Greg Abel has replaced Warren Buffett as head of Berkshire Hathaway. The company’s annual meeting last week was the first he led. Abel previously ran Mid American Energy, a Des Moines-based utility, and then all of Berkshire Hathaway’s utility operations. When Buffett spoke about financial topics, investors listened attentively. It remains to be seen whether Abel attracts the same reverential following. However, it is definitely worth checking out his opinions on electrical service companies, based on his many years in the industry. Their comments can be divided into two parts: positive aspects of the industry (high growth) and negative aspects of the industry (regulatory environment and related risks, such as forest fires).
Artificial intelligence and data centers are the main drivers of the huge demand for electricity right now. And this sudden demand is not distributed evenly. Berkshire owns utilities PacifCorp, NV Energy and MidAmerican Energy, as well as gas pipelines and processing, and other unrelated assets. But Iowa, he noted, could see demand growth of 50% in five years. He also emphasized his belief that the new data center load should bear all the costs of its incremental demand on the system. These new costs should not be passed on to residential and commercial customers. (In the past, the cost of such capital expenditures on public services was distributed among all ratepayers through the regulatory process.) And finally, Abel praised the success of Mid American Energy, the company he previously led, both in keeping up with accelerated growth in demand and in keeping rates 45% below the US national average.
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Having electricity rates about half the national average means the service territory is blessed with an abundance of hydroelectric power generation resources or a fleet of aging coal plants. In the case of Mr. Abel, it is the latter. MidAmerican’s fuel mix is 63% wind and more than 20% coal, plus some gas, nuclear and other resources. Needless to say, this aging coal fleet has come under considerable scrutiny from environmental groups like the Sierra Club, which have advocated for accelerated plant closures. The company’s position is that these plants will remain open until 2049, when the oldest facility in the current coal park will turn 75 years old. For example, the George Neal South unit in Sioux City, Iowa, was commissioned in 1975. The utility has a relatively new coal generating unit, commissioned in 2007, but other than that, MidAmerican’s average coal unit came into service around 1980, meaning that today these facilities are already about 45 years old. This is very old in the power plant years.
Berkshire’s PacifiCorp unit is in a similar position with respect to coal-fired power generation, which comprises about 35% of its generation mix, but is almost exactly the same size as MidAmerican’s coal fleet. Only NV Energy, from the Berkshire-owned US utility, has largely completed the transition away from coal. We mention this because it explains one of the reasons why Mr. Abel has expressed concern regarding a possible downgrade in his various regulatory environments.
We agree. If we had more than 9,000 megawatts of aging, polluting and politically unpopular coal-fired power generation in the US Midwest and Pacific Northwest, we would be concerned about our regulatory environments too. And it gets worse. PacifiCorp has publicly stated that its litigation exposure from the 2020 wildfires in California and Oregon could approach tens of billions of dollars. Berkshire has already paid more than $500 million to settle several related lawsuits. Recently, the Oregon Court of Appeals overturned the most financially damaging lower court ruling against the company, giving it some breathing room in this regard. Berkshire has been active in passing state legislation that would limit its exposure to wildfire liability. The Utah legislature passed a bill that management called the “gold standard” regarding liability mitigation. It remains to be seen how many other states adopt this.
In his prepared remarks at Berkshire’s annual meeting, Abel reiterated that Berkshire could exit states that imposed arduous clean energy mandates. Obviously this is not an idle threat. In February of this year, the company announced the sale of PacifiCorp’s Washington state assets to Portland General Electric for $1.9 billion, citing a desire to “improve our financial stability while simplifying our operations.” In this press release, PacifiCorp’s CEO offered another reason for the impending asset sale: “Divergent policies among the six states PacifiCorp serves have created extraordinary pressure that impacts the company’s ability to meet demand reliably and at the lowest cost to customers.” However, he offered regulators something of an olive branch, reaffirming his belief in the “regulatory compact,” where customers receive reliable service and pay a fair return on capital. He pointed out two things that underscore this model: inflation (which is rising) and other high-cost requirements, such as pollution controls at old coal plants. All we can say here is that PacifiCorp serves about 2 million customers, while Washington state represents less than 10% of the total. So PacifiCorp is selling a relatively small part of the company. Most of the customers are located in Oregon and Utah. Selling this asset seems to us more like a rapprochement effort with respect to the rating agencies Moody’s and S&P, which lowered the ratings of PacifiCorp’s fixed income securities based on the risk of forest fires.
Now let’s try to put this into some kind of perspective. The three U.S. utilities owned by Berkshire Hathaway Enterprises (BHE) have assets of about $90 billion of BHE’s roughly $152 billion in total assets. That is a considerable percentage. But BHE is, of course, just one part of the Berkshire Hathaway conglomerate, which listed assets worth $1.25 trillion in its March 10Q report. U.S. power companies account for only about 7% of Berkshire’s total assets. Financial commentators have been trying to find some way to differentiate Abel from his legendary predecessor, Buffett. We believe this is asking the wrong question. The question for us is: Are these the same utilities, with the same risk profiles, that Buffett bought more than two decades ago? Our answer is a resounding no. The biggest risk we see relates to one of the oldest problems in the electric utility business: the huge cost difference between rural and urban utility customers. It is much more expensive to serve low-density rural customers. It always has been. And now those rural service areas also carry huge, open wildfire liability risk. But what’s worse is that decentralized forms of power generation, such as solar plus batteries, will increasingly offer opportunities for rural customers to go off the grid while reducing their energy costs. If we were advising Mr. Abel, we would tell him to continue selling.
By Leonard Hyman and William Tilles for Oilprice.com
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