Norway’s next oil frontier just got a little closer–and there’s only one stock to play it.

I don’t follow Norwegian politics very closely so you’ll have to forgive me if I’ve been a little slow on the uptake.

The re-election of Norwegian Prime Minister Jens Stoltenberg on September 14 moves the country a little closer to opening the oil-rich but environmentally fragile Lofoten Islands to oil and natural gas drilling.

In the country’s general election parties that favor exploration and production in Norway’s share of the Arctic waters including the Barents Sea added seats. The government is still a coalition with a fragile majority so no one expects quick movement on the contentious issue of drilling in this area, one of the most pristine in Norway. But with Norway’s management plan for the area–which is currently out of bounds for drilling–up for review in early 2010, the odds are that Norway will get more aggressive in exploiting the potential reserves in the waters of the Arctic continental shelf. On the latest numbers a majority of voters are not opposed to drilling in this region.

And the prime beneficiary of any expansion of drilling in the area will be Statoil Hydro (STO), Norway’s national oil company.

Shares of Statoil have been depressed by questions of how the oil company will replace production from its old and declining oil and gas fields off the Norwegian coast. The company doesn’t have a stellar record in finding reserves outside its home waters, so expanding production from Norway’s Arctic continental shelf is critical for Statoil. Estimates say that the Lofoten region holds 2 billion barrels of oil equivalent.

You can see the potential upside for Statoil in the Arctic continental shelf in the Shtokman project of  Russia’s Gazprom  (OGZPY). Statoil Hydro and Total (TOT) are partners with Gazprom in the company building the infrastructure to develop the field. (Just to be clear Gazprom owns the gas.) Thanks to the 2006 merger of Statoil with Hydro the joint company is one of the world’s leading oil infrastructure providers. The giant Shtokman field is projected as the world’s largest offshore gas field with natural gas reserves of 3.8 trillion cubic feet. Gazprom projects that gas will  flow in 2013 if the construction partners can solve the infrastructure problems posed by one of the world’s most hostile climates. (For example, how do you protect drilling platforms from giant icebergs set loose by global warming?)

Nothing that Statoil has discovered in these waters in recent years rivals Shtokman. But the company has added about 233 to 335 million barrels of oil through discoveries in the Norwegian Sea. (On the plus side, nothing Statoil has discovered will be nearly as expensive to develop as Shtokman where final costs are estimated at $30 billion.) And all these discoveries are close to existing infrastructure.

At the current price of about $23 a share the market is assuming that Statoil Hydro will collect cash flows from its proven reserves for another 10 years at a price of about $58 a barrel. That pretty much ignores the potential in the Arctic continental shelf and of the company’s other drilling ventures including  the Gulf of Mexico and the Caspian basin. It also, I think, undervalues Statoil Hydro’s oil infrastructure business (with its deep sea drilling expertise) and its natural gas pipeline system. With Gazprom the company essentially has a duopoly on delivering natural gas to Europe. (The company recently constructed its first floating wind turbine. I don’t know how to value Statoil’s business in this area.)

I think you can take your time in accumulating this one since the long-term story is unfolding slowly. I’m adding the shares to Jubak’s Picks today with a target price of $28 a share by July 2010.

(Full disclosure: I own shares of Statoil Hydro in my personal portfolio.)