On Monday, it was disclosed that Warren Buffett's conglomerate Berkshire Hathaway (BRK.A 1.18%) (BRK.B 1.30%) yet again increased its stake in U.S. oil giant Occidental Petroleum (OXY 0.89%).
After Buffett decided to buy Occidental shares in size, starting at the outset of Russia's invasion of Ukraine, Berkshire's stake exceeded 20% last year, which forces Berkshire to disclose new share purchases when they happen, not just at the end of the quarter.
After buying shares on March 23 and 27, Berkshire's stake in Occidental now stands at around 23.6% of the company, or about 211.7 million shares worth about $13 billion. Berkshire also owns $10 billion in Occidental preferred stock, with warrants to purchase $5 billion more shares at $59.62.
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Between its large equity stake and preferred shares, some think Berkshire may eventually own more than 50% of Occidental, and potentially the entire company. So what does Buffett see in Occidental that would encourage him to buy it? Here are three factors.
1. Deep, diverse inventory, with a concentration in the Permian
With any oil and gas company, an investor should be aware of how many years of inventory it owns, the break-even prices for production, and the method of drilling (unconventional fracking versus conventional wells).
Occidental made a massive purchase of Anadarko Petroleum back in 2019, which gave it the No. 1 position in the high-producing Permian Basin in Texas, along with a leading position in the DJ and Uinta basins in Colorado. Indeed, 80% of Occidental's production now occurs in the U.S., with most of that in the Permian, along with significant production in the Colorado basins as well as offshore in the Gulf of Mexico.
Of note, the fracking revolution in the U.S. unleashed the potential of unconventional U.S. wells, which can be drilled in relatively short order. These "short-cycle" oil projects have a much quicker return on investment than conventional plays. Conventional plays do have the advantage of lasting a long time, with low incremental costs and slow decline rates. On the other hand, the cost of exploring and building up a conventional oil project to production is massive and takes time in the initial stages.
It appears Buffett very much likes the prospects of quick-return projects, particularly within the low-cost Permian Basin spanning Texas and New Mexico. The Permian in particular has a deep, low-cost inventory, containing many years of potential short-cycle oil projects.
Occidental now has nearly half its production in the Permian, and a majority of its production between the Permian and Uinta/DJ unconventional plays. Between the two onshore basins, Occidental owns 3.9 million acres of core production, and another 3.6 million acres outside its core operating territories that could be developed in the future. These are some of the largest acreage holdings in unconventional U.S. basins of any operator.
On the other hand, it also appears Buffett likes some diversification into conventional long-lived assets too -- preferably ones that already exist, and provide a steady stream of low-cost oil. Here, Occidental also has 10 operational platforms in the Gulf of Mexico. Already underway and pumping, these low-decline assets generate significant free cash flow for the company. The same goes for Oxy's international conventional oil projects in Oman and Algeria, which generate significant free cash flow but with low sustaining capital requirements.
It appears Buffett very much likes the growth potential in the Permian, in which projects can be brought online relatively quickly in response to higher oil prices. But it appears he also likes some diversification, with existing conventional plays already active and pumping and throwing off cash without the need for sustained capital expenditures. Those assets can especially be leaned on in a market downturn.
For instance, Buffett has also been aggressively buying Chevron (CVX 1.54%), which has a similar profile to Occidental. Chevron is the second-largest producer in the Permian Basin behind Occidental, but with diversification in global conventional wells as well. And as Occidental also has a profitable downstream chemicals division, Chevron also has significant midstream and downstream operations too.
2. Leading technology and well productivity
Another reason Buffett may be sweet on Occidental is its technology chops, which have led to some of the most efficient drilling practices in the industry. Of note, at the time of the Anadarko acquisition, Occidental noted that despite it only having 4% of total Permian Basin wells, it had 23% of the best-performing wells at that time.
And on the recent conference call with analysts, CEO Vicki Hollub noted Occidental was able to increase well productivity in the Permian for the seventh year in a row, with 2022 wells returning 205% more barrels of oil equivalent per day than 2015 wells. In addition, Hollub noted that eight of the company's new Permian wells -- two in the Bone Springs formation and six in the Barnett formation -- achieved production records relative to same-basin competitors over their first 30 days of production.
On the call, Hollub noted the company's proprietary service modeling and well completion designs as responsible for the outperformance. One advanced technique is called enhanced oil recovery, or EOR, which uses carbon dioxide injection into wells. The CO2 displaces the oil and gas trapped in the porous rock, then gets trapped in the rock itself, taking carbon out of the atmosphere while boosting production and well efficiency. Occidental has been using EOR since the 1980s, and already has lots of carbon infrastructure, such as injection wells, pipelines, and CO2 storage.
This brings us to the final reason for Buffett's enthusiasm for Occidental.
3. Carbon capture tech
Since Occidental already has a lot of experience using CO2 injection in its operations, it's in a great position to invest in new carbon capture technology. Previously, Occidental either sourced C02 from others or recovered it from this own operations. But if it can capture carbon dioxide from heavy-emitting third-party operations, it's a win-win.
Management is looking to seize the opportunity, with seed investments in several carbon-removal and recycling technologies. This year, Occidental will begin construction on its first direct-air capture (DAC) plant in Texas. Occidental has also bought 400 acres of land for several carbon sequestration hubs.
As those projects come online, Occidental stands to collect revenue as well as carbon dioxide removal credits, which it can resell to other industries. The company plans to spend between $200 million and $600 million on carbon sequestration projects this year out of a roughly $5.8 billion 2023 capital budget program.
That's enough investment to potentially be a serious player in carbon sequestration tech in the coming decades. Yet the company has enough scale in traditional oil and gas that the investment won't cost too much relative to its overall size and really dent current profitability that much.
Occidental has current and future upside
We all know Warren Buffett as a value investor, and Occidental certainly looks cheap today at a 5 P/E ratio. However, Buffett has also said that if one weren't ready to own a stock for 10 years, one shouldn't think about owning it for 10 minutes.
While Occidental's stock looks cheap today, its deep inventory of quick-return projects and high-productivity technology bodes well for the next 10 years. Meanwhile, Occidental's capacity and ability to invest in low-carbon technologies points to an additional act beyond that.
With Occidental attractive on present, near-future, and far-off-future terms, it's no wonder the company may become part of Berkshire one day.
