As Oil Falls, Could Buffett's Occidental Play Turn Sour?
Is Warren Buffett (Trades, Portfolio) about to see the share price of Occidental Petroleum (NYSE:OXY) take a turn for the worse? As I sit here watching the price of WTI crude oil plunge, it is a question that I have been thinking about. The price of WTI crude is trading just below $83 per barrel, back to the level it was trading at in January of this year.
While this is significantly below the 2022 high of $120 per barrel recorded at the beginning of March, it is still above the average level of the past couple of years. Indeed, the price of WTI has traded below $75 per barrel for the majority of the past decade, so there is still some way to go before it begins to look cheap.
Still, the falling oil prices will impact the earnings of oil and gas producers, which could have a negative effect on their share prices. Oil prices have declined by around 30% in just a couple of months, which suggests a decline in projected earnings for companies like Occidental.
Buffett has been buying Occidental stock over the past couple of months amidst rising oil prices, despite having disavowed market timing in the past. Is it possible that he might have fallen victim to a mistake he has warned against?
Trying to time the market
One could argue that the situation with Occidental is unique, since Buffett negotiated a pretty sweet deal by investing in the company's debt to fund its acquisition of Anadarko, but that deal did not by any means require Buffett to buy shares on the open market this year.
It's also notable that this isnt the first time the Oracle of Omaha has rushed to buy a stake in an oil business just before the commodity's price plunged. He bought a significant amount of shares in ConocoPhillips (NYSE:COP) just before the financial crisis when oil was trading at around $140 per barrel. He ended up selling the position and booking a significant loss when oil prices plunged.
What is interesting about Occidental is the fact the company has not increased its production as cash flow has surged due to higher oil prices. Total oil production in the second quarter of the year was actually marginally lower compared to the same period a year ago, although operating cash flow hit a record and more than doubled year over year.
Management has been returning cash flow to investors rather than pushing it back into the business, where it might earn a lower rate of return if oil prices fall (that is just what has happened). Moreover, the company's extreme debt did need to be scaled back a little.
It depends on the plan
The question of whether or not Buffett has made a mistake with Occidental really depends on what he wants to do with the equity.
If he wants to acquire the whole corporation, as long as it generates healthy cash flow, then the current stock price will not really matter in the future. However, if he wants to own the stock and sell at a later date, market sentiment will determine the fate of the investment.
Personally, I dont think the Oracle has made a mistake with Occidental. He started buying the stock at a much lower oil price and has much more conservative valuation calculations, building a margin of safety into the figures.
This article first appeared on GuruFocus.
