Can Ivanhoe Energy Commercialize Heavy-Oil Technology?

The Company: Ivanhoe Energy, focusing on heavy oil upgrading technology.
The Filing: FORM 10-Q filed with the SEC on August 11, 2008.
The Finding: Ivanhoe Energy announced Wednesday a definitive agreement with Ecuador state oil companies Petroecuador and Petroproduccion to explore and develop Ecuador's Pungarayacu heavy-oil field, utilizing Ivanhoe's HTL upgrading technology. Although Ivanhoe's thermal cracking technology has the potential to substantially improve the economics and transportation of heavy oil, no commercial-scale HTL plant based on the proprietary technology has ever been constructed.

The Upshot: Third-party studies estimated that Pungarayacu contains between 4.5 billion barrels (Petroecuador-ARCO) and 7.0 billion barrels (Petroecuador) of oil-in-place. Confirmation of these resources would make the Pungarayacu field the largest accumulation of heavy oil in Ecuador and one of the largest in Latin America. Ecuadorean oil officials forecast production from the field at rates up to 120,000 barrels per day within three -to- five years.

The contract type - anathema to big oil, such as ExxonMobil and BP - is a Specific Service Contract, under which Ivanhoe will receive a fixed payment of $37.00 per barrel of oil produced, indexed quarterly for inflation.

Of concern, Ivanhoe's Commercial Demonstration Facility in California has demonstrated overall processing capacity of no more than 1,000 barrels-per-day of raw, heavy oil. And, the company's primary field, the 1,400-acre South Midway heavy oil field in California, is currently processing capacity of only 600 barrels per day, according to the company's results for the second-quarter 2008 ended June 30.

Capital requirements are estimated to total approximately $110 million during the first three years of the contract, primarily for seismic work, assessment wells, initial production wells and thermal-recovery pilot tests. As the company generates limited cash flow from operations ($5.6 million for the first-half of 2008) and has other contractual obligations due in 2008 - 2010 of approximately $51 million, addintional fund raising is a given.

The Question: Can a small energy company with experimental technology meet expected production targets?

David Phillips

David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

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