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  In this environment, corporations that could manage complexity, in both the markets and in regulatory affairs, were the economic winners. And among these companies, a certain kind did better than all the others. There was one sector of the economy that grew far faster than the rest: the financial sector. The decade of the 2000s was defined by the financialization of everything. The financial deregulation acts passed by Bill Clinton launched an industry of trading and speculation activities that dwarfed anything even during the Reagan era, when Wall Street gained the reputation as a greed machine that produced multimillion-dollar paydays for a handful of financiers. Banks started trading exotic instruments based on the value of homes, crops, metals, stocks, and energy. The smartest college graduates went straight from top-tier schools like MIT and Harvard to the trading floors of Wall Street.

  Koch Industries, an industrial conglomerate based in Kansas, seemed particularly unsuited to thrive in this environment. The company seemed confined to the business of making things and processing raw materials in complex, expensive facilities. A Koch engineer in Texas didn’t seem to have anything in common with a banker in New York.

  In fact, while the world was looking elsewhere, Koch Industries built a financial trading desk that rivaled anything operated by Goldman Sachs or Lehman Brothers. Koch Industries, known for crude oil and natural gas, became a world leader in making and trading some of the most complex financial instruments in the world.

  Koch’s trading business was a strategic centerpiece of the company’s growth strategy over the next decade. It was also the most striking example of Koch’s ability to amass and exploit information asymmetries, learning more than everyone else and turning huge profits from this advantage. There were no markets more complex and more opaque than the trading markets born during the Bush administration, and Koch Industries mastered them. To understand how Koch Industries more than tripled in size in ten short years, it is critical to understand Koch’s trading operations.

  When the era of financialization began, Koch Industries was already poised to exploit it. Koch had been building expertise in the field for decades. Unsurprisingly, Koch Industries first entered the world of exotic financial instruments when it started trading in the one commodity Koch knew best: crude oil.

  Koch began trading crude oil in the earliest days of the modern market, back in the 1970s. To understand the world of derivatives and futures markets that Koch later came to dominate, it is helpful to go back to that moment when the markets were newly born, and Koch was just starting to build its beachhead in the financial world.

  Koch’s earliest trading desk was based in Houston. And it was run by a young man who started as a clerk for the company. His name was Ron Howell.

  * * *

  In the late 1970s, Ron Howell made one of the most significant investments in the history of Koch Industries. He went to an office supply store and bought a big oak conference table. It had a leaf in it, so that it could expand and make room to seat about six people. This table was a major advancement in Koch’s trading operations. Howell bought it because he could see that the world of oil trading was transforming, and Koch Industries was poised to dominate the new markets.

  Back then, Ron Howell’s job might have seemed easy enough: he sold the gasoline and other fuels that Koch Industries produced at its refineries. As the senior vice president of supply and trading at Koch, Howell made sure that Koch’s fuel went straight from the refineries to the highest-paying customer. Gasoline was the kind of product that seemed to sell itself—there was always demand for fuel. People at Koch referred to Howell’s job as the “dispossession of molecules,” meaning that he simply had to find a home for the various fuels that Koch produced. This seemed straightforward. But Howell’s job was the kind of job that produced insomnia and ulcers. It forced him to retire when he was in his thirties before the job killed him.

  When he talked about oil trading, even decades later, Howell often used words like whippin’ and savage. The savagery of Howell’s average workday began when he walked into the office in Houston every morning and picked up the phone to sell the first barrel of gasoline or diesel fuel. The stomach acids started to boil the instant Howell tried to establish what might seem like a basic, simple fact: the price of oil that day.

  Determining the price of oil at any given minute was an arcane art practiced by a network of traders around the world. They spent their days on the phone with one another, arguing, cajoling, bluffing, and bullying. The fact is that nobody really knew the price of a barrel of oil, or gasoline, or diesel fuel. Everybody had to guess, and the person who could guess with the most precision walked away with profits that were almost limitless. The person who guessed wrong faced instant, brutal downsides in the market.

  There was a common misperception that the price of oil floats up and down on a global market. Every day, business commentators and journalists talked about the “price of oil” as if it were like the price of General Electric stock—a price that was determined by millions of buyers and sellers who traded on large, open exchanges.

  In fact, there was no global market for oil. Oil was bought and sold inside a constellation of thousands of tiny nodes where transactions and prices were totally hidden to outsiders. One of these nodes, for example, was the big complex of oil tanks that Koch Industries owned in St. James, Louisiana. Another node might be an oil terminal off the coast of Scotland, where oil drilled in the North Sea is stored. These were the kinds of places where oil refineries bought crude oil or Amoco bought gasoline. Prices from the sales were never posted on any exchange. The real price of oil, back when Ron Howell was selling it in the 1970s, was negotiated between two people over the phone.

  When he sat at his desk in the small Koch trading office, Howell made phone call after phone call, trying to figure out how the price of oil might be changing at all these different nodes. Everyone on the phone line was trying to learn from him, bluff him, oversell him, and undercut him. He had to triangulate between truth and lies to figure out the real value of oil before it changed again. “I can’t even tell you how dynamic it all is,” he said. “You almost have to be in it for a period of time to understand the complexity.”

  While this was ulcer-inducing, Howell did have one advantage. Koch Industries was one of the bigger members of a very small club of companies that could even dream of trading crude oil. The market wasn’t open to the masses for a simple reason: a trader needed to be able to ship and deliver huge quantities of actual, real oil. This required barges, pipelines, and refineries to be at the trader’s disposal. Howell was one of those traders. He could buy ten thousand barrels of crude in the North Atlantic and sell it in the US Gulf Coast because Koch could charter the barges to take it there.

  There were, of course, a handful of “speculators” in the early days of the oil markets. These were people who bought oil without ever expecting to actually handle it or deliver it. They were making a bet that they could sell their contract at a higher price before the time came to load a barge. This was a dangerous game. A trader like Howell might be able to sniff out a speculator and simply refuse to buy the oil contract off his hands, putting the speculator in a desperate position because he knew he couldn’t actually take delivery of all that oil. A trader like Howell could hold out until the speculator was forced to give away the oil for pennies on the dollar when it came time to accept delivery. This was a well-known trading maneuver called “the squeeze,” and it was a pitiless tactic that could financially ruin a person in a matter of hours. Traders like Howell (and his counterparts at Chevron and Exxon) were more or less immune to the squeeze. Howell could accept delivery of the barrels of oil, maybe at a loss, but not at a catastrophic loss.

  In the beginning, before he bought the big table, Howell began his trading career in Wichita. But as Koch’s operation grew, he moved the office to Houston because that’s where the talent was. Houston was a hub for the energy industry, home to some of the nation’s biggest producers and pipel
ine companies. By the late 1970s, it was also home to the most talented oil traders. Howell decided to open shop where these traders were willing to work.

  Koch’s trading office resembled a small, boutique law firm. There was a row of offices that ran down a hallway, and inside each office was a trader, with his door closed, frantically working the phone. Each trader focused on a particular niche in the market: selling natural gas supplies in the Gulf Coast, for example, or buying crude oil in the upper Midwest. When one trader learned something significant, he had to leave his office, run down the hall, and tell other traders who might be able to profit from the news. “I would watch our guys, and they’d nearly run into each other, running from office to office,” Howell recalled. All of these traders were trying to piece together the movement of energy prices, based on the pieces of information they gleaned from each sale.

  As he watched his traders run from office to office, Howell had a pivotal realization. Every time a trader sold a barrel of oil, the transaction produced an ultravaluable by-product: information. Each sale was a price signal. And as Koch bought and sold hundreds of thousands of barrels of fuel around the world, it began to accumulate this ultravaluable information in one place.

  This information could then be paired with yet more ultravaluable information that only Koch Industries had access to: the huge output of price signals that were generated by Koch’s oil refineries and pipelines. These physical plants gave Koch’s traders a window into the future. Koch knew, for example, when it was about to shut down the Pine Bend refinery for repairs, or when it might be shutting down a pipeline. When this happened, Howell’s traders could start gaming the downstream effects on local energy markets—all those opaque nodes that would be affected. And they could do this before any other traders even knew it was happening. There is no way to overstate the value of this kind of inside information. If Pine Bend closed one unit, it could create cascading effects throughout the US oil markets. Other refiners and merchants would substitute one kind of fuel for another when they learned that Pine Bend was closing, which, in turn, caused yet other merchants to make substitutions and changes. When a Koch trader knew what was coming, they could buy and sell before anyone else priced in the coming changes. It was like seeing into the future, while at the same time creating it.

  Koch’s stores of information became a growing and vital advantage in the market. And that’s why Howe decided to stop the hectic traffic in the hallways. He wanted the traders to sit together. They should share everything they learned, as they learned it.

  On his lunch break one day, Howell went to the office supply store and bought the big oak table with a credit card. He didn’t remember how much it cost, but it seems possible that the return on investment for that table was the among the highest of any acquisition in Koch’s history.

  Howell moved the big table into a meeting room at the trading office and informed a handful of traders that this would now be their workspace. They weren’t happy about this—they saw their private offices as a sign of prestige. But Howell insisted. First, he seated four traders around the table, equipping them with telephones and trading books. Everybody shared everything they learned as soon as they learned it. These were traders working in different markets and selling different products. But that made them like the proverbial blind men who approached an elephant, each feeling and describing a different part of it. When they pooled their impressions together, a picture of the giant beast began to emerge. Koch was developing a view, in real time, of highly complex and interrelated markets for crude oil, diesel fuel, and natural gas liquids.

  Other traders began dropping into the room, asking about the latest news. Howell installed the leaf in the table to expand it so six traders could sit there. Then he bought a second table and put it in the room. “Before long . . . everybody wanted to be in the office, because that’s where the information was,” Howell said.

  This arrangement would become the foundation from which Koch’s trading floor was launched. Over the next twenty years, the trading infrastructure would expand dramatically, but the underlying strategy would remain the same: the traders working in a cluster, gathering information, sharing it, and using their insights to prosper in complex markets where only a handful of firms dared to do business.

  In 1983, the expansion of Koch’s trading efforts really began. That’s when Howell brought another piece of large furniture into the trading room. This was a heavy, bulbous television screen that was hung on the wall. If the screen had fallen from its anchor, it might have killed somebody. But its presence was vital. The wide screen was filled with simple rows of numbers, in black and white, that blinked periodically. The traders referred to it as the Merc screen, and it changed everything about their job. It also ushered in an era of derivatives trading and financial engineering that would define the economy of the 2000s.

  * * *

  Merc referred to the New York Mercantile Exchange, which was also called the NYMEX for short. It was a Wall Street exchange that celebrated its hundred-year anniversary in 1982. Even though it had been around for a long time, the NYMEX was a backwater of the financial industry. The big shows on Wall Street were the exchanges where stocks and bonds were sold. On the NYMEX, people were trading products like butter, eggs, and cheese. Or, to be precise, it’s where people traded paper contracts that were based on the value of butter, eggs, and cheese. It was something called a “futures” exchange.

  The futures market was very different from the oil market where Koch Industries was doing business in the late 1970s. In the oil markets, people bought and sold physical shipments of crude. In the futures markets, they bought and sold paper contracts. Futures contracts had been around for more than a century and were an integral part of the food system. Corn, pork, and soybean futures were traded on the Chicago Board of Trade. The NYMEX specialized in eggs and butter. The futures market wasn’t big—traders in the market tended to be farmers and big grain millers. They used futures contracts to limit their risk.

  The owners of the NYMEX weren’t content with their sleepy corner of the financial world, and they decided to expand their business and sell contracts for new kinds of products. The NYMEX introduced the first futures contract for crude oil in 1983.

  At first, the birth of oil futures contracts looked like a threat to Koch’s business model. Howell and his team spent years figuring out how to be the smartest blind men in the dark cave of the physical oil business and making the best guess as to the real price of oil. Koch Industries had gained an expertise in exploiting the opacity of oil markets and wringing the best price out of its counterparties. The new oil futures contract created something that was anathema to this business model: transparency.

  When the NYMEX debuted its oil futures contract, it created a very visible price for crude oil that changed by the minute on a public exchange. Again, this wasn’t the price of real crude; it was the price for a futures contract on crude, reflecting the best guess of all market participants as to what a barrel of oil would be worth in the future. Even though the futures price wasn’t the real price, it provided everybody with a common reference point. Now, when Koch called up someone to buy oil from Koch’s tank farm in St. James, that customer could look at a screen and start haggling based on what the markets in New York were saying the price of oil was worth.

  “It was the first time that there was a common, visible market signal,” Howell said. “It just kind of sucked the oxygen out of the room for that physical trading.”

  Some of the older traders wanted to avoid using the futures contract for this reason; it undermined their advantage in the physical market. But there was no fighting the rise of futures. The contracts became indispensable for big companies looking to limit their risk. Airlines, for example, bought oil futures contracts to lock in future jet fuel prices. Big oil refiners bought futures contracts to lock in the price of crude in future months. The number of oil futures contracts proliferated. There were contracts to buy crude oil
going out three months, six months, even a year.

  Howell embraced the new market. He hung the Merc screen in his newly built trading room and urged his traders to pay attention to it. Like other oil refiners, Koch started buying and selling futures contracts on the NYMEX, in part to hedge its own risk. It wasn’t long before executives at Koch Industries realized that the birth of oil futures contracts presented them with more than just a way to cushion themselves from risk. Trading oil futures presented Koch with a chance to make money, independent of its refineries. Speculating in the futures market would become a line of business unto itself.

  Koch Industries had almost inadvertently developed an expertise in trading over the years. Traders like Howell got into the business for the simple goal of “dispossession of molecules”—moving Koch’s product. In doing so, Koch Industries had become one of the world’s best traders in the physical markets for oil—the markets where real oil was bought and sold. Howell and his team realized that those skills could carry over into the newly born paper markets. And the market for paper oil futures appeared to be much larger and more profitable than the market for physical oil. Koch had been able to apply that inside information before, but now it could apply it to a massive market. Oil futures greatly magnified the power of the information that Howell and his traders were sharing around the oak table.

  In the stock market, it is illegal to trade on inside information. If a CEO knows that her firm is about to buy a smaller competitor, she cannot go buy shares of that smaller firm before the news is publicly announced and the shares jump in value. The idea behind the ban on insider trading is that it makes the markets an even playing field for ordinary investors.