Wow….can it be any clearer? And the implications from what Maxwell says are pretty chilling to the prospects of ever returning to what we called “growth.” Yet, in the end, “Wally” Forbes chooses to focus on investment strategy – “hey at least there’s some good oil compnay stocks to buy in all this.”
On The Call With Wally Forbes
Bracing For Peak Oil Production By Decade’s End
Wallace Forbes, 09.13.10, 3:00 PM ET
Charles Maxwell is senior energy analyst at Weeden & Co. Maxwell discusses where oil’s production peak is and how that affects investments.
Charles Maxwell: The use of petroleum in the world is now up to about 30 billion barrels per year. The rate at which we have found new supplies of petroleum over the last 10 years has fallen to an average, of only about 10 billion barrels per year.
We’re obviously in an unsustainable situation. We are now using up a greater number of barrels that we have found in the recent past and that we have reserved in the ground. We are now beginning to use it up relatively quickly–with scary consequences for the future.
The peak of production usually comes sometime between 30 and 50 years after the peak of finding oil. “The peak of discovery,” as they call it. For instance, in the North Sea, the peak of discovery was in the late 1960s, and the peak of production was in the late 1990s. So it was around 30 years between the peak of finding oil and the peak production of that oil.
Wallace Forbes: From those sources in the North Sea?
Maxwell: Yes. In the United States, the actual peak of discovery was 1931, quite a bit earlier. We were the first country to actually peak in the world of oil production. Our peak of production came in late in 1970. So that was a 39-year transition from the peak of finding the oil to the peak of producing it.
Now the question remains in front of us, has the world peaked in its level of discovery and if so, how long will it take the world, if it has peaked, to reach the peak of oil output? I believe that the peak of discovery fell in the five-year interval between 1965 and 1970. So if you took it at, say, 1968, and then you added 50 years, you would get to 2018.
Forbes: Is technology reducing the time between finding and producing oil?
Maxwell: Technology is trying to give us the ability to produce more out of a giant field. In the early days we only produced about 25%. Today we’re producing about 40% of the oil in place when a field is found. These numbers are gaining rather slowly now. What’s happening is that the increase in the world’s population and greater use of oil in transportation, particularly in the emerging countries, is working to lift oil demand, and that spurs us to drain a field more quickly, but not necessarily to get a higher proportion of oil out of it. So we have technology improving production capability, but actually taking the oil out faster rather than getting much more out. I cannot tell you whether we are lengthening the life of a field very much in these times. It’s a slow process, at best.
Forbes: But a bind is clearly coming?
Maxwell: A bind is clearly coming. We think that the peak in production will actually occur in the period 2015 to 2020. And if I had to pick a particular year, I might use 2017 or 2018. That would suggest that around 2015, we will hit a near-plateau of production around the world, and we will hold it for maybe four or five years. On the other side of that plateau, production will begin slowly moving down. By 2020, we should be headed in a downward direction for oil output in the world each year instead of an upward direction, as we are today.
Forbes: As the economies of the world grow, demand is growing.
Maxwell: Exactly. And at around 2015, we will be unable to produce the incremental barrel in the global system. So a tightness of supply will begin to be felt. Let’s say in 2013, we may produce 1% more oil than we did the year before and then if we have a demand growth of 1¼% in 2013, we’ll be very slightly tightening the system.
The difference between supply and demand is not going to be very much at first. It would not normally cause a big rise in price. On the other hand, in 2014, that tightness begins to grow and it is now a trend. By 2015 perhaps we’re only able to produce 0.50% more with about 1.25% higher demand, so that we’re 0.75% short. And now we have to raise prices enough to stop some people from using that oil because it is actually not available.
We call that “the destruction of oil demand.” It is important because it forces the price of oil up on an accelerated basis. This, of course, would be very attractive for the industry if the governments of the world would allow it to fully take place. But they surely would not allow it to fully take place.
Forbes: When you say “not allow it,” there have to be either alternative sources or —
Maxwell: In this case, “allow” means to allow the profits to flow through to the shareholders. What they will do is to put in excess profit taxes or windfall profit taxes on oil. That is the main problem that the oil industry will be dealing with in those future days. But even so, it looks like profits will rise significantly.
Forbes: Wow. So to the degree we’re successful in growing faster on an international basis, we can accelerate this problem of tightening supplies and higher prices?
Maxwell: Exactly. Supply and demand are now in rough equilibrium and that means that prices are in a range between about $69 on the bottom and about $86 on the top. And that $16, $17, $18 range seems like it will be with us through 2010 and probably most of 2011.
We’ll be living in a dream world. Things in the oil world are going to be just fine for the immediate future. We can buy gasoline at $3.00 per gallon or perhaps $2.75. That is fine for now. The problems come around 2013 or 2014, when we begin to find that this higher growth that you spoke about is nowhere matched by higher production of petroleum products and, obviously, we begin to run tight.
That begins to scare people, since they can look ahead and see that the issue is not going to be resolved quickly, since you have to find the oil many years in advance of being able to produce it. We just haven’t found enough oil for a number of years, so this problem is now beyond the reach of some big, major discovery that suddenly would provide us with a sufficiency. And so far, we have no technological breakthrough to assist us.
So we’re going to have to make a switch from using oil to using more coal or more natural gas or more nuclear or other alternatives. But most alternative supplies (such as hydropower) can’t be expanded quickly. Solar power is too small to be meaningful. Wind power, again, is too small, and most of the good places for wind have already been taken.
So it looks like alternative energies will plug only a very small part of the hole. And we’ll have to rely more on coal. But we can’t rely on coal because the emissions people will not allow us to burn coal and the various government agencies are not allowing the establishment of coal-burning plants.
Forbes: Sounds like some things are going to have to change?
Maxwell: Yes. In the same way, the American public has not yet really given the go-ahead for the nuclear power developments of the future. So, it doesn’t look like nuclear can get revved up in the time frame of the next 10 years. Even if we decide to seize the nuclear alternative, it’s still a decade before we can get the plants built and operating.
Forbes: Against that kind of challenging, even scary background, what investments are you recommending to “take advantage” of this? Or what are your thoughts on selling, with this anticipated outlook?
Maxwell: Well, let me follow down a logical path and say that those oil companies that have the widest and the deepest reserve bases, particularly relative to the size of their stock market value, are really the ones that should do the best. We are entering a world in which the value of oil, both above ground and underground, is going to be lifted rather more quickly than anything we’ve seen since some of the early days of the energy crises we have endured already. And this will be on a continuing basis instead of on a temporary basis.
Companies like Suncor Energy and Cenovus Energy, that are located, for the most part, on the great Athabasca oil sands up in the north of Canada, in the Province of Alberta. This is the second largest single reserve base in the world, second to the Orinoco in Venezuela, in oil sands terms. And it also has reserves that are really the equal of the Saudi reserves. And the Saudi reserves are perhaps half produced. But the oil sands of Canada are probably about 1% produced. So, we have an awful lot more oil to produce up there.
I have selected these companies after working with them over many years. For more conservative investors, the more attractive would be Suncor which is the second largest company in Canada and the largest oil company in Canada. Some 55% of their total assets are in the oil sands of Northern Alberta.
As those reserves become critical to the future availability of new oil supplies and as prices rise, SU and CVE will receive a huge lift in their future profits. Owning a piece of them will give you a piece of the largest reserves left in the world that you and I, as private citizens, can buy. We can’t buy into the Saudi reserves. We can’t buy into the Orinoco reserves in Venezuela because of Chavez. But we can buy into the Canadian reserves, and that’s one thing that many portfolio managers I think will wish to do.
Forbes: So Suncor is spotlighted by the kinds of problems and limitations that are coming pretty quickly over the horizon?
The other name is a smaller company, Cenovus. It is also attractive and well run and is equal to Suncor in quality. It’s a new name, but it’s a split-off from a company called Encana, that has always been a well-known Canadian oil and gas company. Cenovus is listed on the New York Stock Exchange, as is Suncor. Because it is a smaller company, it can grow a bit faster than Suncor, but is does not have as much institutional liquidity in the market.
Forbes: Well, it sounds like two very good ideas coming against the background you’ve outlined. Do oil sands have a more prolonged or similar kind of time frame over which to bring oil to market from them?
Maxwell: Well, it’s a good point The average oil company, producing conventional oil in the way that we normally do, by drilling and pumping it out, will peak around the mid-to-late teens, along with the rest of the world, But the oil sands companies average about 2035 to 2045 for their ability to continue producing incremental barrels. So, they keep going for many, many years after the peak has been reached here in the teens by all the other conventional producing companies.
Forbes: I see. So they’ve got both a shorter-term set of circumstances in their favor and they’re going to in fact benefit by bringing product to market down the line while building capacity?
Maxwell: That’s correct. And they should become very much more valued by the market, because they will be relatively alone in their ability to bring new barrels to market.
Forbes: Well, Charley, I thank you very much, once again. It is, tremendously helpful and also educational to get this background, and to see what are the circumstances we’re facing rather sooner than later and to learn of a couple of sound companies in a position to take advantage of these changing circumstances.
Wallace Forbes, CFA, president of Forbes Investors Advisory Institute which publishes the Forbes Special Situation Survey, Forbes Growth Investor and the Forbes Stock Market Course.