Sell-off in InterOil part II

We think an oil disappointment is probable, but already priced in by now. It was never going to be the main value play for InterOil anyway.

We wrote yesterday about what is going on (see here). We did think InterOil had a good chance of getting oil flowing based on:

  1. Even Bertoni (the geologist paid by the shorts) acknowledged there is an oil layer below the gas (see p.12 of his report).
  2. There were oil shows in Antelope1, the problem was the rock, it was too tight at that depth.
  3. The quality rock dips down from Antelope1 to Antelope2 and in fact thickens (the dolomite is considerably thicker at the latter)
  4. The latest DST flew 11MMcf/d of gas. That quality of rock is good enough to flow meaningful quantities of oil from a vertical hole, and the flow rate can be significantly enhanced by horizontal drilling.
  5. Some sources have it that the 11MMcf/d was an understatement due to choke problems, and that the test was still executed in the dolomite. Although we can’t confirm that, it would be nice if true. However, dolomite is not necessary for oil to flow from a vertical well.
  6. So all we need is the rock quality over the tested zone to continue deeper. The drilling break they experienced at the bottom is a promising but hardly a conclusive sign.
  7. Even if not successful, the quality rock dips down so there are likely to be better places still for getting it out.

But the only way one can know for sure is to analyze the logs and to test. Now, considering all this, we arrive at the following conclusion. There are three possible explanations for the sell-off:

  1. Normal profit taking in a stock that has moved from $10 to $85 in a market that has shifted a way from risk
  2. Some aggressive shorting as a last dash effort by the shorts before any news on commercial oil and/or a deal with Mitsui is out.
  3. Disappointing well news.

We think it’s probably a combination of all three. We have never seen major price moves on high volume without some kind of news following, whether good or disappointing.

What do we mean by disappointing well news? Perhaps the quality of the rock at the bottom of Antelope 2 is not sufficient for oil to flow from the vertical well, and horizontal drilling is necessary to make the oil flow. But this will take time, and it produces disappointment, and there are no guarantees for success either.

Would the absence of commercial oil (for now) be a disaster? Not really. The gas is still there, the liquids are still there, we think a liquids stipping plant is coming (in fact, InterOil is already making preparations for that). Oil could very well still flow from a horizontal well, or if not since the quality rock dips downwards there are better places to get it out. But the excitement will wane a bit, that’s undeniable.

10 thoughts on “Sell-off in InterOil part II”

  1. STP just curious, you think that there is disappointing well news because it has been too long and we should have heard of something by now or because somebody knows something and the stock is down, Thanks

  2. I think we need to be careful what we think the “tape” may be telling us. Taking the other side of that rationale, many were saying that the violent move up to the 80’s was telling us that oil was present and flowing the surface. Then we got the DST#2 PR that stated they hadn’t even gotten to the oil yet. My explanation was that there was a tremendous amount of short-covering on the way up, and now those folks are selling. I still think there is a better than 50/50 chance we have commercial oil and you better believe that the stock could be back to the 80’s nearly over-night. Patience people…and yes, I used to be part of the “antsy” crowd but have learned to trust the hydrocarbons in the ground.

  3. Good to hear from you TJ. I lean that way too. I think it will flow in the end. Maybe not vertical but horizontal. I think hedgies are tired of waiting, nervous, shorting, weak hands, bad market dynamics….

  4. How do you go from saying on Wed, 9/27 that “there is a good chance that oil will be produced from A2” to saying on Thur, 9/28 that “it is probable that there is an oil disappointment from A2”?? Did you get some information from a source at IOC to make your 9/28 statement??

  5. Fair question. No, we didn’t get any info, it is based on the combination of:
    – substantial sell-off
    – on large volume
    – previous occasions where pending news has been preceded by heavy buying/selling
    – the knowledge that news travels through many hands, it’s impossible to contain.

    So it’s an informed guess, basically, although we have to say there are many more energy (and non-energy) related small an smaller caps down as much, so we could be wrong.

  6. In the 1st paragraph of Part 1, RE: “Sell-off in IOC”, you stated that you believe IOC stock is being manipulated. If you watch the Level II reports for very long, it seems probable to me that the the hedge funds are trading in a concerted effort among themselves to push the stock down to as low a level as possible for themselves. The volumes are too great on the downward moves that occur within a couple of minutes for these moves to be occuring from retail investors. In my opinion, they are colluding to share in taking relatively minor losses for a period of time so they can drive the stock down and buy in much greater volumes on the way back up. I’m sure that the hedge funds are fully aware of the huge investments by Soros, Goldman, Morgan Stanley & Wells Fargo (i.e., Warren Buffet) in IOC. Why create doubt about the oil probabilities when market manipulation by the hedge funds is a lot more likely. Spend some time watching the Level II detail and see if you don’t agree.

  7. Ok, yes Ron, we stuck our neck out, we might get chopped off. This is not science, and we gave three reasons for the sell-off, one of which is the manipulation you’re talking about. The point is, we’ve never seen a significant sell-off (or “buy-up”) when there was news pending without the tape telling us what the news is going to be and we’re just thinking, why should this time be different? But we sure hope we’re wrong, apart from the fact that an oil disappointment is now fully priced in (or more so), and the oil is not done forever. Horizontal drilling or drilling down dip still offers good posibilities (if we’re right about our gut feeling that the vertical well doesn’t flow enough). And there is plenty of other exitement possible, we think.

  8. In my opinion, since January 11, 2010, IOC stock has been subjected to a very severe short attack by the hedge funds. We have had 2 up days and 13 down days since 1/11/10. I think we are currently in the same situation as we were in in Apr/09 thru June/09 when the short selling overwhelmed the stock. The DST press release by IOC on 1/11 gave the shorts all the opportunity they needed to implement their short attack which has basically cost IOC stockholders about $1 Billion in market cap over a 3 week period. Stp, I know you are very knowledgable about naked short selling and the disastrous impact it has on legitimate market investors. Do you really think we’ve lost almost 1/3 of IOC’s market cap without a very organized short attack orchestrated by several hedge funds.

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