Why Warren Buffett ‘votes’ Occidental Petroleum

Famed investor Warren Buffett is steadily increasing his stake in Occidental Petroleum in what could end up being the biggest acquisition he’s ever made.

Berkshire Hathaway on Friday won approval to buy up to 50% of the shares. Some investors believe this is a step toward a full takeover, which could ultimately cost more than $50 billion.

Why Occidental is attractive to Buffett

Oil

Inflation appears to be the biggest trend for the first half of the 2020s, and crude oil is one of the best natural hedgers around. Russia’s invasion of Ukraine and a lack of investment in new oil fields over the past five years have hit supplies, leading to stagnant production profiles everywhere from OPEC to US shale. Meanwhile, demand for fossil fuels has been strong coming out of the pandemic, even as governments push for a clean energy transition.

With investments across the energy sector, from utilities to solar, Buffett claims to be a realist in the fossil fuel debate. “The people on the fringes of both sides are a little crazy,” he told a 2021 Berkshire shareholder meeting.

Intimacy

Buffett first invested in Occidental in 2019 when the oil company was in a bidding war with Chevron Corp. for the acquisition of its rival company in Houston, Anadarko. Occidental CEO Vicki Hollub flew to Omaha, Nebraska in the company’s Gulfstream V and convinced Buffett to add $10 billion to her “war” fund.

That was enough to get the deal done, and Chevron pulled out soon after. In return, Buffett got preferred shares with an annual yield of 8% as well as options to buy more common shares at $59.62 each. Today, with Occidental at $71.29, those options would yield more than $900 million in profit if exercised.

Value

Initially the Anadarko deal was a disaster because it loaded Occidental’s balance sheet with more than $30 billion in additional debt right before the pandemic. Occidental’s market value fell from $50 billion before the 2019 transaction to less than $9 billion by the end of 2020 as oil prices collapsed.

But on the other hand, this created a good value play for Buffett. When crude turned late last year and was boosted by Russia’s invasion of Ukraine, Occidental was best placed to take advantage. The stock has outperformed the S&P 500 this year, rising more than 140% compared to the index’s 11% decline.

Cash

Plenty of cash has been Berkshire’s biggest investment challenge in recent years. The group had about $105 billion in cash at the end of June. It is expected to generate about $8 billion in free cash flow each quarter for the next five years, according to Greggory Warren of Morningstar Research Services LLC. Inflation at a 40-year high is a big incentive to put that money to good use.

Occidental would work better as a Berkshire subsidiary than as an equity holding “given the volatility that exists in the energy/commodity markets,” Warren said. “This could end up being a slow buyout, though, where Berkshire buys up the percentages that FERC allows it to acquire until it can acquire all of Oxy.”

Shale

Occidental is not only one of the largest producers in the Permian Basin, the largest US oil field, but also has one of the lowest costs with an oil price of just $40 a barrel needed to maintain its dividend. West Texas Intermediate is currently trading at around $90 a barrel. Hollub has cut back on the “drill-baby-drill” mentality that characterized shale in its first decade and now prioritizes profits over production. Free cash flow hit a record $4.2 billion in the second quarter.

Anadarko’s purchase may have been expensive, but it allowed Occidental to increase its Permian land holdings to 2.8 million acres, 14 times the size of New York’s five boroughs combined. It also added stable, cash-efficient assets in the Gulf of Mexico and Algeria.

The CEO

Buffett has a good personal relationship with Hollub, which began at the 2019 meeting in Omaha, mediated by Bank of America CEO Brian Moynihan.

This year, the veteran investor praised Hollub after reading a transcript of Occidental’s Feb. 25 earnings conference call, in which he promised financial discipline even as oil prices rose.

“I read every word and said that’s exactly what I would do,” Buffett told CNBC’s Becky Quick on “Squawk Box” in March. “He runs the company the right way.”

Biden’s Inflation Reduction Act

The oil industry has been particularly critical of the Inflation Reduction Act that President Joe Biden signed into law this month. The $437 billion legislation “discourages needed investment in oil and gas” and offers “the wrong policies at the wrong time,” the American Petroleum Institute said.

But Hollub was surprisingly upbeat, calling the bill “very positive.” This may have to do with the expansion of tax credits for carbon sequestration, of which Occidental is one of the main proponents.

The company plans to build the world’s largest direct air capture plant, which will have a tax credit of up to $180 for every ton of carbon absorbed from the air.