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Is Warren Buffet Betting Wrong on Utilities?

Richelle Elberg — March 18, 2014

In Warren Buffet’s famed letter to shareholders of March 1, 2014, the Oracle of Omaha made it clear that following Berkshire Hathaway’s $10 billion buy of NV Energy last year, he is still shopping for utilities.  Analysts are throwing around names like Wisconsin Energy, Westar Energy, and Alliant Energy because they each provide the returns on equity (historically) that Buffet demands and operate in states with favorable regulatory climes.

Now, Warren Buffet has more investing savvy in his little finger than I’ll ever have.  But is he right on this one?

The Berkshire Hathaway website offers a succinct list of Buffet’s investment requirements.  He’s looking for big (but simple) businesses with consistent earnings, low debt, and good management.  In the latest letter to shareholders, he notes that utilities have “recession-resistant earnings, which result from these companies exclusively offering an essential service.”

The Figures Don’t Lie

There may be a few cracks in the foundation of Buffet’s premise, especially because his broader investment theme has always been an unshakeable belief in America’s ability to innovate and grow over the longer term.  We’re talking 20 to 100 years, not 5.

I examined recent financial reports for MidAmerican Energy Holdings, the subsidiary that includes Berkshire Hathaway’s utilities, and also those of NV Energy.  The buy of NV closed in mid-December.  Here are the MidAmerican figures as shown in Buffet’s letter:

 

Overall, healthy growth for Warren’s shareholders, but look what happened with the utilities (HomeServices is a real estate company).  U.K. utilities (i.e., Northern Powergrid) have experienced a 12% average annual decline in earnings since 2011.  Earnings at the Iowa utility (MidAmerican Energy) have fallen 9%, on average.  Western utilities (PacifiCorp) enjoyed a nice bump in earnings last year, but at NV Energy, revenue was down 2%, cost of fuel rose 38%, and operating income fell 7.5%through September 30, 2013.

In the discussion of results for the various utilities, there are other worrisome comments.  From the discussion of PacifiCorp:  “Certain large industrial customers with generation capabilities began to self-generate in 2012 resulting in lower industrial customer usage across PacifiCorp’s service territories,” and “Net income increased $55 million primarily due to higher retail prices approved by regulators and higher retail customer load, partially offset by higher energy costs, lower renewable energy credit (REC) revenue and higher depreciation and amortization.”

Still Coal-Dependent

Growth is largely predicated on regulators raising rates.  Large commercial and industrial (C&I) customers are beginning to self-generate, and fuel costs are rising.  Buffet also likes to tout his companies’ diversification and investment in renewables.  But at PacifiCorp, it was coal (as a percentage of overall energy sources) that rose from 59% in 2011 to 62% in 2013.

In his letter, Buffet also said, “Our confidence is justified both by our past experience and by the knowledge that society will forever need massive investments in both transportation and energy.  It is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects.”

That may be true, but that American entrepreneurial spirit that Buffet so believes in is exactly why he should be worried.  Cheaper and better solar and wind options for residential – and C&I – customers will affect utilities’ bottom lines whether regulators like it or not.  And they won’t just keep raising everyone else’s rates in response.

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