Interoil Exploration & Production (INOX on OSLO OTC) presently sells for 31 Norwegian Krone (approximately $5.10 U.S). There are 22.25 million common shares outstanding (fully diluted), and net debts of $52 million.  This results in an EV of $165.5 million U.S (approximate).  I estimate that Interoil will generate EBITDA of $31 million U.S. in 2006, and up to $41 million in 2007.  As a result, it is my opinion that INOX is selling for 5.3X forecast EV/EBITDA and less than 4.1X forecast 2007 EV/EBITDA.  This assumes that Brent crude averages $61 U.S. per barrel in 2006, and $55 U.S. in 2007.  Interoil uses successful efforts accounting.

Interoil is a Norwegian  based junior oil and gas exploration and production firm.  INOX has oil operations in Peru and Columbia as well as an exploration concession offshore Angola, Africa.  Net of royalties, the company has 10.7 million barrels of P2 reserves, all crude oil.  Insiders own approximately 53% of the total outstanding shares on a fully diluted basis.  Institutional investors hold an additional 34.2% of the outstanding shares.  Fewer than 12.8% of the outstanding shares are held by retail investors. 

In 2005, net oil production (after deducting royalty payments) averaged 1609 bpd.  For 2006, I estimate that net production (after royalties) will increase to an average of 2671 bpd.

PERU.    Interoil has two producing oil fields in the Talara area of Peru.  These fields (blocks 3 & 4 of the Talara basin) were discovered in the 1930's and have been productive since.  The oil is roughly 21 degree API, and sells for a discount of roughly $7 per barrel off Brent. Since the 1930's, 813 wells have been drilled into these fields. In 2005, net production from these two fields was about 926 bpd.

INOX purchased these fields from Mercantile Petroleum International in late 2005, along with the Columbian fields. Mercantile had owned the fields since 1997, but had lacked the capital required to successfully grow the production base.  

Interoil estimates that up to 52 proven drilling locations exist at the Talara fields.  INOX had initially budgeted over $11 million U.S. of capital expenditures for Peru in 2006.  This is almost 2X the capex spent in 2005 by the previous operator. 

The capex plans for Peru included drilling of a minimum of 8 new development wells.  Thus far in 2006, 7 have been drilled, and all have been deemed successful. The oil formations are found at depths of roughly 4000 feet and take about 3-4 weeks to hit target depths. 

Interoil states that they have found two areas at the Peruvian fields with significant development potential. One area, in particular, represents an extension of a main producing field and has positive implications for reserve increases. 

Daily oil production has grown by almost 40% since December, and presently exceeds 1350 bpd (net of royalties). In light of the drilling success, it appears that the Peruvian drilling program will be expanded well above the initial 2006 budget .

I consider the Talara fields to have excellent development potential.  The previous operator was quite capital constrained.  Consequently, most expenditures involved reworking existing wells to boost production.  This was cost effective, but did not result in finding new oil reserves.  One of the two producing fields has never had 3-D seismic mapping in its history. In short, Interoil doesn't really know how big one of their fields may be.  Since the development drilling is targetting the outer edge of this unmapped area, Interoil management may believe the productive zones to be larger than originally thought. 

COLUMBIA.  Interoil has several smaller oil fields in Columbia, in close proximity to one another.  In 2005, net production after royalties averaged 683 bpd from 42 wells.  Capex for 2006 in Columbia is estimated to be about $8 million U.S.  A total of 7 wells were forecast to be drilled in the budget, and the plans have now been increased to allow for the drilling of an additional well.  As the majority of the wells have been completed, this drilling program may be revised upwards again.  Current production, net of royalties, exceeds 880 bpd.

Plans in 2006 are to spend an additional $2.8 million U.S towards a 3-D seismic map of their license area in Coumbia.  This will allow Interoil to refine a capex plan for Columbia in 2007.  Management suggests that there are more than 23 proven drilling locations yet to be exploited. The high number of proven undrilled locations in relation to the number of producing wells implies that considerable production growth may lie ahead.  Interoil's Columbian assets have excellent exploration potential, but are geologically complex.  The oil must be transported by truck for sale.  This, plus quality differences vs Brent, results in Interoil receiving about $10 less per barrel than Brent crude.

ANGOLA.  Interoil has recently  been awarded a 40% and a 20% interest in two shallow offshore concessions from Angola. These concessions have been unsucessfully explored by 3 previous operators.  A total of 3 wells had tested between 700 bpd and 1100 bpd of oil out of 11 wells drilled on this property. 

In the past, (with lower oil prices) an offshore well testing 1100 bpd was considered to be a commercial failure. In today's higher price environment, 1100 bpd production rates from wells  is still not commercial, but at least appears to hold some promise.  Sonangol (the Angola state oil company) has noted that the block in which Interoil holds a 40% interest has "oil in place" of 50 million barrels.  Oil in place is not a reserve.  This is what is considered to be a maximum amount in the ground.  Generally speaking, OIP is discounted by 75% to 80% amount to arrive at a 3P reserve estimate.  Therefore, if this was an actual reserve (and it is not), then there would be no more than 10 million barrels of 3P offshore in this block.   In short, this is pure blue sky.  The concessions hold no actual reserves to speak of, and Interoil is hoping that new 3D seismic mapping will find some productive structures.  

Interoil will pay an $8.4 million upfront signing bonus.  They will then shoot 1000 sq km of seismic and will committ to drill 2 wells in the next four years.   Interoil's other publicly traded partner on this play is a firm called Vaalco Energy (EGY on Amex).  The market cap of EGY increased by almost $40 million on the announcement that EGY was awarded an equivalent interest in this play.  Interoil barely moved on the news.  One can only speculate that this is due to a virtual unawareness of the existence of this firm.

Overall, Interoil Exploration and Production ASA represents an intriguing value play. The company is adequately capitalized, as it holds about $11 million U.S. of cash (net of the signing bonus to be paid to Sonangol). Interoil's forecast EBITDA is higher than spending plans. The development drilling in Peru holds promise, and production targets appear likely to be exceeded in 2006.  INOX appears quite capable of increasing their 2006 drilling program without requiring additional capital from the market. 

Interoil also appears to be an anomoly in another respect.  Many microcap oils are held by retail investors wth only a handful of important institutional holders. Interoil, in contrast, is almost exclusively held by institutional investors.  87% insider and institutional ownership certainly strikes me as being very high for a publicly traded junior.  Current institutional holders on the shareholders list include Credit Suisse, Bear Stearns and Morgan Stanley.

By the end of 2006, should oil prices remain strong, INOX should be trading on the Oslo stock exchange.  The shares (which trade OTC in Norway) appear to be presently undervalued by almost 40% vs their European peers (Norse Energy and PA Resources).  In the past month, the shares of Interoil had climbed to almost 40 Krone on the news of their rapidly increasing Peruvian production.  Subsequent to that report, the shares have drifted down to what I consider to be a new level of support. 

Investors may also be interested in comparing Interoil to several Canadian firms which have purchased assets in Columbia, Argentina and Peru.  Here are two firms with production that is directly comparable to Interoil, with very similar enterprise values.

1.  Pacific Stratus Resources (PSE $3.99 Canadian).  Pacific Stratus should be familiar to Interoil shareholders, as Pacific Stratus is presently drilling to earn a 50% interest in Puli oil concession in Columbia owned by Interoil.

PSE has agreed to pay $60.2 million U.S cash, assume reclamation costs and will also assume a $7.5 million drilling obligation in Columbia from Sipetrol.  This purchases an estimated 2P reserves in Columbia of 3.8 million barrels (net of royalties).  Net of royalties, the purchased assets provide estimated production of 2400 bpd.  The purchase price was $13 U.S. per barrel, and $25,000 U.S. per flowing barrel (after royalties are deducted).    The relatively low price paid per flowing barrel is based upon the assumption that the asset is extremely mature, and that production will decline.

Pacific Status has priced a financing to pay for this purchase and add capital for development of their Columbian projects.  When added to their existing share base, the EV of Pacific Stratus should be roughly $137 million U.S.  Pacific Status should be able to book the revenue and EBITDA from this purchase for the latter half of 2006.  As a result, I estimate a 2006 EV/EBITDA estimate of 8.2X and a 2007 estimated EV/EBITDA of 5.1X.

2.  Gran Tierra Energy, Inc. (GTRE $3.52 U.S) has recently agreed to purchase Argosy Energy International for $42 million U.S.  This purchase buys 3.83 million barrels of 2P reserves and 856 barrels per day of net production (after royalties).   The net price paid works out to be $10.96 U.S. per barrel of reserves and $49,000 per flowing barrel.  The relatively high price paid per flowing barrel is based upon an assumption that production growth is possible in 2007. 

Gran Tierra will have to raise sufficient equity or debt to complete the purchase.  Once this has been accomplished, GTRE should have an EV of about $238 million U.S.  The company will produce about 3100 boepd net, and will have about 8 million barrels of net 2P reserves.  EBITDA may be up to $20 million in 2006 and $40 million in 2007.  This prices GTRE at an estimated 11.9X 2006 estimated EV/EBITDA and 5.95X EV/EBITDA in 2007.

Overall, if one compares INOX to PSE and GTRE, one observes the following

2P RESERVE COMPARISON.  At current prices, investors in Interol are effectively paying about $15.4 per barrel of 2P reserves.  Investors in Gran Tierra are presently paying about $28.75 per barrel of 2P and investors in Pacific Status are presently paying about $36.05 U.S per barrel of 2P.   This may imply that Interoil is undervalued (in relation to these peers) by at least 46% on an oil reserves basis. 

EV/EBITDA COMPARISON.  The EV/EBITDA forecast suggests that INOX may be undervalued in relation to the sample group by at least 34% on a 2007 forward basis. 

If one also closely reviews the production and asset purchase profiles of Gran Tierra,  Pacific Stratus and Interoil, it becomes apparent that there are important quality differences in the asset base of the three companies. 

Gran Tierra's production purchases are spread out among a number of quite small fields.  Natural gas production makes up a healthy percentage of the revenue stream and the 2P asset base. In South America, natural gas is still considered a very second rate fuel, and is priced accordingly (about $1.40 per thousand cubic feet) .  Production growth is forecast at 1000 barrels in the next year before natural decline rates are taken into account.  When one adds in traditional field declines, Gran Tierra's production rate may increase by about 15% in 2007 over 2006.

Pacific Stratus purchased an asset base considered by the seller, Sipetrol, to be in the twilight years of its life.  The reserve life index on the Sipetrol assets are just over 4 years, which is very short.  With a reserve life so finite, one can may theorize that the purchase will see a sharp decline in productivity in the next year or so.  To put it another way, PSE will most likely have to spend any money made on this purchase simply to hold production around current levels.  It is difficult to envision production growth on this purchase. 

Interoil indicates that production growth for 2007 may be in the order of 40% above 2006 estimates, after taking normal field declines into account.  One might be inclined to take this forecast with a grain of salt.  However, INOX's production rates in May, were what management was budgeting them to be by the end of  2006.  Perhaps this may be one of the few oil firms remaining, that underpromises and overdelivers.   

In the short term, success from drilling doesn't always show up in the share price.  Inevitably, what separates the wheat from the chaff in junior oil companies, is the ability to grow production via successful drilling on operated prospects.  In this respect, Interoil appears to have promise. 

The most recent corporate presentation by Interoil may be found here:

http://www.netfonds.no/news/nfmf/20060512/Interoil_Presentatio_Fondsfinans_120506v1_%282%29_%5BRead%2DOnly%5D.pdf

AUGUST 14th, 2006 UPDATE.  Interoil has announced the results of operations for the 2nd quarter 2006.  You may link to the English text of the announcement here.

http://www.newsweb.no/cdco/atmnt/InterOil_2_Quarter_Report_2006.pdf?id=47309

Of interest is the announcement that Peruvian development plans have been accelerated for the balance of 2006.  There will be up to 10 additional wells drilled in Peru for the balance of the year.

Also, the 3D seismic program in Columbia has been completed.  Interoil now intends to proceed with a 2 well drilling program for the balance of this year.

Production has met my forecast, as has EBITDA.