With the war between Russia and Ukraine escalating in an ugly way last week, some are speculating the West may begin to ban Russian oil imports outright -- a step it hasn't taken yet. If that happens, Russia's 5 million barrels per day of exports could go off the world markets, which would spike oil prices even further than they've already gone. In that scenario, some analysts speculate the price of oil could rise to $150 per barrel or even higher, compared with $115 today.
It appears Warren Buffett's conglomerate Berkshire Hathaway (BRK.A -0.16%) (BRK.B -0.14%) is preparing for this scenario, as the company rapidly bought up $5 billion in the stock of Occidental Petroleum (OXY -2.49%) between Wednesday and Friday of last week, even as the price of the stock was spiking to its highest levels in two and a half years.
This was a large purchase for Buffett
While we don't know if the purchase was made by Buffett himself or one of his lieutenants, Todd Combs and Ted Weschler, this was a significant purchase, which leads me to think it was Buffett himself. The Occidental purchase totaled 61 million shares worth $5.1 billion, nearly the size of Berkshire's Chevron (CVX -0.69%) stake, its largest oil common stock holding as of Dec. 31. Berkshire held $4.5 billion in Chevron stock at the end of last year, which would be worth about $6 billion today after its strong 33% price appreciation year to date.
Berkshire also already owned $10 billion in Occidental preferred stock, which Berkshire issued to Occidental in 2019 to help it purchase Anadarko Petroleum. The preferred stock comes with an 8% dividend and 83.9 million warrants, which are convertible into Occidental stock at $59.62. That compares with Friday's ending stock price of $56.15.
If Occidental stock increases to the point that Berkshire would convert its warrants, the 61 million share purchase combined with the 83.9 million warrants could mean Berkshire may end up with 145 million shares, which would be worth $8.7 billion if Occidental shares hit $60. That would be a significant stake for Berkshire, the sixth-largest common stock holding in its portfolio, larger than its Verizon Communications holding and a bit smaller than its long-held stake in Moody's.
It would also mean Buffett's total bet on rising oil prices across both Occidental and Chevron combined would come to nearly $15 billion, which would become the fifth-largest "bet" in Buffett's equity portfolio, behind the long-standing $24 billion stake in Coca-Cola. The sheer size of the investment means Buffett believes higher oil prices will last for a while.
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Why does Berkshire like Occidental compared with other oil plays?
So why has Berkshire concentrated on Occidental, and not some of the other strong U.S. shale plays? Well, for one thing, Buffett likes to invest in companies in which he knows the management and company culture very well. As an investor in Occidental's preferred stock since 2019, he likely has a strong understanding of Occidental's management and culture in particular.
Second, Occidental Petroleum has much more debt than the typical shale company given its size -- the result of its megamerger with Anadarko. At the end of 2021, the company still had about $30 billion in outstanding debt. That's against a market cap around $52.4 billion today. So, debt makes up a lot of Occidental's enterprise value.
That makes Occidental more of a leveraged play on oil prices than others, meaning if prices go up a lot, Occidental may pay down its debt faster and its equity value will make up a much bigger portion of the total enterprise value. So Occidental's stock could rise even more than other oil companies with less leverage as prices rise. Of course, that goes both ways; if oil prices drop, that leverage makes Occidental more of a risk. Yet Occidental did survive the 2020 crash in energy prices, and has been aggressively paying down debt early on already in 2022.
Occidental management has also boasted it has the most efficient wells in the Delaware Basin of the Permian shale, claiming its Delaware Basin wells generate 33% more barrels with 7% less proppant than the average operator. Buffett also likes low-cost operators, as evidenced by his love for GEICO insurance, which has the competitive advantage of lower costs in its direct-to-consumer business. So, it's yet another reason he may like Occidental.
Occidental also has among the largest U.S. acreages of any oil company, spanning the Permian shale, the Rocky Mountain Powder River and DJ Basins, and the Gulf of Mexico. All in all, Occidental has 9.5 million acres on U.S. land, good for 80% of its total. The other 20% comes from Algeria, Oman, and the United Arab Emirates. Since exploration and production investment has fallen across the oil and gas industry in recent years, amid both low oil prices and ESG concerns, Occidental's large amount of inventory could be an advantage when other operators may need to spend more to look for more oil.
Finally, amid the surge in oil prices, Occidental plans to not only pay down $5 billion in debt this year, but it also just raised its quarterly dividend from $0.01 to $0.13, and just reactivated its share repurchase program, to the tune of another $3 billion.
Adding it all up, Occidental has high leverage, but low costs per barrel, as well as a large amount of inventory. Those characteristics make it an attractive bet on higher oil prices, and its recently boosted shareholder return program is a nice bonus. No wonder Buffett has chosen it as a way to play an oil price spike amid geopolitical tensions.
