InterOil (IOC): "Major Momentum" Or Just A Castle In The Air? (A New Investigation)

InterOil Antelope 2 Flare TestFlow test at InterOil’s controversial Antelope site

Photo: InterOil

Actor Shia Labeouf, the star of the forthcoming Wall Street 2, recently pumped the stock of an obscure oil-and-gas company in the pages of GQ: InterOil (IOC).”IOC’s momentum is major,” said Shia, “and it will surprise to the upside.”

Naturally, we wondered what an actor was doing humping the stock of a little energy company in a magazine, so we made some calls to see if he had been paid for the tout.  We uncovered some juicy stuff, but were unable to determine the answer.

We have, however, received a copy of a fascinating investigation into InterOil’s operations in Papua New Guinea, which we’re publishing excerpts of here.  This investigation provides further fodder for those who suspect that InterOil’s claims of a vast natural gas discovery are not what they appear to be.

We’ll walk through excerpts of this investigation in the following pages.  But first, some background.

INTEROIL: A CONSPIRACY-THEORIST’S DREAM

Regardless of Shia Labeouf’s motivations in touting InterOil’s stock, the motivations of others in the story are clear.

The company’s management and investors want to keep InterOil’s appearance of “major momentum” alive, at least until they can sell a big stake in their energy resources to a partner.  A decade ago, the company acquired the rights to some land in Papua New Guinea that several other energy companies had explored and abandoned.  Since then, for InterOil, it has been one exploration and press release after another–and a stock that has soared from next-to-nothing to $3 billion of market value and $65 a share.

A platoon of shortsellers and sceptics, meanwhile, have been decrying InterOil’s claims from the beginning (and, recently, they have been getting killed in the market for doing so).  These sceptics point to litigation, early drilling disappointments, and a cast of colourful characters including the company’s founder and CEO, Phil Mulacek.  They believe that InterOil hasn’t really found much of anything, and they want the whole InterOil kit and kaboodle exposed as a fraud. (Further background on the InterOil debate here.)

We haven’t made up our minds about InterOil yet.  We’re new to the story, and we’re not oil-and-gas analysts.  But based on what we’ve read and seen so far, we doubt the story is going to end quietly. 

Either InterOil will finally make an undisputed discovery that proves its critics wrong once and for all–in which case the company will actually start producing liquid natural gas, the short-sellers will go bust, and the stock should soar.  Or the whole thing will flame out like a gas flare.

With InterOil now conducting crucial new tests on its latest “world-record” gas drilling site and trying to sell a portion of its energy interests to a big-energy partner, the thrilling conclusion is likely to come soon.  So it’s high-time we tuned in.

THE CONTROVERSY

The vast majority of InterOil’s market value is the hypothetical future value of the natural gas reserves it says it has discovered in Papua New Guinea.  The company began exploring the PNG area almost a decade ago, but most of its early test sites flamed out.  The latest of these, however, a drill site called “Antelope,” has gotten everyone excited that InterOil might finally have really discovered something.  A “flare test” at a site called “Antelope 2” revealed a “world-record” level of gas pressure–a development that the company quickly bragged about in a press release.  As usual, InterOil boosters got excited, while its critics denounced the announcement as yet more sizzle with no steak.

Importantly, as yet, InterOil has not actually produced anything from its exploration efforts.  All it has done is conduct initial tests and estimate the extent of natural gas and “condensate” reserves that lie beneath the ground.  The company is now hoping to sell a stake in these interests to a partner (perhaps a Big Energy company like ExxonMobil) and then begin developing a liquid natural gas (LNG) production and refining business. 

But first, it must prove that the reserves actually exist.

InterOil’s gas reserves have now been estimated and vouched for by an independent Canadian company, GLJ Petroleum Consultants.  InterOil also has a very well-respected geologist, David Holland, on its payroll.  Many major energy companies have examined the company’s data, and none appears to be crying “fraud” (although the company hasn’t managed to sell a stake in its claims, either).  

But that hasn’t stopped the sceptical grumbling.  Recently, when InterOil announced that the results of the latest important drill test on its Antelope 2 site would not be completed on schedule, one analyst derided the news as “the dog ate my homework.”

NEW EVIDENCE THAT INTEROIL IS A GIGANTIC HALLUCINATION?

A few days after we reported our Shia Labeouf findings, we received the primary investigation of InterOil that we’re excerpting here.  We should say upfront that, though the investigation seems fair-minded, the author is an InterOil sceptic.  The author will also benefit financially if InterOil’s claims are not what they appear to be.

The investigation provides more background on the history of the Papua New Guinea area that InterOil is exploring, as well as more logic as to why the company’s reserves may not be everything they appear to be.

Importantly, the investigation does not arrive at a firm conclusion.  The author spoke with many people familiar with InterOil’s sites in Papua New Guinea, and reviewed the frustrating exploration history of the region.  The investigation does not conclude that InterOil is a fraud.  Rather, it simply provides more support for the theory that InterOil’s current successes may not, in the end, amount to much of anything.

Specifically, the investigation suggests:

  • Far from being a “frontier” drilling site, InterOil’s sites in Papua New Guinea were explored and abandoned years ago by other energy companies.  These companies abandoned the site because they had concluded that, despite promising signs, there was not much there there.  The investigation’s author believes that InterOil may eventually conclude the same thing.
  • The type of rock and gas and oil resources at the InterOil sites have a peculiar characteristic that is a great help if one wants to make exciting announcements and pump up a stock price but of less help if one actually wants to produce energy.  Specifically, the sites produce enormous initial pressure of gas and/or oil.  Unfortunately, because of the type of rock, they do not actually prove to be promising development and production sites, because the initial pressure is not sustained.
  • Visiting the sites, as a bullish Morgan Stanley analyst recently did, will not help one determine the extent of the resources they contain, as nor will the “flare tests” that the company has aggressively advertised.  So some of the renewed confidence investors have in InterOil may be misplaced.
  • Some of InterOil’s descriptions of the promise of the new site, Antelope 2, don’t add up, in the opinion of the investigation’s author.  Nothing particularly alarming, but taken together, enough to remain sceptical of the company’s claims.  Especially because critical flow tests have not yet been conducted.

IMPORTANT DISCLAIMER: We are confident in the analytical abilities of the person who conducted this research, but, importantly, we cannot, and are not, vouching for the veracity of any of the conclusions or facts in the report.  We present the author’s findings as a conversation-starter, in the hope that you, our readers, will help us sort fact from fiction.  We also look forward to hearing the response from InterOil.

And now on to the research! >

The background...

A prominent Wall Street analyst is persuaded -- and jumps aboard

Previous attempts to commercialize the obvious oil and gas resources also started promisingly...and then failed. Miserably.

The problem is that this type of rock produces strong INITIAL flows...that then fade away

Despite all the failure, there IS one semi-success story nearby. And it is possible that InterOil has found another site with the same characteristics

When the initial wells failed, the earlier explorers moved on to nearby territory. But they still failed...

And now on to InterOil...

The later InterOil wells

Finally -- The Big Discovery: Antelope

So maybe InterOil has actually found something. But is there enough there to build a Liquid Natural Gas (LNG) plant?

Does Antelope contain enough gas for an LNG plant?

According to Interoil yes. They have had a small Canadian firm vouch for these numbers. However their latest testing well failed -- and seismic surveys (to delineate the size of the field) are notoriously difficult in this terrain.

The old PNG hands I have talked to are sceptical -- with their scepticism being driven by the difficult nature of the reservoir rock and any seismic data. We also do not know what (if any) reserves we should count from the massive amount of fractured micritic limestone underneath the reef. Some people I have spoken to who were around when the Pandora offshore field was discovered thought it was 0.5-1 trillion cubic feet of gas (nowhere near enough for an LNG plant). However, Talisman now talks about it as possible 1.5TCF. The Antelope reef is likely somewhere in this range (though the micritic limestone might contain more -- possibly much more -- but only depending on the connectedness of the fracture system).

But even the field bulls on Interoil -- people who believed in the acreage (and believed in David Holland the geologist) thought that it was way-premature to be talking about an LNG plant. That of course has not stopped Interoil from having that discussion with the market. Certainly, without flow testing, it is vanishingly unlikely that any partner would approve the expenditure on an LNG plant.

Still there are potential partners interested. GAIL -- the Indian national gas distribution company -- has indicated that it is interested in an agreement. GAIL has tended to work with Total in the past.

Source: This excerpt is from an investigation into InterOil's operations in Papua New Guinea provided to Business Insider by its author. Business Insider regards the author and the report as credible but we have not checked any of the facts or assertions therein. The author of this report will benefit financially if InterOil collapses. It is also possible that the author made the whole thing up. If/when we get responses from InterOil or other seemingly credible sources to this report, we will publish them.

So that's the history. Now you have some basis for evaluating InterOil's claims. How will it all work out? Here are some scenarios. And stay tuned for the Antelope tests...

What is the history? Will Interoil repeat it?

I write all of this out so you can see the historical context for the Interoil claimed finds. Interoil and Morgan Stanley (particularly Morgan Stanley) present this as a frontier basin. But there is a history of big-oil exploring and then abandoning the region.

I started this with the cliché that those that do not study history will be doomed to repeat it. Unfortunately the more I look the less certain of which version of history we are doomed to repeat. There are a few:

This could be Arakis mark 2 -- a company with real and prospective acreage -- and geologists in the field who believe in that acreage. But a company that nonetheless is over-promoted to the stock market and which collapses when that over-promotion (and possibly insider selling) is exposed. The evidence for this is strong -- with doubts about the size of the Antelope field, the nature of the reservoir, the condensate claims, the liquid stripping plants all springing to mind.

This could be Talisman/Pandora mark 2 -- where one or more reefs are eventually discovered some of which may contain sour gas.

This could be Oil Search mark 2 -- where some oil and a huge amount of natural gas are found -- and those finds are sufficient to justify a huge LNG operation. Those could be -- as some of my field bulls suggest -- in the Pale or Subu sandstones.

Or it could be an altogether different version of history -- one I have not explored because so many of the key people were hard to find and to talk to. Some of the key people who know about Kundu Petroleum were dead -- and Kundu was only 20 years ago. Finding out stuff about Puri-1 is terribly difficult.

I am hoping to find more PNG old hands -- and I hope they can help me out.

(To contact the author of this report, please send an email to [email protected]).

Source: This excerpt is from an investigation into InterOil's operations in Papua New Guinea provided to Business Insider by its author. Business Insider regards the author and the report as credible but we have not checked any of the facts or assertions therein. The author of this report will benefit financially if InterOil collapses. It is also possible that the author made the whole thing up. If/when we get responses from InterOil or other seemingly credible sources to this report, we will publish them.

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