Last week, we published a detailed investigation of controversial oil-exploration company InterOil (IOC) written by an analyst who is sceptical of the company. As expected, the investigation provoked a polarised reaction: InterOil bulls saw it as the same old shortseller whining. InterOil bears saw it as more evidence that the company is a fraud.
Today, we’re publishing another analysis from the same analyst. The same disclosures apply: This analyst will benefit financially if InterOil collapses; we cannot and are not vouching for the accuracy of the analysis or conclusions.
But we do find the analysis interesting.
The analyst’s broad contention is that the type of rock InterOil is drilling in has been shown to produce huge initial pressure and flares (thus explaining the “world record” flows the company has touted), but that the gas reservoirs InterOil has discovered are not as extensive as the company has said. Also, the analyst believes that the gas that is is is not recoverable at a reasonable cost and, therefore, that the massive future profits InterOil is promising investors are a figment of its imagination . The analyst believes InterOil is having trouble finding a deep-pocketed, experienced partner (such as ExxonMobil) to help it develop the gas field–because the potential partners aren’t buying InterOil’s reserve estimates.
In the report below, the analyst argues that InterOil has mischaracterized the size of its reserves to Wall Street. Specifically, in the case of the “Elk” drilling site, the analyst says InterOil has described a gas reserve reservoir as thousands of feet deep when in fact its own geologists have characterised it as a small fraction of that.
For more background, please read our initial posts on InterOil (IOC):
- Is InterOil Just A Gigantic Fraud?
- Why Is Shia Labeouf Touting The Stock Of An Obscure Energy Company?
- Anonymous Sources Say InterOil Close To Deal, Shortsellers Scoff
* UPDATE: Several readers suggest that the company was referring to a different drill site–Antelope–than the geologist (Elk). If that is true, the analysis that follows is wrong. We checked the source presentation, and it is not clear which site the company is referring to. The comments appear to apply to the Papua New Guinea sites GENERALLY, which is misleading. But it’s possible that the comments accurately describe the Antelope site, while in the analysis below the geologist is referring to Elk.
INTEROIL’s OWN GEOLOGISTS DISAGREE WITH WHAT IT IS TELLING WALL STREET
Interoil has a party-trick. They take a Morgan Stanley analyst (Evan Calio) or someone from Soros funds management or a potential gas off-take customer or even Michael Somare (the Prime Minister of Papua New Guinea) to a well site. They turn on the flow and they produce a massive flare. There is no question it is impressive. So impressive that the Guinness awarded Interoil a world record for the highest gas flow rate ever.
The basic claim for Interoil is huge flows of gas from huge reservoirs. A December 2008 presentation argued that these reservoirs were thousands of feet (indeed over over a thousand meters) deep. To quote:
The carbonate limestone’s have a proven thickness, porosity and deliverability in PNG that qualify as a world-class reservoir…
• The deep marine carbonates range from 900 feet (300 meters) to over 3,000 feet (900 meters) thickness…
• The carbonate reefs have thicknesses from 3,000 feet (900 meters) to over 5,900 feet (1,800 meters)
And when you see such an enormous flare why wouldn’t believe them? Who wouldn’t buy the stock? After all, the gas trumps any questionable stock promoters and it trumps anything that came out at that notorious court case.
From the analysts perspective – shown the gas flare – who you going to believe? Barry Minkow – a convicted fraudster – or your own lying eyes…
Big flares and “proven thickness, porosity and deliverability” imply very big reserves indeed – and nothing Barry Minkow or other shorts can say can trump that.
Are the Interoil claims really true – is there “proven thickness, porosity and deliverability”?
There is no question that the Interoil wells flow at huge rates. Huge gas flares demonstrate this. The “party trick” is convincing.
There are considerable doubts about the reservoir rock, however. It is – according to an old geologist report – fractured, sometimes recemented micritic limestone.
The best description is that the gas (and possibly liquids) are trapped in rock that resembles a large fractured dinner plate. The gas flows out really fast from the fractures but then there is nothing. A big flare proves that there is a big flare but not a sustainable gas resource.
For a sustainable gas resource in such rock you need massively interconnected fractures over large areas or large porosity. Interoil has never proven that such a system exists – and wells drilled by parties other than Interoil (Puri-1, Bwata) both discovered hydrocarbons (oil and gas respectively) but did not show sustainable flows.
Still I don’t expect you to believe me. But perhaps you might believe Interoil’s own geologist (Adrian Goldberg) and his 2007 presentation to the the Australian Society of Exploration Geophysicists. In it he describes the Elk discovery. (Elk is in adjacent limestone well site to the record Antelope discoveries that the company has touted more recently.) Note this paper is dated 2007.
The Elk gas field was discovered by InterOil in 2006 after drilling the Elk-1 wildcat well. The reservoir consists of a thick limestone succession of Eocene to Miocene age. Due to limited outcrop of limestone in the area, complex tectonics and limited geophysical and offset well data, fracture characterization of the reservoir has been a challenge.
From well cuttings and wireline logs at the Elk-1 and Elk-2 the reservoir matrix porosity is relatively low with pay zones of >5% porosity on the order of tens of meters. However drill-stem testing of the Elk-1 well produced impressive flow rates of up to 102 MMCF per day with a calculated absolute open flow of 2,850 MMCFD.
There are a few key lines here. The geologist states that the “fracture characterization of the reservoir has been a challenge”, that the pay zones are on the “order of tens of meters” and despite the small pay zones the flow rates are impressive. [These flows are nearly 20 thousand barrels of oil per day equivalent.]
Take it together – the combination is (a) difficult fractures, (b) small pay zones and (c) huge flows.
Now this agrees with the huge flows (no dispute there) but it notes that the pay zone is only tens of meters deep. This is a long way from Interoil’s claim of reservoirs thousands of feet deep.
Can we test the reservoirs?
Critics have suggested that Interoil should do some production tests. This would of course be wasteful – and geologists have got quite ingenious.
Geologist Adrian Goldberg describes a test where they pumped water into various parts of the reservoir to see how fast it disappeared into fractures. If it disappeared fast then the fracture system was thought to be extensive. If the water stuck around the fracture system was not extensive. They tested how long the water stuck around by measuring the extent to which it cooled the gas coming out of the well. This is pretty ingenious stuff – certainly more scientific than getting off the helicopter guided tour and having the company light a big flare for you.
The Elk-1 well was logged while pumping 2-3 bbls per minute of water into the reservoir under pressure to reduce the pressure at the surface. In Figure 3 (which I have presented below) the difference between the geothermal gradient and wellbore temperature is shaded. This provides an indication of the water cooling effect of the water pumped into the well. Spikes in the temperature log correspond to fractures with significant water flow. The fracture at 1691md significantly reduced the water cooling effect indicating a significant amount of water was lost to the fracture. Likewise the fractures at depths of 1701, 1713 and 1791 and to a lesser extent 1722m make an impact to the water cooling effect.
The slope of the graph in Figure 3 provides an indication of volume of water loss to the formation with depth. The zone between 1690 and 1701m has the most significant impact on the cooling effect. Water loss rate variably lessens downhole to minimal loss from 1739 to 1778m. A significant increase in water loss to formation occurs at c. 1790m. The main flow zones occur in Domains ii and v with lesser flow in Domain iiia, minimal flow in Domain iv and negligible flow in Domain iiib.
The key pay-zone in this test goes from 1690 meters to 1701 meters. It is – oh – 11 meters (36 feet) deep. There is another 38 meters of lesser payzone – but after that water loss to the structure (and hence connectedness of the fractures) is minimal. This is not proven thickness of thousands of feet as per the Interoil presentation – it is proven that the huge flow comes off a mere 36 feet.
Moreover Adrian Goldberg says that the flows are “negligible” only a further 20 meters away. Interoil’s own geologist told his fellows in a peer-reviewed academic paper that the fields do NOT have proven thickness, porosity and deliverability – unless of course you think 36 feet is proven thickness.
The fractures in the Elk-2 well are tested in a similar way.
Now 36 feet of gas flowing at such a huge rate would be meaningful in the USA or near to market. But in the jungle of Papua New Guinea and thousands of miles from market it remains stranded gas.
What Interoil says to Wall Street
Interoil is desperate to say to Wall Street that these huge gas flows come from extended reservoirs. After all – a huge flow from an 11 meter wide crack system just would not drive the stock and is no basis for building an LNG plant.
So Interoil’s presentations continue to tell stories about how these reservoirs are thousands of feet (sometimes thousands of meters) thick. The presentation quoted above – which makes that claim was more than a year after Adrian Goldberg gave his paper. Here is another one – given to the Cairns Chamber of Commerce. (This presentation is very similar to ones given to Wall Street analysts.) On page 11 of that presentation they give the following summary diagram of the Elk field.
Note this presentation – along with almost everything presented by Interoil to analysts – has an enormous gas column. This page cites a 992 meter gas column. It cites this massive gas column for the same field examined by Adrian Goldberg in his paper and in the year following Goldberg’s paper.
Truth depends on the audience
Interoil’s US operations are based in Houston. What can I say? Houston – we have a problem. What you tell Wall Street is not what your geologists say when talking to their peers.
You do have huge flows. Your geologists agree. By lighting a big flare you can impress analysts from New York, guys who have never split a rock with hammer and don’t even think to ask about fracture connectedness. But the story you tell depends on your audience.
To a roomful of Papua New Guinea reservoir engineers your geologists say the fields are 11 meters thick. To Wall Street you cite numbers like 992 meters thick.
Fooling Wall Street analysts (especially Mr Calio)
I asked the question at the beginning of this note: who you going to believe – a fraudster like Barry Minkow or your own lying eyes? It was the wrong question. The eyes show a huge flow – but nobody is disputing that. The question is who are you going to believe – Mr Mulacek – the endlessly promotional CEO or the lowly down-in-the-jungle geologist working for Interoil but writing papers for his peers?
The analysts – particularly Mr Calio from Morgan Stanley — saw the big flares (and they are impressive) and stated that the bear-case for Interoil is bunk.
Calio is a lawyer by training – not a geologist. He saw the flare and he was convinced. In particular, he was convinced by huge flows off huge reservoirs. He got the first bit – the bit he could see right. There are huge flows.
But huge reservoirs has been disproven by Interoil’s own geologists. See the flare and he is a believer – a lamb to the slaughter.
Business Insider Emails & Alerts
Site highlights each day to your inbox.