What’s behind Buffett’s renewed interest in Occidental? | OilPrice.com

Warren Buffett, through Berkshire Hathaway Inc., (NYSE: BRK.A), (NYSE: BRK.B) has quietly amassed a large stake in Occidental Petroleum, (NYSE: OXY). In early August, he had acquired a 20% stake in OXY common stock, sparking speculation about his true plans. Friday the 19the of August the Federal Commission for Energy Regulation-FERC, obtained approval to purchase up to 50% the company. This was necessary because Berkshire Hathaway Energy-BHE (unlisted) participates in oil and gas pipeline transmission and storage services, which are regulated by FERC.

In 2019, Occidental Petroleum launched a bid to acquire Anadarko Petroleum, after it had already agreed to be acquired by Chevron (NYSE:CVX). OXY was ultimately successful in this endeavor after securing $10 billion from Mr. Buffett to replace Chevron’s offer. The final price was approximately $55 billion in cash, public debt issuance and debt assumption from Anadarko. This transaction took place as the oil industry struggled with low prices and high costs. Therefore, OXY arrived in a few months insolvency in March 2020, with the advent of the pandemic. Fortunately, the rebound was so strong in the second quarter that the company started a rebound with higher oil prices. With the WTI pricing regime in place for a year, the company has significantly reduced its debt and should regain investment grade status by the end of the year.

As such, the renewed interest in Mr. Buffett comes as the company generates massive cash flow thanks to higher prices. There has also been a lot of M&A activity in the past two years, with big shale drillers shedding competitors to gain size and scale, in part to avoid being acquired themselves. The question that remains unresolved is whether Mr Buffett will sue the entire company to integrate them into Berkshire’s energy subsidiary. I think there are good reasons for him to follow this course of action and I will discuss them in this article.

cash is king

Buffett likes companies that generate a lot of cash. OXY matches this metric, generating more cash in Q2 ($5.329 billion) than all of Berkshire Hathaway Energy, BHE-untraded, ($5.147 billion). Buffett also owns a large share of Chevron, (CLC). CVX has some commonalities with OXY. They are both throwing huge amounts of money and they are the number 1 and 2 landowners respectively in the Permian Basin. As we will see, rich as he is, Buffett can always use more money.

Buffett needs cash for BHE. Their Renewable energies The segment is aggressively constructing solar, wind, hydroelectric, geothermal and energy mineral farms/facilities across the United States. These facilities are capital intensive (See Exhibit-A). BHE spent $3.382 billion in capex in the second quarter of 2022, which at a going rate would be around $15 billion for the full year. Like us know that renewable energies are capital black holes from which little or no money is issued. (See Exhibit-B) Already. Otherwise for Credit 45Qs (recently supercharged under the Inflation Reduction Act), none of this nonsense would happen on Buffett’s watch. In his mind, tax credits are almost as good as cash because they reduce taxes paid to the government. (See Exhibit-C)

Other traditional oil and gas companies are also entering the renewable energy sector and using their petroleum resources profits to finance these projects. BP CEO Bernard Looney was quoted in a 2021 Reuters article as saying: “Rising oil prices mean BP will be able to raise more cash by selling assets which will be used to grow its business in renewable and low-carbon energy.

For example, BHE completes the large, 550 MW Topaz Solar Project in San Luis Obispo, California. Having OXY’s cash-generating ability would certainly solve a funding challenge for Berkshire’s clean energy business.

The screenshot below (Exhibit B) shows BHE’s capital expenditures for each segment of the renewable energy business. The left column shows spending for Q-2, 2022, the middle column shows spending for the previous year, and the right column shows the total so far for the first half of 2022.

BHE Revolving Footprint – Exhibit A (BHE)

BHE Capex-Part-B (BHE)

Exhibit B reveals the impact of the Production Tax Credits-PTC on overall activity. For the second quarter of 2022, the effective tax rate for BHE Renewables is 5%, on revenues of $6.6 billion. A step up from the federal statutory rate of 21%. As stated above, PTC is like cash.

BHE-Schedule-C (BHE) tax rate

transmission of energy

Buffett loves pipelines. The purchase of Central American Energy-an electricity and natural gas transmission company, in 1999 was its entry into the energy sector. In the years since, he has made a number of other purchases in this space, and currently the BHE Pipeline Group is an energy juggernaut with 21,000 miles of gas transmission lines. An article published in Reuters in 2014 noted regarding where Buffett was likely to spend some of his $49 billion cash hoard,”While not spectacular sources of revenue, regulated utilities tend to be stable and reliable cash generators, a feature Buffett likes. Despite much speculation, the trading that Buffett is famous for encountered a multi-year drought in the energy space that lasted until 2020.

In 2020, Buffett broke the dry spell and caused a stir with his roughly $10 billion acquisition a few years ago from ~ Dominion Energy’s, (NYSE:D) pipelines. As you can see in the graph below, with 21,000 kilometers of pipeline, BHE is one of the largest energy transmission companies in the United States. What does this have to do with OXY, you might be wondering?

OXY owns 51% of Western Midstream Partners, (NYSE: WES), which, as you can see below, fills a significant gap in BHE’s footprint. WES assets include extensive gathering lines in the Delaware Basin, a sub-basin of the Permian Basin and the DJ Basin in Colorado which feed into the Cactus Pipeline which terminates in Corpus Christie, Texas. A hub for the export of crude oil and future LNG facilities. Then there is the Texas Express line which carries NGLs to the world chemical hub, Houston, Texas and the neighboring Houston shipping channel.

WES controls key export infrastructure to markets that BHE does not currently serve and would fit seamlessly into their framework without any overlap. With little overlap, the deal would likely pass scrutiny by the Federal Trade Commission-FTC and other regulators. As big as BHE is, it remains a relatively minor player in the pipeline business. Giant pipeline conglomerates such as Energy Transfer, (NYSE:ET), Enbridge, (NYSE:ENB) and Enterprise Products Partners, (NYSE:EPD) all have multiple multiples of more pipeline kilometers than BHE.

In my view, WES assets would be an essential part of the calculation to make OXY private.

Management

Buffett is a demon for senior executivest. He is known for picking managers and sticking with them through tough times. When Warren gave Vicki Hollub ten billion dollars to do the deal with Anadarko, he was actually “hiring” her as his money manager. If those two hadn’t formed a bond, the loan would never have happened. Let’s get something, Buffett loaned $10 billion to Vicki Hollub, not Occidental Petroleum, whatever the entity was named on the loan documents. Among other things, I think he could have admired his bold approach, flying towards Omaha one weekend to make her pitch.

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Vicki Hollub was absolutely the right person to integrate these two companies. No one knows the Permian Basin like she does. She has worked in the Permian for much of her 30+ year career, in various roles from drilling engineer to area vice president for OXY. When she speaks, this in-depth knowledge of the region permeates the conversation.

Now he’s bolstered his bet on the business by bringing in Steve Chazen-the former CEO, as chairman of the board of directors. Partly to appease Carl Icahn, a well-known activist investor who took a large position in OXY at the end of 2019and wanted Hollub replaced.

Chazen had chosen Hollub to lead the company when he left, making her the first woman to lead a major oil and gas company. This, to me, was further confirmation of his managerial skills in my opinion. The fact that Chazen’s deal with OXY allowed him to continue running Magnolia Oil and Gas, (NYSE: MGY), an operator of Eagle Ford and Austin Chalk, and largely owned by institutional investors, strengthened his position at the head of OXY. Buffett also got the former chairman of Schlumberger, (SLB) Andrew Gould to join the Board of Directors. So Vicki had a lot of “adult supervision”, which made dissident investors happier, but make no mistake, she steered the company through thick and thin. Many people would have started playing the game of “music managers” at the 2020 low. Not Buffett, and now his long-term thinking is paying off. Vicki’s vision of what OXY could be with Anadarko’s assets is now in beast mode.

Your takeaway meals

Obviously, this article involves a lot of speculation on my part. I think Buffett has good reason to issue a stock balance tender. But, something we haven’t discussed is how Vicki Hollub might feel about being part of a corporate conglomerate. In some ways, Buffett can achieve many of his goals by owning 50%. This distances the company from the potential M&A market that could develop if mega-oils, XOM or CVX decided to pull OXY out, which they could easily do.

Buffett has an aversion to hostile takeovers and, with due respect to her, would give her the last laugh. This would put the ball in his court on a possible merger with BHE. At this point, all we can say for sure is that time will tell.

By David Messler for Oilprice.com

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