Did Buffett Make a Mistake With Big Oil?

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Have you noticed how our world seems to be changing at warp speed? It was just a quarter ago that those of us who follow energy closely were wide-eyed at the news that Warren Buffett, through his Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) , had become ConocoPhillips' (NYSE: COP  ) biggest holder

And then, late last week came the news that, with the economy and commodity prices still sagging, Conoco will lay off about 4% of its workforce and take $34 billion in fourth-quarter noncash charges. It'll also shrink its 2009 capital budget below last year's level.

Further, when the company reports its final 2008 results, it'll tell us that its reserve replacement rate is down to a paltry 25%-30%. However, Conoco assures us that it has replaced 80% to 85% of what it produced and that current SEC rules prevent it from counting some North American reserves.

This isn't to imply that Buffett misfired with Conoco. When crude blew through $145 a barrel last summer, a six-month price drive to today's levels was completely unexpected.

Beyond that, most of Conoco's writedowns will be tied to goodwill from recent years' acquisitions, when crude prices were moving steadily higher. As such, they won't affect cash.

The biggest such purchase was the 2005 buyout of major independent Burlington Resources. And beyond that, Conoco will trim $7.3 billion from the value of its 20% share in Russian oil producer Lukoil (OTC BB: LUKOY).

Management now expects this year's capital spending to be in the vicinity of $12.5 billion, down about 18% from 2008. More than 80% will go to exploration and production activities, while the refining and marketing side will be handed only about $2.0 billion in capital expenditure funding.

So the obvious first question involves the extent to which Conoco's situation will spread to other producers like Marathon (NYSE: MRO  ) , not to mention bigger players like BP (NYSE: BP  ) and Chevron (NYSE: CVX  ) . Beyond that, and perhaps more importantly, should Foolish energy investors now avoid Buffett's favorite oil company?

My responses to those two questions are (1) I can't tell yet, although Conoco has generally been especially active on the acquisition trail in recent years and thus would be more subject to writedowns; and (2) no.

As to sinking your pesos into Conoco, do so only if you're patient. But for my money -- and Warren's -- this is a quality company, and the plethora of industry cutbacks will almost certainly lead to a rise in commodity prices sooner than is generally expected.

Conoco wears five stars in the Motley Fool CAPS investor community. Is your vote included in the company's rating?

Related Foolishness:

Berkshire Hathaway is a Motley Fool Inside Value selection and a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire Hathaway. Motley Fool Stock Advisor is offering a special inauguration sale today! You can now get a 12-month membership to the Fool's flagship investment service for only $99 -- a more-than-30% discount. Click here for full details.

Fool contributor David Lee Smith doesn't have positions in any of the companies mentioned. He does, however, welcome your comments or questions. The Fool has a disclosure policy.

Read/Post Comments (9) | Recommend This Article (49)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 21, 2009, at 4:41 AM, dividendgrowth wrote:

    They all expected a repeat of 70s stagflation and got 30s depression handed to them.

    Buffett was no exception.

    But the clown Peter Schiff was burnt far worse.

  • Report this Comment On January 21, 2009, at 9:48 AM, venkytalks wrote:

    Oil stocks are still a safe long term (10-15 year) bet and are a screaming buy at todays prices. Buffet is probably buying more on the quiet

  • Report this Comment On January 21, 2009, at 10:08 AM, SkepticalOx wrote:

    SUV sales in the US picked up again as customers saw the price of oil go down.

    If that's any indication, the addiction to oil ain't over yet.

  • Report this Comment On January 21, 2009, at 10:18 AM, oversea wrote:

    It's too early to ask if W. Buffet did a mistake. We'll know this later this year.

  • Report this Comment On January 21, 2009, at 1:41 PM, MotleyGulibles wrote:

    MF might want to address the issues. We are entering an "era of responsibility."

    To the MOTLEY FOOL

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  • Report this Comment On January 24, 2009, at 11:34 AM, peterjlist wrote:

    Wow, maybe you guys will STFU with your Buffet worship. I really hate your endless worship of him, as if most of us could ever do anything by imitating him.

  • Report this Comment On January 25, 2009, at 12:50 PM, bbeerme wrote:

    Anybody trying to imitate or follow Buffett is at a big disadvantage right from the word go. You see, he does what the rest of us can not do; he buys preferred shares.

    Not only does he buy preferred shares, but he also negotiates a fixed dividend return. Last year, in the case of B of A and J&J, that dividend was 10%. And yes, he is in it for the long run.

    If only the rest of us could be as fortunate . . . Buy preferred shares, negotiate our dividend rate, and be able to hold for ten years or more.

    The author of the above article appears to be truly foolish and unqualified to offer professional advice regarding Buffett or Conoco. If you want to buy into oil, a better recommendation might be to buy an ETF in the oil sector; that would be much safer than any individual stock in the same sector.

    Only a true fool would follow Buffett and expect the same results.

  • Report this Comment On January 26, 2009, at 7:14 PM, GoNuke wrote:

    Morningstar likes COP. The premium service costs $150 a year and with it you get more detailed and more conventional analysis. One of the Motley Fool newsletters recommends investing in Morningstar.

    I own COP and I would be very surprised if it doesn't double in value when the recession ends. Oil is so cheap now that it isn't worth any oil firms while investing in finding more. There is going to be a helluva spike in oil prices when the world gets growing again.

  • Report this Comment On January 26, 2009, at 8:34 PM, gcherry wrote:

    Regarding Warren Buffett's purchase of big oil's Conoco. Warren looks down the road at least 10 years, so his purchase is barely ripening yet. At some point in the next ten years his bet (he rarely bets, except on sure things) on big oil will pay off handsomely. The present price for oil will not hold. Where it will go we don't know, but up it will go once again in the future and Mr. Buffett will be sitting pretty waiting for those big fat growing dividends to come rolling in. Mark my words.

    Gordon C in Vancouver

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