E-Day! – Part II

From Eric’s desk…

We return today with our second and final installment of E-
Day! – A spontaneous three-way debate over the state of the
world after “peak oil.” Yesterday, we presented the views
of both Byron King, editor of Whiskey and Gunpowder, and
Justice Litle, editor of Outstanding Investments.

Today, Dan Denning, editor of Strategic Investments, takes
his shot. And then, to wrap it all up, Justice shares a few
conciliatory and optimistic thoughts. Read on…

E-Day! – Part II
By Eric J. Fry
Dan Denning writes:

“Justice, I think that you haven’t entirely answered the
claim that the ‘peak oil’ problem is a real physical
problem. You wrote: ‘I submit that the peak oil scenario
still represents more of a political threat than a physical

But I see these two threats as inseparable realities. You
assert that peak oil can’t ever produce a genuine and
lasting energy crisis, because eventually high oil prices
will make other unconventional energy sources ‘economic.’
In other words, there is plenty of energy in the world. It
just may cost us more to get it.
“But this is exactly the peak oil argument; that the
production of cheap reserves of high-quality petroleum are
declining, and that this phenomenon will unleash a series
of geopolitical and domestic economic consequences.
“All of this means that energy is getting more expensive
for everyone. It also means that we’ll have to accept lower
energy-returned-on-energy-invested ratios (EROEI). It’s
great to get 30 barrels of oil using only one barrel of oil
as energy. But as we move to other sources of energy, that
ratio is going to drop.
“Furthermore, there’s another aspect to the word ‘economic’
that we’re not even considering. We aren’t accurately
calculating the ‘energy invested’ portion of the ratio
because we are not including the accumulated political and
military cost of coddling, aiding and dealing with oil-rich
and unfriendly nations for the last fifty years.
“I wouldn’t know how to begin to count this cost. But I’m
sure it’s…well…really high, and getting higher. We’ve
invested a lot of political capital, as well as real
capital, in the Middle East, not to mention lives. Surely
that has to be figured in the net petroleum yield we get
from that part of the world. By this math, oil isn’t nearly
as cheap as we’ve been making it out to be.
“And if the last 50 years have proved more energy intensive
on the cost side than first meets the eye, these intangible
costs may seem as nothing compared to the future costs of
relying on Middle East oil. This week, China put its first
blue water warship to sea, no doubt just the beginning of
its effort to secure the sea lanes through which China
receives its oil and other commodities. And Iran, with its
huge energy reserves, is developing a nuclear insurance
policy to prevent an eventual American attack.
“Does the oil price include these costs? If it did, maybe
Middle East oil wouldn’t be as ‘economic’ after all. There
are no mullahs in Utah, hurricanes in Colorado, or
communists in Wyoming. But you will find a lot of gas,
coal, and shale in the Powder River, Green River, and
Piceance basins.
“The second point Byron [King] and I have been trying to
establish is by far the more important point. It refers to
what Jim Kunstler calls, “the greatest misallocation of
resources in the history of the world…America took all
its post-war wealth and invested it in a living arrangement
that has no future.”
“The American economy is not prepared for expensive energy.
The American economy was built on an aberration and abetted
by a mistake. The aberration is cheap oil, which will prove
to be the exception and not the rule of industrial
development. The mistake is fiat money and low interest
rates, which, when coupled with cheap oil, created an
American economy whose current structure can’t survive
higher energy prices.
“Think of our nation’s energy plight in terms of a fat
rhinoceros in a desert oasis. His survival during a drought
is not, to use your terms, a question of trimming the fat.
His survival is in doubt because he’s not built to survive
leaner times. When the ecosystem changes radically, there’s
no Atkins diet for him to go on…He merely perishes.
“Now, you may argue that human beings are more adaptable
than a fat rhinoceros. You would be right. Economies are
too. But the central argument here is that America’s
suburban economy is not built for a world where energy must
get more expensive. In fact, our impressive economic
development has been possible only because of cheap energy
and fiat money. In other words, billions of economic
decisions over the last fifty years, from the macro to the
micro, have been based on erroneous (and unsustainable)
economic assumptions.

“Think about it…Large tract houses 30 minutes to an hour
away from where folks work. The houses are only affordable
through easy credit. The cars and SUVs that transport those
people to work are only affordable when the automakers
practically give them away or turn themselves into
financiers rather than manufacturers. Swarms of shopping
malls sprout up around these suburban developments in order
to furnish, fuel, and feed the locals. And guess what? The
stores themselves are also granting credit to their
customers, or home equity lines of credit perpetuating the
cycle. The retail/consumption economy becomes joined at the
hip to the housing cycle: a mega consumption and credit
“The entire suburban economy is an EZ-credit and cheap-oil
chimera. Unfortunately, the declining supply of cheap oil
is a physical reality, not something that can be wished
“Justice, you wrote: ‘If the political will was there, and
the fear levels were high enough, developing new sources
like shale, etc., etc., would be a matter of years or even
months, not decades. Political will combined with
unrestrained force would absolutely demand it. A program
that slashed consumer energy use by a third and poured
trillions into energy development projects would likely see
stabilizing results in less than a year.’
“Maybe we could develop Colorado’s oil shale within a few
years, for example. And maybe things would stabilize in
less than a year. But those are awfully generous
predictions. And in any case, the real issue is whether or
not we’ve built an economy that’s sustainable with higher
interest rates and more expensive energy. The peak oil
argument says we haven’t. It says, in fact, that the
suburban lifestyle itself is, for lack of a better word, a
bubble, as civilizations go.
“You also wrote: ‘From a technological standpoint, it
remains true that we have the capability of solving our
energy problems for the long run.  It is just a matter of
how much pain we face in the short run due to deadline
“Maybe. But this seems like more of an assertion than an
argument. It would be nice if solving the peak oil problem
were just a matter of suffering a little pain. But my
contention here is that we’ve created something that can’t
survive because it wasn’t built to survive the conditions
we’re headed for.
“In the grand scheme of things, this puts the industrial
revolution and the American dominance of the 20th century
squarely in a strange light: a one-off boom/bubble begot by
the marriage of easy money and cheap energy, creating an
expectation for higher standards of living – standards
which are not possible for six billion people at the
American level of energy intensity. The competition for
this standard of living and the disappointment people will
feel when they realize it is not possible for everyone on
the planet is about to create a geo-political firestorm,
not to mention disappoint a lot of people in the West who
thought that infinitely higher standards of living and
abundant energy and credit are enshrined somewhere in the
U.S. Constitution.
“Like you, however, I’m an optimist. People will adapt.
There’s other energy out there. Money will be made. But I
don’t see any theoretical or technological bullet to save
our fat from the fire. We’re just too damn fat.”

To which Justice immediately replied:

“Dan, as far as I can tell, I’m in full agreement with
you… I certainly agree that peak oil could unleash major
political and domestic consequences.

“As suggested in my hypothetical scenario, government
mandated controls on energy consumption and distribution,
along with some form of martial law to enforce compliance,
would certainly be a far cry from business as usual. By
ushering in a period of extreme hardship, peak oil could
completely alter the west’s political way of life, which in
turn would dramatically curtail our freedoms. Significant
economic hardship goes without saying.

“Death of frivolous consumption, certainly. Death of
representative democracy, quite possibly (in fact we are
already witnessing this). Death of people for lack of basic
survival necessities? Doubt it. We have been coddled for so
long, we have lost perspective as to what the basic
rudiments of survival really are. We will still have food,
water, and shelter in abundance, even if the majority of
creature comforts are given up by the majority of the
populace. The rhinoceros will be in for a hell of a shock,
but he will not die. His way of life will be stripped to
the bone, but not extinguished.

“How the political process might evolve on the other side
of peak oil is anyone’s guess. But here and now, we have
the ability to cut back on energy consumption dramatically,
when all is said and done, without sacrificing more than
our current creature comforts and political freedoms. 
That’s a hell of a lot to sacrifice, mind you – I don’t
look forward to a populist government monitoring my
gasoline consumption in the name of peak oil, dictating who
can spend what on what for the public good – but that is
still a different scenario than people dying in the

“That is why I see the peak oil phenomenon as primarily
political in nature. To say as much is not an attempt to
gloss over the potential for wrenchingly ugly change. I
don’t see any magic bullets, and I don’t see any way to
preserve the irresponsible ways of doing things. But nor do
I see the end of the road for innovation or technological

“Most of the people who experience the pain of peak oil, in
my opinion, will still be around to experience a world
where energy is once again abundant.

“Perhaps one could view peak oil as a desert that the
civilized world must trek across. What we cannot know for
certain is how long the journey will take, or the highest
temperatures we will need to endure along the way. While I
don’t have a firm stance on those questions, I am confident
that we’ll make it to the other side.”

Thanks guys…We eagerly await your next spontaneous

And the Markets…

 ThursdayWednesdayThis weekYear-to-Date
DOW 10,55310,473133-2.1%
10-year Treasury4.
30-year Treasury4.544.502.004.49
Russell 2000665656102.1%
WTI NYMEX CRUDE$66.73$66.38$2.5453.6%
Yen (YEN/USD)JPY 112.98JPY 113.15-0.52-10.1%
Dollar (USD/EUR)$1.2044$1.2037311.1%
Dollar (USD/GBP)$1.7624$1.76781508.1%