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…
“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.)”Are you getting our free Daily Update
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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 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.