|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||149||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
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South American Production Growth.
All amounts are converted from NOK to US at .1975.
Basic shares outstanding: 21.85 million
Market cap. $149.2 million
Total liabilities – cash and oil receivables (as of
Shares outstanding fully diluted (assumes conversion of $20 million debenture into 2.72 million shares, 656,245 out of money options and additional forecast option grants for 2008): 25.22 million.
2P reserves as of
Current enterprise value: $330.7 million.
2007 EBITDA: 0
2008 forecast normalized EBITDA: $65 million
2009 forecast EBITDA (ex
I own shares of Interoil ASA a smallish E&P with production in
An important exploration success in
Full development of the discovery has the potential to drive annualized production to 10,000 bpd, by the end of 2010.
Interoil ASA was founded through an asset purchase of a private oil and gas firm with two small producing fields in
Interoil subsequently listed its shares OTC Norway, where I repurchased a portion of my position. The shares of Interoil started trading on the
The fields and my evaluation of reserves & production potential are as follows.
The fields contain 11.8 million barrels of 2P reserves and encompass one of the first oil finds in
Production licenses are due for renewal on
Productive formations are relatively uncomplicated sandstones. Horizons are located between 2500 feet-6000 feet below surface and oil is reasonably distributed throughout two large areas. Historic data indicates that reserves in shallow formations averaged 100,000 barrels and Salinas wells (deeper) average 140,000 barrels per well. There are large variations per well and per field due to heavy faulting in the fields and the formation targeted. While historic reserves per well seem modest, most wells in these fields were drilled long ago. Extraction techniques have improved greatly over the past 50 years.
Newly drilled wells in shallow formations generally start off with production rates of 50-125 bpd, and within a year, decline to rates of between 5-10 bpd. While production per well is low, so are costs. Most who have operated stripper wells will confirm that EBITDA returns soar when pricing is strong. A 7 bpd producer that doesn’t require much maintenance, has the potential of delivering $100,000 per year of annual EBITDA for IOX, in this pricing environment. Oil prices received are typically WTI less $7 for quality differentials.
At present, blocks III and IV contain about 350 producing stripper wells. More than 900 wells have been drilled on these fields since inception.
Portachuelo was discovered in 1931. Original oil in place of OOIP is estimated at up to 400 million barrels. Less than 8% of the OOIP have been produced to date. This suggests that primary production is still appropriate for many years to come. Other fields (La Brea, Boca and various fields in block IV) are estimated to have as much as 150-200 million barrels of OOIP, with less than 10% of OOIP produced to date.
I have always considered blocks III and IV to be good assets with development potential. A perpetually cash strapped Mercantile was able to boost Peruvian production over its 10 year history using “spit and duct tape”. The former CEO once wondered what would be possible if a few million could have been found back in 2000, to pay for some modern seismic maps.
Post acquisition, Interoil has acquired highly current seismic on unexplored portions of these blocks.
Incidentally, significant amounts of natural gas are located in Block III. 2 wells drilled in the 1950`s and 1960s tested at 20 mcf/day and 40 mcf/day respectively. Up to 610 bcf of gas resource are estimated in the license area, with almost 225 bcf considered already found. Under the current royalty structure and if a market could be had, IOX could quickly book up to 113 bcf of resource for their own account. At one point in the late 1990’s, a contract to sell gas to the Malacas 150mw power plant near Talara, was under negotiation. This was never consummated. Around 2000, discussions took place regarding a contract to sell gas to a proposed 250mw gas fired facility. The plant was ultimately shelved in the early 2000’s as being uneconomic to build. Since there were no other current markets for the gas, and no infrastructure existed to allow for transport, no gas reserves are currently reported by Interoil.
Investors will have to decide for themselves, whether or not 225 bcf of known, but stranded natural gas represents a “hidden value”; for a company with just 15.9 million barrels of 2P oil reserves.
Peruvian oil production appears set to grow rapidly, as a result of a new discovery, ``La Isla``, at the southern margins of block III.
Olympic Oil & Gas (an unrelated company) announced excellent results from a discovery directly adjacent to block III. Several wells were drilled into the Salinas Mogollon sandstone formation and are estimated to be producing about 300 bpd.
Interoil subsequently announced an intention, in early 2008, to drill at least two wells to the
This exploration play is well defined with very modern seismic. Given the size of the prospective formation, the current level of production from the first well and appropriate spacing, it should be possible to drill more than 30 wells into the existing area. Information is sketchy on the Olympic discoveries, but I take it that production declines are lower than expected. Oil produced from this formation is generally 32-34 API.
I estimate that with one rig working year round, an 80% success ratio on further Isla wells, 150 bpd of initial net production per well and a 50% annual production decline rate, IOX net production in Peru could grow to an average of 2,792-3,042 bpd in 2009. Production would be divided between Isla at 1392 bpd, with 1400-1,600 bpd coming from the remaining fields. Workovers and limited development drilling have proven to be sufficient to maintain or modestly increase production at the existing Peruvian fields.
Put another way, at an assumed cost of $1.2 million per well, Interoil may have to spend as much as $21.2 million of further capex at Isla through the end of 2009. This could prove up at least 4-5 million barrels of 2P reserves. At $115 per barrel of oil, the Isla field could add $58 million to 2009 revenues and $33 million of annualized EBITDA. The discovery and exploitation appears to be highly economic. An enormous number of wells, in theory, could be punched into this formation.
Interoil has a production license which represents a 50%-100% working interest in two fields, Toqui-Toqui and Tortare. These production contracts expire on
The Toqui-Toqui field is jointly owned by Interoil (50%) and Ecopetrol (50%). Production is shared equally and the Columbian government is paid an average 15% royalty on Interoil's net production.
Reserves are estimated at 4 million barrels of 2P, based upon a contract expiration date of 2012. Older reports issued by Mercantile`s reserve engineers suggested that 2P reserves could be at least 53-69%% higher, should a license be renewed. It is estimated that original oil in place (OOIP) from the two productive formations in Toqui-Toqui could be as high as 150 million barrels. Only 4% of the estimated OOIP has been produced to date.
Oil prices received are typically WTI less $10-11 per barrel for quality differentials.
Columbian production is set to climb, starting this month.
Interoil has commenced an extensive fracturing program to increase production from Toqui-Toqui. Initial results from the 1st two wells are promising and 10 wells are scheduled to be fractured. 8 shallow and 3 deeper wells are also to be drilled this year.
Columbian production averaged 1376 bpd in May. Net of Ecopetrol’s interest and assuming a 15% royalty, production may grow to average 1900 bpd in 2008, and surpass 2300 bpd in 2009.
Interoil holds African exploration interests.
The firm has a 31.5% holding in an offshore
The next target to be drilled in Tano is “
Tullow ultimately added this concession to their inventory. Interoil has since assumed a 31.5% interest by paying 37.5% of costs. An appraisal well at
IOX also holds two concessions offshore
A new onshore concession called Cabinda North is interesting for wildcatters. Interoil holds a 21% interest in an area which has not been explored since the 1970’s. Several smaller discoveries have been made in the area of late.
I believe that Interoil needs to raise about $50 million this year at the explorco level, to fully maintain their African interests.
In 2007, Interoil expensed $23.15 million on African operations. As the firm uses successful efforts accounting, this is a direct hit against EBITDA. An additional $2.87 million was expensed for
Offshore exploration is high cost and carries low probabilities of success. Replicating the success of a Tullow oil is difficult in smallish independents, and Interoil has bitten off more than I would personally care to chew.
Diverting cash flow from the myriad of promising opportunities in
Separation of the South American and African assets is very sensible.
$30 million of funding could provide a cushion that may carry IOX towards self sufficiency. At forecast production volumes and should oil prices remain above $100, I don’t envision a further need for further equity issues in 2009.
However, there is no way that in its present form, IOX can spend an estimated $50-$60 million on South American capex in 2009, while also coming up with about $50 million towards African capex. Credit markets are such that further debt financing is unlikely at the current production rates…nor would I consider adding more debt to be prudent.
830+ bpd of oil has been hedged at $75 US through 2008, with a further 600 bpd through 2009. I believe that the firm ran out of money in the 1st quarter, and had to curtail most development work in
The lack of development capital largely accounts (in my view) for a drop in oil production from 5020 bpd in January 2008, to just 4329 bpd in May 2008. Management blamed 150 bpd-600 bpd of the drop due to flooding in
Apparently, management doesn’t think much of me either.
I have queried if Interoil intends to build out a market for their natural gas assets, which are quite close to a proposed gas line for
I have also pressed twice in the past 12 months, about a proposed royalty reduction agreement in principal. This was entered into between the Peruvian government and the predecessor company, Mercantile. Under this agreement, Mercantile was to accelerate investments for drilling, well rehabilitation and work commitments. In return,
The program requirements were fulfilled by Interoil in early 2007, but so far, royalty relief has not been granted. Such a reduction would be a material event, and could immediately add almost 800 bpd to net production. Incremental production going forward basis would be much more profitable. EBITDA at current rates could improve by at least $.66 per share per annum, using current oil prices. Reserves net to IOX would increase as well.
My questions as to why royalties have not yet been lowered, have not been responded to.
That said, I now consider the shares to be a bargain.
The Isla discovery is a highly material event. If junior oils are worth 3X-4X EV/EBITDA, a $24 million capex plan at Isla could add $33 million of additional EBITDA in 2009 and some decent longer life reserves. This would be worth $3.5-$4.74 of incremental value for Interoil shareholders in about a year, even assuming 6 million more shares outstanding. For a microcap, this could be a company maker.
I personally believe that royalty relief is pending. This is a hunch on my part and might be entirely off base. As the markets are presently building in no value to my hunch, I don’t mind sharing my views with VIC. (Please don’t splash this report around the internet…many thanks).
Should royalties come down, EBITDA could improve by an annualized $20 million based upon current Peruvian production. Any incremental Peruvian production would pay just a fraction of present rates (20% vs 49.8%), so forecast Isla volumes would be much more profitable. Based just upon current output, a 3X-4X EV/EBITDA multiple on current royalty savings adds incremental value of $2.15-$2.85 per share, on a 28 million share base.
I believe that the African assets hold value, but are being priced like a liability by Interoil shareholders. A spinoff could be worth at least $1 per share, based upon the $26.15 million already expensed on African operations in 2007-2008.
In my view, IOX has the potential to double in the next 18 months.
The production growth catalyst could become evident as soon as August. Interoil announces production figures monthly. Based upon several successful fractures in
Peruvian natural gas is a complete wildcard for IOX that few are aware of. IF BPZ can get funding for a gas plant, there seems to be no reason that other substantial stranded gas producers in this region can’t replicate such a feat. Royalty relief is possible. Reserves, while entirely accurate as per filings, seem quite understated if licenses can be renewed, royalty reductions take place or if natural gas ever gets added to the mix.
Using the current royalty regime, I arrive at a 2009 production estimate of 4692-5342 bpd . Revenue could be $153.4 million-$176.4 million. EBITDA could be $90-$102 million.
Using the new royalty regime, I arrive at a 2009 production estimate of 6695-7087 bpd. This works out to be $223.2 million-$236.4 million of revenue. EBITDA could be $129.5-$137.1 million.
A 4X EV/EBITDA multiple produces a value of $7.25-$13.36 on 31.22 million shares. This assumes that a $30 million capital placement occurs. I also assume that the $20 million convertible debenture, at some point in my forecast period, goes ”in the money”. The capital placement assumes a 20% discount from the current share price and expenses = 10% of gross proceeds.
Add in $1-$2 per share of value for African assets, and the total return could be 20.7%-124% by the end of 2009. Personally, I’m not holding these shares to earn just a 16.7% basic return.
Should management elect to procure a second rig for Isla, my estimates might prove out to be conservative. If oil prices remain above $100 for an extended period of time; a 4X EV/EBITDA multiple will probably start to look quite cheap. Once again, this could make my targets seem conservative. Reserve recognition of natural gas assets on block III might make my targets look conservative.
While it pleases me to see that the African assets are slated for spinoff, many of the concessions are intriguing. This combination rather reminds me of an older deal I wrote about…Lundin Exploration. Lundin was ultimately taken over by Petro
Interoil’s website is here
An overview of the productive petroleum formations in
Investors looking to bone up on the stranded gas assets in block III should review SEDAR filings (www.sedar.com) for Mercantile International Petroleum. The annual reports for 2003 and 2002 mention gas reserves as well as failed attempts to market the gas.
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