My Largest Oil Holding Is on a P/E of 5

LONDON -- My largest shareholding by a long way is Soco International (ISE: SIA.L) , a small oil explorer that has been transformed into a medium-sized producer, thanks to some spectacular discoveries off the southeast coast of Vietnam.

Yesterday I attended Soco's annual general meeting, as I have done for most of the 11 years since I became a shareholder. As per usual, after the official business, Soco's boss, Ed Story -- a larger-than life Texas oilman with more than 40 years' experience in the industry -- gave a presentation, which was followed by a question-and-answer session.

Why choose small oil companies?
When most people think of oil companies, the first names that usually come to mind are such super-majors as BP, ExxonMobil, and Royal Dutch Shell. The oil companies that catch the attention of many private investors like myself are smaller companies like Soco whose share prices can rocket (or collapse) depending upon their drilling results.

A relatively small discovery, such as a 100-million barrel oil field that produces 10,000 barrels per day, is chicken feed to a super-major that is already producing several millions barrels a day. But to a minnow, this could be a company-transforming find that sends its shares into orbit -- and this is exactly what has happened to Soco.

What is Soco?
Soco was floated on the stock market in 1997. In the early days, its main interests were in Mongolia and Yemen, but it's the discoveries off the coast of Vietnam that have been the real company-maker.

Soco is well-known among the community of Fools who specialize in oil shares, and some of us are still holding onto shares that are currently worth between 10 and 40 times what we paid for them. While the last four years haven't been too kind to Soco, as its share price has fallen from a peak of almost 600 pence in 2007 to 282 pence, those of us who got in early can have no complaints, especially if we've taken some profits along the way.

Currently, Soco is exploring for oil in Angola, the Republic of the Congo, and the Democratic Republic of the Congo. But the main interest to investors is Soco's stake in the Vietnamese oil fields, and the substantial amounts of oil it is now producing means that it is no longer seen as a pure exploration company by the market.

It's no secret that Soco, or at least its Vietnam interests, will be sold at some stage. Currently, the management is focused upon proving up the reserves and generating sufficient production data to interest a buyer. Soco is a company where the directors and related parties own a very big stake, so their interests are closely aligned with those of their shareholders. There aren't too many companies for which the same can be said.

TGT = Loadsamoney
Soco's primary asset is a 30.5% stake in the Te Giac Trang oilfield, which is about 100 km off the coast of the Vietnamese city of Vung Tau. Production from TGT started last year and is expected to reach 55,000 barrels per day (gross) by the end of September.

Soco's other Vietnam interest is in the Ca Ngu Vang field, of which it owns 25% and which is currently producing at 8,000 barrels per day (2,000 net to Soco). It is anticipated that production from CNV will rise by somewhere between 3,000 and 5,000 barrels per day in the next 12 months.

Based on the current oil price, I estimate that Soco's price-to-earnings ratio for 2012 is around five. Soco doesn't pay a dividend.

Small oils are not for the nervous
Soco is a textbook example of a small oil company that's come good. Any investor who gets nervous when shares fall by 10% should steer clear of this sector, as movements like this are par for the course. It's not at all unusual to see a small oil company's shares rise or fall by 50% in a week, purely on the basis of good or bad drilling results.

This level of volatility comes with the territory, and virtually every private investor who has spent some time in this sector can tell you a horror story of losses between 50% and 99%.

For every Soco, there are several companies like Frontera Resources and Nighthawk Energy, both of whose names cause a shiver to run down many investors' spines. My gains on Soco, my other big success Dragon Oil, and several other companies like EnCore Oil are many times what I've lost on small oil companies as a whole. If they weren't, I'd have long since given up on the sector.

AGM gossip
Shareholders were expecting a lot of news about the level of production from TGT, and the directors did not disappoint us. Ever since production started at TGT, there have been concerns in the market that the gross production target of 55,000 barrels per day was no longer in reach, and these have cast a shadow over Soco's share price.

It turned out that the bottleneck was because the technical team at Soco's joint venture partner PetroVietnam had capped production at 40,000 barrels per day. This was due to their lack of knowledge regarding this type of oil field (the technical details about reservoir engineering mostly go over my head) and a hangover from Vietnam's communist past where people were strongly discouraged from beating their targets.

This dispute has now been resolved, and the output from TGT should reach 55,000 barrels per day by the end of September. Production should then move on to higher levels -- perhaps 65,000 and maybe even as high as 75,000. There is a four-year development program that involves more appraisal drilling and higher production targets, so if Soco Vietnam isn't sold, then its shareholders still have plenty to look forward to.

Let me finish by adding that higher-risk shares such as Soco can provide superb returns -- if things work out! If small oil companies interest you, then I feel you'd also like this special report: "Ten Steps To Making A Million In The Market." The report is free and for ambitious investors only!

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At the time thisarticle was published Tony owns shares in Dragon Oil and Soco International. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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