Buffet Bond Bet Backfires

Warren Buffet has admitted that he made a two billion dollar mistake. He invested heavily in the debt of Energy Future Holding Corp. and believes that the debt may now be close to worthless. In his annual letter to shareholders, Buffet not only likes to highlight the year’s successes, but also the failures. Energy Futures is a surprising failure in many ways:

  • Berkshire Hathaway made the investment only two short-years ago. The investment did go wrong over a period of years but, tanked almost immediately after the invesment.
  • Bonds are supposed to provide some protections against adverse events. In this case Buffet does not think that he will recover anything of significance from his investment.

The natural question is what happened?

Why was Warren Buffet so wrong and is there a lesson that can be learned?

Energy Future Holding Corp is a company that primarily produces natural gas in the United States. Over the last couple years, there have been enormous discoveries of natural gas all over the United States. In the North East, the Marcellus Shale is thought to hold between 140 to 400 trilllion cubic feet of natural gas. These recent discoveries have put extreme pressure on the price of natural gas, pushing the per mmBTU from almost $14 in 2008 to under $3 today.

Basically, Buffet did not predict that there would be a massive change in the supply of natural gas. Was this event predictable? I don’t think so. Energy exploration is a risky and unpredicatable business, full of false starts and surprising discoveries. Maybe Buffet is blaming himself for not looking at the price elastisity of natural gas. In other words, as gas gets cheaper, corporations and individuals should switch their energy consumption from oil to gas, keeping the price from falling too low. However, that requieres that there are places to convert the gas into electicity. Maybe, there are not yet enough power plants to handle the supply of natural gas.  Maybe, Buffet overestimated the ability of the US to process natural gas.

Its unclear to me what mistake Buffet made, but even great investors make mistakes. I think the lesson from this is simple. Don’t put all your eggs in one basket. There are always unforeseen events that can surpise even The Oracle of Omaha.

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