Warren Buffett's annual letter to shareholders draws a lot of attention to the philosphy and folksiness of the Berkshire Hathaway guru's view of business and life. It also this year was a refresher on the basics of utility regulation: what he sees as the social pact between MidAmerican Energy and its public. And how he sees that same deal applying to Berkshire's newest holding, BNSF, the railroad.
"Our regulated electric utilities, offering monopoly service in most cases, operate in a symbiotic manner with the customers in their service areas," Buffett's letter says.
This brings up that time-honored (some might say time-worn) term "the regulatory compact." Just what the compact means, and whether it has changed at all in the last two decades, can be the subject of discussion. But Buffett seems to have a fairly clear idea of what it means, and to be banking on it.
MidAmerican has consistently kept its end of the bargain with society and, to society's credit, it has reciprocated: With few exceptions. our regulators have promptly allowed us to earn a fair return on the ever-increasing sums of capital we must invest. Going forward, we will do whatever it takes to serve our territories in the manner they expect. We believe that, in turn, we will be allowed the return we deserve on the funds we invest.
BNSF, the railroad Berkshire bought last year, "has certain important characteristics that resemble those of our electric utilities," Buffett's letter this past weekend says. Both provide fundamental, essential services; both require heavy investment that far exceeds depreciation allowances; and both must "plan far ahead to satisfy demand that is expected to outstrip the needs of the past." And "both require wise regulators who will provide certainty about allowable returns .,.."
We see a 'social compact' existing between the public and our railroad business, just as is the case with our utilities. If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should -- and we believe will -- understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without its possessing first-class electricity and railroad systems. We will do our part to see that they exist.
Railroad results will from now on be included in Berkshire's "regulated utility" section, Buffett says. Besides their similar economic characteristics, they both use large amounts of debt that isn't guaranteed by Berkshire. Both will keep most of their earnings and invest a lot "in good times or bad, though the railroad will display the greater cyclicality." And this regulated sector's earnings will grow significantly over time, Buffett says, "albeit at the cost of our investing many tens -- yes, tens -- of billions of dollars of incremental equity capital."
With respect to railroads, it's difficult to know just what the Oracle of Omaha means by the social compact, and who the regulators might be. Congress? The Antitrust Division? The Surface Transportation Board? The biggest temptation is to think of it with respect to coal, which provides a big chunk of BNSF's revenue; Buffett, a typically cryptic oracle, has been said to be betting on coal having a long life left in the power generation sector. It's unclear whether that's true, or whether he sees yet-unnamed possibilities for the rails.
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