Buffett Smile
Great companies that perform well for years are the heart of Warren Buffett's success. Source: The Motley Fool.

Warren Buffett has made billions of dollars for himself -- and made countless others millionaires at the same time -- through his legendary investing acumen. He has consistently picked great companies to invest in for very long periods of time, and many of those companies have rewarded Buffett and investors in his Berkshire Hathaway (NYSE:BRK-B) (NYSE:BRK-A).

However, one of Buffett's biggest self-proclaimed "mistakes of commission" was buying shares of ConocoPhillips (NYSE:COP) when oil prices were peaking in 2008. Buffett would sell off the majority of that investment -- at a loss of billions -- in 2009:

COP Chart

COP data by YCharts.

The thing is, Buffett went big on another Big Oil player -- the biggest of the big in ExxonMobil (NYSE:XOM) -- in 2013, another year that saw oil prices approaching record levels. And here we are in 2014, with oil prices falling yet again, driven down by a combination of growing supply and demand increasing much slower than anticipated:

XOM Chart

XOM data by YCharts.

Let's look at what makes ExxonMobil a more "Buffet" company to own than ConocoPhillips, and why it's one of Berkshire's biggest holdings. 

What Buffett looks for 
One of the most compelling things about Warren Buffett is that he is unwavering on only a few key business aspects when he invests in a company:

  • Margin of safety
  • Long-term competitive advantage, or moat
  • Great management
  • Value over price

One Buffett quote sums up his investing philosophy almost completely: "It is far better to buy a wonderful company at a fair price, than a fair company at a wonderful price."

His mentor, Benjamin Graham, was heavily focused on so-called "cigar-butt" investing, digging through company financials looking for every hidden dollar of value he could find, like a hobo looking for discarded cigar-butts, with one or two puffs remaining.  This asset-focused, deep value method is largely about capturing assets for less than their value today. 

Buffett -- largely influenced by partner Charlie Munger -- has moved away from those pure value-investor roots, and looks for companies that carry sustainable advantages as a business, and will remain profitable for long periods of time, and then invests in them at a price he finds reasonable. 

In short, value is important, but performance matters most. 

What does that have to do with ExxonMobil? 
The explosive growth of solar in the U.S., along with the increasing popularity of hybrid and electric vehicles, has received a lot of press over the past year. More recently, the Rockefeller Brothers Fund -- the charitable trust set up by the founders of Standard Oil (from which Exxon and Mobil were born) -- joined with another 49 charities in announcing it would divest its holdings in some 200 oil and gas companies and coal producers. In short, there's a major groundswell away from fossil fuels and toward renewables. 

Spwr X Series

Residential solar is a tiny fraction of U.S. power production. Source: SunPower.

Another Buffett quote comes to mind here: "Someone is sitting in the shade today, because someone else planted a tree a long time ago." There are really two ways to interpret that.

First, the renewables push is exciting, but it's very early and it's going to take many more years before it ramps up to replace fossil fuels as a global energy source. Plus, Berkshire is already heavily involved in renewables; through its MidAmerican Energy business, the company produces 7% of total wind energy in the country, and its current renewable (both wind and solar) projects will have cost $15 billion when completed. Buffett isn't ignoring the potential of renewables to power the world.

Second, Buffett is not ignoring how important oil and gas will be for decades to come. Even if the pace has slowed, global demand is still growing. Besides, much of this decline in growth is tied to the continued macroeconomic woes of Europe, and not the long-term trends of population growth and increasing demand for cheap energy. 

Looking beyond oil 

Lubrizol
Demand is growing for petrochemicals like those made at Berkshire subsidiary Lubrizol. Source: Lubrizol.

Even as demand for oil remains muted, demand for natural gas is exploding all over the world, and ExxonMobil is one of the world's largest natural gas producers. Its presence in natural gas production in North America will be a source of strength. Natural gas as a transportation fuel is gaining momentum in the U.S. and in Asia -- where pollution from diesel is a major problem -- due to its significant advantages in reduced tailpipe emissions.

Furthermore, natural gas is a major feedstock and energy source for industrial use. Chemical companies alone have more than $100 billion in new projects lined up in the U.S., almost solely based on cheap natural gas. Ethylene -- the most commonly used chemical ingredient in the world -- can be produced as much as 80% more cheaply in the U.S. than anywhere else in the world. 

These major sources of growth don't even include the potential for domestic natural gas exports. Next year, the first major LNG export facility in the U.S. will go live, and the expected capacity of this facility, at about 26 million tons of LNG per year, is about 4% of total U.S. natural gas production from 2013. 

Final thoughts: Looking far ahead
This is the real driver behind ExxonMobil's place in the Berkshire portfolio. The ConocoPhillips mess was just as much a product of the economic crisis of 2008 and 2009 as it was Buffett making a mistake. The investment in ExxonMobil is his acknowledgement that demand for oil and gas both isn't going away, and that ExxonMobil is the best company for the long term. 

ExxonMobil is the biggest of Big Oil, but it also has one of the most conservative management teams when it comes to allocating capital. This approach has been key to increasing returns, but also gives the company a larger margin of safety when oil prices fall. Even if oil prices remain muted for an extended period of time, ExxonMobil is prepared to ride that out. Looking long term, few oil and gas companies are better prepared for the future.

That's as Buffett as it gets. 

 

 

Jason Hall owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. 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.