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Oil Prices: a Pause, Then Up
Interview With Charles Maxwell
Senior oil analyst, Weeden & Co.
By SANDRA WARD
YOU WANT AN INDEPENDENT AND INFORMED APPRAISAL of the outlook for energy? Then Charley Maxwell's your man. For almost 50 years, Maxwell in one way or another has been involved in the oil and gas industry: from when he started working for Mobil in 1957 to when he moved to Wall Street in 1968 and was routinely lauded as the No. 1 oil analyst throughout the 'Seventies and 'Eighties. For more than 20 years, he's belonged to an elite group of industry executives and OPEC members that meets at Oxford University twice a year to assess trends. We dialed him up last week at Weeden & Co., the institutional trading company in Greenwich, Conn., that he's called home since 1999. Here are Maxwell's thoughts on the current energy scene.
Barron's: Did somebody say energy crisis?
Maxwell: We often say there are not a lot of advantages to getting old except that we have seen it all before. After a big move upward, there is always some counterreaction. We saw it during the 1973-74 crisis, in the '79 to '86 crisis and then in the two wars with Iraq. These crises were manipulations of the oil market by human beings. War, economic problems, but particularly military considerations, were creating, as they say, facts on the ground that worked into shortages that were real, but they were shortages created by the actions of man not nature. It is terribly important to differentiate between past periods and now.
How is that?
There are four huge impediments to expanding production in a world in which we need to do this. Hubbert's Peak, the theory that says oil production will peak on a global basis, is a natural impediment. It is not yet the predominant factor but as these crises continue it is the one growing exponentially and by, say, 2015 or 2020 I expect it will dominate the outlook.
What then is the biggest problem now?
About three-quarters of the world's production of oil today is lifted by national oil companies. Companies like Saudi Aramco, Petrobras, the Iran national oil company, the Iraq national oil company, the national companies that operate in Algeria and Libya, produce conservatively 75% of the world supply. Most of them were nationalized in the '70s and early '80s and they have real structural problems today. They bring in a lot of money but most of it goes to support the national Treasuries and the various political constituencies that are in favor in the various countries, whether it's the army or a host of other bureaucratic ministries. In the end, in the political battle for budgetary support the national oil companies tend to be a constituency with little or no political influence. All in all, the national oil companies have been shortchanged and held on a poverty diet for a long time.
What are the other structural challenges they face?
What came out of the 1986-1987 collapse in prices was a huge overcapacity of about 20% in the world's oil production system. The international oil companies began to adjust their capital spending quickly to adapt to that and they more or less serviced a 1% increase in demand each year. The capacity surplus began to come down naturally. We have now had 20 years and taken that surplus down to about 2% to 3%. For efficiency in the energy industry, given the weather factors and political factors and so on, we need something in the 7% to 8% range of excess capacity in order to cover the mountains and the plains of demand and weather and political events. But when the surplus got down to those levels between 1997 and 2000, the companies didn't add to capacity at a fast enough rate.
Bring this back to your point about the national oil companies.
The national oil companies didn't react at all. At least the big international oil companies were producing the 1% to 2% each year that was required, but the national oil companies just tooled along on the backs of the surplus while it got smaller and smaller. The big international oil companies saw all this and didn't prepare for possible future tightening. One reason the NOCs, as the national oil companies are called, didn't respond was lack of money. Also, the NOCs, because of political patronage, have a shortage of skilled workers and experienced managers. Only Saudi Aramco is quite efficient and they are doubling and redoubling their efforts to find oil in the peninsula. They've gone from 10 rigs to 100 rigs and are headed to 125 rigs. They are modern and up to date. They've got a core of around 3,000 expatriates that are well paid and doing a helluva job. But this is unusual.
Where does this lead?
I don't know how we get around the problem of the NOCs. They control so much of the world's production and they are bloody helpless. They don't have enough money and they don't have prestige and they don't have professionalism. These are big factors, any one of which would have been a strike against them and with all three it is a difficult situation.
The multinationals have the money but they haven't been that willing to spend it.
That's another big issue: the problem for the oil companies is coming to grips with the size of the production problem.
Can you elaborate on that.
The oil companies, as a group, seem to believe the future production potential of the world is very large, very wide open and yet their production numbers don't indicate this is so. ExxonMobil (ticker: XOM) took out an advertisement earlier this year saying oil is not peaking, nor is there any peak visible that's going to impinge on production in the next 20 to 30 years and claims there is no practical limit to the oil it can find and there are new supplies that are developable. They are not alone in this thinking, though Dave O'Reilly [Chairman and CEO] of Chevron (CVX) has come around. But John Browne [CEO] of BP (BP) is in the Exxon camp as is industry consultant Cambridge Energy Research Associates.
The technology-will-save-the-day camp.
I'm not downplaying technology at all. But technology will save General Motors, too, if you believe that. Technology can't do everything. I'll give you an example of the vision of the oil companies.
Go for it.
As we understand it, Exxon is not taking on any leases for deep-water drilling after 2008. They haven't leased anything. If you think deep-water leases are going to be very important, and the recent big discovery in the Gulf of Mexico suggests they will be, you would have contracted for the future use of rigs. But if you think the deep-water leases aren't going to be important because the oil found will be more expensive than the common garden-variety Texas oil from 6,000 foot down, and that you will have lots of oil coming from sources like that then you don't need these high-cost leases down the road. On the other hand, many major oil companies have taken these rigs to 2010 and 2012 and 2014 and are pre-empting Exxon's ability to get these rigs. Exxon is putting itself at a huge disadvantage if there should be a need for this type of deep oil. I find that remarkable.
What's the gamble there?
The gamble is they won't need the deep-water leases because there will be big and lush supplies of oil spilling around at $30 a barrel and people will relinquish the rig contracts they've signed. Then Exxon would have the choice of picking up some of these contracts at 50 cents on the dollar, or maybe they won't need to pick them up at all. I think they are dead wrong.
Exxon has gone out of its way to take out advertising and make speeches saying there'll be plenty of future supplies. It verges on the irresponsible because it says to the government there is no problem. It says to the media there is no problem. It says to the public there is no problem. So we are now likely to march with fife and drum, banners flying, into the maw of destruction without so much as a sideways glance because Exxon tells us that the problem is resolved.