Barry Minkow and Sam Antar, who now work to uncover corporate fraud, allege that InterOil misled investors when it indicated that drilling tests it has conducted at its gas find validate its plans to build a gas-processing plant that is critical to the company's future.

So their 'experience' as convicted financial criminals gives them insight into resource evaluation? Really? More insight than GLJ Petroleum Consultants, the premier independent resource evaluator that assessed Elk/Antelope as having 3.43Tcf even before including all the most important data from their best well by far, Antelope1?

The 3.43 is already enough for a single train LNG facility, but since it doesn't include the best data from Antelope1 the figure will be significantly higher. (Indeed, a later report by Knowledge Reservoir put the number at 6.7Tcf.) So we can't wait to see how that geologist hired by Barry Minkow, who is short in IOC and paid the geologist out of his own pocket, will arrive at any different conclusion.

And how is he going to do that? That's another interesting topic. Here is our friend Boston again:

• Investors should know. None of the energy companies mentioned endorses Interoil or their finds. I would advise you NOT, to imply that Schlumberger has endorsed the company or its claims. GLJ, has only made resource evaluations based on data given to it by the company. If you mention this again, I will call Schlumberger and give them your name and let them know that you are using their name to promote a fraud. [Bostonkenmore]
• Interoil and Interoil alone provided the data and most importantly its interpretation. No other firm has endorsed the data they have collected or its interpretation. [Bostonkenmore]

Our question would be: how would this hired geologist arrive at any radically different conclusion when it can only rely on the same data at best, and no independent data (we'll leave aside the nonsense about imposed interpretations by InterOil)? One could say that there are different "interpretations" possible, but that implies that one interpretation is better than the other.

Which one would that be, the interpretation of Canada's most reputable independent resource evaluator, or that of a hired hand of a shorting ex-con. Neither have access to any independent data, according to Boston, and the hired geologist has at best access to the same data, but probably a lot less. We'll leave you to answer that question..

We also strongly believe that many of the parties interested in parts of the InterOil business (see here for a summary) will bring their own geologist to go over the data. The report goes on with:

• Minkow contends, that InterOil misled investors when it said in March that its testing "clearly confirms" its gas discovery has enough resource potential for the company to proceed with plans for the LNG plant. In that same statement, InterOil acknowledged that there is "no guarantee" that the gas it has found will ultimately be able to be extracted and sold commercially.

While the onus is on the critics to prove that GLJ is wrong to conclude that there is 3.43Tcf of gas (even before Antelope1), of course there is 'no guarantee' that it will be produced. InterOil needs government approval (pending) and outside parties to finance the LNG facility. Until that happens, there can't be guarantees, but funny enough, if that happens, much of InterOil's 'contingent resource' will change into 'reserves'. Funny because the shorts argue IOC won't be able to build the LNG facility exactly because they "only have contingent resources, no reserves."

The report goes on:

• What can be said, though, is that this adds to the stockpile of questions about InterOil  - such as the recent concerns about whether InterOil had omitted information from its public disclosures about who helped it raise $95 million in a critical financing last year.

A "stockpile" of questions? The author could mention only one, very tangential, unproven issue of which even Boston argued that the SEC was not likely to take any action. Even Barry Minkow says on his websites that it is the authorities that determine whether any fraud has been committed..

• It's also clear that the company still has nothing to show for its years of work - no proven, viable reserves, still. Years in which it's raised several hundred million dollars from investors, lenders and partners in a series of stock offerings and other financings, aided by those optimistic statements about its progress. InterOil has a market value of about $1 billion. If its claims about a world- class gas find prove valid, maybe it's worth that much, or more. But that's the question, isn't it? If.

Still has nothing to show for it's years of work??? Huh? Three wells flowing way more than all of OilSearch's combined, refinery moved to profitability, balance sheet cleared up, independent resource reports vetting its resource, long-term critics Ross Smith turning around, etc. etc.? Nothing indeed...

And then the market cap of $1B, which the author (a certain Michael Rapoport) claims would be the maximum, if it's claims are valid. No Mr. Rapoport, if IOC's claims are valid, it will be worth a multiple of this, as we've set out, for instance here.

Pretty useful links:

• Morgan Stanley's first IOC report Sept.18 (target $65)
• Morgan Stanley's update Oct.14 (target $67)
• Morgan Stanley's update Oct.26 (target $73, bull $142)
• All InterOil research reports

InterOil is establishing an integrated energy business on Papua New Guinea (PNG). It's record setting Elk/Antelope discovery. It recently got a boost by a research report from Morgan Stanly's top energy analist Evan Calio giving it a strong thumbs up (you can read the whole MS research report here) and providing it with a $65 price target.

That $65 target even excludes anything InterOil is finding in it's appraisal well Antelope2, which has already identified the top of the payzone.

Now, there is a second LNG project on PNG, led by Exxon/OilSearch. In a recent newspaper article, Energy Minister Duma supposedly said that PNG

it will not be possible to have two similar projects running at the same time.

We doubted that Duma actually said that, because he had previously been very supportive of the InterOil LNG project. But without proof of the contrary, we could only express our disbelief.

We didn't have to wait long for proof that Duma hadn't said this, as Energy Minister Duma came out with a statement himself

Minister Duma catagorically denies the statements attributing to him and says that the InterOil led project is also a priority project for the PNG Government.

As a preemptive strike against possible further misinformation he went on to say:

Only signed statements from the Department of Petroleum en Energy representing the position of the PNG government and the Department should be relied upon.

A couple of weeks before that, Prime Minister Somare also felt he had to come out in public support of the InterOil LNG project.

So we know now that there are attempts at creating an overly negative picture on the prospects of prompt project approval for InterOil's LNG plans. Some, like Raymond James' Pavel Molchanov, seem to have changed their stance as a result.

Raymond James even altered it's NAV value (including only the P1 'proven' value for the resource from an earlier report) for the company to accomodate these perceived political uncertainties. 

There are two resource reports on InterOil, one from GLJ Petroleum Consultants and a later one from Knowledge Reservoir. The GLJ report had a cut-off date at 31 December 2008 and could not include all the salient data from InterOil's Antelope1 well:

• over 2000ft of net payzone (more than 10 times those of the previous wells)
• 8.8% average porosity
• confirmation of a reef structure
• record flow rate of 382MMcf/d and 5000MMbbs/d condensates with the choke only 1/3 open.

So the GLJ report ended up ascribing a P2 resource value of 3.43Tcf of gas and a P1 value of 2.32Tcf of recoverable gas and 36.7MMbbs of condensates.

A later report from Knowledge Reservoir argues there is 6.7Tcf of gas if one includes these data from Antelope1, while we remind readers that the drilling of the next well, the appraisal well Antelope2, has already identified the top of the formation.

Raymond James, therefore, has become quite backwards looking. Nevertheless they arrive at a NAV value of $48 per share, and even they admitted that:

Ultimately, we believe the project will be approved

We believe the false newspaper article provides evidence that the political situation is not nearly as grim as people (including those at Raymond James) seem to think. Anyway, the worst case scenario is a delay in approval as the PNG government has much to loose if it dithers for too long.

They have a 20.5% stake in the Elk/Antelope field, they will have at least a 10% (but possibly 22.5%) stake in the LNG facility itself, and they stand to lose a project that could double the size of their economy in a mere six years.

Their reputation as a reliable business partner and the PNG investment climate is also at stake. We also remind people that even without official approval of it's LNG facility, InterOil can go ahead with a liquids stripping plant (the end product can be used at InterOil's refinery) and even has a fair chance of hitting a commercial oil zone at Antelope2.

Oil was recovered in Antelope1, but at a depth where porosity and permeability were insufficient for it to flow in commercial quantities. The payzone at Antelope2 is situated lower, so the chances of recoverability are higher.

But even without a commercial oil leg, there is every reason to be excited about InterOil's prospects, as one can read in the very thorough report from Morgan Stanley, which was titled

Major Transformation Going Unnoticed

And indeed, comparing it with other projects in the region InterOil's metrics came out on top, according to Morgan Stanley.

It's break-even price is $3.70 per Mcf, while that of the rival Exxon/OilSearch project is $5.01, and the Australian projects have a break-even price between $6-8 per Mcf.

The political delay in approving InterOil's LNG project seems therefore related to the threat the other LNG project on PNG (the Exxon/OilSearch project) seems to feel from the superior InterOil project.

But since Exxon/OilSearch has already sold out all it's gas in long-term supply contracts (averaging $12 per Mcf), the waiting is only for them to get their finances sorted out and take the final investment decision, which will happen before year-end.

So InterOil seems a bit of a victim of its own success, but not for long. Before that, possibly exciting news from Antelope2 can arrive any time now and deals relating to a stripping plant are likely in October.

We have written a lot about this company before. It operates in Papua New Guinea, and has discovered a massive natural gas and gas liquids resource called Elk/Antelope.

On count by GLJ InterOil has 3.43Tcf in resouces, a later report including the record braking Antelope1 figures by Knowledge Reservoir puts that number at 6.7Tcf.

The Antelope1 well was so good that even long-term sceptics Ross Smith Energy Consultants became a fan. Not difficult to imagine, with a net pay zone of some 2000 feet, average porosity of 8.8% (with parts of the reef reaching 30%), and a gasflow of 382MMcf/d (plus 5000 barrels of liquids) with the 6 inch choke only open for 1/3.

The company has hired investment bankers to strike deals with interested parties (there have been rather a lot of these, see summaries here, here, and the latest development, Indian Petronet wanting to buy the whole project output) to sell of parts of the resource and stake in the LNG project.

A potential bottleneck is Government approval of the project, and there was news on that this morning.This appeared in the Post Courier:

Decisions vital for LNG plans
By eric tapakau

• PAPUA New Guinea will continue to carry the “developing nation” tag if leaders do not make good decisions on the number of liquefied natural gas projects that the country would like to have. It will also not be good if members from the ruling National Alliance Party are split over which LNG project they are backing.
• Senior NA Party ministers objected last Wednesday to a cabinet submission made by Prime Minister Sir Michael Somare and Minister for Petroleum and Energy William Duma in a bid to get cabinet approval for the development agreement to proceed with their LNG project development. Liquid Niugini Gas Limited (LNGL) is a subsidiary company of a consortium of financial and industry partners led by InterOil Corporation to develop PNG’s second LNG project at an initial investment output of $US5 billion.
• The project is expected to source gas from InterOil’s massive Elk-Antelope gas fields at Upper Purari River in Gulf Province. Mr Duma explained to cabinet on Wednesday that the State and InterOil had exhaustively negotiated all the terms and conditions in the project development agreement over the last two years and the project agreement then before cabinet on that day was project agreement draft version number 13.
• At that stage (last Wednesday) the Department of Petroleum and Energy had formally granted its clearance for development of development of the LNG carrier pipeline from Gulf Province to Port Moresby and for development of the LNG export plant facility development to be developed at Napa Napa adjacent to InterOil’s oil refinery inside Port Moresby Harbour. Minister Duma also explained that the submission before Cabinet also came with State Solicitor’s clearance of the LNGL project development agreement.
• After Mr Duma’s explanation his colleague ministers mostly members of the Ministerial Economic Sector Committee strongly objected to the submission saying that PNG was not ready for a second LNG project at this time. According to Government officials, one of the main arguments for the committee was that the gas found at Elk and Antelope needed to be proven to be commercially viable to support such a massive project before any commitment is made to approve the second LNG project.

-------[End of newpspaper article]--------

So let's summarize:

1. After exhaustive negotiations, there is Government approval and approval by  all the relevant and necessary state agencies
2. On a ministerial level, there exist some objections, but nobody is suggesting it's a bad deal
3. The argments used for those objections are completely bogus (see below)
4. Lets also not forget what's at stake here for the PNG, the Government, and the economic prospects of the country. The government already participating rather significantly (22.5%) in the project. A project like this will more than double the size of the economy over a six year period.

Surely the Government doesn't want to run the risk of delaying these opportunities and taint the image of PNG for years to come?

Let's look at the argument the opponent use for a moment. Lack of proven reserves. A relevant question would be how much proven and probable reserves the alternative project, the one led by Exxon and OilSearch has. The answer is surprisingly. Surprisingly little, that is. Just 70.5Bcf, that's not even 0.1Tcf..

They have ample resources (in fact, there is already talk of a third train for their LNG project), but so has InterOil, 6.7Tcf according to a report by Knowledge Reservoir that included the data of Antelope1, by far the most prolific well. (An earlier report by GLJ largely excluded these data and nevertheless arrived at 3.43Tcf).

In a couple of weeks, when the reef will be confirmed at Antelope2, the "argument" of the opponents will look even more ridiculous. The claim that Elk/Antelope might not be economical already is just that, ridiculous. With wells that are 20 times as productive for 1/3 of the cost compared to OilSearch, and coming from a single resource in the lowlands, rather than six different resources in the higlands as is the case for Oilsearch (forcing the latter to build a pipeline that is three times as long), it is not reasonable to argue this, to put it mildly.

No idiot is questioning the viability of the OilSearch project, despite the fact that many of Elk/Antelope metrics are actually better, much better. And the economics for OilSearch are already good. It has long-term offtake agreements averaging $12 per Mcf, while it's cost base is just $3 per Mcf. InterOil's project, with the resource so much more economical and an LNG facility budgetted at half the cost of OilSearch's, can only be better.

So something funny is going on there with these ministers who are objecting. It is the only rational conclusion possible.We won't spell it out, but we have some ideas.

They will look rather silly when InterOil strikes the reef in Antelope2. They could conceivably look a whole lot more silly still when InterOil announces a preliminary deal with a third party (offtake, farm-out, participation, could be anything like that) before (and dependent upon) formal Government project agreement. That would create a pretty awkward situation for the Government.

Such a situation would basically be tantamount to InterOil demonstrating that they've done their part, "over to you, Government, do you really want to be the one delaying progress?" Would these Government ministers want to be seen as the bottleneck? We don't think that is likely.

Surely the PNG Government wants to avoid a situation in which InterOil would not be able to progress because of the lack of Goverment agreement. Such a situation could potentially be exploited politically by the opposition (and political tensions between Government are already rather high).

InterOil's track record shows it has been a good corporate citizen (one really can't say that of all foreign companies operating on PNG soil), and there is no sign or suggestion they make unreasonable demands. Even the ministers with objections do not argue that the agreement on the table is not a good one.

But ultimately, no Government is going to delay a golden goose of this magnitude..

In fact, we conclude this is actually good news:

1. There is a Government agreement
2. Nobody, not even the detractors, suggests it's a bad agreement
3. The 'arguments' of those who object are silly, and will become a whole lot more silly soon
4. So this objection is not likely to last too long.

And in fact, the market seems to agree with this reading, as the price is recovering from yesterday's sell-off. We think there is compelling value in InterOil's shares, it is profitable, has greatly cleared up it's balance sheet, sits on ample resources that are only in the first state of exploration (it has a further 4.6 million acres to explore with many interesting structures besides Elk/Antelope) and the economics of the LNG and liquid stripping plant are compelling.

There is also a reasonable chance that the oil found at the bottom of Antelope1 will flow in commercial quantities at Antelope2, as the poreus rock is situated deeper in the latter well.

That would turn their 36,500 barrels capacity refinery which operates at just over 20,000 barres refinery which presently imports crude overseas into a real money spinner..

Comparing the two projects that are scheduled to deliver LNG for the lucartive Asian market from 2014 onwards, we arrive at the conclusion that InterOil's project has significantly more upside..

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