Warren Buffett Shareholder Letter – It Appears Peak Oil Was Part of the Burlington Northern Investment Thesis
One thing that I have been hoping to learn is the thinking behind the huge investment Buffett made when he purchased Burlington Northern. Specifically I wanted to get some insight into Buffett’s thinking on the future of oil prices.
After the acquisition I had read much speculation about Buffett making the acquisition because of hidden real estate value hidden inside of Burlington. I thought that was unlikely.
My thinking was that Buffett believed the railroad game had changed from 20 years ago. Once a capital intensive low margin business. Now a business with a huge moat around it. What is the moat ? High oil prices. The main alternative to moving goods around the country is trucking, and high oil prices make moving goods by rail much more attractive.
In 2007 and 2008 Buffett built up big positions in both Burlington Northern and Conoco Phillips which I thought was a pretty clear signal that he believed in high oil prices remaining going forward. But then after the price of oil collapsed in the great recession Buffett greatly reduced his Conoco position. I thought that this selling was likely due to the tax benefits involved with quickly realizing the loss but couldn’t be certain.
Today in his annual letter Buffett let us in on his reasons for buying Burlington and how he now feels about the transaction:
“The highlight of 2010 was our acquisition of Burlington Northern Santa Fe, a purchase that’s working out even better than I expected. It now appears that owning this railroad will increase Berkshire’s “normal” earning power by nearly 40% pre-tax and by well over 30% after-tax. Making this purchase increased our share count by 6% and used $22 billion of cash. Since we’ve quickly replenished the cash, the economics of this transaction have turned out very well.
Both of us are enthusiastic about BNSF’s future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs.
Concurrently, our country gains because of reduced greenhouse emissions and a much smaller need for imported oil. When traffic travels by rail, society benefits.
Over time, the movement of goods in the United States will increase, and BNSF should get its full share of the gain. The railroad will need to invest massively to bring about this growth, but no one is better situated than Berkshire to supply the funds required. However slow the economy, or chaotic the markets, our checks will clear.
Earlier I explained just how important railroads are to our country’s future. Rail moves 42% of America’s inter-city freight, measured by ton-miles, and BNSF moves more than any other railroad – about 28% of the industry total. A little math will tell you that more than 11% of all inter-city ton-miles of freight in the U.S. is transported by BNSF.
Given the shift of population to the West, our share may well inch higher.
All of this adds up to a huge responsibility. We are a major and essential part of the American economy’s circulatory system, obliged to constantly maintain and improve our 23,000 miles of track along with its ancillary bridges, tunnels, engines and cars. In carrying out this job, we must anticipate society’s needs, not merely react to them. Fulfilling our societal obligation, we will regularly spend far more than our depreciation, with this excess amounting to $2 billion in 2011. I’m confident we will earn appropriate returns on our huge incremental investments. Wise regulation and wise investment are two sides of the same coin. “
Buffett sat on a lot of cash looking for a big investment for a long time. Burlington became that investment because it has a durable, sustainable competitive advantage in Buffett’s mind. You can bank on that. And there is no question that competitive advantage for Burlington Northern is directly tied to the price of oil.
It isn’t like Buffett hasn’t told us his opinion on future oil prices before, here he is in the 2008 letter to shareholders:
“I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year.
I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.”
And her he is in 2008 on CNBC talking about the Canadian Oil Sands and oil supply and demand:
I wonder if Warren will find another elephant in the next few years that is a play on oil prices.