Not to say Warren Buffett’s folksy observation this weekend on the US oil business is incorrect, but it gets something awfully incorrect:
Vicki does know how to separate oil from rock, and that’s an uncommon talent, valuable to her shareholders and to her country.
He is referring to Vicki Hollub, chief executive of Occidental Petroleum Corp., the oil and gas producer in which Berkshire Hathaway Inc. owns a roughly 28% stake. The dispute here isn’t with Hollub’s knowledge of oil production or that this constitutes a talent. Rather, it’s the “uncommon” aspect. The history of the US shale boom, including how Buffett and Berkshire got mixed up with Hollub and Oxy, shows how widespread this particular talent is. It was the skill of turning that into profits for investors that eluded most.
Buffett’s praise of the company’s productive prowess is a throwback to the boom times that isn’t likely to persuade other investors to join him.
We are a mere six weeks or so from the five-year anniversary of Oxy locking horns with Chevron Corp. to buy Anadarko Petroleum Corp. In the end, Oxy prevailed by paying a huge premium, mostly in cash, with Berkshire providing $10 billion of crucial funding in exchange for preferred stock, which had the useful effect for Oxy’s management of avoiding a shareholder vote on the deal (see this for a recap).
It was a pyrrhic victory. Oxy made the classic mistake of overextending itself just as oil prices began falling, which accelerated the following year amid Covid-19. The deal capped a decade of excess in shale where the frenzy for separating oil from rocks saw many an investor separated from their capital.
Oxy’s total return since April 11, 2019 — just before the battle for Anadarko began — up to just before Buffett’s latest letter dropped was a princely 2.7%. The smallness of that number is obvious, but just for context, the oil sector returned about 23 times that, and the S&P 500 about 33 times as much, over the same period. Plus, at an annualized rate of 0.6%, Oxy’s common stock has returned less than one-tenth the coupon it pays on those preferreds it handed over to the Sage of Omaha’s shop.
Dreadful as Oxy’s stock performance has been during this time, even that owes much to Russia’s invasion of Ukraine, which boosted oil prices, as well as Buffett himself. Having helped Oxy dig itself into a hole, Berkshire began buying the stock just after that invasion began and oil began skyrocketing. Regulatory filings show a series of further purchases, generally whenever Oxy’s stock is in the upper $50s, around the strike price of the warrants Berkshire extracted as part payment for its $10 billion (the stock trades just above $60 today).
Buffett confirmed this weekend that Berkshire has no interest in buying Oxy outright — given the lock it has already on the capital structure, why go to the trouble and expense?
The influence of Oxy’s largest shareholder, implicit or otherwise, was felt in December, when the company announced a surprise $12 billion acquisition of CrownRock LP, a privately-held operator in the Permian shale basin. In doing so, Oxy pivoted abruptly from a strategy of deleveraging, including starting to redeem those preferreds, while also buying back shares to one of growth via premium-priced M&A, funded by more debt and some disposals. The former approach was very much in line with the oil industry’s post-shale boom mantra of discipline, while the latter rather uncomfortably reminds us of Oxy’s last bout of empire building.
But if you’re Buffett, presiding over a record $168 billion cash pile, the last thing you want is more cash. Instead, you want exposure to an unloved stock operating in a business with a solid future ahead of it. Oxy is damaged goods but does produce a lot of oil; almost as much every year as the amount in the Strategic Petroleum Reserve, to use Buffett’s somewhat odd formulation. Acquisitions raise this further. His letter makes a glancing reference to Oxy’s investments in carbon capture. But his characterization of the company’s output as a source of national security suggests Berkshire’s house view is one of peak oil demand coming later rather than sooner.
At the very least, the Oxy stake offers a potential hedge against any further unforeseen wars and such wreaking havoc on the rest of Berkshire’s portfolio. This is actually one of the better arguments for owning energy stocks and yet Buffett’s reasoning resurfaces all the reasons why so many investors steer clear.
I wrote recently about how even a highly profitable, high paying oil sector is now worth less than just one AI-related stock, Nvidia Corp. The gap has widened since. Downtrodden energy stocks may benefit if and when tech mania abates — but not if oil producers are seen to be reverting to prioritizing volume over value (especially if wrapped in the flag of US energy independence). It is notable that Buffett’s clear interest in oil stocks — Berkshire also owns about 7% of Chevron — doesn’t thus far seem to have drawn in a crowd of followers, as often happens.
Buffett capitalized on Oxy’s hubris to extract steep terms and then ultimately turn it into a leveraged bet on buoyant oil prices and demand. It feels almost redundant to say he may ultimately be proven right on the latter. The irony is that how he got there, and how he now pitches the play, are also reminders of why others deserted the sector in the first place.
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