Warren Buffett and Hedge Funds Don't See Eye to Eye on Big Oil

Everyone invests for different reasons, and different reasons can lead to different investment strategies. For individual investors like you and me, those differing opinions won't make much of a dent in an individual company. When Warren Buffett and Hedge Funds start investing in companies differently, however, it can actually have a deep impact on a stock. A poll from Goldman Sachs just listed the top 25 companies shorted by hedge funds, and two major energy stocks on that list -- Conocophillips (NYSE: COP  ) and Exxonmobil (NYSE: XOM  ) -- just happen to be some of Berkshire Hathatway's (NYSE: BRK-B  ) largest holdings.

What could lead to hedge funds and Warren Buffett seeing these two groups differently? Let's take a look at why someone would short Conocophillips and Exxonmobil, and why someone else would pick up these stocks.

Why short big oil?

Over the past several years, the members of big oil have been under-performing the broader S&P index on a total return basis (stock appreciation and dividend returns). A large reason this has happened is because of the amount of money that big oil players have had to spend on growing their oil and gas production. Even though there has been a boom in oil and gas in the U.S. recently, the larger players like Exxonmobil and Chevron (NYSE: CVX  ) have mostly been left out of that movement. Instead, big oil players have been focusing on mega projects overseas. 

A prime example of this was the Kashagan project in Kazakhstan. The Kashagan oilfield in the Kazakh portion of the Caspian Sea was the largest oil find of this millennium -- we have to go back all the way to the 1970's for a larger find. Both Exxon and Conocophillips were a major part of this project until recently, when Conoco sold its 5% stake in the field, and both of them spent billions of dollars over almost a decade to get this project flowing. Having that much money tied up in an asset that was not producing oil means lots of unproductive capital. 

This isn't the only money pit project that big oil companies are working on, either. There are numerous projects like this one that are taking years to develop and in many cases going billions of dollars over budget. Having this much unproductive capital leads to under-performance, and could lead to these companies seeing their production numbers and earnings slip.

Why Warren Buffett invested in these companies

There are some simplistic ways to explain Mr. Buffett's decision to buy into Conocphillips, and to recently take a $3.4 billion position in Exxonmobil: The companies are big enough for him to own, the stock is cheap on a P/E basis, etc. But Warren Buffet doesn't invest in these types of companies to make a quick buck. These are investments that are geared towards the very long term. When looking at these companies from that point of view, they offer much greater promise.

Looking very far down the road, Exxon, Conoco, and the other players in Big Oil are the only companies with the financial flexibility to take on these mega projects. So while these projects may take a long time to develop, theay are also geared to be long term cash generators. Using the Kashagan oilfield as an example again, the stakeholders in the field want to ramp production up to 1.5 million barrels per day sometime after 2020, and hope it will continue to produce at that level well past 2040. Since assets can be productive cash generators for that long without major reinvestment, the result could make the wait for these projects worth while.

Conocophillps, Exxonmobil, and Suncor (NYSE: SU  ) -- the 3 exploration and production companies in the Berkshire Hathaway portfolio -- are littered with large, long term projects, especially in Canadian oil sands. While it may take years for these assets to get up to full production capacity, they should help these companies sustain production for decades. 

What a Fool believes

Neither approach is necessarily wrong when it comes to investing in big oil. In fact, they are just investing approaches based on different timelines. Shorting big oil -- or any stock, for that matter -- is normally done on a much shorter term approach, whereas Mr. Buffett is normally looking at an investment time horizon measured in generations. For individual investors like you and me, we can follow both approaches, but it's hard to argue against Warren Buffett's.

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  • Report this Comment On December 01, 2013, at 4:36 AM, daverhall wrote:

    I would like to find out just how much of the tax payers' money is going to big oil? Either as subsidies or as tax write-offs. Oil companies do not need tax payers monies for subsidies or so many tax write offs to do their job. They are earning far too much profit to claim any hardship. It is far better to invest and build for long term to make a company worth while.

  • Report this Comment On December 01, 2013, at 11:17 PM, metazip wrote:

    Always follow the money, always...

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