InterOil (IOC) has further twisted the knife in the wounds of its sceptics by signing an agreement with Mitsui to take the next step toward building a condensate stripping plant.This agreement is obviously good news, and the stock is reacting accordingly (up $2). But let’s not get carried away.
What Mitsui has agreed to do is pay half the cost of the next phase of planning and evaluation…as long as the condensate stripping facility is ultimately built. If the plant is NOT built, InterOil will have to repay Mitsui’s share of these costs.
Thus, the agreement is best perceived as a form of convertible debt financing. Mitsui is lending InterOil the money to proceed with the next phase of planning and evaluation (including paying InterOil’s share of these costs). If the planning and evaluation is successful, Mitsui’s loan will convert into a share of the project. If the planning and evaluation is NOT successful, InterOil will be on the hook for all the money Mitsui fronted.
What is also not clear is what percentage of the project Mitsui will end up with if the plant is eventually built. Is it a 50/50 joint venture, as the cash split would imply? Or will Mitsui end up with a significantly greater share? The answer to that question is obviously very important to the value of InterOil’s stock.
It is also not clear from the company’s release whether the deal with Mitsui is a definitive agreement, or whether it is merely a letter of intent. (The release mentions a “definitive agreement” that needs to be signed by December 31, 2010, but does not specify what the definitive agreement refers to).
Here’s a more positive take from Raymond James:
Raymond James IOC Confirms Condensate Stripping JV with Mitsui; FID Expected by Year-End
15 April 2010
♦ Following through on the key terms agreement signed last December, InterOil and Japanese conglomerate Mitsui & Co. have signed a preliminary works agreement for the condensate stripping plant at the Elk/Antelope field. This agreement covers the front-end engineering and design (FEED) of the plant, up to the point of final investment decision (FID). The joint venture is on a 50/50 basis, but Mitsui will cover 100% of the costs during the FEED stage. The current agreement will need to be replaced by a definitive project agreement for the post-FID construction phase, but it goes without saying that Mitsui would not make a commitment like this lightly, and we do not foresee problems in reaching a definitive agreement (expected by year-end 2010).
♦ As InterOil has indicated previously, the timeline from FID to start-up is estimated at two years. However, because FID will be reached roughly one year later than originally envisioned by the plans outlined last year (as detailed in our InterOil brief from July 7, 2009), the construction timeline implies first production in late 2012/early 2013. It is important to point out that, immediately following FID, InterOil should be able to start converting at least some of its condensate from the contingent resource category into the proved reserves category, since a definitive project agreement should qualify as a “plan of development” under the reserve booking rules.
♦ Recall, in mid-2009, InterOil engaged an outside engineering consulting firm to conduct a feasibility study for this project. The plant envisioned under the Mitsui JV essentially follows the study’s conclusions – a processing rate at 400 MMcf/d of gas, generating an estimated condensate yield of 22.4 Bbls per MMcf of gas (or 9,000 Bbls of condensate per day). Under this design and a $90/Bbl condensate price, the study concluded that the project would generate a net present value (discounted at 10%) of over $700 million and a payout of two years from start of production. The capital cost for the first plant is estimated at $450 million. Beyond 2013, we believe it is likely that InterOil and Mitsui will build one or two additional plants. In addition, given that some of the costs associated with the first plant will not be recurring, the economics for the subsequent plants should be even better, all else being equal.
♦ While widely anticipated by the market since December and still preliminary in nature (in that specific financial terms will come after FID), today’s news certainly confirms the viability of the condensate project and, more broadly, provides a public “seal of approval” for the InterOil story from a blue chip company. InterOil management deserves credit for successfully finalising this agreement. The focus can now shift entirely to the ongoing LNG partnership discussions. We would not be surprised to see the long-awaited first LNG partnership announcement over the next few months, though, of course, it will be crucial to see what the specific terms are: (1) whether it is a definitive or contingent agreement; (2) what multiple is being placed on the resources; and (3) whether or not InterOil will receive cash upfront as part of the monetization transaction. Our Market Perform rating continues to reflect our positive stance on InterOil’s long-term cash flow potential and likelihood of near-term catalysts, balanced by the substantial operational, cost inflation, and timing risks as the upstream assets, condensate project, and LNG plant are developed over the next five-plus years.
Here’s the release:
CAIRNS, Australia and HOUSTON, April 15 /PRNewswire-FirstCall/ — InterOil Corporation (NYSE:IOC – News) (POMSoX:IOC) announced today that the Company has entered into agreements with Mitsui & Co. Ltd., to jointly operate and fund the preliminary works involved to develop a proposed condensate stripping facility (‘the Project’) at InterOil’s Elk and Antelope field site in Gulf Province, Papua New Guinea.
The preliminary works program is for all the works required to take us through the Front End Engineering and Design (FEED) stage for the construction of a condensate stripping plant, to the point of Final Investment Decision (FID). The Project is proposed to be designed to process 400 million standard cubic feet per day (mmscf/day) of wellhead gas with an anticipated yield of approximately 9,000 barrels (bbls) of condensate per day. Dry gas will be reinjected into the reservoir for storage until the proposed LNG facility has been constructed. The condensate will be barged to the InterOil refinery in Port Moresby for processing and sale.
InterOil and Mitsui will each be responsible for half of the capital expenditure involved in the preliminary works and Mitsui will fund InterOil’s share.
Standard conditions of the agreements include the completion of FEED, an EPC agreement, and the definitive agreements by December 31, 2010, necessary to reach FID. In the event that FID is not reached, InterOil will be required to refund the capital expenditure incurred to date within a specified period.
Mr. Phil Mulacek stated, “We look forward to a long and prosperous relationship with Mitsui, one of the largest energy conglomerates in Japan. When in production, the condensate project will provide a stable platform of early cash flow enhancing the benefit to partners in our proposed LNG project.”
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