One of the most significant events in the InterOil saga was the recent announcement that the company will give 100% of its production above 4Tcf to the Papua New Guinea government. I take this as an admission that no energy major was interested in partnering with InterOil because of the dubious value of its resources.
Now that the billion dollar question is out of the way I am feeling nostalgic for the days when I would listen to InterOil bulls talk about how Exxon was going to buy them out and other such nonsense.
In 2010 I met Phil Mulacek, InterOil's CEO, and Henry Aldorf, an executive at Pacific LNG. I had always been skeptical of InterOil because of heavy criticism from short sellers, and I went into the meeting with Mr. Mulacek and Mr. Aldorf with a closed mind. Mr. Aldorf talked about the difference between resources and reserves, a controversial point regarding InterOil, and this put the short sellers' criticism more into perspective. I do not believe InterOil is committing fraud. I do, however, believe that it may not be economically beneficial over the long run to build the LNG project that InterOil has proposed and therefore I have a bearish view on the stock.
Some highlights from our meeting:
There's several questions about reserves and resources. Resources are how you build LNG. Every LNG project is built on finding natural gas and it's classified. You sign a little piece of paper saying that you have identified X amount of gas, and there's no difference in the gas. That gas molecules have been there for 4 million years and they haven't changed in two days. Then you sign a contract. The difference between reserves and resources is signing a contract.
It's like asking a cattle rancher in New Mexico that's got 10,000 head of cattle and asking "Does he have beef?" You know, the guy has to slaughter a cow, put it in the fridge, but is he gonna kill all of his cows just to justify somebody saying that it's not prime rib? No! No one would do that! You have to maximize the value and sell it over time and try to put meat on the hoof. And appreciate that value. That's what a rancher does. We do the same thing in energy. We take in natural gas, and we remove as much risk as we can.
I've been in the energy business for a long, long time. My last function was at a major called Marathon. I was the VP of Global Upstream Business Development and part of the executive team leading that company. My claim to fame at Marathon was the building of a LNG facility. Marathon had built a LNG facility, indirectly, about 40 years ago in Kenai, Alaska together with ConocoPhillips. But Marathon didn't do anything until 2003. Didn't have anybody who knew integrated gas. I was at the time the head of Marathon in Asia. They asked me to come back and see if we could get a nat gas project running. So we developed what is today the standard of LNG projects as far as speed, efficiency are concerned.
I should say one more thing. I'm not working for InterOil. I work for the large shareholder Pacific LNG which is affiliated with Clarion Finanz, which is affiliated with Carlo Civelli, the major partner in that.
A little bit about Pacific LNG because nobody knows totally what it is. Set up by Clarion Finanz AG in Switzerland. Pacific LNG owns about 20% of the Elk Antelope Fields. We own about 47.5% of Liquid Niugini which has the project agreement with the government of Papua New Guinea and is therefore licensed to develop gas in Papua New Guinea. We are also a major shareholder of InterOil. So we have a lot riding on this investment.
Where are the Elk Antelope Fields? This is the southeast area of Papua New Guinea. Port Moresby is right under here. And InterOil owns about 3 million acres in that area, which is a huge portfolio. Exxon is up here in the heights. Out of this 3 million acres, the Elk Antelope field is only less than 2%. There are many arteries around here, which are today exploration potential. We say that the comparable is 18Tcf. I think the area could be as high as 25 to 30 Tcf. I can say that because I'm a private company! [Waits for audience to laugh.] Exxon has about 25. It's in all different type of areas, very far apart. And a big margin ranges between it. One of the biggest problems is to aggregate all that gas and bring that all the way down to the coast and then send that all to Port Moresby.
This is what is misleading and people who don't understand gas have to understand what is the difference between resource and reserves. Resource becomes reserves once you have what we call a gas sales agreement and you have a SPE contract in place to develop the gas. These are the SEC rules. Therefore, some people say, well, InterOil doesn't have any reserves. No. Nobody has huge gas resource and has not yet put a full development plan forward and has not signed these particular contracts that can claim reserves. But their resource goes immediately to reserve category once the gas sales agreement and SPE contract are there. It has nothing to do with whether the gas is there.
Disclosure: I am short IOC.