Why Warren Buffett May Be As Wrong About Oil As He Was With Tesco PLC

Warren Buffett has sold his entire Exxon Mobil (NYSE: XOM) stake for $3.74bn, it emerged on Wednesday. It was an unexpected move — but what does it mean for the shares of major oil players and those of their smaller rivals? 

Oil Majors: In A Sweet Spot?

“Oil prices tumbled on Thursday after another big weekly build in US crude inventories and a possible rise in Saudi output stoked worries about oversupply,” Reuters reported on Thursday. In early trade, Brent crude futures for April were down $1.67 at $58.86 a barrel, extending declines from Tuesday’s two-month high of $63, Reuters added. Only two days ago, the headline was: “Oil up from early sell-off as Brent sets 2015 high”.

If you are confused, don’t lose focus. 

Oil prices are holding up relatively well: Brent crude at $30-$40 a barrel is not the medium-term target. Saudi Arabia and other Opec members won’t sit idle for long, in my view. Oil prices go up and down in cycles, and this is simply a time when oil majors must cut back on heavy investment and slash operating costs in order to continue to pay dividends and report economic profits.

Things are a bit different for smaller players. As revenues plunge, they find it more difficult to procure the necessary working capital funding — for survivors, one option would be to consider deeper diversification into, say, services.

It Could Have Been Worse…

Brent crude has halved since July 2014, yet the shares of Exxon are down only 10% over the period, while BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) have lost about 12% of value. Dividends do not mitigate the losses. 

That’s not a terrible short-term performance, however. You’d feel safer if you were invested in oil majors in a world where oil prices surge to $80 a barrel, wouldn’t you? Well. that’s the world you may be living in by the end of this year. 

Either way, it’s not just about oil prices for the stocks of major oil producers. What matters, really, is how quickly producers adapt to a changing environment. Based on trading multiples, Exxon’s 33% more expensive than BP, which, in turn, is less attractive than Shell. Their strategies and the way they have communicated with investors in recent months are elements to like, in my view.

If anything, asset disposals won’t be easy to execute. 

10% Upside 

I have been keeping a close eye on Exxon for a few years now: the world’s largest publicly traded oil company is still a terrific yield and growth play, in spite of depressed oil prices, although I appreciate Exxon does not trade in bargain territory. 

Exxon has had some problems in the last couple of quarters, as one would imagine, yet there’s no reason why a value investor should jump ship now, in my view. In fact, I believe this would be a good time to add Exxon to your portfolio, betting on parity for the USD/EUR exchange rate and on a more stable USD/GBP rate. 

Exxon And Tesco: So Different, So Similar? 

Buffett’s Berkshire Hathaway got rid of 41 million shares in Exxon in the last quarter of 2014, after about a year, having acquired the $3bn-plus stake in the second half of 2013.

At that time, Exxon was high on my radar: the opportunity to invest in such an attractive yield proposition (forward yield above 3%) and on the strength of the US dollar against the euro and the British pound (+20% and +4% since the third quarter of 2013, respectively, on average) was almost too good to be true.

I gave it a pass because I found a higher yield with lower risk elsewhere, recording roughly the same pre-tax performance over the period, but now am tempted to snap up Exxon, and I don’t think current weakness in oil prices justifies Buffett’s move. 

In truth, Buffett’s exit may be a big mistake — just like when he decided to cut his Tesco losses in October. Since he divested, Tesco shares have rallied to record a pre-tax-return return of about 50%…