Tags: Buffett | Berkshire | Energy | Bet

Buffett: Berkshire Energy Future Bet at Risk of Being Wiped Out

Monday, 27 Feb 2012 08:49 AM

Warren Buffett, who bought about $2 billion in bonds of power company Energy Future Holdings Corp., said the investment is at risk of losing all its value after natural gas prices fell.

Buffett’s Berkshire Hathaway Inc. wrote down the debt by $390 million last year, following a $1 billion impairment in 2010, the billionaire said in his annual letter to shareholders posted Feb. 25 on the company’s website. The market value of the investment was $878 million at the end of December, he said.

“If gas prices remain at present levels, we will likely face a further loss, perhaps in an amount that will virtually wipe out our current carrying value,” wrote Buffett, Berkshire’s chairman and chief executive officer. “Conversely, a substantial increase in gas prices might allow us to recoup some, or even all, of our writedown.”

Buffett, 81, invested in the bonds in 2007 after Energy Future, then called TXU Corp., was bought by KKR & Co. and TPG Capital in the largest leveraged buyout. The private-equity firms wagered that gas prices would rise, pushing up the price for wholesale electricity. Instead, gas prices plummeted amid an expansion of drilling in the U.S., putting pressure on power providers that operate in unregulated markets where states don’t ensure utilities make a certain level of profit.

Texas Competitive’s $1.87 billion of 10.25 percent bonds due in November 2015 have tumbled to 29 cents on Feb. 24 from 62 cents on the dollar a year earlier, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Subordinating Debt

Energy Future has sought to reduce its risk of default by pushing out debt maturities and asking bondholders to swap their investments at discounted prices for new securities. Berkshire didn’t participate in an exchange in the fourth quarter of 2010, further subordinating its investment, the company said in a letter last year to the U.S. Securities and Exchange Commission.

While Energy Future has “significant exposure” to natural gas prices, it has almost fully hedged that risk this year, said Allan Koenig, a spokesman for the company, in an e-mailed statement yesterday.

“Having reworked our capital structure to extend our debt maturities until 2014 and beyond, we continue to service our investors’ holdings,” Koenig said. Berkshire has received annual interest payments of about $102 million since its purchase, Buffett said in his letter.

Natural-gas drillers have been using hydraulic fracturing, or “fracking,” and other technology to develop gas in shale fields from Texas to Pennsylvania. The new sources have driven the price from a high of more than $13 per million British thermal units in 2008 to as low as $2.23 on Jan. 23. Gas futures closed at $2.55 on the New York Mercantile Exchange last week.

‘By Storm’

Fracking “has taken the business by storm,” Peter Beutel, president of trading advisory company Cameronhanover.com in New Canaan, Connecticut, said in a phone interview. “All the sudden, we’ve got more natural gas than we can use.”

Prices are “brutal” for Energy Future, Andy DeVries, an analyst at CreditSights Inc., said in an interview last month. Omaha, Nebraska-based Berkshire made the bet by buying issues from the Texas Competitive unit maturing in 2015 and 2016, according to the letter to the SEC.

Energy Future posted a net loss of $136 million in the three months ended Dec. 31, its fourth consecutive unprofitable period. The benchmark wholesale power price in northern Texas, where Energy Future has plants, fell 2.7 percent from a year earlier to average $30.97 a megawatt-hour during the fourth quarter, according to data compiled by Bloomberg.

‘Unforced Error’

Buffett often uses his annual letter to point out his blunders, such as buying ConocoPhillips stock near the peak of an energy boom, even as he has built book value per share by more than 5,000-fold over 47 years. This year, he called his bet on Energy Future a “big mistake,” even if gas prices rise and some of the write-down is recouped.

“However things turn out, I totally miscalculated the gain/loss probabilities when I purchased the bonds,” Buffett wrote. “In tennis parlance, this was a major unforced error by your chairman.”

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Monday, 27 Feb 2012 08:49 AM
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