InterOil (IOC) is a Canadian integrated (exploration assets, refinery, near distribution monopoly) located in Papua New Guinea (PNG). After having struck two earlier profusely flowing natural gas and liquids wells (flowing at 102 and 105MMcf/d respectively), they hit an absolute killer with Antelope1, which flowed at a whopping 382MMcf/d..

Record well
Summing up a few findings:

• 382MMcf/d with the pipe only 30% open for safety reasons, and the log indicated that the permeability at the top did not allow the lower section of the reservoir to contribute to the flow test. That is, all the gas just came from the top 12% of the reservoir
• 5000bb/d in condensates
• 792 meters (2300ft) of net pay zone, which is more than three times the size of the biggest American well (650ft), and the gas/water contact has not even been determined yet
• The largest calculated absolute open flow (CAOF) at 17.7 Billion cubic feet of natural gas per day
• 8.4% average porosity
• From the seismics, the Antelope field is 14 x 7 kilometres

Let’s put that in perspective
Just three wells flow 600MMcf/d, more than enough to supply the daily needs of an LNG facility. This is roughly equivalent to the daily productivity of Southwestern Energy (SWN), enterprise value of 10.5 billion. It is larger than the daily production of Ultra Petroleum (UPL), enterprise value of roughly $6 billion. The record-breaking well by itself has larger daily production than the entire corporation of Range Resources, enterprise value $7.3 billion.

And all that with just three wells, with seismics indicating plenty of potential left for more. This leads to another important point, how InterOil’s location and quality of it’s resource provides it with a large cost advantage over most competitors for the most lucrative LNG market in the world, Asia Pacific.

Even long-time sceptic Ross Smith Energy Group turned around even before the record setting flow test.

Cost advantages
PNG is located next to the world’s most lucrative LNG market, Asia Pacific. PNG is a very low cost location, and has a rather business friendly regulation, which put resources located here at a considerable advantage.

Australia has emerged as the next big LNG play for Asia Pacific, but it’s labour, tax, and regulation cost are a multiple of those in PNG, yet tens of billions of dollars are going into these Australian coal seam projects even in today’s low energy and credit constrained environment.

And where InterOil can supply a LNG facility from just three wells, coal seam gas projects need to drill, treat, and man literally thousands of wells.

InterOil’s planned LNG facility is estimated at just $5-7 billion, low for international standards. Even a rival comparable project on the same cheap PNG location, led by OilSearch and Exxon is budgetted at $11-12 billion for an 6.3 million tonne per annum facility. (InterOil’s facility will have a capacity of 6-9M tonne).

The InterOil project is cheaper because the gas comes from a single resouce and, unlike OilSearch, important infrastructure is already in place. InterOil does not have to build a harbor, housing, power facilities, water facilities, deep water jetty system, InterOil already has land rights, and their pipeline is less than half the distance and is not in the mountainous terrain of the highlands (like Exxon/OilSearch’s).

What will happen next?

1) Determining the condensate ratio at depth and looking for oil
This will be done by side-tracking Antelope1 and proceed with three DST tests for the condensates, which increase with depths, and oil, within the next 30 days.

The first three DST are will not deliver a ‘wow’ factor, their aim is to find out the gas/condensate ratio at different depths. This is a necessary task for getting a grips on designing the best way to produce these condensates.

A wow factor might come from the last DST test, specifically to test an interval where there might be oil. CSIRO, the famed Australian engineering bureau, has commented that the gas is likely to come from an oil system, so there is a reasonable chance there is oil somewhere in Antelope.

However, oil has a habit of migrating to unexpected places, so actually locating it might be problematic.

2) Reserve reports
These might not provide much ‘wow’ factor either, as these reports tend to concentrate on what can be proven now, not on how much more there might very well be (according to seismics), so they have a conservative bias and are unlikely to come close to the numbers going around on the boards (6-12Tcf) or InterOil (11Tcf).

Getting reserves on the books is significant, InterOil doesn’t have any now and exploration companies are mostly valued on their reserves. Also, any reasonable doubt to rest about whether InterOil has enough gas to support an LNG facility will disappear.

3) Selling up to a 25% stake
After preliminary discussions with major oil companies, national oil companies and international natural gas utilities, Interoil and its advisors will determine the most suitable industry farm-in to acquire up to 25% interest in its LNG assets. InterOil has retained the services of BNP Paribas & ABN Amro as advisors.

There is no shortage in potential partners, two categories are most likely, Asian utilities and big oil companies. The latter are looking to add reserves in a world where more and more resources are nationalized, the former are trying to secure long-term energy supplies as a matter of national security.

Both parties have long-term horizons and deep pockets and the extraordinary economics of their Elk/Antelope discovery ensure that it’s one of the most competitive natural gas resources to develop. Getting the gas condensates out would improve the economics even more, as it provides early cash-flow, further derisking the project.

Valuation
Raymond James in a recent research report used two valuation methods, a net asset valuation (NAV), and comparing it with similar deals.

For the NAV exercise, they used the following assumptions: 6.9Tcf of gas , 60% working interest, 50% risk factor, $0.75/Mcf multiple, very conservative in the light of “Asia’s premium priced (typically $10+/Mcf) LNG market and valuations in the depressed US gas market (typically $1.50 to $2/Mcf) and 69MMBbls of condensates at $10 per barrel and risked the same way.

They arrive at a NAV of $55.52 per share, roughly 2.5 times current prices, with substantial upside to both the amount of gas, it’s valuation, and reducing the risk factor (with independent reserve reports).

Perhaps even more interesting was Raymond James comparing a possible InterOil deal with Nippon Oil buying AGL’s 3.6% stake in the PNG exploration interest and LNG facility planned by OilSearch and Exxon, for $800 million last December.

Arguing InterOil’s assets are comparable to those at sale in the above transaction, a 25% stake would fetch$5+ billion and put the enterprise value at a whopping $22 billion. All this suggests that, longer-term, this stock can only move in one way, and that is up.