From drill rig counts to oil/gas ratios and renewables, Pierce Points author Dave Forest shares his thoughts on the direction the energy sector is headed in this exclusive Energy Report interview. Since predicting commodity prices in the short to medium term is almost impossible, Dave looks for companies with a solid track record and the potential for discovery, which is where the real money investing in the exploration sector is made.

The Energy Report: Dave, one of the popular investing theories that you'll see in energy is that there should be a 6:1 ratio of oil to natural gas and that we're starting to see that ratio rise, which makes natural gas look like a great play. Can you give us your perspective on that investment theory?

There is an interesting article in Wednesday’s FT describing BP’s trip “beyond petroleum and back again”. Having staked out the greener high ground of being the multinational oil company most devoutly search for alternative energy solutions, it is now seemingly retrenching, what with close its London office devoted to some such programs, as well as reputedly refocusing internally on petroleum and natural gas investments.

The piece carries many morals. First, it shows that alternative energy remains no cakewalk. Despite the massive capital budget of BP, and despite its vested interest in diversifying beyond fossil fuels, it has struggled to get even a fraction of its revenues from anything other than petroleum and natural gas. Second, the story reminds how difficult it will be for oil incumbents to avoid the Lorax trap of ever-enhancing extraction technology, thus making the eventual depletion curve for resources sharper and more calamitous.

This is the 1st Quarter 2009 edition of our ongoing hedge fund portfolio tracking series. Before reading this update, make sure you check out the Hedge Fund 13F filings series preface.

Next up is Alyeska Investment Group ran by Anand Parekh. This is the first time we're tracking Alyeska in our portfolio series due to the fact that it's a newer fund on the scene. Before starting Alyeska, Anand Parekh was Citadel's head of equities, and was essentially who we were tracking at Citadel when we would examine the fund's equity holdings.

Though I acknowledge they necessarily will have lower operating margins than most oil companies, oil over $100/barrel will mitigate this concern. One has to realize the enormous reserve base of the oil sands, allowing these companies to produce larger quantities of oil for a longer periods of time to a substantial degree. If that doesn’t spark your interest, there are several companies that have an oil sands operation to complement their flagship operations. The three largest projects in the Oil Sands are Synacrude, The Suncor Mine and The Albian Sands. They all continue to grow output year after year which is very significant as many oil companies' production is dropping off in the face of peak oil.

This is part 3 of a 4 part series looking at each of the companies selected and listed by Fortune in their 2009 Fortune 40: The Best Stocks to Retire On list.

Part 1 | Part 2 | Part 3

On the basis of statistical relationships and recent oil price quotes, we raise estimated distribution for the next twelve months to US$2.06 a unit from US$0.55 a unit for buy-recommended Canadian Oil Sands Trust (COSWF.PK). Quite simply, a higher quarterly distribution looks justified by the trend of quarterly oil price.

More rigorously, estimated distributions are covered by estimated cash flow. Though management declines to indicate the distribution level that the board of directors will approve, we suggest C$0.50 a unit for the distribution to be declared on July 27 and C$0.60 for the next three quarters. Two months of maintenance was just completed on Coker 8-3 that should go a long way toward supporting operations near capacity for the next four quarters. Achieving capacity has a magnified impact on cash flow for the remainder of 2009.

There is an important energy (read: oil & gas) connection to the current riots in China’s Xinjiang province. While the region had been independence-minded, that is no longer conceivable to the Chinese leadership, with sad and unsurprising current results:

“The Chinese didn’t want to let Xinjiang be independent before, but after they built all the oilfields, it became absolutely impossible,” said one Muslim resident in Korla, who asked not to be named for fear of retribution by government security agents.

You have probably heard the stories about China National Offshore Oil Company (CNOOC) bidding for Repsol YPF’s (REP) Argentine assets in a quest for more natural resources for China. Well, apparently, the Chinese want a lot more than just Argentina; they want the whole of Repsol’s Latin American asset base.

The Chinese have been buying up African oil assets left and right. But, this is a HUGE asset grab by the Chinese in America’s backyard. Remember the Monroe Doctrine? Well, forget about that now, because it is game on for the Chinese.

Such concerns may be unrealistic and for three reasons:

Documentation obtained by this blog shows that Carl Caserta, who in 1991 was barred by the Securities and Exchange Commission from “association with any broker, dealer, or investment advisor” still has an available, current, and active email address (carl.caserta@interoil.com) at InterOil (IOC). Other documentation obtained by this blog show that Caserta has continued helping InterOil promote its stock to investors. That documentation has been delivered to securities regulators. However, a January 2007 New York Times article reported that Caserta “stopped working for InterOil” after the company found out that he was barred from the securities industry by the SEC.

According to a 2005 report by short seller Citron Research, InterOil used Lighthouse Capital as its investor relations agent. As a principle of Lighthouse, Caserta’s job was “bringing InterOil around Wall Street attempting to attract buyers to the stock.” In 2007, the New York Times made inquiries to both InterOil and Lighthouse Capital about Caserta’s role in helping InterOil promote its stock to investors:

The Canadian economy is the eighth largest in the world according to the IMF. As of 2008, its nominal GDP was $1.274 trillion, with growth of 2.7%. It is part of the G8 and other 'rich clubs' such as the OECD. Although 2008 showed a contraction, Canada appears set for growth momentum in 2009 -2011.

Unlike most developed economies, Canada has moved from agriculture straight to services, which now account for nearly 67.9% of GDP. This industry is very diverse and includes the retail sector, financial services, real estate, education, health, high-tech, entertainment and tourism. All these sectors are developing at a rapid rate with retail and health leading growth. The service industry employs 75% of the 17.9 million working Canadians.

Oil service company BJS Services (BJS) is heavily dependent on North American natural gas drilling activity. Recently, natural gas has been trading at historically low prices, especially when viewed in terms of a ratio of natural gas to oil prices. New supply from shale plays has created a situation where natural gas storage is much higher than for the same month in previous years, depressing prices. US active rig count, as reported by Baker Hughes (BHI), a direct driver of BJS's results, has declined from around 2,000 to 899 as of last report.

Now would be a good time to update my opinion on BJS, with special attention to the context of industry conditions and probable future scenarios.

Canadian construction business SNC-Lavalin Group Inc. (SNCAF.PK) has announced pricing for a new debenture early next month, and the potential for investment growth and new company acquisitions through this offering has Canaccord Adams intrigued.

In July 2019, SNC-Lavalin will issue C$350-million of 6.19% debentures, 276 basis points over ten-year Canada bonds. The cash will be used to fund potential investments in the company's infrastructure concession business, acquisitions, and to retire a C$105-million 7.70% debenture due in September 2010.

We initiate a buy recommendation on the limited partner units of Dorchester Minerals (DMLP) for royalty income from oil and gas production including growing proceeds from shale formations unlocked by new technology. The stock offers unlevered appreciation potential of 54% to a McDep Ratio of 1.0 and identical levered appreciation potential of 54% to Net Present Value (NPV) of $32 a share.

Estimated annual distribution yield is 8% despite unusually low natural gas price relative to the already low Henry Hub industry benchmark. The Bakken Shale of North Dakota is beginning to contribute to oil that accounts for 31% of NPV. In our analysis we add production and reserves from the backlog of shale wells to be transferred to the partnership when cash flow is no longer reinvested in new drilling. General Partner Casey McManemin explains the “Minerals NPI” that holds the backlog in his annual presentation to unit-holders.

Recently I have been posting about a stock Gulfport Energy (GPOR) and how I am bullish on it. Recently we've experienced a slight pull back on the stock and I've been accumulating shares of the stock. I have also started using a new strategy as this stock can move down very fast and although I can lose 100% of my investment it is less than 2% of the risk of buying the common shares and watching the stock go to zero.

My reasons for purchasing the stock are below:

Last week, Baker Hughes (BHI) reported that the U.S. rig count increased by 23 to 899 rigs. The domestic rig count had peaked at the end of August 2008, reaching 2,031 rigs, falling steadily thereafter for 38 out of the last 41 weeks.

While rig count increased from the previous week (ended on June 12), it is down by 1,007 rigs compared to a year ago, marking one of the worst downturns in the industry history.

Company descriptions by Bloomberg:

Tesoro Corporation* refines and markets petroleum products, and provides transporting services. The Company operates refineries, as well as a network of retail and refueling stations in the western United States. Tesoro also markets gasoline and diesel fuel to independent marketers and commercial end users.

While looking through the stock picks from my quantitative ranking systems, I came across Atwood Oceanics (ATW). Atwood Oceanics is a small cap offshore drilling services company which owns a small rig fleet.

Looking at this page it is hardly surprising that Atwood Oceanics receives high marks from my rankings system. It scores better than average on valuation and growth, and also has a solid balance sheet and high margins.

Our outlook for independent refiners in the U.S. remains bearish. After experiencing a very favorable macro environment over the last few years, the independent refining companies have been under pressure since the start of the second half of 2007 due to continued margin contraction, resulting from unusually high feedstock costs (peak-cycle oil prices) and relatively modest product demand.

The subsequent bottoming-out of oil prices has been beneficial to feedstock costs, and as a result refining margins started the year in robust condition, thereby bringing a much-needed reprieve to the refiners. However, this recovery is unlikely to be sustained for much longer as the ongoing long-term fundamental changes to the industry suggest future struggles.