Buffett Poised to Win Wager on America With Burlington

By Natalie Doss - Mar 1, 2012 12:01 PM GMT+0700

When Warren Buffett bought North America’s second-biggest railroad, he called it an “all-in wager” on the U.S. economy. It’s turning out to be a pretty good bet on the oil industry, too.

Burlington Northern Santa Fe’s track network puts it among the best situated of its peers to meet shipping demand for fracking sand, pipe and crude in the northern U.S. Bakken region, where oil production has more than tripled since 2008, according to data compiled by Bloomberg.

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Berkshire Hathaway Chairman and CEO Warren Buffett in front of a mockup of a BNSF locomotive in Omaha. Photographer: Nati Harnik/AP

Gains in mineral and chemical carloads helped Burlington Northern pay a $1 billion distribution to Buffett’s Berkshire Hathaway Inc. (BRK/B) last month. The railroad is the busiest in the U.S. in 2012 by traffic, positioning it to build on a 16 percent jump in 2011 sales that helped narrow the revenue lead of Union Pacific (UNP) Corp., which lacks tracks into the Bakken area.

“It’s kind of like if somebody discovers gold in your backyard but not your neighbor’s,” said John Anderson, advisory director at Greenbriar Equity Group, a private-equity firm based in Rye, New York, focused on the transportation industry. “It’s just good luck.”

Drilling in the Bakken region in Montana and North Dakota is increasing because of improvements in hydraulic fracturing, a technology that uses sand and other chemicals to hold open fissures in shale formations to extract oil. With no pipelines in place yet, railroads are taking oil to refineries and delivering materials such as pipe and specialized fracking sand.

North Dakota

Burlington Northern has “been lucky” to some degree, Tony Hatch, an independent rail analyst in New York, said in an interview. “They’ve got a big presence in North Dakota, which was probably not something that was probably in the forefront in their mind two or three years ago as a competitive advantage.”

That’s adding to the benefits Buffett received when he spent $26.5 billion to acquire the 77.5 percent of Fort Worth, Texas-based Burlington Northern that Berkshire didn’t already own. Buffett, 81, called the deal an “all-in wager” on the U.S. economy when he announced it in 2009.

He negotiated his biggest-ever purchase so Berkshire could benefit from demand for shipping on routes in the U.S. West. The deal has helped boost Omaha, Nebraska-based Berkshire’s profit in the past two years as a recovering economy pushed Burlington Northern’s revenue to $19.5 billion in 2011.

Burlington Northern “has benefitted from the shale play probably more than Union Pacific,” said Lee Klaskow, a Bloomberg Industries analyst in Skillman, New Jersey.

Two Railroads

The railroad serves about 30 percent of U.S. oil refineries, Klaskow said in an interview. It’s also one of only two major carriers, along with Canadian Pacific Railway Ltd. (CP), with tracks into the region. That means Burlington Northern can pick up shipments from drillers and take them to the refineries across its 32,000-mile (51,500-kilometer) system.

Having a “full service” approach contrasts with Union Pacific’s need to exchange carloads with Burlington Northern or Canadian Pacific to move petroleum to refineries on its network, Klaskow said. Freight that stays on one railroad’s system for the full trip is typically more profitable.

Oil and gas-field servicing are “exploding very healthily” for Burlington Northern, said Paul Bingham, economics practice leader at consultant CDM Smith in Arlington, Virginia. “In the west I think the BN disproportionately benefits from that.”

Fourth-quarter net income advanced 41 percent, Burlington Northern said this week in a filing. Buffett didn’t respond to a request for comment e-mailed to his assistant, Carrie Kizer.

Fracking Fallout

The increase in fracking has hurt another Buffett bet: $2 billion in bonds of Energy Future Holdings Corp. He wrote down the investment by more than $1 billion as lower gas prices pressured the power company and told shareholders in a Feb. 25 letter that the investment is at risk of losing all value.

Investors following Buffett’s lead on railroads have outperformed the broader U.S. market.

The Standard & Poor’s 500 Railroads Index (S5RAIL), a gauge of Burlington Northern’s three publicly traded peers, surged 80 percent through yesterday from Nov. 2, 2009, the day before Buffett agreed to buy the carrier. The S&P 500 rose 31 percent in the same period.

Canadian Pacific’s shares were up 57 percent since then in Toronto. Its largest shareholder, Pershing Square Capital Management LP’s William Ackman, has cited Bakken access as one of the railroad’s potential advantages as he pushes for a management change.

Trade Group’s Data

Association of American Railroads data offer glimpses of Burlington Northern’s drilling-related traffic.

Fourth-quarter originated carloads of non-metallic minerals and products grew about 15 percent, while chemicals climbed 5.4 percent. Fracking sand and petroleum are included in the latter two categories, according to the Washington-based trade group.

The railroad doesn’t report oil cargo as a category, and Krista York-Woolley, a spokeswoman, said Burlington Northern doesn’t break down volumes by shipping locations.

Burlington Northern is leading the North American industry in originated carloads of all kinds in 2012, with a four-week moving average of almost 165,000 through Feb. 18. That compares with about 140,000 for Union Pacific, according to data compiled by Bloomberg Industries.

Union Pacific’s chemical volumes also are rising because fracking technology is boosting natural-gas drilling. Chemicals are Union Pacific’s second-biggest commodity by volume, after coal. And its route system blunts the disadvantages of not serving the Bakken region directly, said Tom Lange, a spokesman for the Omaha-based railroad.

Gulf Coast Access

“The majority of Bakken crude shipments ultimately are delivered by Union Pacific to the Gulf Coast refineries,” Lange said yesterday by e-mail. “Other railroads interchange with us in Kansas City and St. Louis.”

The revenue lead for the largest U.S. railroad over Burlington Northern dwindled to only $9 million in 2011 from more than $2 billion in 2003. Sales growth at Burlington Northern has been faster since then, and it eclipsed Union Pacific sales in 2008 for the first time since at least 1987.

Burlington Northern has a “bigger position in what I think in the next cycle will be faster-growing elements -- intermodal, the Bakken, international grain,” Hatch said. “If you just woke any rail analyst in 1990 or 2000 and said, ‘Best franchise?’ They’d have said Union Pacific. I think it’s closer now.”

To contact the reporter on this story: Natalie Doss in New York at ndoss@bloomberg.net

To contact the editor responsible for this story: Ed Dufner at edufner@bloomberg.net