Warren Buffett’s Multi-Billion Mistake with ConocoPhillips (COP)

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Far be it for me to question the master, but what would possess him to by COP last summer?

He should have sold his entire KFT stake. Private label brands are on fire, KFT is going to have trouble maintaining margins and its multiple. Still short.

Now it is also clear that WEB would not have sold some COP @45 if he had cash reserves. I assume ( from his writing) that cop is not over valued at 45. Glad he clarified some things about COP. My biggest disappointment is that he didnot talk about WFC or AXP.

With all due respect, COP is discussed here as if it was an internet startup. It's one of the best run, largest, most sophisticated integrated oil companies in the world. The temporary meltdown will not last forever. You should decide whether you're an investor or a trader. If you're an investor, which most people here pretend to be, why do you care what the quotation is today, and not in 2015? Do you really believe that in 6 years time these shares will be at even close to current level? The dividend only will give you 22% after tax appreciation and the price of oil will take care of the rest. I would like to repeat what Sam Bronfman once said when Segram bought an oil companies "If it's good enough for the rockefellers, it's good enough for me". These companies emerge from recessions, bigger, stronger, richer. We can do without gold, we cannot do without oil. Forget your multiple, forget valuations.

PS. And who cares what Warren Buffet said?

I'm not sure if you are joking or not but assuming you are being serious...

NelsonBenson: "These companies emerge from recessions, bigger, stronger, richer. We can do without gold, we cannot do without oil. Forget your multiple, forget valuations. "

Is that why a large number of oil & gas companies either went bust or caused massive losses for investors in the late 80's, even though that was right after the economy recovered from the nasty 1982 recession and started booming?

Even if oil prices go up 100%, to say $80, it is possible that many of these companies would cause massive permanent losses for those who bought in the last year or two. Valuation is everything! If the market was pricing in $150 oil in perpetuity, you will likely lose.

I'm not sure exactly when Buffett bought COP but it seems to be a clear mistake. You really need an extremely optimistic macro case (such as China going back to 9% growth rate, USA going to 3%, and the world growing at 3%+ at least) to recover back to where it was. It is probable that the world economy won't grow more than 2% for many years. In my opinion, the boom was partially due to world trade and it won't be repeated. Furthermore, a chunk of the growth was due to debt and that likely won't grow like it has.


COP may be a good investment but it clearly wasn't when Buffett bought it. Buffett says it was a mistake and I have little reason to doubt that he is mistaken.

Thanks for your comment, Sivaram.

First, addressing your $150 barrel an oil priced into equity. As a matter of fact, right about $110 PB stocks of oil companies stopped going up.

Second, and with all due respect, the traders are constantly making these analysis about demand, inventories, etc... neglecting the most fundamental fact about oil. No major oil discovery has produced any oil for the last twenty years. The last one was at the Caspian sea near Kazhastan in 2000. Eight years later not one barrel of oil has been produced and we are about three years away from the inaugural drop.

Third, and foremost, the major oil fields which supply around half of the world's oil, are in a permanent decline averaging 5% a year. In reality, what it means is that even without growth, the supply is constraint, and that's under current reserves estimate which have been always over optimistics. Don't forget that the credit crunch puts a damp on exploration and that doesn't help supply either.

Fourth, the rise of India and China, is permanent and will reawaken. Forget pecentages. We, in America, consume 24% of the world's oil and own 850 cars per 1000 people to India and China 85. That's a 10 to 1 ratio. Make this ratio 10 to 2 and you have another 170 million cars on the road. In addition to the increased consumption, which may or may not coincide with reduced supply, you have roads to build, and new houses to heat as more and more people come out of poverty. That's not a question of if but of when. And that is the difference between speculators and investors, the first deals with the if the second with the when.

Lastly, there are very few stocks that did not drop precipiteously this year, and if I had to put my money on which are NOT permanently impaired, I would put it on the major oil companies. Not on any bank.

PS. Read his words carefully: when he says "cost Berkshire several billions" he doesnt mean billions in permanent losses but billions in missed profits HAD he bought at the lower prices. Note also "I believe in the future prices of oil to be FAR higher than 40-50 a barrel" You should also note that COP was selling at $60 when oil was trading at $50 and so you can assume that part of the stock decline is market and not fundamentally driven.

PS2 - I wasnt joking.

"NelsonBenson: "PS. Read his words carefully: when he says "cost Berkshire several billions" he doesnt mean billions in permanent losses but billions in missed profits HAD he bought at the lower prices. "

We can't be certain and it depends how you interpret what he said.

I can see what you are saying and it could be an opportunity cost that he is talking about but it's not clear.

My feeling is that he is talking about permanent losses. Buffett, like most value investors, does not delve into quotational losses most of the time. Generally, if he says he suffered a loss, it is a permanent impairment. He does talk a lot about opportunity costs (all his errors of omission would fall into this) but this case (an error of commission) seems like an actual loss.


"Note also "I believe in the future prices of oil to be FAR higher than 40-50 a barrel" You should also note that COP was selling at $60 when oil was trading at $50 and so you can assume that part of the stock decline is market and not fundamentally driven. "

I disagree with Buffett and don't share the same bullishness towards oil in the intermediate term (say next 2 to 5 years.) In the long run he may be right but I personally don't look at it as a high macro probability event. The answer is more complicated than it seems because it depends on inflation, purchasing power of US$, economic growth and so on. It is likely that oil will be much higher in, say, 20 years just because of the loss in purchasing power of the currency.

The real question is not really whether oil will be higher in the distant future. Rather, it is whether the market is pricing in higher oil into prices or not. This is where I think he suffered a permanent loss and hence was saying he may have lost billions. I don't follow ConocoPhillips but it doesn't seem overvalued right now. But it looks like it may have been a few years ago, near the prices Buffett bought. I think the market was pricing in much higher long-term oil price when Buffett was buying. THis is why looking at the stock price is difficult. Was the market pricing in $100+ oil when oil was at $50 a few years ago? Or was it not? Was it pricing in $150 when oil was at $100? In bull markets, assets tend to be overpriced so it's hard to draw a conclusion based on past stock prices a few years ago.

I dont think the "market" is pricing anything rationally at this time. For instance Valero, which I dont own, and is the most sophisticated refiner in the world, with the ability to process sour crude, is selling at below its replacement cost. In other words, it would be cheaper to buy Valero than build refineries. There is almost no energy company that hasnt dropped in half, so to say these losses are permanent, would quite far reaching, and would be akin to say that the recession is permanent.

You should note that in principal, the largest companies have a lower cost of production, and are more profitable on the rebound of oil prices. Let's not forget that COP is a huge refiner, like XOM, it makes money best in the middle and not necessary at the highest oil prices. Their distribution is vast, and there are only few with the capital and resources to drill in deepwater.

As a matter of fact, where BRK is likely to suffer much more permanent losses is with Banks and Construction related businesses that are quite permanently impaired.
W

Continued:

I think the letter adresses more the embarassment of guessing wrong the direction of oil prices and suffering such a substantial drop so quickly, rather than a view on the futures. And probably, a regret of not deploying so much money into other areas such as fixed income. I don't think private investors should draw any conclusions. Or take any action, I would say though, that as a relatively knowledgeable oil investor, I lose no sleep on the oil stocks, as I do with the Humana's and Citigroup of the world (neither of which I own). The bottom line is that they make something people need and will nee despertately for many many years to come.

Sincerely

One more thing; if you were to assign valuation, go and buy a small private company (I am a businessman) you would most likely pay a multiple of 5-6, take a huge risk, and get no dividend. From that perspective, you have the opportunity to own the 3rd US major at a multiple of 3-5, with 4% dividend, and a great product. Not so bad

Shivaram, you may want to watch this video

[articles.moneycentral.msn.com]

I don't understand Warren's persistence with the ConocoPhillips purchase despite his initial investment thesis i.e. high oil prices continuing being proved wrong.

It's interesting that he notes that he didn't consult Charlie Munger on this investment. As a keen poker player I don't think Charlie would have approved of "holding" in an investment like this after it seemed that cards from the Flop, Turn and River were awful (i.e. a collapse in oil prices) compared with what was required for the investment to work out (i.e. high oil prices).

I only make this comment, not in the spirit of disrespecting Warren, but only in the spirit of wondering why such a brilliant investor can make mistakes like this one.

Applying the logic of a poker game like Texas Holdem to investing can often help to provide a useful framework for an ongoing evaluation of investments. Warren clearly doesn't use it though!

Masked Financier:

I think investing and poker have nothing in common. One is partial ownership in a business concern, the other is a card game. I could say that investing and checkers are similar if that was the case. Warren's investment in COP will work out just fine. Never trust masked men.