It is a play on the word "sharp" to say that someone is of no use, in the sense of them being stupid. The first meaning is sharp, as in able to cut something (hence the reference to a butter knife which is blunt and therefore can't cut). The second meaning is "sharp" as in bright, or intelligent, and because the sentence has a negative meaning it is implying that he is not very intelligent. http://www.oxforddictionaries.com/us..._english/sharp (meanings 1, and 3.2 respectively).
We are told that he "was smoking a cigarette right next to an oil drum", and Mr Habersham also says "fill you up?" implying that the location is a petrol station. Smoking at a petrol station and by an oil drum is not an intelligent thing to do!
You will hear, or read, similar phrases such as, "He's not the sharpest knife in the drawer", "He's one cup short of a cupboard" and "He's about as much use as a chocolate teapot!". The first two mean he's not very bright; the last one can also mean that he's of no practical use as well.