Warren Buffett’s latest letter is full of valuable lessons, including his views on oil and gas companies and the utility industry.

Every year around this time, I always look forward to reading Warren Buffett’s annual Berkshire Hathaway shareholder letter. Last weekend, Buffett released the 2023 edition. This letter was particularly poignant as it followed the passing of Buffett’s longtime trusted partner, the great Charlie Munger, in November last year. Apart from containing a heartfelt eulogy from Buffett to Munger, the letter also includes some brilliant insights from Buffett himself, which I’d like to highlight and share.

To the point (emphasis on Buffett’s words)…

Actions of Exceptional Partners

Charlie never sought credit for himself as a creator but rather allowed me to accept accolades. In a sense, our relationship was both like that of brothers and that of a nurturing father. Even when he knew he was right, he would relinquish control to me, and when I erred, he never—never—reminded me of my mistakes.

Differentiating Good Businesses from Bad Ones

Under the capitalist system, some businesses thrive in the long run while others become failures. Predicting winners and losers is much harder than you imagine. Those who claim they have the answers are usually either fooling themselves or deceiving others.

Long-Term Ownership of Great Businesses—ones that can deploy additional capital and earn high returns—is the Key to Amassing Enormous Wealth

At Berkshire, we particularly favor rare businesses that can deploy additional capital at high returns in the future. Owning just one such company—and merely sitting—can bring almost immeasurable wealth. Even the inheritors of such holding companies—sigh!—sometimes enjoy a lifetime of leisure…

…You might think she put all her money into Berkshire and then just sat. But that’s not the case. After forming the family in 1956, Bertie was financially active for 20 years: holding bonds, putting a third of the funds into publicly held mutual funds, and trading stocks frequently. Her potential remained unnoticed…

Then, in 1980, at the age of 46, Bertie, despite her brother’s urgings, decided to move. Over the next 43 years, she held onto only mutual funds and Berkshire Hathaway stock, making no new trades. During that time, she became very wealthy, even after donating large sums to charity (think nine figures)…

Berkshire’s Size is now a Significant Handicap to the Company’s Future Growth

The combination of the two essential conditions for acquiring businesses that I previously described has long been our goal in acquiring. For a time, we had a plethora of candidate companies to evaluate. If I missed one—and I missed many—another would always appear.

Those days are long gone; size has made us a disadvantage, despite competition for purchases being another factor.

To date, Berkshire Hathaway boasts the highest GAAP net worth among U.S. companies. Record operating earnings and a robust stock market led to year-end figures of $561 billion. In 2022, the GAAP net worth of the other 499 S&P companies (the U.S. Business Hall of Fame) amounted to $89 trillion. (S&P’s 2023 figures have not yet been tabulated, but it’s unlikely to significantly exceed $95 trillion.)

By this measure, Berkshire now accounts for nearly 6% of our nation’s enterprise. Doubling our colossal base within five years is out of the question, especially as we’re staunchly opposed to issuing stock (which would immediately increase net worth)…

…In summary, we cannot achieve jaw-dropping performance…

…Our Japanese purchases began on July 4, 2019. Given Berkshire’s current scale, acquiring positions via the open market requires considerable patience and a long-term “friendly” price. The process is akin to turning around a battleship. This is a significant disadvantage we didn’t encounter in Berkshire’s early days.

Is There a Lack of Large, Excellent Companies Outside the U.S.?

In the U.S., only a handful of companies genuinely drive Berkshire’s growth, and we and others have been selecting these companies. Some we can value, others we cannot. If we can, the valuations of these companies must be attractive. Outside the U.S., Berkshire essentially has no investable candidates.

Occasional Abundance of Bargains Due to External Shocks

At times, the market and/or the economy can lead to severe mispricing of stocks and bonds of fundamentally sound large companies. In fact, the market may and will fail or even disappear unpredictably, as it did for four months in 1914 and several days in 2001.

Today’s Market Participants Exhibit More Speculative Behavior than in the Past

Although the stock market is much larger than in our early years, the sentiments of today’s active participants are no more stable than when I was in school, nor have they received better education. For whatever reason, today’s market exhibits more gambling behavior than in my younger days. Now, many households have a casino set up, tempting residents every day.

Stock Repurchases Should Only be Done at Prices Below Intrinsic Value

All stock repurchases should depend on price. Doing so at prices above intrinsic value would turn a prudent action into a foolish one.

Does Western Oil Play a Strategic Role in U.S. Long-Term Economic Security?

As of year-end, Berkshire holds 27.8% of the common stock of Occidental Petroleum, with warrants allowing us to significantly increase our ownership at fixed prices over a little more than five years. While we greatly cherish our ownership and the optionality, Berkshire has no interest in acquiring or managing Occidental. We’re particularly fond of its vast oil and gas resources in the U.S. and its leadership position in carbon capture, although the economic viability of the technology remains unproven. Both activities are very much in our nation’s interest.

Not long ago, the U.S. heavily relied on foreign oil, and carbon capture had no meaningful supporters. In fact, in 1975, U.S. production stood at 8 million barrels of oil equivalent per day (“BOEPD”), far below its demand. The U.S. enjoyed a favorable energy position during World War II, but today, it has become a nation heavily dependent on foreign (potentially unstable) suppliers. Oil production is expected to further decline with increased future usage.

Historically, this pessimism seems correct, with production declining to 5 million barrels/day by 2007. Meanwhile, the U.S. government established the Strategic Petroleum Reserve (“SPR”) in 1975 to alleviate (though not come close to eliminating) this situation. The U.S.’ self-sufficiency eroded.

Then—hallelujah!—the shale economy became viable in 2011, and our energy dependence ended. Now, U.S. production exceeds 13 million barrels of oil equivalent/day, with OPEC no longer holding sway. Occidental’s annual U.S. oil production alone nearly matches the entire Strategic Petroleum Reserve. If domestic production remained at 5 million barrels/day and heavily relied on sources outside the U.S., our nation would be very, very tense today. At this level, if foreign oil supplies were insufficient, the Strategic Petroleum Reserve would be depleted within months.

Under the leadership of Vicki Hollub, Occidental is doing the right thing for its country and its owners.

No One Knows the Short-Term and Long-Term Trends of Oil Prices

No one knows how oil prices will change in the next month, next year, or next decade.

No One Can Predict the Movements of Major Currencies

Greg and I don’t believe we can predict market prices of major currencies. Nor do we believe we can hire anyone with such an ability. Therefore, Berkshire Hathaway provides financing for most of its Japanese positions with proceeds from ¥13 trillion bonds.

Railways are a Very Economical and Efficient Way to Transport Goods Across the U.S., and Railways Should Continue to be an Important Asset for the U.S. in the Long Term

Railways are crucial to the future of the U.S. economy. Economically, in terms of fuel usage and carbon intensity, railways are clearly the most efficient means of transporting heavy materials to distant destinations. Trucking excels in short-haul transportation, but many goods needed by Americans must be transported hundreds or even thousands of miles to reach customers…

…A century from now, BNSF will still be a significant asset for the nation and Berkshire. You can bank on that.

Railway Companies Consume Capital, Leading to Owners Spending More on Annual Maintenance Capital Expenditures than Depreciation—But This Feature Allows Berkshire Hathaway to Acquire BNSF at a Price Far Below Its Replacement Value

BNSF is the largest of the six railway systems covering North America. Our railways have 23,759 miles of mainline track, 99 tunnels, 13,495 bridges, 7,521 locomotives, and various other fixed assets, valued at $70 billion on the balance sheet. But I’d guess replicating these assets would cost at least $500 billion and take decades to complete.

BNSF must spend more than its depreciation expense annually to maintain its current level of operations. This reality is unfavorable to owners, regardless of the industry in which they invest, especially in capital-intensive industries.

At BNSF, since our acquisition 14 years ago, spending beyond GAAP depreciation expenses totals an astounding $22 billion annually, over $1.5 billion per year. Ouch! This gap means that unless we regularly increase the railroad’s debt, dividends paid by BNSF to its owner Berkshire Hathaway will frequently be far below BNSF’s reported earnings. And we don’t intend to do that.

Therefore, Berkshire Hathaway earned an acceptable return on its purchase price, although below apparent levels, and the reset value of the property was minimal. This is not surprising to me or the Berkshire board. This explains why we were able to purchase BNSF in 2010 for a fraction of its reset value.

Due to Harsh Working Conditions, Railway Companies Face Difficulty in Recruitment

A growing problem is that an increasing number of Americans are unwilling to accept the arduous and often solitary working conditions inherent in railway operations. Engineers must face the fact that among the 335 million Americans, some desperate or mentally unstable individuals will choose to lie in front of a 100-car, overweight train, which cannot stop within a mile or more of distance traveled. Would you want to be the helpless engineer? Such traumas occur daily in North America; they’re even more common in Europe and will be with us forever.

U.S. Railway Companies are Sometimes Subject to Manipulation by the U.S. Government Regarding Employee Wages, and They’re Required to Transport Products They’d Rather Not

Wage negotiations in the railway industry may ultimately be the responsibility of the President and Congress. Additionally, U.S. railroads are required to transport many hazardous products that the industry would prefer to avoid. The term “common carrier” defines railroad responsibilities.

Last year, with declining revenues, BNSF’s profit drop exceeded my expectations. Although fuel costs also declined, wage increases mandated by Washington far outstripped the country’s inflation target. Such disparity may arise again in future negotiations.

Will the U.S. Electricity Industry Become Uninvestable due to Authorities’ Changing Stance on Power Companies?

For over a century, power companies have raised vast sums for their development by pledging fixed returns on equity set by various states (sometimes augmented by modest bonuses for exceptional performance). Through this method, significant investments have been made in capacity that may be needed in the coming years. This forward-looking regulation reflects the reality that utility companies often take years to construct generating and transmission assets. BHE’s extensive multistate transmission project in the West commenced in 2006, with several years remaining until completion. Ultimately, it will serve 10 states, covering 30% of the continental U.S.

Because both private and public electric systems have adopted this model, lights remain on even when population growth or industrial demand exceeds expectations. For regulators, investors, and the public, the “margin of safety” approach seems prudent. Now, fixed but satisfactory return agreements have been broken in some states, and investors are beginning to worry that this rupture may spread. Climate change has exacerbated their concerns. Underground transmission may be necessary, but who would foot the staggering bill for such construction decades ago?

At Berkshire, we’ve made the best estimates of the loss amounts incurred. These losses, caused by wildfires, with more frequent convective storms, have increased the frequency and intensity of wildfires and may continue to do so.

We’ll need many more years to know the final tally of BHE’s wildfire losses and be able to decide prudently on the advisability of future investments in the fragile Western states. Whether regulatory environments elsewhere will change remains to be seen.

Other power companies may face survival issues similar to Pacific Gas and Electric Company and Hawaiian Electric Company. Seizure solutions to our current problems would evidently have adverse effects on BHE, but both the company and Berkshire’s structure itself can withstand negative surprises. We often encounter these in the insurance business, where our basic products involve risk assumption, and they occur elsewhere. Berkshire Hathaway can weather financial setbacks, but we won’t intentionally squander good money on bad.

Regardless of Berkshire’s situation, the ultimate outcome for the utility industry may be ominous: some utilities may no longer attract savings from American citizens and may be forced to adopt a public power model. Nebraska made this choice in the 1930s, and public power operations exist throughout the country. Ultimately, voters, taxpayers, and users will decide which model they prefer.

When the dust settles, U.S. electricity demand and the accompanying capital expenditures will be staggering. I did not anticipate, nor did I consider, the adverse developments in regulatory returns, and I, along with Berkshire’s two partners in BHE, have made a costly mistake: not doing so.