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Mon, May 10, 2010
Crash Course Series in Lancaster, PA
This guest post by Erik Townsend really elevates the discussion around the issue of investing in
Thu, May 13, 2010 oil and energy given the realities involved in what Peak Oil truly implies politically and
Crash Course Series in Groveland, CA
economically. Few in the investing community have really fully internalized the magnitude of the
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predicament, but Erik has.
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By Erik Townsend · May 3, 2010
Testimonials Executive Summary

"I very much enjoyed your Crash Course and
have sent the link to several of my friends and Although there’s more than 100 years’ supply of crude oil left in the ground, the resources that are “cheap
relatives. It's the best summary of our likely and easy” to extract have for the most part already been discovered.
future problems I've come across!"
— Frank By 2012 the decline of production output from conventional sources coupled with much higher extraction
cost of unconventional sources will lead to peak cheap oil, a phenomenon that will put extreme upward
Blog Daily Digest pressure on oil prices.
Chris' Blog To a limited extent, a strong case exists for speculation on a moderate increase in petroleum prices.
Power Outage: Lessons Learned Those who anticipate extraordinarily high prices (upwards of $300/bbl) have failed to consider what George
May 6, 2010 – 11:15am
Soros calls reflexivity. The global economy simply cannot afford such prices, and the rules will be changed
2619 reads / 28 comments
before they are reached.
Why “Peak Oil” Will Never Lead To $500/bbl
Crude Oil The future is likely to bring price controls, government intervention in the petroleum supply chain, and
May 3, 2010 – 10:56am
nationalization of oil resources.
A New Page - In the Media The oil industry will face many unanticipated challenges during this period, capping the price appreciation
April 29, 2010 – 3:16pm potential of both commodity and equity plays in the oil industry.
Wise investors will focus on the initial price run-up expected to occur before large-scale government
Attention Bostonians: Boston Magazine Would
Like to Interview You intervention ensues.
April 27, 2010 – 8:48am
Deflation Is Not On The Menu
April 19, 2010 – 10:21am Background
If you’re an investor and you haven’t yet learned about Peak Oil, you need to drop what you’re doing and go find
more
out all about it. The implications of Peak Oil are far wider reaching than the energy sector. Peak Oil is a
Daily Digest macroeconomic story that will dramatically affect virtually all investments in the coming decade. This article is
intended for those already familiar with the Peak Oil prognosis, and focuses on why I think a lot of investors are
Daily Digest - May 7
May 7, 2010 – 10:52am
making faulty predictions about what Peak Oil will mean for future oil prices. If you’re not already up to speed on
974 reads / 7 comments the background material, here are some resources to start with:
May 6, 2010 – 10:45am The very best basic introduction to the concepts of Peak Oil that I know of is this free video from Dr. Chris
4694 reads / 27 comments Martenson’s Crash Course.
May 5, 2010 – 10:44am From there, read Eric Janszen’s excellent articles on the subject, paying particular attention to the distinction
3691 reads / 16 comments Janszen draws between Peak Oil and Peak Cheap Oil. Some of Janszen’s articles are free while others
Daily Digest - May 4 require a subscription to his web site. Start with this free article to get a taste of Janszen’s perspective.
May 4, 2010 – 10:46am
May 3, 2010 – 10:46am I find it very interesting that Peak Oil has recently begun to get a lot more mainstream attention. Previously,
despite overwhelming evidence, Peak Oil was considered a “fringe idea” and not taken particularly seriously by
more
the mainstream investment community. Suddenly the tide seems to have changed. For example:
1 of 9 5/7/2010 3:27 PM
Chris Martenson's Blog - Why “Peak Oil” Will Never Lead To $500/bbl Crude Oil - May. 3, 2010 - Blogs at Chris Martenson - Chris Mar...
Recent Comments Puru Saxena’s recent interview on CNBC was a milestone in my mind. Although Mr. Saxena didn’t say
anything that came as any great surprise to the Peak Oil-aware community, the fact that this interview was
Re: Dow 11,000 -- Too Much Cheering aired on a mainstream financial station tells me we’re approaching a tipping point of Peak Oil awareness.
Dow 11,000 -- Too Much Cheering
nickbert The United States military recently released a report predicting “massive shortages by 2015” as a result of
13 min 6 sec ago
a decline in conventional oil production.
Re: DOW dropped 1000 pts in intraday trading
Gold back over ... This shocking chart from the U.S. DoE says it all:
DOW dropped 1000 pts in intraday trading Gold back
over $1200
Dogs_In_A_Pile
32 min 28 sec ago
Gold back over ...
over $1200
Dogs_In_A_Pile
34 min 57 sec ago
Re: The Burden of Knowing
The Burden of Knowing
deggleton
35 min 48 sec ago
Gold back over ...
over $1200
Dogs_In_A_Pile
37 min 7 sec ago
Re: Whats Next for the Markets
Whats Next for the Markets
idoctor
45 min 48 sec ago
Re: The Burden of Knowing
The Burden of Knowing
ashvinp
47 min 5 sec ago
Re: Gold:Silver ratio Revisited
Gold:Silver ratio Revisited
Morpheus
56 min 57 sec ago
Re: Daily Digest - May 7
bearmarkettrader
(Source)
1 hour 16 min ago
This chart isn’t from some radical left-wing fringe blog site. It’s from the United States Government. Conspicuously
Re: Trying to Understand Obama's Intentions
Trying to Understand Obama's Intentions absent is any mention of where these “Unidentified Projects” are going to come from. The deepwater well that
docmims was being drilled by the recently-sunk Deepwater Horizon rig in the Gulf of Mexico would appear to be off the
1 hour 18 min ago
table, and the ensuing ecological disaster is likely to encumber the viability of similar projects in the future.
If you’ve done your homework on Peak Oil and Janszen’s Peak Cheap Oil distinction, you should have come to the
following conclusions:
About | Technical Support | Privacy | Terms of Usage
Societal complexity is a function of excess energy availability
Copyright 2006-2010, ChrisMartenson.com (CMAL
LLC) Continued global economic growth is possible only if affordable energy is available
Alternative energy sources (wind, solar, nuclear, geothermal) will be important. However, the world’s
existing systems and equipment are highly dependent on oil. Any plan to eliminate dependency on products
derived from crude oil will take decades to implement fully.
The world isn’t running out of oil. There’s at least 100 years’ supply still in the ground
However, the “cheap and easy to extract” oil has, for the most part, already been found
Existing “cheap and easy” oil resources will or have peaked, and will be in decline by 2012
Declining production from existing resources must be replaced by much more complex and expensive
sources, such as deepwater offshore oil fields, tar sands, and oil shale.
Regardless of supply-demand forces that determine end user price, cost of production of crude oil will
increase considerably as “easy oil” sources are depleted
If these conclusions don’t yet make sense to you, I encourage you to follow the links above and learn the basics of
Peak Oil theory from the suggested sources before proceeding. Once you have this background information under
your belt, you should understand why modern society simply cannot function, and why economic growth on a
global scale cannot continue, unless petroleum products are available. Although alternative energy sources will be
very important, the word’s existing infrastructure (transportation in particular) will remain dependent on oil for a
very long time. This leads many speculators to forecasts about the future price of crude oil that I think are flawed
for several reasons. I’ll first review the argument for extraordinarily high crude oil prices and a super-profitable oil
and gas industry, and then I’ll argue my case for why I believe these scenarios to be improbable if not impossible.
The $500/bbl Crude Oil Argument

I’ve heard interviews and read articles by a variety of pundits who are forecasting an escalation of crude oil prices
in the next five years to $300, $400, or even $500-$1000 per barrel accompanied by a wildly profitable oil and gas
industry. These commentators believe oil companies will be able to expand their profit margins with the
disappearance of the historical crude oil supply glut that existed before the peak of “cheap and easy” oil
production. I disagree with many of their conclusions, but let’s begin by first understanding their argument.
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The world runs on oil and can’t easily change

The world literally runs on the products produced from crude oil, including gasoline, diesel fuel, home heating oil,
and petrochemicals used to produce most plastics. This problem has been understood for decades, but little has
been done until very recently to seriously explore alternative energy sources. Recent investments in wind, solar
and geothermal energy sources are very important to be sure. But for many applications, particularly
transportation, there’s just no good alternative to liquid fuels. There are no battery-powered jet airliners, because
the technology to build them simply doesn’t exist. For short-haul applications like passenger cars, there are viable
alternatives to gasoline and diesel. Perhaps the best alternative is natural gas powered vehicles, which are
already in limited use. But natural gas is a product of conventional oil production and it too is subject to the peak
cheap oil phenomenon. The recent discovery of a large natural gas reserve in North America provides some relief,
but in the end, natural gas - just like crude oil, will suffer from the peak production curve phenomenon. For
longer-haul applications such as cargo ships, there is no known practical alternative to liquid fuels except for an
onboard nuclear reactor, which most people assume will never be viable for anything other than military ships.
Electricity and Hydrogen are not alternative fuels

Electricity and hydrogen are widely misunderstood with regard to their use as “fuels”. In many ways, both of these
energy forms will be important. Electric vehicles are already in limited use and will grow in popularity with the
advent of peak cheap oil. But electricity and hydrogen are not fuel sources. There are no electricity mines or
hydrogen wells. The electricity or hydrogen must be produced from another energy source. Most electricity is
generated from burning coal, which is also in limited supply. Hydrogen production requires electricity. Converting
everything to nuclear power generation is a meaningful alternative, but would take decades to implement on a
large scale. Wind and solar are promising, but here again a complete replacement of oil, gas and coal-burning
systems with alternative-powered systems would take decades. Peak cheap oil will be upon us long before
significant progress along those lines could be made.
Supply-demand curves from heaven

For the reasons cited above, prognosticators of $500 crude oil reason that this is a classic supply and demand
problem, where supply destruction is inevitable due to peak cheap oil. In classical supply-demand analysis,
demand destruction normally occurs when prices rise and consumers turn to alternative products, so large price
dislocations are therefore relatively rare. The $500/bbl oil pundits reasonably argue that this is a very special
situation: Demand destruction in reaction to rising prices will be limited by the absolutely essential role that
transportation plays in the global economy. You can’t have a global economy without airplanes, ships and trucks.
Running trucks on alternative fuel sources is a real challenge, and running ships and airplanes on those sources is
not possible with current technology. The $500 crude oil pundits argue that there will be no choice but to pay the
going price for liquid fuel products. As soon as all present sources of crude oil are running at full capacity and new
sources involve extraction costs several times higher than the conventional sources, prices are certain to rise
dramatically, they argue.
What Peak Oil experts tell us to expect

Most peak cheap oil investment prognostications I’ve heard go about the same way: Expect airline transportation
to once again be the purview of the rich, and for the masses to rely on slower but more efficient rail and bus
transport for long trips. Expect the prices of imported goods to increase considerably, and therefore assume that
the global economy will go back to preferring locally produced products and raw materials. Everything that
requires long-haul transportation will get more expensive, and therefore the globalization trend (in terms of
physical goods) will reverse. Urbanization will increase as commuting long distances in private passenger cars
becomes cost-prohibitive, and communities that thrived on offering luxury homes an hour’s drive away from
centers of employment will decline. People will be forced to make due with less, particularly with regard to
products imported from afar. Economies will become more localized, and the United States will be forced to
rebuild its manufacturing capacity, as wholesale reliance on imported goods becomes uneconomic.
Some say it already happened

Some commentators believe that we actually saw the beginning of a dramatic peak cheap oil price shock in 2008,
when crude oil prices ran all the way up to $147/bbl. They dismiss the popular argument that excess speculation
by hedge funds caused the run-up, and argue that it was actually the world’s first taste of a peak cheap oil shock.
They contend that if not for the demand destruction that resulted from the global economic crash that ensued from
the U.S. housing and credit bubble collapse, crude prices might have quickly doubled again to $300 or more by the
end of 2008. They tell us that another such a price shock is imminent and will occur as soon as the world economy
recovers from the credit crisis.
Common conclusions: Higher oil prices, more profitable oil

companies
The arguments presented above suggest that a dramatic increase in crude oil prices is on the horizon, and some
say the sky is the limit. Some pundits go on to contend that the story gets even better on the equity side of energy
investing. Historically, the supply of crude oil (from which virtually all liquid fuels are produced) has been limited
only by the intentional actions of organizations like OPEC, which sought to artificially constrain supply in order to
boost price. Relatively cheap and plentiful crude oil led to fierce competition in the downstream business of
refining finished products like gasoline and diesel fuel. The U.S. oil industry has been criticized for over-building
high-tech refinery capacity that is more efficient than its low-tech competitors, but not so much as to justify the
enormous capital investments that have been made. As peak cheap oil is realized, higher scarcity and expense of
3 of 9 5/7/2010 3:27 PM
crude oil will mean that refining efficiency has much higher economic value.
Most refineries in the world use a fairly low-tech distillation process to produce gasoline, diesel and other
“distillates” from crude oil. Furthermore, they are only set up to process the easiest-to-refine variety of crude oil,
which is known as light sweet, referring to its low specific gravity and sulfur content. Only relatively few high-tech
refineries have the ability to process heavy sour crude, which may be the only kind plentifully available in future
years. They also have sophisticated cracking equipment that makes it possible to produce a more favorable ratio
of high-value products from a given volume of source product. Simply put, this means the high-tech refineries in
the United States can make more gallons of expensive diesel and gasoline from a single barrel of crude oil than
the low-tech refineries elsewhere can.
Taking stock of all this, it might seem like there’s a sure bet on long-dated, deep out-of-the-money calls on oil
futures and the shares of companies that operate the high-tech refineries that are more versatile and efficient in
their processes, expecting a windfall as peak cheap oil hits and the world is forced to change its ways. But before
calling your broker, please read on as I describe the reasons I don’t things are quite so simple. There will be an
opportunity to ride oil futures up from present levels, but not all the way to $500.
Why it’s really much worse than they think

My primary contention is that the peak cheap oil problem is actually far worse than even most experts have come
to realize. The realization of peak cheap oil will not simply involve a classical economic reaction to a changing
supply-demand balance. Rather, I anticipate a fundamental game changing event that will involve re-writing the
rules of the game in ways that are likely to undermine the investment prognostications and strategies that have
been outlined in the preceding section. This is what George Soros calls reflexivity. The key is not to simply apply
the existing rules of the game to anticipated outcomes, but rather to contemplate how expected outcomes will
ultimately change the rules of the game.
Oil is even more critical to the economy than most people

realize
Most people fail to comprehend the full implications of affordable energy on the world economy. Gasoline prices
are the most visible symptom of the problem, but are far from the most important aspect of peak cheap oil. The
global economy is dependent on cost-effective worldwide transportation of products. The United States in
particular is extremely dependent on inexpensive goods imported from China and other Asian countries. A sudden
dramatic rise in prices of all those goods would cripple an already-struggling economy. But the problem is much
more far-reaching than that. Many of the things we take for granted would never be possible without abundant and
relatively inexpensive energy. Skyscrapers and other large construction projects would not be economically viable
without abundant energy to operate excavators, cranes, and construction tools. Many areas thought to have been
unsuitable for habitation before the advent of modern air conditioning and refrigeration are now major population
centers. Old fashioned supply chains involving warehouses and long-term stores of inventory have been entirely
replaced with just-in-time delivery systems that are highly dependent on fast and reliable long-distance
transportation. In the United States particularly, millions of people are dependent on employment 50 or more miles
from their homes. Energy is a component cost of virtually all products. If energy costs were to increase
dramatically, so would the cost of all other items. In short, the world simply cannot continue to function in the
manner we associate with “modern times” unless energy continues to be available at affordable prices.
Peak cheap oil will become a national security issue

My advice to investors dreaming of windfall profits from $500/barrel crude oil futures would be this: Pretend it’s
1940 and you have a magic crystal ball that tells you in advance that the United States will be drawn into World
War II. You might start to speculate that by investing in rubber, airplane parts, materials needed to make bombs,
and so forth you’ll make a killing. Those products will become so important and so valuable that you might
presume you’ll be able to name your price and demand any amount you like for them. But of course you’d have
been mistaken. World War II wasn’t a routine macroeconomic event. It was a game changer. Laws were
re-written, often retroactively. A state of national emergency was declared and people in possession of materials
essential to the war effort were ordered to hand them over as price controls were implemented to thwart
profiteering from speculation on the supply needs of the war effort. I predict that the onset of Peak Cheap Oil will
eventually be met with a similar re-write of the rules of the game. We’re not just talking about an “investment
theme”. We’re talking about a threat to the viability of the entire global economic system, and we should expect
governments to intervene in previously free markets in the name of national security. I contend that any Peak
Cheap Oil investment strategy that fails to consider government intervention scenarios is flawed and likely to
underperform. That’s not to say that there’s no money to be made from an early awareness of peak cheap oil.
But it will be a complex puzzle and those with high-level connections in government will have an upper hand over
other investors.
Perhaps you think my assertions that governments will eventually intervene in the free market system are
far-fetched? If so, I’d encourage you ask yourself this question: What if governments had actually been planning
for years to intervene exactly as I’ve described? Sound preposterous? Before you answer, consider this quote
from a speech former Vice President Dick Cheney gave to an oil industry group while he was still campaigning for
office more than a full decade ago, back in September of 1999:
“By some estimates there will be an average of two per cent annual growth in global oil demand
over the years ahead along with conservatively a three per cent natural decline in production from
existing reserves. That means by 2010 we will need on the order of an additional fifty million
barrels a day. So where is the oil going to come from? Governments and the national oil
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companies are obviously controlling about ninety per cent of the assets. Oil remains
fundamentally a government business.”
(Source)
Clearly, Dick Cheney understood the looming threat of peak cheap oil a full decade ago, and he made it
resoundingly clear that he considers it the government’s business to manage the problem. I strongly disagree with
Mr. Cheney’s politics, but his words should make it crystal clear to investors that the government will involve itself
in this matter. Some believe the entire reason the United States has pursued war with Iraq under dubious
pretenses of connections to Al Queda and non-existent WMDs is precisely because Mr. Cheney understands so
well just how critical the problem of peak cheap oil will be to the U.S. I humbly suggest that if invading sovereign
nations is on the table, investors should consider what else might be on the table that could derail their peak
cheap oil speculation strategies.
“Curve Balls” Peak Cheap Oil speculators should anticipate

In my opinion, a peak cheap oil investment thesis must contemplate several potential eventualities. Let’s explore
but a few of them.
Price Controls
In the short to intermediate term, I share the view that crude oil prices are headed higher. But not as much higher
as many have speculated. The $150 level tested briefly in 2008 put an enormous strain on the economy. A number
of economists believe that the brief oil price shock of early 2008 may have had as much causal effect on the great
recession as the subprime housing debacle. I think another run-up to $150 or maybe even $200/bbl is entirely
possible in the course of the next two to three years. But the economy can’t function – and certainly cannot
recover from an already deep recession – in the face of $300+ crude oil. For that reason, I expect government
intervention of some kind to occur before prices get much above $200/bbl. I do expect high inflation to be part of
our future, so perhaps $500/bbl is possible in nominal terms. But in 2010 dollars, I don’t think the economy could
ever support prices anywhere near that high. The fundamentals are certainly in place for an escalation to such
levels, but I anticipate government intervention long before such a level is reached.
Price controls have proven over and over again to lead to certain disaster, manifested primarily in the form of
shortages and rationing. Readers old enough to remember waiting hours in line for gasoline from one of the few
stations that had any to sell back in the early 1970s know this all too well. But unfortunately, just as price controls
have proven ineffective, governments have proven over and over that they seldom learn from their past mistakes. I
think that an entirely likely scenario would involve a government-dictated fixed price for crude oil imports.
Oil resource nationalizations and war casualty costs

There’s good reason to assume nations with “cheap and easy” oil resources will seek to nationalize them. The oil
industry has a long history of nationalization (that’s a euphemism for theft by expropriation of privately owned
assets in a given country). International oil companies have invested billions building oil rigs in foreign countries. In
theory, the rights of these private enterprises to operate those assets under pre-agreed terms are protected by
signed contracts. But signed contracts aren’t worth much when your counter-party is the government of the nation
in question, which has the ability to pass new laws both voiding your existing contract and having your personnel
executed if they resist in any way. Thus, there are only two real reasons that foreign countries allow oil companies
to operate in their nation rather than just expropriating the privately owned rigs. The first reason is that they need
to cultivate an ongoing relationship with the oil companies in order to drill the next well and to build the next rig that
will produce revenue for the country. But when they figure out that the rigs already in place will be the last of their
kind because all the conventional oil fields have been exploited, this reason becomes moot. The second reason is
that military force may be used to thwart such expropriations of private property. That might solve the problem,
but it also leads to significant financial loss when the oil rigs themselves are proximal to the fighting or become the
targets of sabotage by either side in the conflict.
The whole point here is that the prognostication that oil companies will have an easy ride through the times that
are coming is badly flawed. It may well be true that oil companies with the right senior level connections in
government will have their assets and profits protected by military action in reaction to a nationalization attempt by
a foreign government. But by the same token, other oil companies who are less well-connected but are direct
competitors of the well-connected just might find that their rig was the one that was “necessarily sacrificed” in a
military conflict, making the company the target of a distressed takeover by the better-connected competitor.
My conclusion is that there will be both extraordinary profits realized and extraordinary losses suffered by equity
investors in oil companies during the peak cheap oil era. Stock picking takes on a whole new meaning under such
circumstances, and so I’ll leave the equity plays to those better equipped than myself to understand the power
game and which companies have the most political capital. Those with an insider’s view of the politics and policy
decisions involved will make a killing.
Market force vs. Military force

One of the strongest arguments made by Peak Oil speculators is that prices will rise in large part because
emerging economies (particularly China) are industrializing, radically growing their vehicle fleets, and generally
likely to create enormous new demand for decades to come. On its face, this is a sound and well-reasoned
argument and the fundamentals in those countries strongly support this conclusion. But this argument assumes
that oil prices will continue to be set by a free-market supply and demand system. I think that a dangerous
5 of 9 5/7/2010 3:27 PM
assumption.
I’m convinced that as Peak Cheap Oil arrives, a series of peak oil price shocks will cripple developed economies,
including the United States. If and when rising energy prices due to peak cheap oil begin to impose a markedly
lowered standard of living in the United States, I fear that this will become the justification for further American
imperialism. I can easily envision Dick Cheney returning to politics, campaigning on a “take the gloves off”
platform, and proposing to simply tell the middle east that their choices are to either sell the United States all the
oil it wants for (say) $85 per barrel, or be annexed by military force. At present the American public would not
support such an imperialistic policy, but sadly, history has shown that any time a developed, comfortable society is
faced with the threat of loosing its way of life and standard of living, the rules change and the previously
unthinkable becomes acceptable. The last fellow to use this phenomenon as the center of his political strategy
was wildly successful in convincing his people that previously unacceptable things were now somehow
“necessary”. His name was Adolph Hitler. And make no mistake; peak cheap oil will create an economic challenge
for the United States very similar to the one that Germany faced at the time of Hitler’s rise to power.
Punishing those evil speculators

A recent trend in politics seems to be to scapegoat “speculators” for the policy mistakes of government. When the
United States’ staggering national debt and unfunded liabilities finally bring on the greatest sovereign debt fiasco
the world has ever seen, there’s no doubt in my mind that when treasury bond markets collapse, “speculators” will
be assigned the blame. There’s no reason to assume Peak Cheap Oil will be much different. Investors should be
acutely aware that if they make large windfall profits in a short period of time, there will likely be pressure to claw
back or retroactively tax those profits in the name of the common good. No amount well-reasoned argument that
the investor put capital at risk for an extended period in order to eventually reap that reward will even be given due
consideration. As the economy is crashing harder and deeper than it did in 2008, the government will need a
scapegoat and the peak cheap oil speculator is a likely target. Investors should consider the possibility of profits
from speculation on crude oil futures being confiscated.
Forming an Investment Strategy

The “curve ball” scenarios discussed above are presented to encourage you to think about a broad array of
possibilities. This is not a complete list and I have no idea whether these particular scenarios will ever come into
play. The point is that peak cheap oil is going to be a big deal for the world – possibly dwarfing the Cold War as
the biggest international diplomacy challenge the world has ever seen. I humbly suggest that viewing the
investment opportunity in the narrow context of supply-demand economics is naïve. Nobody can possibly predict
how this will go, but it’s certain to be a complex potpourri of politics, diplomacy, and economics, not to mention
unknown advancements in oil exploration and production technology.
From all this, my conclusion is that the clearest and most opportune speculative investment plays will come early
in the cycle. As “cheap and easy” resources go into cumulative decline by 2012, there will be price escalation and
probably dramatic price shocks. During this period, speculating on crude oil futures seems a ripe opportunity,
since government market intervention is relatively less likely in the near term. I’m not as comfortable with equity
plays on oil companies, because I think they’re much more susceptible to reality catching up with the presently
delusional equity markets. The biggest potential price shocks will come later, when the realities of Peak Oil’s
implications are fully understood and the world realizes there are few alternatives for new supply creation. The
few alternatives available (such as tar sands and shale) involve a relatively low EROEI and very high production
costs, so the magnitude of the market reaction could be extreme. But they’ll likely be so extreme as to provoke
government intervention, price controls, or even nationalization of the entire oil industry as a matter of national
security.
I conclude that the key question in forming a speculative investment strategy is, At what price level does
government intervention become a significant risk? I’m inclined to focus the investment strategy on deriving the
maximum possible profit from the rise from present price levels to that figure. Presumably the number is at least
$147, which the market already tolerated once. But I don’t think it’s a whole lot higher than that. Perhaps $200.
There’s theoretically a much larger profit to be had beyond that, but I just can’t see it happening without
governments stepping in and changing the rules. I’d rather lever up more profit in the $100 - $200 price target
window using spreads to trade off the potential for even greater profit beyond $200 in exchange for more
leverage on the rise up to $200.
Finally, I want to emphasize that any long play on crude oil futures – particularly a leveraged one – needs an
economic hedge. Equity markets are presently delusional, pricing in a robust “economic recovery” when none
really exists. Everyone is excited about improvements in personal consumption expenditures. Sadly, very few
analysts bother to check the facts and notice that rapidly declining state sales tax receipts strongly refute the
commonly accepted “wisdom” that consumers are spending again. Momentum indicators suggest that the false
rally in equities has room to go much further, which means that when reality eventually sinks in, the correction will
be that much deeper and more abrupt. America is not presently facing reality with respect to its economic
condition. When America’s economic reality is eventually recognized, a major equity correction will occur and
crude oil prices are certain to correct as well. What remains to be seen is how far long-dated oil futures correct. I
expect a repeat of 2008, where near-term contracts collapse but contango blows out as long-dated contracts
suffer a relatively smaller correction. For nearly a year, I had waited to enter my speculative long-term peak
cheap oil trade, believing that the buying opportunity would come when economic reality set in. But the world is
slowly waking up to the reality of peak cheap oil, and has been slow to come to terms with America’s economic
reality. I now spend most of my time designing the optimal peak cheap oil trade – one which immediately gains
long exposure to oil futures in what I call the early crisis window, of 2012-2014, while hedging the likely downside
risk that oil prices will go way down before they go way up. That can be accomplished in several ways, including
calendar spreads on oil futures and use of an economic hedge such as an equity short to balance long exposure
6 of 9 5/7/2010 3:27 PM
to crude oil futures in the crisis window.
Erik Townsend is a private investor based in Hong Kong.
Full disclosure: Long crude oil futures and call spreads on crude oil futures
© 2010, Erik Townsend
Chris Martenson's Blog Erik Townsend investing Peak Oil Resource Nationalization what should I do
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Mon, 05/03/2010 - 11:39 #1
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Davos
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Re: Why “Peak Oil” Will Never Lead To $500/bbl Crude Oil
Super read!
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Mon, 05/03/2010 - 12:06 #2

Joined: 08/05/2008
Erik T.
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Posts: 786
Thanks for the upgrade to the main blog, Chief!
Subscribers will recognize parts of this - some of the best content including that amazing chart and the quote from
Cheney were actually Chris Martenson's finds. I stole them from his posts over in the enrolled member area. Chris,
thanks for letting me share them with everyone here.
Erik
Mon, 05/03/2010 - 12:44 #3

Joined: 09/28/2009
Beaver
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Erik
What are your thoughts on investments in natural gas. I have been watching Natural gas through UNG, and it
appears to be carving put a bottom right now. How do you see natural gas performing in the next couple of years.
And how do you see natural gases role in peak oil.
Mon, 05/03/2010 - 12:47 #4

Joined: 02/17/2009
bearmarkettrader
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Posts: 358
I also never thought that crude would reach those heights. Cant happen, wont happen. Nevertheless, $200 oil might
7 of 9 5/7/2010 3:27 PM
as well be $500 as our magic economy would begin to go to sleep.
Mon, 05/03/2010 - 12:48 #5

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Mike Pilat
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Posts: 903
Yes, this was excellent and I think it was a point that needed to be made. Far too many people (including some
geologists) subscribed to the delusion that oil prices will seamlessly go into the multiple hundreds of barrels range. In
addition to government intervention and future wars, I think people will rapidly find that trying to live their lives the way
they normally would is just not sensible. Doing "whatever it takes" to keep a guzzler in the driveway and maintain a
100 mile / day commute might prove harder than simply changing lifestyle.
My greatest concern is civil unrest and military crackdowns at home. America seems to have one of the most
"entitled" cultures around and being told that nothing can be done is politically unacceptable here. Additionally, our
infrastructure systems are among the least flexible to peak oil. Perfect storm.
__________________
-formerly StudentOfJefferson, reporting live from the Washington D.C. Metro Area
Mon, 05/03/2010 - 13:32 #6

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dcm
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Posts: 100
Excellent piece Erik. I applaud your point that when the time comes that our comfortable lifestyle is challenged,
history shows that we all have a little Dick Cheney in us. Didn't Cheney also say "the American way of life is not
negotiable." It is amazing how apt that statement is. A couple of years back, I was arguing about the war
with my brother in law who is a self proclaimed "liberal" when he said, "if they had just told me it was for the oil,
I might have supported the cause." I wonder how many people truly feel this? What other principles will we give up as
we start to get squeezed? It is sad ultimately, that ninety percent of our last decades energy has been spent end
running around the issues, the law, and our morality. Where would be now if we would have just laid it out and
got straight to work on the most dramatic transition we will ever see.
Mon, 05/03/2010 - 13:52 #7

Joined: 02/18/2009
plato1965
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Posts: 256
Great article Erik, one quibble... I assume you mean $500 in today's $ ...
The 2012 "$" may be a significantly different animal to todays "$".
"Why Peak Oil will never lead to 200 big-macs/bbl Crude Oil ?" :-)
Mon, 05/03/2010 - 13:57 #8

Joined: 08/05/2008
Erik T.
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Posts: 786
@Beaver
I think NG will play a very important role. The problems are (1) the contango is huge, so it's hard to invest in it, and
8 of 9 5/7/2010 3:27 PM
(2) the UNG ETF has serious structural design problems that make it destined to fail. Google should turn up the dirt
on it. It was discussed some recently at iTulip. Try googling "iTulip UNG".
@Mike Pilat
Yeah, the unrest and crackdown stuff is what scares me the most too. The handling of people during the Katrina
fiasco should send a warning message. As much as constitutionalists want to believe in their right to bear arms, the
reality is the government doesn't want you to have guns and the first thing they're gonna do in a crisis is take them
away. A lot of people won't give them up without a fight. That's why Haliburton built all those detention camps.
@dcm
Excellent points. They bring to mind a key concept I just can't get most Americans to think about in a constructive
way. Most people think "Those Germans, how could they have done those atrocities in WWII?". That's naive thinking.
We all know Germans are smart, rational people. Just look at their engineering industry. What was proved in WWII is
that when human beings are put in a situation where their very way of life is threatened and they are struggling just
to eat and stay alive, the rules of human morality change. The reason Hitler rose to power had nothing to do with the
Germans being German. It had everything to do with Germany being in economic ruin and full of miserable, despeate
people. When people are put in those circumstances, they will do and believe whatever their leaders tell them. That's
human nature, like it or not. Americans are no different, and will follow America's Hitler when the time comes.
"We all have a little Dick Cheney in us" - now that's a really scary thought!
Erik
Mon, 05/03/2010 - 14:09 #9

Joined: 11/13/2008
mono
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Posts: 41
An Eyeopener. Thank you very much.
Mon, 05/03/2010 - 14:11 #10

Joined: 09/02/2009
phildenn
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New Member
Posts: 3
Excellent read, it landed in my in box just as I had begun to try to consider the implications of all of this. Very timely,
and scary stuff (shaking my head). Thanks Erik. Well done.
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Testimonials Executive Summary

The $500/bbl Crude Oil Argument

The world runs on oil and can’t easily change

Electricity and Hydrogen are not alternative fuels

Supply-demand curves from heaven

What Peak Oil experts tell us to expect

Some say it already happened

Common conclusions: Higher oil prices, more profitable oil

Why it’s really much worse than they think

Oil is even more critical to the economy than most people

Peak cheap oil will become a national security issue

“Curve Balls” Peak Cheap Oil speculators should anticipate

Oil resource nationalizations and war casualty costs

Market force vs. Military force

Punishing those evil speculators

Forming an Investment Strategy

to crude oil futures in the crisis window.

Erik Townsend is a private investor based in Hong Kong.

© 2010, Erik Townsend

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Mon, 05/03/2010 - 12:06 #2

Thanks for the upgrade to the main blog, Chief!

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Mon, 05/03/2010 - 12:44 #3

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Mon, 05/03/2010 - 12:47 #4

as well be $500 as our magic economy would begin to go to sleep.

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Mon, 05/03/2010 - 12:48 #5

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Mon, 05/03/2010 - 13:32 #6

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Mon, 05/03/2010 - 13:52 #7

The 2012 "$" may be a significantly different animal to todays "$".

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Mon, 05/03/2010 - 13:57 #8

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Mon, 05/03/2010 - 14:09 #9

An Eyeopener. Thank you very much.

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Mon, 05/03/2010 - 14:11 #10

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