Behind Buffett's purchase of railways: belief in crude oil depletion?
STEVE AUSTIN | 2009/11/12
From long-term passion for model trains to stake-building of several years, Warren Buffett, the billionaire investor, has decided to acquire one of United States' largest freight railway firms, Burlington Northern Santa Fe (BNSF), for $34 bn. Berkshire Hathaway INC., the company run by Buffett will pay $100 per share in cash and stock, the biggest ever deal for this company. BNSF is America's second highest-grossing freight railway company, with 220,000 freight cars. It is also one of the oldest railway companies founded in 1839 in Texas and covers about 32,000 miles.
Where is the value?
The railroads are considered by many an ailing business. The decrepit US railroad system puts the US to shame compared to other advanced nations: Amtrack, the intercity passenger service in the US, is one of the slowest among the advanced nations. A comparison: the 393-mile journey from London to Edinburg takes four and a half hours. But in the US, the 40 mile Cardinal from New York to Charlottesville takes seven hours. No respectable speed trains in the US matches to France's TGV which has enabled passengers to affordably commute at 200mph for the last 30 years.
So at first glance it comes at a surprise that Buffett, known as value investor would invest so much in something perceived by many as having so little value. Well there is more than meets the eye.
Buffett sees little oil in the US future
The 'Sage of Omaha' built, what we would like to call, an insurance empire. An empire built on guessing what is likely to happen and how likely it is to happen. Warren has an army of Math PhDs at his fingertip who study, analyze the world, run statistical simulations and provide insight on trends and things to come. Crunching numbers to figure out what is likely to happen to anyone is what the insurance companies do, and Buffett's insurance companies are some of the most profitable, meaning they tend to be more right than others.
So why would anyone with the cumulative intelligence of Buffett and his advisers buy a major stake in the decrepit US railroad system? Warren's move to buy this railroad is motivated by the following calculated bets:
- His awareness of the imminent oil crisis and his long term vision of what life will be like with oil shortages. Oil is on a roller-coaster ride. Demand is soaring, particularly from energy hungry economies like India and China. But production is decreasing with Peak oil, point where the maximum rate of oil extraction is reached, predicted in 2010 by the ASPO (Association for the Study of Peak Oil and Gas). If not 2010, as previously reported in Oil-Price.net many analysts believe that the oil peak would most certainly be achieved by 2020. This will cause serious adjustments in nations around the world and the US in particular.
- Buffett loves to buy companies with an unfair competitive advantage (read monopoly) over anyone else. BNSF was started in 1839 when land was plentiful and cheap. Back then and still today, trains travel mostly in a straight line and buying lined-up parcels of land, while trivial back then is impossible with today's population density. In other words, it is impossible for someone to start a new large-scale railway today. All railways that will ever exist already do. Creating new ones requires seizing properties on a large scale, politically unlikely to happen. Buffett bought a business with no competitor.
- Railways made the industrial revolution happen 150 years ago. Trains brought us the modern world as we know it before there were cars and trucks. When cars and trucks are not suitable anymore our civilization will revert to the last known modern means of tranportation, the train. As peak oil sends everyone scrambling for new energy sources, coal which once powered trains will rise again as a suitable fuel for heating and power generation. BNSF virtually has all the coal it needs in its own backyard: the Powder River Basin in the Rockies. 1/5th of all US coal is already being hauled by BNSF, representing 25% of the company's revenue.
It's about the insurance after all
For all the above mentioned scenarios, the oft suggested move is energy efficiency and a shift to more renewable energy sources. The entire infrastructure of transport will have to be moved from oil to what? Railways; What Buffett tells us here, is simple: rail is good insurance.
- Diesel trains an inherently more efficient than trucks or cars. A train gets about 100 miles per gallon per ton whereas a semi gets 10 miles per gallon for the same payload. When used for transporting passengers instead of freight the difference even increases: 468 passenger-miles per gallon for trains versus 30 for a compact car. Trains do not have to stop and go, there is less friction on rails and this makes them very efficient. As Diesel becomes more expensive, this 10 fold difference in freight efficiency and operating costs will fast become the determining factor favoring trains over trucks.
Source: US Dept. of Transportation
|Cost of Freight Transportation by mode
(cents per ton mile)
Source: Wikipedia, Oil-Price.net
|Passenger transportation - Fuel consumption by mode
(passenger-miles per gallon)
(passenger-liter per 100km)
- Railways are cheaper and thus help move goods from place to place economically and efficiently. Railways are more reliable as their time schedule is known earlier, and they are consistent for the same reason
- Train carries more cargo than a truck, that too in a short period time. A single cargo train is equal to 62 trucks on the road. Safety of railways is more compared to road and congestion is less
- Building roads grabs a lot of agricultural land whereas railroad takes up only fraction of the land. Long term capability, viability and competitive advantages are unparalleled as international trade is on the rise in the railway system
- When you consider fuel economy, you just can't beat trains .Trains are almost 18 percent more-energy efficient than air travel and road transport. Energy consumption of Amtrack is 2,100 BTU per passenger mile, while planes (3,890 BTUs), buses (3,698 BTUs), and cars (3,597 BTUs) eat up more fuel
- Railway produces the lowest amount of carbon emissions compared to other modes of transport like planes and vehicles on the road. Trains work on electricity and diesel. In case of diesel shortage trains will still run on electricity produced by power plants and get people and merchandises places.
- The US is a spread out country and in an extended oil crisis travelling even 100 miles will suddenly become a luxury. The entire economy will be dependent on affordable long-haul transportation otherwise unity will be a challenge to maintain for the central government. In a large place where communication becomes harder due to high energy costs, things will naturally evolve to become less centralized. In the best case you will see independent states with more authority. In the worst case with a central government unable to spread its wings, societal breakdown may ensue. Railways will become a central strategic asset. Whoever controls the railways will control... a lot of things.
- Not all exchanges require travelling. In today's highly connected world lots can be accomplished in front of a computer with an internet connection. High-speed internet connectivity was made affordable by telecommunication companies rolling optical fibers alongside railroad tracks for a cheap lease. Whoever controls the railways will really control a lot of things!
Buffett sees lots of coal in the US future
Okay, now to the question of coal and railways. In the US, Coal is, predominantly, moved from the mine to power station by rail, thus coal accounted for about 44 percent of the total tonnage moved by rail, which also contributed to about 21 percent of the gross revenue (last year). Doesn't that come under emission too? Not really, Coal helps to relieve the dependency on crude oil imports as the US has the world's largest recoverable coal reserves. In spite of coal's role as one of the most pollutants of the fossil fuels because of its high carbon dioxide emissions, new technologies like CCS (carbon capture and storage) and IGCC (Integrated Gasification and Combined-Cycle) generation help to curb the emissions. Well, the technologies aren't just new jargon. A new 'zero-emission' power plant using CCS and IGCS is expected to be fully operational by 2016. Coal is on-big time.
In short, the railroad is an economic and strategic player for the future; it brought up entire civilizations before car and crude oil, and will sustain it afterwards too. Whoever owns the railroads will control energy, communications an exchanges.
To some, the scenarios described above may seem far-fetched. However would some of these scenarios take place in the coming years, the purchase today of BNSF would become Warren Buffett's best value investment.
Published on 2009/11/12 by STEVE AUSTIN