Karl Moore : This is Karl Moore of the Desautels Faculty, Talking Management for The Globe and Mail. Today I am in Calgary, Alta., where I am sitting with Adam Waterous, who is the global head of investment banking for Scotia Capital, the investment banking part of Bank of Nova Scotia , and is also the president of Scotia Waterous, which is one of the leading firms in the world for M&A [mergers and acquisitions]in the oil and gas business. Good morning, Adam.
Adam Waterous : Good morning, Karl. Nice to see you.
KM: Yesterday I spent some time with Jeff Rubin, who is the former chief economist of CIBC [World Markets] on a big book talking about peak oil [ Why Your World is About to Get a Whole Lot Smaller: Oil and the End of Globalization ] What is your view on peak oil? Have we hit it or is it an illusion?
AW: It's an excellent question. There is 'physical' peak oil, and then there is what we describe as 'economic' peak oil. Peak oil in its strictest sense is, from a given basin, when do you start to go into decline? So, as you may have talked about yesterday, the United States, I think, went into peak oil decline, peak physical production, in the early seventies. That's the United States oil.
If you want to look at, for instance, natural gas in Canada, then we've actually been in decline since early 2000-01; we're actually in declining production. So it depends on which hydrocarbon you're looking at and what kind of basin you're looking at physically.
Economic peak oil is trying to identify what price can you maintain production in a given basin. Put another way, if you spend enough money you can actually start increasing production. But again, it gets very, very expensive. So in the case of oil in Canada, we actually are going to be able to increase production of oil in Canada. So we are certainly not in peak oil in the Canadian sense.
KM: But that includes the tar sands.
AW: That includes the oil sands, so that's my point. While we will be increasing [production] it's going to be at a much higher cost. That cost, depending on what the project is and what kind of time frame you're looking at, maybe's $70-$80 a barrel is effectively the full development cost to be able to do it. So what you are seeing in Canada, in terms of very high cost [to]increase production, you are seeing in different parts of the world. Most obviously in places like offshore Brazil, deep water Gulf of Mexico, where the economic cost for bringing on new barrels is not far off from what it costs bringing on new barrels in the oil sands; meaning these are very expensive projects. So the marginal costs of these new barrels are extremely, extremely high.
So while you may have the ability to build an increase in production, it's going to be increasing production at a much different price environment than we've seen in the past. So, it's a long way of saying, I would generally speaking agree with the theory behind peak oil in that the cheap barrels have largely been found and the new barrels are going to come from much more expensive sources. If you look at marginal supply economics, the world's going to have to get used to much more expensive hydrocarbons going forward.
KM: Jeff talks about $200 [U.S.]a barrel in the next four to five years. Does that fit with your view of the market?
AW: I would say that forecasters make soothsayers look good. I think going out on a limb and saying exactly where the prices will be like in four to five years … at $200 a barrel, that's obviously an aggressive target. Is it possible? It could be, it could be.
I always like thinking about the binary choices and if you looked out five years from now, what is the probability that you have $200 oil versus the probability you've got $20 oil? Well, I'd say it's a far higher probability you've got $200 a barrel oil than you've got $20 a barrel oil. Twenty dollars a barrel of oil was not that long ago and we hit $33 within the last six months, so 20 is not that far from 33, where 200 is a third higher than where the all-time high was just recently. Which, again, is a way to say I'm bullish on the medium-term price. Will it hit $200? We'll see.
KM: So what drives the price of oil? You've been studying it for years. What are the two to three key determinates of where the price of oil is going to end up?
AW: Well, the easiest way to think about it is just like economics; you look at supply, you look at demand, then you get results. What really drives our optimism on the price of oil is, firstly, on the supply side, what I was just mentioning, it's very tough to find the stuff. We've got clients all around the world, and the largest companies of the world, the supermajors, are all struggling to meet their production forecasts.
Their production forecasts, generally speaking, have modest goals: 2-per-cent growth, 3-per-cent growth, compounded annual growth, very modest amounts and, generally speaking, they are quite open with saying how difficult it is to be able to achieve that. They achieve that not only because of the high costs of organic growth, like in oil sands or offshore assets, but also [because]access to the resource itself in a lot of countries which, historically, have been welcoming for investment, today are not as open. Places like Venezuela, to use that as an example. It's just not as easy to get into those kinds of opportunities as you did before.
So, the supply situation is very, very difficult, where demand has been a fantastically long-term positive trend line. Our view is that what drives demand more than anything else for oil is transportation fuel, and transportation fuel most importantly being automobiles. So you have to be able to think about what automobile patterns are going to develop over the next five, 10, 20 years, and if you look at these emerging markets that are discussed so frequently - China, India and other new emerging economies - the development of large markets for automobiles is a very powerful, very, very powerful driving force for commodity prices.
So if you buy that, then you really have to get to the core issue, being what drives the increasing wealth of these emerging markets, and it's really globalization. This is where I think maybe Jeff Rubin and I might disagree a little bit in that I know Jeff's quite bearish on continued globalization, whereas my view's quite different. And that is, globalization has been the most successful social policy, fiscal policy, in the history of mankind. Meaning there has been, depending on how you measure it, something 300 million people in the last 20 years [who]have been lifted out of poverty because of globalization. I mean, there is nothing like … it's not like health care, universal health care, or pensions, or anything like that, have ever provided as much benefit to as many people in the history of the world.
Because it has been so successful, the policy of globalization, you know, reducing trade barriers, encouraging import and export markets, has been so successful on such a massive scale, I think it's very difficult to put that genie back in the bottle. And while it will become more expensive to ship goods, it won't do anything to decrease the desire to be able to maintain open borders. Even today, in the financial crisis that we've just been going through, many of the world leaders are reaffirming their commitment to globalization.
So that's a long way of saying if you buy the argument that globalization is here to stay, then what you're going to see is more and more people in emerging markets come out of poverty, and one of the first things they do is they buy a car, and when they buy a car it's good for the oil business.
KM: But the negative side to that is the environmental impact of hundreds of millions of additional cars, where the Chinese and Indians want to have our lifestyle; and it's a good life, so that makes sense, but can the world sustain that? That is a question that we are beginning to think more about.
AW: The environmental impact is going to be very important to be able to monitor. That is why the automobile manufacturers are spending so much time trying to reduce emissions from vehicles and make their own products more green-friendly. But the combustion engine still is the most cost-effective method to power an automobile, so I don't see that changing in the near term.
KM: In the sense of being in the oil and gas industry, are you nervous about electricity, wind power, and all these things as taking away your business in the medium to long term?
AW: Well, I think we need to encourage alternative energy, whether it's solar or wind, geothermal. But if you look at the total supply, we're told demand on energy, some of the stats I've seen show what worldwide consumption of alternative fuel, alternative energy, is going to be. If you make some assumptions that alternative energy, wind, solar, grows at a compound annual rate of 15 per cent a year, which is a fantastically successful business - if you have a 15-per-cent compound annual growth rate, that would be stunningly fantastic - I think the number is, by 2030, so, 21 years from now, alternative energy is still less than 5 per cent of total energy consumed in the world. Meaning you'd have to have fantastic, fantastic growth rates in alternative energy to ever replace, in any meaningful way, other major sources - primarily hydrocarbons, coal, oil and gas.
KM: This has been Karl Moore, Talking Management for The Globe and Mail. Today I've been in Calgary talking to Adam Waterous, who is the global head of Scotia's investment banking as well as the president of Scotia Waterous, one of the leading M&A firms in the global oil patch. Thanks for your time, Adam.
AW: Thank you, Karl.