| blast_investor Sat Dec 03, 2005 11:03 pm |
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Short IOC ($25.00) <InterOil > by jaxson905
8/15/2005 9:43:00 AM IOC ($25.00) <InterOil > by jaxson905 Rating 6.6 (26 users)
Description:
Investment Thesis
- I recommend a short position in InterOil (Ticker: IOC) with a target price of
between $3 and $9/share vs. the current stock price of
$25/share.
Price: $25.00
Shares Outstanding: 33.1mm
Market Cap: $827mm
Net Debt: $120mm (excluding $125mm in cash for pre-funded exploration JV)
Enterprise Value: $947mm
- Long investors and sell-side analysts value IOC’s one oil refinery at
$15-$20/share based on management guidance ($60mm in EBITDA / $44mm or $1.33/share in net
income) and view the stock at $25/share as a cheap option on potential exploration
success in the company’s remaining 7 well drilling program in eastern Papua New Guinea
(PNG), where management has represented that the basin has the potential for
world-scale oil & gas discoveries (i.e. you are only paying $5-10/share, or $165-$330
million, for the E&P optionality).
- However, I believe the earnings power of the refinery is significantly less than
$60mm (I calculate $0-$10mm in EBITDA) based on my reading of the refinery’s
pricing contract with the state of PNG (management has historically refused to discuss
detailed terms of the contract, but it is available publicly in PNG and is attached
below). In my best case scenario (laid-out below), the refinery is worth $0-3/share
(net of debt).
- IOC’s refinery is currently operating at negative EBITDA and 60% utilization, a
situation management blames on operational issues as the refinery ramps-up (it went
into service in summer 2004). As recently as June 2005 management reiterated their
long-term guidance of $60mm EBITDA / $44mm net income. After examining IOC’s
pricing agreement with the state and analyzing regional refining crack spreads, I believe
the refinery’s problems are not temporary operational issues: the refinery has no
long-term earnings power given its limited product slate (it is a very low complexity
refinery, discussed in more detail below) and a pricing agreement that does not
yield IOC any material pricing benefits.
- If one values the refinery at $0-3/share and backs it out of the current stock
price of $25/share, the E&P business is actually being valued at $22-25/share, or
$720-$830mm, and not $5-10/share as the bulls/sell-side analysts seem to think. Based
on comparable PNG E&P valuations (see detail below), a $22-25/share valuation
implies that IOC has already found 450-620 million barrels of oil equivalent (whereas IOC
has actually discovered no commercial oil or gas in the 7 wells it has drilled over
the last 5 years). To put this quantity in perspective, in the history of PNG’s
oil & gas industry there has been only one large oil field found in the country (the
Kutubu field, which was a 300 million barrel field) and three commercial oil fields
found in total. Kutubu was discovered almost 20 years ago (1986) and is located in
western PNG (all of IOC’s acreage is in eastern PNG). The other two sizeable
discoveries were Gobe (discovered in 1991) and Moran (discovered in 1996). Both Gobe and
Moran (also located in western PNG) had 100-150 million barrels each. There have
never been any commercial oil or gas discoveries in eastern PNG. Any gas discoveries
would be uneconomic unless the gas is found in massive quantities that would justify a
liquefied natural gas (LNG) or pipeline project to bring it to market (such as the
one large PNG gas field, the Hides field (also in Western PNG), from which Oil
Search is building a gas pipeline to Australia). Therefore, any gas that IOC might find
will have minimal to no value unless it is a massive find.
- Is IOC’s E&P business worth $22-25/share ($720-$830mm)? This assumption is a
stretch given: 1) management’s weak exploration track record (most recently a month
ago but totaling 7 over the last few years – this company has never found any
commercial oil or gas reserves. See the chronology of management’s drilling guidance and
actual results below); 2) assessment from other large current and historical PNG
operators (Oil Search, Chevron, BP) that Eastern PNG (where IOC operators) is not
prospective and that the potential for large finds is very low (the reason why both BP
and Chevron left PNG (BP exited in 2002, Chevron left in 2003), and Oil Search refuses
to spend any more exploration dollars in the east); 3) the extremely difficult and
high cost exploration/drilling conditions in PNG (very mountainous terrain, no
infrastructure, inability to cost effectively shoot 3D seismic which leads to low
success rates).
- Based on numerous sources and research (detailed below), I believe it is
unlikely that IOC will find any commercial oil or gas in its remaining 7 well drilling
program, which would make the E&P business worth $0. However, one would attribute some
option value to the drilling program for the possibility that IOC has a commercial
find. I would suggest a value of $100-$200mm, or $3-$6/share ($100-$200mm implies a
45-170mm barrel of oil equivalent find, see detail below). If you think the market
is currently valuing the downstream business at $15-$20/share, then it follows given
the $25/share stock price that the market thinks it is valuing the E&P option at
$7-$8/share, so this only slightly above my $3-$6/share valuation. Combined with my
$0-$4/share valuation of the refinery, I arrive at a price target of between $3 and
$9/share for the stock.
- Given the current bull market in energy, it’s not surprising that these types of
companies/management teams are coming into favor. Investors have forgotten the
spotty drilling and execution record of this company during its 8 years of existence.
In fact, Eastern PNG has become a magnet for similar start-up E&P companies, such as
Cheetah Oil & Gas (Ticker: COGL) and Transeuro Energy (Ticker: TSU in Canada),
because it is so easy (and cheap) to acquire acreage given that all the major E&P operators have shunned the play. The key question this raises is: if eastern PNG was
truly a prospective E&P basin and given how easy it is to get drilling licenses there,
why in a world of $65 oil is there not a single major E&P company with a proven
track record operating there?
- Trading in IOC has liquidity surges as retail investors play a meaningful part
in day-to-day trading. While liquidity over the last few weeks has been low (100,000
shares/day), trading goes up to 500,000-1.0mm shares per day around events (wells,
earnings, etc). There should be ample liquidity to build a meaningful investment
over time.
Company Overview
InterOil is an energy company focused on exploration & production (E&P) and oil
refining in Papua New Guinea (PNG). The company has three key assets: 1) a 32,500
barrel per day simple distillation refinery that was completed in 2004 at a capital
cost of US$230 million (the only refinery on the island); 2) exploration rights on 8
million acres in the eastern portion of PNG on which it has been exploring for oil
& gas for the last five years; 3) a chain of 40 gasoline stations and 10 refined
products terminals (“Downstream”) in PNG purchased from BP in 2004 for $12.5 million
($6.8 million of which was for refined products inventory), giving IOC 20% market
share in retail refined products sales.
At 3/31/05, total debt is $132 million and cash is $137 million, of which $125
million was funded by institutional investors to purchase a minority interest in an
eight-well exploration program (first well in this program was drilled in Q2 2005 and
was dry). The $125mm funding is convertible at the investors’ option into 3.3
million shares but also gives investors the option to take a 25% working interest in any
of the remaining 7 wells. Net of the $125 million in committed drilling funds in the
joint venture, IOC’s net debt is $120 million.
IOC went public in Q2 1997 through a merger with a publicly-traded Canadian shell
company with no assets and remained a penny stock (<$3/share) until January 2002,
when IOC announced that they had “discovered a new oil system in eastern PNG” based on
samples they took from two dry holes they drilled in 2001 (see press release
hyperlinks below). Before 2002, IOC’s business was focused entirely on the refinery (the
CEO purchased an abandoned Alaskan refinery that Chevron had built in 1963 and
closed in 1991, dismantled it, and shipped it to PNG to be reassembled). After IOC came
public, the stock rose to $10/share after the Company indicated that Enron and
others were going to invest in the refinery and that the refinery would be completed by
year-end 1998 (it was ultimately completed in 2004). After a series of upward cost
estimates and project delays, Enron pulled out of the refinery in September 1998 and
the stock fell to <$1/share. After Enron pulled out, IOC attempted to obtain
third-party financing from private sources (they hired BT Alex Brown to raise the capital)
but failed, ultimately doing a deal with OPIC (U.S. government) for a much smaller
portion of the financing than originally indicated (they got $85mm versus the $130mm
they targeted in the BTAB-led private placement). The stock remained at low levels
(<$5/share) until the Company began promoting the E&P potential in 2002.
As many who are reading this posting probably already know, this stock has been
very controversial for some period of time. The standard long thesis on the stock is
that the refinery and downstream businesses are worth most of the stock price
($15-$20) and that you are getting a cheap exploration option. For example, Raymond James
(the biggest bull on the stock with a $70 price target) values the
refinery/downstream at $24/share. These valuations are based on the company’s guidance (reiterated
as recently as 6/28/05) of $60 million in EBITDA and $44 million ($1.33/share) in
net income from the refinery/downstream.
Shorts in the name have cited: 1) a promotional CEO who has indicated to Wall
Street that IOC has the potential for Saudi Arabian-sized oil and gas finds in order to
maintain his stock price and raise capital; 2) poor historical drilling results
(IOC has been drilling on the acreage for the last five years with no success, most
recently drilling a dry hole on 7/18/05); 3) an abysmal history of execution (first
production from the refinery was originally promised in 1999 at a cost of $160mm --
first production was actually realized in 2004 at a cost of $230mm); 4) the fact
that current and historical oil & gas operators in the country (Oil Search, Chevron,
BP) have chosen not to pursue E&P in the eastern half of the island (where IOC has
all of its acreage).
Given that the drilling history is well known to most who are familiar with the
story, I won’t focus this posting on IOC’s drilling track record (however, to be
complete, I have put together a chronology of the E&P press releases that compare the
company’s claims/guidance to actual drilling results below with hyperlinks to the
original press releases). Instead, I will focus this posting on valuing the
refinery/downstream operations, which many of the bulls have taken for granted and instead
relied on management’s earnings guidance.
In order to analyze the potential profitability of the refinery, I tracked down
the agreement that governs the pricing of the refinery’s products in PNG. After
analyzing the agreements as well as historical Asian refining crack spreads, my analysis
indicates that IOC’s refinery will be permanently unprofitable and therefore has
little to no value. When you back out real value of the refinery from IOC’s stock
price to figure out what you are paying for the E&P upside, you quickly realize that the
market is making heroic assumptions about what IOC will find in order to justify
the current valuation.
1997 Contract with the State of PNG (Regulates Refinery Pricing)
The sales price for the refined products from IOC’s refinery are regulated by a
1997 Project Agreement between IOC and the government of PNG (referenced in IOC’s 40-F
and filed on SEDAR in November 2004, although this filing excluded Appendix A which
has the specific details of the pricing arrangement). The company has refused to
offer the details of the agreement but (unsurprisingly) an agreement which regulates
the price which consumers and businesses will have to pay for energy is typically in
the public domain. A little digging in PNG produced the document (attached here
[http://www.swimediaservices.com/1997pa.pdf]) and confirmed that the document is in
the public domain. The exact formula for the pricing agreement is laid out in
Appendix A (page 48).
In concept, the agreement allows IOC to price the products based on import parity.
IOC is allowed to charge the Singapore posted price for any refined product sales
plus a transportation differential that is designed to compensate for the full costs
of transportation (tanker rates, insurance, ocean/inland loss, landing charges,
additives, demurrage).
Currently, the transportation differential is around $3/bbl (see pages 2-4 of the
attached pdf file for the exact calculation based on the formula
[http://www.swimediaservices.com/interoil.pdf]) by my calculation. This is consistent with current
tanker rates from Singapore to Papua New Guinea (the most recent tanker quotes for
Singapore-Port Mooresby are Worldscale 220, which equates to $1.75/bbl. Insurance/loss
provisions/etc makes up the difference. See page 4 for the detail).
The Refinery
IOC’s 32,500 b/d refinery is a simple distillation refinery that lacks any ability
to process heavy or sour crudes (it can only run light, sweet crudes). The product
slate of the refinery (from the company’s most recent management presentation) is:
38% diesel
17% naptha
16% gasoline
14% marine fuel oil
8% jet fuel/kerosene
4% liquid petroleum gases (LPGs)
3% process loss/refinery fuel
Management claims the refinery is capable of running at 36,500 b/d (vs. nameplate
capacity of 32,500 b/d) and 96% utilization, implying that it can process 12.8
million barrels annually. Cash operating costs for the refinery (also from the
management presentation) are $21.5 million ($1.70/bbl at full utilization).
The economics (EBITDA) of IOC’s refinery, then, should be:
1) the crack spread for the above product slate using light, sweet crude oil in
Singapore;
2) Plus: the import pricing premium as per the 1997 Project Agreement (+$3/bbl)
3) Plus/(Less): the discount / (premium) for IOC’s purchased light, sweet crude
to the Singaporean light/sweet crude benchmark (called Tapis). If IOC runs Kutubu
(the local PNG light sweet crude that is equivalent to Tapis), it will gain a roughly
$0.50/bbl discount to Tapis for its feedstock (over the last 10 years, Kutubu FOB
Papua New Guinea historically sells for a $0.50/bbl discount to Tapis FOB Malaysia.
This discount has widened out in the last few months to $1.50-$3.00/bbl due to the
high naptha yield of Kutubu as naptha pricing has declined; however, my understanding
is that IOC is not currently running Kutubu and is instead importing oil with lower
naptha yield to feed the refinery, as the crack spread on Kutubu is currently worse
than other crudes despite the more advantageous pricing of recent weeks (see
attached pdf page 7 for a graph of the 10 year historical Kutubu-Tapis spread
[http://www.swimediaservices.com/interoil.pdf]).
4) Less: cash operating costs ($1.70/bbl as per mgmt guidance)
So what is the crack spread for a simple distillation refinery like IOC’s in the
current market? Currently, the crack spread (applying IOC’s product yield laid out
above and using Tapis feedstock) is -$6.00/bbl (see page 5 of the attached pdf for
the exact calculation using current product prices
[http://www.swimediaservices.com/interoil.pdf]). The prices for IOC’s products and feedstock are posted daily on
Bloomberg and are calculated using the yield slate that management indicated. The
current -$6.00 crack spread, however, is abnormally low (crack spreads are very volatile
on a week-to-week basis) and doesn’t represent a normalized spread. To assess
normalized earnings power of the refinery (vs. at any given point in time), I looked at
this spread over time (from 1995-2005) and it has consistently cycled between $0 and
-$2/bbl (see page 6 of the attached pdf for a graph of historical crack spreads
[http://www.swimediaservices.com/interoil.pdf]). In coming up with normalized economics
for the refinery, I have assumed the midpoint of the range (-$1/bbl).
A negative crack spread isn’t surprising given the refinery’s lack of any
complexity whatsoever (i.e. it has no ability to process heavy or sour crudes; as a pure
distillation tower, it is the most basic and simple of all refineries). Distillation
margins (as any refining industry analyst will confirm) have always hovered around
$0/bbl and are even worse in Asia versus the rest of the world due to structural
oversupply of distillation capacity. The margin in refining is made in upgrading
(through catalytic crackers, cokers, etc).
To summarize on the economics of IOC’s refinery, IOC’s EBITDA per barrel will
equal:
1) Singapore crack spread (-$1.00/bbl)
2) Plus: import parity premium (+$3.00/bbl)
3) Less: cash operating costs (-$1.70/bbl)
4) Plus: Kutubu oil discount to Tapis (+$0.50/bbl)
which equals $0.80/bbl. Multiply this times 12.8 million barrels processed and
the result is a $10mm in annual EBITDA. This compares with management’s $60 million
EBITDA guidance. It should be noted that management’s guidance also includes the
Downstream business (they don’t breakout refining and downstream); however, given the
$13mm price tag InterOil paid for its Downstream business it should be safe to
assume that it does not contribute meaningfully to the $60mm in guidance (see further
discussion below). To corroborate that point, note that in Q1 2005 IOC’s downstream
business did $600,000 of EBITDA.
What’s worse is that this analysis assumes that all of the refined products are
sold in PNG. If any of the product is exported, then gross margins deteriorate
further (turn negative) due to the shipping costs of export (i.e. if IOC then had to ship
any of its refined products to Singapore to market them, per barrel margins would
deteriorate by another $1.75/bbl, or the cost of shipping product to Singapore).
After all, why would it make sense to ship light sweet crude (in high demand currently)
to a very small scale refinery in the middle of the Pacific Islands for processing
to then be exported? The problem for IOC is that the domestic market can only absorb
50-60% of their output according to management. The remainder was optimistically
targeted for export when the refinery was commissioned. Assuming real domestic
demand for refined products in PNG grows at 5% per year, it would take 12 years before
the refinery is fully utilized (i.e. before demand grew into the domestic capacity
that IOC built). At that point, we could expect to see $10 million in EBITDA.
Given the above, it is not surprising that in Q1 2005 (the first full quarter of
IOC’s refinery operations) the refinery and downstream were EBITDA breakeven.
Furthermore, management stated in its June press release that the refinery is currently
running at 22,000 b/d (60% of capacity) in Q2, on par with the same low utilizations
achieve in Q1. My guess is that this may have more to do with the fact that
exporting is not profitable than it does with the need to optimize the refinery operations.
Furthermore, management’s claim that the current unfavorable crack spreads for
naptha are also responsible for the refinery’s poor financial performance seems
implausible given that: 1) naptha is only 17% of the output of the refinery; and 2)
Singapore crack spreads for the fully refinery product slate have consistently been
negative over the last 10 years (i.e. this is not a temporary situation due to abnormal
supply/demand for one single product such as naptha).
Valuing the Refinery
Given the analysis laid out above, it appears to me that InterOil made a strategic
mistake in siting a sub-scale, simple distillation refinery in PNG. It is unlikely
that the refinery will be meaningfully cash flow positive over the next decade
without major capex to add to complexity (something that doesn’t make sense on a small
36,000 b/d refinery in a remote market), and it is furthermore highly unlikely that
management’s $60 million EBITDA guidance will be achievable.
If we were to be optimistic, however, and value the refinery on invested capital,
one could argue it was worth $0-3/share. Invested capital in the refinery according
to IOC was $230 million ($6,300/daily barrel at 36,500 b/d capacity). If we assume
the refinery is worth invested capital of $230 million, then the asset is worth
$6.95/share. Net of $3.62/share of net debt (excluding the $125 million in drilling
financing) = $3.33/share of equity value for the refinery. Original costing for the
project (also disclosed in the 1997 Project Agreement) was $162 million ($4,400/daily
barrel). So the project ended up 42% over budget (which may have been the key
reason Enron backed out of the investment). Regardless of IOC’s invested capital, a
$230mm valuation is hard to justify based on cash flow multiples (a $230mm valuation
equates to 23x the $10 million EBITDA run-rate we would expect to see once the
refinery is fully selling in the domestic market). Using a more realistic number of 10x
the $10 million EBITDA figure, the refinery would be worth $100 million ($3/share), or
zero to the equity once the $3.50/share of net debt is taken out. Using IOC’s
original cost estimate for the investment of $160 million, the refinery would be worth
$1/share net of debt.
This is a far cry from the $15-$20/share valuation referenced by the bulls on the
stock. At $15-$20/share (plus $3.62/share of net debt), the refinery/downstream
business is being valued for $615-$780 million, or $17,000-$21,400/daily barrel of
capacity. This is an absurd valuation relative to market: recent refining asset
transactions (El Paso/Valero’s Aruba refinery deal, El Paso/Sunoco’s Eagle Point refinery
deal) traded for $2,500-$4,000/daily barrel and both refineries were meaningfully
more complex than IOC’s. Furthermore, Valero’s recent bid for Premcor (a high
complexity refiner acquired in a corporate transaction for a 28% premium) went for
$10,000/daily barrel. In addition, replacement costs for a greenfield high complexity
refinery currently run around $10,000/daily barrel.
E&P
Ex-the refinery, IOC’s E&P business is an option (IOC has no reserves or other E&P assets of any material value). In my view, the two key questions to ask in
assessing the value of the option are: 1) what is the likelihood this management team
finds hydrocarbons? and 2) if they do find hydrocarbons, then how much can we
reasonably expect them to find and what are the barrels worth?
In assessing the exploration capability of this management team, it is worthwhile
going back and reviewing the chronology of IOC E&P press releases vs. the actual
results. It is worth noting several of the dry holes (there were 7 in total) were
preceded by press releases indicating major hydrocarbon finds, and in a number of
instances the company raised significant equity financing in the wake of the stock price
increase that preceded later announcements that the wells were dry (this is most
notable in 2003/2004 – see the history below of the Moose-1 and Moose-2/Sterling Mustang
wells).
Chronology of Company’s E&P Claims - See post #1 for details
Valuing the E&P Option – See post #2 for details
Catalyst:
8/15/2005 9:46:00 AM
To: jaxson905
From: jaxson905
Subject: E&P History: Part 1
March 1999: Claim their first PNG well (Stanley-1 well) is successful, stating
that there is “significant potential recoverable reserves.”
- IOC has since not
mentioned the well and has not developed the
field.
http://www.sedar.com/csfsprod/data13/filings/00157580/00000001/e%3A%5Cdocument%5C13797-1%5Cmar99-2.pdf
January 2002: Claim to have discovered “new oil system in Eastern PNG” based on core
samples from two dry holes they drilled (Subu-1 and Subu-2, both were shallow
wells)
- Stock goes from $4 to $9/share.
- Say they are going to drill 4 wells
in 2002 to test “large structures” (no wells were actually
drilled)
http://www.sedar.com/csfsprod/data29/filings/00418198/00000001/w%3A%5C3w_out%5C21162%5Cpress.pdf
December 2002: Announces a 6-8 well drilling program starting Q1 2003
with the “Moose-1” prospect, which IOC says has a mean reserve estimate of 350 million
barrels.
http://www.sedar.com/csfsprod/data34/filings/00499524/00000001/C%3A%5Cfilings%5CInterOilpr2dec3.pdf
http://www.sedar.com/csfsprod/data34/filings/00501429/00000001/C%3A%5Csedarfilings%5CSupplementary.pdf
April 2003: Moose-1
well begins. IOC says remaining 7 wells would follow immediately and will be done
by YE2003 (no other wells ended up getting drilled in
2003)
http://www.sedar.com/csfsprod/data36/filings/00525462/00000001/C%3A%5Csedarfilings%5CInterOil%5CPRMooseMarch11.pdf
April 2003: IOC raises C$10mm through a private placement days
after launching Moose-1
well
http://www.sedar.com/csfsprod/data36/filings/00528795/00000001/C%3A%5Csedarfilings%5CInterOil%5Cprapril1420031.pdf
July 2003:
Announced that Moose-1 had “14 oil shows” confirming their view that the basin has
large oil potential, although well is “not conclusive.” Stock goes from $12 to
$25/sh
are
http://www.sedar.com/csfsprod/data39/filings/00560047/00000001/C%3A%5Csedarfilings%5CInterOil%5Cmoosejuly28.pdf
July 2003: The same day as the
Moose-1 announcement, IOC launches a $15mm convertible debt financing and a $12mm equity
deal. IOC also increases the drilling program from 8 to 16
wells
http://www.sedar.com/csfsprod/data39/filings/00560049/00000001/C%3A%5Csedarfilings%5CInterOil%5Canno
uncejuly28.pdf
http://www.sedar.com/csfsprod/data39/filings/00560046/00000001/C%3A%5Csedarfilings%5CInterOil%5Cjuly27.pdf
August 2003: IOC says the
Moose-1 structure has been tested and has shown the “further potential for a
commercial
resource”
http://www.sedar.com/csfsprod/data39/filings/00562498/00000001/C%3A%5Csedarfilings%5CInterOil%5Caug7.pdf
August 2003: IOC announces that it
is raising C$50 million in equity at around US$25/share.
http://www.sedar.com/csfsprod/data39/filings/00563665/00000001/C%3A%5Csedarfilings%5CInterOil%5Caug12pp.pdf
September 2003: Announces that they are accelerating their drilling
program and launching the “Sterling Mustang” well in October 2003
- States that
“testing is still underway on Moose after 14 encouraging oil
shows”
http://www.sedar.com/csfsprod/data40/filings/00575621/00000001/C%3A%5Csedarfilings%5CInterOil%5Csept232.pdf
September 2003: The next day, IOC announces that it is “updating”
its Moose mean reserve estimate to 118 million barrels from 350 million barrels in
its earlier release (see April 2003 above). Stock falls from $25 to
$22.
http://www.sedar.com/csfsprod/data40/filings/00576117/00000001/C%3A%5Csedarfilings%5CInterOil%5CSept24.pdf
http://www.sedar.com/csfsprod/data40/filings/00578761/00000001/C%3A%5Csedarfilings%5CInterOil%5CRobSearch.pdf
November 2003: IOC abandons
the Moose-1 well, saying that the “fastest and most economic means of determining
the Moose structure’s potential is to suspend operations on Moose-1 and move on to
drill Moose-2”. Stock falls to $17.
http://www.sedar.com/csfsprod/data41/filings/00592183/00000001/C%3A%5Csedarfilings%5CInterOil%5Cnov25.pdf
December
2003: Begin drilling the “Moose-2”
well
http://www.sedar.com/csfsprod/data42/filings/00597930/00000001/C%3A%5Csedarfilings%5CInterOil%5Cdec9.pdf
January
2004: Begin drilling the “Sterling Mustang”
well
http://www.sedar.com/csfsprod/data42/filings/00603456/00000001/C%3A%5Csedarfilings%5CInterOil%5CJan6Mustang.pdf
June 2004: Put out first formal report on Sterling Mustang and say they are
abandoning the well (stock had fallen from $25-30 range to $20 as unpromising drilling
reports and well delays indicated wells were likely dry holes)
- Sterling
Mustang: “Data has shown increasing gas shows (quantity of gas is increasing as the well
is drilled deeper”, however IOC has decided it needs a rig with more depth capacity
to finish the well so it abandons Sterling Mustang
- Moose-2: Say limited
progress is being made due to technical glitches but they will continue
drilling
http://www.sedar.com/csfsprod/data47/filings/00663390/00000001/C%3A%5Csedarfilings%5CInterOil%5Cjune291.pdf
August 2004: IOC suspends drilling of Moose-2. Company
says that the “gas shows in Sterling Mustang and oil shows in Moose continue to
support IOC’s geological model.” Stock falls to $15.
http://www.sedar.com/csfsprod/data48/filings/00678670/00000001/C%3A%5Csedarfilings%5CInterOil%5CAug16.pdf
September 2004: IOC raises US$45mm in
converts
http://www.sedar.com/csfsprod/data49/filings/00687521/00000001/C%3A%5Csedarfilings%5CInterOil%5Csept2.pdf
8/15/2005 9:46:00 AM
To: jaxson905
From: jaxson905
Subject: E&P History: Part 2
February 2005: IOC raises $125mm to fund a new 8 well drilling program. Stock
goes to $40/share.
http://www.sedar.com/csfsprod/data52/filings/00742921/00000001/C%3A%5Csedarfilings%5CInterOil%5CFeb27.pdf
April 2005: IOC starts
drilling Black Bass (first well in the 8 well
program)
http://www.sedar.com/csfsprod/data55/filings/00769037/00000001/C%3A%5Csedarfilings%5CInterOil%5Capril25.pdf
June 2005: Announces that Black Bass encountered “several gas shows” causing the
well to “flow at surface.” Initiate testing of the well. Stock goes from $25 to $32
on the news.
http://www.sedar.com/csfsprod/data58/filings/00799695/00000001/C%3A%5Csedarfilings%5CInterOil%5CJune21.pdf
July 2005: IOC announces final
results on Black Bass: “Confirmation of reservoir quality sandstones and
liquid-rich natural gas in a more regional play has opened up a larger exploration opportunity
along the coast”…however, “testing proved inconclusive and the well will be plugged
and abandoned.” Stock falls from $32 to $24.
http://www.sedar.com/csfsprod/data58/filings/00806787/00000001/C%3A%5Csedarfilings%5CInterOil%5CJuly18.pdf
8/15/2005 9:47:00 AM
To: jaxson905
From: jaxson905
Subject: Valuing the E&P Option
Given the $22-$25/share ($720-$830mm) implied value of IOC’s E&P option in the
stock price, it’s logical to ask what this business could be worth. Given that the
company has $125mm of third-party money left to spend drilling 7 more wells and despite
the fact that the first 7 wells were all dry, there is certainly some value that
should be put on the option of a commercial find.
Based on the EV/Barrels of
oil equivalent (BOE) multiple of the closest comparable (Oil Search, Ticker: OSH
in Australia – US$2.8 billion EV, proved+probable reserves = 1.2 billion BOEs) or
$2.30/BOE and the most recent E&P transaction in Papua New Guinea of $2.75/BOE (AGL’s
July 2005 acquisition of 110mm BOE in Oil Search’s PNG assets for $300mm), an E&P value of $720-$830mm implies that IOC has already found 450 – 620 million barrels of
oil equivalent in reserves (these are gross figures before taking out: 1) the PNG
government’s 22.5% royalty plus participation option which would obviously be
exercised in the event of a commercial find; and 2) the investors’ 25% working interest).
Taking the low-end of the range (450mm barrels), the math is: 450 million gross
barrels x 77.5% (to take out the government’s 22.5% royalty) x 75% (to take the
minority investors’ 25.0% working interest) = 260 million barrels x $2.75/barrel = $720
million. See page 1 of the attached pdf for detailed calculations
(http://www.swimediaservices.com/interoil.pdf).
If one wanted to be even more aggressive and
assume 1/3-1/2 of the current U.S. E&P multiple of $12/barrel of oil equivalent
(~$4-$6/bbl), IOC would have to find 200-350 million barrels of oil equivalent to
justify its value. Using a U.S. multiple is a stretch for two key reasons:
1. The
average U.S. E&P company has 70% of its reserves that are already online, producing,
and for which all the capex to develop the reserves has already been spent. This
contrasts to PNG where (in the case of a commercial find) all of the development
capex would need to be incurred going forward (not included in the $125mm funding for
the drilling JV), there is no infrastructure to produce oil in the east (pipelines and
other facilities would need to be constructed), and it would be many years before
any oil production is achieved (negative impact on NPV of the project); and
2. Natural gas located in the U.S. has value equal to oil (vs. in PNG where a gas find
will be largely worthless unless it is of such a large quantity that it could justify
an LNG project).
3. One would obviously use a higher discount rate in a
country like Papua New Guinea than in the U.S. given political and economic
risk
As noted above and to add perspective to these quantities of oil, in the history of
PNG’s oil & gas industry there has been only one large oil discovery in the country
(the Kutubu field) and that field was 300 million barrels in size and was
discovered 20 years ago (in 1986). Furthermore, it is located in Western PNG and not in
Eastern PNG (where there have never been any commercial oil or gas finds and where all
of IOC’s 8 million acres reside). The two other commercial oil fields found were
100-150 million barrels and were also in Western PNG.
In my view, it would
be difficult to argue for more than $100-$200mm of option value ($3-$6/share) for
IOC’s E&P business given: 1) the limited size and number of historical oil & gas
discoveries in Western PNG; 2) the lack of prospectivity in PNG’s eastern basins (where
all of IOC’s acreage resides); 3) management’s abysmal drilling and execution track
record. $200mm of value would imply a 45-170 million barrel find at a value of
$2-$4/bbl (45 million barrels x 77.5% (to take out PNG government back-in) x 75% (to take
out minority investor working interest) = 25 million net barrels x $4/barrel =
$200mm). |
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