Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial), led by legendary investor Warren Buffett (Trades, Portfolio), has been aggressively investing in Occidental Petroleum Corp. (OXY, Financial) over the last few months amid volatile oil prices.
The strategy of the Omaha, Nebraska-based company's leader has been the subject of widespread discussion among investors given the conglomerate could have allocated recent energy investments among a few other large-scale companies. The latest SEC filings from Berkshire Hathaway reveal it bought 7.9 million Occidental shares between March 13 and March 15, bringing its ownership stake to more than 23%. The company's total investment is now valued at more than $11.8 billion as of closing share prices on Wednesday.
In addition, Berkshire owns $10 billion worth of preferred stock and warrants to buy up to 83.86 million additional Occidental shares.
There could be several factors influencing Berkshire’s strategy, which will be covered in this discussion.
Occidental’s stronghold in the Permian Basin
The Permian Basin of West Texas is home to some of the lowest-cost oil-producing wells in the U.S. According to the latest available public data, the Houston-based company is the leading acreage holder in the region with approximately 2.8 billion net acres in its combined Permian Basin portfolio (Texas and New Mexico).
According to Bloomberg, 63% of the oil wells in the Permian Basin have not been developed yet, but this region is already driving the growth of domestic oil production. With the majority of wells waiting to be developed, the area offers a massive opportunity for oil producers to capitalize, and Occidental Petroleum is well positioned to lead the charge.
As such, the company's access to oil wells in the Permian Basin could be one of the main factors behind Berkshire’s decision to accumulate a sizeable ownership stake.
The low breakeven oil price
Occidental’s breakeven oil price, according to company filings, is just above $40, which makes it one of the lowest-cost oil producers in the world.
After reaching record highs last year, oil prices have been volatile so far in 2023. This volatility is expected to continue with little visibility into future demand and supply trends. Macroeconomic and geopolitical uncertainties have not made life easy for energy investors, and it makes a lot of sense to invest in a well-capitalized, low-cost producer to mitigate the risks associated with investing in oil companies that will plunge into losses if oil prices retreat from the current levels of around $70 (West Texas Intermediate crude).
Berkshire might have been attracted to Occidental partly due to this reason.
The diversified product portfolio
Occidental is not just about oil and gas. Subsidiary OxyChem is one of the leading producers of several chemical products in the U.S. The business' product portfolio includes caustic soda, calcium chloride, caustic potash and sodium silicates.
Further, the company is either the market leader for most of its products or is a close second, which highlights the progress OxyChem has made in the last decade to establish itself as an industry leader. The exposure Occidental offers to the chemical production industry could be another factor driving Buffett's investment in the company.
In addition, Occidental is aggressively investing in carbon capture facilities and aims to build the biggest such facility in the U.S., positioning the company to emerge as a big winner of the tax credits the federal government is offering to companies that pioneer the carbon capture movement.
Buffett, as empirical evidence suggests, does not try to time the market. However, the guru has a strong track record of thriving amid different market cycles and conditions, and this success comes down to his prudent asset allocation strategy.
Although inflation has cooled down over the last couple of months, prices are expected to rise at above-average rates in the foreseeable future due to supply chain challenges and the impact of the ongoing war between Russia and Ukraine. Crude oil – although not as recognized as gold - has proven to be a top inflation hedge in the past, with oil prices performing well during several inflationary periods.
As a result, Berkshire’s investment in Occidental Petroleum could have been inspired by the relationship between inflation and oil prices.
Good free cash flow
Occidental Petroleum generated more than $12 billion in free cash flow last year, making it one of the biggest cash cows in the oil and gas industry. Buffett has time and again highlighted the importance of positive cash flows, and Occidental’s strong position on this front could be one of the reasons why he likes the company.
The massive free cash flows generated by Occidental help the company fund its expansion projects without burdening shareholders with more debt or ownership dilution and also pave the way for the company to reward shareholders handsomely through dividends and share buybacks. Buffett has always been a fan of companies that reward long-term shareholders, which makes it easy to understand Berkshire’s bullish stance on Occidental.
Berkshire Hathaway is going big on Occidental, indicating the insurance conglomerate might end up bidding for absolute majority ownership of the company in the future. With billions of dollars held in cash, Berkshire does not seem to be slowing down its investments in Occidental. Although Buffett has yet to officially explain his decision to invest billions of dollars in the stock in recent months, the factors discussed in this analysis could have played an important role.