A few thoughts – I’ve been directly involved in several (many) recertification exercises and understand how it works. Total will game the mid case estimate lower and IOC will do the opposite. Independent assessments are not independent…but either way, there is only so much conservatism or optimism that can be incorporated into a reserves and resource study... Just a few % recovery factor one way or another using completely fair arguments can sway the results significantly.
So..here goes:
We have a great deal with Total but where did the 3.5 and 5.4 TCFE increments come from???... because this is exactly why the stock dumped..
Given the GLJ low estimate is over 6 TCFE, I find the deal structure absolutely, without question, calls into question the GLJ estimate. The XOM deal (as announced some months back) also called for a 2 – 3 well appraisal program and recertification of the resource. Recoverable Resource is our #1 uncertainty....I believe the 3rd well is to prove upside if the second well works (could be wrong about that). If Total and IOC did a resource certification today and reported both, we would have a great understanding of the range….I’d really like to know what XOM & Total’s internal assessment of recoverable resources are (these are more meaningful and usually more accurate than a 3rd party)…..and if IOC was so sure that this is a 10 TCFE field then they wouldn’t be opposed to a NSAI or D&M estimate of field resources right now (60 days to do the work ( or less) and then put it out there)…but this is tough – because picking and choosing a 3rd party while legal, could be considered suspect…normally you pick one with credibility and the resources to deliver the study on time and you stick with them. Saying that, I think IOC will not use GLJ for the 2015 certification…..it’s a perfect opportunity to switch horses. So.. IOC has done a few (under the previous regime..probably gamed a bit to hype the story and sell it), GCA did one for the PNG authorities (as I understand it was lower…but didn’t include the Ant3 well..probably more balanced analysis (again just guessing)), and now both Total and XOM have pushed for deals that require recertification. Not surprising: as this is very common (meaning – firm commitments come after a field is fully appraised), but it is without question a challenge to the GLJ assessment. I’m not questioning their competence….this deal is questioning their range of resource (period). And more wells are required to prove it up. If the wells come in as IOC expects – then we stand to make a lot of money. If they don’t meet expectations of the mid case then what is the range? I think the answer is in the shape of this deal. Conclusion #1 – field is not yet appraised for optimal LNG plan…this also means a low case resource estimate is possible….i.e 3.5 tcfe (although Total wouldn’t have done the deal if they believed this…they worked this to be as low as possible while being a competitive bidder so I can appreciate the commercial aspects of this figure not being directly linked to size of the prize).
Conclusion #2 – 2 (possibly 3) wells is all that is required to assess…good news: not very many wells.
Conclusion #3 – Because the deal is incremental to 3.5 and 5.4 and more (not capped) TCFE, the existing well stock firmly underpin a gas recovery estimate of at least 3.5 TCFE. (Total firmly pays for 3.5 TCFE knowing that worst case for Total is 1. E/A resource is on low side of range and 2. They can always sell it to PNG LNG partnership (i.e XOM) as feed gas if the Gulf LNG doesn’t materialize to recover all or part of the $825 million. BUT I suspect the low side of 3.5 tcfe was a commercial angle ( lowest size that would support 1 train … per Raymond james?? I do not know this to be true but seems plausible) and the 5.4 TCFE is Total’s true P90 internal low case estimate)…just a guess.
Conclusion #4 – Total would be delighted to pay max value in this deal..and worked a deal that delays capital closer to first gas. But 18 months (perhaps as soon as 15) we will know for sure.
Question #1 – what must we see from these wells to support 6,8, 10, 12?? TCFE? Are we chasing more areal extent or are we planning a dymanic test to understand lateral connectivity? What is the exact purpose of these 2 or 3 wells? Is recovery factor the key uncertainty or is areal extent of the enclosure or both
Question #2 What is risk / mitigation plan for this project?
I believe the comment MH made in the November call was something like this: “if we can align ourselves with a particular major partner across the value chain, then that would be a strong consideration”….pointing to Total/OSH being well positioned in offset leases and also being a 2nd major to the PNG game. Good risk/mitigation for IOC and for Total.
Risk: E/A is only big enough for 1 train..could be a connectivity issue, could be a gas-in-place issue…but the risk is real.
Mitigations: optionality down the road exists to sell it to the PNG LNG partners for train 3 or 4 feed gas; portfolio expansion (spread the risk and capture potential upside) Total buys into Triceratops and other IOC licenses to spread the risk (i.e. let’s guarantee we get enough gas to underpin a 2 train project)
I believe, as many have stated here, that IOC will sell down more of its licenses to Total and perhaps OSH (via Total in E/A) and that AT LEAST enough gas for a 2 train LNG project will be discovered and then built. In fact, Total has been given that first right of refusal. The value question for this deal is will all the gas for a 2 train project come from E/A or will this turn out to be like the PNG LNG that needed several fields to contribute?
Ok…so what is the value of 30% equity in a 2 Train LNG Project to Interoil that produces over 9 tcfe (>100 mmbls liquids included)?
Using PNG LNG as model on capital and annual operating expenses: $18b gross 100% capex/ and similar offloading agreements for pricing yields $5.8 B NPV 10 discounted to Jan 1, 2014. I’ve done the full cash flows and assume late 2019 startup. The primary risk to this in my mind is the offloading agreements and price…it’s a long time to FID and first gas and the world can change quickly
Another way to look at it: And as we get closer to first gas in 2018/2019 …value should (will) trend up as the capital investment is made (i.e. sunk). That’s why its tough to compare IOC directly to OSH today….but certainly a good price target for 5 years from now. As OSH is 1 year from first gas and has invested a significant portion of the capital. OSH has 5.7 tcfe net and trades at $2.22/mcfe. 30% of E/A is about 3 tcfe…so on an equivalent basis and looking forward to 1 year prior to first gas, IOC would be at equivalent of $7b. That’s just another way to value a 2 train stake. Again it’s still 2 or more years to FID and first gas.
If we assume that the cash from the deal is based on roughly the same amount of gas or 9.9 tcfe then the cash in the next 5 years has a discounted value of $4.6B NPV 10 if the $4.1b payment is incremental (I’m unsure at this point if its incremental or if its offset by the “fixed” payments). Doesn’t matter much…it’s a big number.
Combined 30% LNG - $5.8 plus cash value of deal of $4.6 = $10.4B company less the 20% partners or $8b company. Requires line of site to an LNG Project with firm offloading agreements and FID, and E/A resource size certification of 9.9 tcfe. Now, if the cash is lower than this because E/A turns out to be smaller and if the 2 train project is made up of gas from the other fields, I’m still projecting a $5.8b value (and this discounted to 1/1/2014) today trending up over time (excludes 20% parters)
This stock has huge upside (3,4 or 5 bagger – for the sake of norm / reality let’s agree that $20 billion is about as much as we can imagine!) and frankly….very little downside. With Triceratops discovered (4 tcfe “pre-drill” in slides is confusing but I think they meant that’s what they believe it is today…before we drill the next well) and more prospects to be drilled…could be sitting on some pretty impressive gas discoveries..but then again, may not be there.
I can see a low case we combine together a few tcf from Triceratops, 4 or 5 tcf from E/A (remember low case), and perhaps a bit more from the others and come 2019 (1 year before LNG sales…like OSH is now) we are a $7-8b company ($160/share). $55 to $160 by 2019….worst case….and that is because it’s possible we may have to string several fields together to make this work..and because I believe commodity pricing in the LNG space will hold in this part of the world (but the market will/has discounted this assumption).
A major discovery in addition in the next year or so, realization of E/A at 10 or 12 TCFE or more, and this is a very big company even sooner than 2019. Fact: we will know how to value this deal in 18 months. And even if E/A is only 5.4 TCFE…..by that time the other fields will likely be of sufficient maturity to underpin a 2 train development (hence my belief that a 30% stake in a 2 train development is a good low case target for interoil).
Conclusion: keep buying and be patient. The Total deal has reduced the risk significantly. Shorts will begin to exit here (not much more downside to this stock from here). LNG will happen. Hession is a very strong leader – very good at what he does. We are very lucky to have him. I do not believe in the trading conspiracy….we were right about the business and wrong about the stock price…my theory: due to the very long time it took to get this deal done (which gave shorts a reason to call bullshit) and combined with the 3.5 tcfe and 5.4 tcfe deal increments that we have in the Total SPA (lower that I would have liked to see)..…. the short theory of there not being enough resources is a real risks……of course the shorts have made a living off this with a lot of non-sense. ..and phil didn’t really help (he made it all possible but couldn’t make it happen)…I do think if they had fired Phil 2 years ago, that the credibility factor would be closer to where it should be….unfortunately – I think the lack of a deal over the last 2 years (until now…which Hession did in less than 6 months!!), combined with low threshold reserve ranges in the deal created some concern. Folks like Paulson are selling…not buying more. The stock at $88 had priced in the belief that we would be very close to first gas and reserves booking with an XOM deal with firm offloading agreements, and that did not materialize. As it stands now it will be late 2015 earliest and probably 2016 before we FID and book proved reserves. But the key will be building credibility around the reserves base. My guess is we will end up in the 6 to 7 tcfe range on the E/A part of the deal with several other discoveries to underpin a big 2 or 3 or 4 train LNG project. The talk around reserves and what people know and don’t know because they have seen seismic and what not…isn’t really helpful. These studies are very very complex analysis that use 6 or 8 5 ½” boreholes to make judgments about an area the size of Manhattan…the science is solid, but it’s not perfect and it is absolutely 100% true that dynamic performance data is absolutely critical...so don’t be fooled into thinking GLJ estimate is where we will end up. The appraisal wells could help the number…but they could also hurt the final certification number. Saying this….I believe the total PNG asset for IOC to be a world class asset…with much more gas to be discovered….a very strong portfolio with optionality. It’s unfortunate we have to to wait 2 more years…but we do…..Prediction: $200 by Oct 2015….as we add to the E/A total with at least 1 more large field (we start the march up sooner if/when Total starts to hype the resource base in the media or with investors…this could be quite meaningful if Total came out and said they believe the low case is 5.4 tcfe or bigger, or even suggest they believe it’s a 10 tcf field).
That’s all for now..typing fast, hope it makes good sense!
