An Interview with Michael Economides

By Lloyd & Noah Graff

Michael Economides

Originally from Cypress, Michael Economides holds a degree in petroleum engineering from Stanford University. He is a professor at the Cullen College of Engineering, University of Houston, and the Managing Partner of a petroleum engineering and petroleum strategy consulting firm. Three years ago he gained notoriety for predicting that oil would reach $100 dollars a barrel.

Lloyd Graff: Michael, how much of the price of oil is speculation and how much is demand driven?

Michael Economides: There are four components to the price of oil and these go up and down. It may surprise you to find out that the price of oil should be trading a bit over $50 per barrel.

LG: It doesn’t surprise me.

ME: You need to ask how much money it takes to activate the stabilized flow of one barrel per day, for instance, and then take into account things like decline analysis. Anyway, you throw all of those things in there, you put a reasonable discount rate to make a living, business, let’s say 25 percent, 20 percent, and voila you have this $50 as an average. However, it’s not going to come close to that because there are three other components that are huge fractions of the price of oil. For instance, $30 is because of energy militant nations – Russia, Iran, Venezuela. If you look at the discount rate that involves risk in working in Venezuela, we’re calculating it escalated to 100 percent. In Russia, you realize that it doesn’t matter who you are, what company you are, the Russian government decides how much money you’re supposed to get and they decrease it to $25. Oil companies in Russia get $25 a barrel and then everything else goes to the state treasury essentially feeding [Vladimir] Putin’s cronies.

LG: Right.

ME: Russia has a huge premium because there is no incentive for anybody to produce. $30 is because of environmental radicals – in this country and in Europe in particular. Those hash smoking characters of the ‘70s put on neckties and they are on the covers of national news magazines, and they set the agenda in many countries.

Then you add another $25 for speculation and you have $135. So $50 is what it should be selling for, $30 because of militant nations, $30 because of environmentalism.

LG: So $85 is political.

ME: The United States won the Cold War and lost power, which is an amazing thing. It’s still very powerful, the only super power country, but projection of power right now has become very intolerable and out of fashion. For instance, we accept Hugo Chavez in Venezuela. That’s not the kind of character that a super power should tolerate. Inside the U.S. no politicians are honest enough, both the left and the right, to admit that in fact environmentalism is a major, major destroyer of America’s well being.

NG: Do you think that fossil fuels are causing global warming?

ME: Yes, of course. I’m a scientist; I’m an engineer myself so there is an element, but it’s certainly not the sole element. By diabolical coincidence I did my master’s degree in radiation heat transfer, and there is no way in hell that anthropogenic manmade global warming is the cause of “global warming.” There is no way that the Stefan-Boltzmann Law, which controls radiation, would have shown the differences in temperature that they claim they do. It’s political issue. The global warming rhetoric is yet another attempt to social engineer often coming from upper middle-class activists. This is no different than Ehrlich’s Population Bomb which you had to read as a student in the ‘70s. You realize, Ehrlich, who’s a professor at Stanford, had suggested, and people forget, that by the ‘80s two billion people on this earth would die from starvation because of overpopulation. This hasn’t materialized and yet Ehrlich is still a cult hero among liberals.

LG: Do you have a conspiratorial view of global warming theory?

ME: No, I don’t, unless you want to put it like this: I want to tell every American that wants to think and listen, and I work in 70 countries, that global warming rhetoric is a full frontal attack on the United States. The United States enjoys a standard of living that no other country in the world enjoys. There are many people who believe that the United States is wasteful in the use of energy. Everybody in the world thinks that we are hogs for energy. I beg to differ. Based on my studies I have suggested that it is obvious that this country will use more energy, but what is often missed in this debate is that the use of energy generates wealth. There are no alternatives to fossil fuel sources out there in the foreseeable future. We’re still going to be in the year 2030 a profoundly dependent economy on fossil fuels. Oil doesn’t go. There are no alternatives for that.

Noah Graff: Is alternative energy or conservation going to have any real effect on the price of oil?

ME: Conservation has never been able to reduce consumption anywhere, definitely not in the history of the United States. There is something by the way that you definitely need to quote me on known as the Jevons Paradox. Jevons, was a prominent economist of the Nineteenth Century. Let me paraphrase him. It is a confusion of ideas to suppose that the economical use of fuels is equivalent to a diminished consumption. The history has been repeating itself over and over again. If your car becomes more efficient, you know what you do, you buy a bigger car. If your house becomes more efficient, you buy a bigger house, or a second house or a vacation home. Why this works is because the use of more energy has been subconsciously associated with better living. So conservation doesn’t fit human nature. Second, if you look at alternative [energies], there are none. Solar and wind people lie through their nose and teeth. Solar and wind will never account for more than one half of one percent of the energy mix.

NG: Then why is everybody saying the opposite?

ME: First, I have nothing against solar. I’m Greek, I love the sun. In fact, in Greece it would be stupid not to use solar for space heating or heating your water. But let me give you some numbers. There is a highway called the 610 Loop that goes all around Houston. That’s the size of the mirror that we would need to power Houston with solar energy – at the cost of several trillion dollars. So this idea that solar can feed the world energy is ridiculous. There is a second problem with solar – how do you replace oil with solar when oil goes to transportation while solar is for power generation?

LG: The link is the electric car.

ME: Okay, now how do you do the electric car? Batteries?

LG: Yes.

ME: I’m in favor of electrifying transportation myself, but it’s not going to be solar. Solar is too diffuse for the amount of electricity we need here.

LG: But if you have nuclear power and rechargeable cars don’t you change the transportation dynamic?

ME: Yeah, and I want it to happen by the way, but it’s a 40-year proposition. Just a little secret, please do not call me just an oil guy. I came to the energy business from the geothermal industry, so I’ve been advocating electrification of transportation for many years now. But this is a 40-year proposition. It is not something that happens today.

LG: But what if the General Motors’ Volt is successful in 2010, that they actually pull it off? What does this do to the expectations of oil pricing?

ME: That is something that we do not really know. First of all, I have news for most of my American friends. Don’t look at the energy world as America-centric. You have China, you have India. 1,000 new cars enter the market in China per day right now. The turning point of per capita income is about $1,000. That’s when private ownership takes off. In the United States we have 1.2 cars per one person right now. In China, the ratio is one car per 120 people, and in India it’s even worse. So it is going to be a very excruciating transition from fossil fuels to electrical. I don’t think that batteries will ever solve the issue, but I do think hybrids or electrical cars may work if we develop guide ways in the future so people can pick up electricity from the highway of the future itself. Again, this is trillions of dollars of infrastructure, nothing happens overnight. But you’re in the right direction in this area.

NG: Do you see wind as something that could generate much power?

ME: That’s where a lot of people lie. You need to be careful not to confuse installed capacity and actual output into the grid. Wind energy capacity means that somebody built a windmill. However, how much of that wind will actually output electricity into the system? I’m just going to give you my own take on this. In the Greek islands last summer windmills caused enormous misery – even deaths – because there was no wind on a couple of islands where they depend on it. They shut down their diesel generators and people actually died because their air conditioners were not working. In Europe, I have a report that I’m checking, that somebody has shown that wherever windmills have been built, natural gas generators followed shortly thereafter, and here is why: wind is very unreliable and so you have to have something to kick in, and that thing to kick in is usually natural gas. The problem is not the equipment. The wind itself may not be reliable. That’s the problem with windmills.

LG: Would you argue that we have an oil bubble?

ME: A bubble that may burst at any time and take the price back down to $75 or $80. I don’t think it’s going to burst down like that. The reason is because energy militant countries are not going to let it happen. By the way, this is a margin business – one-half of one percent over or under supply can have a devastating impact on the price of oil. And I agree with you, it’s possible. But it’s going to be a very temporary thing. Venezuela today is producing at the lowest level it has produced since the first nationalization in the ‘70s and yet the revenues of Venezuela are triple what they were just a couple of years ago.

LG: On a one to 10 scale, one being extremely unlikely or virtually impossible and 10 being almost certain: what is the number that you would put on the likelihood of seeing $75 oil within the next five years?

ME: Zero. One. Extremely unlikely.

NG: What would have to happen?

ME: What would have to happen is substantial drilling in the United States. That would make a lot of difference.

LG: If we started drilling offshore and in the ANWR would that change the perception?

ME: I would say a serious announcement that we’re going to do that would cut the price of oil about $35.

LG: Would you say the person most likely to be able to pull that off would be Obama?

ME: That’s an interesting and paradoxical question. If [Obama] wins he may have the right flavor to level with people because nobody has leveled with the American people about their lack of options today and how much the United States, the super power in the world today, is kicked around by the likes of Hugo Chavez. By the way, being traditionally a Democrat, I have been telling all of my Democrat friends that energy should be the most populist of issues. It should not be any different than the air we breathe, the water we drink, and the food we eat. It should not have been delegated to the right-wing fringes of the Republican Party with a dark knight like Dick Cheney. It should be a Democrat issue. But in this topsy-turvy political landscape in the United States, it went the other way; and that’s ridiculous.

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