This looks likely, sifting through the evidence…
Such a judgement is based on answering four questions:
- Is Elk/Antelope an economic resource?
- Is there enough future demand for LNG?
- Are there enough interested deep pocketed third parties?
- Are there concrete signs of interest from such third parties?
Is Elk/Antelope an economic resource?
- The latest independent resource appraisal argues there is 8.2Tcf of gas and 156.5 million barrels of condensates. While this is an ongoing process, this should in principle be enough for a two train LNG plant and at the minimum the initial liquids stripping unit (9700 barrels per day capacity).
- If one compares total project cost, the indications are strong that InterOil once again is the lowest cost project. It’s LNG plant is budgeted at $5-7B, while other projects in the region are at least double that. Exxon/OilSearch is budgeted at $15B. Some of the Australian projects are even way more expensive (Gorgon is budgeted at $50B). No surprise. Australia is a high cost location compared to PNG and the gas resources are either coal seam gas (where wells don’t flow and thousands have to be drilled, treated and manned to supply sufficient gas to feed an LNG plant), or expensive offshore projects like Gorgon.
- InterOil holds further advantages in having a single resource in the lowlands versus six scattered resources in the highlands at almost three times the distance to the proposed LNG plant for OilSearch, they also have to construct way more pipeline in more difficult terrain.
- InterOil also has considerable infrastructure already in place. According to Wayne Andrews: “We have very high productivity wells. We’ve got the land ready to go to build the LNG plant. We own, we have a 99-year lease on the former Australian Naval Base in Papua New Guinea because so have no landowner rights issues, nothing that’s stopping us. We have a jetty system there. We own the harbor rights. We’ve got a deep-water forest. We’re taking tankers now to bring crude oil into our refinery. All that’s ready to go with low cost gas.”
- So, since these locational and infrastructural advantages result in the project is basically half the cost of the rival project led by Exxon/OilSearch, InterOil has a lot of leeway in terms of the number of wells needed. However, it very much looks like InterOil’s wells are more productive, giving it another advantage
- Wayne Andrews, former analyst at Raymond James and now at InterOil argued in a taped interview that InterOil’s wells are three times less expensive and 20 times more productive compared to OilSearch.
- One has to realize the size of these wells. Not only the record flow rates (382MMcf/d and 705MMcf/d for Antelope 1&2 respectively, and that after the Elk wells already established flow rates of 102 and 105MMcf/d. The Exxon/OilSearch resources have nothing comparable), but also the sheer size of the payzone in the Antelope wells (see p.15 of the latest Investor Presentation) having 2277ft and 1175ft of net payzones and average porosities of 8.8% and 14% respectively.
- Despite all indications to the contrary, there could still be a theoretical possibility that the Elk/Antelope resource is not economical. If the resource is so compartmentalized it would lead to wells depleting fast and too many have to be drilled as a result. There are several ways to look at this.
- One way is to compare it with Australian coal-seam projects (as we’ve done here). Coal-seam gas doesn’t flow at all, it has to be made to flow and the wells flow at such low flow rates (typically less than 1MMcf/d) and deplete rapidly, so thousands of wells have to be drilled, treated, and manned to supply an LNG facility. Yet there are many of these projects under construction or planned at the moment in Australia, a much higher cost location.
- If coal seam projects can be profitable supplying a (two-train) facility with 5000 wells over the lifetime of the LNG facility (the Conoco/Origin project needs 20,500 wells for four trains) and even assuming InterOil’s wells would be ten times more expensive, Elk/Antelope would still be economical if it needed 500 wells. And as we have set out in the article, these assumptions are already quite generous.
- InterOil holds several advantages over these coal-seam gas projects. It’s gas is much cleaner (5-6% CO2, see p.25 here), doesn’t have to treat the wells to make them flow (expensive and not environmentally risk free), it doesn’t have to hook up so many wells at the same time as they are way more productive (leading to high infrastructure and manning cost), it produces very profitable condensates as a by-product, it operates in a low-cost environment, etc.
- Another way of looking at that is that drilling 500 wells could amount to perhaps $10B in drilling cost, which would put the total budget for exploiting the resource at a par or slightly above of the Exxon/OilSearch project (which took the final investment decision in December last year).
- We think drilling cost of $20M per well is rather onerous, as most of the present drilling cost are highly inflated by (waiting for) extensive third party testing and meandering around at the bottom of wells which wouldn’t be needed for production wells). InterOil also recently bought a more efficient rig.
- The 500 wells would have to produce 8 Tcf over a 25 year period, that’s 16Bcf per well. Basically, these Antelope wells have to perform for less than a month! This is very unlikely considering the 1000ft+ net pay-zones and average wells lasting 2-10 years. Not even the coal-seam wells peter out that fast.
- If they cost $20M to drill and produce that 16Bcf, they produce revenue of $160M (providing a long-term off-take price of $10 per Mcf), so we see that drilling cost would still only amount to 8% of revenue, and that’s not even taking into account profitable byproducts like liquids (already embarking on FEED work for that), butane and propane.
- We have seen no data at all which suggest that Elk/Antelope would uneconomical, and multiple signs that Elk/Antelope is:
- The quality of the rock (large stretches of dolomite reef), the size of the vertical pay-zones, and the world-record flow rates at the minimum suggest that this is a resource that is cheap to develop.
- Further indication comes from Morgan Stanley, which calculated before Antelope2 the break-even prices for LNG projects in the region. IOC came out as the lowest with $3.70 per Mcf, followed by Exxon/OilSearch ($5.05 per Mcf) and the Australian projects ($6-8 per Mcf)
- New Liquid Niugini CEO Aldorf has gone further than that after the very successful Antelope2 well in stating the break-even price for InterOil is $2.25 per million BTU (roughly equal to 1Mcf) and citing a calculation from Wood Mackenzie showing the Exxon/OilSearch break-even price is $7.49 per million BTU.
Is there enough LNG demand?
- Natural gas has significant advantages in being a lot cleaner than coal and cleaner and cheaper than oil. This is particularly significant for countries with insufficient energy resources and/or severe pollution problems like many countries in Asia.
- The LNG demand is set to double by 2020
- The LNG market is not a global one, witness the large price differentials between different regions. The Asian market is by far the most lucrative market as there are many countries that have little if any energy sources of their own (Japan, Korea), or have large pollution problems (China). Asia Pacific region’s gas use has risen from 14Bcf in 1990 to 47Bcf now (see p.17 of this)
- Fighting global warming obligations might very well accelerate the shift towards natural gas, as will a shift towards electric cars.
- Although traditionally, Japan and Korea are the region’s (and the world’s) top LNG importers, China and India are rapidly increasing their import capacity:
- Chinese and Indian LNG imports rose by 53% and 29% respectively in 2009
- And despite the severe economic crisis, demand for gas was up 16% in China and 2% for the world as a whole.
- LNG imports from China and India are set to seven-fold.
- China’s gas use is only 3% of it’s energy consumption, globally the figure is 25%.
- China experiences a gas shortage and is building a lot more infrastructure to import LNG
Are there enough deep-pocketed third parties?
- There is a scarcity of new resources, especially ones which are conventional and therefore relatively easily accessible.
- New large discoveries are increasingly difficult and expensive to get out of the ground (consider Petrobras off-shore findings) or access is largely restricted by nationalistic resource policies (a phenomenon known as ‘political peak-oil’).
- Oil majors find it increasingly difficult to replace their reserves, or even keep up production, not withstanding they are awash in profits and eager to expand.
- Chinese interest in resource plays everywhere is pretty rampant, and the Indians are joining in.
There are numerous deals in the region for more expensive projects, like:
- Petronas paid $4.75 per Mcf for P2 coal seam gas reserves from Santos
- Conoco paid $3.24 for a stake in Australian coal seam project from Origin
- Nippon paid $800M for a 3.6% stake in the Exxon/OilSearch PNG project
- Exxon/OilSearch project had offtake agreements at $12 per Mcf and quickly sold out
Is there concrete interest from third parties?
There really is quite a bit of evidence of that:
- A summary part I including Petronet (India) CNOOC (China) ENI (Italy) PTT (Thailand), talks with 30 interested parties
- Summary part II including Petrochina and CNOOC (China), Petromin participation (PNG)
- Part III
- Part V
- Part VI
- Part VII
- Part VIII
- Ramond James email: 50 interested parties
- CNOOC deal with PNG government
- RJ interpretation
Apart from that, there is other evidence that work has already begun, not only by InterOil, but also by the provincial government:
- InterOil embarked on FEED
- InterOil ready to start
- InterOil MOU with Mitsui
- PNG province embarking on infrastructure investment for IOC’s projects Feb2010
- PNG province part II Feb2010
Research firms take the LNG facility as a near certainty already. Here from the latest Morgan Stanley update on InterOil [Feb 16 2010 p.3]:
- As such, rather than model an additional train or some type of FLNG off-take in our target price, we are de-risking the LNG partner risk in the asset today (to 90%). Meaning, we believe this higher resource in the Austral-Asian markets, increases the likelihood a deal is done and gets down in 1H2010. The higher resource estimate also lowers our implied price per mcfe in the sell-down process to $1.34 per mcfe vs. $1.75 for in-region, comparable transaction, where we see room to the upside.
Nataxis Bleichroeder went even further, in an update [Dec 1 2009], it arrived at a $98 target and said the following (p.1)
- Complete De-Risking of LNG Business Marks Major Change in Valuation. Previous iterations of our IOC price target were at various risk levels of the company’s proposed LNG terminal materializing (50%, 65%, and a recent 75%). With the magnitude of natural gas and condensate tapped with the Antelope-2 well — which is about 2.5 miles from the Antelope-1 well — and the resulting likelihood of a growing attraction for the company and its assets to potential strategic partners, if not corporate buyers, we have now fully de-risked InterOil’s LNG facility, as reflected by the substantial increase in our previous $53 target price to $98 per IOC share.
Against that, the critics have come up with very little.
- They hired a geologist, Bertoni who argued (before Antelope2 was successfully drilled and tested) that it’s too early to say and pressure depletion of the wells (as a result of resource compartmentalization) could be a risk. Bertoni didn’t actually quantify this risk at all (apart from saying that it was ‘non-zero’), but we’ve shown above (and here) that this is very unlikely to be anywhere near significant, and the Antelope2 results have further solidified the resource.
- Minkow’s Fraud Discovery Institute (FDI) just took the Bertoni report as “evidence” that InterOil is a “Ponzi scheme” but we have shown that this is in no way substantiated by the facts. In reality, one has to make rather onerous assumptions to show that Elk/Antelope is not economical.
- And they go on to produce laughable stuff like this.
- How the FDI operates has been set out here.