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I want exposure to oil reserves in my portfolio. I’m convinced we have enormous supply and demand challenges ahead of us in the oil market in the coming decade. With $108 oil I’m sure I’m not letting you in on something you haven’t considered yourself.

And over the past several years I’ve looked at a lot of oil stocks and have kind of settled on a blueprint for investment success. It goes like this:

1) I don’t want to pay much more for a stock than the value of its existing reserve base. That reserve base assuming oil prices stay reasonably high should offer me my downside protection.

2) I also want exposure to significant upside through high impact exploration targets or unrecognized resource plays that modern technology is unlocking.

3) I want these reserves to be in a developed country where I have a pretty good idea what the rules of the game are.

One company that fits numbers 2 and 3 perfectly but is a pretty weak on number 1 is Tag Oil (OTCQX:TAOIF).

Tag Oil has 57 million fully diluted shares with a share price of just under $7. Net out the working capital of about $70 million and you have an enterprise value of about $330 million.

So for $330 million what does a shareholder get?

Two plays. Both of them located in the North Island of New Zealand. One play called the Taranaki Basin in the west. The other called the East Coast Basin in - as you might imagine - the East.

East Coast Basin

I’ll start with the East Coast Basin because it is what is going to get your attention.

Tag’s independent analysts Sproule and AJM have identified as the mid-case OOIP 14 billion barrels on 1 million plus acres that the company holds rights to in the Eastern basin.

Of this, 12.6 billion are in unconventional shale opportunities and the other 1.4 million in conventional exploration opportunities.

The suggestion by the company is that the shale play is very similar to the Bakken play in North America. The upside potential on 3,000 sections of land is thousands of well locations and a property worth in the billions. With an enterprise value of $330 million this could be a homerun.

Taranaki Basin

This basin is already home to 600 million barrels of proven oil reserves and 7 tcf of natural gas, containing significant underutilized infrastructure and plenty of exploration opportunities.

Tag and their independent analysts believe that on their acreage there is 100 million barrels of OOIP.

The problem with investing in Tag Oil is that basically all this company has is potential. As of June 30, 2010, which was its last year-end, the company had proven and probable reserves with a PV10 value of $30 million.

This reserve number will likely need to be updated for the recent drilling success the company has had at their Sidewinder prospects the first of which came on production at a stabilized rate of 1,461boe/day.

With cash of $70 million and booked reserves of $30 million (plus Sidewinder) there really isn’t downside protection should there not be any exploration success.

However, I think the likelihood of Tag not having some exploration success is highly unlikely given the basin they are currently drilling in. And maybe that along with the fact that this could be 10 bagger should make it worth a punt.

But How to Explain Insiders Selling?

Although I’m not much for taking a punt on a company like this anyway, what really keeps me out is the fact that there is a pretty steady stream of insider selling. Now I understand that there are lots of good reasons for insiders to sell, and generally is doesn’t bother me. But when the prize you are promoting is 12 billion barrels of oil I would think you would never let those stock certificates out of your sight if you really believed this ship was going to come in.

So I’m going to watch this one play out as it is a great story and is in a great location near oil hungry Asia. If insiders were buying I’d be a little more enthusiastic. At the very least I can’t get my head around why they would be selling if they believed their story.

Here is some detail on the insider selling in 2011 ytd:

Ronald Bertuzzi, Director - Started year with 513,000 shares now has 443,000

Drew Cadenhead, Senior Officer – Started year with 100,000 shares and sold them all. Exercised 50,000 options and then sold 34,000 of those shares.

Blair Johnson, Senior Officer – Started the year with 23,400 shares and sold all of them.

Garth Johnson, Director – Exercised options on 75,000 shares and has sold them all but 9,400.

Again, the selling could be meaningless but my brain tells me that if you are sitting on the second coming of the Bakken those shares are not going to be sold.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Tag Oil May Sit on 14 Billion Barrels of Oil, But I'm Watching Insiders