Nikiski News
Featuring the Latest on InterOil Corporation • Exclusively for Nikiski Partners, Ltd. July 2008 • Volume I, Issue I
Elk-4 Antelope Hits Big
A Letter from the Chairman I t has been a while since you received a newsletter. We are working to improve our communication with our partners and I hope you find the format of this newsletter more informative. I want to start by telling you how much I personally appreciate the understanding and support provided by many of our partners. The last few years have been a trying and volatile time in establishing a solid business. The overall responsibilities and time demands are quite restrictive, and are compounded by the substantial time differential between Houston and Papua New Guinea. In addition, InterOil and Nikiski Partners have been under added pressure recently, and although we have had some successes, we still have to remain constantly vigilant and dedicated to our goals. With this newsletter most of you have been delivered a substantial distribution of InterOil Corporation stock. These shares are unrestricted, and are yours as an additional return on your investment. Although you can certainly decide the best way to manage the shares distributed to you, we hope you will be aware of current market activities as well as the possible effects of your decision on your investment and to Nikiski. 1. Be wise if you sell shares. Selling large blocks of stock should be done on an arranged basis or spread over a few days to ensure the selling does not damage the remaining value of the portfolio. 2. “Borrowing the stock, so others short the stock.” I hope you won’t allow your stock to be loaned out to cover “naked” short sellers. As you know, InterOil has more short sellers than any other company. It is my opinion that in attempts to depress the value of the company, the short sellers
Nikiski News
have spread untrue and malicious rumors about the company. These rumors hurt us all. Loaning out the shares allows this behavior to continue, and will work to erode the value of the remaining position. We recommend that you hold the certificates in a cash brokerage account and ensure your broker does not loan the stock out. The safest way is to keep the stock in certificate form, in a safe place, until you sell it. Since May 1, there have been several very good developments for InterOil. Elk-4 results are apparently very positive (see the accompanying article, “InterOil: Uncertainty Fading”). We are especially proud that InterOil paid off $130,000,000 in debt with new equity. Financial results for the first quarter of 2008 were well received by the market. The refinery is finally performing closer to target goals, with a payment to OPIC this quarter. We have attached some additional public information to the newsletter. You can also access the InterOil website for current developments (interoil.com). Unfortunately, I am still traveling as much as ever. Our upstream development plan requires substantial capital, and I have to be on the road to ensure continued value for all. Considering our recent successes, InterOil is becoming quite well known in the financial capitols of the world, and that should help the underlining investment. Over the years I have received great personal support from my friends and long term supporters. I thank you for that. You have been there since the beginning and believe me, I appreciate your support. I pledge that I will continue my dedication and efforts. –Phil Mulacek 1
InterOil Corp. (IOL:TSX) (IOC:AMEX) (IOC:POMSoX) recently concluded Drill Stem Test (DST) No.2 at the Elk-4 well in the Antelope structure in Papua New Guinea. InterOil representatives say they are pleased with the extremely positive results. “New data from the wellbore continues to surpass our initial pre-drill expectations and we will be looking to target additional gas column,” said Phil Mulacek. The next steps to be undertaken at the Elk-4 well are Drill Stem Test No.3 and the evaluation of logs and other test results. NN
Highlights from InterOil’s First Quarter Results • Increased earnings before interest, tax, depreciation and amortization • Increased sales and operating revenue • Gas discovery at Elk-4 well • $130 million loan facility repaid • Finalized conversion of $60 million of debt in exchange for issue of 2.7 million common shares at a price of $22.65 • Closed on gross proceeds of US$95 million from the sale to institutional investors of 8% Subordinated Convertible Debentures due 2013. • These combined transactions have resulted in a significant reduction in InterOil’s debt, strengthening its balance sheet while providing additional funding for exploration and corporate activities
Did You Know? • InterOil has between 700-800 employees, most located in Papua New Guinea. There are 120-140 employees at the refinery and 350 at distribution facilities. There are about 100 working at the rigsite. The Cairns office has about 40 employees. The Woodlands office has three employees. • The shortest flight time from Houston George Bush to Port Moresby is 30 hours, 55 minutes. The least expensive economy airfare is $3,062 round-trip. July 2008
InterOil: Uncertainty Fading S
ince the last time we wrote about InterOil here at Seeking Alpha (May 5, seekingalpha. com) , a lot has happened – apart from the share price rallying 30+%. A lot of uncertainty is being taken out as we speak, and the upside is now very, very significant. The outstanding loan to Merrill Lynch and Clarion Finanz ($130M) was settled by two deals. Clarion agreed to a straight debt for equity swap of their part of the loan ($60M). InterOil issued 2.7M shares at $22.65 (which was about a dollar higher than the market price when the deal was announced, and probably quite a bit more when it was negotiated). The remaining $70M was owed to Merrill Lynch. They apparently did not like the conditions Merrill Lynch were setting, so they went around with their hat, and hey presto, ended up with $95M in it. This is a pretty bullish sign, to get that much at such short notice at these conditions, and the market took it as such. Elk-4 DST #1 and 2 We now had two DST tests, and there are several noteworthy points. 1. Flow rates increased with depth, from 8.3MMcf/d to 14.1MMcf/d. 2. Flow rates have been negatively impacted by heavy skin damage resulting from “kill operations using heavy mud and lost circulation material. The calculated stabilized
flow is the rate expected at the sandface of the reservoir if all the skin damage is cleaned up, which is a relatively simple operation in limestone reservoirs.” 3. Apart from heavy skin damage, flow rates in the second DST test were also limited by “the capacity of the Drill Stem Testing equipment at surface” and “tubular constraints” (Which suggest they’re using a very small pipe. Using a bigger pipe would significantly increase flow rates). Nikiski News
Matrix Porosity? The heavy skin damage also indicates the existence of matrix porosity. In the words of Wayne Andrews, analyst at Raymond James, in an update May 14: “First, the company described pumping heavy mud with Lost Circulation Material (LCM) to stop the flow of gas and liquids into the well bore. The LCM works to seal porous formation, but depending on the type of material may not be as effective on fractures. The fact that the LCM was effective is a potential indicator of real matrix porosity, a very positive sign for reserve potential. However, and more importantly, the heavy mud probably caused near well-bore formation damage which may have hampered the flow rate of the well in addition to the drilling fluids that were being recovered during the test. Both of these give us confidence that the well will be capable of flowing at substantially higher rates.” It’s not the only indicator, as Andrews argues: “The visible matrix (vugs, chalky limestone) and fracture (visible micro-fractures) porosity along with shallow marine fossil evidence observed in cuttings from the well within the recently tested limestone reservoir.” So, if these multiple signs of matrix porosity play out, expect a big increase in the resource estimates.
This is an article we found on seekingalpha.com, an independent website that provides some interesting analysis of recent events. InterOil does not warrant the accuracy of the assumptions or conclusions in this article.
bigger. This is another reason we can expect a big increase in the resource estimate. Condensates According to Wayne Andrews, “The condensate to gas ratio continues to rise - coming in at 12.4 Bbls/ MMcf in this second Elk-4 DST, up from 11.2 Bbls/MMcf in the first
Elk-4 DST and 5 Bbls/MMcf in the first Elk-1 DST. This higher liquid content suggests increasing condensate with depth, consistent with findings in gas caps on oil reservoirs and increasing the probability of encountering an oil leg with further drilling.” And indeed, in the second Elk-4 DST, the condensates level increased further from 82 to 175 barrels a day. After the first DST test, Wayne already allowed for condensates to be included in his valuation of IOC: “Based on the estimated liquids content given the initial Elk-4 results, we are adding incremental value for liquid resource potential (69 MMBbls at $15.00/Bbl, risked at 50%) into our risked NAV, which essentially offsets the increased share count from the recent equity offerings.” These condensates can be used directly in InterOil’s refinery, providing instant cash-flow. Oil? As we have seen above, the increasing condensate level with depth (not only increasing depth within Elk-4, but one also has to realize the payzone at Elk-4 is a lot deeper than at Elk-1) certainly point to the possibility of an oil leg. Further, lab analysis of the specific gravity of the condensate, at room temperature rather than the heated temperature from the well bore, indicated 48 degree API, very close to crude oil. The fact that the specific gravity of the condensate is increasing with depth increases the probability of encountering an oil leg as the company deepens the well.
Resource Thickness One has to remember that Elk-1 (the discovery well) was not drilled to a finish, as the well was not initially designed for drilling a very permeable high pressure gas formation. Elk-1 was drilled to 1983m (6,506 feet), with a pay zone of about 1,100 feet thick. The pay zone of Elk has been increased from about 1,100 feet thick to about 1,900 feet thick. And since InterOil has already cored until 7815 feet and still hasn’t encountered the water contact, it keeps getting
Valuation Wayne Andrews first calculated the value of Elk by taking 6.9Tcf, the midpoint of the then-reigning recov2
erable resource estimate, then taking it at 75 cents per Mcf and risk at 50%, effectively valuing it at 37.5 cents per Mcf. He then deducted third parties’ stakes and applied a 10% discount factor for cash flow. Now, consider the following: 1. At the time of that valuation, gas was trading at $4, now, in Asia, it trades at close to $20 2. The 37.5 cent per Mcf valuation will have to increase as a result of a quadrupling in gas prices. But not only that, risk will also be removed when Elk-4 completes and an independent third party assessment of the Elk/Antelope resource comes out. 3. From a story by Bloomberg: Petronas agreed to pay A$4.91 a gigajoule for proven and probable coal seam gas reserves from Adelaide-based Santos, which Santos Acting Chief Executive David Knox said sets “a new benchmark” for reserves valuations. Calculating it back to US$ and Mcf, that’s a valuation of US$4.75 per Mcf, 13 times the valuation Wayne attached to InterOil’s resource. Other Possible Catalysts We’re now close to proving a resource. The shorts are still there because they didn’t believe this would be possible and it’s very difficult for them to get out without inflicting heavy losses on themselves. IOC has also been for 448 consecutive days on the naked short list, which is all but proof of foul play. Also, the following items are set to propel the share price higher pretty soon after Elk-4 has been completed: 1. Netherland Sewell, a worldclass engineering firm, will perform an independent audit of the Elk property. 2. An agreement with the PNG government about the LNG facility, giving Liquid Niugini (of which IOC holds a third) an almost unassailable lead over competing LNG projects. 3. An agreement with outside (Japanese, Korean) investors for a participation in the LNG facility. 4. The active negotiation with a strategic partner for the sale of a 10% interest in Elk, which has the potential to create an implied “industry” valuation several-fold higher than the market’s current valuation. In addition to all this, the possibility of farm-out opportunities to industry partners could further accelerate the exploration of the company’s extensive acreage position. This article was reprinted with permission from seekingalpha.com and shareholdersunite.com. July 2008