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Warren Buffett’s Shale Oil Investment Could Turn Into Another Kraft Heinz Disaster

Last Updated September 23, 2020 1:38 PM
Mark Emem
Last Updated September 23, 2020 1:38 PM
  • Berkshire Hathaway’s stake in Occidental Petroleum has fallen drastically in a span of months.
  • An 8% dividend in preferred stock that Warren Buffett negotiated is not looking attractive anymore as oil prices plunged.
  • With the supply glut and demand shock, oil prices are likely to sink even further.

Warren Buffett’s record as an investor is unrivaled. From the mid-1960s to 2018, Berkshire Hathaway (NYSE:BRK.A) witnessed a compounded annual gain of 20.5%  against the S&P 500’s 9.7%. The overall gain during the same period was 2,472,627%.

But the disastrous investment  in Kraft Foods five years ago proved that the Oracle of Omaha is not infallible. A recent investment in shale oil producer Occidental Petroleum Corporation (NYSE:OXY) now looks likely to add to Buffett’s pile of regrets.

Following the oil price war that Saudi Arabia started over the weekend, OXY had plummeted by 53.4% at Monday’s close. With Berkshire Hathaway owning 18,933,054 shares  in the shale oil pioneer, this translated to paper losses of over $268 million in Monday’s session.

Berkshire Hathaway
Berkshire Hathaway holds nearly 19 million shares in Occidental Petroleum. | Source: CNBC 

Warren Buffett’s biggest investing mistake since 2015?

If you stretch the losses incurred over a longer time period, it begins to look like Occidental is Warren Buffett’s biggest mistake since merging Heinz with Kraft Foods in 2015.

The investing conglomerate acquired ordinary shares of Occidental at an average price of $41 . Based on this, by Monday’s close Berkshire Hathaway’s stake in Occidental plunged to just $240 million from around $780 million.

Though it pared some of the losses on Tuesday, Occidental will have it rough as long as crude prices remain low. Brent oil futures are still priced below $40 . With Saudi Arabia in an all-out war with Russia over market share, shale producers like Occidental will bear the brunt due to higher production costs.

Last year, Saudi Aramco revealed that its average crude oil production cost stood at $2.80  per barrel in 2018.

Occidental Petroleum
Source: Twitter 

Russia enjoys lower onshore production costs compared to the U.S. at $18 per barrel .

High drilling costs

U.S. frackers, on the other hand, have production costs that are over 15 times higher than Saudi Arabia’s. Their production costs are more than double those of Russia.

Per the Federal Reserve Bank of Dallas, the break-even prices in the Permian Basin , where Occidental is the top producer , ranges between $48 and $54 per barrel.

Warren Buffett
Oil production costs in the Permian Basin are above $48. | Source: FRBD 

At these production costs, how will Occidental compete when oil prices are below the break-even price?

To make matters worse, oil prices could sink even lower in the face of a supply glut and demand shock. Goldman Sachs, for instance, expects crude prices to plunge to nearly $20 per barrel.

Occidental Petroleum’s high debt-to-equity ratio

The plunge in oil prices has come at a particularly bad time for Occidental as it is heavily indebted. At a time when bond yields have plunged across the globe, investors are fleeing Occidental’s 4.4% bonds indicating  their low confidence.

A large portion of the debt was taken up to finance the oil producer’s takeover of Anadarko. Currently, its long-term debt stands at over $38 billion.

Before the acquisition of its rival, the debt was around $10 billion. Occidental’s debt now exceeds  Chevron Corporation’s (NYSE:CVX) $27 billion even though the latter has a market cap that’s more than ten times larger.

Just like in the case of Kraft Foods where Warren Buffett acknowledged that he “made a mistake,” Occidental could soon turn out to be a purchase that the Oracle of Omaha will regret.

Last August after Berkshire Hathaway had lost nearly $5 billion on its Kraft Heinz investment, Buffett acknowledged the mistake  was primarily because he paid too high a price for Kraft Foods in 2015.

He told CNBC:

I made a mistake in the Kraft purchase in terms of paying too much.

Occidental fails to learn from Buffett’s mistake

Occidental seems to have made the same error as the famed investor. Worse, its woes are being multiplied by low oil prices.

Occidental bought Anadarko at $76 per share (78% in cash and 22% in stock) managing to outbid Chevron. The acquisition of Anadarko was valued at $38 billion .

At the time, one of Occidental’s shareholders Carl Icahn called the deal “hugely overpriced.” 

Oil stocks
Source: Twitter 

On the day the deal closed, the share price of Occidental was $47. On Monday its market cap stood at under $12 billion, about a third of the value of its Anadarko acquisition.

Analysts expect Occidental to reduce its dividend. If it doesn’t, Tudor, Pickering, Holt & Co analysts expect the firm to outspend its cash flow by approximately $2.6 billion .

Having invested $10 billion in Occidental’s preferred stock earning $800 million in dividends  a year, Berkshire Hathaway stands to lose a significant income on top of its massively depreciated stake.

The year might not end before Warren Buffett acknowledges this other mistake.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.