InterOil: Ripples In The LNG Project, But Not Cause For Concern

| About: InterOil Corporation (IOC)
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Discord in Papua New Guinea (PNG)? Not really.

We wrote a piece on Monday arguing that InterOil is well positioned to profit from the booming Asian LNG market. However, later that Monday evening (Tuesday morning in PNG), a newspaper article appeared that seemed to suggest there is some discord between InterOil and some PNG officials. Here are some relevant parts:

Govt warns InterOil Ltd

THE Government has warned that InterOil Limited, the developer of Papua New Guinea’s second liquefied natural gas project that it was not carrying out the project as agreed to in the Project Agreement. Minister for Petroleum and Energy William Duma yesterday issued the warning to InterOil Limited and its associate company, Liquid Niugini Gas Limited, the developer of the LNG project in the Gulf Province. In a press release, Minister said: “LNGL (Liquid Niugini Gas Limited) was not proceeding with the project which was agreed to between the State and the LNGL in the Project Agreement on 23 December 2009. “LNGL continues to misunderstand fundamentally the nature of the contractual obligations that it has under the Project Agreement, and is moving closer to repudiatory breach of the Project Agreement by proceeding with the Gulf Project. “At this point, the State will have no option but to accept that breach and seriously consider terminating the Project Agreement.”

Mr. Duma said. He is to meet with the InterOil officials in the next few days to iron out the matter. [PNG Post-Courier]

This sounds serious, so we feel it's necessary to provide a few explanatory remarks:

  • Yes, Mr. Duma does have something of a point. The agreement InterOil and the PNG Government signed in December 2009 contains a plan for monetizing InterOil's Elk/Antelope that has been subsequently changed somewhat.
  • InterOil's original plan was to build a large, traditional LNG plant next to its refinery at Napa Napa.
  • This plan shifted when Henry Aldorf came aboard (previously working at Marathon (NYSE:MRO), where he was responsible for building Marathon's LNG plant in Equatorial Guinea in record time.)
  • The new plan involves a modular (expandable) LNG plant (with partner Energy World Corporation, EWC) and a floating LNG plant (FLNG) build by Samsung (OTC:SSNLF) and Flex (The FLNG company from Norway), both in a different location (the Gulf province).
  • The new plan is at least a year and a half in existence and involves many advantages (faster monetization, no re-injection of condensates necessary, much shorter pipeline, sharing of infrastructure, cheaper LNG plants largely pre-built under controlled circumstances (Samsung wharfs and the like) rather than on site with complex logistics, skill shortages, etc.
  • Contacts between InterOil and the government are ongoing (the InterOil project is one of the largest prospective tax revenue generating project for PNG), so it is simply unfathomable that the government is unaware of the strategy change.

Indeed. Read also the following older (February 2011) newspaper article from PNG (for the whole article, click the link at the end):

Second LNG PNG Gets Thumbs Up
By Mohammad Bashir

Papua New Guinea's second LNG project which is expected to bigger and expected to produce 11 to 15 million tones got a step closer yesterday witnessed by Prime Minister sir Michael Somare, Treasurer and Finance Minister Peter O'Neill, Petroleum and Energy Minister William Duma, Gulf Governor Havilla Kavo and Police Minister Mark Maipaka and industry executives.

Pacific LNG Operations Ltd witnessed Liquid Niugini Gas Ltd, its Joint-Venture liquefied natural gas project company with InterOil sign a Project Funding and Construction Agreement (PFCA) and a Shareholders Agreement with Energy World Corporation Ltd. [AX: EWC] to construct a three million tonne per annum (mtpa) land-based LNG plant in the Gulf Province of Papua New Guinea (PNG), which is developed in two places, 2mtpa and 1mtpa expansion following immediately thereafter.

The agreement follow Pacific LNG Operations Ltd, September 2010 announcement of the formation of the partnership with EWC.

The PFCA and Shareholder Agreements with EWC are conditional reaching FID no later than 31 December 2011. However, as previously disclosed the current joint venture project schedule is for FID to occur simultaneously for the LNG plant and CSP by June 30, 2011 and combined plant start up approximately 30 months after FID. This now adds blessing to the already arranged agreement between Gulf Provincial Government and Energy International to have a Petroleum Park established at Orokolo bay in Ihu District Gulf Province. [LNG Watch]

So the same Mr. William Duma who is now, in his capacity as Energy Minister, 'warning' InterOil was actually present at the celebrations marking the agreement with a partner (EWC), executing a new strategy which is not (entirely) reflected in the 2009 agreement between InterOil and PNG. (There is another report confirming the above here).

So it's not that he wasn't aware of the change in strategy but the problem is that it's not entirely reflected in the 2009 agreement document. However, if reality on the ground doesn't (entirely) reflect the 2009 agreement, then the easy option is to change the agreement.

Since InterOil and partners are close to final investment decisions (FIDs), expected before the end of this year, it is clear that abandoning the new plan and going back to the old is not a realistic option. It is in the interest of nobody, least of all the PNG government, as it will lead to (significant) delays, which would also delay a tax revenue bounty for years.

There might be some unresolved issues between the parties but as the (first) newspaper article above states, InterOil and government officials are going to meet in the next few days to sort things out. We have seen this kind of stuff quite a number of times so we don't lose any sleep over it, (so far, neither has the market, IOC shares are actually up since this came out).

InterOil shares are cheap, valued at below 50 dollar cents per Mcf (thousand cubic feet of gas). Basically, there is 8.59T of gas in their main field, Elk/Antelope, with prices well above $10 per Mcf in Asia. This alone represents $80-$120B in value (not even including the condensates or other fields). With total project cost budgeted at $3.6B (and most of that paid out of gas revenues with 14.5% earmarked to the plant builders), there really is ample margin for error here.

You might also have noticed (in the second newspaper article above) the presence of Peter O'Neill at that ceremonial signing of the agreement with EWC. As it happens, O'Neill is now PM, and he is very supportive of InterOil's LNG project. From Wednesday's PNG Industry News (for whole article, click the link):

PRIME Minister Peter O’Neill has increased his commitment to supporting the Gulf LNG project in Papua New Guinea after Petroleum Minister William Duma threatened to terminate the government’s LNG agreement with the InterOil-led consortium.

The Gulf LNG project is targeting 5 million tonnes per annum in 2014 with 3 million tonnes per annum from an onshore modular LNG plant and the rest from a floating LNG facility, while a slated expansion aims to ramp up the total Gulf operations to 8Mtpa through 2015 and 2016.

These plans to commercialise the Elk-Antelope discoveries in the Gulf province are somewhat different from the project’s earlier Liquid Niugini Gas incarnation which aimed to build a 6-9Mpta LNG plant adjacent to InterOil’s oil refinery at Napa Napa.

In a statement reported by the Post-Courier newspaper this week, Duma attacked InterOil’s joint venture partner Liquid Niugini Gas Limited for moving close to breaching the Liquid Niugini Gas agreement struck with the government in late 2009.

“At this point, the state will have no option but to accept that breach and seriously consider terminating the project agreement,” Duma reportedly said.

InterOil is yet to make a statement responding to these claims – but O’Neill has already made a swift response.

The new prime minister recently stated that his government will not tolerate “any interference” designed to delay the progress of the Gulf LNG project.

With a final investment decision expected by year-end, O’Neill said all government assistance would be provided to InterOil and its partners to reach this milestone.

He believes this project is as important to the country as the ExxonMobil-led PNG LNG project.

Consequently, O’Neill intends to appoint a senior member of his staff to liaise directly with both joint ventures to ensure that neither project is hindered by “political and bureaucratic nepotism”.

Last, but certainly not least, you might also want to consider a PNG newspaper article from The National on Monday (for the whole article click the link):

PM assures security for investors

PRIME MINISTER Peter O’Neill has assured foreign investors, especially in the mining and petroleum sector, that government will not create insecurity, political risk or threaten foreign investment with expropriation. “Let me reassure you that the goal posts have not been shifted and relocated because the playing field remains the same and shall be maintained that way for the foreseeable future,” he said du­ring a business luncheon.” [The National]

We conclude by saying that for all sorts of reasons, politicians everywhere say stuff, (PNG is no exception, needless to say). It's better to focus what they actually do.

With respect to that, the picture is actually a lot brighter. InterOil's own history on PNG is rather smooth and there are plenty of other foreign companies present. PNG, with a bounty of natural resources (metals, energy, etc.) is actually a pretty welcoming destination for foreign direct investment (FDI).

Although there are the problems you'd expect to be related to a relatively underdeveloped economy (infrastructure, skills, etc.), the PNG economy is actually booming as a result of the foreign investment.

FDI remains critical for that growth to continue; we don't expect the politicians to seriously endanger that.

Disclosure: I am long IOC.