Warren Buffett, through Berkshire Hathaway Inc., (NYSE:BRK.A), (NYSE:BRK.B) is quietly amassing a significant stake in Occidental Petroleum, (NYSE:OXY). Since the beginning of August he had acquired 20% of the common shares of OXY, causing speculation about his real plans. On Friday, August 19, the Federal Energy Regulatory Commission-FERC approved the purchase of up to 50% of the company. This was necessary as Berkshire Hathaway Energy-BHE (not traded) engages in oil and gas pipeline transportation and storage services, which are regulated by FERC.
In 2019 Occidental Petroleum launched a takeover bid for Anadarko Petroleum when Chevron, (NYSE:CVX) had already agreed to buy it. OXY ultimately succeeded in this venture after securing $10 billion from Mr. Buffett to replace Chevron’s bid. The final price was ~$55 billion in cash, a public debt issue and an assumption of Anadarko debt. This transaction took place when the oil industry was struggling with low prices and high costs. As a result, OXY came within months of insolvency in March 2020, with the advent of the pandemic. Fortunately, the recovery was so strong in the second quarter that the company began a recovery with higher oil prices. With the WTI price regime in place for the past year, the company has dramatically reduced debt and is expected to regain investment grade status by the end of this year.
As such, Mr. Buffett’s renewed interest comes as the company generates huge cash flow from higher prices. There has also been a lot of M&A activity over the past two years, with larger shale drillers gobbling up competitors to gain size and scale, in part to avoid being acquired. The question that remains unresolved is whether Mr. Buffett will seek to fold the entire company into Berkshire’s energy subsidiary. I think there are good reasons to take this course of action and we will discuss them in this article.
Cash is king
Buffett likes businesses that generate a lot of cash. OXY fits that metric, generating more cash in Q-2 ($5,329 billion) than all of Berkshire Hathaway Energy, BHE-not-traded, ($5,147 billion). Buffett also owns a significant chunk of Chevron, (CVX). CVX has a few things in common with OXY. Both are throwing around huge amounts of cash and are the No. 1 and No. 2 landowners in the Permian Basin, respectively. As we’ll see, no matter how rich he is, Buffett can always use more cash.
Buffett needs cash flow for BHE. The Renewables sector aggressively builds solar, wind, hydroelectric, geothermal and energy fossil farms/facilities throughout the US. These facilities are capital intensive (See Exhibit-A). BHE spent $3,382B in capital in 2Q22, which at current rate would be ~$15B for the full year. As we know renewables are capital black holes that emit little or no cash. (See Exhibit-B) Always. If not for 45Q credits (recently supercharged under the Inflation Reduction Act), none of this nonsense would have happened on Buffett’s watch. In his mind tax credits are almost as good as cash as they reduce taxes paid to the government. (See Exhibit-C)
Other legacy oil and gas companies are also entering the renewable energy industry and using their oil-generated profits to finance these projects. BP CEO Bernard Looney was quoted in a 2021 Reuters article as saying, “Higher oil prices mean BP will be able to raise more cash from selling assets to go towards building renewables. energy sources and low-carbon activities’.
For example, BHE is completing the large 550 MW Topaz Solar project in San Luis Obispo, California. Having OXY’s cash-generating capacity will certainly bridge a funding challenge for Berkshire’s clean energy business.
The figure below (Exhibit-B) shows BHE’s capital expenditure for each segment of the renewable energy business. The column on the left shows spending for Q-2, 2022, the middle column shows spending for the previous year, and the column on the right shows the total so far for the first half of 2022.
BHE’s Renewable Footprint-Exhibit-A (BHE)
BHE Capex-Exhibit-B (BHE)
Exhibit-B reveals the impact of Production Tax Credits-PTC on the overall business. For Q2 2022, the effective tax rate for BHE Renewables is 5% on revenue of $6.6 billion. Quite a step below the federal statutory rate of 21%. As noted above, PTC is just like cash.
BHE-Exhibit-C Tax Rate (BHE)
Buffett likes pipelines. The purchase of MidAmerica Energy – an electric and natural gas transmission company, in 1999 was his entry into the energy business. In the intervening years, it has made several other purchases in this space, and currently, BHE Pipeline Group is an energy juggernaut with 21,000 miles of gas transmission lines. An article published in Reuters in 2014 noted about where Buffett was likely to spend some of his then-$49 billion cash, “While not spectacular earners, controlled utilities tend to be steady, reliable generators of cash , a trait Buffett likes. ” Despite much speculation, the deal-making for which Buffett is famous, faced a multi-year drought in the energy space that lasted until 2020.
In 2020 Buffett broke the spell and made some noise with his ~$10 billion acquisition a few years ago of pipelines ~Dominion Energy, (NYSE:D). As you can see in the chart below, with 21,000 miles of pipelines BHE is one of the largest energy transmission companies in the U.S. What does this have to do with OXY you may ask?
OXY owns 51% of Western Midstream Partners, (NYSE:WES), which as you can see below fills a significant gap in BHE’s footprint. WES’s assets include extensive gathering lines in the Delaware Basin, a sub-basin of the Permian Basin and the DJ Basin in Colorado that feed the Cactus Pipeline that terminates in Corpus Christie, Texas. A hub for crude oil exports and future LNG facilities. Then there’s the Texas Express line that carries NGLs to the chemical hub of the world, Houston, Texas, and the nearby Houston Ship Channel.
WES controls key export infrastructure in markets that BHE does not currently serve and would fit right into their framework without any overlap. With minimal overlap, the deal would likely pass review by the Federal Trade Commission-FTC and other regulatory agencies. As big as BHE is, it’s still a relatively minor player in the pipeline space. Giant pipeline groups such as Energy Transfer, (NYSE:ET), Enbridge, (NYSE:ENB) and Enterprise Products Partners, (NYSE:EPD) all have many times more miles of pipeline than BHE.
In my view, the WES assets would be a critical part of the equation to take OXY private.
Buffett is a killer for top management. He is known for picking managers and sticking with them through tough times. When Warren gave Vicki Hollub ten billion dollars to complete the Anadarko deal, he was essentially “hiring” her as a manager of his money. If these two had not formed a bond, the loan would never have been made. Let’s get this straight, Buffett loaned Vicki Hollub $10 billion, not Occidental Petroleum, regardless of the name of the entity on the loan papers. Among other things, I think he might have admired her bold approach, flying to Omaha one weekend to make her pitch.
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Vicki Hollub was absolutely the right person to bring these two companies together. 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 he speaks, this in-depth knowledge of the area permeates the conversation.
Now he’s upped his ante on the company by bringing in former CEO Steve Chazen as Chairman of the Board. Partly to appease Carl Icahn, a well-known activist investor who took a large position in OXY in late 2019 and wanted Hollub’s replacement.
Chazen had hand-picked Hollub to run the company when she left, making her the first woman to run a major oil and gas company. This, to me, was further validation of her talents as a manager in my view. The fact that Chazen’s deal with OXY allowed him to continue running Magnolia Oil and Gas, (NYSE:MGY), an operator of the Eagle Ford and Austin Chalk, and is largely owned by institutional investors, further cemented its position at the helm of OXY. Buffett also had former Schlumberger (SLB) Chairman Andrew Gould join the board. So Vicki had a lot of “adult supervision” which made dissident investors happier, but make no mistake that she runs the company through thick and thin. Many people would have started playing the music manager game in the lows of 2020. Not Buffett, and now his long-term thinking is paying off. Vicki’s vision of what OXY could be with the Anadarko assets is now in full beast mode.
Obviously, this article involves a lot of speculation on my part. I think the case is strong for Buffett to start a competition for the rest of the stock. However, something we haven’t discussed is how Vicki Hollub might feel about being part of a corporate conglomerate. In a way, Buffett can achieve many of his goals by keeping 50%. It removes the company from the potential M&A market that could develop if mega oils, XOM or CVX decide to acquire OXY, which they could easily do.
Buffett has an aversion to hostile takeovers, and with the respect he has for her, he would give her the last word. This would put the ball in its court for 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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