Should We Buy the PetroChina Stock Buffett Sold?

First of all, I think Warren Buffett's investment in PetroChina (PTR) was probably one of the most impressive bets he has ever made. Before China or energy were hot commodities he found a company that was emblematic of both and turned a $488 million investment into $4 billion, an astounding 700%+ return in five years. I'm not sure where that ranks among his all-time best investments (Buffett experts, please let us know), but it is surely his best in recent memory.

Buffett sold his PTR stake in the 150's, after which the stock soared to above $260 per share. China's market has since dropped precipitously, and PetroChina shares now sell for around $120 each. Despite Buffett's decision to exit the stock (20% above current levels), I think PetroChina looks like a good investment today. Before I get into why I think so, let me share what Buffett had to say about his PTR investment in his recently released annual letter to shareholders:

We made one large sale last year. In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $488 million, a price that valued the entire business at about $37 billion. Charlie and I then felt that the company was worth about $100 billion. By 2007, two factors had materially increased its value; the price of oil had climbed significantly, and PetroChina's management had done a great job in building oil and gas reserves. In the second half of last year, the market value of the company rose to $275 billion, about what we thought it was worth compared to other giant oil companies. So we sold our holdings for $4 billion. A footnote: We paid the IRS tax of $1.2 billion on our PetroChina gain. This sum paid all costs of the U.S. government - defense, social security, you name it - for about four hours.

First of all, the paragraph quoted above tells us that when Buffett says his desired holding period for an investment is "forever," that is not entirely true. He buys a stock that he feels is undervalued, and when it reaches fair value in his mind, as PTR did, he sells it. I think any investor trying to outperform would be advised to do the same.

There are some interesting things about this story to mention. When Buffett started buying PetroChina the price of crude oil was $25 per barrel. He tells us in his letter that at that time he felt the stock was worth about 1.7 times its actual market price, or $100 billion.

If we use his own valuation and simply adjust it to reflect higher oil prices, we can determine an approximate value for PTR right now. Oil trades at $100 per barrel today, so that implies Buffett's valuation model gives PTR an intrinsic value of $400 billion, or $223 per share.

Now, you might ask if that math should be trusted why would Buffett choose to sell last year for only $150 per share? Well, it just so happens that crude oil was trading at $70 per barrel when Buffet sold PTR. Since then oil prices have jumped another 50%, which would imply that had he used a $100 oil price assumption, Buffett's fair value for PTR would be about $225 per share. Pretty darn close if you ask me.

So, did Buffett sell PetroChina too early? Well, that depends on how you view the energy landscape. If you think that energy prices are in "bubble" territory and are overvalued at current prices, then he probably got out at a great time.

However, if you are like me and think the bull market in commodities (including energy) has a lot of time left to go which could push crude oil to $150 or more in coming years, then yes, Buffett left a lot of money on the table that investors can now take for themselves. After all, PTR trades at $122 per share right now, about 80% below Buffett's own fair value calculation if you believe oil prices stay elevated long term.

Full Disclosure: Long shares of PetroChina at the time of writing.

Comments

[Will Morris...:]

In his most recent article, Jim Jubak describes the effect of price controls on oil in China. Page 3:
articles.moneycentral....

2008 Mar 25 07:58 AM

[redbeard20000:]

if will posted what i think he did, he hit it right on the head. Trying to tie PTR's market value to the price of oil is laughable at best. Its sad that seeking alpha lets you post articles when you have no clue what you're talking about.

2008 Mar 25 01:30 PM

[Phil G.:]

Will probably meant to point to this page from the Jubak article:
articles.moneycentral....

And while price controls in China have had a deleterious affect on PTR recently (in one of its businesses, PTR buys crude at market, refines, then sells at retail with govt. price caps), I think Brand is still right to say that PTR should profit in the long run from inflated oil prices.

2008 Mar 25 02:03 PM

[adamnb:]

My problem with PTR is that with reserves of slightly over 20 billion b/o, its prices and market cap is nearly is over 15 times that of competitors like giant Russian oil company Rosneft, with nearly equal reserves. Rosneft also has far more potential for discovery within in home country, while PTR is trying to acquire reserves in foreign countries at a time when oil prices are sky-high.

2008 Mar 25 02:32 PM

[milloy:]

Chad Brand = not a fan of the Darfurians

2008 Mar 25 02:40 PM

[live_long_a...:]

Well, Chad ... I HAD PTR as well ... have had for quite some time. Sold half at 150 - 160 on way up .. sold the rest at 160 on the way down.

PS .. I live in Omaha, and go -- every year -- to a 4 or 5 hour meeting with Warren. Just he and I ... and (last year at the Qwest Center) 20,000 others. I've really done quite well over the years by paying good attention to what W.E.B. buys ... AND SELLS. I'm smart enough not to argue with him. (except maybe politics)

2008 Mar 25 03:26 PM

[Mr. Zhao:]

All of you seem to be forgetting that PTR deserves a multiples premium because of its status as a MONOPOLY. I'm fairly certain that the price control on gas is a temporary measure that will be loosened in the long run as China's inflation eases. Further, PTR refines mostly its own oil. PTR is a much better buy than SNP.

2008 Mar 25 09:44 PM

[Al Rob:]

There is a big difference between being bullish on oil prices and being bullish on a chineese oil distribution company that is influenced by a corupt regime.

2008 Mar 25 11:39 PM

[Shanghai Ad...:]

Do any of you folks above actually live in China ? I do. So let me comment briefly - PTR will be the defacto arm of the govt forever. If this means setting price controls for a loss then so be it. It will happen. Also "middle of the barrel" products like diesel will be increasing as a percentage of output and also will squeeze profits further. From a strict valuation standpoint it is impossible to accurately forecast profits for PTR. However, PTR may remain as a good investment because in the long run, China will not let itself be hostage to world markets and the 30-60 day reserves it is building up will be even larger thus resulting in PTR long run strength.

2008 Mar 26 01:26 AM

[fausten:]

will below $100

2008 Mar 30 06:09 PM

[BillR:]

As others have already pointed out, Buffett sold because he didn't want to be associated with the leading company funding the genocide in Darfur. Pressure on this stock will increase as others become aware of this issue and act on it.

Consider the Fidelity funds shareholder proposal where 27/28% of the shareholders in funds voting so far have voted to become genocide-free (and therefore dump PTR).

2008 Mar 31 01:34 PM

[Ames Tiedeman:]

Canadian Oil Trusts look to be far better bets to this investor.

2008 Mar 31 01:57 PM