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Ethanol and Rails Through the Eyes of Buffett


Whether people like it or not, the U.S. is going to use a lot more ethanol, and the rails will be a primary transport mechanism.


On What Buffett Was Seeing Versus The Rest Of The Markets

A major reason Buffett may be buying the rails is due to the ethanol mandate. Whether people like it or not, the U.S. is going to use a lot more ethanol, and the rails will be a primary transport mechanism. This could be a primary contributor to his purchases of the Rails, as it is the main method to transport this fuel.

On Buffett Avoiding "Crazes" (e.g. Tech Bubble)

Ethanol isn't a craze, but better said, it's a mandate and that mandate will become an industry which will live on for a bulk of our adult lives or longer – or until something much better, more efficient in the non-oil fuel world gets developed. Think Brazil but on a smaller percentage usage scale for the U.S.

As far as Buffett staying away from tech and the bubble, I don't think the bubble had anything to do with it. Buffett just doesn't buy tech and hasn't bought a tech stock in his life at Berkshire (BRK.A) as far as I know. So basically, he just avoided the bubble because he didn't ever buy into the space. He also never shorted any tech as far as I know, but then again, I don't think Buffett shorts much either.

On Ethanol's Future

So here is where Buffett on the rails gets interesting, as you have to go to the third derivative or so in this food chain.

Ethanol keeps growing and getting more space on the rails. This in turn crowds out some space (as you can't pull an infinite number of boxcars, though if you're waiting for a train it seems like they do) -- thus pricing remains firm or increases to other goods being transported. All this makes the rails even better consistent cash flow machines as Buffett likes. Here are the bullish and very bullish scenarios:

Scenario 1: Ethanol could be even bigger than people currently think, and if so, then it's a big win for Buffett on just ethanol transport and a massive crowding out pricing effect.

Scenario 2: However, I think what happens is that ethanol transport simply takes up a good bit of available space on the rails. Think of it like airlines and how expensive tickets would get if every plane only had a third or half the seats starting out because half of the others are now always booked.

My money is on Scenario 2 and it is what I think could happen with the rails regarding ethanol transport. Ethanol takes space, and a good portion of it, on many of the loads. Then all the other stuff gets charged slightly higher freight prices due to good ol' scarcity.

So unless there is a massive new building of new railroads and more trains to go on them (an unlikely scenario), the industry is sitting pretty given the ethanol push. Over time there should be some other mechanism to move a lot of ethanol, but currently it's rail, barge and trucking.

On BNI's Charts

Now I will say this: Buffett says he's not a technician. But when I look at Burlington Northern Santa Fe's (BNI) chart, I would say the man may pull out the daily and weekly charts from time to time. BNI looks to be consolidating recent gains quite well. Recessionary concerns hit it and caused some selling – now all the MA's are converging, with the shorter term MA's turning up again. All this is with the backdrop of many levels of solid long term support from BNI's long trip higher.

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