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Small Stocks, Big Gains in the Oil Patch

Attention Getter

Chernoff suspects that his final pick, Vaalco, could eventually catch more attention.

Chernoff himself discovered the company while scanning the news a few months back. When Vaalco announced a new discovery, he says he "saw very large numbers for a very small company." Through further research, he learned that Vaalco owned offshore Gabon properties known for their valuable "Brent-quality" crude. He said that Gabon, located in West Africa, also offers "very favorable tax and operational policies" for international companies.

Chernoff walked away from his research impressed. But he soon turned around and jumped into the stock when it fell, he felt, without good reason.

Chernoff said investors worried when Vaalco announced that it had "temporarily abandoned" a project. But he said "the key word was 'temporarily'" because the company fully intended to resume the project after it had finished another well.

Since Chernoff bought Vaalco for around $2 a share on the OTC Bulletin Board, the stock has more than doubled and moved on to the energy-dominated Amex. It climbed 1% to $4.94 on Friday.

Chernoff expects the run to continue.

"Capex in 2005 will be for bringing on stream recent major discoveries, meaning a big increase in production and revenues," he said. And "extremely low overhead and variable costs mean that an unusually large percentage of revenue drops to the bottom line."

Jennings Capital analyst Andy Gustajtis likes one of Vaalco's partners. Pan-Ocean owns properties with Vaalco offshore but also boasts valuable onshore Gabon discoveries as well.

Gustajtis notes that Pan-Ocean has enjoyed success with both so far. Indeed, he says the company has announced an "incredible string of 17 successful drilled wells since 2000 without a single dry hole." And he marvels at that performance.

"This kind of major value creation through exploration drilling makes us ask, 'What the heck is going on?'" he wrote in late September. "Put simply, the company has unlocked a secret."

He points to new seismic technology as the weapon. And he now expects the company's earnings to triple in 2005 -- and then double again in 2006 -- as it explores its other properties.

"Our hypothesis," Gustajtis wrote, is "that Pan-Ocean holds exploration rights to a world-class reserve potential with a technical skill set that should deliver well-above average success."

Pretty Pick

Chernoff agrees that Pan-Ocean has "a lot of potential." But he doesn't buy everything that looks attractive.

Otherwise, he would already own TransGlobe Energy.

Three years ago, TransGlobe sold its U.S. oil and gas properties to focus on opportunities in energy-rich Yemen. Since then, the company has managed to increase production by 38% annually. It expects to grow production by an even greater 50% next year.

But it could be poised to really explode. Chernoff notes that TransGlobe owns a Yemen field located near some major discoveries owned by big oil companies. He says that TransGlobe also owns a large, unexplored field in Egypt that features geology similar to valuable fields located elsewhere in the Middle East.

"TransGlobe's key Yemen field, Tasour, is big and potentially huge," he said. "The upside potential, if they hit the big one, is just astronomical."

Still, Chernoff says he wants to do more homework before he places any bets on the stock.

But recent investors have already fared well. Standard & Poor's analyst Charles LaPorta recently noted that TransGlobe shares gained 33% -- 11 times more than the broader market -- last month alone. Moreover, LaPorta expects the favorable industry conditions that have lifted stocks like TransGlobe to continue.

"We believe the market's legitimate concerns on the supply side ... and the demand said ... have led to persistent elevated oil prices," he wrote. "And the lack of a foreseeable resolution should continue to allow our coverage universe to earn superior returns."

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