InterOil Corporation (USA) (IOC): Is This Natural Gas Play Undervalued?

Whenever a company is in the midst of a major transformation, there are lots of risks along the way that could potentially turn sour. So, as investors, we try to mitigate this risk by digging deep into these respective companies so we have as clear a picture as possible. InterOil Corporation (USA) (NYSE:IOC) has flown under the radar for a while, but it has big plans to capture the Asian natural gas market. Is InterOil an unspoken gem that the market is undervaluing? Or are its ambitious plans too big for the company to handle? Let’s take a better look at these questions to get a clearer picture.

Undervalued?
One of the reasons InterOil Corporation (USA) (NYSE:IOC) doesn’t get much attention is its location. The entirety of the company’s natural gas assets are on the island nation of Papua New Guinea. This doesn’t make them any less valuable, though. The company owns leasing rights to almost 4 million gross acres in the country. A study done by GLJ Petroleum Consultants estimates that the company’s acreage has as much as 6.0 trillion cubic feet of recoverable reserves.

If the company’s estimates are correct, it is quite possibly one of the most undervalued assets around. This would give the company a market cap value of about $0.62 per thousand cubic feet equivalent of reserves. Compare that with Linn Energy LLC (NASDAQ:LINE)‘s 4.7 Tcfe of proven reserves and market cap value of about $1.87 per thousand cubic feet equivalent of reserves.

Here’s the catch: Not all of InterOil Corporation (USA) (NYSE:IOC)’s 6.0 Tcfe are proven. Since its inception, InterOil has spudded 14 exploratory wells on all of its its holdings. While some of the initial production rates on these wells have been exceptionally high, they were immediately shut in. It is difficult to determine metrics such as the decline rate and the estimated ultimate recovery for these wells without their having produced for some time. It’s also hard to determine the full potential of a 4 million-acre site based on a dozen exploratory wells and seismic mapping. While the potential for something great is there, it’s still too early to give a final verdict on Interoil’s prospects.

Overreaching?
InterOil Corporation (USA) (NYSE:IOC) currently has two business segments that generate revenue for the company: its midstream and refining segment, and its retail and marketing operations. So far, almost all of the profits from these segments have gone into exploration and production. It has also used the sale of interest stakes in some of its upstream assets to help finance both its upstream operations and its initial efforts to build an LNG export facility. Unfortunately for the company, the proceeds from these operations aren’t enough to fund its plans at a very rapid pace. This is why the company has for quite some time sought out partners to execute this strategy. It found two last year. Both the Papua New Guinean government and Colombian E&P company Pacific Rubiales took minority interest stakes in some of its exploration fields.