Oil prices have surged past $100 per barrel, creating renewed turbulence in global markets. However, an energy investment made by Warren Buffett years ago is demonstrating its value, raising a classic question once again: should your investment portfolio include energy assets?
Is holding energy stocks still a wise move in the age of AI? Look no further than Berkshire Hathaway (BRK.B) for an answer. Due to the spike in oil prices driven by conflict involving Iran, its energy investment has rapidly generated approximately $2 billion in profits.
Of course, compared to the company's overall scale, this gain is not massive—Berkshire reported a net profit of $67 billion last year—but it is certainly not insignificant. More importantly, it may help reduce the overall risk of the company's investment portfolio.
Berkshire's Energy Bet and Recent Gains
Berkshire holds 264.9 million shares of the major U.S. oil and gas producer Occidental Petroleum (OXY) and possesses the right to purchase an additional 83.9 million shares at a pre-agreed price within the next few years.
These investments in Occidental were made prior to Buffett's planned retirement as CEO of Berkshire by the end of 2025. Last year, when Occidental's stock price declined, these investments resulted in significant paper losses within the company's portfolio. Late last year, Berkshire also reached an agreement to acquire Occidental's chemical business.
Unlike many other large energy companies, Occidental does not lock in future sales prices for its oil and gas through derivative contracts. Consequently, its stock price has a very high exposure to fluctuations in oil and gas prices, whether they move up or down.
This has turned into a positive development since Israel and the U.S. launched joint attacks on Iran on February 28th. The global crude benchmark, Brent crude, rose by about two-thirds in less than three weeks, climbing from around $60 to $100 per barrel.
Simultaneously, in the early stages of the conflict, Occidental's stock price rose by as much as 12%, while the S&P 500 Index (SPX) fell by 3%.
The $6 increase in Occidental's share price added approximately $1.6 billion to the value of Berkshire's stake, raising it from $13.6 billion to $15.2 billion. Berkshire also holds warrants, which are effectively a derivative instrument allowing it to purchase an additional 83.86 million Occidental shares at a price of $59.62.
While these warrants are not publicly traded, traded call options on Occidental stock exist. Call options expiring in December 2028 with a strike price of $60 (allowing the purchase of stock at that price before the expiry date) rose from $9 to $14 within a few weeks.
Given their longer time to expiration, the warrants held by Berkshire should be worth more, but even at current prices, this portion of the holding is valued at $1.2 billion—representing an increase of about $400 million since the start of the Iran conflict.
Upside Oil Price Risk and Portfolio Hedging
These investments provide Berkshire with a buffer to hedge against the risk that persistently rising oil prices could pose to other parts of its portfolio, which includes all its other stock holdings.
Despite a pullback on Monday, U.S. crude prices remain above $90 per barrel, and according to the American Automobile Association, the average U.S. gasoline price has climbed to $3.72, having risen 80 cents over the past month.
However, the real focus now is not on what has already happened, but on what might happen next. Experts are widespread with predictions of oil reaching $150, $200 per barrel, or even higher, warning of various potential disasters. They might be right, or they might not. There are reasons to be skeptical of the most pessimistic forecasts.
But it is undeniable that such scenarios are at least a possibility. If they were to materialize, they would pose a risk to the economy and to the rest of your portfolio. Energy stocks like Occidental would likely thrive with $200 oil, whereas most companies in the S&P 500 would not. The bond market probably wouldn't favor it either: rising oil prices push inflation higher, at least until the economy is dragged into a recession.
Therefore, Berkshire's investment in Occidental effectively acts as a useful diversifier: it could rise even if high oil prices weigh on stocks and bonds.
Historical Data: The Diversification Effect of Energy Allocation
This is a point worth noting for ordinary investors as well. This is not about making short-term predictions, and certainly not about attempting to trade the Iran conflict.
But from a long-term perspective, analysis shows that adding an energy sector component—for example, by allocating to an energy sector fund like the State Street Select Energy SPDR (XLE)—to a traditional portfolio of stocks and bonds can typically significantly reduce volatility and risk, while actually slightly improving long-term returns.
Since the beginning of 1999, a portfolio consisting of 90% Vanguard Balanced Index Fund (VBAIX) and 10% XLE has, on average, yielded an additional 0.4 percentage points of return per year compared to holding the balanced index fund alone. (The Vanguard fund's allocation is 60% U.S. stocks and 40% U.S. bonds, a classic default portfolio.)
Moreover, contrary to what conventional wisdom might suggest, this combination has been more stable. It performed better during the downturn of the 2000s, and during the 2022 energy and inflation crisis, its decline was only half that of the traditional 60/40 portfolio.
Naturally, this does not guarantee future performance will be the same—as investment disclaimers often state, past performance is not indicative of future results.
But by the same token, there are no guarantees for the other assets in your portfolio either. No one can guarantee that stocks will outperform bonds in the future, or even that stocks will necessarily outperform inflation over the next 10 or 20 years.
The only reference anyone has for judging the future is the past. And historical experience suggests that allocating to energy assets has consistently been a very useful method of diversification.
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