Major media has painted Warren Buffett’s acquisition of Burlington Northern Santa Fe as a “bet on the future of America”. While Buffett’s purchase does indeed signal a bet on the future prospects of America – that doesn’t necessarily mean the future looks good.
Major media has painted Warren Buffett’s acquisition of Burlington Northern Santa Fe as a “bet on the future of America”. While Buffett’s purchase does indeed signal a bet on the future prospects of America – that doesn’t necessarily mean the future looks good. Financial media has put a big spin on this story, portraying outright bullishness for the collective United States economy. Instead of taking a one sided view of the story, lets look at this event from other angles and answer this important question: What exactly is Warren Buffett “betting” on for the future?
Rising Fuel Costs
It is well known that prices of fuel have been creeping back up. Crude oil is already touching $80.00 again. Since Burlington Northern Santa Fe is a transportation company utilizing trains, it would seem that Buffett is betting on oil maintaining or more likely increasing in cost (inflation). Transportation by train simply isn’t nearly as efficient as transporting by truck with crude oil below $50.00 per barrel for prolonged periods of time. However, as fuel costs move higher transportation by train gains a competitive advantage. If you take the entire loaded weight of a typical freight train and divide it over the amount of gasoline it uses – freight trains could potentially move one ton of material over 400 miles on a single gallon of gas. Warren Buffett’s bet on train freight becoming increasingly popular over trucking is a bold bet on the price of oil and other fuel sources rising.
Dollar Devaluation (Inflation)
Trains transport a variety of goods, but are notorious for their use in commodity transportation. As you might already know commodity prices rise when demand increases or currency devalues. With the dollar at a 14-month low it would seem like Mr. Buffett is also betting on a inflation. Not only is Buffett buying a hard asset in Burlington Northern Santa Fe, but he is also betting on increased commodity prices. Companies utilizing train freight benefit from increased margins when commodities rise in price. This is especially true when the value of the commodities they transport rise more than the fuel used. Since trains are one of the only methods for transporting commidities they have huge negotiating leverage for shipping rates.
Because of the massive amounts of land requirements and infrastructure needed to operate a railroad, increasing competition is highly unlikely. Only existing railroad companies will compete with Buffett’s acquisition. Secondly, the railroad industry has been hard hit by the recession. This makes the price attractive to a value investor like Buffett, scrambling to diversify out the US Dollar. Providing the economy doesn’t double dip or fade Buffett may very well be getting in at the trough. Lastly, transportation by train is environmentally friendly and therefore appeals to the green movement.
The railroad industry is a great place to be in the current economic environment. Rising inflation coupled with increased fuel costs give transportation by train a major advantage over other forms of transportation. Gold bugs solidified this thesis immediately after the buyout announcement, sending gold higher by 25 dollars per ounce to $1089.10. Oil also staged a small rally after the news was released. All of these factors support the thesis that Buffett’s bet on the railroad industry indicates serious potential for inflation and increased fuel costs. Examining this purchase more closely seems to hint their is more too it than meets the eye.
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