Oil prices are through the roof and most people assume the reason is simple "supply and demand." Investment adviser Andrew Horowitz disagrees. Uncontrolled speculation is the real culprit he says...and we should all take action to stop it now.
       Everyone's talking about oil prices, and no wonder. In early January the price of a barrel of oil broke the $100 mark and has been rising ever since. On July 11, it hit a new record high of $147.27. Prices have since fallen to just over $127 a barrel, easing prices at the pump a little, but even so, it seems as though the days of cheap or even affordable gas are over. The upward spiral has affected almost every sector of the US economy and has made consumers feel angry and helpless as they continue to pay high prices at the pump. You may believe this is happening because there is too much demand for a limited resource - due to China's booming economy, for instance - but is it really that simple? Andrew Horowitz says no.
       "Supply and demand might be part of the story, but when you put 2 and 2 together I just don't think it adds up," says Horowitz, nationally noted investment adviser and author of The Disciplined Investor: Essential Strategies for Success (HFactor Publishing, 2007, ISBN: 978-09787083-7-5, $19.95). "Recently, a group of economists testified in front of the Subcommittee on Oversight and Investigation of the House Committee on Energy and Commerce and agreed that there is a supply/demand problem. However, they said that if that were our only problem, the price of oil should be no higher than $80 a barrel - a price many Americans would welcome today."
       So what's accounting for the extra $60 or so a barrel? Horowitz and other experts blame speculation and possibly manipulation of the oil futures market. And he traces the problem back to what is called the Enron Loophole, which allows energy futures to be traded online without regulation.
       "If the name isn't damning enough for you, here's the history behind it," says Horowitz. "The Enron Loophole was pushed through as a last minute attachment to a bill as the Senate was trying to finish up for Christmas break in 2000. It was drafted by Enron lobbyists and turned the energies market into a 'dark' or unregulated market. It also led to the California Electricity Crisis in 2000 and 2001. And just as it is being blamed for the high price of oil today, supply/demand was erroneously blamed for the high cost of electricity eight years ago."
       In fact, former director of the Division of Trading and Markets at the Commodity Futures Trading Commission (CFTC) Michael Greenberger recently testified in front of the Senate Commerce Committee that in May 2002 then-chairman of the CFTC James Newsome made a speech blaming supply/demand for the electricity crisis. Greenberger said it was later discovered that, in actuality, unregulated online speculation was responsible for driving up energy prices in California by 300 percent.
       Fast forward eight years and we have another situation in which supply/demand is being blamed for the skyrocketing price of a commodity. And once again that commodity is one that is difficult for us to live without.
       "As I mentioned earlier, supply/demand is likely part of the problem, but only part," says Horowitz. "There is still oil coming in. There are no gas lines like we saw back in the '70s when our oil supply was cut off. And there is evidence that Americans' gas consumption is down, and yet the price of oil continues to rise. The only other explanation is that speculation is driving up the price."
       Here's how speculation works. Essentially, a speculator can buy a stock and keep buying shares of that stock. Every time that person buys the stock, his shares from the day before would be worth more. He could do this day after day and the price of his holdings would keep moving up. The person could make a ton of money on his trailing positions. Since the speculator can use huge leverage, money is free and almost unlimited.
"Add to the speculation the fact that major financial firms are essentially stoking the fire to their own benefit," says Horowitz. "I discussed this phenomenon in a recent podcast with Greenberger, and he basically confirmed my fears. Investment firms - Goldman Sachs and Morgan Stanley, for example - make predictions about how high oil prices could go. Goldman has predicted $200 while Morgan Stanley made a prediction that prices would reach $150 by July 4. Greenberger said that many suspect these firms have bets heading in the direction of their predictions."
       Is there any good news in this situation? As it turns out, says Horowitz, the passing of the recent Farm Bill gives reason to believe that there might be. The Farm Bill includes a provision called the CFTC Reauthorization Act, which closes the Enron Loophole for the natural gas market. The Act leaves open what is called the London-Dubai Loophole, which allows US contracts for crude oil traded online through foreign exchanges to go unregulated even though the computers being used for the trading are in the US.
       However, now there is work being done on the Hill to close up the London-Dubai Loophole. On Thursday, June 26, the House of Representatives approved a bill that would allow the CFTC to enact emergency measures to "maintain or restore orderly trading." The catch is that the CFTC has said it will use this power to curb only manipulation, not speculation.
       "When I spoke to him recently, Greenberger pointed out that there is a new piece of legislation from Congress that if passed instructs the CFTC to look for manipulation in all markets," says Horowitz. "The idea is that just the passing of such an Act could start to bring down the price of oil because traders who are back under the watch of the public eye won't try to get away with some of the things they have been doing.
       "The bottom line is that there may be some light at the end of the tunnel," he continues. "My hope is that the naysayers who continue to blame supply/demand will let these markets be examined. They should give those of us who think speculation and manipulation are at play a chance to prove them right by opening these markets back up to regulation. In the meantime I strongly advise anyone dissatisfied with the current oil prices to contact their local Congressperson or Senator. Let them know that you won't tolerate legislators who don't take their constituents' interests to heart by working to bring an end to these out of control oil prices."
       About the Author: Andrew Horowitz, CFP, is the founder and president of Horowitz & Co., a registered investment advisor. Mr. Horowitz has been managing money for individual and corporate clients since the late 1980s. Mr. Horowitz writes the popular investing blog "The Disciplined Investor" (thedisciplinedinvestor.com/blog/) and hosts a popular podcast of the same name (thedisciplinedinvestor.com/blog/category/podcasts/). Both the blog and the podcast help investors at all levels take control of their financial situation by learning to view it from the vantage point of a pro trader and investor.
       His book The Disciplined Investor: Essential Strategies for Success and the bestselling audiobook, released June 2008 is available in bookstores nationwide and from all major online booksellers. For more information, please visit thedisciplinedinvestor.com.