Reading the report, the reasons are pretty curious, and so is the timing…
We are somewhat at a loss to explain the downgrade, to be honest. A few remarks.
1) Political uncertainty
The reasoning is as follows:
- “Our growing recognition over the past few months that many InterOil investors are overly focused on near-term catalysts without fully recognizing the long-term challenges inherent in monetizing the gas that InterOil has discovered” [p1]
It’s curious that he hasn’t recognized these challenges before, we’re inclined to say. The only possible catalyst for such worries could have been the opposition of some members in the PNG cabinet. But, as Pavel himself acknowledges, this opposition is temporary. At worst, there will be some delay (until the other LNG project gets its finances sorted (which they’re well underway of doing) and take the final investment decision.
So the worst case scenario for that is having to wait a couple of months for that formal government approval. But this is not necessarily a static situation. The Prime Minister and Energy Minister have expressed their strong public support for InterOil’s project. And, as we’ve argued before, InterOil is not without influence itself.
Strong Antelope2 results and/or the backing of a partner willing to sign could exert pressure on PNG politics to yield, as this will make the arguments of those ministers who want to delay the project look rather silly.
The formal arguments used by these ministers are that formal approval now would send the “wrong signals” to prospective Asian LNG buyers. This is clearly nonsense. The OilSearch project is as good as sold out on its LNG already. Does Australia delay approval of one of their ongoing LNG projects because it would spoil the market for those that have already been approved? No.
2) Resource evaluation
We’re even more surprised by Pavel’s reasoning to lower the NAV value of the project.
- “As InterOil moves into the execution/exploitation phase in its upstream segment, we are updating our NAV methodology in order to provide a clearer picture of the company’s de facto “proved” resource base – realizing, of course, that SEC-defined proved reserve bookings will only be brought about following the creation of a formal development plan (i.e., the final investment decision for the proposed LNG facility). As such, we are now only taking into account the “low end” (P90 or 90% engineered probability of being recovered) of the estimated resource range calculated by GLJ Petroleum Consultants as of year-end 2008, which comes out to 2.32 Tcf of recoverable gas and 36.7 MMBbls of recoverable condensate. We would underscore that this move in no way reflects uncertainty regarding the third-party resource assessment, but rather, we are choosing to place the company on a similar playing field as other E&P companies we cover. The updated NAV for InterOil is more directly comparable with the “proved NAV” that we calculate for other E&P companies.” [p2]
So, in essence Pavel now takes the low end of the evaluation of a report which doesn’t even include all the sallient data of the best well by far, and he’s doing that weeks before InterOil is entering the payzone (which they’ve already located) of the next well.
To refresh your memory, the GLJ report doesn’t include:
- The fact that Antelope discovered a reef, which has much better resource properties
- Data about the vertical payzone of Antelope1, which is at least 10 times those of the Elk wells (Elk1&4)
- Data about the average porosity of Antelope1 (8.8%, much higher than in any of the Elk wells)
- The record flow rate of 382MMcf/d and 5000bbs/d of liquids, which all came from just the top 20% or so of the well and with the choke only 1/3 open.
In effect, Pavel bases his NAV on the independent (GLJ) LOW END estimate of just the Elk wells. And why he hasn’t done so before, and does it now that we’re weeks away from entering the payzone at Antelope2, well, we’re at a loss to explain that, to be honest.
The argument he uses is that it is in line with how RJ values other companies. Then why now? Indeed, in his own words, his NAV calculation doesn’t include:
- (1) the “high end” (or even the midpoint) of the year-end 2008 resource range;
- (2) presumed increase in the resource estimates subsequent to year-end 2008, notably given the record flow rate from the Antelope-1 well, some of which is likely to be reflected in year-end 2009 resource estimates, due to be released next spring;
- (3) credit for the potential oil leg;
- (4) credit for the asset value premium InterOil may receive as part of its monetization deal(s) with strategic LNG partners; or
- (5) credit for resource potential at prospects other than Elk/Antelope.
So even by his own implicit recognition, his NAV calculation leaves out a lot that has already been shown to exist.
On a more positive note, two interesting features from the report:
- For 2009, Pavel expects InterOil to have a cash flow per share of $1.30 and EBITDA of $55 million, rising to $63 million next year
- He values the refinery and downstream assets as $16 per share.