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“World Record Oil & Gas Discovery” Matt Badiali

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There were any number of teasers I could have chosen to get back in the swing of things after vacation, but this one from Matt Badiali was forwarded to me more than any other over the last week or so, and it seemed a reasonable place to start.

Like so many of the great teaser emails, it involves a trip to a remote area of the world, and a record-breaking discovery that is colored with risk, and even with hints of fraud … all the better to bring in sexy gains for astute investors, of course!

Badiali’s teases often spin such tales, of course, and the teased stocks don’t always work out, but his letter is reasonably well-liked by my readers (his S&A Resource Report is in the top five commodities/resources/gold letters on the Stock Gumshoe Reviews site). So let’s have a look, shall we?

Here’s the Indiana Jones adventure part of the story:

“I just spent 40 hours traveling on 4 different planes across 9 time zones…

“Slept in a mosquito and cockroach infested ‘hotel’ and tramped through a ‘Jurassic Park’ like jungle and 100% humidity…

“Why?

“Because a small group of geologists in a remote corner of the Earth have reported a ‘WORLD RECORD’ oil and gas discovery.

“Since the rumors of this discovery first surfaced on the Internet, the entire oil and gas industry has been buzzing about this industry-changing find.

“In fact, the initial test results are so extraordinary, that many in the industry (including some folks I genuinely respect) are calling it a fraud.

“If the geology is only half as good as these initial tests show, early investors are poised to make gains of 1,000% or more…

“Of course, if it’s a fraud… well… anyone who invests in this find will probably lose every penny.

“In my nearly two decades in the oil and gas industry, I have simply never seen a situation where the stakes are so high.

“That’s why I recently flew 12,000 miles around the globe to investigate this situation first-hand.”

The exciting and dramatic part of his visit to this “situation” was witnessing a flow test on a natural gas well that blew his socks off:

“You see, in the majority of wells of this type, the natural gas sits near the top of the deposit. So naturally, the first thing a company tests is the amount of natural gas that flows from the well.

“And I have to tell you, this ‘flow test’ was the most incredible thing I’ve ever seen in my 13 years as a geologist and investment researcher… and that includes the time I spent on an oilrig off the coast of Florida.

“When they lit the gas flowing out of the well, it shot a flame easily 200 feet long and the roar sounded like a jet engine….

‘The heat was so intense, it set a couple hundred yards of jungle on fire.

“In geologist speak, the well spewed out gas at a rate of more than 700 million feet per day.

“(Just for sake of comparison, that’s 23-times larger than Devon Energy’s headline-making Texas strike earlier this year, which spewed out “only” 30 million cubic feet of natural gas in a 24-hour period—and one of the biggest gas discoveries on U.S. record.)…

“In fact, this company’s ‘flow test’ nearly doubled the standing Guinness Book world record for a natural gas flow test. (The previous record was held by the same company on a well not too far from the spot where I was standing.)”

OK, so that provides some clues to help us narrow it down … we also hear that Badiali thinks this resource might be worth $30 billion, which is ten times the market cap of the company.

So we can do some complex Gumshoe math (it’s patented, don’t try this at home!) and note that this is a $3 billion company.

And Badiali goes on to give us some more tidbits — or as we like to call them here, “clues.”

“… because there had been some skepticism about the record-breaking numbers, this small company made a clever move…

“They brought in Weatherford International, one of the industry’s biggest independent oil & gas consultants, to verify the deposit (Weatherford has been in the industry for 37 years… worked in over 100 countries… and provided a wide range of estimates for industry giants like Exxon, so they are well respected in the industry.) “

And the company’s project is apparently very near to some of the major natural gas importers in the world, Japan, North Korea, China and India — all of whom seem likely to keep increasing their reliance on imported gas. But since transporting and processing gas, especially for ocean transport in the form of liquefied natural gas (LNG) requires some very expensive infrastructure, the company is apparently looking for deals and partners …

“The resource is new… undeveloped. The company is too small to build a pipeline and refinery on its own.

“Which is why at least 5 major oil companies, in exchange for a small percentage of the profits, are in talks for the rights to partner with this small company.

“One of them was the group of executives we saw at the site… a huge Japanese oil company called Mitsui.

“The other 4 that have expressed interest in partnering with this small firm are China National Offshore Oil Corporation (CNOOC), Petro China, France’s Total, and India’s state-backed Petronet.

“There are rumors that a sixth firm – a major U.S. player – has expressed interest too. Though we couldn’t confirm it. “

So that’s another little swath of clues — anything else?

Well, Badiali apparently thinks that the announcement of some kind of big deal could come in the next few months and send the shares higher — and that there is even potential that the firm could discover meaningful oil reserves to go along with all this gas, possibly announced within days (or maybe announced already, the tease has been running since just before Christmas).

Here’s how he sums up the opportunity:

“* This little company owns rights to 3.9 million acres
“* They’ve already found two world record gas wells and they have 40 more sites targeted
“* They haven’t even fully explored the next three oil and gas fields.

“And I have to tell you, from the data I’ve studied, this could be the next great sweet spot for oil and gas in the world.

“You see, the sheer size of these fields are awesome. The geology is one of a kind.

“Imagine a fairly good sized coral reef, say a mile by two miles, filled with oil and gas. That’s what this is.

“Now think about how reefs form – you rarely find one all by itself. They usually occur along a trend (fringing a shoreline).

“This small company could easily repeat their success with the well I saw over and over again on its nearly 4 million acres.”

So who is it? Well, some of you have probably already guessed that this is an old teaser darling from early 2008 …

InterOil (IOC)

InterOil was also heavily teased by Ian Cooper back in February 2008, based on this same natural gas discovery (or the same area, at least — the discoveries have obviously moved forward a bit in a year and a half, this latest wellhead test that Badiali witnessed was very recent) — and based in large part on T. Boone Pickens’ large stake in the company, which at the time was about a fifth of the current size. The stock did get a quick jump a few months later (not exactly as he predicted, but reasonably close), but it fell back dramatically in the months that followed — especially late in 2008, when the shares dipped under $10.

InterOil is a company that is focused entirely on oil and gas in Papua New Guinea, just north of Australia — with the two notable gas resources, Elk and Antelope, both being onshore gas finds (they also have some offshore interests nearby, though they’ve been selling those interests to focus on the big gas fields). They also operate as an integrated oil and gas firm in PNG, with a refinery and distribution network to serve local needs for (primarily) gasoline, but the big gangbusters performance of the past year (moving from $9 to about $75 as I type) is because of the potential for Elk and Antelope to provide massive LNG export capacity to feed the gas-hungry asian countries to their north. That’s also what’s driving the increased offshore gas exploration in Australia, as well as the enthusiasm for coal bed methane extraction in Australia’s big coal seams — Japan and South Korea have been big importers of liquefied natural gas for decades, and imports seem likely to grow as China and India (and the rest of the world) focus on cleaner burning natural gas.

The US, which has massive natural gas reserves that have depressed prices as shale gas plays have come online, consumes all that it produces and a bit more, and US companies are effectively prohibited from exporting LNG (the significant historical exception has been a deal to export gas from Alaska to Japan) — so though gas companies have often been in a slump over the past year as domestic gas prices have suffered, it’s worth noting that when it comes to natural gas, the domestic US market and the global LNG market are not necessarily in sync. This is an area where the US is not the major consumer, and natural gas pricing, due to the relative lack of infrastructure for LNG, has historically been very local. That’s probably going to continue to change, perhaps somewhat gradually, but it’s worth noting that the gas prices we hear about and obsess about here in the US are not necessarily directly applicable to a discovery in Papua New Guinea that, assuming it’s developed over the next few years, will largely be super chilled, packed into pressurized tankers, and sent to Japan and South Korea.

I don’t know anything about the potential scandal or fraud that’s been talked up as part of the InterOil story — there is a bear case laid out extremely aggressively by Barry Minkow at a special site called www.InterNoOil.com, parts of which seem at least as hype heavy as Badiali’s bull case, and parts of which don’t make any sense (InterOil doesn’t have the earnings to support its share price, obviously, but the share price is driven by expectations for these new finds, not by their success at their current operating business, which is gasoline refining and retailing in Papua New Guinea) and there are some significant short sellers who have been betting against InterOil, like Whitney Tilson. I don’t know if the short sellers are just skeptical of the valuation for a company that has run up quickly this year and that owns resources that are effectively stranded without pipelines or processing or LNG liquefaction available yet (none of their discovered gas counts as “reserves” yet), or if they think there’s really something fishy behind the company’s self-promotion. The short position is quite high, at about 12% or so of the float, but the shares also trade in pretty high volume, so the “days to cover” is not insanely high (around 2.5 or so — that means it would take two and a half days of normal trading volume to cover all those short positions, all else being equal). Some of those short positions were probably put on in the run up from $40 to $75, so it could be that we’ve already seen some short covering helping the price jump, since the reported short data is usually at least a little bit old.

And with shares having climbed so dramatically, there are certainly a lot of folks buying the shares, too — this isn’t a top-secret company that only Matt Badiali knows about, I don’t think T. Boone Pickens owns a big position any more, but George Soros does (he owns about 6.5%), and for some reason Wells Fargo has made a pretty big bet on these shares. Analysts expect them to earn only about 46 cents per share by the time they report this year’s final numbers, and they see those earnings dropping by 30% next year — but as I noted, this story is about getting a deal to build the LNG liquefaction plant, preparing for production, exploring more to book reserves, possibly including oil as well as more natural gas, and probably not actually exporting any gas for at least three or four years if all goes swimmingly. It doesn’t mean the shares can’t go up, it just means they’re not going to go up because of current operating earnings.

InterOil has certainly seen some good news coming lately — there was the record flow test that Badiali witnessed (here’s a quick article about the “Guinness World Record” part), and they also now have a signed agreement with the government for the development of their LNG facility. It does seem to me, very definitively a non-geologist and someone who has not seen the wellhead tests, that the gas is probably really there, and probably large amounts of it … but I also lack the wildcatter’s confidence that would have you investing millions in pipelines and processing plants to export that gas. If everyone felt like that, of course, then the “hard” resources would never be produced — commodity and energy companies have a pretty solid history of, over time, discovering valuable resources in inaccessible locations and finding ways to bring those resources to the world for profitable consumption. Eventually. Will InterOil sign deals with the oil majors to bring in the needed equipment and infrastructure, or will it end up being less than worthwhile after ExxonMobil, Mitsui or the other potential deal partners look over the details? I have no idea — the crux of the plan is the development of a big liquefaction plant, which they propose to essentially sell to a partner, probably along with a minority stake in their gas fields, in exchange for the funding to develop the fields and build the pipelines and processing plants.

It would not surprise me to see many more bumps along the road, since InterOil’s plan doesn’t even have them producing LNG for another three+ years, but it is certainly possible that the removal of uncertainty that would come from some big joint venture deals for that infrastructure could send the shares appreciably higher — and of course, an unexpected bonanza of oil from one of their wells would be big positive news as well, and they are still small enough to be acquired by an energy major, though the long range of the project and their location makes me guess it would be a Chinese firm. That’s just a wild guess — ExxonMobil might be a find candidate, too, since they’re backing the other major LNG project in Papua New Guinea (there’s a quick article from Bloomberg here about PNG’s huge potential as a gas producer, FYI)

So what do you think? Are things looking up for InterOil since the last time we considered the shares almost two years ago? Or does the share price reflect a bit too much optimism these days? Feel like you have any insight on the very aggressive investors on both sides of these shares? Let us know with a comment below.

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25 Responses to “World Record Oil & Gas Discovery” Matt Badiali


  1. This is why I love the Stock Gumshoe! I have owned IOC for 3 years. Based on my experience with IOC, I believe your analysis is dead on. You give a very good assessment of both the Bull and the Bear case. I personally favor the Bull case which is why I am still long IOC. Barry Minkow has another website where he claims IOC is a fraud. That site is http://www.frauddiscovery.net but as you concluded, I don’t think his arguments make sense. The stock is not an earnings play. I think there is a huge amount of gas in the wells they have drilled to date and I suspect there is another huge amount of gas waiting to be discovered in the other 9 million acres they have rights to adjacent to the existing wells. I think we will see a large partner join the party soon to build the LNG plant.

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  2. I looked into this several months ago and for some reason Bre-X flashed through my mind. Strange that that should happen.

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  3. I’ve been looking At PNG LNG now for a few weeks and FYI. The PNG gov along with Exxon, Oil Search Limited, Santos and a couple other small players approved construction of a pipeline to Port Morseby on Dec 8/9. Construction to begin 2010. That probably makes (Interoil IOC) worth more down the road. Looks like to me Oil Search Limited would be a better play. Still have to wait a few years for the plant to come online.

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  4. Some other IOC news. Antelope-2 well is even bigger than the “Guinness” well, Antelope-1. The PNG government approved IOC’s application for an LNG plant permit. IOC mgt. says cash flows from the “liquids” (NG-oil mix) in the field can finance the LNG plant. The co. should have results from a “drill stem test” in the bottom of Antelope-2 in the next 2 weeks. Any pooled oil is pure gravy.

    The stock keeps setting new highs. I am long IOC– the best stock performer I have ever owned. I am putting my $$$ where my mind is. My first post on here.

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  5. I like these crummy teasers. Anyway, Stockgumshoe, best wishes for 2010. You’re always interesting to read and your investors’ letters feedback section is great.

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  6. You are spot on. I subscribe to the S&A Resource Report and IOC is the correct stock.
    This newsletter is one of my favorites, and Matt Badiali has (usually) made great recommendations.

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  7. We’ve been covering this for almost two years. The FDI short case is nonsense:
    http://seekingalpha.com/article/138153-interoil-resists-an-orchestrated-pr-attack
    http://seekingalpha.com/instablog/191022-shareholders-unite/34614-barry-verus-bertoni
    http://seekingalpha.com/instablog/191022-shareholders-unite/40006-pressure-depletion

    We also have ALL research reports on InterOil:
    http://seekingalpha.com/instablog/191022-shareholders-unite/34179-interoil-reseach-reports

    And one big catalist is not mentioned in the article above: the real likelyhood of stripping the liquids from the gas. We expect a deal pretty soon, and this could add very significant cash flow within 18-24 months, way before any LNG plant.

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  8. The stock is in E Wave 3, and the resistance is around $80. I bought it around $75 and waiting with a stop…in case! If it does then wait for E4 to get back in.

    Happy New Year to all at Gum Shoe!

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  9. I have been doing a lot of work in Papua New Guinea over the past several months and have written about the country – and the oil and gas developments – on my blog http://www.emergingmarketsoutlook.com (search for “Papua” and you will find a few articles).

    The story is about gas far more than oil. ExxonMobil in December 2009 signed the final investment agreement with the government to develop the Southern Highlands gas field and build a pipeline to the new LNG plant it will construct in Port Moresby, the capital. This project entails and investment of around $10 billion and will generate total proceeds of more than $50 billion over the next 40 years.

    The InterOil deal concerns a second, even larger, gas field in Gulf Province, and the government in December signed an agreement granting InterOil the right to develop it. The gas is almost certainly there (and there are a few other finds in the country that could also prove significant), but the project is at a much earlier stage of development than Southern Highlands, on which construction has already begun.

    The big question is whether InterOil will end up as the principal developer and if not, what kind of money will larger companies pay to obtain its rights. PNG is fantastically corrupt, which means that no deal, especially one like this, at a very early stage of progress, can be taken for granted. InterOil is not well-liked in the country, partly because it exercises a government-granted monopoly over domestic oil refining and the importation of refined petroleum products, which runs until 2027.

    InterOil’s finances, moreover, are not rock solid, nor are they overly transparent, at least according to what I have been told and have read.

    InterOil is in many ways an attractive play, since if it does get to the finish line it will be be worth vastly more than it is today, which you can’t say about ExxonMobil, Total or other giants, for which these discoveries, however significant, don’t amount to more than a few per cent of company revenues or reserves.

    It will be far more than 3 years before any gas from this field gets exported. The Southern Highlands development won’t export its first shipment until 2013, and given the time it took to negotiate that deal the Gulf Province field is unlikely to start pumping LNG much before 2017 or 2018, if then. A lot can happen in eight years, and in PNG those things will include a transfer of power, orderly or not, from the current Prime Minister, who is nearly 74 and has stated that he will not run for re-election, to a successor, who may or may not be his son.

    I would keep an eye on InterOil and maybe invest on positive news, but I’d also use a stop-loss order since a stock this thinly traded can crater fast. Don’t believe Matt Badali’s breathless claims. Of course major oil companies have expressed an interest. Why wouldn’t they? Maybe as Badali says, “This small company could easily repeat their success with the well I saw over and over again on its nearly 4 million acres.” Then again, maybe not.

    Oh, take Badali’s Indiana Jones-style account of his adventures with a grain of salt. Flying to PNG from the U.S. does take a long time, but on Singapore airlines or Qantas in business class it’s not too painful, and though the hotels in some of the remoter parts of the country may not merit five stars, I have stayed in worse in other countries. And here’s a news flash: parts of PNG do have cockroaches and 100% humidity but so do Washington, DC and Houston for much of the year.

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  10. I think the price ran too high too fast. 81 bucks is too much. I looked at interoil after i got the newsletter (yes, i fingered it out too). Although I wasn’t quite sure I was right.
    According to morningstar, their price over book is 8.3. That is way too high. The shorts are right. I see this as a loser at least for the short term. I wouldn’t buy for more than 20 bucks. At this level, you can’t expect any serious run from here.

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  11. First of all, I really liked Chip’s comments. Very insightful. In my mind, $80 is way too much to pay for this stock. So maybe it does go up another $10 or $20 bucks a share. So what? For most of us, we couldn’t buy very many shares at $80, so we wouldn’t get much leverage off of those gains. And the downside is too risky. It could just as easily retreat to $10 or $20 per share as it could go up by $10 or $20 per share. Be very wary of this one. On a related note, check out Northern Oil and Gas, Inc. (NOG) sometime. I don’t own any of their stock, but I do follow them as they claim that they can make money on their wells even if oil was only selling for $15 per barrel. I know, I know. That sounds like they must be based in Saudia Arabia or some other middle eastern country to make those kinds of claims, but they have the majority of their wells in the Bakken Formation in North Dakota. The Bakken produces incredibly light oil, with almost no refining necessary, so maybe that’s why they claim that they can make a profit at a price ($15 per barrel) where most other oil companies would stop production.

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  12. It’s all about the potential oil discovery, at this point.

    Some folks believe that there is oil beneath the gas. OIC had not drilled below the gas to ensure that they don’t mess up the integrity of the field (I’m obviously not an O&G tech).

    But they are drilling now and we should know within a couple of weeks if there is a major oil find or not. If so, it’s off to the the races. If not, she drops back.

    Is the runup this week due to short covering? Or leaked results or indications from the ongoing drilling?

    Who knows. I’m holding with nice gains.

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  13. Under the radar a huge discovery of natural gas is right under our noses; it's called the Utica shale. Most prominently is Questerre Energy, QTEYF; Altai Resources, ARSEF… there are others; check website aheadoftheherd.com and search for the Utica story.

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  14. Early Friday morning March 26, 2010 this story by William Lobdell was posted on iBusiness Reporting: http://www.ibizreporting.com/home/2010/3/26/compa… By the end of the day InterOil (IOC) had plunged from its March 25 close of $70.89 to a low of $57.22 before bouncing back to close at $62.01 on about 10 times its average volume. I think something important is happening here.

    Lobdell documents that this month five InterOil directors and officers have dumped nearly $10 million of their IOC stock. Earlier this year the CEO Phil Mulacek (through his Nikiski Partners) sold almost $1.5 million of IOC stock, two days before declaring bankruptcy for Nikiski. A federal judge has declared the bankruptcy filing as "in bad faith" since its purpose was to protect Nikiski from a potential civil judgment which could seriously harm Mulacek and InterOil. Check out this story. I have no position in IOC.

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  15. This is a very risky play. Basically the entire case for investing here relies on them hitting a homerun in Asia. Otherwise, they haven't met expectations regarding leadership, return on equity, keeping their margins up or anything else. Plus their management (as noted here) has been in the news for the wrong reasons all too often. I would look for other players in Oil Gas Stocks before venturing into this one. It's pure speculation.

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  16. Well, considering that the stock was trading at $16 in 2009 and is now trading around the $70 mark, this discovery worked pretty well for them. It's interesting to see events like this happen – it only works in two sectors: oil and gas stocks and technology (usually internet startups). Both can "strike it rich", very quickly or fail spectacularly. It's always nice to see the former happen.

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  17. Good ‘ol Bre-X! It is, at least, far harder to fake natural gas surveys and drilling than it is to seed a core sample with gold.

    I was going to say such an all-out fraud would be “impossible”, but I’m not enough of an expert … and not quite enough of a gullible chump to use that word.

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