Know What You Are Buying With This Natural Gas Company

Sometimes when we analyze companies, we can fixate on a major growth catalyst without looking at the threats. This is the case of InterOil (NYSE: IOC  ) . This quarter the company announced that it would finalize negotiations with several big oil players to monetize its natural gas fields in Papua New Guinea, which sent the stock soaring. Is the simple act of getting a deal done enough to send InterOil into the stratosphere? Let's take a look at the situation.

It's all about that natural gas

Don't kid yourself, you aren't buying InterOil's stock for its single refinery and its various retail and marketing operations in Papua New Guinea. People own this stock because the company has 3 million acres of what are looking to be increasingly lucrative natural gas fields on the island nation. So the fact that the company netted a $6.3 million loss overall is pretty inconsequential in the grand scheme of things. In reality, the marginal gains delivered by the downstream side of the company are exclusively there to partially fund the appraisal and development of those natural gas fields.

With little to no natural gas consumption on the island itself, InterOil is going to have to get its gas to overseas markets one way or the other. For several years it looked to build its own LNG liquefaction terminal, but it would be nigh impossible for the company to secure enough financing to make that project happen on its own. That is why this year, under new CEO Michael Hession, the company has decided to table its LNG terminal plans for now and instead try to negotiate with ExxonMobil (NYSE: XOM) because Exxons' PNG LNG facility is 90% complete and will be ready to start shipping natural gas in the middle of 2014. By doing this deal with Exxon, InterOil will be able to monetize some of the development it has already done, which will provide more cash to increase development activity; a virtuous cycle, isn't it? 

Let's make a deal ... but it better be with Exxon

InterOil well location in Triceratops field (Source: InterOil Media Center)

There have been rumors that some other Big Oil companies could be interested in these resources as well. Total (NYSE: TOT  ) bought into five of Australian company Oil Search's offshore exploration wells, and given their less than stellar results it could turn to InterOil's assets instead. However, based on Total's recent moves to wind down capital spending, it seems less likely the company would be willing to make any big purchases. The other thing to keep in mind is that no matter what company InterOil decides to partner with, the only way for natural gas to leave the island for the next several years is through Exxon's LNG terminal.

So not only is ExxonMobil the de-facto gatekeeper of the natural gas market for the island, but InterOil will need to compete for terminal space with other companies like Oil Search and Talisman Energy (NYSE: TLM  ) that will want to monetize their natural gas assets in Papua New Giunea. What this means is that Exxon has a much stronger hand than anyone else in these negotiations. Also, InterOil needs this deal more than Exxon does, so Exxon can afford to drag its feet and wait for a better deal. With so much negotiating leverage in Exxon's court, the outcome of the deal will have a great bearing on the success of InterOil for the next several years.

What a Fool believes
The fact that InterOil may be close to signing a deal with Exxon- -- or anyone else that can help the company fund the company's development -- is good news. Before gobbling up shares, though, you should ask yourself this question: Is getting in early on what could turn out to be a less than stellar deal better than waiting and buying when the details of the agreement are more certain? With Exxon having so much leverage right now, it may be worth waiting to see what kind of deal InterOil gets before taking making any final investment decisions yourself.

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  • Report this Comment On November 12, 2013, at 2:44 PM, jmu1986 wrote:

    You may be correct to wait and see if they are going to do a deal with Exxon, Total, or one of the 6 majors mentioned today by Dr. Mike Hession. However, the first rise in stock price would be a terrible thing to waste. Just in March 2013, news of an Exxon deal pushed this to over $105 per share. Just imagine what it will rise to upon a complete deal being complete? Would you like to capture that profit? As you stated, Exxon will begin in 2014 to sell LNG to the Asian markets and IOC has the lowest cost from drill sight to the refinery. ( about 2-3 cents per) Buy 1,000 shares now and reap the rewards. After the first announcement, IOC goes to $128-$136 and sell 25%. Then wait for the next NAV to be calculated and sell the next 75% at $388-$408 and buy a yacht!

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