For the past few years I have been reading everything I can about world oil demand and supply and also been analyzing publicly-traded oil companies on a pretty steady basis. My basic thinking has evolved into a belief that the world is heading for a real oil crunch as demand for oil increases in emerging economies, while our maximum daily production rates are pretty close to having peaked already. As a result, I’ve loaded my portfolio with companies that own undervalued oil reserves.
This week I read a recap of a question and answer session Warren Buffett did with some students at the University of Maryland. Buffett was asked about future oil prices. His reply was that he believed that oil demand might increase over time from 86 million barrels a day to 110 million barrels a day and then decline. So he is with me on that. But he then said that higher oil prices are not a signal to buy oil stocks because of the likelihood of a windfall profits tax being instituted in the United States.
Okay. Let me process that for a minute. My average mind takes in this information and spits out: “Buy oil stocks.” Buffett’s slightly more powerful brain takes the same information and concludes that windfall taxes are likely.
I think it is pretty clear that Buffett believes that we are going to experience higher sustained oil prices. There is no way he can think that the world can increase daily oil production to meet his 110 million barrels a day of production forecast. And I think his investment portfolio shows some serious commitment to the belief in higher oil prices as he has invested billions in:
1. Railroads: Burlington Northern (BNI) ($34 billion). Buffett looks for permanent competitive advantages. With railroads, that permanent competitive advantage comes from its cost advantage over trucking. That cost advantage comes from high oil prices. Here is Buffett from his annual report this year:
Both of us are enthusiastic about BNSF’s [Burlington Northern] future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs.
Concurrently, our country gains because of reduced greenhouse emissions and a much smaller need for imported oil. When traffic travels by rail, society benefits.
2. An electric car company: BYD (OTCPK:BYDDF) (bought 10% of the company). Same story. No way an electric car company is a good investment if oil is at $30. To commit to this young company, Buffett must have a view of permanently higher oil prices, which create a strong demand for electric cars.
3. Conoco Phillips (NYSE:COP), the oil and gas producer (originally invested $7 billion but reduced stake to $2 billion). When Buffett was putting on this large position in 2008, I got very interested in oil. At the time he had about $7 billion invested in Conoco Phillips and another $7 billion invested in Burlington Northern. I thought that showed a huge belief in a future of high oil prices.
He has since sold a lot of the Conoco position, much of which was to realize losses for tax purposes, but he wasn’t buying any other oil producers in 2009, when oil fell below $40. So it appears through his huge Burlington acquisition that he still believes in high oil prices but that he feels exposure to oil producers is not the way to go.
So where does that leave me?
Firstly, still committed to the belief in high oil prices that I have held for quite a while. But I'm also now leery of a potential windfall tax in the United States. What I need to think about is the potential for such a windfall tax in Canada, which is where most of my exposure to oil producers exists. The Canadian economy will be booming with high oil prices, and attacking the beast that is feeding the growth might not be a smart move by Canadian politicians.
If you are interested I’ve written about my two favorite Canadian oil producers, which are somewhat in the doghouse right now even with $105 oil and might be attractive investments: Petrobank (OTCPK:PBEGF) and Petrobakken (PBKEF.PK).
Disclosure: I am long PBEGF.PK, PBKEF.PK.