(HNZ) Warren Buffett and the U.S. Oil and Natural Gas Boom

On March 4 Warren Buffett had a little sit-down with CNBC’s Becky Quick for his annual “Ask Warren” appearance on “Squawk Box.”

Throughout this special edition of the morning show, Buffett answered questions submitted from viewers by way of email, Twitter, Facebook and LinkedIn. He responded to a host of different questions ranging from his annual letter to Berkshire Hathaway (NYSE: BRK-A) shareholders to M&A activity like the recent Heinz (NYSE: HNZ) deal.

Here’s a quick recap of his thoughts on the current environment:

  • First and foremost, Warren Buffett believes there is still “good value” in stocks, despite the fact the Dow has been hitting historical highs over the past week.
  • Buffett stated that the dumbest investment right now is a long-term government bond. (Go figure.)
  • Right up there with equities are single-family homes. Buffett called them a “very attractive” investment at the moment.
  • The U.S. economic recovery is healthy and it shouldn’t be hindered by the upswing in oil prices. You are making a big mistake if you’re pessimistic on the United States for the long term. (We agree.)
  • Mr. Buffett wasn’t overly concerned with the sequester being too much of a burden on the U.S. economy. Slow and steady should continue to be the best way to describe the recovery.

Touching on the Oil and Gas Boom

Beyond the broad critique of today’s market, Mr. Buffett touched on the current natural oil and gas boom that could reap some benefits for the long term.

Love him or hate him, Jim Cramer, host of CNBC’s “Mad Money,” decided to get in on the act. As he was listening to the interview, Cramer emailed a two-part question for Buffett. The first question was, “Are we at the golden age of oil and gas, and how is Burlington cashing in on it [train to refinery]?”

Pipelines on Wheels

Buffet believes the oil and natural gas explosion in the Bakken Shale in Montana, North Dakota and Canada will be a catalyst for growth for Burlington Northern Santa Fe.

As far as the present being “the golden age,” Buffett stated that Bakken oil represents about 5% of shipments at Burlington. He added, “We ship 190,000 cars a week… Coal is 20%. So what we’ve lost in coal we more or less made up in oil. But it’s a growth factor, no doubt about it.”

Now we need to dig a little deeper. Warren Buffett bought Burlington Northern Santa Fe in 2010 for $26.5 billion. Bakken oil has created an opportunity for railroad companies that can seamlessly convert their lines to load and ship it.

In 2012, coal shipments dropped about 10% amongst the seven biggest railroad companies, but oil has made up the difference. Last year, the spike in oil production from shale caused a 46% increase in petroleum shipments for Burlington. For 2013, Burlington forecast a 40% increase in crude oil shipments.

The company has made statements that the railroad carries about 25% of the oil from the Bakken fields. It was also noted that Burlington can ship higher volumes from North Dakota or Alberta in the future.

There are other railroads in the Buffett portfolio you can directly invest in, though, now that Burlington Northern is private under the Berkshire Hathaway (NYSE: BRK-B) umbrella.

For instance, Union Pacific Corporation (NYSE: UNP), which has gained 103% since The Oxford Club initially recommended it in August 2010.

UNP reported record results last year. It was the railroad’s most profitable year in its 150-year history. Union Pacific reported 2012 full-year diluted earnings at $8.27 per share. That was an increase of 23% from the prior year.

Norfolk Southern Corp. (NYSE: NSC) revenue is up more than 38% since 2009. Take note that NSC increased its dividend more than 18% in 2012 with a nice 30% payout ratio.

Converting Locomotives to Run on Natural Gas

Cramer’s follow-up question asked, “Will [the railroad] switch to natural gas engines on its locomotives?”

In reply, Buffett stated that they have already begun experimenting with the changeover. He talked about the process as “real enough, so we’re spending real money.” Buffett continued, “When you get natural gas, you know, at $3.50 and you look where oil is… You’ve got to look at converting any kind of an engine to natural gas.”

Later that week, Berkshire Hathaway announced it would be testing both Caterpillar-EMD and GE-made locomotives. These locomotives would run by way of liquefied natural gas – referred to as LNG in the industry – and the testing would determine performance and reliability.

The experiment was attempted back in the 1980s and 1990s, but it proved to be too expensive. At that time, the cost of natural gas was much more than diesel fuel. But thank God for technology. We can now extract oil and gas pretty cheaply from the Marcellus and the Utica shales, and this boom is here to stay.

For an alternate play – other than railroads – look for General Electric (NYSE: GE) and Siemens (NYSE: SI) to increase profitability and dividends going forward. Both companies manufacture natural gas electric turbines, railroad components and energy-industry necessities.

As LNG becomes a more prominent factor in the industry, these two giants will take advantage of the new business.

How to Invest Directly in the Source

If you want to invest directly – with a few tax advantages – into those Pennsylvania and West Virginia gas wells, there is always the option of oil and gas unit investment trusts (UITs).

UITs are riskier than your typical energy-focused mutual fund that only buys shares in oil, gas and/or other energy companies. Beware that UITs are buying directly into wells that may not produce, or may only be profitable for a small amount of time. However, UIT investors are in it for long-term capital gains.

Also, tax laws allow investors to be able to deduct the losses in an UIT, referred to as their depletion percentage.

Good Investing,

Jason

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