Whatever Happens in Egypt, Oil Will Hit $300 by 2020 - Barrons.com
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| SATURDAY, FEBRUARY 12, 2011
Whatever Happens in Egypt, Oil Will Hit
$300 by 2020
By LAWRENCE C. STRAUSS
Regardless of what path Egypt now follows, a leading analyst says the
price of oil is headed toward $300 a barrel based on basic supply-anddemand forces.
The oil market breathed a small sigh of relief Friday after Hosni Mubarak resigned as
president of Egypt, sending prices to a 10-week low. But Charles T. Maxwell, an analyst who's
been toiling in the energy business since 1957, all but shrugged off the toppling of the dictator.
He's sticking with a bold prediction: Prices will climb to $300 a barrel in 2020, or about $225
in today's dollars. The world simply won't have enough oil to meet demand, he says. Barron's
interviewed Maxwell, 79 years old, by telephone from the Greenwich, Conn., offices of Weeden
& Co.
Barron's: How will Hosni Mubarak's removal from power and Egypt's political unrest
affect the global oil market?
Maxwell: Even though Egypt is an oil producer, it is a small one, producing a little bit less
than 1% of the world's total. But what is so critical is that roughly 30% of the Arabs in North
Africa and the Middle East live in Egypt. So it is terribly important as a population center, and
also as the center of publishing, education, medicine, technology and manufacturing in that
region. In so many different ways, Egypt represents leadership in various civilized activities in
the Arab world, and in keeping the peace in the Middle East, thanks to 30-plus years of
agreements between the Egyptian state and Israel. It's been critical to keeping the Middle East
stable. So it is in this wider context that Egypt is so important, should its government change
over to, say, an Islamist party like the Muslim Brotherhood, and should it in some way begin to
default on the diplomatic agreements it has already made.
There's been a lot of talk about the Suez Canal. Is it still significant in shipping oil?
It isn't as important these days. It was very critical in the famous days of the past. These days,
the Suez-Mediterranean pipeline does about 1.1 million barrels a day, and the canal itself does
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about 1.9 million. So putting them together, that's three million barrels a day out of a total of
about 88 million barrels around the world every day. So we are looking at about 3.5% of world
production. If the Suez Canal were cut off, we could easily get over the problem, but we would
have to pay more to carry it around the bottom of Africa, with an extra 12 days on the ocean. I
don't think the Suez Canal will be shut down, but if that were to happen, it wouldn't be a
disaster.
Oil prices have moved a lot higher lately. West Texas Intermediate, for example, is at around
$87 a barrel, versus a shade over $71 last August. What's driving that increase?
There are various reasons given for that, including the economic recovery, which is requiring
more crude oil. Another reason would be that Russia had been increasing its production, until
just recently, to about 10.2 million barrels a day. But currently they aren't expanding any
further, and Russia's oil production will probably be flat or a little down. So that contribution
appears to be over for the moment, not for the longer term. And the political problems in
Nigeria are coming back. But I think these reasons for the recent spike in oil prices pale in
comparison to the true long-term cause, which is that demand for oil continues to rise from
greater economic activity around the world. Societies that are modernizing are using more oil
for cars, trucks, airplanes and boats and, suddenly, we are back on that growth-of-demand
upward ramp. It is pretty obvious to analysts and to the general public that oil companies are
straining to get more oil to meet the world's needs. And the question behind it, of course, is
this: In three or four years, will the ability to produce the extra barrels needed be met? The
answer is increasingly a question mark, and that pushes higher and higher the present values
of the oil in the ground and the desire of holders of oil to add to their supplies.
What's the current capacity for global oil production?
We are producing about 87 million to 88 million barrels a day, and I would put global capacity
at another five million barrels on top of that. So our capacity is about 92 million to 93 million
barrels a day, and I see our capacity as reaching perhaps as much as 95 million barrels a day at
the peak in about four or five years, probably around 2015. But I think production will go very
modestly above that point, if at all, and, in effect, we will reach a plateau. It will be a little
bumpy in 2015, 2016, 2017 and 2018. But by 2020, the first signs will become very evident that
we can't go any higher than that in production. So we will begin to settle very slowly and
gradually in a world in which we need more oil each year, but we can't get more.
How high will the price of oil go?
By 2020, I'm looking for about $300 a barrel, which is closer to $225 a barrel in today's
dollars. So it reaches a production plateau around 2015 or 2016 and stays flattish on a bumpy
plateau until about 2020, at which point output starts to recede slowly.
What about the impact of increasing
production?
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Let's say you increase production by half a
percent. But if your demand is up by 1½%, you
still don't have enough to meet your full
demand, so then prices have to step in to ration
supplies and, in effect, destroy the incremental
production by making 1% of the use [too
expensive] for those people who can't afford it.
View Full Image
Peter Murphy for Barron's
Charles T. Maxwell
Where do you see oil prices going over the
next year or two?
These are guesses, but they are the best I can do. Using West Texas Intermediate, which is the
marker for crude in the U.S., it averaged about $78 a barrel in 2010, and I'm projecting it to
rise to $85 this year. That's around where it was last week.
Then it goes to $95 in 2012 and $115 in 2013. The following year, 2014, we see the price going
to $140 a barrel, followed by $180 in 2015. And then, by 2020, it's at $300, or roughly $225
discounted back to the present.
At what point do those price increases start to put too much pressure on the world economy?
Strangely enough, I don't think that it would bring the economy down. Rather, it is the
suddenness of change that does that. That rise we saw three years ago, where in one year it
went from $62 a barrel on average to $100, created a huge amount of economic damage. On a
more gradual scale, and giving the effect of inflation its due, we will probably simply walk away
from two-tenths or three-tenths or four-tenths of a percentage point of potential grossdomestic-product growth, which we will give up by being caught in this energy vise. But the
world economy will advance, and it won't be brought down by this. However, it will touch off a
huge effort to change the cars and the aircraft engines—and to use a greater amount of
substitutes for oil, such as coal and natural gas. And, of course, this has a lot of positive aspects
as well, because in the longer term, we would have to begin making these changes anyway. But
it seems that we can't be asked to do that. We must be forced to do that, and price is the means
by which that force is applied.
But how feasible are some of those alternatives to oil? Consider the concerns about nuclear
power, for example.
That's the guts of the whole issue, which is, yes, we all understand that price will make people
use oil more efficiently and, in many cases, they will be able to substitute some other fuel for it
or find a manufacturing process that doesn't require it. But nevertheless, how do we get out of
this problem? If you look at the next 20 years, which are critical to our future, we are going to
struggle with this energy problem. So, we have got to recognize that coal is probably not going
to be part of the solution, at least for the next 20 years, until the environmental concerns can
be addressed.
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As for natural gas, technology has made it easier to find it, and the availability has increased.
That, of course, has caused a lot of problems for the natural-gas producers, because it has
allowed them to produce more gas than we really can use in the near term, and it has brought
the price down.
What's the outlook for natural gas as an alternative to oil?
Natural gas is going to be one of the saving graces in this search for substitutes for oil, and we
will be learning how to use it for a lot more things, and it will be wonderful. So coal is down as
a percentage of the total fuel mix. Oil will be down. Gas will be up, and a help to our energy
needs. With nuclear power, it takes so long to develop those machines, equipment and
operating stations. But eventually, nuclear power will be part of the solution, but probably
somewhere beyond 2030, when it is accepted as being safer and more attractive to individuals.
So we will have to go through quite a lot of pain with higher energy costs and restrictions on
energy use before we get to nuclear power. But it will be a solution, and it will work
wonderfully well. I just don't think it is going to be very much of a solution in the next 20
years, when we need it. So that takes us to alternatives.
Which are?
It includes solar, wind, hydropower, biofuels and geothermal. But the key point is that these
sources are so small and they can't be sharply increased. With hydropower, most of the good
places are already taken. We obviously have a lot of solar power. But it starts from one-tenth of
1% of our energy supply. So even if we do 10 times better, it doesn't represent something large
enough to fill the hole of oil and coal coming down. So alternative energy sources are going to
be helpful, but they will be sideshows. But what really counts—and this one isn't talked about
too much, because, in fact, it isn't a fuel—is energy efficiency and conservation. That, and the
fuel of natural gas, will be the two great solutions to our energy dilemma.
Just One Long-Term Direction
Veteran energy analyst Charles Maxwell sees
oil prices rising steadily as world demand
tops supply. Energy conservation and natural
gas are the two best U.S. alternatives right
now, he says.
What do you see ahead for natural-gas prices,
which have been under a lot of pressure?
I think that we have seen the bottom. Natural
gas is at about $4 per thousand cubic feet;
2009 saw a big drop in prices, with the average
price a little under $4. Last year it was around
$4.40. This year I expect the price to drop to a
little under $4 again. Next year I expect it to be
about $4.40 again. Then I think the recovery
really begins in 2013, driven by higher demand
and less supply. Because this is an industry
that needs to straighten itself out and
consolidate, it means essentially that fewer rigs
need to drill. But this year a lot of rigs will have
to continue drilling, because they have been
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contracted to drill in order to create production to hold the land for the longer term. So it
becomes an obligation that they would rather not fulfill, but they must in order to keep the
reserves. So that's why we expect this odd drop in prices in the short term.
Let's turn to a few energy companies whose prospects you like.
Our choices are mostly in the oil area, and mostly oil companies with very large and long-life
reserves. Most of these companies are going to be running up against the production plateau I
mentioned previously, starting around 2015, but these particular companies will be able to
meet the needs of their customers by producing substantially more.
Now, the industry as a whole won't be able to do so. In fact, only about 5% or 6% of the
companies in the industry will be able to go through this production plateau period and keep
their volumes rising. But being able to do just that has several important effects. It gives a
handful of companies a lot more actual volume, and—by the industry tightening its whole
production—it pushes up prices, so the profits per unit should be higher with those higher
prices. And for those companies that are producing a lot more units, they are able to keep their
costs under control. But those companies that are flat on units or coming down on units will
find it very hard to control their costs, so their profits per unit are likely to decline.
This would suggest, for instance, the Athabasca oil sands producers in Canada. The two
publicly owned companies where you get the maximum exposure to the earnings power of the
sands are Suncor Energy [SU] and Cenovus Energy [CVE], both of which are based in
Canada.
How would you sum up their appeal—that their production costs are under control and their
margins will improve?
I've calculated that over the next 10 years Cenovus is going to be able to increase its total
production by about 9½% to 10% per year, and Suncor by about 8% to 8½% per year, which
will put them No.1 and No. 2 among all major integrated oil companies in terms of oil
production.
Thanks, Charley.
E-mail: [email protected]
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