A Decision Deadline for InterOil

There are one-hit wonders, and then there are those stocks that get hit only to come back for bigger and better gains in the future.

Who falls where takes more than just looking at a stock's price. The fact that natural gas driller InterOil (NYSE: IOC  ) saw its stock rise 7% over the past month, though it's still down 40% from its 52-week high, means we need to dig a little deeper to see whether there's any reason to expect this run-up to continue.

A mighty temblor
Drilling for gas in Papua New Guinea (hereafter abbreviated as PNG) hasn't been an easy process for InterOil, which has to deal with parochial interests and greedy prejudices to bring its LNG operation to fruition. The government keeps grabbing at a greater share of the project, and the driller recently agreed to cede half of the gas supply from its Elk and Antelope fields in a bid to move it forward.

In reality, though, it shouldn't matter who InterOil sells its output to. It might not have originally planned to monetize its resources by selling to the government, but so long as PNG can pay for it -- and with a recent $3 billion loan from China to rebuild its roads there's no reason to think it can't -- having it as a buyer is a net positive. Reserving output for local consumption is almost a cost of doing business in some countries.

While regimes in Argentina and Venezuela have regularly forced oil companies to direct a portion of their output to local markets, even in markets like Australia the aluminum industry is pushing the government to enact such set-asides so that it can have access to cheap gas. The size of the stake PNG wants might raise some eyebrows, but not the concept behind it.

Greedy fingers
Yet InterOil has been plagued by delays from the government, which accused the company of changing the agreements they originally had in place (it finally relented). The gas driller ultimately agreed to split the production equally if it could just get the plans approved; what may be the saving grace for InterOil is that the proposal gives it the right to the first half of the production output. It gets its money upfront, with the balance going to the government. 

Of course, what price the government will pay is another matter. What may help determine that is the private sector partner that it signs up. After receiving several proposals from major oil companies and utilities, InterOil has set a firm deadline for them to get their final proposals in: Feb. 28. InterOil will then take up the offers in early March to see who gets the right to help build its PNG facility and get the output. Just remember, these are proposals and not actual bids, so whether any come through or are found to be sufficient remains a wild card for investors. But with early results from its Antelope-3 well looking positive, there may be greater interest in the opportunity.

One step forward, two steps back
Investors have learned to be disappointed in InterOil. Drilling delays have hampered progress, rumors of a partnership with Royal Dutch Shell never panned out, and ExxonMobil will be firing up its own LNG operation in PNG next year.

But one of the "bidders" for InterOil's resources is Korea Gas, also known as Kogas, which has substantial experience in building and operating LNG facilities. It's the biggest supplier of LNG to South Korea and the world's biggest buyer. Asia may prove to be the biggest market for gas exporters and InterOil may like the potential Kogas represents.

Others recognize the opportunity in Asia, too. Apache (NYSE: APA  ) wants to build an export facility in northwestern Canada with Chevron (NYSE: CVX  )  which also bought half of a pipeline project to supply the terminal, underscoring how Canada's vast oil and gas resources makes it a huge rival to plans others are developing. Asian markets provide a pricing premium compared to those in North America.

A short story
As the proposal deadline nears, the number of shares sold short continues to mount as expectations of further disappointment grow. Nearly 11.5 million shares were sold short at last count, translating into more than 18 days to cover (the Fool believes anything over seven is a lot).

Should the driller receive the bids it's looking for (and the deadline it set suggests the proposals at least are hopeful), the shorts could be left holding the bag as the stock runs up and the rush to cover those short positions leads to a squeeze.

While I'm not confident enough in the short thesis to actually go that route -- surprises do happen -- InterOil's history has not been one that instills confidence, even if sometimes it hasn't been the company's fault. That's not enough, however, to warrant an investment here, at least not by diving in headfirst. Because such industry giants like Kogas have publicly expressed an interest, I'm thinking InterOil will pull it off. I'm going to rate the stock to outperform the broad market indexes on Motley Fool CAPS as a way to track my mildly bullish stance, yet let me know in the comments box below if you agree that InterOil finally gets a chance to grab the brass ring, or will investors once again come to know the hollow disappointment its delivered so many times in the past.

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Read/Post Comments (4) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On February 04, 2013, at 4:49 PM, APM72 wrote:

    The writer might want to visit Interoil's website for some "due diligence" as a part of his article development.

    A good link would be their January 24th press release "http://www.interoil.com/investor-relations-news-and-press-re...

    In this link IOC states "the final binding bid solicitation period for the partnering process currently being undertaken will close on February 28, 2013". Where the writer found the suggestion these were just "proposals" and "not actual bids" is anyone's guess, but with well over 10 million shares short there certainly is motivation to publish errors of fact, omission and good old innuendo.

    The writer might also take a look at that same press release which showed Antelope 3's 1,810 feet of net pay in its 2,301 foot hydrocarbon column, comparable to the enormous Antelope 1 and 2 wells. And this is an "early result" that just "looks positive"? I think more accurately the completed tests have confirmed of the continuity of the massive Antelope structure. How many other gas fields around the world can the author cite that have nearly 2,000 feet of net pay?

    And then there's the reporting about the PNG government's desire for 50% of the gas. PNG's Oil and Gas Act requires any amount above 22.5% to be paid for "at market prices", And while it is not impossible the country would try to steal, err expropriate, the additional 27.5% there is absolutely no precedence in PNG for such a move. Rather, PNG will be challenged to come up with its 22.5% capitalization share ( ~US$1.6 billion) much less the additional amount necessary to purchase another 2+ trillion cubic feet.

    I could pick at other items raised like "drilling delays" but won't. Instead I'll conclude methinks we have here another MF potshot at IOC, deserving of the subtitle "damning with faint praise".

  • Report this Comment On February 04, 2013, at 5:17 PM, TMFCop wrote:

    APM72,

    While IOC has received proposals it hasn't previously indicated those bids would be binding, whereas if you read the latest release you'll find that the Feb. 28 date will have the potential partners submit binding bids. I think that's a significant departure and actually quite good for IOC. As I note, despite a history of hemming and hawing, I state I think it can actually pull it off this time.

    As for the government wanting more out of the company, it may indeed pay market rates, but if its prior stall tactics were used to extract a larger share of the production out of IOC then I don't think it's beyond the realm of possibility to see other than market rates.

    Moreover, while the Oil & Gas Act does provide for "equivalent export terms," meaning what a company could get on the market, it does allow for adjustments to be made based on "quality, quantity, delivery, transportation, and other terms." That sounds like a pretty large hole the government could drive a truck through if it so desired.

    I think you mistake my unwillingness to come out and be a full-bore bull cheerleader as somehow thinking I don't think IOC can be successful. There's been a long wait for IOC investors for this to come to fruition and the end finally appears to be in sight. That doesn't mean I won't hold my breath a bit just to make sure all the pieces fall into place.

    Thanks for reading,

    Rich

  • Report this Comment On February 05, 2013, at 11:37 AM, APM72 wrote:

    Rich -

    Thank you for your response as it is clarifying. I would only highlight what you actually wrote initially:

    "Just remember, these are proposals and not actual bids," They are required to be binding bids and

    "and the driller [IOC] recently agreed to cede [to the government] half of the gas supply from its Elk and Antelope fields".

    "Cede" means "to yield or formally surrender to another". Perhaps the more accurate verb would have been "sell", better yet "sell at market price".

    Whether "quality, quantity, delivery, transportation and other terms" is a large hole in the O&G Act is debatable. If so, debatable then also is whether PNG's access to the vast quantities of outside capital necessary to develop its resources would be undermined by actions suggesting any expropriation of developer assets.

    Again, thank you for your clarification.

    Best regards,

  • Report this Comment On February 23, 2013, at 8:27 AM, MICROBIOBOB wrote:

    I think it should also be noted that the CEO who has been responsible for pulling out of the bid process in the past has been replaced by a chairman of the board who is committed to the finalization of the bid process. This is supported by the fact that three major world banks are evaluating the bids. Competition from other (Exxon, e.g.) major LNG projects around the world and government horse play may, however, decrease bid prices. Although, I understand that the new government is a more committed and cleaner operation. I am an investor in IOC.

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