Three quality energy stocks to buy now

The energy sector offers investors a wealth of opportunity, says professional investor John Dodd. Here, he tips three quality energy stocks to buy now.

Each week, a professional investor tells MoneyWeek where he'dput his money now. Ths week: John Dodd, co-manager of theArtemis Global Enegry Fund.

Against a background of concerns about sovereign debt and higher levels of geopolitical uncertainty, one theme remains intact the rising global demand for energy. Demographic changes are the main driver, as is recovering economic activity in most of the developed world and the well above average growth in the emerging economies. All told, demand will rise by more than 40% between now and 2035.

This means we are seeing a persistently high level of spending on energy imports by many countries. Total spending on oil and gas imports will more than double from $1.2 trillion in 2010 to $2.6 trillion in 2035. The United States will be overtaken by China around 2025 as the world's biggest spender on oil imports. India will overtake Japan around 2020 as the world's third-largest spender.

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At the same time, global energy intensity the amount of energy needed to generate each unit of GDP has fallen steadily over the last few decades. This is down to several factors, including improvements in energy efficiency, fuel switching and structural changes in the global economy away from energy-intensive industries.

Demand for energy is also becoming increasingly price-insensitive. As western economies look increasingly towards renewables for their energy and eastern nations continue to focus on petrochemicals, the energy sector grows ever more complex, but also interesting.

For investors, this spells opportunity. We target stocks with an initial 20% internal rate of return. In terms of stock selection, we look for key indicators such as production growth rates, research and development (R&D) spending and, most importantly, a company's reserve replacement record'. A company could be spending massively on R&D, but not discovering much of any use. Many investors buy on news of, say, an oil discovery, which can quadruple a share price. But what you should do instead is wait for the drilling result.

The opportunities are global. For example, Africa and the Middle East are starting to shine in 2012. The potential formation of a petroleum law in Kurdistan should pave the way for Exxon, Shamaran and Genel to start drilling and producing in this new, world-class market. Meanwhile, Africa Oil, Tullow Oil and Cove Energy are all benefiting from new basins discovered in east Africa and in the eastern deserts of Egypt. Transglobe Energy in particular is starting to exploit old basins with new technology.

The three UK-listed stocks whose prospects we think are particularly good are Tullow Oil (LSE: TLW), Premier Oil (LSE: PMO) and Salamander Energy (LSE: SMDR). Tullow is seen as an overvalued producer, but this misses the importance of Tullow's superior exploration and appraisal portfolio, particularly in the east Africa rift and on the Americas side of the Atlantic. Its 80% exploration success rate adds to its appeal.

Premier Oil has tremendous cashflow strength and is undervalued as a producer. Salamander is entering a long-awaited drilling phase in the Far East with great promise in its Bualuang and Kutai basin projects. In short, the energy sector offers investors a wealth of opportunity. Given improved market sentiment, these energy investments could produce good returns for investors in 2012.