Buying wave in InterOil part 2

We have been following this story for years. What is happening now can be explained in very simple terms.

Some funds shorted it before InterOil discovered anything. This is understandable. Exotic country, unknown company, loss making refinery. Then they discovered Elk, with the Elk1 discovery well that showed 100MMcf/d gas flows through a 5 inch pipe.

That caused a bit of a stir, but hey, it’s only one well. Not a resource yet. We’ve even heard that the short funds just refused to believe that they found anything significant.

Then, the drilling just went very, very slowly. And the next well was inconclusive enough for the shorts to pull a stunt, exercising a lot of put options which halved the stock price from $44 last year in just three days.

But now we are in the third well, and as the title of our SeekingAlfa article suggests, uncertainty is really declining by the buckloads. Which really produces a compelling investment thesis even now:

  1. The upside is really very significant, as we argued in that SeekingAlfa article
  2. With two successful DST’s already, the risks have declined considerably. Also note that these DST’s were severely hampered by skin damage and testing equipment (most notably, a small pipe), which severely underreported the gas flows. We believe once these problems are removed in one of the coming DST’s, the well’s true potential will shine
  3. The catalysts that Wayne Andrews talked about for some time are about to happen after the conclusion of Elk4 and third party report.
  4. We’re still not at total depth. The longer it takes, the bigger the resource. And the chance they’ll find oil is still there.

But we have to draw attention to another situation. There are almost 12M shares short, over half the float. These people now face serious problems, and this is an understatement. What is happening now is that other funds have not only recognized the fundamental situation of InterOil, but also noted that the shorts are in a terribly weak position.

No doubt in the dog-eat-dog world of Wall Street, there are funds that derive great pleasure (not to mention almost risk-free profit) out of turning the screws. We believe we’re in the early stages of the mother of all short squeezes. Sit back and enjoy the show.

We do have to stress that while the risks have receded greatly, InterOil is not risk-free. You best bet with at least some protection.