A summary of our position on InterOil

1) It’s too early for any conclusion to be drawn with respect to the results of Elk4. It has not been drilled deep enough, and no DST tests has been performed. There were delays in the drilling, but these say nothing about the outcome.

2) It’s prospects, therefore, have not changed in any way. So, neither has our opinion. We still have every reason to believe that it’s chances are good in proving the deliverability of, what no geologist of name has disputed in the public domain, sufficient amounts of natural gas to go ahead to supply the proposed LNG facility long enough to make it feasible.

3) Hence, the sell-off is, in all likelihood, related to the uncertainty regarding the refinancing of the outstanding loan to Merrill Lynch (about $70M). We are not privy to these negotiations, but, as we have argued on several occasions, these negotiations might not run as smooth as we liked to see:

  • Merrill’s financial position might lead to a tougher stand
  • Merrill does have a pretty strong short-term negotiating position
  • It might want to exploit that to grab a bigger share of Elk (or other IOC properties)

However, we also argued:

  • Merrill is 1/3 owner of Liquid Niugini, the company which will run the proposed LNG facility
  • So both InterOil and Merrill stand to win in the longer-term from cooperation
  • short-term hardball might endanger those mutually beneficial longer-term prospects, which will put a limit on the hardball games that might be going on (we don’t know if they are)
  • Merrill has been very accommodating in the past with respect to financing IOC, as recently as last December, when they took $15M out of a private placement, and earlier in the year, when they refinanced the very loan that is due early May (and causing all this uncertainty) at a generous 4%
  • The reason for that accommodative stance has been to enable InterOil to prove it’s reserves. It would be odd to change that stance at the very last moment. Odd and endangering longer-term gains, but not impossible
  • InterOil’s bargaining position vis-à-vis Merrill will be enhanced greatly at the moment Elk4 results are positive (which will open up finance at good conditions elsewhere), so a hardball game from Merrill is really not without risks
  • So if there is a game of brinkmanship going on now, this does really not imply a bad outcome is necessary. Bargaining often takes parties to the brink, but if they have enough common interest, rationality usually prevails
  • Merrill might very well also just wait for the results of Elk4 to make a decision of the terms of finance.

In the meantime, the resulting uncertainty and the descending shorts are not good for the share price, to use an understatement. But it’s also encouraging to see that there are buyers who can look over the short-term volatility, and see an opportunity here.

As ever, hedge your positions.