eResearch | Last weekend, Berkshire Hathaway Energy (BHE), a subsidiary of Warren Buffett’s investment conglomerate Berkshire Hathaway Inc., (NYSE: BRK.A) announced that it had acquired Dominion Energy’s (NYSE:D) natural gas transmission and storage assets in a deal valued at US$9.7 billion.
As part of the deal, BHE will pay $4 billion to acquire about 7,700 miles worth of natural gas transmission pipelines, Dominion’s sizeable natural gas storage facilities (about 900 billion cubic feet), as well as 25% of Cove Point LNG – one of just six export-import and storage facilities for Liquefied Natural Gas (LNG) in the U.S.
The deal will also see BHE acquire $5.7 billion of Dominion’s debt, which left some investors scratching their heads. Buffett after all is famous for being “cheap” – at Berkshire Hathaway’s annual meeting in May, he told shareholders that he hadn’t made any purchases during the Covid-19 market downturn because he hadn’t seen any deals that were “that attractive”. Acquiring Dominion’s hefty debt is arguably not in line with his typical value investor thesis.
Fossil Fuels: Why Now?
Some critics of the deal also pointed out that natural gas futures fell to a 25-year low in June. In a Barron’s article titled “Warren Buffett’s New Big Deal Could be a Dud”, it is argued that with the increasing availability of renewable energy sources such as wind and solar, our days of relying on fossil fuels for energy are numbered.
In fact, one of the reasons that Dominion went ahead with the deal was because the Company is pursuing plans to transition to a state-regulated utility company that focuses on wind, solar, and natural gas.
It is true that renewables are becoming more prevalent and reliable, and, for the good of the planet, they should eventually overtake fossil fuels, such as natural gas and coal, to become the world’s main source of energy.
However, despite the renewables industry being heavily subsidized by governments, according to the International Energy Agency (IEA), fossil fuels will continue to be the world’s main source of energy for at least the next two decades. The IEA predicts that the demand for natural gas will increase by 36% from now to 2040, more than any other energy source. This demand will be driven mostly by developing and newly industrialized nations with increasing standards of living, who will look to natural gas as an affordable and reliable energy source that produces lower carbon emissions than coal or oil.
GRAPH 1: Growth in the Global Energy Mix from 2016-2040
Closer to Home: America’s Energy Consumption and Production by Sector
Despite a global increase in demand for natural gas, one could argue that the Dominion deal is an acquisition of natural gas infrastructure assets that span the U.S., not China or India. But when we look at what’s been happening in the energy industry in America over the last 10 years, Buffett’s reasoning becomes clearer.
As the below chart from the Energy Information Agency (EIA) shows, Americans use far more energy than they did 50 years ago – this isn’t surprising when we look to how much of our daily lives now revolve around smart phones, computers and high-speed WiFi.
Most of the activities we undertake online require the hosting and storage of enormous amounts of data – provided by data centres – which gobble up vast amounts of energy. The number of data centres is in the US and globally is predicted to keep rising in the future, as more people become connected online and the demand for access to high-speed WiFi continues to grow.
GRAPH 2: U.S. Primary Energy Consumption by Major Sources (1950-2019)
While America’s use of coal as an energy source has decreased over the past decade, and the use of renewables has increased, natural gas and petroleum are currently still the predominant sources of energy consumption in the U.S.
Meanwhile, since 2010, the production of oil and natural gas in the U.S. has actually risen quite substantially. Throughout the 2010’s domestic oil production in the U.S. rose by 8.6% annually, and domestic natural gas production rose by 4.6% annually. As the below chart shows, the US currently produces more natural gas than it does any other energy commodity:
GRAPH 3: U.S. Primary Energy Production by Major Sources (2019)
Playing the Long Game
Natural gas exports from the U.S. to the rest of the world have also increased substantially since 2015, driven by an increase in LNG exports, as well as the removal of a ban on oil exports in 2015. The EIA now predicts the US will be the world’s leading exporter of LNG by 2025. This is most likely where Berkshire Hathaway Energy’s acquisition of 25% of Cove Point, the LNG export-import and storage and transmission facility based in Maryland, comes into play.
Buffett isn’t known for making impulsive decisions, therefore you can bet he did his homework before pulling the trigger on this latest acquisition – the largest by Berkshire Hathaway since its takeover of Precision Castparts (NYSE: PCP) in 2016, for US $37 billion.
It must also be pointed out that regardless of the current price of natural gas futures – which will always be susceptible to volatility – what critics are perhaps failing to recognize is that the Dominion deal is not an investment in the commodity of natural gas itself.
Rather, it is likely based on the logical assumption that despite inevitable fluctuations in the price of natural gas, transporting it will remain a necessity now and for the foreseeable future – and will therefore continue to be a cash-generating business.
Putting Cash to Work
At the end of March 31, 2020, Berkshire Hathaway had US$137.2 billion of Cash & Short-Term Investments looking for assets to purchase with acquisition of Dominion acquisition representing approximately 7%. Currently, Dominion generates solid dividends, paying out 85% of its earnings, an important factor in this low interest rate environment.
Berkshire Hathaway closed the week at $273,900 per share, up $6,349 or 2.4%.
//
