I have established a reputation as a bit of a contrarian in certain areas of the energy market. I have been tough on pipeline companies in particular. Pipelines have attributes that simply can’t be mitigated. Among them the fact, that they must cross long distances to deliver their products, and pass native populations that are against their construction for reasons of their own. They are also hostage to the political whims of local, state, and federal leaders who typically rail against them being built. That adds up to a negative impact that has restrained shares of pipeline operators, even as the general energy market has rallied this quarter. For example, in my last OilPrice article, I called into question whether Energy Transfer, (NYSE: ET) was a colossus ready to cast off its chains and revert to its glory days? Or did it have farther to fall as a result of an adverse court decision, and more importantly to some, was its lofty ~20% distribution in jeopardy? ET is currently mired in travails over the aptly named, Dakota Access Pipeline. The market has largely discounted an adverse outcome for the company as ET’s stock remains under pressure while the continued operation of the DAPL is litigated.
So having established my creds as a pipeline doubter with broader concerns that I documented in an OilPrice article last winter about the gas market in particular, when I saw what Warren Buffett had done, my immediate reaction was…He’s finally lost it!
If you haven’t been following closely, last week Warren Buffett made a move no one anticipated by forking over $10 bn for Dominion Energy’s natural gas assets. In this article we will move a little beyond the headlines and postulate what this move, by one of America’s cagiest investors might hold in store for both the pipeline and gas markets.
Warren buys Dominion’s Gas assets
It was an odd timing given that on that very same day the company involved, Dominion Energy, (NYSE:D) canceled a gas pipeline with another utility player, Duke Energy, (NYSE:DUK). Perhaps they were just tired of buying their lawyers new Tesla’s, all the time. This project had been embroiled in controversy for years. And, just as it looked like they might be winning with a favorable ruling from the Supreme Court on June, 15th, they cancelled it, unemploying a raft of legal talent in the process one presumes.
It turned out to be a busy day in the pipeline business as that same day, the deal with Buffett was announced. In a nearly US$10-billion deal, Dominion Energy with its sights set squarely on its goal of achieving zero-carbon electric generation by 2050, said it would be selling substantially all of its gas transmission and storage assets to an affiliate of Berkshire Hathaway.
So…what was Warren thinking?
This could be viewed as a contrarian play. The environmental lobby is pushing utilities to move away from gas, using a strategy after the success they’ve had pushing U.S.coal over to China, which incidentally has been building coal-fired plants, at a rapid rate. A Bloomberg article recently noted that rather than going after oil companies, the pipelines present a softer target.
“The keep-it-in-the-ground movement has increasingly turned its attention to the pipes, rather than the wells themselves, because they require various federal and state permits, which, for the most part, can be more easily litigated.”
This move makes it seem that Buffett is looking past all the noise in the market currently, and is just doing what he does better than anyone else. Buying good assets cheaply in a down cycle and waiting for the market to realize their true value. He appears unfazed by the current horrifically bad prices for gas. Does that tell us anything?
It may be a bet on the unrealized value that installed pipelines have now. It is much harder to litigate a thing once it’s built and providing services to people, an exception perhaps being the oft-litigated DAPL. A look at the financial statements for pipeline companies like ET reveal $10’s of billions of dollars of debt used to build these lines. Debt that must be repaid whether a line is put into service, or not.
If the market for gas does grow as we discuss in the next section, owning a transmission line could be a pathway to enhance profits in a few years.
Does Warren think the underlying commodity is underpriced?
The price of natty-natural gas is just awful right now. It’s supposed to be getting better, but the gas market appears not to have gotten the memo on this plan.
Warren’s bet on Natty comes at near-25 year lows for this commodity with lows coming at a time when pricing should be ramping. The general idea going into spring was that the shale production that was shut-in would take a lot of associated gas off the market. It sounded good and for a time the gas driller’s stock prices ramped in anticipation, but it just hasn’t worked out so far.
Another supposition is that cheap gas will displace dirty old coal, most of which is now going to third world international markets. Last year the EIA estimated that in 2019, Natty supplied 38% of utility generating needs. Wind and Solar will take some of that market to be sure, as the Dominion move toward zero carbon in 2050 suggests, but Warren must be thinking that gas will dominate for years to come, the Greenies manipulations not-withstanding. Warren was heard to comment on this deal.
“We are very proud to be adding such a great portfolio of natural gas assets to our already strong energy business.”
This move by Buffett probably puts a floor on equivalent assets in companies we have discussed. This is a strong statement by one of the cagiest and most successful investors of all time.
The difficulties posed by regulatory and environmental groups in recent years to block or slow to crawl the development of key pipeline infrastructure projects, like ET’s Dakota Access Pipeline, the closure of which could lead to stranded assets in the Bakken, as the chart below suggests. Or their success in delaying Keystone pipeline from Canada, which probably holds the world’s record for being cancelled and then approved, and then cancelled again put a fairly fine point on existing infrastructure.
This infrastructure and the underlying commodity prices are undervalued by the market at present. This bet by Buffett bodes a change in the foreseeable future. This could be a catalyst for strong transmission companies like Enbridge, (NYSE:ENB), and Energy Products Partners, (NYSE:EPD) to see a move higher off multi-year lows as this reevaluation takes place.
What it says about the underlying gas market remains to be seen in my estimation and will depend on a move down in production and average storage volumes headed into the withdrawal season, still a few months in the future. The latest EIA Drilling Productivity Report suggests that production is falling off from lack of new drilling.
Current market expectations are for the weekly average to remain above the 5-year historical levels as we head into the winter withdrawal season. Having nearing topped out gas storage in recent weeks that scenario doesn’t support a bull hypothesis for this commodity. We’ll see if Buffett’s optimism for Natty is justified in the coming weeks.