Some big news on the investing front, as the New York Times’ Dealbook newsletter put it: “Warren Buffett Is Back in the Game”. After sitting back, Buffett and his partner at Berkshire Hathaway, Charlie Munger, did their first big deal in a while.
Berkshire Hathaway purchased a gas pipeline network from Dominion Energy for $9.7 billion. The amount might at first seem crazy given current news, but it’s a strategically smart move for the future.
Dominion and Duke Energy announced that they would cancel the Atlantic Coast Pipeline. The construction was supposed to expand a pipeline network hundreds of feet under the Appalachian Trail. Environmental opponents, who point to the regular occurrence of pipeline accidents and their consequences, according to federal government data, tried to block the project in court.
Dominion and Duke managed to move decisively past one legal challenge that went to the Supreme Court, but then faced “new and serious challenges” to a necessary permit. With costs having swelled from the original $4.5 billion to $5 billion estimate, reaching $8 billion, the two companies gave up.
Although the companies specifically referred to a decision out of the United States District Court for the District of Montana and a chilled reception from the Court of Appeals for the Ninth Circuit, they could also been thinking of the shutdown of the Dakota Access Oil Pipeline. Native American tribes reportedly prevailed in court when the pipeline was ordered to shut down by August 5 for a new environmental review that will likely take more than a year.
The more projects get drawn out, the more expensive they become and the less of a chance they can return sufficient profits fast enough to satisfy investors.
Between spiraling costs and an apparent growing skepticism on the part of courts, it would seem clear why Dominion might want to exit this part of the business. But why would Buffett and Munger decide to get involved?
First stop is to check Dominion Energy’s most recent annual report. A combination of “about 10,400 miles of natural gas transmission, gathering, and storage pipelines; and a liquefied natural gas terminal” led to about 24% contribution to the company’s 2019 operating earnings of $3.4 billion, or $800 million.
The $9.7 billion deal includes an assumption of $5.7 billion in existing debt, so the value of the actual pipeline network is about $4 billion. Even at nearly $10 billion, it puts only a small dent into the $137 billion in cash that Berkshire Hathaway had, according to data and analysis from Morningstar. That firm projects about $1 billion in ongoing annual net income.
Then there is also expansion of Berkshire Hathaway’s hold on the transmission of natural gas. The acquisition should increase the portion of national capacity to 18%, according to Dealbook.
The emphasis on transit and not extraction or sale is critical. Markets have seen wildly swinging prices of energy products. Gas never followed oil into negative territory, but last month saw at least a ten-year low.
That’s bad for producers, good for buyers, and fairly immaterial for those that operate distribution. Gas will continue to run electrical generation and both heating and cooling systems. A post-pandemic economic recovery will only increase demand and prices.
Today’s market has weighed in on who seems to have gotten the best of the deal. As of about 3:30 p.m. eastern, Dominion shares are down about 10.5% while Berkshire was up 2.6%.
As true for Buffett and Munger strategies, the full value will become apparent in the long run. In this case, it’s a reminder for investors to consider which companies in a market are absolutely necessary while remaining disconnected from the whims of commodity pricing. A pipeline business is like an electrical grid, gaining its own profits for a service that can’t easily be circumvented.