Warren Buffett, through Berkshire Hathaway Inc., (NYSE:BRK.A), (NYSE:BRK.B) has been quietly amassing a significant stake in Occidental Petroleum, (NYSE:OXY). As of early August, he had acquired a 20% stake in the common shares of OXY, arousing speculation about what his true plans were. On Friday the 19th of August the Federal Energy Regulatory Commission-FERC, granted approval to buy up to 50% of the company. This was necessary as Berkshire Hathaway Energy-BHE (not traded) 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, when it had already agreed to be bought by Chevron, (NYSE:CVX). OXY was ultimately successful in this endeavor after securing $10 bn from Mr. Buffett to supersede the Chevron offer. The final price was ~$55 bn in cash, public debt issuance, and the debt assumption of Anadarko. This transaction occurred when the oil industry was struggling with low prices and high costs. As a result, OXY came within a few months of insolvency in March 2020, with the advent of the pandemic. Fortunately, the rebound was so strong in the second quarter, that the company began a rebound with higher oil prices. With the WTI price regime that’s been in play for the last 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 is generating massive cash flows from higher prices. There has also been a lot of M&A activity in the last couple of years with larger shale drillers taking out competitors to gain size and scale, in part to avoid being acquired themselves. The question that remains unresolved is whether Mr. Buffett will pursue the entire company to fold them into Berkshire’s energy subsidiary. I think there are good reasons for him to carry out this course of action and 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 bn) than all of Berkshire Hathaway Energy, BHE-not traded, ($5,147 bn). Buffett also owns a sizeable chunk of Chevron, (CVX). CVX has a couple of things in common with OXY. They are both throwing off massive amounts of cash and they are the number 1, and 2 land holders in the Permian basin respectively. As we will see, rich as he is, Buffett can always use more cash.
Buffett needs cash flow for BHE. Their Renewables segment is aggressively building solar, wind, hydro, geothermal and energy minerals farms/facilities across the U.S. These installations are very capital intensive (See Exhibit-A). BHE spent $3,382 bn on capex in Q-2, 2022 which on a run rate basis would be ~$15 bn for the entire year. As we know renewables are capital black holes from which little or no cash is emitted. (See Exhibit-B) Ever. If not for 45Q credits (recently supercharged under the Inflation Reduction Act), none of this nonsense would be happening under 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 renewables business and using their petroleum-generated profits to fund these projects. BP CEO, Bernard Looney was quoted in a Reuters article in 2021 as saying, “Higher oil prices mean BP will be able to raise more cash from selling assets that will go towards building its renewables and low-carbon business.”
As an example, BHE is completing the large, 550MW Topaz Solar project in San Luis Obispo, California. Having the cash-generating capacity of OXY would definitely bridge a funding challenge for Berkshire’s clean energy business.
The capture below (Exhibit-B) shows BHE’s capital outlays for each segment of the renewables business. The column on the left shows the outlay for Q-2, 2022, the middle column shows the outlay for the prior 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 Q-2, 2022 the effective tax rate for BHE Renewables is 5%, on revenues of $6.6 bn. Quite a step down from the Federal Statutory Rate of 21%. As noted above the PTC is just like cash.
BHE Tax rate-Exhibit-C (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, he has made a number of other buys in this space, and currently, BHE Pipeline group is an energy juggernaut with 21,000 miles of gas transmission lines. An article carried in Reuters in 2014 noted in regard to where Buffett was likely to spend some of his, then-$49 bn cash hoard, “While not spectacular earners, regulated utilities tend to be steady, reliable cash generators, a feature Buffett likes.” In spite of a lot of speculation the deal-making for which Buffett is famous, encountered a multi-year dry spell in the energy space that lasted until 2020.
In 2020 Buffett broke the dry spell and made a bit of a splash with his ~$10 bn acquisition a couple of years ago of ~ Dominion Energy's, (NYSE:D) pipelines. As you can see in the graphic below, with 21K 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 assets include extensive gathering lines in the Delaware basin, a sub-basin of the Permian basin, and the DJ basin in Colorado that feed into the Cactus Pipeline that terminates in Corpus Christie, Tex. A hub for crude oil export and future LNG facilities. Then there is the Texas Express line that carries NGLs to the chemicals hub of the world, Houston, Texas and the nearby Houston ship channel.
WES controls key export infrastructure to markets that BHE does not currently serve and would fit right into their framework without any overlap. With little overlap, the deal would probably pass Federal Trade Commission-FTC and other regulatory agencies' review. As big as BHE is, it is still a relatively minor player in the pipeline space. Giant pipeline conglomerates such as Energy Transfer, (NYSE:ET), Enbridge, (NYSE:ENB), and Enterprise Products Partners, (NYSE:EPD) all have several multiples more pipeline miles than BHE.
In my view, the WES assets would form a critical part of the calculus to take OXY private.
Buffett is a fiend 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 consummate the deal with Anadarko, he was in-effect "hiring" her as the manager of his money. Had those two not formed a bond, the loan would never have occurred. Let’s understand something, Buffett loaned Vicki Hollub $10 bn, not Occidental Petroleum, regardless of the entity name on the loan papers. Among other things I think he might have admired her gutsy approach, flying to Omaha on a weekend to make her pitch.
Vicki Hollub was absolutely the right person to integrate these two companies. No one knows the Permian basin the way she does. She's worked in the Permian for much of her 30+ year career, in various roles from Drilling Engineer to Area VP for OXY. When she speaks this in-depth knowledge of the area permeates the conversation.
Now he did reinforce his bet on the company by bringing in Steve Chazen-the former CEO, as Chairman of the Board. In part to placate Carl Icahn, a noted activist investor who took a large position in OXY in late 2019, and wanted Hollub replaced.
Chazen had hand-picked Hollub to run the company when he left, making her the first woman to run a large oil and gas company. This, to me, was further ratification 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 Eagle Ford and Austin Chalk operator, and largely held by Institutional investors, further cemented her position at the helm of OXY. Buffett also got the former Chairman of Schlumberger, (SLB) Andrew Gould to join the board. So Vicki had a lot of “adult supervision,” which made dissident investors happier but make no mistake she has run the company through thin and thick. A lot of people would have started playing the "musical managers," game at the lows of 2020. Not Buffett, and now his long-range thinking bears fruit. Vicki's vision of what OXY could be with Anadarko's assets is now in full beast mode.
Obviously, this article involves a lot of speculation on my part. I think the rationale is strong for Buffett to launch a tender for the balance of the shares. 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 a lot of his objectives by holding 50%. It takes the company off the potential M&A market that might develop if the mega oils, XOM or CVX might decide to take out OXY, something they could easily do.
Buffett has an aversion to hostile takeovers, and with the regard, he has for her, would give her the final say. That would put the ball in her court about a possible merger into 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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