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On August 19, Warren Buffett’s holding company Berkshire Hathaway (BRK.B) was granted regulatory approval to acquire up to a 50% ownership stake in U.S. oil giant Occidental Petroleum (OXY).
Occidental was already one of the top-performing stocks in the entire S&P 500 prior to this news, but the potential for Buffett to buy more Occidental stock initially sent shares of the oil company up another 10%.
The Federal Energy Regulatory Commission (FIDE) has granted Berkshire the right to buy up to 50% of Occidental—some traders are speculating Buffett may be eyeing a full acquisition of the company.
Warren Buffett’s History with Occidental Petroleum
Warren Buffett’s history with Occidental Petroleum goes back to 2019, when Berkshire helped finance Occidental’s $35.7 billion acquisition of Anadarko Petroleum.
At the time, Berkshire purchased $10 billion in Occidental preferred stock, as well as warrants to buy 83.9 million shares of common stock. The preferred shares gave Berkshire roughly an $800 million annual dividend, which Occidental has paid out partly in stock and partly in cash since Buffett’s initial investment.
Buffett began adding to his Occidental holdings in the first quarter of 2022, disclosing a new stake of 136.4 million shares of OXY’s common stock in late March. The initial Berkshire common stock investment was worth about $7.2 billion and represented about a 13% ownership stake in the company.
Because Berkshire holds a more than 10% stake in Occidental, Berkshire must disclose any OXY stock trades to the U.S. Securities and Exchange Commission (SEC) within two business days. As a result, investors have gotten regular updates on Buffett’s buying throughout the year.
Berkshire added more than 22 million shares of Occidental in the second quarter, upping its ownership stake to 16.4%. A new filing in early August revealed Buffett had upped Berkshire’s Occidental stake to 188.4 million shares representing a 20.2% ownership stake.
Read More: The Top 10 Warren Buffett Stocks
Even without including the value of the preferred shares or the warrants, those 188.4 million shares are currently worth nearly $13 billion, making Occidental Berkshire Hathaway’s sixth-largest portfolio investment.
Why Is Warren Buffett Buying Occidental Petroleum?
Buffet is known as one of the most successful value investors of all time. He’s also well known for having an extremely long-term investment horizon.
“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes,” Buffett famously said in his 1996 letter to Berkshire shareholders.
Following Russia’s invasion of Ukraine in early 2022, energy prices around the world have soared. That trend is certainly bad news for consumers who need gasoline for their cars and natural gas for their homes, but it has been great news for energy sector profits.
In the second quarter, Occidental reported net income of nearly $3.56 billion, compared to a net loss of $97 million in the same quarter a year ago. Total revenue was up 79.1% in the quarter, to $10.6 billion.
With no end in sight to the Ukraine conflict, Buffett likely anticipates the favorable energy climate will continue for the foreseeable future. In addition, Berkshire’s history working closely with Occidental on the Anadarko deal suggests Buffett is familiar with the company’s business.
Buffett has also praised Occidental CEO Vicki Hollub for “running the company the right way.”
Occidental has taken advantage of its higher profit margins in 2022 by using excess cash flow to pay down debt and reduce risk for investors. In the first half of 2022, Occidental paid down $8.1 billion of its debt.
Finally, Buffett is likely itching to put more of Berkshire’s massive $101 billion cash balance to work in the market any way he can. Buffett has said he is committed to maintaining at least $30 billion in cash and cash equivalents on Berkshire’s balance sheet, but inflation will be eating into the value of the excess cash until Buffett finds better places to invest it.
Buffett Bullish On Oil
Buffett may be going all-in on Occidental, but his aggressive buying is also telling about his stance on the outlook for the energy sector and the economy in general.
The energy sector has been by far the best-performing S&P 500 market sector of 2022 and for good reason. At the same time inflation has sent oil prices to multi-year highs, rising costs have eaten into profit margins in other market sectors. In addition, the Federal Reserve‘s aggressive monetary policy tightening, including back-to-back interest rate hikes of 75 basis points each in June and July, are raising the cost of capital for many companies.
As a result, the performance of the energy sector sticks out like a sore thumb so far in 2022. In the second quarter, S&P 500 earnings were up about 6.7% overall. However, without the energy sector’s $47.7 billion increase in earnings in the quarter, the S&P 500’s overall earnings would be down 3.7% compared to a year ago.
Buffett is also not focusing his energy bet exclusively on Occidental. He has also been aggressively building a large stake in U.S. oil and gas major Chevron (CVX) as well.
In the second quarter, Berkshire purchased another 2.2 million shares of Chevron, bringing its total position up to 161.4 million shares worth about $23.3 million.
Occidental has been a stand-out even among high flying energy stocks this year. In fact, Occidental’s 145.9% year-to-date gain makes it the top-performing stock in the S&P 500 by a more than 50% margin.
Buffett gained a reputation for being a contrarian investor, often adding to his holdings by buying the short-term dips in their stock prices. The fact that Buffett is seemingly still scooping up shares of the top-performing stock in the S&P 500 suggests he believes the energy sector boom may be just getting started.
Would Berkshire Hathaway Acquire the Rest of Occidental Petroleum?
Now that Berkshire is authorized to acquire up to 50% of Occidental, the million-dollar question for investors is will he eventually take over the entire company?
Berkshire has reportedly not informed Occidental management of any plans for a full acquisition.
In reality, Buffett may not even be interested in acquiring anything close to a 50% stake in Occidental. Instead, he may simply be giving Berkshire a bit more wiggle room on the regulatory front.
Prior to the FERC ruling on Aug.19, Berkshire was only authorized to own up to 25% of Occidental, a limit it would have exceeded at any time if Buffett had chosen to exercise Berkshire’s warrants.
Regardless of how much more Occidental shares Buffett buys, CFRA analyst Catherine Seifert says she does expect Buffett to keep buying.
“We expect Berkshire to continue to add to its OXY position, but also note the company has an $11B commitment late this year when it closes on its acquisition of Alleghany Corporation,” Seifert says.