The Buffett Shareholder Letter & Alt Energy

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It is fair to say that most people continue to equate the terms "alternative" and "energy" with expensive, unreliable and plain unpractical. This naturally leads a majority of people to view alternative energy investing as a high-risk play on some unproven technology with an uncertain probability of success.

This is a perception we’ve tried to dispel on several occasions, whether we were talking about blue chip alt energy stocks, dividend alt energy stocks or utility alt energy stocks.

It’s also fair to say that most people don’t typically associate value investing and, by extension, Warren Buffett, with alternative energy. Yet after finishing to read the 2008 edition of his annual letter to Berkshire Hathaway’s shareholders, I couldn’t help but think that there were a couple of interesting nuggets (I know, I’m a week late).

A Few Classic Buffett Quotes

Although they have nothing to do with alternative energy, I couldn’t help but include the few quotes below:

  • On the markets: "By yearend [2008], investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game."
  • On the economy: "By the fourth quarter [2008], the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed." [Italics mine]
  • On markets and the economy: "We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall."
  • On investor psychology: "When investing, pessimism is your friend, euphoria the enemy."
  • On acquisition opportunities at the GEICO unit: "[…] Tony and I feel like two mosquitoes in a nudist camp. Juicy targets are everywhere." [This is my personal favorite]

Warren Buffett On Alt (and not so alt) Energy

Wind Power

Berkshire’s Regulated Utility business owns 87.4% of MidAmerican Energy Holdings which, in turn, owns a number of power and gas utilities. Buffett mentions he loves it when this business comes up with new projects "because in this capital-intensive business these ventures are often large. Such projects offer Berkshire the opportunity to put out substantial sums at decent returns."

And it so happens that many of these new projects have been in wind power. Buffett notes that MidAmerican’s investments in wind capacity have made "Iowa number one among all states in the percentage of its generation capacity that comes from wind."

He further notes that since Berkshire purchased MidAmerican, "wind-based facilities have grown from zero to almost 20% of total capacity." When MidAmerican bought out PacifiCorp in 2006, installed wind capacity was expanded from 33 MW to 794 MW, a nearly 500% expansion.

In 2008 alone, the Oracle tells us, MidAmerican spent $1.8 billion on wind generation. Assuming a cost per installed MW of $2.5 million, that’s about 720 MW – not bad for an energy source that’s expensive, unreliable and unpractical. And so where has MidAmerican gone under Berkshire ownership? It has become the regulated utility with the largest ownership of wind capacity in the US.

Keep in mind that all this investment activity most likely had to be approved by Buffett, and that he is no "flavor of the month" guy – if the economics made no sense there would be no Berkshire money going into wind. The exact nature of their thinking on wind (i.e. is it a play on the PTC?) is unknown, but their actions certainly indicate a strong interest. 

Oil Prices   

Buffett identifies one of his biggest investment mistakes of 2008 as buying ConocoPhillips when oil and gas prices were still high. He "in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year." But he makes this prediction: "I still believe the odds are good that oil sells far higher in the future than the current $40-50 price."

Not much of a prediction huh? This is someone who thinks the following of forecasts: "But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and loosing years [in equity markets] in advance. (In our usual opinionated view, we don’t think anyone else can either.)"

Of course he would never say how much higher, nor does he need to for people to find him credible. But given Buffett’s typical time horizons (i.e. decades), it’s probably fair to assume that he sees what many of us alt energy investors do: a fundamental and, in the long run, unbridgeable (at a reasonable cost) gap between supply and demand for oil.

Conclusion

This doesn’t leave us with much in terms of concrete investment ideas. However, it does confirm that some of the trends upon which the alt energy investment thesis is based are occurring, and that they are being picked up by some of the sharpest investing minds out there.

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