Warren Buffett has made a massive wager on oil prices this year. His company, Berkshire Hathaway, has built up a more than 20% stake in oil giant Occidental Petroleum (OXY -1.40%) and received regulatory approval to boost that up to 50%. Berkshire has also spent nearly $25 billion to take a sizable position in Chevron (CVX -1.59%).
Those bold bets have paid off big time. Shares of Occidental have rocketed 145%, while Chevron’s stock is up more than 35%, easily outpacing a more than 15% decline in the S&P 500. They could deliver even bigger gains for Buffett if Goldman Sachs is right about oil prices. The investment bank expects them to surge in the coming months — returning to the recent peak of more than $120 a barrel — once the market realizes that a recession won’t offset persistent supply problems. That would give Buffett’s oil stocks more fuel to keep rising.
Drilling down into Goldman Sachs’ bold oil call
Analysts at Goldman Sachs have been pounding the table on oil prices for quite some time. While the bank has trimmed its oil price forecast for the second half of this year from $130-$140 a barrel to $110-$125, it kept its 2023 price target at $125 a barrel. Meanwhile, analyst Jeff Currie recently doubled down on that view, stating that oil would likely return to $120 a barrel as energy shortages in various regions come to light.
That’s well above the current price, which has been hovering around $90 a barrel. Crude prices have cooled off from their summer highs, driven down by fears that a recession would dent oil demand.
However, Goldman Sachs believes the potential demand destruction from an economic downturn won’t be enough to rebalance the oil market. It sees unsustainable supply deficits at the current price point, leading its analysts to believe that crude prices will head higher. That would help incentivize oil producers to increase spending on drilling more wells to boost output.
A potential boon for Buffett’s oil stocks
Occidental Petroleum and Chevron have feasted on higher crude oil prices this year. Occidental Petroleum reported a record $4.2 billion of free cash flow in the second quarter, thanks to surging oil prices. That enabled it to pay off more debt than anticipated, exceeding its full-year repayment target. This debt reduction helped ease the pressure on its balance sheet and enabled Occidental to return more cash to shareholders. It significantly boosted its dividend and launched a $3 billion share repurchase program.
Chevron also produced a cash flow gusher in the second quarter. Cash from operations reached $13.8 billion, while free cash flow came in at $10.6 billion. The company used its surging cash flow to double its investment spending to grow its traditional and new energy business lines, including spending over $3 billion to buy Renewable Energy Group. Chevron also strengthened its balance sheet and increased the top end of its share repurchase authorization range to $15 billion.
The companies will produce even more cash if oil surges like Goldman Sachs expects. That would give Occidental more money to pay off additional debt used to acquire Anadarko Petroleum in 2019. It could also start redeeming the $10 billion in preferred stock it issued to Berkshire to help finance that deal. It needs to start buying back that preferred stock before it can return more than $4 per share in dividends and buybacks to investors, which is possible over the next year.
Chevron has even more flexibility to return any additional cash flow gusher to shareholders, which it would likely do via its share repurchase program. The company could also use the incremental funds to accelerate spending on its transition to low-carbon fuels.
The fuel to keep rising
Warren Buffett has been buying shares of Occidental and Chevron hand over fist this year, wagering that oil prices will continue rising. While crude prices have cooled off over the past few months on recession fears, Goldman Sachs believes they’ll rebound sharply in the coming months. That would be great news for Buffett and other oil stock investors since it should send shares even higher.
Matthew DiLallo has positions in Berkshire Hathaway (B shares). The Motley Fool has positions in and recommends Berkshire Hathaway (B shares) and Goldman Sachs. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.