After the first independent resource assessment, there is little to stop InterOil from going higher, as much of the risk had been removed and there is plenty of good news to come..

The downside

There is one major argument left to be cautious, it’s that IOC doesn’t, as of yet, have a way to monetize the resources it has. There is no LNG facility nor stripping plant. How much of a risk is that? Not a lot.

The main reason is that there already is enough gas to support an LNG facility, and this can only increase. Marathon started an LNG facility when they had just 1.5Tcf in Equatorial Guinea, so the 3.43Tcf present is enough already. However, what matters more is InterOil’s competitive position, and this is actually it’s core strength.

The Elk/Antelope resource has enormous competitive advantages:

• High quality gas with low CO2 and contaminants
• Located next to the most lucrative LNG markets
• Located on a low cost and regulation and tax friendly economy
• Most important of all, unprecedented deliverability
• We covered these issues earlier here.

Three wells that have 1.5Tcf per well (a number which will increase substantially still, see below) and flow 600MMcf/d (more than enough for the daily needs of an LNG facility) is unprecedented. Tens of billions go into to competing projects where the metrics (as well as location cost) are not anywhere near what InterOil has in Elk/Antelope.

The upside

• Reserve reports are conservative
• Not all info was included
• Additional gas
• Additional valuation
• Additional coverage
• Oil
• Liquids stripping
• Additional wells
• Additional fields
• Deals
• Energy price recovery
• EBITDA/Cashflow

Reserve reports are inherently conservative

• And what’s more, they might not include the most important porosity at Elk1&4, fracture porosity
• There is more in Elk, it has not been properly appraised yet

The most important info from Antelope1 wasn’t even included

• At best, info up until Dec 31 was included
• That is, up until Antelope1 Drilling report No.4
• Which doesn’t include any of the impressive record data about pay thickness, average porosity, flow rates, and the like. It has basically just discovered the top of the payzone..
• CEO Mulacek said during the March 30 2009 conference call (minute 9) that other third parties were reviewing the newer data in Houston and have shown “a lot more strength in our capacity” ..

Additional gas

• Inclusion of all the Antelope1 data should have a large impact on the figures, the payzone was 16x that of those of Elk1&4 (average) and porosity almost double.
• Could be an additional 430 meters (1400ft)..
• And there seems to be some confirmation..
• CEO Mulacek indeed confirmed this in the March 30 2009 conference call (14th minute)
• New third party report has gas at 6.7Tcf

Additional valuation

• From the above, we know that the 3.4Tcf in P2 is just the start. Much more will come in when Antelope, which is much bigger than Elk in every respect, gets proper appraisal through Antelope1 and subsequent wells. Resource numbers are likely to be in the double digit after Antelope2 is drilled, and could very well be there already after Antelope1
• That will put InterOil on a par at least, resource with the competing Exxon/OilSearch project. You might be surprised to know that Nippon Oil bought a 3.6% stake in that (both in the gas fields and the LNG plant) for a cool… $800 million. Ramond James already argued in a previous report that this would imply a $22 billion valuation if InterOil could get a comparable deal, and we know that in many ways, InterOil has the better project (much better deliverability, infrastructure, 1/3 of a pipeline, landowners on board, etc.)
• InterOil owns half it’s planned LNG facility, from the deal above we know that Nippon paid almost half of that $800 just for a 3.6% stake in a similar lNG facility (also just in the planning)..
• In that same report, they argued that even in the depressed US markets, where gas sells at less than half prices in Asia, companies are valued at $1.50-$2 per Mcf. InterOil doesn’t even come close to that yet. In fact, we have a few numbers on other deals in the region.
• Conoco/Origin for $3.24 per Mcf P2 and $1.53 per Mcf P3
• Petronas/Santos $4.75 per Mcf in P2
• In a newer report, Raymond James also noticed these deals with valuation of $1.60-$2.50 for P3 reserves (the comparable P3 number from the reserve report for InterOil is 5.3Tcf), that is, much higher than the market currently gives for InterOil’s more demanding comparable P2 number.
• We have a good view of what IOC management think their company is worth when all the dust settles..

Additional coverage

• Now that InterOil has moved to the NYSE big board (March 31) and has a third party resource evaluation, there will be more analysts covering apart from the three there already are (Raymond James, Monness, Crespi, Hardt & Co., Nataxis Bleichroeder). Check our website for research updates!
• On top of that, the arrival of Wayne Andrews as vice president of capital markets (as well as the independent resource evaluation and the move to NYSE) will also increase exposure to big mutual funds and institutional investors.
• It’s already Kaufman’s favourite stock, see CNBC

Oil

• DST#4 is specifically targeting an oil leg. It’s likely oil is there (there has been no oil find without gas)
• The signs are increasingly good. There is oil, the remaining questions seem to be whether the rock that holds it will flow sufficiently, or whether it needs treatment (with acid) to help it flow and how thick the oil payzone is.
• A Raymond James report now argues oil flowed to the surface
• And cleaning the well and treating it with acid could significantly increase the flow, according to a petroleum engineer.
• If there is oil there could be rather a lot
• But the jury is still out, we’re awaiting a production test

Condensates

• We will have to wait for the DST’s #1-3, ongoing at Antelope1 for a clearer picture on these, but the flow test flowed 5000 barrels of condensates a day just from the top 12% of the reservoir.
• Keep in mind that normally, the condensate to gas ratio increases with depth.
• Producing these liquids is not terribly complicated (and the facilities are needed anyway), and the important part is that they provide early significant extra cash-flow which will de-risk the LNG financing in a meaningful way.

Additional wells

• Elk/Antelope is going to be appraised by at least one (Antelope2) and, in all likelihood, a couple more wells at least. The seismics have turned out to be reliable here, and the Antelope structure is 14×7 kilometres at least, although there are people who expect it to be substantially bigger even than that.

Additional fields

• From the March 30 report from Raymond James, further drilling prospects include Mule Deer, White Tail, Wolverine, and Raptor.
• IOC has licenses for 4.6 million acres, these can be seen on their website

Deals

• From a conference call on March 30 (2009) we know that InterOil has been approached by a vast number of LNG investors..
• We also know that the Chinese are using their financial clout today to secure energy supplies long-term (here and here). In fact, for many of these Asian countries securing energy supplies for the long-run is a matter of national security
• Two kinds of possible parties (Asian utilities and major oil companies) each have the deep pockets and long-term horizon to look beyond the current energy glut and be part of this project
• Two kinds of deals most likely on the table are an off-take agreement (financing of part of the LNG facility for guaranteed long-term LNG deliveries) and farm-out agreement (selling part of the resource in exchange for finance and drilling participation, which would speed exploration up by getting multiple rigs to work).
• And, in an accompanying email to a research update, Raymond James argued that InterOil talked with 50 firms already and was structuring the deal as 5% incremental sell-offs, but not before they’re done at Antelope1 (somehow, they expect that the well might materially impact the valuation..)

Energy price recovery

• Energy prices are very depressed at the moment, but this is related to the deep recession. This isn’t going to last and the longer it takes, the more depressed investment in new resources become so the greater the shortage of energy will be when the world economy (and energy demand) recovers.
• One thing to keep in mind is that the major existing oil fields are declining 6.7% on average, that trillions of dollars of investment are needed just to replace that, much more when energy demand starts rising again (IEA)
• Natural gas is growing faster than oil because it’s cheaper and cleaner, which is why it is still on the receiving end of much investment (at least there where prices are higher than production cost, the latter is a particular problem of US shale gas as US prices are much lower than those in Asia and shale gas is expensive)
• We’ve assembled material on these markets and IOC’s position in it here, and here.

EBITDA/Cashflow

• If energy prices would not have fallen in an unprecedented way in Q4 2008, InterOil would have been profitable overall. This is quite an achievement considering that exploration and the LNG facility (the latter alone is responsible for $7.9M of the 11.8M loss in 2008) do not generate any revenue
• The main lossmaker was a write-down on inventories as a result of the energy price fall, a whopping $52.3 million (of which a substantial part, $27.8 million were recovered through hedging wins, with a further $18.0 already booked for 2009).
• The refinery swung a whopping $13.5 million to yield a net profit of $4.7 million for 2008 while operating under 2/3 of capacity, this is quite unique. Capacity utilization and crack spreads are steadily increasing though, and the former will receive a big boost when LNG plant construction commences, so we can look forward to the refinery and distribution as financing at least part of the exploration program.

All in all, it won’t surprise you if you’ve read these pages before, we think the company still offers really compelling value, even after tripling in three months. We expect a stead appreciation (with the unavoidable breathers) until prices are significantly higher still. There is plenty of potential news left to provide the necessary fuel…