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InterOil Daily Distortions 26

April 24th, 2009 · 6 Comments

This really goes to the heart of the matter, which is why it’s terribly important. Don’t be fooled..

A couple of characters on message boards are trying to deliberately and repeatedly exploit the fact that a third party report, which assessed InterOil’s find, speaks of contingent resources instead of reserves. What they’re trying to suggest is somehow that the third party assessment (which they claimed would not happen, but anyway) has not proved anything.

Just an example (from a now disturbingly familiar character) who argues when confronted by a statement that the difference between contingent resources and reserves has nothing to do with the amount of gas in the ground flatly argues:

  • Yes it does. It makes it much more likely that the quantity is ZERO. That’s why the SEC doesn’t allow you to book a resource as an asset.

And he keeps arguing it. Not only that, but a securities litigation lawyer Howard Sirota also repeatedly tried to exploit the difference as to suggest that InterOil hasn’t found what it claims it has.

So what is the difference between reserves and contingent resources?

A gas/oil/condensate finds basically faces two types of risk, which, together form the chance of commerciality. The chance of commerciality is a product of the chance of discovery and the chance of development.

The only difference between reserves and ‘contingent resources’ pertains to the chance of development, not the chance of discovery, that is, whether a find is classified as a contingent resource or a reserve doesn’t change the amount of gas (oil/condensates) in the ground.

In other words, a reserve has 100% chance both of discovery and development. A contingent resource also has 100% chance of discovery, but less than 100% chance of development (see page 6 here).

From the same source, Canadian Securities Administrators the factors that determine the chance of development (that is, the factors where resources and reserves differ):

Chance of development – This applies to both prospective resources and contingent resources. It is derived from a number of factors that may include, but are not necessarily limited to:

  • project economics;
  • recovery technology;
  • technology under development (refer to section 7 of this Notice for further discussion on technology under development);
  • regulatory (including environmental) approval;
  • market and facilities;
  • corporate commitment; and
  • political risk – the quantification of political risk is not within the usual practice of oil and gas evaluators, but organizations exist that provide this information (e.g., The Economist’s Global Political Risk Index, produced by the Eurasia Group).

Now, we can safely say that the project economics for the Elk/Antelope field are way better than most, due to the really prolific flow rates and the low-cost environment of PNG (we have often compared it to Australian coal seam gas projects which have to drill, treat, and man thousands of wells in a high cost location to get the same amount of gas as just three wells from Elk/Antelope, and also OilSearch gas flows are only a fraction of the wells in Elk/Antelope).

Recovery technology is no problem, it’s a conventional gas source, not shale gas or coal seam gas, or offshore deep under the ocean. This also covers the ‘technology under development’ item.

Regulatory approval won’t be a problem either, save to say.

Market and facilities. That’s where the problem lies. There isn’t yet an off-take agreement, and there arn’t yet facilities to separate the condensates or process the gas (that is, an LNG facility). But this is hardly news, let alone shocking.

Corporate commitment, well, that doesn’t strike us as a problem either..

Political risk. Small, but not entirely negligeable. InterOil has an excellent relation with the present government, who is managing the country much better than many other countries of similar levels of economic development (that isn’t the same as saying there aren’t any problems or there isn’t any room for improvement, but that holds for all countries).

We simply conclude the following:

  1. The fact that InterOil’s gas find has been classified a ‘contingent resource’ doesn’t in any way detract anything from the amount of gas that they have found
  2. People who repeatedly and knowingly try to suggest otherwise are, well, you can fill in any word you like here…
  3. More importantly, you might want to think about the reasons certain people keep trying to exploit this difference, and what bearing that has on other things they say
  4. The difference between reserves and contingent resources only relates to the chances of development (deemed 100% for reserves, less so for contingent resources)
  5. Of all the factors listed as having an impact on that chance of development, the only serious one is the absence of production facilities (like pipelines, LNG facilities, condensate separators, and the like).

But that InterOil doesn’t (yet) have those facilities is hardly news. If they would have, their stock price would be at a large multiple of what it is today.

And someone foresaw that that the shorts would try to exploit the difference..

Tags: Daily Distortions · IOC · Public Policy

6 responses so far ↓

  • 1 Darcy Patten // Apr 24, 2009 at 7:06 am

    Professor, this is an excellent post as it provides exceptional clarity. Thank-you.

  • 2 Jim Tate // Apr 24, 2009 at 12:56 pm

    STP is one of the good guys.

  • 3 Darcy Patten // Apr 24, 2009 at 6:21 pm

    No kidding Jim, without this site their is absolutely no way I own 8500 shares. Without this site I work another 20 years. I cannot express with words my gratitude for STP’s tireless efforts.

    Before this is all said and done I will being taking a trip to the Netherlands to shake this man’s hand!

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  • 6 InterOil’s gas relatively cheap to develop? — // Apr 29, 2009 at 7:18 am

    […] painstakingly explained the difference between ‘contingent resources’ and reserves (here). IOC’s gas find is classified as ‘contingent reserves’. The difference between […]