2 investment lessons learned from Warren Buffett’s massive energy bet | Smart Change: Personal Finances

And for good reason. Its holding company, Berkshire Hathawayhas generated an annual rate of return of approximately 20% since 1965, twice the rate of return of the S&P500 during the same period.

This year, Buffett has bet big on energy, especially oil companies. According to Berkshire Hathaway’s most recent 13F (an SEC-mandated form that institutional investment managers file on a quarterly basis), Buffett invested more than $25 billion in oil companies in the first quarter of 2022.

Here are two valuable investment lessons we can learn from this massive bet on the fossil fuel industry.

The oil and gas industry has done exceptionally well in 2022, a year when the overall market is in steep decline. The reasons are quite obvious. When the shutdowns came into effect in 2020, people stopped driving and demand for gasoline plummeted almost overnight. This has led to a significant reduction in drilling by oil companies. But more recently, as people have started returning to work and venturing out of their homes after lockdowns, demand for gasoline has skyrocketed.

Then Russia invaded Ukraine, which further reduced the oil supply. In other words, the demand has increased and the supply has decreased. You don’t need a PhD in economics to understand why oil prices have skyrocketed this year.

So, it makes perfect sense that Warren Buffett has recently invested in oil companies, but is this really a “secular tailwind?”

According to forecasts by the US Energy Information Administration, US crude oil production will likely average 11.9 million barrels per day (B/D) in 2022 and 12.8 million B/D in 2023, which would establish a record for most US crude oil production in a single year.

Although it may seem like we are on the verge of breaking our dependence on fossil fuels, in reality we are setting new records for oil production. If these predictions are correct, it is clear that our society will not turn to renewable energies as a main source of energy anytime soon.

That’s what Buffett is betting on, and so far it’s paying off.

Buffett and Berkshire Hathaway have been investing in energy companies for many years, so it’s safe to say it’s a sector they understand well. While the rest of the world seems to have viewed the fossil fuel industry as an aging dinosaur, Buffett has used his extensive knowledge of the oil production process to his advantage.

In the first quarter of 2022, Buffett bought $7 billion worth of shares in western oil (NYSE:OXY) and increased its stake in Chevron (NYSE: CVX) over $20 billion.

So far, these bets have paid off extremely well:

CVX Total Return Level Data by YCharts

At first glance, you might think that this investment is just a short-term lucky speculation on the price of oil. But if you dive deeper into the intricacies of the industry, you begin to understand why Buffett placed such a big bet on these two companies.

The fossil fuel industry is complex, but the two charts below could shed some light on Buffett’s strategy for investing heavily in this sector.

First, the oil and natural gas industry is divided into three streams: upstream, midstream and downstream. Here is a breakdown of each role in the overall production process:

Some companies operate in a single stream, while others participate across the spectrum. These are known as “integrated” oil and gas companies.

While it’s understandable to think that any company operating in this industry would be hit hard by rising or falling oil prices, that’s not necessarily the case, and Buffett understands that.

The following chart shows how each flow is affected by oil prices.

Both Chevron and Occidental Petroleum are integrated oil companies, meaning they own and operate assets in all three parts of the production and refining process.

So while these companies have largely benefited from higher oil prices, they are also sheltered from future price declines.

The main takeaway from Buffett’s energy bet is to look to sectors and industries in your area of ​​expertise, as you will recognize unique opportunities. And when these sectors benefit from macroeconomic tailwinds, you might consider a once-in-a-decade buy scenario.

As a long-term investor in the oil and gas industry, Buffett could see the writing on the wall and understand that this is probably not a short-term boom for integrated oil companies like Chevron and Occidental Petroleum.

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Mark Blank has no position in the stocks mentioned. The Motley Fool holds positions and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $200 short puts in January 2023 on Berkshire Hathaway (B shares) and short calls of $265 in January 2023 on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.