Six small-cap oil stocks for adventurous investors

Consider the following: The number of cars on China's roads has gone up by a staggering 25% in a single year. So Nick Su, the finance chief of the AIM-quoted Chinese oil refiner Haike Chemicals (LSE: HAIK), told me on Tuesday.

Consider also that China has thrown a sizeable portion of its four trillion yuan stimulus package on a mammoth programme of infrastructure development: Bullet trains will connect major cities and brand new highways will be built across the entire country.

This ensures that demand for steel and other natural resources, especially energy, remains sky-high. That's of big interest to you as an investor. So far, so good. But it begs a major question

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Where is the fuel going to come from? If you know that, then you'll know where the serious money is going to be made...

Take uranium for example. Uranium is in big demand. Here's what Richard Lockwood, manager of the City Natural Resources High Yield Trust, has to say: "China's southern Guangdong province is planning a six-fold increase in its nuclear power generating capacity. Interestingly, this target is approximately 2.6 times China's total uranium generating capacity. Even more interesting is the lack of any direction as to where the necessary uranium might come from".

Interesting indeed, and as compelling a reason as I can think of for you to buy a stake in uranium miners such as Kalahari Minerals (LSE: KAH).

Of course, one reason why uranium is in demand is because other fuels for generating electric power are in short supply. There is not much chance of oil being diverted to power generation because most of us still need petrol to get about. And with China alone needing fuel for 25% more cars on its rapidly expanding road network, one thing is abundantly clear: the world needs more oil.

Why it pays to think small about oil

It's clear that a good investor should have some exposure to oil and gas. But you need to know where to look and here it pays to think small, not big

There's a problem with buying into the oil majors, such as BP and Shell. They sell so much of the stuff each day that they a face a continual, expensive challenge to replenish their reserves. But small explorers are not in this position. This is of real significance to you as an investor. Let me explain

If a small explorer makes a good oil discovery it does not simply offset the oil that it's selling. Instead, it takes them from a position of having no oil and consequently, a very uncertain outlook into one where they have a profitable long-term future. So shareholders who look to small explorers can make big money. But where exactly should you be looking?

For me, the crucial factor is whether the explorer's licence area has the potential to host a really major reserve.

That is why I like Kurdistan, home of Gulf Keystone (LSE: GKP) which this week further increased the estimated size of its Shaikan find and Sterling Energy (LSE: SEY).

I also like the Falklands, where the licence holders are Borders & Southern (LSE: BOR), Desire (LSE: DES), Rockhopper (LSE: RKH) and Falkland Oil & Gas (LSE: FOGL).

But remember: there's no getting away from the fact that these ventures pose risks. For example, for the Falklands companies, the attitude of Argentina presents a political risk. There is also a major technical challenge to extract the oil.

This article was written by Tom Bulford and is taken from his free twice weekly email the Penny Sleuth .