12-28-2011, 04:27 PM
It appears the arguments about the quality of Elk/Antelope (E/A) have faded away. Political risk still exist that could further impede E/A's development, but that too seems to be fading. Of course, there is execution risk with any large project, but that is nothing new.
So, to see if this risk is justified one needs to look at the potential reward. Since cash flows are still 3-4 years away let's value IOC based on similar transactions. Note not all transactions are the same, but we can likely agree that the lower the extraction cost the higher the profit margin and the higher the profit margin the more one would be willing to pay for the asset. Of course, extraction cost is a function of many variables, but here are a few that are important. Size of the asset: E/A is a huge find and therefore about to supply multiple trains which greatly enhances the economics. Flow rate: E/A has had world record flow rates with pressures that almost immediately return to full pressure, more drilling is required, but it should be obvious that the total required cost per mcfe to be extract is lower than the majority of reservoirs in the world, especially coal seam gas projects out of Australia. Pipeline distance and terrain: Unlike XOM/OSH pipeline there is no subsea section no substantial changes in altitude and IOC’s is a much shorter distance through areas with lower population and its Gulf location will support a poorer region of PNG . Processing costs: Using modular and FLNG production have the benefit of being built in a controlled area and not having to compete as much for skilled labor in PNG. Location: On the doorstep of the largest LNG users in the world. Important consideration given the cost to transport LNG is around 150,000/day and rising (see http://www.businessweek.com/news/2011-12...ssels.html). Not to mention it is a long way from the often volatile Middle East All positives that increases the price for IOC assets. Potential negative is that the potential buyers know that IOC needs money and a partner to move forward at a pace suitable for the government. Another potential negative is political risk, but note that there is no history of asset seizure by the government in PNG. Also, note that both the old PM and the new PM support IOC and they know the importance to the wealth of their country. Look at the budget and Sovereign Wealth Fund legislation for evidence of such.
Prior to the 2011 spike in LNG transactions for similar properties were ~2/mcfe, more recently ~3/mcfe has been seen. The question is at what price will a selldown of IOC assets occur and at how much of a discount will IOC trade for after the transaction? Feel free to use your own estimates, but to allow for a suitable margin of safety I am going to say 2/mcfe and that IOC will trade at 50% of NAV post-transaction. If 1.50/mcfe price is placed upon IOC’s contingent reserves (5.5 Tcfe from E/A and 2.75 Tcfe from B/T), then the firm would be worth 257.94/share. Of course, it is unlikely to trade at the selling price per mcfe, so let’s say it trades at 50% per mcfe, then IOC should trade at 128.97 per share. Very nice given the firm current trades at 50 per share and has a huge inventory of prospects and the likely substantial increase in the size of B/T based on seismic results. These numbers also help explain why insiders spent 42 million of their own money to buy IOC shares during the last offering.
To see how the price per share calculations are made go to: https://docs.google.com/spreadsheet/ccc?key=0AshAH1SVj0t5dHB0b3A1c1hQT0FscHBtcHpzZVMwZXc&hl=en_US#gid=0
I welcome discussion about these numbers.
Best,
Sam
So, to see if this risk is justified one needs to look at the potential reward. Since cash flows are still 3-4 years away let's value IOC based on similar transactions. Note not all transactions are the same, but we can likely agree that the lower the extraction cost the higher the profit margin and the higher the profit margin the more one would be willing to pay for the asset. Of course, extraction cost is a function of many variables, but here are a few that are important. Size of the asset: E/A is a huge find and therefore about to supply multiple trains which greatly enhances the economics. Flow rate: E/A has had world record flow rates with pressures that almost immediately return to full pressure, more drilling is required, but it should be obvious that the total required cost per mcfe to be extract is lower than the majority of reservoirs in the world, especially coal seam gas projects out of Australia. Pipeline distance and terrain: Unlike XOM/OSH pipeline there is no subsea section no substantial changes in altitude and IOC’s is a much shorter distance through areas with lower population and its Gulf location will support a poorer region of PNG . Processing costs: Using modular and FLNG production have the benefit of being built in a controlled area and not having to compete as much for skilled labor in PNG. Location: On the doorstep of the largest LNG users in the world. Important consideration given the cost to transport LNG is around 150,000/day and rising (see http://www.businessweek.com/news/2011-12...ssels.html). Not to mention it is a long way from the often volatile Middle East All positives that increases the price for IOC assets. Potential negative is that the potential buyers know that IOC needs money and a partner to move forward at a pace suitable for the government. Another potential negative is political risk, but note that there is no history of asset seizure by the government in PNG. Also, note that both the old PM and the new PM support IOC and they know the importance to the wealth of their country. Look at the budget and Sovereign Wealth Fund legislation for evidence of such.
Prior to the 2011 spike in LNG transactions for similar properties were ~2/mcfe, more recently ~3/mcfe has been seen. The question is at what price will a selldown of IOC assets occur and at how much of a discount will IOC trade for after the transaction? Feel free to use your own estimates, but to allow for a suitable margin of safety I am going to say 2/mcfe and that IOC will trade at 50% of NAV post-transaction. If 1.50/mcfe price is placed upon IOC’s contingent reserves (5.5 Tcfe from E/A and 2.75 Tcfe from B/T), then the firm would be worth 257.94/share. Of course, it is unlikely to trade at the selling price per mcfe, so let’s say it trades at 50% per mcfe, then IOC should trade at 128.97 per share. Very nice given the firm current trades at 50 per share and has a huge inventory of prospects and the likely substantial increase in the size of B/T based on seismic results. These numbers also help explain why insiders spent 42 million of their own money to buy IOC shares during the last offering.
To see how the price per share calculations are made go to: https://docs.google.com/spreadsheet/ccc?key=0AshAH1SVj0t5dHB0b3A1c1hQT0FscHBtcHpzZVMwZXc&hl=en_US#gid=0
I welcome discussion about these numbers.
Best,
Sam