ConocoPhillips: Buffett’s Most Disastrous Macroeconomic Bet

I. Timing and Context Purchase Period: Continuous buying from 2006 to early 2008 Admission of Error and Exit: End of 2008 Buffett’s Age: 76 to 78 years old 2008 was an exceptionally turbulent year in Buffett’s investment career. The global financial crisis erupted, Lehman Brothers collapsed, stock markets crashed, and global financial markets plunged into panic. For Buffett, this year not only meant extreme external volatility but also signaled the rapid collapse of a major energy-sector bet—one that was unraveling at an unprecedented pace. That bet was ConocoPhillips. Starting in 2006, Buffett steadily accumulated shares of ConocoPhillips. By early 2008—when oil prices surged past $140 per barrel—Berkshire Hathaway had become one of ConocoPhillips’ largest shareholders. Yet just months later, as the full force of the financial crisis hit, oil prices plummeted from $140 to below $30, triggering a catastrophic collapse in ConocoPhillips’ share price. Buffett was forced to substantially reduce his position by year-end 2008, publicly acknowledging his error—and absorbing losses totaling several billion dollars. This represented one of the largest single-position losses in his investment career—and stands as a classic cautionary tale about the risks inherent in macroeconomic forecasting. II. What Kind of Company Is ConocoPhillips? ConocoPhillips is one of the world’s largest independent exploration and production (E&P) companies for oil and natural gas. It was formed in 2002 through the merger of Conoco and Phillips Petroleum. It owns upstream exploration assets across the globe, boasts vast proven reserves, and maintains strong refining capabilities. Between 2006 and 2008, ConocoPhillips ranked as the third-largest integrated energy company in the United States—behind ExxonMobil and Chevron—and operated in dozens of countries worldwide. Its asset portfolio included mature fields on Alaska’s North Slope, deepwater exploration projects in the Gulf of Mexico, oil sands operations in Canada, and international assets across the Asia-Pacific region and the Middle East. From an industry standpoint, ConocoPhillips possessed the scale advantages Buffett admired—massive proven reserves, mature development capabilities, and a globally diversified asset base. At historically high oil prices, these assets were valued by the market at exceptionally high multiples. III. Investment Rationale: Why Did He Buy? The ConocoPhillips investment differed fundamentally from Buffett’s prior failures. This was not an acquisition—it was a pure equity investment: he purchased publicly traded common stock, not protected preferred shares or a full buyout. 1. Unwavering Belief in Sustained Oil Price Increases This belief formed the core of the entire investment thesis—and proved to be the critical, ultimately erroneous judgment. Between 2006 and 2008, international oil prices experienced one of the most dramatic rallies in history. Brent crude rose from $30 per barrel in 2003 to a record high of $147 in July 2008. Key drivers behind this surge included: rapid industrialization in emerging economies like China and India, generating massive oil demand; years of underinvestment in exploration, resulting in new discoveries failing to keep pace with consumption growth; OPEC’s supply constraints, rendering the supply side inelastic; and persistent political instability across the Middle East. These factors led many market participants to believe the world was entering a new era of “peak oil”—where supply would soon plateau while demand continued rising, locking oil prices into a long-term high range.

International | The 2018 S&P 500 Energy Index Performed Abysmally—Yet ConocoPhillips Stood Out. Why?

Although conditions improved slightly in the following days, it was insufficient to reverse the full-year downturn. ConocoPhillips clearly stood apart: as of December 31, 2018, its annual gain stood at 11.86%, making it the top performer within the energy sector. 2018 Was a Terrible Year for the S&P 500 The S&P 500 index edged close to bear-market territory in December 2017 and continued performing poorly throughout 2018, posting a cumulative decline of 7.05%—its worst annual performance since the 2008 financial crisis. Especially notable was December 24, 2018—the first time all S&P 500 sector indices simultaneously posted losses: Health Care fell 2.3%, Materials dropped 22%, and Industrials declined 20%… Among them, the Energy sector fared worst, plunging 25%. A sharp oil-price correction beginning in October 2018 dragged down the broader energy stock index. Major U.S. energy stocks nearly erased all their gains for the year. Investor concerns over an impending economic recession dampened sentiment toward energy equities—even though these stocks, after years of cost-cutting and productivity improvements, generated robust cash flows, they still failed to restore investor confidence. According to data from Fidelity Investments, among the 11 industry sectors comprising the S&P 500 in 2018, only three posted gains: Consumer Discretionary, Health Care, and Utilities—with modest increases of roughly 2% each. By contrast, the Energy sector performed worst, falling 18.31%. Closely related sectors—Industrials and Materials—also underperformed, declining 14.54% and 17.39%, respectively—reflecting broad-based weakness across the U.S. economy. Divesting Non-Core Assets and Focusing on Core Business Against this bleak backdrop, ConocoPhillips managed to stand out in the oil industry—a feat attributable directly to its precise and decisive strategic decisions. In early 2018, when ConocoPhillips announced its decision to exit portions of its acreage in the Permian Basin shale play and South Texas, some observers expressed confusion: Given the Permian’s bright outlook, shouldn’t everyone be rushing there? But ConocoPhillips made it clear this was not a case of “at any cost.” To sharpen focus on priority initiatives and pursue higher shareholder returns and high-return projects, the company sold non-core assets valued at $250 million. Earlier in 2018, following its announcement to divest Permian and South Texas assets, ConocoPhillips also declared plans to spin off its UK North Sea operations. The price tag for this asset was striking: As of Q3 2018, this $3 billion field produced up to 67,000 barrels per day. ConocoPhillips was engaged in exclusive negotiations with INEOS regarding this asset. Additionally, ConocoPhillips actively pursued claims against Petróleos de Venezuela, S.A. (PDVSA), seizing PDVSA’s assets in the Caribbean and compelling the state-owned oil company to negotiate payment terms. Victory in this protracted dispute bolstered investor confidence. Raising Dividends and Repurchasing Shares Despite reporting a net loss in 2017, ConocoPhillips repaid $7.6 billion in debt and repurchased $3 billion worth of its own shares.

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