There you are attending a party in your boss' home. He keeps on descending into his basement, bringing up one excellent bottle of wine after another. Then, towards the end of the meal, he asks you to estimate the total value of the contents of his wine cellar.

Being a rational person you readily admit that you have insufficient data to perform that task. Personally, I think that is the correct answer. However, in the process, you have demonstrated that you could not work in the financial industry as an energy analyst.

Nor would you be a candidate for a TV program, the objective of which is seemingly to scream investment tips at hearing-impaired viewers. These folks routinely make pronouncements on

All barrels of oil are not alike; the heavier the oil, the lower the price the value of oil and gas securities on the basis of the price per flowing barrel. Thus a research report may tell you that shares of ABC are a "buy" because it only trades at $40,000 per barrel of daily production.

This methodology would have some validity if the company's production were a good predictor of reserves. Unfortunately such is not the case.

Just as the number of bottles being brought out of the cellar should give little comfort as to the size of the wine collection, current production says little about the size of the underlying reserves. Before you make any determination of what to pay for a barrel of production you need to know the size of the reservoir.

Additionally there are at least two major flaws associated with this type of analysis. In fact, using such a loose definition of analysis brings to mind Truman Capote on the Johnny Carson Show when he was asked how he felt about other leading contemporary writers, such as Harold Robbins. Capote replied: "That's not writing, it's typing."

In this instance an investment analyst might correctly state that this is not analysis, it is long division. But I digress.

When describing energy companies, analysts use the term barrel of oil equivalents (BOE) to quantify production or reserves. Using a BOE is simply the moral equivalent of attempting to quantify the content of baskets containing both apples and oranges.

On an energy equivalent basis, 6,000 cubic feet (mcf ) of natural gas packs the same punch as a barrel of oil, and that is the ratio analysts use when converting to BOEs.

However, in the U.S. market place, a barrel of oil currently commands US$94 while an mcf of natural gas can be had for US$6.71.

With the ratio on a price basis being 14 times, barrels of oil are extremely profitable, while at those prices natural gas is a break-even proposition at best.

As a result no rational acquirer would use a six to one ratio when valuing corporations, regardless of the long-term orientation of the investor.

Leaving aside natural gas, all barrels of oil are not alike; the heavier the oil, the lower the price. For instance, in Canada the price differential between light oil and heavy oil is currently $24.

In the circumstances it does not take a rocket scientist to figure out that Baytex, Energy Trust, a predominantly heavy oil producer, should trade at a discount valuation, notwithstanding what the TV screamer may have told you.

Which brings us to the second factor not captured by the ratio of price per flowing barrel: Remember our host with the wine cellar. The rate at which he brings the bottles out is an extremely poor predictor of the volume resting in the basement. Likewise in oil country, reserve lives vary widely. Let's face it; no rational buyer would pay the same price for five years of production as he would for 10 years.

In my opinion the only proper way to figure out what oil and gas companies and wine cellars are worth is by doing an inventory of what is beneath the ground rather than being distracted by the rate at which it is being extracted.

When analysing oil and gas companies this is accomplished by calculating the net present value of the reserves, in the process taking into account both the quantity and quality of the reserves. - John Sartz is president and chief investment officer at Viking Capital Corp. in Toronto.