Warren Buffett was poised to add Texas' largest electricity transmission and distribution network to Berkshire Hathaway's energy portfolio, but a quiet campaign by California utility Sempra Energy has spoiled the Oracle of Omaha's carefully laid plans.
The battle over Oncor highlights the value that billionaire investors like Buffett and Paul Singer assign to the businesses that move energy across America. This week, Buffett backed out of the deal after Sempra topped his $9 billion bid, a coup for Oncor bond investor Singer, who argued Berkshire's offer was too low.
The transmission and distribution business — linking power plants to businesses and residences via critical infrastructure — may not seem like the type of sector that would produce this sort of drama. But in a power industry that has been rocked by disruption from cheap natural gas and the adoption of renewable energy, the transmission business has proven relatively safe.
The companies that operate the wires and transmission towers that deliver electricity generate a steady return from rates that are set by state utility commissions. Buffett has called those earnings "recession-resilient" because utilities provide an "essential service for which demand is remarkably steady."
"Although there are some potential risks to that return, historically there have been few, if any, interruptions to the remuneration," said Ross Baldick, a strategic consultant and professor at the University of Texas at Austin who researches the economics of power systems.
"Moreover, current regulated rates of return are attractive compared to other low-risk investments, such as bonds," he explained.
Texas is particularly attractive because electricity demand is growing in the Lone Star State, while power consumption stagnates throughout much of the country. Growing demand for electricity will typically require investments in new infrastructure, said Baldick.
The Texas Public Utility Commission, like agencies in other states, regulates transmission rates. When it identifies new infrastructure needs, it bakes in a return on investment into those rates. That mitigates risks for the companies that operate and invest in the transmission lines.
"That's essentially a guaranteed return for them on that investment eventually because we do continue to see growth," said Robbie Searcy, communications manager at the Electric Reliability Council of Texas, which operates the electric grid and manages the energy market in the state.
In Texas, transmission projects are underway or under consideration to address growing needs in the Houston metro area, the Lower Rio Grande Valley, the Dallas-Fort Worth area and the shale oil producing parts of Western Texas, she said.
The growth of wind and solar power is also creating new opportunities for transmission companies. Wind and solar farms are typically located in remote areas, creating the need for high-voltage wires to carry their clean power to demand centers.
At the same time, utilities are increasingly focused on using network sensors and other equipment to create a "smart grid," which would allow them to better monitor the flow of power from renewable sources subject to disruptions from weather.
To modernize and strengthen the U.S. grid, utilities need to add about 42,000 miles of high-voltage wire to the country's existing 450,000 miles — an endeavor that would cost about $8.5 billion per year over 10 years, according to Massoud Amin, an expert in grid reliability at the University of Minnesota.
"Transmission becomes the superhighway of our ability to actually integrate diverse and disparate sources of energy into our network," said Amin, who has been called the "father of the smart grid."
In the process of building out this infrastructure, companies will not achieve "huge" double-digit earnings and revenue growth, but they can generate "very, very stable single-digit growth," Amin said.
Buffett and his Berkshire Hathaway Energy — run by one of Buffett's top deputies, Greg Abel — understand this paradigm, in Amin's view.
Berkshire Hathaway has invested heavily in wind, solar and hydropower on the electricity generation side of the business, while building out a portfolio of transmission businesses from Texas and the Great Plains, through the Southwest and the Rockies and up the Pacific Coast.
But the Oracle of Omaha is also known for avoiding bidding wars. In the case of Oncor, hedge fund titan and distressed asset investor Singer appears to have successfully exploited that tenet of the Buffett philosophy.
Singer's Elliott Management threatened a $9.3 billion rival bid for Oncor. In the end, Singer's gamble that someone would top Buffett's offer paid off when Sempra swooped in.
In a statement on Monday, Abel suggested that Berkshire Hathaway Energy is not done hunting for deals in Texas.
"Texas is a great state for business, and we look forward to future opportunities to invest," he said.