Warren Buffett is known as the Oracle of Omaha because of the incredible investment success he has achieved with his investment vehicle, Berkshire Hathaway (BRK.A -2.20%) (BRK.B -2.03%). When Buffett says something, investors listen. Right now, Buffett is warning about the increasing risks being faced by regulated utilities, a sector long known as a reliable source of income for investors. Here's what you need to know.

What Warren Buffett said in the annual report

The truth is that Warren Buffett doesn't talk publicly all that often; he prefers to provide his wisdom in written form in Berkshire Hathaway's annual reports. The 2023 report was a doozy for investors who own utilities. Although Berkshire Hathaway is a large and diversified entity, one of its biggest exposures is to electric utilities.

According to Buffett: "[T]he regulatory climate in a few states has raised the specter of zero profitability or even bankruptcy (an actual outcome at California's largest utility and a current threat in Hawaii). In such jurisdictions, it is difficult to project both earnings and asset values in what was once regarded as among the most stable industries in America."

Still, he highlighted the benefits of the regulated utility model, which provides monopolies in exchange for utilities having to get rates and capital investment approved by the government. This relationship has, over time, resulted in slow but steady growth for most utilities. However, as Buffett stated: "Now, the fixed-but-satisfactory return pact has been broken in a few states, and investors are becoming apprehensive that such ruptures may spread. Climate change adds to their worries."

These are not unfounded concerns, with Buffett noting that "other electric utilities may face survival problems resembling those of Pacific Gas and Electric and Hawaiian Electric." Both were impacted by the costs associated with wildfires that were attributed to their systems. Berkshire Hathaway's utility operations were similarly impacted. This is not an idle threat, given that wildfire costs can be huge.

Is Buffett's warning a sign to dump utilities?

What is an investor to do about all of this? That's a hard question to answer and will, obviously, end up being an individual decision. However, Buffett also noted in his annual commentary that "Berkshire can sustain financial surprises but we will not knowingly throw good money after bad." It certainly sounds as if he is going to, at the very least, pull back on investment in the utility space.

The problem is that utilities are, indeed, reliable high-yield stocks. Their monopolies create stable income streams that support regular, and often growing, dividends. That's hard to ignore for investors who are trying to live off of the income they generate from their portfolios in retirement. To put a number on that, the S&P 500 index is yielding a scant 1.3% or so today while the average utility has a dividend yield of around 3.2%. Some utilities, like Dividend King Black Hills Corporation, have yields of 4% or more.

Moreover, many prominent utilities are growing fairly strongly. For example, NextEra Energy is projecting earnings growth of between 6% and 8% a year for the foreseeable future, a rate that will support 10% dividend growth. That company isn't alone. WEC Energy is looking to achieve earnings growth of 6.5% to 7%, with dividend growth likely to trail earnings growth higher.

NextEra Energy's rapid dividend growth has resulted in investors affording it a premium price, and thus, its yield is a below-average 2.7%. However, WEC Energy's yield is a relatively attractive 3.9%. Both have increased their dividends for decades.

The big reason for the rapid growth expectations is demand driven. Growing population centers need more spending to keep up with demand from new customers. And, even more important, the world is increasingly shifting toward electricity as a power source (think electric vehicles and electric heating systems).

Then there's demand from still developing industries, like data centers. In an increasingly technological world, notably including huge artificial intelligence (AI) expansion, electricity is the vital power source and demand is growing quickly. Even Buffett notes that "America's power needs and the consequent capital expenditure will be staggering."

At the end of the day, utilities could actually become more growth-oriented investments. But the risks have also become more elevated. Buffett's concern is that utilities will end up being taken over by the government, perhaps in confiscatory fashion in bankruptcy situations.

However, the current public model has worked so well for so long that it seems more likely that it continues and that there is a compromise on the liability front, assuming utilities don't knowingly create situations in which wildfires can start. And, more to the point, the need to reduce wildfire risk might lead to more electric wires being placed underground, a huge capital investment that would lead to more opportunity for utilities to grow.

Utilities were never risk-free, but the risks are increasing

No stock investment is risk-free, even in a sector as boring as regulated utilities. That said, wildfires have, as Buffett suggests, increased the uncertainty in the utility sector.

But this risk could also increase opportunity in a sector that is already seeing electricity demand rise. You have to make the risk/reward decision for your own portfolio, but it seems likely that most utilities will continue to thrive because they provide essential products and services. Add in generally attractive yields and slow and steady growth, and income investors should likely continue to invest in the sector.

Don't ignore Berkshire Hathaway's utility headwinds. However, Buffett's experience with wildfire risk doesn't appear to be the norm in the perhaps increasingly attractive utility sector.