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Warren Buffett Shareholder Letter – It Appears Peak Oil Was Part of the Burlington Northern Investment Thesis

February 26, 2011 | About:

A great time of the year for Warren Buffett fans. This morning his annual letter to shareholders was released. And as usual it provides us with much to stimulate our investing brains.

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.

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Josh Zachariah
Josh Zachariah - 6 years ago    Report SPAM
I don't think peak oil was part of the rationale, but instead the absolute cost advantage trains have over trucks. He's denied ever buying commodities on speculation of inflation. The "peak oil" concept is equally speculative. Even if we discovered all the oil underground, which is a big if, prices would not remain in a perpetually high range.

Prices generally become elevated because of supply shocks and the fact that gas consumption is relatively inelastic in the short run and consumers are unable to immediately change their behavior (ie relocate closer to work, buy hybrids). Peak oil hysteria has littered history over the last 100 years. An excellent book on the history and dynamics of the oil market is "The Age of Oil." Definitely worth a read for those bullish on oil.

Josh Zachariah

Grandpagates - 6 years ago    Report SPAM

1.) I wish I wrote down the source, but I distinctly remember a pair of interviews where Warren talked about oil demand going up and supply going down. Here are the "echoes on the web" of the interviews that I just tracked down:



2.) I think the BYD investment (electric cars) has to be viewed along with COP and BNI as gas price bullish. I claim to vaguely recall Warren or Munger making stray comments about cars running on electric in the future.

3.) Again, I wish I recorded the source, but I recall WEB pontificating about the oil industry where although oil prices might go up, oil companies would have to spend all their profits looking for new oil. The beauty then of BNI is that it has to spend NO money looking for oil. All it has to do is raise prices less than trucking if oil prices go up (an easy talk to accomplish).

4.) Finally, I would add my personal thoughts .... BNI could convert to natgas (or perish the thought electric) easier than trucking. Also, the BNI investment does not require oil prices to go up .... just for GNP/population to go up - oil prices going up would just be a (potentially ginormous) kicker. BNI (and to a lesser extent COP and BYD) are more businesslike than commodities speculation, and given WEBs comments about gold, I think it's clear that he prefers business.
Jonmonsea premium member - 6 years ago
I really like this comment. Thanks!
MrEnergyCzar - 6 years ago    Report SPAM
Buffet won't say it but he knows that our growth depends on cheap liquid transport fuels and that we are running out of such cheap oil.... I've been preparing my family for Peak Oil for several years and made some short videos to help and show people what they can do to prepare.....



AlbertaSunwapta - 6 years ago    Report SPAM
Rail can only compete so much with trucking until it too hits a wall. To expand, rail then has to buy rights of ways to reach new markets. If costs on both fronts rise too much then people will simply keep reducing their purchases of shipped goods until they reach the level of their core needs where they have no alternative but to buy. (Also look at how the economics of shipping televisions has changed. We could expect the same progress on any number of other bulky items. IKEA may face a lot of competition.) So too for raw materials shipping whose economics would change with shipping costs - triggering more intermediate processing thus reducing the amount shipped by rail.

As for cheap oil It's obvious - it's running out.

However, as the price of oil rises more alternatives become economic and thus adopted by various industries and thus slow the decline of cheap oil. (solar, wind, natural gas, etc.)

Conservation measures also get implemented as the price of oil rises. (ie people plan their driving routes.) Expenditures to conserve even more also get incurred. (ie people change vehicles)

Additionally, like gold, there's a LOT of oil that becomes economic to extract at higher prices. (oil sands, shale oil)

Time and money also get spent on improving existing extraction from cheap pools (horizontal drilling, etc.)

Exploration introduces a wild card scenario. Deep sea drilling or some other discovery could at any time yield Saudi Arabia sized pools. I expect the Mr. Market will go through several manic-depressive cycles as a result. Whether the new discoveries are cheap or costly to extract only time will tell.

Nonetheless, growth in demand can overwhelm many new discoveries and many of our societies' current benefits have come from cheap resources. (food, fertilizer, transport etc.) So raise the input costs and/or rarity of anything you buy and you may find that you're going to have to do without.
Jaumepared - 6 years ago    Report SPAM
You all are pretty much on target. One moat that we should not forget is the environmental and regulatory for ANY new challengers. The pricing differential and improved logistics for semi perishables gives it a long term guarantee of decent pricing and margins.

Like a regulated utility, doesn't the USA want to have healthy and profitable freight lines? WEB is spot on this one.

Peak oil is not a mover and a shaker. As others have pointed out, WEB does not want to make macro calls on pricing of commodities.

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