(Bloomberg) — Famed investor Warren Buffett has been steadily building a stake in Occidental Petroleum Corp. in what could turn out to be his biggest acquisition in history. His Berkshire Hathaway Inc. received approval on Friday to buy up to 50% of the shares. Some investors see it as a step toward a full takeover that could ultimately be worth more than $50 billion.
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Here’s why Occidental is attractive to Berkshire:
Butter
Inflation appears to be the mega-trend for the first half of the 2020s, and crude oil is one of the best natural hedges. Russia’s invasion of Ukraine and a lack of investment in new oil fields over the past five years have hit supplies, leading to stagnant production profiles everywhere from OPEC to US shale. Meanwhile, demand for fossil fuels is strong after the pandemic, even as governments push for a shift to clean energy.
With investments in the energy sector from utilities to solar, Buffett claims to be a realist in the fossil fuel debate. “People who are on the extremes of both sides are a little crazy,” he told a 2021 Berkshire shareholder meeting.
Familiarity
Buffett first invested in Occidental in 2019 when the oil company was in a bidding war with Chevron Corp. for the purchase of its Houston international rival Anadarko. Occidental CEO Vicki Holub flew to Omaha, Nebraska, in the company’s Gulfstream V and convinced Buffett to add $10 billion to his war chest. That was enough to change the deal, and Chevron pulled out soon after. In return, Buffett received preferred shares with a yield of 8% per year plus warrants to buy more common shares at a price of $59.62 each. Today, with Occidental at $71.29, those warrants would net a profit of more than $900 million if exercised.
Value
The Anadarko deal was initially a disaster because it loaded Occidental’s balance sheet with more than $30 billion in additional debt just before the pandemic. Occidental’s market value went from $50 billion before the deal in 2019 to less than $9 billion in late 2020 as oil prices collapsed.
But on the other hand, it created a good value play for Buffett. When crude turned late last year and was overwhelmed by Russia’s invasion of Ukraine, Occidental was in prime position to take advantage. The stock has been the best performer in the S&P 500 this year, up more than 140% compared to the index’s 11% decline.
“Oxy started this year heavily leveraged with huge exposure to oil,” said Bill Smead, who manages $4.8 billion at Smead Capital Management Inc. and is a top 20 shareholder in Occidental. Rising crude oil prices mean “they’re now paying off that debt and cash is pouring in. It’s the best of all worlds.
Cash
Too much cash has been Berkshire’s biggest investment challenge over the past few years. The conglomerate had about $105 billion at the end of June. It is expected to generate about $8 billion in free cash flow each quarter for the next five years, according to Gregory Warren of Morningstar Research Services LLC. The highest inflation in 40 years is a great incentive to put that money to work.
Occidental would work better as a subsidiary of Berkshire than as a holding company “given the volatility that exists in the energy/commodity markets,” Warren said. “However, this could turn into a slow takeover where Berkshire buys up to the stakes that FERC allows it to acquire until it can acquire Oxy outright.”
slate
Occidental is not only one of the largest producers in the Permian Basin, the largest oil field in the US, but also has some of the lowest costs with oil prices of just $40 a barrel needed to sustain the dividend. West Texas Intermediate is currently trading at around $90 per barrel. Hollub has mastered the drill-baby-drill mentality that characterized shale in its first decade of life, and now prioritizes profits over production. Free cash flow hit a record $4.2 billion in the second quarter.
Anadarko’s purchase may have been expensive, but it allowed Occidental to increase its holdings in the Permian to 2.8 million acres, 14 times the size of New York’s five boroughs combined. It also added stable cash assets in the Gulf of Mexico and Algeria.
CEO
Buffett has a good personal relationship with Holub, which began at a 2019 meeting in Omaha brokered by the Bank of America Corp. chief executive. Brian Moynihan. This year, the veteran investor praised Holab after reading a transcript of Occidental’s Feb. 25 earnings conference call in which she pledged financial discipline even as oil prices rose.
“I read every word and said that’s exactly what I’m going to do,” Buffett told CNBC’s Becky Quick on “Squawk Box” in March. “She runs the company the right way.”
Inflation Reduction Act
The oil industry has been particularly critical of the Inflation Reduction Act, which President Joe Biden signed into law this month. The $437 billion legislation “discourages needed investment in oil and gas” and offers “the wrong policies at the wrong time,” the American Petroleum Institute said.
But Holub was surprisingly upbeat, calling the bill “very positive.” This may have something to do with the expansion of carbon sequestration tax credits, of which Occidental is a leading proponent. The company has plans to build the world’s largest direct air capture plant, which will claim a $180 tax credit for every ton of carbon sucked from the air.
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