Warren Buffett blazes a trail through the oil field

Following Warren Buffett, one of the world’s top investors, is always interesting but why not go a bit deeper and monitor what Buffett is following – a move which takes you to the two mega-trends of the next decade: inflation and energy.

A glimpse of the strategy behind Buffett’s personal fortune, which Forbes magazine estimates at US$100 billion, was covered by Small Caps in June.

Trading through the company he founded, Berkshire Hathaway, Buffett made two significant investments early this year (as well as selling a handful). There was the acquisition of an insurance company and the purchase of an extra US$9.6 billion worth of shares in Occidental Petroleum (NYSE: OXY).

The obvious way to follow Buffett is to buy a stake in Berkshire Hathaway but that’s probably not practical for most Australian investors who would be restricted to the company’s B-class shares priced at around US$290 each, which is a fraction of the A-class currently trading at US$435,000 each.

Following Buffett’s theme

But nothing is stopping anyone from building exposure to the energy theme like Buffett, which is something I have been advocating for some time.

An example of Buffett’s increasing focus on energy came last week when he won government regulatory approval to lift Berkshire Hathaway’s stake in Occidental to 50% – raising the potential for a full takeover of the company currently valued at US$68 billion.

If Buffett does bid for the rest of Occidental, it will be easily the biggest investment made by Berkshire Hathaway a business which already has a US$300 billion portfolio of shares in stocks such as Coca Cola (NYSE: KO), Apple (Nasdaq: AAPL) and American Express (NYSE: AXP).

Occidental, however, is not the only oil company in Buffett’s portfolio. Berkshire Hathaway is also a major shareholder in Chevron (NYSE: CVX), the second biggest US oil company after ExxonMobil (NYSE: XOM).

The fact that Chevron is the fourth biggest investment in Berkshire Hathaway’s portfolio and Occidental seventh, according to a 15 August filing with the US Securities and Exchange Commission, is telling a powerful story about Buffett’s interest in energy.

The reasons for the heavy-duty exposure to politically-incorrect oil and gas is a classic Buffett strategy best summed up in his advice: “Buy when others are fearful, and sell when others are greedy”.

Fear of investing in oil and gas

The fear factor in oil and gas is complex because it involves understandable concern about potential climate change, which might be influencing some investors with a finely-tuned approach to the ethics of where they invest.

There is also fear about being exposed to a commodity with what appears to have a built-in use-by date as governments try to regulate it out of existence through the encouragement of electric vehicles and bans on those with internal combustion engines.

Not factored into government regulations are three components ensuring a longer-than-expected, and highly profitable life for oil and gas companies such as Buffett’s twin targets of Chevron and Occidental.

Price driving factors

The first of the price driving factors is discouragement of exploration and project development, a widespread government policy which has ensured a shortage of most forms of fossil fuels, a group that includes deeply unloved coal which is currently trading at an all-time high of US$417 a tonne, up 700% in two years.

The second is the attempts to ostracize Russian energy exports because of the Ukraine war, and tit-for-tat Russian embargoes on selling energy to Europe, a market churning dispute which shows no sign of ending.

The third issue underpinning Buffett’s big oil bets is a disbelief in the preferred power replacements of solar, wind and other forms of renewable energy being able to successfully plug the fossil fuel gap – not yet anyway.

Energy index surges

Ethically pure investors might be horrified by Buffett’s plunge into oil, but investors focused on profits are streets in front, like the man himself.

A simple test of Australian stock market indices highlights the point because over the past 12-months the ASX all ordinaries index has slipped 6.7%. The metals and mining index is up a tiny 1.9%. The gold index is down 22% – and the energy index is up 45%.

Occidental, one of the great names of US oil since its founder Armand Hammer pioneered development of the Libyan oil industry and became a major player in the North Sea oilfields, almost destroyed itself in 2019 with a mistimed and high-priced takeover of rival US oil producer, Anadarko.

Buffett, through an injection of US$10 billion saved Occidental, which was able to beat a rival bidder for Anadarko, Chevron.

Buffett bets on oil

For oil-deal observers what appears to be underway is a whopping Buffett bet on oil, either simply through Occidental, or by acting as a marriage broker through the potential merger of Occidental and Chevron.

Events at the top end of the oil sector are pointers for small cap investors because there is an industry-wide theme which everyone can follow can that’s the near certainty that oil and gas will remain a valid and handsomely profitable form of investment for years, if not decades and that’s not simply because of supply/demand fundamentals.

There is another theme running through oil and gas and it’s sure to be one that Buffett has studied and that’s the performance of most resources during a recession.

While not always the case there is the well documented example of resources during the Great Depression of the 1930s when everything crashed, except mining and oil, which took a hit but bounced back quickly – led by gold.

Underinvestment in most resources has created widespread shortages with the first sniff of an outage or supply gap sparking a sharp price reaction as seen in coal, oil, lithium and copper.

Buffett has probably never been described like this, but he is very much a canary in the coal mine acting as an early warning indicator of a long-term up-trend in fossil fuel prices, not the more widely expected down-trend.

His approach might not be popular with everyone but if there’s one thing Buffett knows it’s how to make money – and he’s got US$100 billion to prove the point.