MS on IOC

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IOC 1Q14 operational results were in-line. Three exploration wells drilling, results of 2 wells in 2Q14, 1 exploration well in 3Q14 and 2 Elk/Antelope appraisal well in 2H14, we see event driven upside.

What happened? IOC reported results that exceeded expectations yet included asset sale proceeds from Total. We believe exploration and appraisal results are significantly more important to IOC than refining and marketing, which, in our view, become less critical and could be monetized at some point in the future. The call was a progress update and contained no results, yet given the pullback, we see upside into expected 2H14 results and June shareholder meeting (NYC).

Focused & funded: exploration next. IOC spud 3 exploration wells in 1Q14 (Wahoo, Raptor and Bobcat). We expect results of at least two exploration wells in 2Q14 (Wahoo and Raptor) and the third in 2Q14-3Q14 (Bobcat). IOC stated on its conference call that they will disclose results of each well with log and DST data that will help dimension preliminary meaning (i.e., size). Mgt also discussed the frontier nature of exploration and typical success rates (10%) that, in our view, was cautiously construed by markets given three wells are in progress. We expect Wahoo results first where we see higher geological risk given the step-out from Antelope.

Focused & funded: Elk/Antelope appraisal in 2H14. We expect two Elk Antelope appraisal wells before year-end, up from one well prior to conference call update. The location or decision by the partnership to drill the third well is conditioned upon results of the first two wells. If the third well is not drilled, it could accelerate the time for the resource payment. We expect appraisal well results will provide context for what was generally assumed in the IOC’s published resource assessment. Given the variable price per $/mcfe and resource size, the appraisal wells are the biggest potential catalyst (binary) for up to +2Bn resource payment from TOT. IOC also retains a 27.5% interest of similar to value to what was sold, so implied valuation and size accrete to the NPV of its retained interest.