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Weeden’s Maxwell: Brace For $300/Barrel Oil
By Olivier Ludwig | November 03, 2010

When IndexUniverse.com Managing Editor Olivier Ludwig caught up with Charles Maxwell, Weeden & Co.’s senior energy analyst, it was to talk about so-called “peak oil,” the theory that holds that the day when oil production around the planet is no longer sufficient to meet demand is nearly upon us. Maxwell, who has been involved in the oil industry for more than half a century, speaks with the slow cadence and easy charm of a man who has mastered his subject. The problem is that if you take his message seriously—and there are plenty of reasons to believe it unreservedly—it can pretty much ruin your day. From having to eat more root vegetables in winter instead of enjoying oranges from Chile, to watching oil prices spike to $300 a barrel by 2020, a world of slowly but steadily dwindling supplies of petroleum would be very different indeed. But there is an upside, once the shock of it sets in: Peak oil will undoubtedly unleash a wave of technological innovation, most importantly in energy efficiency. Ludwig: You’re a believer in the peak oil theory, correct? Maxwell: Yes, but remember, we won’t run out of oil for thousands and thousands of years. There will always be some kind of drilling going on in some isolated place in the world and new supplies will be available. What we’re saying is that there are oil fields around the world that are young and vigorous and still full of gas with good pressure—remember, it’s the gas that drives oil out through the rock. But the older mature fields have had a good deal of their gas taken off, and with pressures dropping, they’re slowly reaching the stage where they can’t move the oil through rock, and production begins to falter. Normally the production life of an oil field is shaped like a bell-shaped curve on the first half of production. Ludwig: You’re sounding a bit like M. King Hubbert, the Shell geologist who successfully predicted that U.S. oil output would peak in the 1970s. Maxwell: Well, Hubbert thought there was a continuation of the bell-shaped curve, that the second half of an oil well’s productive life was a mirror image of the first half. But we’ve learned now through the use of high technology that we can make the second half of production look more like a crocodile tail. We used to get about 25 percent of the oil out of a field about 100 years ago, and we had to leave the rest. Today, we probably get an average of about 40 percent, so that’s a huge increase. But on the other hand, it’s still a very unsatisfactory number relative to the 100 percent that’s there. But by and large, we’re now making progress rather slowly. I would think that in 10 years, we’ll be at 41 or 42 percent. So what’s happening is that the old fields are beginning to fail. Ludwig: It seems like it’s a pretty ubiquitous phenomenon, from Mexico’s biggest field to Saudi Arabia, where it’s the deepest, darkest secret in the whole kingdom. Maxwell: Yes. Globally, I believe we’re quite close to the peak, simply because we’ve gone from 6 percent increases in production to 3 percent per year increases, to half a percent per year increases. I think peak will come between 2015 and 2017. So, we’re nearly on it. Ludwig: Is this going to dawn on the market quickly, or is this something that looks clearer in the rearview mirror? Well, it will look clearer in the rearview mirror. But I think we’ll have a lot of people beginning to see this only when the world economy recovers. What I’m saying is that at the rate at which we were chewing up oil between 2000 and 2008, we would have reached peak oil peak somewhere around 2013 or 2014. But now that we’ve had a very definite drop in the rate of growth related to this great worldwide recession, it will take longer before we can see the peak. And if it turns out to be 2018, I wouldn’t expect anyone to stand up and call me a liar. By the way, America reached “peak oil” in November 1970. Ludwig: That was M. King Hubbert’s thesis that everyone laughed at when he was at Shell, right? Maxwell: Yes, they laughed at him. He predicted in 1956 that the time of peaking would be in the early 1970s. By the way, we can get a good sense of this phenomenon by looking back at the peak of discovery. That’s the first peak that comes. In the United States, to take an example, in 1931 we reached a peak in finding oil that we were never able to equal after that. And then we peaked in production in 1970. So we had 39 years between the peak of what we were finding and what we were actually able to produce. Now in the entire world, it appears that the peak in finding oil was reached sometime between 1964 and 1968. I can’t be exact because we just don’t have good numbers for all countries, particularly those that used to be communist. So that would suggest that we are in a “tick-tick-tick” mode, running on borrowed time before we reach the second peak, which is that of production. Ludwig: This all seems sensible and yet there’s been no response. You talk to the typical citizen and there’s really no sense of urgency, let alone awareness. How do you explain that? Maxwell: It’s a good question, and I’ve often struggled with it. Given that we’ve created a world that needs a lot of oil to run it, it’s not a happy message that we may be near the point where we cannot produce oil at an increasing rate. By the way, when we get there it will probably be a plateau lasting three or four years—say between 2015 and 2020 when supply and demand are more or less in balance. But once production starts to fall, it’s going to be bad news for an awful lot of people. Ludwig: What are the overall prospects for working our way out of this upcoming energy crisis? Maxwell: Well, there are a few ways out of this problem. The first is that when there’s more demand for oil than supply to meet it, rationing of oil will have to take place. And since internationally there isn’t any group or country large enough to do this, it will have to be done by the market, which is just another way of saying the price of oil will have to rise. The next way out is to particularly expand production of fuels that compete with oil, particularly in advance of when oil might make that peak. That means we utilize a lot more nuclear power, produce a lot more natural gas and use our large reserves of coal. But when you hear me talking about coal, you’re probably already thinking that’s not going to be possible, and that’s correct. Ludwig: You mean coal won’t be possible in a political sense? Maxwell: In a political sense and an environmental sense, we’re not going to be able to switch over to coal. So let’s move to natural gas. It looks like we have a lot of it and it looks like it can be used and that it certainly is a big improvement on oil and coal in terms of emissions, even if it has more emissions than we would like. So natural gas is one of the classic ways out. By the way, we also believe there is a peaking coming for natural gas, maybe in another 60 years; and we do believe there’s a peaking in nuclear fuel, uranium, in maybe 80 to 100 years. Ludwig: What about the cutting-edge technologies, the alternatives, as a way of dealing with peak oil? Maxwell: There are two more ways out that I haven’t mentioned: It’s a six-sided box: oil, gas, coal and nuclear are the four traditional fuels. The fifth fuel I’ll call alternative energies, and it’s a grab-bag of things: hydropower, for instance, although most of the good hydro sites in the United States and Canada have already been taken, so the growth there is pretty modest. Then there are wind and sun. It isn’t that they won’t be increasing rapidly; they will be. They both have their sponsors and they both have reasonable subsidies, and they both are going to be important for the future. But wind is starting at about 1 percent of total energy, and will probably move up over the next 20 years to a maximum of 3 or 4 percent. Ludwig: You don’t see it going beyond 3 or 4 percent? Maxwell: Well, it’s just that it takes so much land to do it and it takes so much organization, and there’s a certain push-back from the public that doesn’t want it here or there because it mars the landscape. Ludwig: I’ve heard the U.S. described as the Saudi Arabia of wind energy in terms of potential. Do you agree with that? Maxwell: I think that’s true, but it may be meaningless. The problem is that we don’t have the wind where the people are. The Great Plains are the classic place to get your wind, but using these big lines from nowhere to, say, Chicago, to pick up the market, you lose about 40 percent of the electricity that you’ve generated. Ludwig: So what about solar—thermal and photovoltaic—those are two very different realms with promise, no? Maxwell: Solar has huge potential, but people need to know that about one-tenth of 1 percent of our fuel needs is met by solar. So it would take a huge effort in photovoltaics to make a lot more panels and put them in a lot more places, and also, to make them a lot more efficient will probably carry us over the next 20 years to maybe 1 percent or 1.5 percent—the point being that this, like wind, is not going to be big enough to solve the huge gap that we have from oil pulling back. Oil is about 40 percent of our energy needs and it will pull back to 30 percent, so we have to fill that 10 percentage points with something, and unfortunately it can’t be wind and solar because they just can’t expand fast enough. Ludwig: So what’s the sixth side of that six-sided box you described earlier? Maxwell: The sixth is the wonderful one, the “killer app,” because it solves the problem: It’s energy efficiency and conservation. That’s where the big changes will occur. We will use less electricity in our appliances; we will find ways of running electricity around the country through superconductor wires that don’t waste so much energy; we will use cars that get 100 miles per gallon. Overall, we’ll find ways to make the energy we already have go an awful lot longer for us. Ludwig: Do you have any near-term anxiety as people find out they’re out in the cold without their pants on? Maxwell: Yes. And what we have to keep in mind is that oil is particularly useful in the transportation sector—starting with airplanes and boats and going on to trucks and trains and cars. About 97 percent of transportation depends on oil. So when we talk about oil production slowing down and reversing, you’re talking about a huge cost to the transportation sector. For instance, right now we don’t worry about winter when we go to the supermarket—you get a head of cabbage or lettuce, but it will say: “Grown in California.” Ludwig: Or oranges from Chile? Maxwell: Yes. These items are brought to us on boats and planes and trucks, and a lot of that will become too expensive to do. So, we’ll have to grow an awful lot of food locally, and perhaps even change our diet a bit to use more root vegetables that can be stored, as opposed to eating so many things that are perishable. That’s just one example of how peak oil will change our way of life. Ludwig: What is your oil price outlook as this whole new world order begins to take shape? Maxwell: The supply and demand of oil in the world today are pretty close to each other, and there shouldn’t be too much deviation in 2010 and 2011. We think prices will stay within a band roughly between $67-$87 a barrel. When it gets up toward $87, it seems to retreat, and when it gets down toward $67, it seems to take off again. That’s because supply and demand are in rough balance. But as the economic recovery continues, as more people use oil because there are more people in the world, and China and India continue to progress with rapid expansion of cars and the roads they are offering their people, demand for oil will continue to climb between 1 and 1.5 percent per year. That, combined with the depletion of these mature oil fields we’ve talked about, will bring us to a plateau by 2015-2017, where the rising production of newer oil fields will equal the falling production of old fields. At that stage, prices will break through this $87 boundary—in about 2013, I’m thinking. And by 2015 we’ll be up to around $130-$150 a barrel. And then by 2020, when we have 1.5 percent increases in demand each year and 0.5 percent declines on the downside, then we’ll really be in a fix. At that time, I’m looking at $300 a barrel in money of the day. But remember, by then we will have the full effects of inflation over the prior 10 years, so it would probably be something like $200 a barrel in today’s terms, but it will have a nominal price of about $300 a barrel.