Warren Buffett's $6 Billion Energy Bet

The Oracle of Omaha looks like a believer in the sustainability of domestic oil and natural gas production, based on Berkshire Hathaway's investments in ExxonMobil, National Oilwell Varco, and Phillips 66. Toss in the recent announcement to acquire part of Phillips 66, and it's even more apparent that Buffett believes in domestic energy.

Jan 6, 2014 at 2:04PM

Berkshire has more than $6 billion invested in National Oilwell Varco (NYSE:NOV)ExxonMobil (NYSE:XOM), Phillips 66 (NYSE:PSX), and ConocoPhillips (NYSE:COP). Grouped together, these holdings make up almost 8% of Berkshire's portfolio, and would be the fifth-largest single investment, trailing only the "big four" of Wells Fargo, Coca-Cola, IBM, and American Express

What can individual investors take away from this? Should you follow Buffett into oil and gas? Let's take a closer look.

Oil is here to stay, despite domestic consumption falling

G

Source: ExxonMobil 2014 Outlook for Energy

As the middle table shows, demand is falling in North America -- and this is a great sign for several reasons: First, when tied with the growth in international demand, it will increase the amount of product that can be exported, which is a boon to the domestic employment picture. Next, the continued swing from being a net-importer to being a net-exporter could have massive benefits to the domestic economy.

Canada and Mexico also have production capacity far in excess of domestic demand, which plays right into the strengths for several of the companies, especially ConocoPhillips and ExxonMobil. Mexico's expansion of private investment in its oil and gas production also presents plenty of upside for a supplier like National Oilwell Varco. Worldwide demand for these cheap and flexible fuels is expected to grow for decades -- even as alternatives like natural gas and electric vehicles become more viable, and traditional engines become more efficient.

The biggest key driver of this is population growth, which will continue to put pressure on producers to feed the world's addiction to oil. 

Speaking of Mexico
ExxonMobil and ConocoPhillips are two producers likely to benefit from this market being opened. ExxonMobil is already the largest U.S. producer of natural gas, and has significant expertise in both shale exploration and offshore fields like the recently discovered Julia field in the Gulf of Mexico, much of which resides in more than 7,000 feet of water. This is the kind of partner that Pemex (the Mexican state oil company) could use to maximize its resources. 

ConocoPhillips continues to expand its deepwater production in the Gulf of Mexico, announcing just last week that it had discovered its fourth large reserve in the Gulf this year, at a well depth of more than 29,000 feet, under 4,900 feet of water. The company's expertise in this area could be attractive to Pemex, as Mexico looks to expand its offshore production. 

But it really comes back to growing global demand
Buffett's decision to significantly reduce Berkshire's stake in ConocoPhillips just a few months back, tied to the recent announcement that Berkshire would acquire Phillips 66's Phillips Specialty Products (PSPI)  points this out. The risk with investing in ConocoPhillips is that, as an exploration and production company, the price of oil and gas (which oil companies can't really control) can really impact the company's profitability. On the other hand, things like the chemicals that PSPI makes aren't affected as heavily by the ups and downs of the price of oil, while still receiving the benefit of increased demand for energy.

It's likely that both last quarter's move to cut Berkshire's position in ConocoPhillips in half, and the use of the majority of Berkshire's Phillips 66 shares to acquire PSPI, are both part of Buffett's efforts to limit the downside of falling oil prices, should they occur in the next few years, while also maintaining exposure to the long-term growth in energy demand. 

The biggest hedge against falling oil prices?
National Oilwell Varco is in an enviable position, often called "No Other Vendor" due to the company's incredibly diverse products and services that cater to the oil and gas industry. No other company involved in energy offers so much to so many, with so little direct competition. While shares in NOV, as the company is called, have underperformed the market since 2010, there are reasons to be positive about the future.

The company's long-term results are unmatched in its field, and investors who held shares for any five-year period since 2000, with the exception of 2008-2012, have outperformed the S&P 500. And for investors who bought in 2008, the company's history of strong long-term earnings growth points toward a reversion to market outperformance, especially when considering the following:

Unlocking value for shareholders
In September, NOV announced that it would spin off its distribution business, to be called DistributionNOW, distributing shares in this new and separate public company to shareholders in what will likely be a tax-free manner. Robert Workman, who has led what will become DistributionNOW,  will become CEO once the spinoff is complete. Workman has been with NOV since 1991, and has been president of the distribution business since 2001, growing it (both organically and through acquisitions) to more than $4 billion in annual sales, from less than $700 million in sales in 2002. 

This spinoff will simplify what is a very complex company with a lot of moving parts and divisions, allowing both separate entities to better function and grow. The end result will be two companies that should be more highly valued than NOV is as a single company. 

Final thoughts
With nearly 10% of Berkshire's portfolio in oil and gas, some exposure to this segment probably makes sense for most investors. The advantage of following Buffett (besides the amazing track record) into a company is the understanding that he invests for the long-term -- with other money managers this isn't always the case. If you're looking to buy and hold for years, each of these companies in the Berkshire portfolio offer unique advantages and long-term benefits. Do they make sense for yours? That's up to you do decide.

More on Buffett's energy investments
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!

Jason Hall owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway and National Oilwell Varco. The Motley Fool owns shares of Berkshire Hathaway and National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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