Warren Buffett has previously advised that when you find yourself in a hole the best action is to stop digging.
This advice apples to Berkshire Hathaway’s (NYSE:BRK.A) investment in Occidental Petroleum (NYSE:OXY). Berkshire Hathaway has about a 2% stake in the shale-oil giant.
In 2019, Berkshire helped Occidental finance an acquisition deal for a rival. The equity financing deal has now taken a turn for the worse after the shale giant offered Berkshire discounted stock in place of $200 million in quarterly dividends.
Occidental obtained $10 billion in equity financing from the investing conglomerate. The terms included a dividend yield of 8% on the preferred stock. This amounts to $800 million a year for Buffett’s firm.
Under Occidental’s current proposal, Berkshire Hathaway stands to gain if OXY stock appreciates.
But what happens if the current trend continues? So far, the signs aren’t good.
Year-to-date, Occidental Petroleum has plunged from around $45 to $12, a depreciation of about 70%.
The chances of the stock rising with oil prices still depressed are slim, which means Berkshire Hathaway could end up hurting for the foreseeable future.
A fall in oil demand of 20 million barrels per day is expected in April. The depressed demand is expected to continue until normalcy returns to the global economy. Until then, downward pressure on oil prices is going to continue.
Currently, Brent crude futures are trading under $30 despite a historic deal to cut production announced over the weekend. The only hope for OXY to get out of this is more protectionism and government aid.
In the lead-up to the announcement of the oil deal, Brent crude futures reached nearly $35 per barrel. The global benchmark has since fallen to around $28 a barrel.
For prices to rise to a level that Occidental can extract crude profitably, deeper production cuts are required.
The damage record-low oil prices are having on U.S. shale is unsettling. According to Reuters, shale producers have abandoned drilling new wells as they put off maintenance.
Some producers have partially shut production as the measures put in place to fight COVID-19 drastically reduced travel and manufacturing. Storage for the crude is also running out and some producers may be forced to sell well below costs. Refiners are also asking producers to cut their deliveries.
U.S. jobs will also be lost, with Rystad Energy estimating 240,000 oil-related positions to be cut in 2020.
Occidental has already acknowledged that it might not survive without the government’s assistance. Last week, CEO Vicki Hollub urged employees in an email to pressure U.S. lawmakers to offer “liquidity to the energy industry.”
The email also asked employees to seek congressional assistance in accessing the Asian markets. Additionally, they were asked to lobby the government to buy more oil for the Strategic Petroleum Reserve.
Clearly, OXY has set aside all pretensions that this is a free market economy. Warren Buffett may be an avowed capitalist but his shale oil investment is looking more like a dud. Unless the government steps in to help.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.
This article was edited by Sam Bourgi.