Berkshire Hathaway (NYSE:BRK-B), a holding company led by legendary investor Warren Buffett, has been accumulating a large stake in integrated oil giant ExxonMobil Corp. (NYSE:XOM) while selling off its position in oil exploration and production company ConocoPhillips (NYSE:COP). Mr. Buffett, who made his fortune buying into companies possessing good management with decent prospects at an attractive price, does not usually purchase or discard shares casually. So why would he undertake this shift in the oil and gas sector? What's so special about ExxonMobil? Let's try to find out.
ExxonMobil, not a bargain purchase
It doesn't appear that Berkshire Hathaway's interest in ExxonMobil was based primarily on valuation. Though Berkshire likes to pick up bargains, Exxon shares don't appear particularly cheap. The oil giant looks to have been trading at 10 times cash earnings around the time Berkshire's purchases were made, based on expected earnings of $39.6 billion -- not much different from peer-company Chevron Corporation, priced at near 9 times estimated cash earnings of $26.1 billion.
Berkshire's sales of ConocoPhillips stock apparently wasn't driven by price either. With a market value at near 7 times cash earnings of $10.8 billion, the company looked to have been trading at a discount to some comparable oil and gas producers. Marathon Oil was valued at around 11 times earnings, and Pioneer Natural Resources was priced aggressively at over 20 times earnings in the same period. But if Berkshire's switch wasn't due to valuation, could the companies' differing prospects be the cause?
The companies have equally good prospects
ConocoPhillips seems to have fine prospects, however. Though the company has operations in 29 countries worldwide, producing North American-based oil has been its most recent focus. Total liquids, meaning oil and natural gas liquids, production in North America increased an impressive 15% year-over-year in the latest quarter. The lucrative business now accounts for 51% of the company's total oil and gas production versus 46% a year ago. Successful activity in shale plays such as the Eagle Ford and Bakken get much of the credit. These finds saw a 40% year-over-year production jump in the latest quarter with Eagle Ford production climbing a whopping 66%.
The company looks to continue its growth. Efforts to further boost production persist in highly regarded U.S. locations like the Niobrara and Permian Basin Wolfcamp regions, and increased conventional drilling in the Gulf of Mexico and Asia should help to replenish any reserve declines.
ExxonMobil looks to have an equally attractive outlook. It has its own presence in North American shale, drilling over 1,100 U.S. wells in 2012. Overseas development offers additional potential. The company has initiated production from the largest oil and gas project on Australia's eastern coast, and a successful Nigerian deepwater project, started in 2012, has shown it could produce up to 180,000 barrels of oil per day.
ExxonMobil's hidden gem
While offering great possibilities, ExxonMobil and ConocoPhillips' on-land and offshore prospects have been well known for some time. But Exxon holds one particular "under the radar" project that could be a huge winner: the Kearl Canadian oil sands development.
This property, with operations begun in early 2013, could provide Exxon with substantial benefits. Kearl's initial production rate is about 110,000 barrels per day, but a fully funded expansion plan will add another 110,000 barrels per day by late 2015 and ultimate production is anticipated to be 345,000 barrels per day by about 2020 -- a significant boon considering the company's total U.S. liquids deliveries currently average around 430,000 barrels per day.
Are oil sands the attraction?
Such growth from Canadian oil sands might be the major reason for Berkshire Hathaway's interest in ExxonMobil. With safe locations, relatively easy production management, and reduced exploration risk, the "sands" method of oil extraction appears to offer a lot of advantages.
Berkshire's engagement might have been confirmed by its 2013 purchases of Suncor Energy (NYSE:SU) shares. Suncor, focused on developing one of the world's largest oil reserves, the Athabasca oil sands, recently announced impressive guidance for 2014. The company expects its average production to be around 590,000 barrels of oil per day, with oil sands deliveries increasing over 14% from last year. Superb growth from a large oil company.
The company's future looks just as bright. Its 2014 capital budget includes $4.2 billion for new developments, with the Fort Hills oil sands mining project being one of the most esteemed. Fort Hills is expected to produce up to 73,000 barrels of oil per day, with first production in 2017. Holding approximately 3.3 billion barrels of best estimate reserves, the site is expected to achieve 90% of its 180,000 barrels per day capacity within twelve months of start up. The mine's long life, in excess of 50 years, suggests it will generate a lot of cash for a long time.
Berkshire Hathaway has been buying ExxonMobil shares and selling off its ConocoPhillips holdings. A primary reason for this trade might be related to Exxon's exposure to Canadian oil sands. It's easy to see why. The "sands" method for extracting oil seems to offer potentially higher production growth with less risk. Investors may want to consider following Berkshire's lead into the oil sands. While shares of ExxonMobil and Suncor Energy have both advanced since Berkshire's purchases were made public, any meaningful pullback might offer an attractive entry point for a compelling oil and gas sector story.