Greg Abel has replaced Warren Buffett as the head of Berkshire Hathaway. The company’s annual meeting last week was the first one helmed by him. Mr Abel formerly headed Mid American Energy, a utility based in Des Moines, and then all of Berkshire Hathaway’s utility operations. When Mr Buffett spoke on issues of finance, investors listened attentively. Whether Mr Abel attracts the same reverential following remains to be seen. However, his views on electric utilities, based on his many years in the industry, are definitely worth reviewing. His comments can be divided into two parts, industry positives (high growth) and industry negatives (regulatory environment and related risks like wildfires).
AI and data centers are the main drivers of outsized demand for electricity right now. And this sudden demand is not evenly distributed. Berkshire owns utilities PacifCorp, NV Energy, and MidAmerican Energy along with gas pipeline and processing, and other unrelated assets. But Iowa, he pointed out, could see 50% demand growth in five years. He also emphasized his belief that new data center load should bear the full costs of its incremental demand on the system. These new costs should not be transferred to residential and commercial customers. (In the past, the cost of utility capital expenditures of this type were spread across all the ratepayers via the regulatory process.) And lastly Mr Abel touted the success of Mid American Energy, the company he formerly helmed, for both keeping up with accelerated demand growth and maintaining rates 45% below the US national average.
Having electricity rates roughly one-half that of the national average means that one’s service territory is blessed with either an abundance of hydroelectric power generating resources or a fleet of aging coal plants. In Mr Abel’s case, it is the latter. The MidAmerican fuel mix is 63% wind and 20+% coal plus a little gas, nuclear, and other resources. Needless to say, this aging coal fleet has drawn considerable scrutiny from environmental groups like the Sierra Club, who have advocated for expedited plant closures. The company’s position is that these plants will remain open until 2049, by which point the oldest facility in the present coal fleet will be 75 years old. For example, the George Neal South unit in Sioux City, Iowa was commissioned in 1975. The utility has one relatively new coal fired generating unit, commissioned in 2007, but apart from that, MidAmerican’s average coal unit entered service around 1980 which means that today these facilities are already about 45 years old. That is very old in 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 the exact same size as MidAmerican’s coal fleet. Only NV Energy of the Berkshire-owned US utilities has mostly completed the transition away from coal. We bring this up because it explains one reason why Mr Abel has stated his concerns regarding a potential degradation in his various regulatory environments.
We agree. If we owned over 9,000 megawatts of aging, polluting, politically unpopular coal-fired power generation in the US Midwest and Pacific Northwest, we’d have concerns about our regulatory environments too. And it gets worse. PacifiCorp has publicly stated that its litigation exposure from 2020 wildfires in California and Oregon could approach tens of billions of dollars. Berkshire has already paid over $500 million to settle various related lawsuits. Recently, the Oregon appeals court set aside the most financially damaging lower court ruling against the company, giving it some breathing room in this respect. Berkshire has been actively involved in getting state legislation passed that would limit its wildfire liability exposure. The Utah legislature passed a bill that management referred to as the “gold standard” with respect to liability mitigation. How many other states adopt this remains to be seen.
In his prepared remarks at the Berkshire annual meeting, Mr Abel reiterated that Berkshire might exit states that imposed arduous clean energy mandates. This is obviously no 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: “Diverging policies among the six states PacifiCorp serves have created extraordinary pressure affecting the company’s ability to meet demand reliably and at the lowest cost to customers.” However, he did offer regulators a sort of 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 stress this model, inflation (which is increasing) and other high cost requirements— like pollution controls on aging coal plants. All we can say here is that PacifiCorp serves about 2 million customers while Washington state accounts for less than 10% of the total. So PacifiCorp is selling a relatively tiny piece of the company. The bulk of the customers are in Oregon and Utah. Selling this asset looks to us more like an outreach effort with respect to the rating agencies, Moody’s and S&P, both of which downgraded PacifiCorp’s fixed income security ratings based on wildfire risk.
Now let’s try to put this in some kind of perspective. The three US utilities that Berkshire Hathaway Enterprises (BHE) owns have assets of about $90 billion out of BHE’s roughly $152 billion of total assets. That’s a sizable percentage. But BHE is, of course, only one part of the Berkshire Hathaway conglomerate which listed assets of $1.25 trillion in its March 10Q. US electric utilities are only about 7% of Berkshire’s total assets. Financial commentators have been trying to find some way to differentiate Mr Abel from his legendary predecessor, Mr Buffett. We think this is asking the wrong question. The question for us is: are these the same utility businesses, with the same risk profiles, that were purchased by Mr Buffett more than two decades ago? Our answer is an emphatic no. The biggest risk we see relates to one of the oldest issues in the electric utility business—the huge cost differential between rural and urban utility customers. It’s much more expensive to serve low density rural customers. Always has been. And now those rural service areas also come with enormous, open ended wildfire liability risk. But what’s worse is that decentralized forms of power generation, like solar plus batteries, will now increasingly offer opportunities for rural customers to leave the grid while lowering their energy costs. If we were advising Mr Abel, we would tell him to keep selling.
