EFTA01299930.pdf

From:
Sent Monday, July 7, 2008 5:16 PM
To: jeevacation@gmail.com
Subject: Eye on the Market, July 7, 2008
Forwarded by Jes Staley:JPMCHASE on 07/07;2008 12:14 PM
Michael
Centhalest/JPN1CHASE ToMichael Ceinbalest/JPMCHASE@JPMCHASE
07/07/2008 09:17 AM cc
Subject Approved for external distribution: Eyc on the Market, July 7,
2008
Eye on the Market, July 4, 2008
1776. "I have come to the conclusion, that one useless man is a Disgrace, two are a Law Firm
and three are called a Congress". So said John Adams on U.S. Independence. The same applies
to Energy Independence in 2008. As the U.S. endures an energy crisis and imports 60%+ of its
energy needs, the House and Senate decided to take action: they overwhelmingly voted to allow
OPEC to be sued in U.S. courts for running a cartel. The mind reels...Over the last 30 years, U.S.
elected officials blocked nuclear build-out and spent fuel storage construction, impeded construction
of oil refineries, refrained from passing meaningful alternative energy legislation, imposed an import
tax on cheaper Brazilian ethanol, prevented offshore drilling in Alaska, California and Florida, delayed
for 30 years tighter "CAFE" auto fuel efficiency standards, blocked the construction of LNG ports (in
the Oregon Democratic primary, Clinton claimed to be more anti-LNG than Obama), killed wind farms
in their own backyards (and back bays), and neglected opportunities for public-private sector
partnerships on energy R&D. They got it wrong; Congress should sue itself instead.
Instead of ineffectual and counterproductive OPEC lawsuits, look at other countries. Germany has
reached 14% renewable electricity use (they're shooting for 27% by 2020, and Denmark is already at
40%). Check out the attached "insolation" map: except for Seattle, the entire continental U.S. is much
sunnier than Germany, yet Germany has 17 times the installed solar base per capita. Same goes for
Japan, where "feed-in tariffs" (subsidies) have ended, and yet the solar business is thriving and
competitive. The head of the U.S. government's Renewable Energy Lab said that the Federal
Government is doing "embarrassingly few things" to foster renewable energy (a). Renewable energy
research has fallen by 78% since 1978, and the Lab's budget is a paltry $200 million (I will not
mention the cost of the Iraq War again. It's $1 trillion). This despite the fact that a handful of
successful DOE R&D projects yielded benefits that exceeded the total cost of the entire energy R&D
program (b).
The "just rely on the private sector" solution isn't sufficient, particularly when intellectual property
rights aren't long enough for many energy-related investments (Congress did get around, however, to
passing the "Mickey Mouse Protection Act", which extended that particular copyright for 120 years
after creation). A National Task Force recommended in 2006 that the Federal government fund
demonstration projects to provide proof of concept for carbon capture storage and other complex
technologies (c), but it's not happening on any grand scale. Meanwhile, China signs oil and gas
SDNY_GM_00076885
Confidential Treatment Requested by JPMorgan Chase JPM-SDNY-00000012
EFTA_0018 7357
EFTA01299930

supply deals with Venezuela, Indonesia, Kazakhstan, Iran, Saudi Arabia, Brazil, Gabon, Russia,
Ecuador, Myanmar, Turkmenistan and Australia, and is not wasting much time applying Chinese anti-
trust laws to OPEC. The world is changing, much faster than the ability of the U.S. legislature to
comprehend it. The bill's misplaced sense of entitlement is matched only by its pandering delusion.
On oil prices, they are likely approaching a breaking point of some kind later this year. Yes, the
supply-demand equation is tight (U.S. reserves per well are half the levels they were a decade ago),
and marginal costs are going up (more costly horizontal and directional drilling now account for 40%
of wells drilled). Even so, marginal costs are $70 a barrel, not $140, and OECD demand is being
destroyed at a rapid clip. China uses more energy per unit of GDP than any country in the world, so
they're not exempt from energy pressures either; food and transport account for 45% of their CPI.
As for global economic data, it's all pretty downbeat (housing, labor markets, manufacturing surveys,
service sector surveys, leading indicators, and small business surveys). A JPMSI research report on
the ISM service sector survey captured the essence of the recent data: "There were no redeeming
features in the details". Secretary Paulson's speech in London indicating that the U.S. needs more
tools to deal with failed securities firms (and not just banks) is another sign of the times. I was also
struck this week by a research report which referred to over $100 billion in financial sector assets
deemed "inestimable and undefined".
"Investing in the time of cholera" is still the strategy we're pursuing, which includes oversold first-lien
leveraged loans, structured notes with principal protection down to 1150 on the S&P 500, Asian
infrastructure funds (to accommodate the $1 trillion being spent by China alone), and private equity
funds sifting through the remains of the day (banks and their mortgage holdings). Our largest
diversified hedge fund has generated positive returns this year, and remains the foundation of our
hedge fund offering. As mentioned last week, subprime assets are priced assuming 80% default and
50% loss severity. The backdrop reminds me in some ways of February 2003, when Bloomberg
headlines were filled with unyielding forecasts of bear markets, Al Qaeda manufacture of biological
weapons, Spitzer lawsuits against the banks, PIMCO's description of the U.S. being perched on a
deflationary cliff, weakening job markets, and skepticism about fiscal and monetary stimulus. I don't
know if we've hit bottom yet, but I am pretty sure that when we do, you won't be reading about it in the
press.
Notes:
HR 6074, which passed 324-84, allows energy cartels to be "prosecuted" in U.S. courts for
anticompetitive activities; the Sherman Antitrust Act would be modified to apply to foreign states. The
Senate version, S. 2976 (the OPEC Accountability Act), is similar to a bill passed by the Senate last
year 72-23.
(a) Dan Arvizu, director of the U.S. Department of Energy's National Renewable Energy Laboratory,
at the Harvard Center for the Environment's "Future of Energy" lecture series.
(b) National Research Council: "Was It Worth It? Energy Efficiency and Fossil Energy Research 1978
to 2000" (Washington, DC: National Academy Press, 2001).
(c) Task force members included officials from the Ford, Reagan and Clinton administrations, the
World Bank, the National Science Foundation and the World Wildlife Fund. The project was chaired
by former Secretary of Defense and Energy James Schlesinger.
LNG = Liquefied natural gas
DOE = Department of Energy
R&D = Research and Development
SDNY_GM_00076886
Confidential Treatment Requested by JPMorgan Chase JPM-SDNY-00000013
EFTA_0018 7358
EFTA01299931

Insolation: solar radiation energy comparison (kW-hours per year)
Germany leads with solar despite Seattle weather conditions
Source: Amencan
Council on Renewable
Energy, January 2007
rr
rr
Michael Cembalest
Chief Investment Officer
JPMorgan Private Bank
345 Park Avenue
The above summary/prices/quotes/statistics have been obtained from sources deemed to be reliable,
but we do not guarantee their accuracy or completeness. Past performance is not a guarantee of
future results. Securities are offered through J.P. Morgan Securities Inc. (JPMSI), Member NYSE,
FINRA and SIPC. Securities products purchased or sold through JPMSI are not insured by the
Federal Deposit Insurance Corporation ("FDIC"); are not deposits or other obligations of its bank or
thrift affiliates and are not guaranteed by its bank or thrift affiliates; and are subject to investment
risks, including possible loss of the principal invested. Not all investment ideas referenced are
suitable for all investors. These recommendations may not be suitable for all investors. Speak with
your JPMorgan representative concerning your personal situation.
This material is not intended as an offer or solicitation for the purchase or sale of any financial
instrument. Private Investments often engage in leveraging and other speculative investment
practices that may increase the risk of investment loss, can be highly illiquid, are not required to
provide periodic pricing or valuation information to investors and may involve complex tax structures
and delays in distributing important tax information. Typically such investment ideas can only be
offered to suitable investors through a confidential offering memorandum which fully describes all
terms, conditions, and risks.
SDNY_GM_00076887
Confidential Treatment Requested by JPMorgan Chase JPM-SDNY-00000014
EFTA_00 I 87359
EFTA01299932