2 Investment Lessons From Warren Buffett’s Massive Energy Bet | Smart Change: Personal Finance

(Mark blank)

When Warren Buffett bets big on something, the financial sector takes notice. To be honest, if Buffett does anything, the investment community is watching closely.

And for good reason. Holding him, Berkshire Hathawayproduced an annual rate of return of about 20% dating back to 1965, which is double the rate of return of the S&P 500 during the same period.

This year Buffett has been betting a lot on energy, particularly oil companies. According to Berkshire Hathaway’s most recent 13F (an SEC-required form that institutional investment managers submit on a quarterly basis), Buffett invested more than $ 25 billion in oil companies in the first quarter of 2022.

Here are two valuable investment lessons we can draw from this massive bet on the fossil fuel industry.

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Invest in stocks with centuries-old favorable winds

The oil and gas industry did exceptionally well in 2022, in a year when the overall market is in steep decline. The reasons are quite obvious. When the lockdowns went into effect in 2020, people stopped driving and gasoline demand plummeted almost overnight. This has resulted in a significant reduction in drilling by oil companies. But more recently, as people started returning to work and leaving the house after the lockdown, the demand for gasoline has skyrocketed.

Then Russia invaded Ukraine, which further reduced the oil supply. In other words, the demand has increased and the supply has shrunk. 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 recently invested in oil companies, but is this really a “centuries-old favorable wind?”

According to forecasts by the US Energy Information Administration, US crude oil production is likely to average 11.9 million barrels per day (B / D) in 2022 and 12.8 million B / D in 2023, which would establish a record for most US crude oil production in a single year.

While it may appear that we are on the verge of ending our dependence on fossil fuels, we are actually setting new records for oil production. If these predictions are accurate, it is clear that our society will not move towards renewables as our primary energy source anytime soon.

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

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 appears to have dismissed the fossil fuel industry as an aging dinosaur, Buffett used his deep knowledge of the oil production process to his advantage.

In the first quarter of 2022 Buffett bought shares worth $ 7 billion Western oil (NYSE: OXY) and increased its participation Chevron (NYSE: CVX) of over $ 20 billion.

So far, these bets have largely paid off:

YCharts CVX Total Return Level Data

At first glance, you might think that this investment is just a lucky short-term speculation on the price of oil. But if you dive deeper into the intricacies of the industry, you begin to understand why Buffett has bet so much on these two companies.

Two tables to understand the oil and gas industry

The fossil fuel industry is complex, but the two tables below could 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 a breakdown of the role of each in the overall production process:

Upstream

Midstream

Downstream

Identification of new oil fields

Storage of crude oil and gas

Refining of crude oil and natural gas into the finished product

Drilling wells / offshore equipment

Transportation of oil and gas

Sale to distributors (service distributors, domestic gas suppliers, fertilizer producers, etc.)

Pumping crude oil from the ground

Operational pipelines

Sometimes by selling the finished product 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 industry would be heavily impacted by the rise or fall in the price of oil, that’s not necessarily the case, and Buffett understands this.

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

How different energy flows are affected by oil prices

Upstream

Midstream

Downstream

Most affected

Less impressed

Less impressed

This is why…

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

This is why…

These companies charge a fee for transporting the crude oil, they don’t sell it. This means they are more isolated from price fluctuations; however, they are not immune. When prices fall, less oil is extracted and less has to be transported.

This is why…

Since these companies refine crude oil into usable products, they charge a premium, which gives them pricing power.

Both Chevron and Occidental Petroleum are integrated oil companies, which means they own and manage assets in all three streams of the production and refinery process.

So while these companies have largely benefited from rising oil prices, they are also insulated from price falls in the future.

Play to your strengths

The main focus of Buffett’s energy bet is to look at the sectors and industries within your area of ​​expertise because you will recognize unique opportunities. And when those sectors take advantage of macroeconomic favorable winds, you might be looking at a buying scenario that occurs once every decade.

As a long-term investor in the oil and gas sector, Buffett was able to see the writing on the wall and understand that this probably isn’t a short-term boom for integrated oil companies like Chevron and Occidental Petroleum.

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Mark Blank has no position in any of the titles mentioned. The Motley Fool has positions and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $ 200 call on Berkshire Hathaway (B shares), short January 2023 $ 200 put on Berkshire Hathaway (B shares) and short January 2023 $ 265 call on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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