A third (as far as we know) Ross Smith (RS) report appeared this week on InterOil (dated Jan 15 2009). For those not in the know, Ross Smith used to write the short thesis. Their elusive reports (we tried for a long time to get our hands on them in vain), in all likelihood paid by the shorting hedgefunds, had some nasty things to say on InterOil. No more. They don’t even advise to short anymore..

Backtracking is what Ross Smith had to do for some time. Purportedly (we stress that we’ve only seen a copy of their first report, and that was some two years ago) they started backtracking from the start, when they under-reported the Elk1 flow rates massively, and embarrassingly had to ‘correct’ this.

The second report we now have. It’s very funny reading. Let’s start with the timing. It appeared when InterOil was just hitting the payzone in Elk4, or at least that was the cut-off time for including data. Very odd timing indeed. Why not wait for Elk4 to conclude (like the two independent engineering bureaus working now are waiting for the conclusion of Antelope1)??

Would you write a match report of some football game when it is just 15 minutes under way? Well Ross Smith seems to think that provides an accurate picture.

It’s a high risk strategy, and this exploded in their face. Consider the following. Describing ‘the first 15 minutes’ of Elk4, they argued, triumphantly, that the gas pressure could not be high. Their evidence? A picture of a pipe with gas flaring (that is, gas found in the well is burned off).

The flame was vertical, indicating low gas flows and pressures. So Elk4 could not amount to much. Here is what they wrote:

• A photograph posted on IOC’s website (Figure 2) shows a near-vertical flare flowing from horizontal pipe. Unlike the jet engine-like flare seen in the photos of Elk-1’s well test, a vertical flare from a horizontal pipe possesses low pressure. [RS May 13, 2008 p3]

That same Elk4 only went on to establish the highest known gas flows in PNG (and Australia), so one could conclude they were perhaps a tad premature with their conclusions, to use an understatement.

Why would they write at such an odd time, with such obviously preliminary conclusion? We’ll leave that to your imagination, but one has to remember that someone commissioned Ross Smith to write about InterOil. Which institution, boy we would like to know..

They go on to argue that Elk1 is on a major fault line which caused the high flow rates, as according to Ross Smith, there were no signs of matrix porosity. This is something the company strongly disagrees with. Not only did Elk4 experience the same high flow rates, there were signs of matrix porosity in all three wells (Elk1&2&4), confirmed by logs, cores, and physical samples and by linking known parameters so seismics.

And this is not something IOC does, as the new (Jan 15, 2009) RS report admits, the logging is done by a third party.

We give you two more quotes from the RS May13, 2008 report:

• The results of Elk-4 thus far prove up IOC’s original 2005 structural interpretation of seismic and disprove its recent stratigraphic, reefal interpretation in our opinion. In the 2005 interpretation, the Puri immediately south of Elk-1 was down-faulted to a depth consistent with where IOC reported Antelope limestone.
• The structural model predicts that it was Puri limestone encountered in Elk-4, not the shallow water Antelope variety described by IOC. This means without enhancement from natural fracturing, it will probably not possess significant reservoir quality. The model also strongly suggests that the Antelope structure is not a reef but upthrusted Puri. [RS May 13, 2008 p1]

And:

• The Puri is a deepwater limestone that is fine-grained with little if any matrix porosity. Typically, such limestone has low porosity and permeability, do not hold significant volumes of gas and are not prolific unless naturally fractured. [RS May 13, 2008 p3]

What they seem to say is that what Elk4 found was Elk, not Antelope. And, according to them, it would probably not possess significant reservoir quality….

Apart from the fact that we all know better now, this statement is actually very significant. Why? Because in their view, the Elk limestone cannot significantly flow if it’s not on a fault line (and if it is, they should have expected it to flow, which they didn’t). So Elk4 is not on a fault line, and therefore, it could not flow. Yet it did flow, in record quantities, no less (even with the small pipe they were using).

Which can only mean Ross Smith is just plain wrong. It’s not Elk what was discovered at Elk4, but Antelope, and InterOil’s new interpretation is, in fact, the right one. InterOil’s position on this has more evidence, there is a facies change from deep to shallow marine. This is confirmed by a third party, already at Elk4, but even more so at Antelope1.

And read the two quotes above above once again, especially:

• The model also strongly suggests that the Antelope structure is not a reef but upthrusted Puri. [RS May 13, 2008 p1]

So they basically denied the possibility of a reef in the old report (how Elk4 could flow so profusely without being on a fault line is something we leave Ross Smith to explain..)

Ross Smith is still in denial here, or at least they do not admit that they were just plain wrong. But, probably for legal reasons, they at least admit the possibility of a reef in the new report (it would be rather silly to keep on denying it), although with some convoluted language:

• It is not yet possible to prove conclusively whether there is a reef immediately associated with the dolomite encountered at Antelope. IOC indicated it interprets the Antelope feature as a reef; however, the shallow marine facies found above 5,837 feet could also be from a regional reef platform then structurally emplaced. The alternative scenario to a reef would be that Antelope is a structured platform that has been dolomitized. [RS Jan 15, 2009 p2]

And they have to admit that:

• Both cases are positive [RS Jan 15, 2009 p2]

There, that wasn’t too difficult, now was it?

And they are backtracking as well on the existence of matrix porosity in the earlier wells (Elk1&2&4) in the new report, although again, not wholeheartedly:

• The presence of dolomite is a positive factor as it could signify enhanced reservoir quality that previously was not part of the Elk-Antelope reservoir model. Until now, fracture porosity and very modest evidence of matrix porosity has been encountered in otherwise very tight Puri limestone. [RS Jan 15, 2009 p2]

What has now become “very modest evidence of matrix porosity” they just flatly denied (or disregarded) in the earlier report, which was difficult enough, because Elk4 flowed profusely, and how could that be, without matrix porosity or being on a fault line?? Perhaps that’s the reason of the very, very curious timing of that May 13, 2008 report, just before things got really interesting at Elk4…

Waiting for Elk4 results would have forced them to explain things they couldn’t, at least not without admitting the possibility of either matrix porosity or a reef.

Just how nasty that May 13, 2008 report was becomes abundantly clear from the following quote:

• Notwithstanding the outcome of Elk-4 or Antelope-1, the entire Elk-Antelope volumetric resource estimate of IOC needs to be reconciled with Elk-4 well results, in our opinion. This would necessarily trim the Elk resource estimate south of ELK-1 and also the Antelope estimate which appears to have a minimum of 1,100 ft less rock volume above the gas water contact. [RS May 13, 2008 p2]

So by ‘reconciled’ they mean reduced. Why on earth draw such preliminary conclusions?? Elk4 had hardly hit the payzone when they wrote this let alone any significant testing had been done, and Antelope1 hadn’t even commenced. Why not wait for the drilling and testing to terminate, especially since these preliminary RS conclusions seem so wrong now??

The best argument they had in that May 13 report was that the seismics is unreliable, and indeed, at Elk4, Elk, which was supposed to be at 1600 meters, wasn’t there. However, with each well, additional knowledge is gained, and the understanding of the structure improves a lot. At Antelope1, the payzone is actually very close to were it was supposed to be.

All they do is stress what, in their view, is not yet known. They did that in the earlier May report as well, and that now looks rather comical, as IOC’s interpretation has been vindicated, not Ross Smiths’, and they (albeit implicitly) have to admit as much.

But one also has to stress that it’s almost certain that Ross Smith has no access to all the data. What they consider not yet known is not necessarily the same as what the company, or those who do have access to all the data, consider unknown (yet).

And what’s more, they also argue that the existence of a reef cannot be concluded from this single well. But there actually is a second well pointing to this, Elk4, that well which they wrote a report on before things actually became interesting (the May 13, 2008 report). No wonder they disregard that, as they got that well so wrong.

All in all, it’s a pretty embarrassing backtracking action, and they have quite a track record with that already. It’s only implicit in the new (Jan 09) report that their previous report (May 08) got it so wrong.

Perhaps the most upfront statement is that on the first page:

• We believe porosity enhancement derived from dolomite could be a game changer and legitimize the resource potential of the Antelope feature. [RS Jan 15, 2009 p1]

That, at last, is a statement we can wholeheartedly agree with, and perhaps they were at their most honest here in an otherwise rather embarrassing backtracking action.