This is a great time to buy oil explorers

This is a great time to invest in penny oil explorers, says Tom Bulford. Oil stocks are benefiting from high oil prices and some are making the kind of discoveries that have eluded the oil majors.

You'd have to be brave to invest in oil explorers right now. Most investors are running scared, and in the rush, many oil stocks have fallen hard.

But this might surprise you I think this is a great time to invest in penny oil explorers.

Not only are penny oil stocks benefiting from high oil prices. But they are also making the kind of discoveries that have eluded the oil majors. As some oil drillers seek to unlock vast deep sea reserves, there is the potential for pretty remarkable returns.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Take Dominion Petroleum (DPL) . Dominion has exploration licenses in Tanzania, Kenya, Uganda and the Democratic Republic of the Congo and the immediate excitement is provided by its 100% interest in license off-shore Tanzania. One prospect alone contains an estimated seven trillion cubic feet of gas (equivalent to 1.1 billion barrels of oil) and Dominion is now acquiring and assessing data prior to a drilling campaign.

If their efforts are successful, its investors could enjoy a return of 1,389%! That is one of the calculations found in Goldman Sachs' latest review of the exploration and production sector. And is just one example of the type of gains that are possible for those brave enough to invest in small oil explorers.

This is similar to the sort of high reward play that I like to find for Red Hot Penny Shares. True, the risks are high, and in the event of failure Goldman Sachs sees Dominion's shares falling by over 80%. But Dominion is by no means the only share with this sort of risk/reward ratio.

Why penny oil stocks are making the big discoveries

Aside from Dominion, five other oil plays have a potential upside of 1400% or above, in the opinion of Goldman Sachs. Borders & Southern (BOR), which will be drilling in early 2012 in the south Falklands basin and Chariot Oil & Gas (CHAR) which expects to drill offshore Namibia later this year, also look very promising.

As Goldman Sachs points out, the environment for frontier drilling is improving. The world's major oil companies have been struggling to replenish their reserves from established hydrocarbon basins. In response, and buoyed by the income they are receiving from today's high oil price, they are upping their exploration budgets and increasingly willing to farm in to frontier developments.

Over the last five years the most significant new discoveries have been made in deep waters off-shore, notably off the coast of Brazil and Ghana and in the Gulf of Mexico. On-shore discoveries of significant size have been limited to Kurdistan and Uganda. Looking ahead the potential new basins lie off-shore Namibian and the Bahamas and in the South Falklands Basin.

As well as independent oil majors, national oil companies are also looking for reserves. The Chinese National Offshore Oil Corporation, the Korean National Oil Company, Malaysia's Petronas, India's Reliance and Russia's Rosneft have all bought into energy projects. These government owned players are keen to acquire strategic oil supplies and have lower target financial returns than are typical in the private sector. So they are willing to pay good prices for confirmed reserves. This presents Goldman Sachs with a second theme. Where else could these national behemoths strike next?

The huge promise of "unconventional" energy

Consistent with their strategic role of securing energy supplies for the future, national oil companies tend to look at discovered resources of a good size. In recent years they have been ready to buy more complex assets and on this basis, Goldman Sachs picks out three possible take-over targets the coal bed methane play Green Dragon (GDG) , Cove Energy (COV) , which has a deepwater LNG (liquefied natural gas) scheme and Bankers Petroleum (BNK) , which is developing heavy oil fields in Albania.

Finally, Goldman Sachs highlights the trend towards unconventional' energy plays. Unconventional liquids are sourced from shale or tar sands, or else converted from coal or gas. Unconventional gas could be coal bed methane, deep gas' sourced from at least 15,000 feet below the surface, shale gas and tight gas, the latter exploited through the use of fracking'.

With Japan likely to increase its demand for gas, Goldman Sachs sees the price of LNG, which essentially sets the world market for gas, heading upwards. Furthermore, it believes that investors generally apply an unreasonably large discount to unconventional gas assets, pointing out that techniques for recovering gas from these difficult sources is improving all the time. Its favorite shares in the unconventional' space include Igas (IGAS) , Great Eastern Energy (GEEC) , and Nighthawk Energy (HAWK) .

Completing the picture with a selection of shares that have good upside potential from exploration programs, but in the event of failure are otherwise well supported by the value of existing assets, Goldman Sachs picks out Rockhopper (RKH) , Bowleven (BLVN) and Aminex (AEX) . Overall Goldman is bullish on the sector and its research shows that there are many ways to play the world's persistent thirst for energy.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth . To start receiving this and get your bonus report FREE, "10 Simple Rules for Maximising your Penny Share Profits", add your name here .

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.