By Marin Katusa, Chief Energy Investment Strategist

This week's energy Dispatch is more of a musing. I've been on the road a lot lately, which always gives me lots of time to think, so here are three of the thoughts that have been running through my head.

First off, I want to tell everyone a story that illustrates perfectly why Rick Rule is one of the best in our business. I'm lucky to have Rick as one of my mentors, but I'm even luckier to be able to call him my friend. The funny thing is, the more I get to know Rick and the more business deals we complete together, the more impressed I am with how smart he really is and how good he is at making great calls.

This specific story started in late 2008, right smack in the middle of a horrible market. After completing his in-depth due diligence, Rick became one of the big financiers of Africa Oil (V.AOI) through an early 2009 fundraising. It just happened that I was a significant shareholder, alongside our subscribers, in a company called Turkana Energy; and I was involved in arranging the sale of the company to Africa Oil. Our subscribers in the Casey Energy Confidential and Casey Energy Report were both alerted to AOI's potential and were able to get in at the same price as Lukas Lundin, Keith Hill, and Rick.

During the next three years Africa Oil needed to raise money several times, and Rick Rule was the first to write a big check each time to support the company through its growth phase. Fast-forward to March, 2012 – I meet with Rick and say, "Rick, we are up a lot on AOI. Maybe it's time you reduce your risk exposure at $2.40?" His response was, "Marin, my clients pay me to make investments that will change their lives, and my analysis tells me that Africa Oil has as good a possibility as any of doing just that, so I'm holding." Wow, was Rick ever right on that call. Within 60 days Africa Oil went from $2.40 a share to $8.50.

That is precisely why Rick is one of the best in the business. If you are a new investor in the resource sector looking for a full-service broker, I highly recommend that you do your portfolio and your bank account a favor and set up an account with Rick's firm by calling (800) 477-7853 or +1 (760) 943 3939.

As for how my AOI recommendations worked out, the three different calls I made were all sold for +100% gains. In hindsight I sold too early, and the gains could have been greater. It's never easy watching a stock run like Africa Oil has after you sell, even when you still more than doubled your money. But that leads me into my next thought: disciplined buying and selling.

Currently one of my favorite stocks in both the Casey Energy Confidential and Casey Energy Report portfolios is one where we notched a gain of +60% in less than four months. At that point we recommended taking a "Casey Free Ride," which means selling enough shares to recoup your initial investment and holding on to the remaining shares for risk-free upside. A sharp gain like the one we experienced with this pick is often followed by a correction, and if the price fell like I thought it might I planned to buy more of the stock at lower prices, all the while still collecting a nice dividend from our original, risk-free shares. The price did swing downward, and at the most recent Casey conference this company was my top pick. Now my subscribers and I can buy more shares at a good price and play the game again.

Risk mitigation is the most important aspect of disciplined resource investing. A gain is not a gain until you sell and lock it in, and even though it's hard to watch a stock continue to climb after you sell, it is even harder to watch a gain evaporate or turn into a loss before you actually add a penny to your bank account.

As for the company in question, if you'd like to find out more I urge you to take us up on our ninety-day, risk-free trial subscription to the Casey Energy Report. You'll find out what company I'm talking about – it happens to be the single best way for your portfolio to profit from the fracking boom.

My last thought for the day concerns natural gas. As I've discussed before in these pages, oil and gas reserves depend on the price of the commodity. A "resource" is an estimate of how much oil or gas exists in a particular reservoir; the reserve in that reservoir is the portion of the resource that has a good likelihood of being economic to recover using current technology. The word "economic" is very important here: it means the cost to produce the oil or gas must be less than the amount for which is can be sold. In short, the producer has to be able to make money producing the fuel, or else he's not going to bother.

As such, reserve estimates depend on the price of natural gas. When gas prices are high, even reservoirs with tricky geology or limited regional infrastructure can become economic. When prices are low, like they are now, a whole bunch of reservoirs that would have turned a profit a few years ago become completely uneconomic.

The thing is, a lot of these uneconomic reservoirs are still being listed as reserves. Gas producers across North America are inflating their reserve counts by including reservoirs that are nowhere close to economic at today's gas prices.

This is happening for a somewhat legitimate reason. Reserves are generally calculated using the average gas price over the previous 12 months, which usually reflects current and future pricing reasonably well. Our current situation, however, is far from usual – the price of natural gas has fallen so dramatically in the last six months that the 12-month average price is far above the spot price. For example, in the benchmark Alberta AECO natural-gas exchange the 12-month strip price is still C$2.73 per MMBtu, while the spot price for June delivery is currently just C$1.905 per MMBtu. In the US, the Henry Hub spot price is US$2.36, while the 12-month strip is $3.09 per MMBtu.

Since it is the convention, producers and analysts are continuing to use 12-month strip prices to calculate reserves counts. But at the moment those 12-month strip prices are 30 to 40% above the spot price! Moreover, the impact of suddenly delineating trillions of cubic feet of natural gas resources will not go away overnight – almost every player in the North-American natural-gas market agrees that prices will trade sideways and perhaps even slightly further down for the next 12 to 18 months because of the supply glut. As such there's even more reason than usual for producers and analysts to base their calculations on a price reflective of today and tomorrow, instead of one that reflects the stronger prices of yesterday.

Yet analysts and producers continue to use the 12-month strip to calculate reserves. Adding to the inflation of natural gas reserves, companies only reassess their natural gas reserves annually. Companies that recalculated their reserves six months ago used a gas price of US$3.50 or even US$4.50 per MMBtu, since that was the strip price at the time. Now their reserves – which will remain on the books for at least another six months – are based on a gas price that's more than twice the current value! The situation is very misleading, but it will soon come to an end.

Over the coming months, 12-month strip prices will fall, gradually coming into line with spot prices. As that happens, one gas producer after another will write down their reserves. The writedowns will eliminate 30 to 40% of each company's gas assets, and the market's reaction will be to pummel a sector that is already struggling.

The end result is this: the worst is yet to come for natural gas. Prices have probably fallen almost as far as they will fall, but when these writedowns hit, natural-gas equities will bear the brunt of investor discontent. That being said, the phenomenon of shale gas introduced fundamental changes to the gas market in North America, and the impacts have to work their way through the whole system before the sector can continue its evolution.

When I assess a gas company, I use a gas price of $1.50 per MMBtu. To me, that price is a fair if slightly conservative reflection of the value of natural gas in the short and medium term.

I always say that the best cure for low prices is more low prices, and that's a lesson natural gas is learning the hard way.

Additional Links and Reads

Oil Falls, Hit by Greece, Eurozone Turmoil (Reuters)

Oil prices fell to start the third week of May as Greece's inability to form a government and worries about a slowing Chinese economy stoked concerns about the outlook for petroleum demand. In the two weeks ending Friday, May 11, Brent crude oil futures were down 6.2% and US crude off 8.4%. Sentiment turned decidedly bearish for oil in the second week of May as hedge funds and large speculators made the biggest-ever cuts in their net long futures and options positions, and the weakening of the euro against the dollar has only made things even worse for oil.

Oil Bulls Face Severe Test of Faith… and Pockets (Reuters)

The collapse in oil prices since the start of May is posing a severe test for oil-market bulls, who must meet big margin calls to maintain their positions or close them out and accept their losses. Several big banks, including top oil-price forecaster for 2011 Goldman Sachs, recommended long positions in West Texas Intermediate crude oil as recently as February, expecting the reversal of the Seaway pipeline to ease the supply glut in Cushing and reduce the discount on WTI relative to Brent. The concept generated a near-record long position in WTI-linked futures and options, equivalent to some 300 million barrels of crude. But the idea was doubly flawed: WTI now carries an even bigger discount to Brent; and Brent prices have fallen $10 per barrel. As such, the long WTI futures positions are doubly underwater; and the week ending May 8 saw the largest one-week drawdown in hedge fund long WTI positions for more than five years. With oil prices still carrying downside momentum, the focus for most traders still holed in by long positions has shifted from maximizing gains to minimizing losses.

Australia Says Shale Could Double Its Gas Resources (Financial Post)

While North America's gas producers are facing looming reserve downgrades because of falling natural gas prices, Australia is looking to double its gas resources as strong prices for liquefied natural gas (LNG) render the country's shale resources economic. Australia is already the world's fourth-largest exporter of LNG and has 390 trillion cubic feet of gas resources. That count does not include shale resources, as shale gas exploration is still just getting started in the country, but a new government report estimates the country's shale gas potential at 400 trillion cubic feet.

India's Foreign Mine Hunt Not Going Well (Wall Street Journal)

One major stumbling block remains along India's path to growth: lack of raw materials. Industrial activity hinges on the availability of steel, aluminum, copper, and coal, but India's ability to increase production of these resources continues to be hampered by the country's complex and contentious mine-licensing system. Mining has a bad reputation across the country, derived from years of illegal and very damaging small-scale mining, and the government's system for allocating mines is opaque and notoriously corrupt. Tired of waiting for new domestic mines, a few years ago metals factories and power plants started looking overseas for iron ore and coal, but most of these efforts have failed as Indian companies, both private and state-run, were bested in their quests by international rivals or saw potential deals unravel in the face of resource nationalization in the targeted country.

Cameco to Buy Uranium Broker for US$136M (Leader-Post)

Cameco strengthened its diversified approach to the nuclear-fuel sector with the acquisition of Nukem Energy, a broker of nuclear fuel products and services, for US$136 million. Cameco is also assuming Nuken's net debt position of US$164 million, though the company expects to reduce that debt load substantially through ongoing activities before the deal closes. Nukem sold 12 million pounds of uranium in 2011 and expects to sell 10 to 15 million pounds in 2012. The company's assets also include uncommitted inventory and a portfolio of purchase and sales contracts.

Does Sending Alberta's Oilsands Crude East Make More Sense? (CBC News)

Former Bank of Canada Governor David Dodge has joined the small but growing chorus of voices advocating for pipelines to take oilsands crude east, not west. All of the proposed pipelines to take bitumen to the west coast have generated significant opposition, and it is unclear when any of them might actually be developed. In the meantime, refineries in Ontario and New Brunswick buy and process crude oil from across the Atlantic, which is more expensive than oilsands crude. The idea of sending bitumen eastward, rather than to a west-coast port for export to Asia, has been around for years. Now it seems some of the big players in Canada's oil and gas industry are starting to act on the idea by considering various plans to convert underutilized gas pipelines into oil lines.