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  • getitrt2 getitrt2 Dec 20, 2012 12:02 PM Flag

    MS Nov. 15 Comprehensive Update Correction and Reposting

    MORGAN STANLEY
    November 15, 2012
    InterOil Corporation
    Onto the Sell-down

    IOC received indications of NEC approval for IOC’s Project Agreement after over one year of political challenge and change. The path is finally clearing for IOC to finalize a value-clarifying sell-down.

    National Executive Council (NEC) approval close at long last. Today, the PNG Prime Minister, Peter O’Neill affirmed that IOC would receive NEC approval for amendments to IOC’s LNG project agreement.
    Government approval will mark the end of a volatile, 14-month period extending through a Constitutional crisis, a national election, formation of a coalition government and direct challenges IOC’s leases and development method. The process further extends to early 2010, when the monetization efforts of the 9.2Tcfe of gas/condensate began. Today’s approval allows IOC
    to conclude the illusive yet value clarifying sell-down.

    The next Act: shorter and shorted. Now that government support is becoming clear, and soon to be memorialized in the amended Project Agreement, IOC is free to consummate a transaction in next 1-2 months. The next Act, in our view, will be much shorter than the enigmatic government approval process. A sell-down will: (1) provide cash/carry for up to 32.5% Elk/Antelope sale; (2) establish a clear value for IOC’s gas; (3) begin the process of cash flow generation associated with a late 2016, 3.8MTPA LNG start-up; and (4) capitalize IOC allowing it accelerate Triceratops appraisal (PRE deal
    final) and prospect exploration. IOC enters the “Next Act” with a near record short of ~23% (float).

    What changed in the Project Agreement. The amended Project Agreement will (1) allow IOC re-locate the LNG plant to the Gulf Provence (vs. Port Moresby); (2) allow IOC to build a staged development, starting with a ~3.8MTPA plant (vs. 7.6MTPA); (3) allow PNG via the national oil company, Petromin, to take its 22.5% interest in-kind (vs. owning 22.5% of an LNG facility); and (4) grant PNG an option to acquire some additional amount of Elk/Antelope at commercial terms. 3Q12 results were positive, beating Street ($0.11/sh) with better cash position, yet less relevant to the stock.

    A Win-Win Approval: Onto the Next Act, The Sell-down

    National Executive Council (NEC) approval close at long last. Today, the PNG Prime Minister, Peter O’Neill affirmed that IOC would receive NEC approval for amendments to IOC’s LNG project agreement. IOC is to meet with the PNG Department of Petroleum & Energy to kick off the next stage of the project tomorrow. Government approval and alignment will mark the end of a volatile, 14-month period extending through a Constitutional crisis, a national election, formation of a coalition government and direct challenges IOC’s leases and development method. The process further extends to early 2010, when the monetization efforts of the 9.2Tcfe of gas/condensate began. Today’s approval allows IOC to conclude the illusive yet value clarifying sell-down.

    The next Act: shorter and shorted. Now that government support is becoming clear and soon to be memorialized in the amended Project Agreement, IOC is free to consummate a transaction in next 1-2 months. The next Act, in our view, will be much shorter than the enigmatic government approval process. A sell-down will:
    (1) provide cash/carry for up to 32.5% Elk/Antelope sale;
    (2) establish a clear value for IOC’s gas;
    (3) begin the process of cash flow generation associated with a late 2016, 3.8MTPA LNG start-up; and
    (4) capitalize IOC allowing it accelerate Triceratops appraisal (PRE deal final) and prospect exploration. IOC enters the “Next Act” with a near record short of ~23% (float).

    What changed in the Project Agreement. The amended Project Agreement will: (1) allow IOC re-locate the LNG plant to the Gulf Provence (vs. Port Moresby); (2) allow IOC to build a staged development, starting with a ~3.8MTPA plant (vs. 7.6MTPA plant); (3) allow PNG government via the national oil company, Petromin, to take its 22.5% field interest in-kind (vs. owning 22.5% of an LNG facility); and (4) grant PNG an option to acquire up some additional amount of Elk/Antelope at similar terms determined in the sell-down. These changes are within expectations. See Progress in PNG report, Oct 14, 2012. The complexity and broader objectives of gas use or option expansion, likely is the reason for the 1-2 month delay in government approval versus expectations.

    Win-Win: tax revenues, electric power and industry.

    Tax Revenues. Pacific LNG, IOC’s LNG project, is now cleared to move forward. This project represents PNG’s second LNG project and, based upon published company estimates, tax revenue from the project represents up to 40% increase in PNG GDP, post-phased startup (2016-2020) vs. 2011 levels. The impact of the project is of clear benefit to PNG (revenue and collateral impact basis) and to IOC. This compares to PNGLNG (Exxon project) that is the single largest investment in PNG history (~$15.7Bn), is currently in peak employment (over 15,000 workers), and is over 50% complete with a planned start-up in late 2014. Real GDP growth is tracking +8% in 2012, primarily due to XOM’s project.

    Social objectives. PNG will also benefit by taking its 22.5% interest in the project in-kind (natural gas) with an option for additional gas (unclear amount today) at commercial terms. We believe Prime Minister O’Neill is trying to advance dual objectives of: (1) providing electricity to PNG citizens (90% without power today) and (2) potentially grow Petromin, its young national oil company. Petromin has a strategic venture with Shell “to pursue upstream hydrocarbon potential in PNG.” Minister for Petroleum and Energy William Duma stated the alliance agreement with Shell “will provide financing for the joint exploration and development of new oil and gas prospects in the country.” Shell could potentially benefit via the Government’s gas option, yet unlike fears, we believe the price (government option gas) will be on the same level as defined in the upcoming sell-down.

    IOC benefits as well. IOC clearly benefits as its project is finally approved, clearing the path to production, cash flow, and reserve bookings. Having the government take gas in kind has two benefits:
    (1) IOC does not having to build a facility to handle government’s gas (22.5% less) and likely having to carry PNG until start-up; and
    (2) marketing a smaller size train (3.8MTPA vs. 7.6MTPA), which could have broader appeal to buyers. The staged development also likely reduces the size of the stake sold (up to 30% of 4Tcfe vs. up to 30% of 9.2Tcfe) and the government option remain less clear (size, tenor and or when or if it will be exercised and; hence, IOC receives proceeds). Expect more clarity soon from DPE.

    Who is the NEC? The national government is responsible for major resource development and the NEC is the cabinet-level body that approves development. The NEC is comprised of 33 Ministers, to whom oil & gas matters are presented by William Duma, the Minister for Petroleum & Energy. Pre-election statements this Spring (by Duma) that IOC was in violation of the project agreement, which led to a government notice to potentially terminate the project agreement, have been rescinded. Post-election, the new coalition government, led by Prime Minister O’Neill, stated clear support for IOC’s project and removed the notice to terminate. Today, the Project Agreement has been signed and government risk, an overhang for the past year, has been largely mitigated.

    Progress in the field. Significant progress in field has been made where IOC’s continuing LNG pre-investment will contribute to lower LNG development costs. IOC has constructed access to PRL 15 via two wharfs: (1) Hou Creek collection point in northern PRL 15 on the Puri Creek, which is closer to fields yet access is seasonally limited due to water levels and (2) Herd collection area in southern PRL 15 on the Puri Creek with year-round barge access. Both areas have full camps that will facilitate construction logistics. Further, IOC has largely completed a 25km access road through the jungle connecting both staging areas and all Elk/Antelope drilling locations. The road reduces mobilization costs and will significantly reduce costs for this segment of the pipeline (run parallel). The road bridges more challenging project terrain around the Elk/Antelope field, moving south of Puri Creek where the road ends there are significantly fewer elevation changes and access should be relatively less challenging than the portion IOC has already constructed. The staging area in Port Moresby, a deep-water port with a warehouse and storage area, has also been significantly expanded to handle supplies moving into country. Camps at all locations will facilitate full development and mitigate front-end infrastructure costs.

    Exploration plan. Despite the current focus on the sell-down process and the path to “P” or production, the “E” or exploration story is also improving. On the exploration/appraisal front, the next two wells are PRL 15 work obligations: Elk-3 and Antelope-3. Antelope-3 was spud on 9-29-12 and is located between Antelope-1 and Antelope-2. Antelope-3 will be designed and completed as a producing well on a higher part of the structure than Antelope-2 and will de-risk resource (move C-3 into C-2 and C-1 contingent resource). Expect results by year-end. Elk-3 is between Elk -2 and Elk-1 and is targeting a quality matrix reservoir in the lower limestone interval, which was discovered in Elk-2. Elk 1 never reached this depth while Elk-2 (no seismic pre-drill) went too deep in the zone and, while there was good rock quality and porosity development, it was below the gas-water contact producing a big water well. Elk-3 could add resource, particularly if there is any reef or better matrix rock in gas window. The InterOil #2 rig (heliportable) spud Antelope-3 and the InterOil #3 rig (less mobile, 1,500hp triple) is being rigged up to spud Elk-3 by November end.

    Triceratops is another potentially material structure (PPL 237). Triceratops-2 discovered 795 meter of gross pay (~45% net-to-gross) with gas and condensate charge in two distinct reservoirs (upper and lower zone). Porosity was between Elk and Antelope at ~5% (tighter than expected) with C-2, pre-drill resource estimate at ~4.6Tcfe. Gas flow rates were 27mmcfd in the upper zone with 16-17bbls/mmcf of condensate, which is comparable to Antelope DSTs at similar choke. In the lower zone, gas flowed 3mmfcd with 45-60 bbls/mmcf of condensate. Water contact was higher than expected. Based upon the vertical seismic profile, IOC believes there is an additional 500-600 meters of carbonate below where Triceratops TD’d. Seismic indicates this lower region could have better porosity than the drilled section of T-2. Based on this estimate, carbonate undrilled and the 795 meters of reservoir drilled in T-2, the total gross carbonate thickness for the Triceratops structure could approach 1,395 meters or 4,575 feet. Up-dip to the west, this section moves above the gas/water contact and presents a significant potential reservoir. Further, in the T-2 limestone, there were shallow water indicators that are consistent with the down-dip of a reefal buildup and similar to what IOC witnessed in the Elk-4 well (down-dip Limestone from the Antelope reef). Seismic also appears to confirm reefal buildups to West.

    The next Triceratops exploration wells will test “Antelope-like” structures as well as an undrilled lower zone at T-2. The Triceratops structure is massive with closure of over 125km2 and potentially extending outside of the current seismic footprint. Resource potential could exceed Antelope resource yet it is early days and further exploration is necessary to prove potential. It is unclear when the next Triceratops well will be drilled with partner Pacific Rubiales. If IOC is successful in securing a third rig, either the new rig or InterOil#2 rig could move to Triceratops after Antelope-3 well in early 2013. Tuna and Mako in PPL 236/238 are likely next in the queue as they are commitment wells and any acceleration of Triceratops would likely require acquisition of a third rig.

    Potential extension of reefal trend: PPL 236/238. IOC expects to spud 2 wells in block PPL 236 and 238 in 1H13: Tuna and Wahoo/Mako trend. Both are lease requirement wells and will test IOC’s reefal extension theory. Seismic on both prospects indicate potential reefal buildups as found in Antelope. The prospects also conform to IOC’s theory on the Eastern Papuan basin where sediment shed from the mountain range buried marine carbonate platforms and reef complexes and were subsequently covered by clay mudstone shale (seal). IOC believes Antelope and Triceratops invalidate old palageographic models and PPL 236 and 238 represent extensions of the reefal carbonate trend.

    Development Update. IOC introduced a new economic forecast to phase a 3x4Mtpa train program, which likely comports with their request for 4Mtpa change to the Project Agreement. Marketing each 4Mtpa could also appeal to a broader number of buyers than a 7.6Mtpa train, given its lower cost. Start-up is targeted for late 2016 and cost for a conventional train vs. a third-party-funded train in prior plans remains on the bottom of the LNG development cost curve. We expect IOC’s project to cost less than PNGLNG ($2,272/Mtpa), given a lower well count and significantly lower pipeline costs due to site/field location (~$2Bn of $15Bn PNGLNG project), and a range (+30%) on their $1,160/Mtpa would be success.

    Sentiment: Strong Buy

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IOC
56.24+0.80(+1.44%)Jul 29 4:02 PMEDT

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