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IOC Announces Results of Drill Stem Tests; Holds Annual General Meeting
Sal Ilacqua

InterOil (IOC – BUY – $24.75): On Friday June 19th, InterOil announced results of its Drill Stem Tests (DST) #14 and #15 on the Antelope I well in Papua New Guinea and held its Annual General Meeting. DST #14 tested an interval from 7,940 ft. to 8,045 ft. and recovered gas, condensate, oil and drilling fluid extending the oil leg an additional 187 feet from the previously announced 89 feet for a total of 276 feet. DST #15 drilled to 8,170 feet and was unsuccessful due to a down hole valve failing to open. While the tests have not flowed at meaningful rates, the known presence of a considerable oil horizon bodes well for future drilling opportunities. As can be clearly seen on the well logs provided by the company in its presentations, the rock is relatively tight in this local area. However with the knowledge of oil and the depth range over which it occurs, InterOil intends to target areas more likely to be porous with future drilling activity. Additionally, the company is placing the well on a long term production test which should provide additional information about the condensate-to-gas ratio at the base of the gas column and the oil zone in the open hole as drilling fluid is produced over the next few weeks. Despite the positive signs, some shareholders may have chosen to lock in profits, as the IOC common shares had already recorded major price appreciation from a low of $9 per share in late November to this June’s peak of around 38. We suspect short sellers noise and convertible debentures being converted into common shares contributed to the recent selling pressure.

We expect continued success from both the long-term test of the Antelope-1 side track and future drilling objectives and believe some of the recent selling seems to overlook the recent outstanding success at InterOil which continues as an attractive world class drilling play. We suggest investors focus on some of the significant positives in this situation that we note below:

• The Antelope-1 well appears to be a major gas and condensate discovery. Tests on the upper part of the Antelope-1 well reached an astounding flow rate of 382 million cubic feet per day of natural gas along with 5,000 b/d of condensate. This is the largest flow rate ever recorded in PNG and possibly the largest from a single vertical onshore wellbore anywhere in the world.
• The company has now accumulated substantial resources of natural gas and condensates. In a June 19th presentation, the company noted an up to date outside third party resource estimate of 6.7 trillion cubic feet of natural gas equivalent on a gross basis for the entire Elk/Antelope structure. Some observers would value these resources at several billion dollars in the current market. We believe the total spent by InterOil in its on-going exploration program has probably reached the area of $300 million.
• Side track 2 confirmed 257 feet of heavy condensate and oil in the lower section of the Antelope-1 well. Apparently, considerable oil and gas have been encountered, but a sustained flow has yet to be attained. This accumulation, if similar to most oil and gas fields, should blanket an area over 7 miles north to south and 2-4 miles east to west. Just as it found the best location to drill for natural gas, now that InterOil has confirmed the presence of oil in the Elk/Antelope structure, the company can target areas of improved porosity and permeability.
• Current plans include a long-term production test in the open hole section from 7,698 to 8,052 feet (354 feet). This identified zone of interest has recovered gas, condensate, oil, and drilling fluids in previous Drill Stem Tests.
• InterOil’s refining/marketing operation has recently generated around $15 million per quarter and we estimate cash flow of $50-$60 million in 2009. This internal cash flow, combined with the $42 million of cash reported on March 31st and $70 million from the sale of 2.0 million additional common shares, leads us to anticipate IOC will have about $90 million on hand at June 30th.
• InterOil has nominal outstanding long-term debt which essentially includes a working capital loan that finances crude oil purchases and a long-term OPIC loan of about $61 million that is being amortized to maturity on December 31st, 2015.
• The recent cash infusion will help accelerate drilling. The Antelope-2 well should be spudded in late July approximately 2.2 miles from the Antelope-1 well at a location selected after the accumulation of extensive seismic information. Negotiations are underway for a second drilling rig that we believe should arrive in the third quarter.
• Studies are underway on the feasibility of installing a facility to strip the condensate liquids from early production of natural gas with the dry gas then reinjected for future sale. We suspect a facility of this type could be installed by late 2010 or early 2011 and immediately generate some meaningful cash flows. A potential production rate of 10,000 b/d – 20,000 b/d would appear likely.
• Finally, we are optimistic with respect to the establishment of an affiliation with a strategic partner to join in the creation of an LNG export facility in PNG. We understand numerous private and public companies have expressed an interest in the PNG project, and we look forward to a larger, better financed partner to participate in both an LNG facility as well as in the exploration for additional oil and gas reserves.

We believe InterOil is on the threshold of attaining its most optimistic objectives after a long struggle of some fifteen plus years during which the company has had a bare minimum of financial resources. The Company now has reached the critical mass of natural gas resources to backstop at least a single train, and more likely a two train, LNG plant. They have documented extensive resources of condensate that could be more valuable than the natural gas. Finally, some oil has been encountered in at least two well bores which should improve the prospects for commercial oil in the general area. With the improved financing in place, drilling will be accelerated, but more importantly, industry interest in participating in InterOil’s future seems to be rising. At least three public entities have stated their active interest. The stage has now been set for outside parties to make real bids for active participation. Current investors in the InterOil common shares may well participate in the fruits of a decades long effort within a relatively brief time span.