prized energy business faces upheaval

When Berkshire Hathaway announced the acquisition of MidAmerican Energy in 1999, Warren Buffett hailed the Iowa gas and electric utility as squarely in the conglomerate’s “sweet spot”.

Unheralded at the time, the $2bn transaction catapulted Buffett into the energy business, kicking off a quarter of a century of dealmaking that has transformed Berkshire into a major player, operating across 28 states, transporting 15 per cent of America’s natural gas and serving 13mn customers.

The $138bn of assets owned by its subsidiary, Berkshire Hathaway Energy, are varied but the appeal of the businesses — and their place within Berkshire — have gone unquestioned. Its utilities, accounting for the bulk of BHE’s assets, boast the economic moats against competition prized by Buffett and have long been an attractive home for the cash that the conglomerate generates.

But if predictability was hardcoded into the sector’s DNA 25 years ago, global warming is bringing epochal change. The threats confronting Berkshire are multipronged: from billions of dollars in potential damages from wildfires, to criticism over how quickly it plans to retire its coal-fired power stations and the increasing politicisation of climate change in the US.

“I thought the energy business was going to be the place that absorbed a few billion dollars every year and has a consistent and steady return attached to it and it’s protected,” said Darren Pollock, portfolio manager at Cheviot, a California-based investment firm and Berkshire shareholder. “That’s no longer the case.”

This is the third in a series looking at the future of Berkshire when 93-year-old Buffett is no longer at the helm.

The energy division arguably faces the most fundamental upheaval of any part of the Berkshire empire. When Buffett no longer has the reins, deciding whether to allocate more capital to utilities — or remain in the business at all — will fall to Greg Abel, chair of BHE and the man Buffett has picked as his successor. BHE declined to put any executives up for interviews.

The 61-year-old Abel can expect to be subject to far more public criticism over its controversial parts, such as 28 coal-fired power units, one of the largest such fleets in the US, and a more recent bet on natural gas, than Buffett, the most celebrated American business leader of the past half century.

“People have this vision of Berkshire Hathaway and Berkshire does a great job, honestly, with the PR to elevate Warren Buffett as the face of the company,” said Kerri Johannsen, energy programme director at the Iowa Environmental Council.

The scale of the potential financial threat tied to climate change was laid bare last summer when an Oregon jury found PacifiCorp, the largest electric utility owned by Berkshire, liable for causing a series of deadly wildfires in 2020 by failing to shut off power lines.  

As claims against the company mount from separate cases, PacifiCorp has estimated it could face more than $8bn in damages, though its lawyers last year outlined a scenario in which the figure could reach $45bn. The company has said it would “vigorously pursue appeals”.

This week PacifiCorp faced an expansion of an existing class action lawsuit, seeking up to $30bn in damages, in the wake of the Oregon judgment. PacifiCorp blasted the move, saying utilities were in danger of becoming “de facto insurers of last resort”.

The Oregon verdict had already prompted Buffett for the first time to cast doubt over the future of the utilities business.

“Berkshire can sustain financial surprises but we will not knowingly throw good money after bad,” he noted in his annual letter to shareholders in February, warning of the “spectre of zero profitability or even bankruptcy” across the industry.

Wildfire lawsuits pushed California’s PG&E into bankruptcy in 2019 and Hawaiian Electric has seen its share price collapse amid mounting lawsuits over devastating fires on the island of Maui last year.

“I think part of Warren Buffett’s point was that you’re seeing excessive damages being awarded, that means that power companies are essentially underwriting what is a societal risk that is being driven by climate change,” said Pedro Pizarro, chief executive of Edison International, the owner of Southern California Edison, one of the country’s biggest utilities. “That breaks the model.”

Berkshire is one of several companies pushing states, including Wyoming and Idaho, to pass laws that would cap payouts if a utility is found culpable in the event of a wildfire. Utah recently adopted a law that shifts some of the cost of wildfire claims on to a utility’s customers and caps damages.

If other states passed similar legislation it would mark a “happy ending” for the company, said one big Berkshire shareholder. “They have some leverage with these legislatures to say we need you to change the rules.”

A decision to eventually abandon utilities would represent a sharp reversal of Buffett’s long-standing enthusiasm. Two years ago, he described the energy business as one of the company’s “four giants”.

BHE generated $2.3bn in operating earnings for Berkshire in 2023, down sharply from $3.9bn the previous year, as the group made provisions for damages. Although the subsidiary accounted for less than 10 per cent of Berkshire’s overall earnings, analysts and investors say this understates its role within the conglomerate.

“It’s a place that Berkshire can take some of their excess cash — a lot of it from their financial businesses — and put it to work every year consistently at scale,” said Steve Fleishman, managing director at Wolfe Research, an investment research group.

Regulators look at the amount of capital a utility invests when setting the level of returns owners can generate, which has made the sector a perfect fit for Berkshire.

Some utilities have been faulted for not spending more on technology, satellite modelling and sensors that could help them better predict conditions that would spark a wildfire. If such costs are not approved by state public utility commissions, they eat into the profit margins as the utility earns nothing on its spending.

Berkshire estimated it would have to spend more than $1bn over the next three years across its utilities to mitigate the risk from wildfires.

Former industry executives and regulators say that such levels of spending on a permanent basis, alongside the danger of legal risks, would undermine the case for owning utilities.

“They all are unfortunately financially rewarded by how much money they spend on capital expenditures, so it’s all structured around how much they can spend,” said Jon Wellinghoff, a former chair of the Federal Energy Regulatory Commission. “You can’t fault them for that. That’s the way the system is set up.”

While the PacifiCorp ruling exposed the rising litigation threat from climate change, the increased weight institutional investors are giving to it has thrust a reluctant Berkshire into the spotlight.

A decade ago, MidAmerican won plaudits for pouring money into wind power in Iowa, an investment credited with turning the state into the country’s biggest player in the renewable energy source after Texas. Today, BHE is the largest owner of wind generation among regulated utilities in the US, giving the group a significant renewable energy business.

“We are committed to managing the energy transition in a cost-effective, customer-centric manner,” BHE said in a statement, noting it had invested $39.9bn in renewables through to the end of last year. “We will continue to move forward in the energy transition at a speed our customers can afford and at a pace that allows us to maintain reliable service for our customers.”

But Berkshire has faced pressure from shareholders, including the California Public Employees’ Retirement System, BlackRock and State Street, to provide greater disclosure on the risks the company faces from climate change.

“The company does not meet our aspirations for disclosing a plan for how their business model will be compatible with a low-carbon economy,” BlackRock said last year as it backed more disclosure.

At this year’s annual meeting on Saturday, the state treasurer of Illinois has tabled a resolution calling on BHE to publish a detailed annual breakdown of its emissions. Berkshire has urged shareholders to vote against the motion, pointing to existing disclosures and arguing that such a report was not “necessary at this time”.

Buffett, who has long adopted a hands-off approach to managing Berkshire’s subsidiaries, has previously labelled calls for a company-wide climate report as “asinine”.

The billionaire has acknowledged that global warming is happening, but in past years he has signalled his reluctance to use it as a factor when deciding whether or not to invest.

“I would hate to have all hydrocarbons banned in three years,” Buffett said in 2021. “We’re going to need a lot of hydrocarbons for a long time . . . but I do think that the world’s moving away from them, too.”

Charlie Munger, who helped build Berkshire and died in November, was more sceptical. Last year he said that he thought there was “a good chance that climate change will be less important than a lot of people think”.

Last year, Berkshire was given one of the lowest grades for its engagement on climate change in an analysis compiled by Climate Action 100+, a coalition of about 700 global investors including Amundi and Fidelity. Only a handful of companies including Saudi Aramco have received such a low designation.

“Berkshire has been resistant to climate scrutiny,” said Danielle Fugere, president of investor advocacy group As You Sow, which has tabled a number of climate motions at the company.

BHE declined to comment on the analysis by Climate Action 100+. Berkshire Hathaway did not respond to a request for comment.

Under fire from climate campaigners, the decisions that Abel will face over the future of the business are likely to grow more complex as the speed of the transition to renewable energy is reassessed.

As a major shareholder in US oil producers Chevron and Occidental, Berkshire has benefited from an emerging argument, since the energy crisis generated by Russia’s full-scale war on Ukraine, that weaning the world off fossil fuels will take longer than previously expected.

Munger was an outspoken defender of the investments, saying last year that “having a big position in the Permian Basin [America’s most prolific oilfield] through those two companies is likely to be a pretty good long-term hold”.

There are signs that Berkshire is prepared to make a significant wager on a slower pace in the green energy shift, even if it draws criticism.

In 2020, Berkshire paid $8bn for Virginia-based utility Dominion Energy’s natural gas infrastructure business just as some other industry players were seeking to cut exposure to the fossil fuel.

Gas has proved contentious. Advocates point out that it emits less carbon dioxide than coal when burnt and has a significant role to play in weaning countries such as China off the dirtiest fuels. Opponents highlight that natural gas is largely composed of methane, which when it escapes generates more warming than carbon dioxide even if it is shorter-lived in the atmosphere.

The Dominion deal handed Berkshire thousands of miles of natural gas pipelines and a 25 per cent stake in the Cove Point liquefied natural gas terminal in Maryland, a big export facility. Last year, Berkshire paid $3.3bn to take its stake in Cove Point to 75 per cent.

The Biden administration in January indefinitely paused the issue of new permits required to construct LNG export terminals, in a move to win climate conscious voters in an election year and aligned with its UN pledge to cut emissions by about half of their 2005 levels by 2030.

The pause should benefit existing facilities such as Cove Point, potentially creating a new competitive moat for Berkshire and other operators of export terminals. It also illustrates the combustible mix of politics and a fast-changing landscape that Abel will have to navigate to keep energy part of Berkshire’s sweet spot.

“Everything is changing all at once: the climate is changing; the financial climate is changing; the consumer and shareholder climate is changing,” said Michael Webber, professor of energy resources at the University of Texas at Austin and author of Power Trip: The Story of Energy. “These are big challenges — it will take a change in thinking and companies will have to consider their options.”

With reporting by Attracta Mooney in London

This article is part of a series looking at the future of Berkshire Hathaway when Warren Buffett is no longer in charge. To read the other pieces in the series on Berkshire after Buffett click here.