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High Oil Prices: The Truth About Obama's Misguided Witch Hunt

It has been less than a month since President Obama declared war on those evil oil speculators.

Standing in the Rose Garden on April 17th, the president laid out a $52 billion initiative to increase federal supervision of oil markets in an effort to crack down on oil price spikes.

At the time, oil was trading at $117.41 a barrel and $5 a gallon gas seemed all but inevitable.

According to the p resident, evil speculators had been working behind the scenes to screw the rest of us while engorging themselves on riches beyond our wildest dreams.

I said it then and I'll say it again...the president is chasing a ghost he'll never catch. Spending $52 billion on additional oversight is a complete waste of money and a misguided witch hunt.

I mean, think about it. If speculators are the same ones responsible for high oil prices, ask yourself why they're the ones getting raked over the coals these days as oil prices fall.

The short version: It's because speculators don't control oil prices and never have.

The Real Culprits Behind High Oil Prices

Pricing inputs - for better or worse - are driven by geopolitics, supply constrictions, war, tyrants with spigots and buyers who will only purchase as long as the prices are low enough.

This is not complicated. Any time there are more buyers than sellers, prices go up. When there are more sellers than buyers, prices go down.

Whether or not what's happening now turns out to be short- term noise or a long- term trend remains to be seen.

As I noted in a widely read article on April 20th, legitimate speculation has a valuable and essential role in the markets. It's very different from the already illegal manipulation that the president seems to confuse with speculation.

Oil prices are driven by two groups of participants - hedgers and speculators.

The former are typically producers or suppliers with a vested interest in securing as high a price as possible for their output. They can also be manufacturers who depend on procuring as low a price as possible for their raw materials. Both parties are interested in delivery as a function of pricing.

Speculators don't care about delivery and, in fact, go to great lengths to avoid it.

They profit from price changes that would otherwise hold hedgers apart while also providing liquidity to other market participants.

Here's an example that may help bring this to life.

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How to Profit from High Crude Oil Prices

Despite a recent price pullback, my "oil constriction" approach for how to profit from high crude oil prices has not gone away.

In fact, it is right on track.

But we need to remember that the constriction in oil availability will not hit all oil sector shares the same way.

There are four overriding elements in what is coming.

1) Crude Oil and Gas Prices on the Rise

The markets have witnessed a rise in both crude oil and gasoline prices - West Texas Intermediate (WTI) prices are up 37% since Oct. 4, while RBOB (the gasoline futures contract traded on NYMEX) is up 29% since Nov. 25.

The constriction, however, is not simply reflected in the price.

We have a very different dynamic underway than the one experienced in 2008. Three years ago, it was a speculatively driven rise in oil prices that came crashing down when an outside crisis hit (the subprime mortgage mess and the corresponding credit freeze).

This time around, the constriction results from the rapid decline in prices from the third quarter of 2008 through a sluggish leveling-off through the fourth quarter in 2009. This period produced a significant cutback in new drilling.

Consider this: The top 15 oil producers in the world have replaced barely 70% of the extractable reserves they extracted over the past three years.

With conventional production, therefore, the constriction is already in place.

However, we have moved quickly into accelerating unconventional oil production.

That is element number two.

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Not Even Saudi Arabia Can Save Us From High Oil Prices

With oil prices soaring ever higher, Saudi Arabia stepped in last week and vowed to increase its production by 25% if necessary.

But while that assurance managed to siphon a few dollars off of oil futures, the reality is there's nothing Saudi Arabia - or anyone else, for that matter - can do about rising oil prices.

In fact, crude is still on track to reach $150 a barrel by mid-summer.

As Saudi Oil Minister Ali Naimi pointed out last week, current oil supplies already exceed global demand by 1 million-2 million barrels per day.

For its part, Saudi Arabia is already breaking its own OPEC-imposed production quota limit, churning out about 10 million barrels of oil per day - close to its 12.5 million barrel capacity.

Yet the effect of that production has been negligible.

Oil is still trading at $106 a barrel on the NYMEX - something that has clearly flummoxed the world's largest oil producer.

"I think high prices are unjustified today on a supply-demand basis," said Naimi. "We really don't understand why the prices are behaving the way they are."

Naimi and his colleagues may not understand oil's price gyrations, but Dr. Kent Moors, an adviser to six of the world's top 10 oil companies and energy consultant to governments around the world, does.

"Despite the excess storage capacity in both the U.S. and European markets and the contracts already at sea, oil traders set prices on a futures curve," said Moors. "In a normal market the price is set at the expected cost of the next available barrel. During times of crisis, on the other hand, that price is determined by the cost of the most expensive next available barrel."

And with tensions with Iran running high, we are currently in crisis mode. Pushed to the brink by Western sanctions, Iran has threatened to close the Strait of Hormuz - the narrow channel in the Persian Gulf through which 35% of the world's seaborne oil shipments and at least 18% of daily global crude shipments pass.

If Iran closes the Strait of Hormuz, crude oil prices will pop by between $30 and $40 a barrel within hours. Should the strait remain closed for 72 hours, oil trading will push up the barrel price to $180 in New York, and closer to $200 in Europe.

The situation is further complicated by potential military conflict - such as an Israeli air strike on Iran's nuclear facilities.

And with indications that Iran will have the ability to develop nuclear weapons in the next 18 to 24 months, Western powers have apparently shifted their focus from halting Iran's nuclear program to sowing instability in the country with the hopes of catalyzing a regime change.

So what does that mean for investors?

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