Let’s start with IOC first. This gripping story is nearing the finish line. In two or three weeks, we’ll know the outcome of a DST test which will say a lot more about the deliverability of the gas they found at Elk. We’ll also know the outcome of the renegotiations of the loan from Merrill Lynch (about $70M of the total $130 is due to Merrill, the rest to Clarion Finanz).
These two uncertainties are what keeps the price down these days, but they could have a dramatic impact on the share price (hence we advised a hedged option strategy). We argued that the bar is pretty low for Elk4, they only have to prove the deliverability of the gas already found at other locations for it to be enough for at least a single-train LNG project to go ahead.
SInce Merrill is 1/3 owner of that planned LNG facility, logic has it that they have every reason to be accomodating with IOC in terms of finance, at least until the drilling results are out (and depending on those results). However, there are two arguments that mitigate this:
- Merrill is not in the best financial shape
- Merrill might have a pretty strong bargaining position vis-à-vis InterOil in the short-run (as any student of transaction cost economics would recognize). Getting $70M elsewhere on such short notice might not give InterOil the terms they would otherwise be able to get, so Merrill could ask for a bigger slice of Elk, or other prospects.
Although we seriously questioned whether this would be in their own longer-term interest, we do have to acknowledge the possibility that Merrill might be tempted to play hardball in the short-run. The shorts seem to take advantage of this possibility, as the short-count has gone up to over 10M.
InterOil’s bargaining position would be tremendously boosted if we had positive drilling results before the loan is due. We do think positive results are likely, but whether they can make it in time, well, the jury is still out.
If Merrill is indeed trying to take advantage of a short-term advantage in bargaining positions it would jeopardize relations with InterOil and the progress of the LNG facility (IOC and Merrill are ahead, but are not the only ones planning such a facility in Papua New Guinea). That would be stupid. But stupid things do happen.
We think it is all most likely part of a ritual negotiation dance. Both parties have too much to lose in the long-term to seriously jeopardize their relation. But you never know. Sometimes, this kind of bargaining acquires a dynamic of its own.
Our theme has repeatedly been, cheap (considerably less so than when we first argued it as a buy, less than two weeks ago), fantastic company, but… repeatedly running into resistance (200 day moving average at 45/46), and, general market basically is not to be trusted.
Well, today seems to be another good example of all three of these themes. Good fundamental news, as we reported earlier, enthusiastic run-up from the open today, then running into resistance and a bad general market to boot. Patience, patience. We had a nice run-up already, so little reason for complaint.