Earlier this month, Oil and Gas Investor examined the Arctic oil drilling market, in which the U.S. government is allowing more drilling permits and companies such as Royal Dutch Shell are first in line to crack a vast supply of oil and gas in the region.

As a follow-up to that piece, Oil and Gas Investor recently sat down with oil and gas expert James DiGeorgia, editor and publisher of Gold and Energy Advisor, to evaluate just what is at stake in the Arctic drilling zone, and which companies may benefit most.

Here is what DiGeorgia had to say:

OGI: Why is the Arctic such a hot market for oil drillers these days?

DiGeorgia: It’s an ironic story how global climate change is melting ice in the Arctic, but the melting ice is allowing new exploration for more hydrocarbons, oil and natural gas.

One of the other aspects that make this investment theme interesting is that 20 years ago , exploring in the Arctic would have been impossible, but also economically and technically laughable. Exploring in the Arctic confirms that the world has depleted the cheap, low-hanging fruit of energy reserves. We are now exploring for energy in the Arctic, oil sands of Canada, the deepwater Gulf of Mexico, Brazil, Africa and the South China Sea. This says a lot about where we are in terms of global energy reserves. Investors need to have energy in their portfolios.

OGI: Just how much oil are we talking about up in the Arctic?

DiGeorgia: The Arctic is estimated to hold about 22% of the world’s oil reserves. The three largest areas that have the most energy potential are Russia (132.6 billion barrels of equivalent), Alaska (72.8 billion barrels of equivalent) and Scandinavian countries (61.8 billion barrels of equivalent).

There is a big caveat: Exploration and production in the Arctic will be expensive, dangerous environmentally and politically, and technically very difficult. Also, weather is a major risk. Exploration and production activity can only occur when weather permits, a few months out of the year.

OGI: What companies stand to gain the most from Arctic drilling?

DiGeorgia: Most of the action will be with the mega global integrated energy companies like Royal Dutch Shell, Exxon, ConocoPhillips, Rosneft, British Petroleum, and Statoil.
But let’s start with the energy equipment companies.

Transocean
RIG could be a beneficiary of the search for energy in the Arctic. RIG is one of the largest offshore energy drilling equipment and service companies in the world.

RIG was involved in the British Petroleum Gulf of Mexico oil-spill disaster and has been fighting legal and financial responsibility. The stock has suffered because of their fight and the uncertainty over an outcome. The stock was around $85 before the disaster, and is currently around $46. The consensus Wall Street price one-year target for RIG is $62, potentially good upside.

Consensus earnings forecasts are expected to be $3 for 2012 and $4.74 in 2013. If RIG could get their Gulf of Mexico problems behind them, and the multiple could expand to a moderate 14, the stock could rise to about $66 in 2013.

Rosneft
Now let’s look at the Russian Siberian area.

According to some estimates it would take about $500 billion to explore and develop the energy resources of the offshore Arctic, near Russia.

The biggest Russian energy company that has the lead in the exploration of the Arctic is Russian energy giant Rosneft. Rosneft does offer shares to the public, but I would recommend that most investors should stay clear of the stock for the following reasons: the company and its substantial reserves are owned by Russia and not shareholders; corruption; transparency; taxes and royalties, which can be as high as 70%.

There are several global ways to invest in Rosneft. They have been dead money for the last few years. Prices are about where they were in 2009. The shares are volatile, so they may be a good trading vehicle, but likely for the experienced trader.

ExxonMobil
One of Rosneft’s biggest partnerships to explore and produce energy in the Arctic is a deal with XOM.

Drilling is expected to start in 2015, and production could start early next decade. This is important information for investors, as developing and producing oil is risky, expensive and does take time. And building the infrastructure and deploying employees does take years.

According to their target dates -- from exploring to developing to getting (the product to) the market -- it will take at least five years.

Currently XOM is around $89, and pays a 2.60% dividend. The consensus Wall Street price target is $92. XOM consensus earnings estimates for 2013 is $8.09. Currently the P/E is a historically low 9. If the P/E could expand to a low, reasonable 12, the stock price could reach $97 in 2013.

XOM has proved reserves of 24.9 billion barrels of oil equivalent. These proved reserves are not fully reflected in its stock price. Proved, possible and probable reserves could be as high as 87 billion BOE.

XOM is considered not only one of the best-managed energy companies, but also one of the best-managed companies overall. They are known for their excellent capital allocation, in an industry known for taking too much risk.

The investment risks for XOM include volatile prices; repatriation in foreign operations; environmental and geopolitical risks; strikes; technological challenges; weather.

I would consider buying XOM with a short put and sell calls against the stock at resistance levels. Both strategies could enhance the total return of the investment.

Statoil
The best company to take advantage of energy in the East Barents Basin Arctic region is Norwegian energy giant Statoil.

Most of STO energy reserves are in the North Sea. Production and reserves have been declining, so STO could greatly benefit from Arctic exploration and production. They plan to drill nine wells in the Arctic region in 2013.

The stock price is around $25.75. The consensus Wall Street price target is $27.39.

Because of declining reserves and production, STO has a very low P/E, 6.15. Earnings have been flat.

STO does pay a nice dividend of 3.60%.

The investment risks include: volatile prices; repatriation in foreign operations; environmental and geopolitical risks; strikes; technological challenges; weather.

Entry on a pullback would be key to provide for a reasonable total return. A short put on the purchase and call writing at resistance could also help for a better total return.

Royal Dutch Shell
The political and environmental challenges of exploring in the Alaska Arctic are more difficult than the other Arctic regions.

The company that has been the most aggressive, and has taken the lead in the Alaska Arctic, is Shell. They have already invested $4.5 billion in the area, and Shell has started its first project this summer, after working for at least seven years with politicians, regulators, environmentalists and citizens, including native Eskimos of the region.

RDS-A is an energy giant. They have 15.45 billion proved BOE.

Currently RDS-A is around $70, and pays a healthy 4.70% dividend. The consensus Wall Street price target is $77.81. The total return for the stock looks good. Especially if the short put on purchase and selling calls at resistance levels strategy is used.

ConocoPhillips
COP is Alaska's biggest producer and the U.S.'s third-largest oil company.

They have lots of infrastructure in Alaska, including pipelines, resources, technical skills and relationships. They will probably be a player in the Alaska Arctic.

Although RDS-A is ahead of COP in Arctic exploration, there are a few things to like about COP.

- COP has the highest ratio of oil and natural gas liquids to dry natural gas of most of the global mega energy integrated companies.
- COP has been going through a major restructuring and recently spun off its refining business. It was doing business in some of the most dangerous places in the world, but with their restructuring 66% of their revenues is in the U.S.
- The stock valuation does not reflect the new restructuring.
- The stock is undervalued by many metrics.
- They have 8.3 billion of proved BOE.

Currently COP is around $56, and pays a high 4.70% dividend. The consensus Wall Street price target is $62.47. The total return for the stock looks very good. Potential investors should consider a short put on purchase and selling calls at resistance. These price targets are based on traditional valuation models, and do not reflect the substantial valuable reserves on their books.