The Who, What and Where of Energy Investing: James West

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TER: Starting with oil and gas, which fundamentals are pushing you to invest?

JW: I have to qualify that oil and gas no longer track each other in prices. In fact, they are so widely divergent as to be almost opposing markets. Gas in North America is much cheaper than gas in the Ukraine. In the Ukraine, you are looking at $10/trillion cubic feet (Tcf) at the wellhead; in Canada and the U.S. it is below $2/Tcf. Oil and gas companies are valued on a premium depending on how much oil and condensates they produce relative to gas.

In domestic Canadian plays, I look for a much higher oil:gas ratio, in excess of 70%. If the ratio is reversed, I am not interested. However, for TSX-listed companies in Poland, Germany or France, the oil:gas ratio is not important. Large quantities of both are excellent, especially if the companies are producing light, sweet crude and low-sulfur gas. That is the best-case scenario.

Once I've evaluated a company's asset base, I look at the people behind the project. I look at capitalization and management's fundraising abilities because a lot of oil and gas plays are very expensive. If the company will be an operator, does management have operating experience?

Next, I look at location. Is the project in a politically tricky jurisdiction? The Niger Delta is somewhat of a hotspot now. Kurdistan is a bit problematic; Uzbekistan, Afghanistan-the -stans are always problematic. The elections in June make Mongolia a question mark right now.

TER: Recently, Canada's National Post reported that oil majors like Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) and Malaysia's Petronas Nasional Bsd are evaluating plans to build terminals in the Kitimat, British Columbia area to export liquefied natural gas (LNG) to Asia. The Post speculates that the need for more natural gas could lead to a rash of takeovers with names like Talisman Energy Inc. (TLM:TSX), Painted Pony Petroleum Ltd. (PPY.A:TSX.V), Progress Energy (PGN:NYSE) and even Encana Corporation (ECA:TSX; ECA:NYSE). What are your thoughts on that speculation?

JW: The oil majors are considering LNG terminals for export to Asia because they get a better price in Asia, where there is a big and growing market. A lot of fundamental market drivers support that idea.

Companies like Talisman, Progress and EnCana are looking down the road. Building an LNG terminal can take up to 10 years from baseline environmental studies to the time you turn on the tap and start loading ships. This talk and activity is about capturing opportunities to move gas from its source to where it is needed, and in anticipation of the time when the global inventory diminishes.

Today, fracking and horizontal drilling have created new opportunities and new reserves of oil and especially gas. Now, you can drive a drill bit anywhere you want. Trillions of cubic feet of gas are in the global inventory. The market-always irrational-overreacted to that and now gas is at an all-time low. That will not last.