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Dry hole?

April 25th, 2008 · No Comments

There are those that argue that Elk2, InterOil’s first appraisal well after they discovered a massive amount of natural gas at Elk, is a ‘dry hole’. It’s an argument one encounters with some regularity on the message boards, and it has an important bearing on Elk4 and the whole Elk property. Does it have any merit?

Well, yes and no, but mostly no. First of all, message boards in general, and the InterOil Yahoo board in particular are places were some oddballs compose rather loose rantings. In this case, there is even a guy who argued Elk1 is a dry hole, really.

He could not name any source (let alone a credible one) and he’s certainly not hampered by any in-depth knowledge about the company (he was blissfully unaware who Hamilton was – CEO of Liquid Niugini -, and he argued that the refinery had a decade of losses – it’s only in operation for three years -, which he vehemently denied just a day later until someone showed the quote).

We might bring some more amusing examples of those rantings on the boards in the future, but now back to Elk2. A dry hole, the shorts argue. Well..

Here are some facts on Elk2

  • It flowed 40.000 barrels of water (hardly dry, ha!) in a DST test
  • The water was heavily gas saturated.

What conclusions can draw from this?

  • The limestone that contains the gas was largely under the water contact at Elk2
  • However, the limestone did flow. And this is crucially important. Porosity and permeability, indications on whether the gas flows, and how saturated a formation can be, were good. Otherwise it would not have flowed 40.000 barrels of water a day in a DST test.
  • If the limestone at Elk2 would have been above water, it would almost certainly have flowed substantial amounts of gas.

The market had a sell-off, so on the surface, it seemed the doubters were right. However, we published a newspaper article yesterday containing several interesting quotes on the aftermath of Elk2. It might be worthwhile to revisit that.

There are a few other facts which put further doubt on the ‘dry hole’ thesis:

  • resource estimates were, in fact, increased (from 3.0-15Tcf to 3.5-18.8Tcf). Not quite the disaster, apparently
  • T Boone Pickens bought a very big part of the company (10%) after it became known what happened at Elk2. Now we don’t say Boone will never make a mistake, but there must have been something he liked. Most likely, the market misinterpreting drilling results. He saw an opportunity.
  • Experienced analyst and geologist Wayne Andrews of Raymond James said that positives outweighed the negatives and increased his target price to $65.

Now there are people on those message boards who have used every conceivable argument to belittle Boone’s 10% stake. (He might have sold already, he got his shares for free, he can afford to lose, etc. etc.).

The fact of the matter is, he holds a 10% stake, he is an industry legend, and holds a masters in…. geology. Now could it be, that he saw something in those drilling results that others didn’t? We’re somehow pretty sure he did his homework.

To conclude, the naysayers do not have any geologist of reputation, in fact, they do not have any geologist at all, who will come out and argue the short case. Now why would that be? (The same guy from the boards argued that they were afraid of lawsuits. Indeed.).

How is this all impacting Elk4? Well, it says something about the likelihood of success.

  • Two out of two drills in Elk showed gas, and good porosity and permeability
  • The limestone at Elk4 is not below the waterline. We know that from the extensive seismic studies done in the meantime.

Although he gets ridiculed these days, Wayne Andrews argued today he came out arguing the early signs at Elk4 are promising. Do we have any experienced geologist arguing the opposite?

Tags: IOC