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Buffett’s Favorite Energy Investment Just Got Better

By Robert Rapier on December 19, 2017

The tax bill that is working its way toward President Trump’s desk should be a boon to corporate America. The current proposal, which looks like it has the votes to pass, will drop the corporate tax rate to 21% from the current 35%.

But energy companies stand to benefit the most.

The Highest-Taxed Sector

According to the corporate tax calculator of MarketWatch, the energy sector has had a median tax rate of 36.8% for the last 11 years, far above the 30% average tax rate for all S&P 500 companies.

Companies at the top of the list, like Marathon Oil Corporation (NYSE: MRO) and ConocoPhillips (NYSE: COP) pay substantial foreign taxes as well. But even most of the lowest-taxed companies on the list pay more taxes than the average S&P 500 company.

Phillips 66 (NYSE: PSX) is one of the largest refiners in the country. Its average tax rate is 31.3%. Since being spun off from ConocoPhillips in 2012, Phillips 66 has delivered a total shareholder return of 170%. Over the same time span, the S&P 500 returned 95%.

Phillips 66 also happens to be Warren Buffett’s largest energy holding.

Buffett’s Favorite Energy Company

Berkshire Hathaway (NYSE: BRK.B) began to buy shares of Phillips 66 in 2012. Berkshire now owns nearly 16% of PSX with a market value of $8.1 billion. This makes Phillips 66 the 7th largest holding in its investment portfolio.

One reason Buffett likes Phillips 66 is that it offers synergies with one of his other companies.

In 2010, Berkshire Hathaway bought the Burlington Northern Santa Fe (BNSF) railroad. One of BNSF’s key customers is Phillips 66, which has multiple refineries along BNSF lines. One of those is the Phillips 66 refinery in Billings, Montana, where I worked a decade ago.

Higher Earnings A Certainty

If Berkshire wanted to acquire PSX, it would have been better to do it before tax reform looked like a certainty. Energy companies should benefit disproportionately from the tax changes.

Bloomberg recently calculated that Phillips 66 could see its earnings next year increase by 16% from the tax change. One reason for the increased benefit to refiners is they have enjoyed positive pre-tax income in recent years. In contrast, many of the oil and gas producers have been losing money in recent years.

But one item in the tax bill will benefit the entire energy industry. The energy sector requires a lot of capital spending. Each year, numerous energy companies invest billions of dollars into new projects.

For instance, Chevron Corp. (NYSE: CVX) recently announced a 2018 capital budget of $18.3 billion. ExxonMobil (NYSE: XOM) spent $22 billion on projects this year.

Under current tax law, these expenditures can’t be deducted in the year they are incurred. Expenditures could be deducted in the year of their occurrence under the new law. This change will further lower the tax burden for the energy sector while encouraging more capital spending.

Here Comes A Rally

Energy companies have rallied since August as oil prices have climbed higher. But because the new tax law preferentially benefits oil and gas companies, the sector could easily outperform the S&P 500 because of expectations for higher earnings.

Of course, oil and gas prices must be accounted for, but that’s less problematic for the refining sector. Expect the overall energy sector, but especially the refining sector, to emerge as a significant winner from the tax reforms.


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