Warren Buffett's moves into the energy sector over the past few years led to speculation that the Oracle of Omaha's purchases were shaped by a bullish long-term view on energy. But according to Berkshire Hathaway's latest regulatory filings, Buffett has significantly downsized the energy component of his portfolio. What's the reason behind this move? And should investors follow suit?
Buffett offloads energy stocks
According to Berkshire's 13F second-quarter filing, it sold off $688 million worth of shares in Houston-based ConocoPhillips, the world's largest independent exploration & production company, bringing its stake in the company to just $108 million as of last Tuesday.
Berkshire also sold $279 million worth of shares in Phillips 66, effectively cutting its stake in the Houston-based refiner by a third, and divested some $125 million worth of shares in oilfield equipment provider National Oilwell Varco, bringing its total stake to $611 million as of last Tuesday.
Interestingly, however, Berkshire reported no changes to its position in ExxonMobil. The oil giant remained one of the biggest holdings in Berkshire's portfolio as of the end of the second quarter, with the stake valued at $4.1 billion. Does this mean Buffett has suddenly turned bearish on energy stocks?
Not necessarily. We don't always know the motives underlying large, sophisticated investors' quarterly moves. It could be because oil prices are expected to remain pressured in the near term. Or it could be for entirely different reasons, which is all the more reason not to follow Berkshire's moves blindly.
In fact, Buffett may not even have made the decision to sell; it could have been portfolio managers Todd Combs' and Ted Weschler's call. As Buffett has said before, smaller investments like National Oilwell Varco and Phillips 66 could very well be made at Combs' and Weschler's own discretion. Only major buys, like ExxonMobil, would require the man himself to sign off on them.
It is safe to say, however, that Berkshire's decision to pare down its ConocoPhillips stake was widely expected. Since buying $6 billion worth of shares in 2008, a move Buffett called a "mistake of commission," he has been gradually winding down his position in the company. Basically, he bought Conoco at the wrong time, when oil prices were high and the company's share price was very close to its peak, and was caught off guard by the subsequent plunge in both.
Should you follow Berkshire's moves?
Even though Berkshire may have downsized its energy holdings in the second quarter, there are compelling reasons to have a part of your portfolio invested in energy. First, the energy sector is one of few sectors that are relatively cheap on a price-to-earnings and price-to-book basis, both compared to the broader market and to the sector's own historical average.
Second, the sector's cash flow outlook and financial health are finally improving as expensive shale projects come to fruition. According to an analysis by Factset for the Financial Times, operating cash flow for 25 leading North American exploration and production companies will, in aggregate, exceed their capital spending in 2015 for the first time since 2008. This greatly reduces these companies' funding risks and vulnerability to a rise in interest rates and/or a decline in oil and gas prices.
Third, institutional ownership of the sector is low compared to its historical average ostensibly because large fund managers are bearish on oil prices in the near term. This might make it an opportune time to get in. And fourth, escalating tensions in key oil-producing regions suggest the risk to oil prices over the long term is skewed to the upside. In other words, there's a good chance oil prices will be higher five years from now than they are today.
All told, despite what Berkshire's recent moves might suggest, there are some very compelling reasons to stick with energy stocks.