The shift towards clean energy is leading to questions about future demand for fossil fuels, but contrarian investors might find that this is the time to invest in the sector. After all, while clean energy might be the future, fossil fuels are the present. In fact, according to BP, 84%of the world’s energy needs is still met by fossil fuels, which means that even if usage declines demand will remain enormous. (https://www.forbes.com/sites/rrapier/2020/06/20/bp-review-new-highs-in-global-energy-consumption-and-carbon-emissions-in-2019/?sh=7bdac63166a1)
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The demand side of the equation
Consider again that fossil fuels still provide 84% of the world’s energy needs. All of the world’s planes fly on gas. How long would it take to retire all the current planes and replace them with say, solar powered planes? How much money would that cost an industry that’s already decimated by the pandemic?
The vast majority of the world’s cars drive on gas. And even California, perhaps the most progressive state, has given a decade and a half before mandating that in 2035 all new car sales will have to be from zero emission vehicles.
Many of the world’s power plants run off of natural gas or coal, and utility companies are unlikely to just abandon those plants. So while the cost of solar and wind power has declined by more than 2/3s in the past decade, there will still be a lengthy transition period before existing fossil fuel plants are retrofitted or shut down. (https://www.nrdc.org/cost-building-power-plants-your-state)
In other words, even if the world wanted to abandon fossil fuels, doing so would take many decades. But the whole world does not, in fact, want to move to clean energy. Ask yourself; does Russia, with its vast reserves of oil and gas, want the world to move away from fossil fuels? Does Saudi Arabia, Kuwait, Nigeria, Brazil, or Abu Dhabi? What about North Dakota, Oklahoma, or Texas? The answer to all of the questions above is: probably not.
So, structural demand for fossil fuels provides intermediate-term support. In the shorter run, we are currently experiencing a surge in coronavirus cases, but broad distribution of effective COVID-19 vaccines will likely lead to a pick up in travel, which could lead to higher energy demand over the next year or two. And that increased demand would occur right at a time when supply is shrinking.
The supply side of the equation
Oil and gas are commodities, and like any commodity their price is determined by supply and demand. We’ve already discussed why worst-case scenarios for fossil fuel demand may be overblown, but the supply side may also be bullish for the sector. Last spring’s price collapse and COVID-related demand declines resulted in 35 North American energy producers declaring bankruptcy in just the second and third quarters of 2020, which will reduce future supply. (https://www.haynesboone.com/-/media/Files/Energy_Bankruptcy_Reports/Oil_Patch_Bankruptcy_Monitor) And even surviving companies haven’t launched many new projects, which will exacerbate any future shortfalls.
Getting paid to wait
From the investor’s perspective, even if the price of energy stocks stagnates in the near term, in some cases you are getting paid well to wait. That is because beaten down prices combined with steady dividend payouts have resulted in some really high dividend yields. For example, Exxon (XOM 0.51%) is currently yielding 8.35% and Chevron yields (CVX 0.78%) 6.03%. Looking abroad, BP (BP 1.80%) is yielding 6.11%, and Royal Dutch Shell (RDS.A) yields 3.78%.
Of course, if energy prices and profits remain low there is no guarantee companies will be able to maintain their current dividend payments. But given the essential role energy, and energy companies, play in the global economy, it seems unlikely the sector will disappear anytime soon. So, if you have the opportunity to collect a few fat dividend checks from stocks in a sector with attractive short-term supply and demand characteristics, why wouldn’t you do so?
