Our Inevitable Conversion to Renewables

 | Oct 31, 2013 | 4:00 PM EDT
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The recent surge in the efficiency of photovoltaic technology, which has given rise to a surge in investments in the solar-energy space, is one of the best things that has ever happened to the oil industry.

Bear with me for a moment. Yes, fossil fuels will inevitably become uneconomic. This is, in fact, the single most important issue facing humanity today, and it's challenging the viability of all economic models used globally. Ultimately, this issue promises to necessitate a transition from economic models based on fossil fuels to ones based on renewable resources -- and dominant among these is solar energy.

The truly profound lack of understanding of this issue, even by those who are most knowledgeable on the subject globally, cannot be overstated.

Over the past few years, Real Money's Glenn Williams has written volumes of fantastic columns on the subject of energy, including solar, and I will not reiterate his points here. I have in past columns discussed the net economic impact of oil prices being sustained at above $100 per barrel: uneconomic growth. Yet if the price of oil continues to grow faster than the rate of inflation, even uneconomic growth becomes impossible, and continued oil consumption after that point will actually cause an economy to contract.

This is all actually very good for oil companies, because they have a captive market: Their customers have no immediately available alternative to use as a substitute. If oil prices -- and, therefore, fuel prices -- become unbearably high, consumers' current primary option to combat the trend is merely to consume less of the product. But, on a broader level, this is problematic in an economy based on consumption given the ubiquitous nature of oil, which is priced into essentially all goods and services in some way.

The rise of Tesla Motors (TSLA) is a testament to the fact that consumers are finally seeking real alternatives to oil-based products. The important point here is: Only after the expense of oil became too painful did we witness the creation of a natural market for an automobile that may be based on something other than oil to propel it. Government subsidies alone were unable to do this.

This is part of the catch-22 involved in any attempt to convert at least some oil-based parts of the economy to an alternative. People like the status quo, and they generally accept change only when it is forced upon them.  

Consider that about 95% of oil is used to create fuel for internal combustion engines, and that about half of that is consumed in the retail markets by overland passenger vehicles -- automobiles and buses. Here's that catch-22: If society fails to consider an alternative until the cost of oil is so high that its consumption actually causes economies to contract, the cost of building the infrastructure for that alternative system will make the existing system even less affordable.

That brings me to my point about why the oil industry will richly benefit from this transition. If we wish to build out a grid of solar plants capable of meeting the needs of an electric-automobile fleet in the U.S., we need to build it with the current methods and equipment available for doing so -- which are all oil-based.

The longer this process takes, the more expensive it will be. Resources that are currently being consumed will have to be diverted in order to be used to build the alternative replacement infrastructure. That will cause prices to rise for existing supplies of oil-based fuels. Yet this extraordinarily simple concept is not being used to factor in the cost of converting our economy from one based on liquid fuels to one that's electricity-centric.

More troubling, though, is the existing primary meme within energy-policy circles. Namely, these folks tend to believe that if we continue creating more energy-efficient internal combustion engines and expanding the supply of liquid fuels through fracking and associated technologies, we will never witness the economic necessity to replace oil and gasoline.

The problem with this is that it is causing valuable time to be wasted. Increases in corporate average fuel economy standards should be considered a means of minimizing the economic disruption by shortening the time needed to convert from liquid fuels to something else. Unfortunately café standards and fracking are being used to avoid making the tough choices about how to allocate existing financial resources, and to avoid the conversation entirely.

The silver lining for investors, though, is that all of these issues ensure that the existing companies entrenched in the oil space will remain viable and increasingly profitable for many years to come.

At Exxon Mobil's (XOM) price of $90 per share, the annual dividend of $2.52 works out to a yield of about 2.8%. At BP (BP), the $2.16 payout works out to a yield of about 4.6% at $46 per share. Total (TOT) pays about a 4.3% yield with its $2.67 distribution, and the stock is priced at $61. As for Chevron (CVX), the firm pays a dividend of $4 per share, which works out to about a 3.3% dividend at $120 per share. Lastly, ConocoPhillips (COP) is yielding 3.7% with a dividend of $2.76, and the shares are trading for around $74.

These represent the largest, safest investments in the oil industry, and that will remain the case regardless of whether the U.S. or other countries soon begin to accelerate their conversion from liquid fossil fuels to something else. These companies make the product that makes the conversion possible, so whenever this does finally transpire, that fact will prove very profitable for them.

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