First, I agree that Hank was only dreaming of going to bed with Karen. Recall that the next morning he said something to her about nearly having got it on the night before.
Californication is now the best written show on TV, it seems to me. Near the end of last night's episode, we hear Mia, in voice over, reading from what I thought was the story she had written, which Hank had agreed to help her with. This happened as Hank's one night stand from earlier has returned Hank's guitar and records and is coming into his place for renewed sexual congress. After writing about Hank's sadness, Mia's final words are:
Here we are at the edge of the world, she thought, the very edge of Western civilization, and all of us are so desperate to feel something, anything, that we keep falling into each other and f**king our way toward the end of days.
What a way to sum up Hank! Very smart, very sweet, very sad.