2 Investment Lessons From Warren Buffett’s Huge Energy Bet | Personal Finance

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When Warren Buffett bets on something big, the financial industry takes notice. To be fair, if Buffett is doing anything at all, the investment community is watching closely.

And for good reason. His holding company, Berkshire Hathawayhas yielded an annual return of about 20% dating from 1965, which is double the return of the S&P 500 Over the same period.

This year, Buffett has invested heavily in energy, especially oil companies. According to Berkshire Hathaway’s most recent 13F (an SEC-mandated form that institutional investment managers file every quarter), Buffett invested more than $25 billion in oil companies in the first quarter of 2022.

Here are two valuable investment lessons we can learn from this huge commitment to the fossil fuel industry.

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Invest in secular tailwind stocks

The oil and gas industry has performed exceptionally well in 2022, in a year in which the overall market collapses. The reasons are pretty clear. When the lockdowns came into effect in 2020, people stopped driving and demand for petrol collapsed almost overnight. This resulted in a significant reduction in drilling by oil companies. But more recently, as people went back to work and left their homes after the lockdowns, the demand for petrol has skyrocketed.

Then Russia invaded Ukraine, putting further pressure on oil supplies. In other words, demand has increased and supply has decreased. You don’t need a PhD in economics to understand why oil prices have skyrocketed this year.

So it makes perfect sense that Warren Buffett has recently invested in oil companies, but is this really a “secular tailwind?”

US crude oil production is forecast to average 11.9 million barrels per day (B/D) in 2022 and 12.8 million barrels per day in 2023, which would be a record for most US crude oil production in a single year.

While it may seem like we are about to break our dependence on fossil fuels, in reality we are setting new records for oil production. If these predictions are correct, it is clear that our society is not moving quickly to renewables as our primary energy source.

This is what Buffett is betting on, and so far it has paid off.

Invest in what you know

Buffett and Berkshire Hathaway have been investing in energy companies for many years, so it’s safe to say this is an industry they understand well. While the rest of the world seems to have written off the fossil fuel industry as an aging dinosaur, Buffett used his in-depth knowledge of the oil production process to his advantage.

In the first quarter of 2022, Buffett bought $7 billion in shares of Occidental Petroleum (NYSE: OXY) and increased its stake in Chevron (NYSE: CVX) with over $20 billion.

So far, those bets have paid off immensely:

CVX Total Return Level Data by YCharts

At first glance, you might think that this investment is just a happy short-term speculation on the price of oil. But if you dig deeper into the intricacies of the industry, you’ll begin to understand why Buffett made such a big gamble on these two companies.

Two tables to understand the oil and gas industry

The fossil fuel industry is complex, but the two tables below may shed some light on Buffett’s strategy to invest heavily in this sector.

First, the oil and natural gas industry is divided into three streams: upstream, midstream, and downstream. Here is an overview of everyone’s role in the overall production process:

Upstream

Midstream

Downstream

Locating New Oil Fields

Storage of crude oil and gas

Refining crude oil and natural gas to end product

Wells/Offshore Installations

Transporting oil and gas

Sales to distributors (gas stations, home gas suppliers, fertilizer producers, etc.)

Pumping crude oil out of the ground

Operational pipelines

Sometimes the end product is sold directly to the consumer

Some companies operate in a single stream, while others participate across the spectrum. These are known as “integrated” oil and gas companies.

While it’s understandable to think that any company operating in this sector would be hit hard by rising or falling oil prices, this isn’t necessarily the case, and Buffett understands this.

The following table shows how each flow is affected by oil prices.

How different energy flows are affected by oil prices

Upstream

Midstream

Downstream

Most affected

Less affected

Least affected

It is like that because…

The cost of extracting the raw product is extremely high and largely fixed, while the price they can sell it fluctuates. If the price of oil falls, profit margins also fall.

It is like that because…

These companies collect a fee for the transportation of crude oil, they don’t sell it. This means they are better insulated against price fluctuations; however, they are not immune. If prices fall, less oil is extracted and less has to be transported.

It is like that because…

Since these companies refine the crude into useful products, they charge a premium, which gives them price power.

Both Chevron and Occidental Petroleum are integrated oil companies, meaning they own and operate assets in all three streams of the production and refining process.

So while these companies have benefited greatly from the rise in oil prices, they are also isolated from price falls in the future.

Play to your strengths

The main takeaway from Buffett’s energy bet is to look at sectors and industries within your area of ​​expertise as you will spot unique opportunities. And if those sectors are benefiting from macroeconomic tailwinds, you could look at a once-in-a-decade buying scenario.

As a long-term investor in the oil and gas industry, Buffett saw what was written on the wall and understood that this probably isn’t short-term growth for integrated oil companies like Chevron and Occidental Petroleum.

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Mark Blank has no position in any of the listed stocks. The Motley Fool holds positions in and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 Berkshire Hathaway calls on Berkshire Hathaway (B-shares), short January 2023 on Berkshire Hathaway (B-shares) and short January 2023 $265 calls on Berkshire Hathaway (B-shares). The Motley Fool has a disclosure policy.

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