The well is running dry for big oil

Last week, I mused on the death of cars and big-picture factors working against the auto industry, including urbanization and declining driving rates in younger Americans.

Now, I’ll trot out my crystal ball again and offer you another prediction: This is the beginning of the end for Big Oil, too.

Now before you jump down my throat for trolling you again with hyperbole, I will state up front that I don’t expect Exxon Mobil XOM -1.01%  , BP BP -2.13%  and Chevron CVX -0.69%   to disappear tomorrow any more than I expect I-95 to start sprouting daisies.

But as with the decline of automobile ownership — and in part because of it — we may also be witnessing a protracted decline in major energy stocks and fossil fuel demand.

That’s bad for big oil, and bad for investors in these stocks.

Efficiency and alternatives sap demand

The first big reason big oil is in trouble: Oil demand keeps dropping.

Technology continues to help us do more with less and implement cleaner alternatives to crude oil.

Consider that U.S. oil demand fell to a 16-year low in 2012 despite energy-hungry gadgets and the addition of some 40 million people to the total population.

Also consider that fuel oil demand was the lowest on record in 2013 and has been steadily declining since the 1970s as the energy source has fallen out of favor for cleaner, greener options.

It’s not just the U.S., either. Even with a bullish outlook for the global economy fueling oil demand this year, the IEA has boosted consumption targets a meager 1.3% as efficiencies in the West offset faster-growing demand in emerging markets.

However you slice it, global crude oil appetites simply aren’t what they used to be. Even energy-hungry emerging markets aren’t making up for the weak demand in the developed world.

The easy supply is gone

I don’t pretend to know when supplies in the ground will run out, or whether we are truly living after the era of “peak oil.”

But one thing is clear: Oil production is getting much more costly as easy-to-access fields are drilled dry, and new production is reliant on more difficult and costly extraction for the fossil fuel.

Take the shale oil boom. Margins are lower thanks to the cost of production. The story is the same for oil sands production , same for offshore drilling, same for oil in Africa as opposed to oil in Canada.

A great example of how the quest for new oil sources has gotten increasingly high-tech and high-cost is Exxon’s partnership with Russia’s Rosneft RNFTF +4.93%  on an ambitious deep-water project in the Arctic. Even if the company executes perfectly, avoiding the risk of a disaster like the one we saw in the Gulf of Mexico across mid-2010, the costs are going to be huge for this Arctic oil venture because of the work that goes into accessing previously inaccessible reserves.

Unfortunately, there’s not any real alternative to ventures like this for big oil if they want to keep profits and revenue up. Exxon has projected a 1% drop in output in 2014, and its 2013 10-K filing showed 7.51 billion barrels of total proved crude oil reserves — down from 7.74 billion barrels of crude oil liquids in at the end of 2007 . If the company wants to keep oil production up, it has to keep reserves up, too.

Perhaps most telling is that Exxon itself knows that it’s fighting a losing battle on the crude oil front. Hence the $31 billion buyout of natural gas giant XTO Energy in 2009 to pivot away from oil and to its abundant, cleaner-burning cousin.

The fact that a giant like Exxon is hedging its bet against oil says a lot about long-term trends.

Should you buy big oil?

Again, Big Oil isn’t exactly going anywhere anytime soon. And if you have been holding stocks in this sector for years with a great cost basis and a yield on cost that is around 10%, you can feel comfortable hanging on.

With $420 billion in market cap, Exxon is the second-largest U.S. stock behind Apple AAPL -0.79%  . It also is one of just four companies — along with ADP ADP +0.08%  , Microsoft MSFT -1.20%   and Johnson & Johnson JNJ +0.83%   being the others — with a AAA credit rating.

And with roughly $42.3 billion in the bank, there’s plenty of cash to keep the lights on for a while.

But stability for entrenched players should not be confused with the prospects of growth. And new money should carefully consider the risks of buying into Big Oil right now.

Once again, let’s look at Exxon — the poster child for big oil. Revenue has been declining slowly since peaking in 2011, and earnings growth has been almost wholly dependent on cost-cutting and stock buybacks between $3 billion and $6 billion per quarter since the Great Recession.

Investors clearly haven’t been fooled, since Exxon has seen its stock basically go nowhere since 2008.

And even if you want to say you’re only in it for the income, dividend investors have plenty of reason to complain, too.

While Exxon has paid dividends for over a century, its dividend payout rate has dwindled to a miserly percentage. The company is forecast to make about $8.20 per share in fiscal 2014 earnings but pay out $2.52 in dividends for a measly 30% payout ratio. With a yield of just 2.6% right now — less than 10-year Treasurys — Exxon Mobil needs to up the ante.

Unless, of course, it could be worried it can’t support a more robust payout over the long-term.

Trends are similar across the rest of Big Oil. BP paid out $2.19 per share in 2013 dividends and earned $7.39 a share for a 30% payout. Chevron paid out $3.90 a share in dividends on earnings of $11.09 for a 35% rate. Hardly a blockbuster payday

And lest you think this is a good thing with lots of upside for dividend increases, consider this comparatively weak payout ratio is the norm. Back in 2004, Exxon paid $1.06 in dividends on $3.89 in diluted earnings per share — a rate that’s 27% of earnings.

Given the pressure on production and margins, anemic revenue and the historically low payout ratios… there’s not a lot to like in big oil right now.

A company like Exxon Mobil clearly isn’t going anywhere. But does that mean you should buy its stock?

I say no way.

marketwatch