Interoil: Let's Get Ready To Fumble

On the other side are those that argue that, even with IOC's $4 Billion valuation (despite any potential production of its resources being years away IF it can manage to pull together a multi-billion dollar monetization scheme), the stock is not only cheap, but very cheap, and shareholders are on the cusp of imminent riches.

Good luck trying to find someone with a position in between these extremes. The truth often lies in the middle.

One of the reasons the debate has raged on and intensified is quite simply because, for whatever reasons, the company has yet to deliver on a monetization scheme for its Elk/Antelope natural gas field in Papua New Guinea that was first drilled in 2006. IOC's independent resource evaluator, GLJ Petroleum Consultants has estimated 5.1 Tcf of initial recoverable sales gas (net to InterOil, best case) of initial recoverable sales gas based on a total estimate for the Elk/Antelope fields of 9.1 Tcf. An older report by internationally recognized Gaffney Clinecompleted a "full review" according to InterOil. Apparently parts of this report have been leaked on the Internet showing that, while a lower gross number of 6 TCF (which would represent about 3.5 Tcf net to IOC), the contingent resource estimate is large. I would also note these figures do not include a material amount of associated natural gas liquids.

One would think that an attractive resource that was first drilled over 7 years ago (with the higher quality Antelope reef penetrated over 4 years ago), that IOC would have had many credible options to bring that gas to market.

Unfortunately, as a gas field located in harsh terrain deep in the Papua New Guinea jungle, things get a little more dicey. With no local infrastructure (InterOil had to fly in drilling rigs by helicopter and wells were enormously expensive costing many $10s of millions each), and no use for the gas in PNG, the only realistic way of monetizing the resource is through Liquified Natural Gas (LNG) technology and infrastructure. This would involve the construction of an LNG liquefaction plant and associated infrastructure, a pipeline to the plant from the gas field, and a ready market to purchase the LNG once it has shipped from PNG.

As you may well imagine, such things do not come cheap. They are very complicated, and very expensive, costing many billions of dollars. Exxon Mobil (XOM) and Oil Search Limited are currently building out PNG's only LNG project at a cost of over $19 Billion. InterOil claims it can build a project 20% larger for about 50% of the cost (a phased 8mtpa plant for $9.3 Billion).

Adding further wrinkles, Papua New Guinea is politically unstable(despite the current period of post-election relative calm), with high levels of corruption.

Not surprisingly, as a relatively small company with no LNG experience, and about $100 million in working capital as at Dec 31, 2012, InterOil has had to go looking for partners to develop a proper monetization scheme for the field. The following table gives a very brief summary of the history of IOC's attempts to monetize Elk/Antelope:

You'll probably notice that the table above stops in September 2011. That is because the process started over 19 months ago is still ongoing. This is interesting as the company seemingly had a running start with "inquiry from potential LNG partners" in September 2011.

Rather than explain what has happened with the partnership process since 2011, I will instead provide direct citations from IOC filings. I will avoid verbal comments made by InterOil's CEO during this period as the filings and press releases are sufficient to give readers a sense of what the company has indicated:

Date	Quote / Source
Sep 30 2011	"The considerable strengthening of the Asian LNG market, the increased interest in exploration and investment in Papua New Guinea, as well as the Company's reservoir analysis and project design fundamentals lead the Company to believe that now is an attractive time to seek a partner."Press Release
Nov 14 2011	"While we look forward to a prompt conclusion to this process and to our discussions with the PNG Government concerning the Gulf LNG Project, we continue to pre-invest in our Gulf LNG Project and the civil works and the front-end engineering and design" Press Release
Dec 22 2011	"InterOil Corporation (NYSE: ) ("InterOil" or the "Company" announced that it has extended the dates by which certain conditions are to be met and Final Investment Decisions (FID) made in LNG project agreements with Mitsui and Energy World Corp, until March 31, 2012." Press Release "The Board of Directors of InterOil is ready to make a Final Investment Decision to proceed with its LNG project in the Gulf Province, and is committed to working together with the PNG Government to move the project forward." Press Release
Mar 19 2012	"We continue to work with our existing LNG development partners and the PNG government to advance our LNG project towards first production. Simultaneously, our advisors are managing the process of soliciting and evaluating proposals from potential strategic LNG partners"Press Release
Apr 17 2012	"The Company is pleased with the process being conducted by the investment banks and the number of bidders involved in the process. Selection of the preferred LNG operator is targeted for the second quarter of 2012." Press Release
May 14 2012	"We are continuing to work with our advisors to obtain a strategic partner. We have received conforming and non-conforming bids for the LNG partnering and sell down of an interest in the Elk and Antelope fields that we believe would be accretive to shareholders. We are now set to engage with a shortlist of significant LNG industry participants with a view to concluding discussions and entering into an agreement this quarter." Press Release
Aug 13 2012	"With the sound backing of the new administration in PNG, we are continuing to work with our advisors to finalize selection of an LNG equity partner" Press Release "We have received conforming and non-conforming indications for the LNG partnering and sell down that we believe would be accretive to shareholders. We are engaged with a shortlist of significant LNG industry participants with a view to concluding discussions and entering into an agreement." Press Release
Nov 15 2012	"Following receipt of the required PNG Government approvals, InterOil believes it will be able to conclude the LNG partnering process." Press Release
Jan 2 2013	"On November 15, 2012, InterOil was notified that the National Executive Council (NEC) of Papua New Guinea had approved a proposal to build a 3.8 million tonnes per annum LNG plant in the Gulf Province of Papua New Guinea. The approval received from the NEC is in line with the proposals from our potential LNG partners. Since then, InterOil has been working with the PNG Government to complete a modified LNG project agreement and to secure an internationally recognized operator of the proposed facilities, consistent with the NEC approval. InterOil expects that these actions will allow it to promptly complete the partnering process." Press Release
Jan 24 2013	"Separately, InterOil announced that it has advised bidders with which the Company has been in discussions that the final binding bid solicitation period for the partnering process currently being undertaken will close on February 28, 2013. The InterOil Board of Directors intends to meet the Company's advisors during the first week of March 2013for the purpose of evaluating bids received and selecting our partner(s) for the development of the Gulf LNG Project utilising gas from the Elk and Antelope fields in Papua New Guinea." Press Release
Feb 27 2013	"On November 16, 2012, we were notified by the Prime Minister of Papua New Guinea Hon. Peter O'Neill that the National Executive Committee had conditionally approved our LNG development project in the Gulf Province. We believe that this decision clears the way for us to complete the LNG partnering process and proceed with our plans for the development of an LNG plant in the Gulf Province with initial planned output of a minimum of 3.8 million tonnes per annum." Press Release "Subsequent to year end, on January 24, 2013, we announced that we have advised potential bidders with whom we have been in discussions that the final binding bid solicitation period for the partnering process currently being undertaken will close on February 28, 2013. Our Board of Directors intends to meet our advisors during March 2013 for the purpose of evaluating bids received and selecting our partner(s) for the development of the LNG Project utilizing gas from the Elk and Antelope fields. " Press Release
Mar 1 2013	"("InterOil" or the "Company" is pleased to announce that its advisors have informed the Company that several bids to partner with InterOil in its Gulf LNG project have been received. Our advisors are now evaluating the submissions. The InterOil Board of Directors will meet the Company's advisors during March 2013 for the purpose of evaluating bids received for the development of the Gulf LNG Project utilising gas from the Elk and Antelope fields in Papua New Guinea." Press Release
Apr 15 2013	"InterOil has received bids from potential partners in connection with the development of the Gulf LNG project and an interest in the Elk and Antelope fields in Papua New Guinea. Confidential negotiations with more than one bidder are ongoing, and the process is moving forward as planned. InterOil will provide further comment once these discussions have closed and an agreement has been reached." Press Release

IOC's share price has been understandably volatile since late 2010 when the company raised capital at $75 per share:

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Now just when it seems that maybe, just maybe, InterOil is about to finally ink at least some kind of deal with one or more partners, what happens?

InterOil ("InterOil" or the "Company" today announced theretirement of its founder and Chief Executive Officer, Phil Mulacek, effective April 30, 2013. Mr. Mulacek will continue as an InterOil director and will provide advisory services to the Company. A global search is now underway for a new CEO to lead the Company through its next stage of development. InterOil Chairman, Dr. Gaylen Byker, will assume Mr. Mulacek's duties on an interim basis from May 1, 2013 until the search process is complete.
- Press Release April 23, 2013

Quite a curious development that the founder and major shareholder of the company would "retire" with only a week's notice while the company is supposed to be on the verge of signing what is clearly the most important deal in the history of the company.

Expectations seem to be very high, as IOC's enterprise value approaches $3.8 Billion:

IOC's Midstream - Refining business sporadically generates EBITDA ($2.1 million in FY 2012, $61 million in 2011):

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The downstream (gas stations and fuel distribution in PNG) fares a little better:

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Taking the average EBITDA of both business over the past two yeas I get approximately $70 million. Applying a generous 5X EV/EBITDA multiple to these business they are perhaps worth $350 million, or $7 per share.

What this means is that virtually the entire market cap of IOC is relying upon a successful monetization of its gas resources. And that success must support a net present value of at least $3.5 billion to keep IOC's share price flat.

Some investors clearly expect a "blockbuster deal". The delivery of such a transaction would certainly skewer many a short thesis and could trigger a short-covering rally. If, on the other hand the company fumbles and either delays the process further or delivers a sub-par deal, I would expect heavy pressure on the shares.

"There's an old saying in Tennessee - I know it's in Texas, probably in Tennessee - that says, fool me once, shame on - shame on you. Fool me - you can't get fooled again."

- George Walker Bush

Additional disclosure: This article reflects my personal views only. I have a short position in IOC stock. All data and calculations presented are accurate to the best of my knowledge but have not been vetted, checked, proofread, or independently verified. This article should not be relied upon for any purpose other than for entertainment. I welcome comments and or corrections.