I'll Give Them Quail Prices

A look at some of Buffett’s most obscure oil investments over the years.

At age 13, Warren Buffett purchased Texas Pacific Land shares.

80 years later, Berkshire is the largest owner of Occidental Petroleum. If Buffett made TPL a 10% position back in 1944, he would’ve owned ~$500 worth of stock. His look through ownership of OXY today is worth more than $6 billion.

When he bought Disney shares in the 1960’s, he equated Mary Poppins to an oil well:

“Mary Poppins had just come out. Mary Poppins made about $30m that year, and seven years later you’re going to show it to kids the same age. It’s like having an oil well where all the oil seeps back in.”

Charlie Munger had his share of oil investments. Munger’s greatest investment ever may have been Belridge Oil. Belridge had 380 million barrels in proven reserves. Its market cap was $110MM. Meaning Belridge’s reserves were being valued at $0.29/barrel. Oil was selling for $5-6/barrel at the time.

Munger also invested $1,000 in oil royalties in 1962. At the time of his death he was receiving in excess of $50,000 per year from this investment.

Today I’ll talk about two oil investments from Buffett’s younger years.

1. Delta Duck Club (1966)

2. Oil & Gas Property Management (1955)

Delta Duck Club (1966)

A duck hunting club was formed in Louisiana. 100 guys were each supposed to contribute $50 a piece to get the club started. Apparently two of the original partners backed out. So, there were 98 shares outstanding. Somewhere along the way a hunter accidentally shot into the ground and oil came bubbling up - just like Jed Clampett.

In 1966, Buffett got a call from a man looking to sell his share in the club. The asking price was $29,000. That valued the business at $2.8MM. Let’s have a look at the financials from the preceding year.

Balance Sheet

• There was $2.2MM of net cash.

• Mineral rights were recorded at $0, but Buffett mentioned that the oil fields were long lived. So he must have pulled reserve numbers from management or other sources.

Income Statement and Statement of Retained Earnings

• Oil prices in 1965 were ~$3/barrel.

• Operating margins were 90%. The club was taking no operational risk in extracting the oil.

• SG&A was kept low.

• The dividend yield was 13%. The dividend payout ratio was 55% for both 1954 and 1955. At this payout ratio, the business would have net cash in excess of its market cap in the next 2-3 years.

Buffett was strapped for cash at the time he received the call to buy a share. So he went down to the local bank and borrowed money in his wife’s name. At the time, the Fed funds rate was ~5%. Let’s say Buffett was borrowing at 10% from the local bank. His dividend, which was certain to grow in future years, would’ve exceeded his cost to borrow. This reminds me of his recent Japanese trading company purchases. Buffett borrowed at less than 1% to buy Japanese companies yielding more than 5%.

The duck club would generate oil royalties for decades into the future. I believe it was producing oil and gas up until 1995 or so. Buffett would’ve slept soundly knowing he had 30 years’ worth of oil underneath his club. Somewhere along the way the club was sold. I don’t know what it sold for, but I’d say Buffett made one hell of a profit on the deal.

Here’s a video of Buffett telling the Delta Duck Club story in 1990’s:

Oil & Gas Property Management (1955)

The Delta Duck Club was obscure, but our next case study is virtually unknown.

Oil & Gas Property Management “O&G” was formed in 1953 with the purpose of owning and managing oil and gas properties. O&G issued $10MM of debentures along with 380,000 shares of stock.

O&G purchased most of their properties in 1954. Purchases were made “subject to large oil payments”. I’m not exactly sure what these oil payments mean in a legal sense. Practically, it looks as though these oil payments act as debt. Maybe the best comparison would be to a seller note. For our purposes it doesn’t matter all that much. We just know that oil payments are senior to our common stock interest in the business.

By the time Buffett writes about the stock in 1955, the company has borrowed a bit more money. Here’s a breakdown of the capital stack at the time of his investment.

So, the common stock sits at the bottom of a seemingly leveraged balance sheet. Interestingly, the oil payments are scheduled to be paid off quickly in the early years. GAAP accounting reflected the oil payments as reduction of revenue. So when readers screened through the Moody’s manuals it appeared revenue and net income were much lower than they actually were. While O&G was booking a net loss for accounting purposes, the enterprise was rapidly increasing its equity stake in its properties as the “oil payments” balance was reduced.

Additionally, $33MM of the total oil payments were due to one property. And oil payments were secured by a given property without recourse to other properties. So that $33MM could be removed from the capital stack without penalty to shareholders (aside from taking a single property).

Murky accounting and legal nuances buried the true value of the investment. But it gets better.

Buffett pulled reserve data from the annual report. He did some quick math on how many reserves were needed to retire oil payments and loans. Here’s what it looked like:

Buffett took the gross reserves and backed out the amount that would be needed to cover “oil payments”. This left $91MM of net reserves. After paying off loans/debentures and accounting for operating expenses to run the business over the extraction period, he estimates there is ~$40MM of value available for common shareholders. Again, the market cap is $5MM.

But this was 1955. Oil was being held at $2.75/barrel. If oil prices rose, as they certainly would, shareholders could make an even greater profit.

Effectively, O&G presented investors with a low risk, leveraged bet on oil at a deep discount to asset value. This is quintessential early Buffett. He got the data nobody cared about and was able to think about it from first principles.

Lessons Learned

Delta Duck Club was pretty straightforward. The numbers jumped off the page. I don’t know how you could see the deal and not like it. O&G was a bit more involved. We still see situations like this today. GAAP accounting misrepresents reality.

Getting the “oil payment” recourse details was integral to understanding downside risk in O&G. Buffett knows how to use leverage in a safe and profitable manner. In the case of Delta Duck, he used leverage personally to generate an infinite IRR. At O&G, the leverage came at the company level. He understood the nuances of those obligations and used it to his advantage as a buyer.

In “There Will Be Blood”, Daniel Plainview disguises himself as a quail hunter in order to buy an oil rich farm at a discount. When his son and business partner asks how much they’ll pay for the property, Plainview says “I’m not going to give them oil prices. I’ll give them quail prices.”

Buffett said “Price is my due diligence”.

A couple of shrewd oil investors.