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  Koch went so far as to fold its origination group into its trading group, to encourage information sharing: “Now it’s all one company. There’s one trading book,” a former senior executive recalled. “There’s no more origination profit and trading group profit. There’s one profit.”

  This profit flowed from inside information. “The most important thing you can have as a trading company is deal flow. The more flow you see, the more knowledge you have,” according to the former senior executive. “And sometimes you don’t mind even if the [deal] flow just breaks even for a while. That’s okay. Because that gives you new knowledge on price direction and all that. You’ll ultimately make much more money long term.”

  This gave traders like O’Neill an advantage in the trading markets—Koch’s pipelines and origination teams were an information-generating machine. The United Gas Pipe Line system, which was renamed Koch Gateway, included 120 connections with other pipeline systems, each one a node that could yield information about natural gas prices.

  O’Neill spent his day on the phone, calling around to brokers and other traders and customers, feeling out where they might be on price. He also called other Koch traders to find out what they were hearing. One of his favorite colleagues to call was Jeff Stephens, who traded at Koch Gateway’s connection to the “Henry Hub,” a Louisiana pipeline distribution complex that became a major market for gas sales. The Henry Hub was one of the industry’s price setting markets, and in the late 1990s Stephens seemed to be single-handedly brokering most deals on the hub. “He was the Henry Hub cash market,” O’Neill recalled. Stephens berated and cajoled other brokers and customers. When they said they didn’t want to place an order because the low market might “bounce,” Stephens would scold them by saying “Eggs don’t bounce!” Before the era of the electronic exchange, Stephens was a living, breathing market ticker, and O’Neill made full use of his services.

  At the end of his first year of trading, O’Neill produced promising results. His trading book yielded $7 million in profits. Of course, that was back in the quaint and early days of the gas market, before things really picked up steam.

  * * *

  Koch’s traders often got off work early, between four thirty and five o’clock in the afternoon, after US market trading ceased. The traders were mostly in their late twenties or early thirties, and they enjoyed going out for drinks after work. They didn’t party hard, in the way that later became synonymous with the hard-charging world of Wall Street traders. The Koch people didn’t snort cocaine and visit strip clubs. In fact, their drinking sessions might have seemed disappointingly dull to outsiders: a bunch of engineers sitting around in golf shirts sipping craft beers.

  One of their favorite gathering places was a pub called the Ginger Man, located near Rice University, not too far from 20 Greenway Plaza. The pub was located on a quiet side street, set back behind a grassy patio area. It was a small, wood-framed bungalow that was obscured from view during summer months by leafy trees that sheltered picnic tables and a large front porch. Customers walked past a small picket fence to enter the patio and then up a set of rickety wooden steps. A small placard by the front door announced drink specials on a hand-written menu scribbled in brightly colored chalk.

  Inside, the bar was pleasingly dim and cave-like. Although the Koch traders were unaware of the fact, the bar was a near replica of the Coates Bar in Minnesota, where the union workers used to gather in the 1970s after their shifts at the Pine Bend refinery. The layout of the two establishments was virtually identical, with a long bar extending along the left side of the room and wooden tables clustered along the right side. The ceiling was low in both places, and the wood-paneled walls seemed to be stained the same honey-blond color. But the Ginger Man was more refined—it was like the Coates Bar reimagined by an interior designer who kept the charming elements and jettisoned the unseemly parts. While the Coates Bar served Miller Lite or its equivalent, the Ginger Man had a menu of dozens of craft beers that were arrayed along the bar with their own custom taps. The Koch Industries traders didn’t drink like their blue-collar counterparts up in Minnesota—they didn’t line up shots of hard liquor to be pounded one after another, as the OCAW president Joseph Hammerschmidt had done.

  But the Koch traders were just like their unionized predecessors in one way. When they got together and drank at the Ginger Man, they bitched about how underpaid they were.

  Koch had hired engineers to staff its trading desk, and it continued to pay them like engineers once they learned the job. O’Neill, for example, was still making $60,000 a year. There was a creeping awareness spreading throughout the trading floor that things didn’t have to be this way. There were rumors that traders over at Enron were making multiples of $60,000. And Wall Street banks started calling with job offers that were far richer than what Koch offered.

  O’Neill was not a disloyal person. He had worked for Koch his entire career. But financial pressures were beginning to press down on him. His credit card debt, in particular, was problematic. In this, he wasn’t alone. America’s middle class stopped seeing significant pay increases after the 1990s, but they did enjoy a new source of spending power: an easy availability of credit. The loosening of laws around banking during the eighties and nineties paved the way for a flood of consumer debt. At places like nearby Rice University, credit card companies set up booths to greet incoming students, promising easy access to large lines of credit. It had never been easier for Americans to borrow, and they used the privilege to supplement the lag in their paychecks. The tide that lifted all boats during the 1990s was fueled by credit cards that carried 14 percent interest rates or higher. The monthly payments could eat a person alive. O’Neill and his wife were happily married, but that didn’t mean it was easy. They lived within a constricting web of household spending budget. It was hard not to argue when money was tight.

  It might have been disappointing, then, to discover that Koch’s trading floor wasn’t an easy path to riches in the mid-1990s. When O’Neill earned $7 million for the company that first year, he might have reasonably expected a large bonus. At the end of the year, he discussed his performance with Sam Soliman and was told that his incentive reward would be $25,000. That was about 0.004 percent of what O’Neill had just earned for the company. Soliman seemed sympathetic to the idea that traders should earn a bigger cut of the profits. But Charles Koch seemed intent on paying the traders like engineers. And O’Neill’s bosses knew that his best annual bonus at the refinery was $10,000 a year.

  “Sam’s like, ‘It’s a lot better than the refinery, right?’ ” O’Neill recalled with a laugh. “And I’m like, ‘Yep. Yep. You’re right. It is.’ ”

  Not all traders were as compliant. Some of them quietly slipped away to join Enron or big banks. They did so with the knowledge that there were fortunes to be earned. Just seven months after he joined the Gulf Coast Basis desk, Brenden O’Neill got his chance to see this world for himself. He was promoted to trading natural gas derivatives, and ushered into the world of real money.

  * * *

  Sam Soliman stretched his top traders. When a trader did well at one thing, Soliman tended to promote them into a new role with which they had zero experience. If they performed well in this spot, they could be promoted once again. If not, tap on the shoulder. Good-bye.

  Brenden O’Neill was promoted to the natural gas options desk. A natural gas option is a derivatives contract, and O’Neill knew virtually nothing about derivatives before joining Koch’s trading team. He would now be trading millions of dollars a day in contracts. He figured that he’d better learn what he was doing, and fast.

  A person couldn’t just enroll in college and take a class in trading natural gas options. O’Neill didn’t take time off and attend Harvard Business School. He didn’t have a mentor, and he didn’t have an industry group that he could turn to for training. So he bought a textbook off the shelf, called Option Volatility and Pricing Strategies: Advanced Trading Strategi
es and Techniques, by Sheldon Natenberg. It was basically a high-end version of Options Trading for Dummies. He read the book on his own time and started to learn the mechanics of how things worked inside the black box of the derivatives market.

  Here is a brief description of a derivatives contract, in one paragraph, that is still torture to read. Pretty much all derivatives traded by people like O’Neill were either “calls” or “puts.” A call is a contract that lets somebody buy something at a certain price. O’Neill could sell you a call that would allow you to buy a tank of natural gas for $5 in March, even if the real price for gas at that time was $10 a tank. It was like an insurance contract against rising prices. He could also sell you a put that would allow you to sell a tank of natural gas in March for $5, even if the real price at that time was $2 a tank. It was like an insurance contract against falling prices.

  Again, these derivatives contracts didn’t even deal with real gas. They dealt with gas futures contracts. So, O’Neill was buying and selling insurance contracts on futures contracts. He spent his days examining these futures contracts, and watching their price rise and fall. This was complicated. For natural gas, there were several different futures contracts: there were contracts for delivery of gas in March, then April, then May, then June, and so on. In the eyes of a trader like O’Neill, each month’s contract was like a different commodity in and of itself. The May contract might be doing one thing, while the March contract was doing something different. He examined the behavior of all the different contracts and sold people insurance products—derivatives—for every different month.

  O’Neill started experimenting with these new markets. He bought and sold puts and calls options, and then started to figure out more complex maneuvers. He could buy a put on a May futures contract, and then turn around and start buying and selling volumes of that futures contract as a way to hedge the option in a complex interplay that is called trading the “underlier.” It didn’t take long before he realized that these machinations could generate tens of millions of dollars.

  Where did all this money come from? Why were the profits so enormous? The best way to understand it is to know that O’Neill was sitting in the middle of a giant game of tug-of-war. On one side of the rope, pulling hard, was every company that drilled natural gas and sold it. This side of the rope wanted gas prices to be as high as possible, because they were selling it. On the other side of the rope, also pulling hard, was everyone who bought natural gas and burned it. These parties wanted gas prices to be as cheap as possible, since they were buying it.

  Back and forth these opposing interests tugged, and the bright red line in the middle of the rope was the going price for gas. Sometimes the gas producers were winning the game and pulled the red line way over toward their side, making the price very high. At other times, the consumers won the game and pulled the red line way over to their side, making the price very low. The stakes of this game were almost incomprehensible—the total national market in natural gas was worth several hundred billion dollars a year. When the red line of price went one way or the other, it was the financial equivalent of a tectonic plate shifting in the earth. The rumbling and shaking shook loose billions of dollars in one moment, money that flowed from the pockets of consumers to producers as the price moved positions. And when that money was disgorged, it passed through the hands of traders like O’Neill, who kept a portion of it for themselves. In the final analysis, the people who were buying his derivatives contracts might be a big utility company in Ohio that burns natural gas, or a big company in Oklahoma that drills and sells natural gas. These entities would pay real money for insurance contracts that protected them from shifts in the price. If the price was moving, O’Neill and Koch Industries stood to make millions. Volatility was the trader’s best friend.

  O’Neill honed his trading strategies over the year. And he began to make one bet more than any other. He didn’t bet that gas prices were going to rise, and he didn’t bet that they were starting to fall. He just started betting that they would be volatile. He did this by snapping up options and then snapping up their underliers in the futures markets, buying them and selling them in a way that stripped out the price component of the bet. He didn’t want to bet on price. He wanted to bet that the price was going to change and change more than people expected it to. One reason he kept betting this way was because it kept making money. After the natural gas markets were deregulated, volatility started to become the norm. The sleepy days of price controls were over, and now the price could shoot up or down in minutes.

  That’s why, when he came into work in the early winter months of 2000, O’Neill started to get excited. He was starting to see a very large play unfolding, one that would dwarf anything he’d attempted at Koch before. All of the data that he’d amassed was pointing in one direction as the weather got colder in January and February. All of the signs were pointing toward unprecedented volatility.

  * * *

  When O’Neill turned his computer on in the morning, he would find numerous reports available to him that were produced by Koch’s teams of analysts and traders. He was on an e-mail list for an internal report called WinterSkinny, for example, which was sent to a long list of Koch employees both inside and outside the trading unit. The WinterSkinny report had a commentary section that summarized the state of the market in simple language—one e-mail read: “To sum up the commentary section in fewer words, ‘I don’t know where it’s going, and nobody cares anyway.’ ”

  Other internal reports, such as the Daily Analysis, were not written in English—or in any language that most people would understand. It was composed of complicated graphs and spreadsheets that showed electricity usage, as well as weather pattern analysis for cities like Denver, Las Vegas, and Eugene, Oregon, that compared “Temps vs. Normal.” One graph even showed detailed water levels for a reservoir above the Grand Coulee Dam in Washington State, which provided hydroelectric power.

  These reports were coupled with flash alerts from throughout Koch Industries. Plant managers, refinery operators, and others were encouraged to share any information they learned that might affect markets. The trading unit built an internal instant messaging system called Koch Global Alerts that sent the news to traders in real time—an innovative technology in the late 1990s and early 2000s.

  Traders sitting shoulder to shoulder in O’Neill’s office read through these reports and news flashes all morning, synthesizing what they learned into trading strategies. The traders created PowerPoint slideshows outlining their strategies and presented them in conference rooms to their colleagues. The presentations were shared across trading groups—Cris Franklin, who traded interest rate swaps, might find himself sharing a strategy with natural gas and crude oil traders, and vice versa. The traders were encouraged to pick apart each other’s plans, criticizing the strategies and, ideally, making them stronger.

  In 2000, two Koch analysts and a reservoir engineer produced a slideshow entitled “Natural Gas Point of View 2000–2001.” In this report, they accurately predicted a coming disaster that would contribute to blackouts along the West Coast, the bankruptcy of major utilities, and skyrocketing costs for many consumers.I The seventh slide of the presentation concluded that in the case of a cold winter, “storage inventories will be depleted.” This blunt conclusion was the only sentence on the slide that was underlined and written in bold type.

  The assessment matched what O’Neill was seeing in the markets. During the 1990s, cheap and abundant natural gas had been taken as a given in the American economy. Large new wells had been discovered, and supplies were plentiful. More power plants were built to burn the fuel, which was used as an alternative to coal and nuclear power. In the late 1980s, the price of gas spiked to $2.27,II and it hovered around that level for the decade and was trading for $2.22 in late 1999. The long years of price stagnation seemed to have convinced many consumers and producers that low volatility and cheap gas were the normal state of affairs.

 
In early 2000, O’Neill and his team realized that this was a deeply mistaken assumption. Koch was in a privileged position to see the coming shortage. The company didn’t just operate a huge pipeline; it also owned a huge but obscure company called IMDST,III which arranged gas storage leases for about one billion cubic feet of gas. Managing storage was a critical part of the business. As O’Neill liked to say, there wasn’t a lot you could do with gas once it was pumped out of the ground: “You either burn it, or you store it. You can’t do anything else with it.” Companies stored it by injecting it into underground storage units, and Koch saw that the inject rates were historically low. The industry was behind its historical storage levels, according to the “Natural Gas Point of View” slideshow, which stated that “More prolific injection path seems impossible with current fundamentals.”

  The squirrels were not burying enough acorns, in other words, and the winter was about to hit. At the same time, there were more hungry squirrels than ever. US energy consumption was on the rise as people plugged more and more devices into their walls, from extra television sets to home computers. A historic shortage of gas appeared to be in the making. Koch Industries wasn’t the only company to see the coming storm. Traders gossiped over beer and shared tips over the phone, so it was well known in certain circles that firms like Enron were starting to put on trades betting that gas prices would rise.

  While traders might have seen what was coming, it appeared that the general public did not. O’Neill saw a gap in the market in early 2000. A giant gap. The price of gas options was cheap—too cheap to account for what was apparently coming down the road. In other words, the insurance policies against a sudden price spike were not as expensive as they ought to have been. So O’Neill started snapping up the options and holding on to them, knowing that they would become more valuable.