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IOC’s Elk property

So far, there have been two holes drilled, Elk1 and 2 (Elk3 was supposed to be a horizontal dril from the depth of Elk2, but drilling Elk4 and an adjacent property, called Antelope, were given priority).

Elk1

Elk1 has been a company changing event. It is worthwhile to quote a resepected geologist at length, Joseph Dancy (get some of his articles here), manager of the LSGI fund, and Adjunct Professor, SMU School of Law, FSU Contributor, FSN Team Energy Expert had this to say in a report for his LSGI fund in May 2007:

“The Elk #1 well encountered some incredibly high pressures for the PNG area, and large amounts of downhole fracturing. In a standard drilling operation “mud” is pumped down the drill pipe to cool and lubricate the drill bit, and to exert downward pressure on the formations to keep the natural gas or oil from streaming up the wellbore and ‘blowing out’ the well. In the Elk #1, the more than one mile deep mud column disappeared down the well – most likely due to massive downhole fracturing or porosity in the target formation. IOC thus had to use a unique drilling method to complete the well – injecting water into the well to keep it under control, with no ‘returns’ to the surface as the water based drilling fluid entered the formation matrix. The petroleum engineer we consult with on this well has told us in 30 years of drilling he has never personally been assigned to a well drilled in this manner. It is a very rare occurrence. He noted the drilling method is appropriate, and probably one of the only ways to get the well drilled economically – mud is not inexpensive, could damage the formation in huge amounts, and logistically would be a nightmare to transport and continuously mix at a remote well site.”

After considerable effort to stabilize the well due to the enormous gas pressures (IOC’s CEO Phil Mulacek likened it to stemming the tide of the Mississippi), they finally did a DST test to quantify that pressure. The result was, well, quite astounding.

Elk-1 well flowed 100+ MMcf/d through 5” tubing at 2,000 psi surface pressure. (If you want to read more technical stuff about it, read, here, here, and here, for instance)

According to Dancy, “Not many wells open flow test at over 100 MMcf/d thru a 5 inch choke.” Those high gas pressures are also a result of the excellent sealing rock, a quality which has been found at Elk2 as well (and we have a feeling that it is this same hard rock that is partly responsible for the delays at Elk4).

This caused quite a stir, read the local newspaper

Geologist from highly respected finance house Raymond James, Wayne Andrews, had this to say:
“After years of waiting, the market finally has a quantitative assessment of InterOil’s reserve potential. Following recent testing of the Elk #1 discovery well, InterOil estimates that the Elk/Antelope structure has gas in place of 3.1 to 15.7 Tcf, of which 2.5 to 11.3 Tcf is believed to be recoverable. The low end of the range assumes only fracture porosity contribution to reserves and excludes matrix porosity.” (RJ 29/12/06 p1)

Not only gas…
Another unique characteristic of the Elk #1 well was that it produced high quality hydrocarbon liquids. These hydrocarbon liquids increased with depth. The quality of the liquids was very high – ‘light’ and had few impurities (Dancy) The quantity of liquids produced was not insignificant, and these would be easier to market than the natural gas.

Those liquids tested by third party, the Australian Government research agency, CSIRO, analysis indicates the Elk condensate originated in the peak to late oil generation window of the source rock, materially increasing the possibility of an oil leg deeper in the Elk structure and/or the adjacent Antelope structure.

A presentation held by Mulacek at RJ conference (listen to it here, or read it here) impressed Joseph Dancy: “Incredible, just incredible presentation by IOC yesterday in my opinion. Yeah, I know this one is speculative, but I really REALLY like the positioning of the firm and the technical drilling data to date.

The reserves of the Elk field, if confirmed with the Elk #2, will rival those of Marathon Oil or Anadarko – assuming the structure and formation is proven up with drilling according to the presentation. These guys are hunting elephants.

CEO’s comments on the chance of oil in the structure, and why they think an oil leg can exist, are also interesting and confirm what petroleum engineer contacts have told us. If the structure contains oil all bets are off, and the odds are long they will in my opnion. Not many wells open flow test at over 100 MMcf/d thru a 5 inch choke.

If you understand the energy markets, and the problems we will have meeting the global demands as older fields like Mexico’s Cantarell decline (expected to decline another 15% next year according to experts), this is just an incredible opportunity. The stock traded down after the presentation with the market.”

But he raised an interesting question, does Elk2 confirm these impressive results at Elk1?

Elk2

One has to understand that to properly appraise a potentially very large find like Elk, at least a couple more holes need to be drilled. With the next hole, IOC took a little bit of a risk, as the site was right at the edge of the Elk structure. It’s a so called ‘delineation’ well, drilled to do just that, delineate the resource.

“The Elk #2 appraisal well is designed to encounter the top of the limestone target approximately 1,000 feet below the position at which the Elk1 encountered the target and further down-dip from the major fault in the structure.” (RJ 11/04/07 p4). When all the dust was settled, we got a mixed bag of results from Elk2.

This is how Wayne Andrews from Raymon James interpreted the results from Elk2 (from a report dated 6/10/2007). “While the update includes both positive and negative data points, we remain encouraged by InterOil’s progress, and from a long-term standpoint, we look at the update as a net positive.

Positives:

  • A major highlight of this drilling report is the fact that the well confirmed meaningful porosity, with average log porosity of 4.5%, including 6.3% in the Mendi limestone, and with the high end at 12.5%.
  • Also, the limestone thickness was greater than previously expected in both the Puri (1,749 feet) and Mendi (958 feet) formations. The logged net reservoir has a measured thickness of 663 feet.
  • As a result of these and other observations, which includes the possibility of reef development, the company has increased its estimated resource range for the Elk/Antelope structure from 3.0-15.0 Tcf to 3.5-18.9 Tcf.
  • Lastly, completion of a full suite of formation evaluation logs has produced a far clearer picture of the reservoir quality, and the vertical seismic profile (VSP) firmly ties the seismic data to subsurface formations.

Negatives:

  • The well tested eight zones via drill stem testing (DST), but all eight were below the hydrocarbon/water contact. The well flowed at high rates, documenting the porosity and permeability within the reservoir, but produced primarily water. The produced water did have high gas saturation which separated and was flared at the surface. However, the documented combined flow rate of 40,000 Bpd clearly indicates productive capacity of the reservoir.

What happened was not pretty though, the market sold off heavily even before the information on Elk was in the public domain. We’ve been told that was at least partly a classic short attack. They bought puts, and excercised them, causing the market makers to shake the whole thing down.

This was happening anyway as investors did misrepresent the results, according to Peter Koven from Canada’s Financial post (unfortunately the old link to the original story is dead, but you can read it here).

A month later, the share price recovered a lot of lost ground as it became known that billionaire T Boone Pickens had taken a very substantial position in IOC (2,943,964 shares, to be precise), not only for his fund, but also for himself.

This could (and perhaps should) be seen as quite an endorsement for the Elk2 results, Boone holds a masters in geology and is a legend in the energy markets.

It’s not unlikely an investor of his caliber had a private viewing of all the log and other technical data from the wells, and he has the required knowledge to interpret these.

Wayne Andrews again:
“Based on yesterday’s conference call, along with further discussions with management, we believe that InterOil’s partners are encouraged by the final test results from Elk-2 and the continuing process of delineating the structure.

This can be evidenced in the fact that all of the company’s exploration partners have maintained their ownership stakes in the exploration program, along with full participation in future wells. On the liquefied natural gas (LNG) front, the latest results are viewed favorably by InterOil’s partners in the LNG project, given that the higher resource estimate goes even further in underpinning at least the first LNG train.

With many concerns from investors surrounding the company’s liquidity position, we would point out that a large portion of its short-term debt is a term loan to LNG project-partner Merrill Lynch (MER/$74.78). Merrill has been very accommodating in the past and could possibly be willing to restructure InterOil’s current debt obligation. Furthermore, we would argue that the sale of a portion of InterOil’s interest in either the LNG project or the Elk prospect would generate enough capital to support InterOil’s exploration activity for years to come.” (RJ 6/10/07 p2)

Improved seizmic data
“A further, and potentially even more significant, improvement in upstream operations is the vastly improved seismic data acquisition program. Recently, the chief geophysicist from CGG Veritas was in PNG to supervise the testing of new data acquisition parameters. The geophysical crew re-shot certain portions of previous lines to test new acquisition parameters in an effort to improve the quality of seismic data. The old seismic parameters are useful for structural interpretations. The new, higher-quality data could be used to help reduce hydrocarbon risk if the AVO response correlates well with natural gas content in the limestone.” (RJ 11/04/07 p4).

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