If we had to summarize, it’s simple. The economics are just way too good. Here is why.
1) The favourable geology at InterOil’s resource (Elk/Antelope) produces very low extraction cost. It’s a conventional gas resource, which flows without special drilling techniques which have to be used in unconventional gas fields like shale gas or coal seam gas (CSG). The latter are hobbled by having to drill, treat (fracture), and man thousands even up to 20,500 (Conoco/Origin) wells.
Why? Because the gas doesn’t flow without expensive fracturing (and horizontal drilling, as in the case of shale gas), and because over the life time of unconventional wells they produce only a fraction of the gas compared to conventional wells. InterOil’s two wells flow so profusely that with the two wells already finished, they can already supply 40% of the LNG facility.
2) Those very low resource cost as a result of favourable geology are compounded by other, very hard to beat cost advantages:
- Some of the lowest labour cost around. Compare that to the competing CSG projects in Australia
- Few, if any restrictions on using foreign labour (like Filipinos). Compare that to the competing CSG projects in Australia
- Very favourable tax and regulatory environment, compare that to, well.. CSG in Australia, Canada, not even mentioning many politically much more awkward places like Algeria, Nigeria, Iran, Russia, etc.
- No participation in expensive carbon trading schemes (compare that to.. CSG in Australia, Canada, etc.)
3) Supplying gas to a high demand, high price area. There is no world market in LNG (the infrastructure to create that is just not there), so gas prices differ hugely. PNG, and therefore InterOil, has the luck to be the lowest cost supplier in the highest price environment, Asia. Prices are more than double those in the US.
4) InterOil’s potential partners are not meaningfully affected by the credit crisis and have deep pockets and a long-term view. Partners come from two categories:
- Big Oil companies
- Asian Utilities
The first have their coffers filled with cash, and actually have too few new exploration possibilities, mainly because regimes in many places where these are located, from Russia to Iran to Venezuela, to Saudi Arabia play either hardball or have nationalized the oil and gas industry (this is known in the industry as ‘political peak oil’).
5) The consequences of ‘political peak oil’ are:
- Many, if not most of the best prospects for oil and gas drilling are now off-limits to big Western oil companies, increasing the value to them of those that are.
- Huge under-investment in world energy infrastructure (exploring, drilling, maintaining, building facilities, etc.). There where the best resources and potential resources have come under political control, political motives usually reign, and the authorities (many of which would not be in power without their energy bounty) have little to no incentive to invest billions of dollars, only costing them money and lower prices in the future. They have every incentive to keep prices up and just spend the money lavishly for political purposes. This further increases the value of those promising prospects on territories with more market friendly approaches.
One of these promising prospects definitely is Papua New Guinea. So we have oil companies with plenty of cash and too few exploration and drilling prospects, and we have InterOil with exactly the opposite. A pretty good match, we would say.
6) Asian utilities are scrambling to secure gas supplies.
- Indonesia, the regio’s big supplier, is cutting back exports. China has even started to import coal last year.
- Asia is much less affected by the credit crisis (compared to the US or Europe), it has too little energy resources of its own, and energy needs are growing rapidly, with middle classes swelling in places like India, China, Vietnam.
- Asia is the most populated continent, and has huge pollution problems, the need for clean energy is even higher than that for energy as such. Gas is much cleaner compared to oil and especially coal
7) In the present climate, with falling energy prices and tight credit, marginal projects will falter, like CSG in Australia. But this fall in energy investments will only set us up for more dramatic energy price rises when the world economy recovers. Which will likely be well before 2014 when InterOil is planning its first LNG deliveries..
Supply might suffer because of decreasing investment, but when demand recovers, this can only mean one thing..
9) Why is there no deal yet, some people wonder? Well, InterOil just finished only the third well. Independent resource evaluation hasn’t even been concluded. But they had talks with many (14 is the number we hear) interested parties. We think a deal probalby more than one, will be in before the year is out. The economics are just too compelling.
10) We might also have to remember people that:
- InterOil has a profitable retail business and refinery, the latter only producing at less than 2/3 capacity, with further important room for improvement, especially with other big projects (Exxon’s LNG, for instance) going ahead on PNG
- Have almost 9M acres with many structures with similar geology, many different promising drilling prospects
- Will likely get a liquids stripping plant going, providing lots of cash flow within two years
- Absolutely none of this is priced in.