IOC Sizzle or Steak, pt. deux

Interestingly, Morgan Stanley has a research report showing Enterprise Value/reserves of all the major N American gas producers. Interesting because MS is the one solid supporter that give IOC its legitimacy.

But what does this report have to do with IOC? Let’s see.

The report divides companies into two groups, the large producers and the small to intermediate producers. The large producers sell anywhere from $12 to $22 EV per Barrel of Oil Equivalent (BOE) in reserves. The smaller producers from $8 to $18 EV per BOE in reserves.

IOC with 6.7 trillion cu. ft. of natural gas (ng), has about 1.1 billion BOEs in potential reserves. Currently it has an EV of at least $3.4 billion, the current market value of its stock.

How do we compare N American producers to Papua New Guinea (PNG) producers?

The American producers deliver their ng to a third party pipeline that takes it to market. That cannot happen in PNG because the country has fewer people than many states in the US and they certainly don’t need gas to provide heat in PNG.

Without a domestic market, the ng will have to shipped to markets where it’s needed. So a liquefaction, LNG, plant will have to be built. The cost has been estimated at $6-8 billion. That gas has to get to its destination and go through a regasification plant to get to the same point the N American ng is when it enters the third party pipeline.

This means that regardless of how ownership is split up among cooperating entities it takes an enterprise value of IOC plus $7 billion to get an apples to apples comparison between it and the N American producers. $3.4 billion plus $7 billion equals an EV of $10.4 billion to get it in operation. Whoever puts up the $7 billion in hard cash is going to make sure they have a fair deal. $10.4 billion/1.1 BOEs equal $9.50 per BOE in reserves. This number fits in near the low end of the range.

The N American companies like XTO CHK DVN ECA get most of their value as producers. They produce and they are in the US and there is an existing infrastructure in place. IOC in contrast does not produce any ng and they have no reserves because they have no current way to sell ng. Plus they are in PNG and not the US. PNG does not have a good reputation as a third world country, so there is significant country risk.

There is a discount for the company’s relatively small size. There is a discount for not being a producing company. There is a discount for country risk. There is a discount because they don’t yet have a partner with $7 billion. They don’t have a fully measured resource, just 4 holes. There are huge discounts for juniors without funds to complete to production, and without a fully delineated resource. It is not on the order of a 20-30% discount. It is more on the order of a tiny fraction of the N American companies.

Forget about whether they are hyping their resource. Assume they are like any other junior at this stage. They are worth a tiny fraction of that $12-$22 range. $9.5/BOE is more than a nose bleed price for this stage junior. This explains why they are having so much trouble getting a partner for the LNG plant.

We have all seen this situation before whether it is oil or technology or anything else, that a start up without operations can be worth more than a whole operating industry. It is only when they start getting revenues that their prices come into line. A real paradox, but that’s the way it is.

Barry Zee


One Response to IOC Sizzle or Steak, pt. deux

  1. hhill51 says:

    Disclosure: I will assume Barry still has his short/married put positions on, as I still have my long/covered calls. My December calls were exercised, as expected, but I have positions out as far as March.

    – hh

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