Buffett lifts fossil fuel bets as global ESG push mints bargains

Warren Buffett’s multibillion-dollar purchases of oil and gas investments early in the pandemic paid off when the sector cranked out record earnings in 2022. But instead of selling out for a huge profit this year, the Oracle of Omaha wants more.

Berkshire Hathaway is using this year’s dip in commodity prices to load up on some of Buffett’s favourite oil and gas investments, showing that history’s most famous investor sees opportunity in a sector long disfavored due to its volatility and effects on the climate.

Earlier this month, Berkshire agreed to spend $3.3 billion to boost its stake in a liquefied natural gas export terminal in Maryland. This year it has also increased its holding in Occidental Petroleum by 15% and bought more stock in five Japanese commodity traders. Meanwhile, Berkshire’s energy division is lobbying hard for a bill that would see Texas spend at least $10 billion on natural gas-fired power plants to back up its grid.

On one level, it’s classic bargain-hunting by Buffett and Berkshire Vice Chairman Charlie Munger. Persistent concerns over the sector’s environmental, social and governance performance, poor pre-pandemic returns and the risk of declining demand for fossil fuels in the decades ahead have soured many investors on the industry. Energy trades at the lowest price-to-earnings valuation of any sector in the S&P 500 Index, according to data compiled by Bloomberg. But it also generates the most cash flow per share.

“People are missing the economics that Buffett and Munger are looking at,” said Cole Smead, chief executive officer of Smead Capital Management, which manages $5.4 billion, including Berkshire and Occidental shares. “The returns on capital in coal, oil and gas are off the charts compared with other sectors. And with ESG, you can buy them cheaper than you otherwise would.”

Nuanced bet

But Buffett’s fossil fuel bet isn’t without nuances. While Berkshire remains the third-largest shareholder in Chevron Corp., it cut its stake by about 21% in the first quarter. Occidental, Cove Point LNG and Japan’s trading giants all have unique assets that will play a key role in powering the world no matter what path the energy transition takes, if it occurs at all.

Even Berkshire’s seemingly straightforward investments in oil have their subtleties. Take Occidental. Buffett invested $10 billion to help Occidental beat Chevron in a bidding war for Anadarko Petroleum Corp. in 2019, and the company now owns an area the size of Jamaica in the world’s biggest and lowest-cost shale oil field.

At this year’s annual meeting, Buffett stressed how shale is different from conventional crude sources in Russia and the Middle East. Shale wells, which make up the majority of US production, can be brought on quickly and have short lifespans, making operators more flexible in responding to oil demand and prices.

“In the United States, we’re lucky to have the ability to produce the kind of oil we’ve got from shale, but it is not a long-term source like you might think by watching movies,” he said, dubbing it “short-lived oil.”

Buffett also said “both extremes” in the climate debate have gotten “ridiculous” in their arguments.

“We will make rational decisions,” he said. “We do not think it’s un-American to be producing oil.”

Cove Point LNG provides another example of a nuanced energy play. The facility buys gas from the nearby Marcellus shale and chills it into a liquid before shipping around the world. It also has the rare ability to import gas, something rival plants on the Gulf Coast can’t do. Global LNG demand has risen substantially in recent years as Europe replaces Russian gas, Asia uses it to generate more power for its growing economies and countries seek cleaner alternatives to coal.

But Cove Point also has several unique advantages. In contrast to the several multibillion projects along the Gulf Coast that have been sanctioned since Russia’s invasion of Ukraine, Cove Point is well established, having operated since 2018. It’s located in Maryland on the East Coast where laws make rival facilities difficult to build, reducing competition. Crucially, it’s underpinned by long-term contracts with buyers including Tokyo Gas Co. and Sumitomo Corp. Berkshire is Sumitomo’s second-largest shareholder after the Japanese government’s pension fund.

Outside of Buffett’s stock holdings, Berkshire Hathaway Energy, which owns utilities, power generation facilities and transmission lines, is in robust shape. Earnings for the division, overseen by Buffett’s anointed successor Greg Abel, reached a record high of $3.9 billion in 2022, almost doubling in five years. Berkshire is scheduled to report second-quarter results on Aug. 5.

It’s a clear sign that the world’s thirst for energy, both fossil fuels and renewable, is insatiable, even as the climate crisis accelerates. Both temperatures and oil demand are hitting record highs this year and are poised to keep rising through the rest of this decade. Environmental concerns may have prompted others to shun energy, but they may also have left the door open for Buffett to profit, Smead said.

“I love ESG” because it helps keep oil and gas stocks cheap, Smead said. “I’m sure Buffett and Munger love ESG as well.”