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Morgan Stanley puts a $65 target on InterOil

|Includes: InterOil Corporation (IOC)

InterOil is establishing an integrated energy business on Papua New Guinea (NYSE: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.