Warren Buffett’s Favorite Energy Hedge Fund

The names of the investors stopped me in my tracks.

Warren Buffett owns 17.9 million shares. David Dreman owns 11 million shares. And Bill Nygren owns 2.5 million shares.

You may not know Nygren... but his Oakmark Select Fund has returned 18% since its inception in 1996. The fund was ranked 30th in a recentBarron's/Value Line Top 100 Mutual Fund Survey. He's easily among the top 20 value investors in the world.

Dreman literally wrote the book on the contrarian investing... it’s called Contrarian Investment Strategies. The book recommends investing in stocks; however, in 1979 when it came out, nobody believed in stocks. That was the yearBusinessWeek declared “The Death of Equities.” The greatest bull market in history began in 1982. Put simply, Dreman is a hero to contrarian investors everywhere.

And Warren Buffett? He’s Warren Buffett.

My own analysis of this company tells me Dreman, Nygren, and Buffett are on to something here...

Let’s cut right to the chase. I think ConocoPhillips (COP) is one of the best ways to play the bull market in oil. It is big, safe, and compared to its peers, undervalued. Let’s take a look at some of their assets:

I’m sure you’ve heard about the massive oil deposits of Alberta’s tar sands. Some estimates peg the tar sands as larger than in all of Saudi Arabia. Syncrude is the world’s largest producer of tar sand oil and reportedly supplies 13% of Canada’s total petroleum requirement. Conoco owns 9.03% of Syncrude.

Conoco holds operating interests in other Athabascan sites, as well as other heavy oil deposits around the world. Most notable is their interest in Venezuela's Orinoco tar sand deposits, which contain an estimated 1.8 trillion barrels (even larger than the Athabascan tar sands). COP has a bitumen processing plant in Venezuela, which produces a synthetic crude.

But there’s more to like about COP than just tar sands. Let’s talk about turning that tar into gasoline...

Conoco has 12 U.S. refineries and 6 international refineries in five countries. They process 2.6 million barrels of oil equivalent per day mostly into gasoline, diesel, jet fuel, and liquefied natural gas (LNG). The refining and marketing assets alone are worth around $29 billion.

You've heard of Lukoil, right? The Russian oil giant is new on the international scene and has a near monopoly on Russian oil. They made news last year by competing with the Chinese company CNOOC for control of PetroKazakhstan.

Well, Conoco owns 16.1% of Lukoil. The two companies also have a deal to explore Arctic Russia and expand a Barents Sea port facility. The former Soviet Union is rich with onshore oil and gas reserves and the Arctic has excellent potential.

This under-explored region is the perfect place to apply tried and true methods. If you want to place a speculation on Russian oil, Conoco is a good way to do it...

Oil transportation is another large market. Conoco owns 28.3% of one of the single-greatest feats of engineering ever attempted: the 800-mile Trans-Alaskan Pipeline. This pipeline stretches from above the Arctic Circle to the Port of Valdez, Alaska. It carries 9.06 million barrels of oil per day from the oil-rich fields of the North Slope.

In terms of total proven reserves, Conoco is the fifth largest oil company in the world and the fourth largest producer of petroleum products.

I've tried to discuss the best parts of Conoco’s business for you, but the real takeaway is two-fold. First, Conoco is 20% to 30% undervalued compared to its peers on a price-per-barrel of reserves valuation. Against ExxonMobil, the discount recently hit as high as 40%.

Second, by making investments in three of the largest, yet non-traditional sources of petroleum (Russia, Athabascan, and Orinoco Tar Sands), I think Conoco is making an excellent contrarian bet. I like this strategy.

And one more thing... with their purchase of Burlington Northern last year, ConocoPhillips is the largest natural gas producer in North America!

By now you realize COP has a finger in all kinds of energy projects in all kinds of countries.

My colleague Tom Dyson has written in the past about how the world’s largest diversified resource companies are like “hedge funds with stock symbols.” They give investors broad exposure to commodities with the convenience of a single stock investment.

Consider an investment in Conoco as your exclusive seat next to Buffett, Nygren and Dreman in the world’s best “energy hedge fund.”

Good investing,

Matt Badiali