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Berkshire Hathaway Expands Its Bet on North American Natural Gas

publication date: Jul 6, 2020
 | 
author/source: Callum Turcan

Image Shown: A look at the Cove Point LNG export facility in Maryland, one of half a dozen that are currently operational in the US. Image Source: Dominion Energy Inc – February/March 2018 Fixed Income Investor Meetings Presentation

By Callum Turcan

On July 5, Berkshire Hathaway Energy, a majority-owned subsidiary of Berkshire Hathaway Inc (BRK.A) (BRK.B), announced it was acquiring natural gas pipeline and storage assets along with an equity stake in a liquified natural gas (‘LNG’) export facility in Maryland from Dominion Energy Inc (D). This deal is valued at $9.7 billion by enterprise value and is expected to close by the fourth quarter of 2020. We continue to like Berkshire Hathaway in the Best Ideas Newsletter portfolio.

Berkshire Hathaway’s Existing Natural Gas Midstream Assets

As of the end of 2019, Berkshire Hathaway owned 90.9% of Berkshire Hathaway Energy’s common stock. Berkshire Hathaway Energy’s asset base “has grown to a $100.8 billion portfolio” according to its early-July 2020 press release.

That asset base includes two long haul pipelines networks which route natural gas from producing to consuming regions in the US. The now 1,700-mile long Kern River Pipeline was acquired by Berkshire Hathaway back in 2002 for almost $1.0 billion when including the assumption of debt, which routes natural gas supplies from the Rocky Mountain region (starting in Wyoming) down to Western US markets (including Utah, Nevada, and California). Also, in 2002, Berkshire Hathaway acquired the now 14,600-mile long Northern Natural Gas Pipeline which runs from Texas up to the Midwest and Great Plains region (catering to multiple natural gas producing and consuming regions) for roughly $1.9 billion including the assumption of debt.

Combined, these two long haul pipelines have the capacity to route 8.5 billion cubic feet of natural as per day across the US. Berkshire Hathaway Energy has steadily grown the transportation capacity of its Kern River Pipeline over the past two decades. The deal with Dominion Energy will significantly grow Berkshire Hathaway’s exposure to the natural gas transportation and storage space (also referred to as the midstream industry). Store capacity is needed to support normal operating activities at pipeline assets, though that storage capacity can also be used to speculate on raw energy resources as well.

Deal Overview

Berkshire Hathaway is acquiring all (appears to be the equity) of Dominion Energy Transmission (transports natural gas across six states along the Atlantic Coast and in the Midwest), Questar Pipeline (transports natural gas across Wyoming, Utah, and Colorado) and Carolina Gas Transmission (transports natural gas in South Carolina), half of Iroquois Gas Transmission System (transports natural gas across New York and Connecticut), and a quarter stake in the Cove Point LNG export facility in Maryland (connected to major domestic producing basins through its own pipeline). This one of six LNG export terminals that are currently operational in the US, according to Berkshire Hathaway Energy.

Along with the stake in the LNG facility, this deal includes 7,700 miles of natural gas transmission pipelines with 20.8 billion cubic feet of daily transportation capacity, 900 billion cubic feet of operated natural gas storage capacity, and 364 billion cubic feet of company-owned natural gas storage capacity.

Once the deal closes, Berkshire Hathaway will become operator of the LNG export facility with Dominion Energy retaining a 50% equity stake in the venture alongside an infrastructure fund (Brookfield Super-Core Infrastructure Partners) managed by Brookfield Asset Management Inc (BAM), which acquired a 25% equity stake in the asset for a cash consideration of $2.1 billion back in 2019. The facility exported its first LNG cargo in early-2018.

The Cove Point LNG facility houses one LNG train with the nameplate capacity to export 5.25 million metric tons of LNG per year, with authorization from the US Department of Energy (‘DoE’) to export up to 5.75 million metric tons per year (equal to roughly 0.8 billion cubic feet of natural gas per day). That capacity is primarily contracted out under long-term fixed fee arrangements to buyers based in India and Japan, meaning that the commodity pricing risk of this asset’s future financial performance is reduced to a degree. Cove Point LNG contracted out its capacity under 20-year contracts to India’s state-owned GAIL and the ST Cove Point joint-venture owned by Sumitomo Corporation (SSUMY) and Tokyo Gas Co. Ltd. (TKGSF).

For Dominion Energy, this divestment represents the company shifting back to a rate regulated utility while retaining a passive stake in a US LNG export facility. Rate regulated utilities have very stable cash flow streams, supported by the ability to near-continuously grow their rate bases through several ways including; upgrading old wires (electric transmission and distribution) and pipeline networks, expanding existing systems, shutting down coal-fired power plants and replacing those with natural gas-fired power plants, and making renewable energy investments (such as solar and wind power plants). As an aside, Dominion Energy and its partner Duke Energy Corporation (DUK) cancelled the embattled Atlantic Coast Pipeline project, which Berkshire Hathaway did not purchase.

Given the US is swimming with natural gas supplies, made possible through the advent of “fracking” (combining horizontal drilling and hydraulic fracturing to unlock vast raw energy resources), there are likely long-term competitive advantages at the Cove Point LNG export facility. However, unexpected events such as the coronavirus (‘COVID-19’) pandemic highlight some of the hurdles such assets can face, namely the perennial risk that some buyers may declare force majeure if times get really tough, including GAIL (though it is not clear what impact, if any, the temporarily cargo deferments for March-April LNG deliveries to GAIL had on the Cove Point LNG asset’s financials).

Concluding Thoughts

Berkshire Hathaway’s cash pile is simply massive as we covered back in early-May 2020 after its first quarter earnings report (link here), and it appears the industrial conglomerate’s CEO Warren Buffett is finally ready to put some of that cash to use. We view this purchase as a bet on the long-term demand outlook for natural gas in North America and one that complements Berkshire Hathaway’s growing bet on renewable energy, namely wind power plants in the US and Canada (which we covered previously in these two articles here and here).

Renewable energy is steadily becoming a much bigger player in North America’s electricity grid (including wind power in the US), but to meet demand when the “wind isn’t blowing” given the economical limitations of current battery storage technology (while prices for lithium-ion batteries have come down significantly over the past decade, they are still quite expensive relatively speaking for utility-scale operations), natural gas-fired power plants will be required to fill in the gaps for some time. Natural gas has steadily gained market share in the US electricity generation space over the past decade and is the single largest source of domestic electricity supply on a monthly net generation basis.

Going forward, natural gas will remain a core part of the US electricity mix for some time. Modern natural gas-fired combined-cycle power plants are very economical and represent a consistent source of low cost electricity supply. Additionally, plummeting natural gas prices in the US over the past decade likely encouraged greater use of natural gas heating options in certain regions (roughly half of US households rely on natural gas heating options as of a few years ago), and furthermore, cheap feedstock prices helped encourage new natural gas-hungry industrial developments to come online in the US (such as petrochemical plants and refinery expansions).

This purchase fits in with Berkshire Hathaway’s long-term infrastructure and utility strategy in North America. It will be interesting to see how Mr. Buffett views the deal during Berkshire Hathaway’s next update.

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Utilities (Mid/Small) Industry - AEE, ALE, BIP, CNP, CMS, DTE, ES, LNT, MGEE, NFG, NI, PEG, PNW, SCG, SJI, SR, SRE, WEC

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Callum Turcan does not own shares in any of the securities mentioned above. Berkshire Hathaway Inc (BRK.A) (BRK.B) Class B shares are included in Valuentum’s simulated Best Ideas Newsletter portfolio. Kinder Morgan Inc (KMI) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Enterprise Products Partners L.P. (EPD), Magellan Midstream Partners L.P. (MMP), and Utilities Select Sector SPDR (XLU) are all included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios include a SPDR S&P 500 ETF Trust (SPY) put option holding with a $295 per share strike price that expire on August 21, 2020. Some of the companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.

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