Interoil (IOC – AMEX)

Dear Bottarelli Research Member,

I still feel strongly that we’ll re-test the January lows underneath the 12,750 level on the Dow. Therefore, I want to make sure that everyone still carries a position in the DIA March 116 Puts (DIA OL). After adding to these puts this week, our cost average will be $1.57 per contract. All it’ll take is one swift market down-turn and we’ll have a handsome return on this protective put position, so continue to carry this position until the coast is clear.

In terms of a time horizon, I feel that mid-April will mark the beginning of the next sustainable turnaround. Therefore, we’ll continue to take advantage of this market weakness by adding quality small-cap stocks at depressed levels.

For this week’s newest small-cap pick, we’ll dive into a sector that we’ve been waiting to get into. And now, the timing is finally right. In fact, the natural gas and refining sector is giving bullish signals, and I firmly believe this sector is going to lead the markets higher in the coming months. Supplies are dwindling yet consumption remains extremely strong around the world. Not only that, but as we move into the spring and summer, demand will increase as AC units are flipped on across the globe.

For this particular pick, our thesis is two-fold. One, we’re buying ahead of the curve. You see, the company I’ll be revealing this week has been quietly working on what could be a major natural gas find in Papua New Guinea. They have petroleum licenses that cover about 9 million acres in this region. Plus, PNG LNG Inc. (which is a joint venture between Merrill Lynch Commodities and Pacific LNG ) is getting ready to construct New Guinea’s first LNG (Liquefied Natural Gas) plant adjacent to this company’s existing refinery. This is quite a bullish catalyst.

And two, we’ll also be riding the coat-tails of one of the savviest investors of our time. You see, as I looked over this company from every angle, I became aware that a man whom I have followed for years has been buying up shares both personally and through his investment firm. That man is none other than T. Boone Pickens. That’s correct, one of the nation’s top oil speculators owns about a 10% stake in this company through his investment firm BP Capital Management , and he also owns another 2,000,000 shares in his personal account. Combine this substantial investment with Merrill Lynch Commodities, and this little stock already has some huge money working behind the scenes. Therefore, the time to jump is now.

This week’s pick is Interoil (IOC – AMEX), and let’s take a small position under $24.00 per share. I think it’ll pay off handsomely.

UPDATES

Puda Coal (PUDC.OB): As I mentioned last week, this stock just isn’t moving the way I expected, so the time to say farewell is now. Let’s go ahead and sell shares of PUDC. For all of you who wrote in and asked that I continue to follow it, I’ll be sure to stay up to date on any news and alert you to any significant developments. But at this time, we have no choice but to close it out. Our money can be put to better use elsewhere. Sell.

Oceanfreight (OCNF – NASDAQ) & Star Bulk Carriers (SBLK – NASDAQ): Shipping stocks across the board are now recovering from the market turbulence that resulted in weakness on global slow-down fears. But like always, Wall Street over-reacted and created a great opportunity for us to add to each position. Later this year, we’ll be very happy owning these two small-cap shippers as the dry bulk shipping market continues to thrive off the global demand for commodities of every kind. Add to both positions.

US Geothermal (UGTH.OB): I have to say, at these prices, I would urge you to own shares in UGTH. After all, I believe we’ll see UGTH double once again this year. Now that they are providing power up in Idaho, we should easily see this one increase 100% from current levels by year’s end — perhaps even more. Hold.

Uranium Resources (URRE – NASDAQ) & Uranium Energy (UEC – AMEX): For those of you who never jumped into these two small-cap uranium plays, you are being given a great entry opportunity right now. Oil is once again trading at $100 a barrel, yet nobody is talking about the uranium demand in years to come. That’s why we should buy URRE and UEC while nobody is looking. UEC owns one of the largest historical uranium exploration and development databases in the U.S. And just recently, they added another project that is comprised of 36 lode claims covering 640 acres. Both stocks should be staples in our small-cap ledger. Add to both positions.

Have a great week everyone.

Sincerely,

“Interoil has found gas, a lot of gas, in Papua New Guinea. The question is, is it enough gas to justify a LNG facility? The company thinks so. As does an analyst at Piper who has a $65 price target.”

- Seeking Alpha, January 30^th 2008

According to Forbes.com, “Stocks with the most favorable positions, given the worldwide energy shortage, are the independent exploration and production companies. They have proven reserves available for sale, and are not running to keep up with extraction schedules that constantly threaten to reduce their reserve ratios. Ultimately many are likely to be acquired by the major integrated companies that must have crude to refine.”

When it comes to finding a company that fits the description above, you must be selective. After all, there are probably less than a dozen publicly-traded companies that fit this mold. But InterOil Corporation (IOC – AMEX) iscertainly a match.

Founded in 1990 and based in Cairns, Australia, InterOil engages in the exploration and production of oil and gas properties in Papua New Guinea. As you’ll see from the map below, IOC owns four exploration licenses and two retention licenses covering approximately nine million acres.

The sections outlined below in purple represent areas where IOC owns a 100% working interest. Sections in gold and yellow represent areas where IOC owns a split working interest.

According to InterOil’s Web site, their business operations are broken down into three categories: Upstream, Midstream, and Downstream.”

Here is a summary of each segment:

Upstream Assets: As Mark mentioned above, InterOil’s exploration asset portfolio is one of the largest held by a single company. It comprises 9 million acres which contain a total of four discoveries. Their primary licenses are located in the Eastern Papuan Basin northwest of Port Moresby, known as Petroleum Prospecting Licenses 236, 237, and 238. These are IOC’s 100% working interests which represent the greatest asset to IOC’s share price appreciation. You see, their “ELK 1” gas discovery in 2006 was recorded as the highest gas flow in Papua New Guinea’s history, with a gas flow rate over 100 million SCF/day. Right now, IOC is drilling in “ELK 4,” located in PPL 238, which the company believes holds substantial gas resources to underpin a full scale LNG project.

In addition to these 100%-owned locations, IOC also owns a 15% working interest in Petroleum Prospecting License 244, located offshore in the Gulf of Papua, a 43% working interest in Petroleum Retention Licenses 4, and a 28% working interest in Petroleum Retention License 5. These are noted in the map above as well.

Midstream Assets: In addition to their land discoveries, InterOil also owns a 32,500 BPD Commercial Oil Refinery. This is the only refinery in Papua New Guinea, supplying the country’s entire refined product needs. Prior to the construction of this refinery, Papua New Guinea was among a small handful of countries in the world that did not have its own refinery — which meant that they relied entirely on imported petroleum products from Singapore and Australia (which are 1,375 to 4,375 miles away!) As you can imagine, this new refinery enables IOC to capture most of the freight costs and refinery margins, which were previously paid to international shipping and oil companies. When you own the country’s only refinery in an oil-thirsty world, this is a big advantage. It’s like having the only gas station in the entire state of North Dakota! And since they’ve now secured crude oil supply contracts with BP Singapore and refined product sales contracts with Royal Dutch Shell, they’re in a very good position going forward.

Downstream Assets: And finally, as the third segment of their business operation, InterOil is the largest distributor of refined products in Papua New Guinea. They distribute these products under its brand name InterOil Products Limited. They also engage in liquefaction, refining, and marketing of jet fuel, diesel, and gasoline, as well as naphtha and low sulfur waxy residue. Plus, they own and operate distribution depots, seaboard terminals, trucking systems, and a comprehensive retail network — and they’re getting positioned to develop the first LNG project in Papua New Guinea, targeting 2012 as the delivery of “first gas.”

Now that you’re familiar with the company’s structure, a little history is in order, because I need to explain the reason for the stock’s downside move that began in October of 2007. And more importantly, I need to outline why the shares are due for a bounce-back.

There is no question that Interoil has found a lot of gas in Papua New Guinea. But what has yet to be determined is whether or not their gas discovery can justify a LNG facility. Of course, the company thinks so. But until that question is resolved for good, Wall Street (and the subsequent share price) is left in a state of limbo.

The all-important answer to this question will be determined by the third well on the ELK structure. The ELK area is part of their 100%-owned discovery — and it contains multiple high porosity limestone with an excellent shale seal.

According to results announced in October of 2006, their ELK 2 appraisal well confirmed conductive fractures, porosity, and deliverability, and a larger rock volume and better-than-anticipated reservoir quality. All of this indicated increased potential for a gas resource in the ELK structure. When it comes to appraising the value and quality of a potential well, this is certainly what early investors want to hear.

But then it was discovered that the well was drilled to a total depth of 10,922 feet. The highest known water recovered in the well was at 8,777 feet, and everything above that level was tight with only small amounts of gas produced and no liquids. Based on this finding, IOC said that they were suspending the well for possible future re-entry and moving the rig to the Elk 4 location. As a result of this news, IOC shares dropped 24%.

Despite this disappointing news from ELK 2, all was not lost. Far from it. After all, IOC simply turned their attention to their next big event, their ELK 4 location. As you read this, ELK 4 has been drilling for several weeks, and IOC expects the well to encounter pay zones much earlier than ELK 2. After all, ELK 4 is much closer to the discovery well than ELK 2, and the preliminary results on ELK 4 could include gas saturation with the right amounts of porosity and permeability. The drills are turning right now, and if this well turns out to be a winner, shares of IOC could move aggressively past $30.00. Perhaps much higher.In fact, an analyst at Piper has a $65 price target. That tells you just how much potential this gas reserve holds.

Let’s turn to another bullish catalyst: IOC’s majority shareholders.

Right now, institutional owners hold 47% of the company. Included in this group is a company called BP Capital, which is managed by T. Boone Pickens. After seeing IOC’s results in August of 2007, they took a stock position. Not only that, but T. Boone also owns around two million shares personally as Mark mentioned.

Another strong upside catalyst is IOC’s short interest. You see, out of the 30 million outstanding shares, 11 million of them are currently sold short. That means over 33% of the stock’s shares are short, setting up a massive short-squeeze potential. If any positive news comes out of IOC, it’ll send the short running for cover. They’ll quickly cover their positions, and the stock would blast higher. In fact, given the current short interest and IOC’s average volume, it would take 18 days to cover this massive short position. My friends, this could set up a short-squeeze like never before. And I certainty want to benefit off this potentially huge upside move.

Now I admit, unlike recent small-cap picks, this is not an earnings-related play. According to IOC’s November 13^th earnings report, they announced a net loss of $17.9 million for the third quarter of 2007, compared with $7.3 million net loss for the third quarter of 2006. But remember, these numbers do not include the huge potential of their natural gas reserves. Therefore, the expense of drilling and discovery eats into their earnings.

But like I mentioned, the play here hinges on successful results from their ELK 4 location. Based on Mark’s analysis, T. Boone Pickens’ stock ownership, and the short-squeeze ability for shares to move up very quickly on any positive announcement, this could be a very big winner for our small-cap ledger.

Now keep in mind, this is a little more speculative then our standard small-cap play. But if the company performs the way we think it could perform, a 100% return could certainly be within reach.

Over the last 52 weeks, the stock has traded as high as $44.24 and as low as $15.45. With shares currently trading near the low-end of this range, the time to establish a small position is now. Therefore, let’s add a small position in Interoil (IOC – AMEX) to our small-cap portfolio.

PLAY: Buy shares of Interoil (IOC – AMEX) at or under $24.00, good for the week.

Sincerely,