First problem: ERROR: PAE is disabled on this Pentium M
Preliminary solution: https://help.ubuntu.com/community/PAE: append "-- forcepae" to end of boot options. The space is mandatory.
Additional steps needed: press any key during boot to activate boot settings menu.
Second problem: Can't mount loop1 on /cow
Preliminary solution: http://ubuntuforums.org/showthread.php?t=1306277: "choose "discarded on shutdown" [in Ubuntu Startup Disk Creator].
Additional steps needed: for some reason this option was not available for Xubuntu 14.04 LTS image. I had to use Unetbootin instead. Make sure the USB stick is formatted using FAT and is empty.
Connecting to a WLAN AP did not work during installation. After installation was complete, this problem went away.