Investors have taken a dim view of carbon-based fuels lately, putting added downward pressure on shares of companies like ExxonMobil (XOM -0.65%). The general theory is that oil and natural gas are going to be replaced by electricity in the energy space. That's actually likely to be true, but it isn't going to happen overnight, which is why Exxon remains upbeat about its prospects. Dividend investors looking at the integrated oil giant's generous 4.9% yield shouldn't get scared away by the carbon issue today.
It takes time
Exxon recently provided investors with an interesting timeline, showing the rise of oil within the world's energy mix. Oil was first used as an energy source in 1870. Its use increased over time, but was overshadowed by biomass and coal until the 1970s, when oil finally became the largest piece of the energy pie. In other words, the transition to oil took 100 years. It is projected to remain a dominant fuel until at least 2040, according to Exxon and the International Energy Agency (IEA).
What's interesting here is that the IEA offers two different projections. One uses the current environmental rules and shows that oil demand doesn't peak until after 2040. (That, as you might expect, is the view Exxon likes to highlight.) The other scenario looks at a world in which every country works in unison to reduce carbon emissions, in which case oil demand peaks around 2020. But even in this scenario oil demand doesn't go away; its use falls by roughly 25% from recent levels.
That sounds bad for Exxon, and perhaps it is, but there's two things to keep in mind. The worst-case scenario for oil assumes the world actually comes together on carbon reduction. Early evidence suggests that isn't happening, since most countries aren't hitting their current carbon reduction goals. Second, oil is a depleting resource. Once you pull oil or natural gas from the ground it is gone forever. You have to find more or demand will quickly outstrip supply. Even in the IEA's low-carbon scenario, energy companies like Exxon need to keep drilling.
There are more big-picture factors to consider here as well. The assets to produce and support the use of energy need to be built out. The reason it takes so long for an energy source to grow is that there are costs involved with this process and integrating new fuels into the system just takes time. Yes, the cost of solar power cells has fallen dramatically over the years, and that has led to increasing installations, but there's more to replacing oil than just installing cheap solar panels (an effort that, in itself, takes time to get done).
For example, advances in battery technology have lagged behind solar panel technology. That's a key issue if gasoline and diesel are to be replaced. Both of these vehicle fuels are highly portable and refilling a car, truck or airplane is quick, easy, and cheap. The infrastructure to support electric vehicles is expanding, but it's nowhere near as robust and convenient as the infrastructure supporting vehicles powered by oil-based fuels. It will take a lot of time and money to catch up. And while the growth of electric passenger cars may catch your eye, electricity is going to take a lot longer to displace oil-based fuels in the heavy-duty truck and aviation markets. And electricity can't replace petrochemicals, which is another key sector in the oil industry. Petrochemicals get used throughout the economy to produce everything from lubricants to plastics, and a lot in-between.
Which brings up another important factor: Developed markets aren't the growth engine for oil demand, emerging markets are. Asia is going to be the driving force behind energy growth as less developed nations step up the socioeconomic ladder. This is notable because the IEA projects falling demand in developed markets, which are wealthy and can more easily afford to shift toward alternatives. Slower-growing, or shrinking, populations and conservation efforts will also lower oil demand in developed markets. But demand in developing markets -- where populations continue to expand and cost and ease of use are likely to be bigger issues -- is expected to remain strong.
When you step back and look at the big picture, oil and natural gas are indeed going to be replaced at some point. But that point looks like it is decades away. There's still plenty of time for energy giants to make money here. And Exxon isn't the only energy company trying to explain this to investors; Royal Dutch Shell recently highlighted similar issues. In fact, the key quote from the CEO of Shell's interview with Reuters was, "Despite what a lot of activists say, it is entirely legitimate to invest in oil and gas because the world demands it."
The big picture here is that oil and natural gas aren't going away anytime soon, which suggests that Wall Street is overly pessimistic about the long-term future of Exxon and its peers. But there's one more bit of information that's worth considering. The IEA warns that based on current environmental rules, the world could fall as much as 50% short of its oil needs unless it finds more black gold. More natural gas investment will be needed, too, or shortfalls of that fuel could occur as well. That makes the future for an oil and natural gas company like Exxon sound a lot better.