Warren Buffett's Surprise Natural Gas Investment

NEW YORK (TheStreet) -- Natural gas is an interesting topic for Warren Buffett.

As I mentioned at the start of the week, one of the bad news bullet points found in this year's Berkshire Hathaway letter to shareholders related directly the battered fuel source. As the Oracle of Omaha pointed out, his company has already been forced to write down a substantial portion of his $2 billion bond investment in Energy Future Holdings, a Texas-based utility firm, as natural gas prices have plummeted. Calling it a "big mistake," Buffett notes that if the fuel's prices continue to crumble, the carrying value of the Berkshire bet could be wiped out entirely.

At the same time that natural gas is causing the investor's Energy Future Holdings investment to sour, growing activity in this corner of the energy sector is acting as a boon for another notable component of the Berkshire Hathaway Investment Empire, the Burlington Northern Santa Fe Railroad.
Warren Buffett

When Buffett announced his decision to spend more $26 billion to purchase the remaining 77% of BNSF railroad in late 2009, some fans who had monitored the investor's buying habits over the decades were left scratching their heads.

Whereas Buffett had historically shown preference for undervalued companies that had a great deal of upside potential, BNSF's size ensured that any upside action would likely be slow and steady. Rather than looking for a short-term pop, however, the Nebraska native stated that the railroad investment was considered an "all in bet" on the United States that would ultimately benefit Berkshire Hathaway for decades to come.

Living up to Buffett's hopes, BNSF has managed to take advantage of the nation's economic recovery. In his shareholder letter, Buffett likens U.S. rail to an economic circulatory system. Being responsible for 37% of the total inter-city rail freight, BNSF is highlighted as the largest artery.

Burlington Northern's reach across the U.S. has helped it gain attractive positioning for specific industries like energy. In the past, I have highlighted the railroad's heavy involvement in the coal industry. However, as Bloomberg points out this week, the railroad also has a staggering lead over many of its competitors when it comes to taking advantage of growing activity in the Bakken shale formation.

At this time, there is no pipeline in place to transport the oil and gas extracted from this region. In the interim, producers have increasingly relied on railroads to move their goods. The report notes that Burlington is one of only two transporters with rail currently laid in this region, the other being Canadian Pacific Railway ( CP).

Washington lawmakers, including President Obama, have increasingly begun to warm up to the idea that our nation has the potential to become major global player in the natural gas realm. With the government's support and ongoing improvements in alternative extraction methods like hydraulic fracking, the environment appears primed for increased production. As yields head skyward, demand for transportation will grow in tandem. Buffett's personal railroad is currently in an attractive position to benefit here.

I still feel that funds like the First Trust ISE Revere Natural Gas Index Fund ( FCG) offer the best pure-play bet on natural gas proliferation. However, the iShares Dow Jones Transportation Average Index Fund ( IYT) may also be an interesting product to watch here.

In addition to boasting ample exposure to the railroad industry, IYT also sets aside a portion of its portfolio for truckers. We are already witnessing a number of companies in this subsector express interest in this energy source. Widespread adoption here could thrust natural gas into the mainstream.

Buffett has taken his lumps with natural gas. However, given BNSF's exposure to the industry, it is likely that the investor is still a fan. What are your feelings on natural gas? Feel free to leave a comment in the space below.

Written by Don Dion in Williamstown, Mass.

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At the time of publication, Dion Money Management did not own any equities mentioned.

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