Nothing one couldn’t have thought off oneself, but useful anyway..

IOC Encounters Oil Shows at Antelope-2, but Don’t Pull Out the Bubbly Just Yet

• This morning, InterOil announced the confirmation of oil shows from its Antelope-2 appraisal well. The obvious question is: Does this amount to a commercial oil discovery? Additional testing will be required to determine this, which could take up to a month (or even longer). In fact, the company has its sights set on drilling laterally into the potential oil leg, a move that should provide a far clearer glimpse at this lower, liquids-rich zone, but would likely extend testing into the spring.
• After IOC shares reached an all-time high two weeks ago, a fairly neutral drilling update took some of the wind out of its sails and sent the shares drifting lower – a natural result of some profit-taking in the face of apparently inflated market expectations. Today’s news release has once again perked investors’ ears, but what has really changed? As it stands, this confirmation of oil shows essentially restates what the market has already known from the days of Antelope-1. While confirmation of oil commerciality would certainly be a “game changer” for the story – in that it would enable much more rapid cash flow generation relative to liquids-stripping, to say nothing of LNG, since the oil could be shipped by barge directly to the company’s refinery – we would still caution investors from calling this an oil discovery just yet.
• Let’s rewind back to the Antelope-1 sidetrack, in which InterOil encountered a potential oil leg spanning nearly 300 feet in height. Oil was encountered in three separate Antelope-1 drill stem tests (DSTs). That said, the company encountered difficulty when testing this lower section in Antelope-1 given the tight nature (i.e., limited porosity) of the rock within that particular interval. In other words, the company was unable to obtain a clear picture of the heavy condensate levels (let alone the oil leg) at the base of the reservoir. What could be different this time around? We would point out that InterOil has seen better porosity levels throughout its drilling at Antelope-2. Furthermore, the presence of dolomite throughout the entire upper reservoir section bodes well for the porosity levels in the lower, liquids-rich zone. Bottom line, we will have to wait and see, but the signs thus far have been positive.
• As InterOil moves into its next growth phase, balancing exploration with commercialization efforts, there will undoubtedly be more milestones to come – the most obvious being the market’s current focus on the potential oil leg at Antelope. We readily acknowledge that the confirmation of a commercial oil leg could lead to meaningful upstream earnings in the relatively near term versus the extensive timeline set forth for the proposed LNG facility – with first production not expected until at least late 2014. On the other hand, there are obvious execution risks in a “well watching story,” as exhibited by the sell-off over the past two weeks. While recognizing the longer-term valuation upside, we believe it remains essential for investors to recognize that the operational and timing risks as the upstream assets and the LNG plant are developed over the next five-plus years have not disappeared. We maintain our Market Perform rating.