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“He understood what the process was. You have members of Congress. They get elected every two years. And it’s hard to be independent. It’s hard to get things done. It’s hard not to spend a lot of time being political and raising money. And he just—I think he saw the system as broken,” the person said.
The political machine that Charles Koch built was immensely successful—not at fixing this broken system, but at ensuring that it remained hobbled and incapable of passing the kind of sweeping business regulations that defined the New Deal. He applied long-term thinking to a system defined by short-term election timetables, and he won many of the most important fights he cared about.
After the Palm Springs conference wrapped up, Charles Koch traveled back to Wichita. He reported for work at the Koch Tower and found paperwork waiting for him in his executive suite on the third floor. While he spoke about politics in terms of war and destruction, the state of affairs inside Koch Industries told a different story. One of the surprising truths about life under the Obama presidency was that it was very good, economically speaking, for Charles Koch and Koch Industries.
During the Obama years, Charles Koch’s net worth doubled. His fortune would grow larger and faster than during any previous period. One reason for this explosion in wealth was the death of the cap-and-trade bill. There would be no price on carbon to constrain the fossil fuel business. Instead, the new drilling technique called fracking would help enshrine fossil fuels as a central part of American economic life.
Koch Industries stood at center stage during this shift in America’s energy industry, and it reaped rewards in ways that people on the outside could not see. When it came to the business side of Charles Koch’s life, the whale was still deep underwater, growing larger and more powerful than ever before.
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I. No version of the Affordable Care Act ever proposed to implant a microchip in every American. The theory that such a provision was part of the law appears to be based on early draft versions of the bill that were never passed. The proposal would have allowed the US Department of Health and Human Services to collect data on medical devices like pacemakers. This data collection would have helped speed recall notices of such devices and could also help gauge their efficacy.
II. This story was not true. When Pelosi became Speaker of the House, she was afforded the use of a military aircraft to travel to her home district in California. She did request a plane that was larger than that of her predecessor, Republican Dennis Hastert. He had used a smaller plane because his home district was in Illinois, and the smaller plane could not make the trip to California without refueling.
III. The other three pillars were: media outreach, litigation, and political influence (or lobbying).
IV. The connection between IER and the Institute for Humane Studies was first revealed by the journalist Lee Fang. He reported in 2014 that the IHS temporarily lost its charter, and then reformed as the IER.
V. Greenpeace’s analysis might overstate Koch’s support for so-called climate-denial groups. Greenpeace’s tally includes the total funding for entities like the Cato Institute, which created doubt about climate-change science but which also engaged in other antigovernment activities. Still, the difference in funding is so dramatic that it seems almost certain that Koch invested more than Exxon did during this period.
CHAPTER 21
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The War for America’s BTUs
(2010–2014)
In the winter of 2010, while the cap-and-trade bill was languishing in the US Senate, Koch Industries began to quietly execute a series of business deals. The deals might have looked strange—maybe even irrational—to outsiders. In March of 2010, for example, Koch announced that it was expanding its pipeline capacity in southern Texas by 25 percent. This was akin to building a very large parking garage outside a shopping mall that no one visited anymore. Southern Texas was a sleepy backwater of the oil business, an oasis of barren scrub brush and scattered towns with lonely oil derricks. Oil production in South Texas had stagnated for years. But Koch was spending millions to increase its pipeline network there.
In the following months, Koch’s series of deals accelerated. In September, Koch announced a partnership with an obscure company called Arrowhead Pipeline to move 50,000 barrels a day of crude oil out of southern Texas. This was roughly half of the entire region’s production at the time. Then, a month later, Koch announced a partnership with another little-known firm, called NuStar Energy, to reopen sixty miles of defunct pipeline, to carry 30,000 barrels of oil a day.
In November, Republicans won control of the US House of Representatives. A month later, Koch announced another deal, this one the largest yet—the company would build a brand-new sixteen-inch pipeline from remote Karnes County, Texas, to Koch’s refinery in Corpus Christi, capable of carrying 120,000 barrels of crude oil a day. The new pipeline had the potential to be expanded to carry up to 200,000 barrels a day. In February of 2011, another deal: Koch bought the Ingleside Pier in Corpus Christi, an export terminal through which Koch could ship 200,000 barrels of oil a day on barges. Two months later, Koch announced a new twenty-inch pipe running from Pettus, Texas, to Corpus Christi, capable of carrying 250,000 barrels a day.
These deals garnered very little attention. There were a few corporate press releases and small stories in local media outlets. What outsiders didn’t realize was that Koch Industries had just built a superhighway for crude oil, carrying hundreds of thousands of barrels a day from southern Texas to Koch’s refinery in Corpus Christi, with an off-ramp at the Ingleside Pier that could carry excess supplies to foreign markets.
The puzzling part about this superhighway was that it was built to carry oil supplies that didn’t seem to exist. The highway began in a region of Texas called the Eagle Ford Shale. Production there had been flat. In fact, the one accepted truth about US oil production was that it had peaked in the early 1970s and would never again increase. The Eagle Ford region was no exception. In 2007, there were fifty-one oil-drilling rigs in Eagle Ford, producing about fifty-four thousand barrels of oil a day. By late 2008, there were sixty-two oil rigs in the region, producing fifty-seven thousand barrels a day. In 2010, Eagle Ford’s production actually fell to about fifty-five thousand barrels a day.
Nonetheless, Koch was building a system to move hundreds of thousands of barrels of crude from the region. These deals were part of a strategy that Koch had been formulating for over a year. Koch saw something in Eagle Ford. It was something that others also saw, but that Koch was the first to exploit. While production was flat until early 2010, the number of drilling rigs had more than tripled in just over a year, from thirty to 104. This number was a leading indicator. The wells would start pumping, and new oil would start to flow. Koch Industries was poised for the change.
The wells being drilled into southern Texas were the face of an energy revolution that would redefine global oil markets and the American economy. They were part of a once-in-a-generation transformation that crept up quietly and then changed everything. In one short decade—from 2005 to 2015—America went from being the largest importer of refined petroleum products to the largest exporter of refined petroleum products. A country that was once the poster child for peak oil discovered that it was home to oil and natural gas deposits that were likely larger than those found in Saudi Arabia. The entire story about fossil fuels was reversed before many people even realized what was happening. These changes were every bit as cataclysmic for oil markets as the OPEC embargo had been in the 1970s. But this time, the changes accrued to America’s benefit. The cost of oil plummeted, OPEC was defanged, and America became essentially self-sufficient as an oil consumer.
The revolution was catalyzed by a suite of oil-drilling technologies that were used together in a drilling process called hydraulic fracturing, or fracking. Fracking had been around for decades, although it was fatally unprofitable. The method was kept on life support only by giant and long-lasting government subsidie
s and tax breaks. Fracking only became commercially viable thanks to the oil price spikes of 2007 and 2008. When fracking became widely deployed, it opened up massive fossil fuel reserves in the United States that were long considered unattainable.
This revolution, while far reaching, did not change one important element of the energy business. The revolution did not change who benefited most from the energy business (at least during its first decade). The fracking economy was new, but the primary beneficiaries were old. The companies that benefited most were the long-standing legacy players, like Koch Industries.
The fracking boom played to Koch’s advantages, and one of these key advantages was Koch’s capacity to thrive in volatile markets. The fracking boom unleashed a period of almost unprecedented volatility between 2010 and 2014. Koch Industries was built to respond to volatility, and its expertise was evident in Koch’s hidden effort to build the oil superhighway out of the Eagle Ford region.
The effort began when Koch’s commodity traders started to receive early signals that something big was about to happen in oil markets.
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The first signals emerged on the natural gas trading desks sometime around 2009. This is when the advent of the fracking boom was first detected.
The previous two years had been wildly unstable. In 2007 and 2008, crude oil prices spiked to record highs. Natural gas followed crude oil upward, as it tends to do. Energy prices crashed during the recession due to weak demand, which was predictable. But then something strange happened: oil prices started to climb again, but natural gas prices didn’t follow them upward. Instead, gas prices started to slide. Then fall. Then collapse.
The reason for this was startling. Natural gas supplies, long thought to be growing scarcer every year, had suddenly started to increase. In late 2009, the United States produced 1.65 trillion cubic feet of natural gas a month. In two short years, the supply skyrocketed by 23 percent, reaching 2.03 trillion cubic feet a month in 2011. And this wasn’t a fluke. By 2015, the supply would reach 2.3 trillion cubic feet.
This was the start of the fracking revolution. Fracking is a shorthand term that refers to a group of three technologies that, when used together, make it possible to extract natural gas deposits that were once unreachable. The first technology is called microseismic imaging, a system used to map underground gas deposits trapped in dense shale rock. Shale gas deposits were previously considered unattainable because of their weird formation: the deposits are composed of broadly diffused gas droplets trapped in rock. The deposits are shaped like a giant dinner plate—wide and shallow. Drilling into them is like punching a nail through the plate, which allows the drill to tap a tiny portion of the gas.
This is where the second technology comes in: horizontal drilling. With horizontal drilling, the nail could penetrate the dinner plate and then make a sharp right turn, traveling through the heart of the entire deposit. The final technology was a group of chemicals, known as proppants, that could be injected into the shale rock along with sand, dislodging gas and allowing it to be sucked to the surface. When gas became expensive in 2007, it finally justified the expensive process of extracting it through fracking.
The earliest waves of the fracking boom came as a surprise to Koch’s leadership team. The boom was catastrophic for gas prices, which fell roughly 85 percent between 2008 and 2012, from a peak of $12.69 per million BTUs (or British thermal units, a metric that’s widely used as the basic measurement of energy use) to a mere $1.95. As it turned out, this catastrophe played to Koch’s advantage because natural gas is the primary ingredient for nitrogen fertilizer. When prices fell, Koch was suddenly able to make its fertilizer for a fraction of the cost. It was a breathtakingly lucky break. Retail prices for fertilizer stayed high because of strong demand from farmers, who needed fertilizer more than ever to keep production high. When gas prices and production costs collapsed, Koch’s profit margins swelled. Koch was the fourth-largest fertilizer maker in the United States thanks to its purchase of Farmland’s fertilizer plants in 2003, for pennies on the dollar. Now those plants were printing cash.
Still, Koch’s senior management was uneasy. They hadn’t seen it coming.
“You look back and go, ‘Yeah that was obvious! How’d I miss it?’ ” said Steve Feilmeier, Koch Industries’ chief financial officer. “We started reflecting on ‘How did we miss that?’ ”
This reflection occurred largely in the offices of Koch’s crude oil and refinery division, Flint Hills Resources. Once they began looking into the fracking business, Koch’s managers began to anticipate where it might go next. They missed the advent of new gas supplies, but it helped them see the next step. Brad Razook, who was CEO of Flint Hills, had reason to believe that the fracking revolution wouldn’t stop with natural gas deposits.
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Brad Razook and other senior executives at Flint Hills worked in windowed offices that ring the top story of the Tower, offering them views of downtown Wichita to the south and flat grasslands and suburban subdivisions to the north. The middle of the top floor is filled by a sprawling maze of cubicles. This is where Flint Hills’ traders work.
The trading pit could easily pass for a branch office of any insurance company in central Kansas. No one was shouting orders or waving their hands in the air. There was just the quiet murmur of people on the phone. The beige dividing walls between desks were decorated with drab attempts to individualize each cubicle, like cardboard cutouts of the Wichita State University mascot—a scarecrow-like figure called WuShock—and family photos. The only signs of the global reach of the young traders were the multiple computer monitors at the desks, flashing with numbers and charts. A set of clocks along one wall display the local times at trading hubs around the world.
Koch’s young traders observed odd occurrences in oil markets during 2011. The traders who bought oil supplies for Koch’s Pine Bend refinery observed chaos in local midwestern markets. New supplies were coming into the market from North Dakota, of all places, causing supply gluts, bottlenecks, and transportation problems. And all of this was happening in a region where the oil industry had been dead for decades. The new oil coming out of North Dakota was similar to the new natural gas supplies: they were drilled by frackers in a region called the Bakken Formation. A fountain of crude oil sprang up in the Northern Plains, and no one knew how to deal with it. “It was almost comical how much crude was coming online,” said Tony Sementelli, Flint Hills’ chief financial officer. “It was very curious to us because it was almost unthinkable.”
Razook and Sementelli started holding meetings to figure out what was going on. The signals from the marketplace were confusing. Fracking had already opened new pools of natural gas. But the big question was whether the process could be repeated with crude oil. The oil glut in North Dakota was an uncontrolled experiment to answer this question. But the results from that experiment raised only more questions. If fracking could work in North Dakota, could it work elsewhere? If it did work, how large were the oil reserves that might be tapped for drilling?
When faced with this uncertainty, Razook responded in a way that reflected twenty years of training. Razook had joined Koch Industries in 1985, after graduating from Kansas State University with an undergraduate degree in business administration. His real education came at Koch University. His education included the lessons of Charles Koch’s mentor, Sterling Varner, who told his rank-and-file employees to keep their eyes open for opportunities at all times. By 2010, Sterling Varner’s wisdom had been formalized into a routine process. Koch’s traders reported what they saw, then Razook and Sementelli shared what they were learning, and Koch Industries moved fast to exploit the opportunity.
Razook reassigned one of his most important employees, Brad Urban, to study fracking full-time. Eventually Urban’s team grew to include more than a dozen people. They studied the North Dakota market and explored where the fracking boom might lead next. They wanted to discover the next Bakken Formation before anyone else.
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One reason why the fracking boom caught everyone by surprise was that fracking had been around since the 1970s. The technology failed to deliver any meaningful results for forty years. It was simply too expensive to be economically viable. Fracking, in fact, was only kept alive thanks to repeated government intervention. The fracking industry was essentially a ward of the state for decades, kept alive by lavish government subsidies, tax breaks, and government-funded research.
In 1980, a federal law called the Crude Oil Windfall Profits Tax Act included a tax break for natural gas supplies produced in unconventional ways, like fracking. The purpose of the tax break was to nurture new energy sources. The tax break was stupendously generous, providing 50 cents for every thousand cubic feet of gas. The so-called Section 29 tax break remained in place for decades. The National Bureau of Economic Research estimated in 2007 that the tax break would cost the federal government $3.4 billion between 2007 and 2011 alone.
The federal government also stepped in to support the frackers with long-term, expensive, experimental research. It was the kind of research that private companies were reluctant to provide for risky technologies. The government-run Sandia National Laboratories developed the three-dimensional microseismic imaging that made fracking possible. A federal project called the Morgantown Energy Research Center, or MERC, partnered with companies to set up experimental drilling operations to put fracking to the test. It was two engineers with MERC who patented the vital technology to drill horizontally—or directional drilling, as the industry called it. In 1986, a Department of Energy program, partnered with private companies, was the first to demonstrate a multistage, horizontal fracture in the Devonian Shale.