Kochland Page 6

  And if markets were Hayek’s religion, then entrepreneurs were his saints. He saw entrepreneurs as the lifeblood of adaptation and efficiency. They were the ones who spotted new ways of doing things. They were the ones who created new products, created new technology, established new orders when it was time for the old orders to decay.

  Charles Koch believed this, too. From the very earliest days of Koch Industries, Charles Koch sought to stock his workforce full of entrepreneurs, employees who would keep their eyes open, learn constantly, and spot new opportunities on the horizon before others saw them. That’s why one of the first and most important jobs that Charles Koch and Sterling Varner tackled was bringing new blood into the company.

  The two of them quickly began hiring some of the smartest minds they could find.

  * * *

  Roger Williams was an engineer with Mobil Oil Company, based outside of Houston, Texas. Williams had worked for Fred Koch back in the early 1960s but left the company to strike out on his own as an entrepreneur. His independent business venture had failed, so he took the job with Mobil and was still happily working there in 1968. That year, Williams was in a management meeting when he got a phone call from Sterling Varner, whom he’d worked with years before. Varner said he had a job offer for Williams: he wanted him to move to Wichita and help run Koch’s pipeline system. Williams politely declined. He was very happy with Mobil and felt no need to go job hopping.

  Varner told him, “Well, you haven’t ever met Charles.” Williams remembered. It was true—he had never met Fred Koch’s son. At Varner’s suggestion, Williams took a trip to Wichita to meet Charles, just to talk and hear him out. Shortly after the meeting, he quit his job and moved to Kansas.

  One of Williams’s first assignments was to open an office in Alaska, near the North Slope region, where Koch would set up a shipping business. Charles Koch and Sterling Varner came to visit his new operation, and they invited him to come back to Wichita with them on their corporate plane. As they flew over the densely wooded mountainsides of Alaska, the three men began discussing a thorny issue: What should they name the new company? Charles and Sterling had successfully fused the many companies Fred Koch ran into one firm, but now they needed to name it. Why not call the company Koch Industries? The name would honor Charles’s late father, and it was an easy enough catchall title for a group of businesses that were already very diverse.

  Charles Koch wasn’t wild about the idea. He seemed embarrassed by the thought of having his last name stamped on the entire company. His name would be embossed on the letterhead, emblazoned on the sign outside the company headquarters, spoken on the lips of everyone who worked for him. There was a vanity about this that seemed at odds with Charles Koch’s nature. But Williams argued in favor of naming the company Koch. In his mind, the benefit of the name was that it was neutral, in the way Exxon was neutral. For many industries, neutrality was the enemy. Companies like Coca-Cola spent millions to ensure that their names weren’t neutral and forgettable. But the oil industry was different because Big Oil was cast as the villain in so many economic stories.

  For this reason, “Koch” was the perfect moniker for the firm. It was slippery, hard to grasp. Everybody mispronounced it when they read the name, and when they heard the name, they confused it with the much better known soft-drink maker. Koch was the perfect flag to fly for a firm that sought to grow, and grow exponentially, while simultaneously remaining invisible. In June of 1968 Charles Koch announced that his father’s holdings would be consolidated into one company. And it would be named Koch Industries.

  * * *

  When he was in Wichita, Roger Williams met with Charles Koch and Sterling Varner in their new corporate suite. And that’s where he learned about the strategy at the heart of Charles Koch’s corporate reorganization.

  Fred Koch’s fragmented holdings would be fused into one organization, but they would be combined in a loose way that made the new Koch Industries nimble. The new company would be divided up into a set of divisions that could be more easily managed than the stand-alone companies had been. As a single entity, these divisions would be bound together with one simple goal: to grow.

  Koch Industries would grow in a way that reflected Sterling Varner’s approach to business. Varner was “opportunistic,” in a way that Koch employees used the word, meaning that he was always looking for new deals that were connected to businesses in which he already operated. When Koch was shipping natural gas, for example, Varner pushed the company to build a specialized natural gas refinery in Medford, Oklahoma, to process the gas into liquid by-products. In this way, Koch could expand while building on the skills it already possessed. The gas refinery, or “fractionator” as they called it, became a huge moneymaker.

  Varner encouraged his senior managers, like Williams, to think the same way. Williams was told that his job wasn’t just to keep his head down and run his division—his job was to keep his eyes on the horizon, to scan the environment of his business for new opportunities. Even more important, Varner told Williams to pass this mentality on to everyone who worked for him. The pipeline employees, the engineers, the oil gaugers—all of them needed to look for new deals as they went about their daily work. Everybody was supposed to act like an entrepreneur who worked in the mergers and acquisitions department.

  “When you get that idea spread among your people, then you’ve got gaugers out there with their eyes open. The ideas come in. If you’ve got a couple of thousand [employees] looking for things, you’re going to get some stuff that comes in that’ll be all right.” Williams said.

  Charles Koch and Sterling Varner held quarterly meetings to evaluate how managers like Williams were doing in this regard. Williams was expected to report on his pipeline business and also to bring up new “high-quality investments” that he had spotted in the field.

  A ritual was formed at these meetings. A manager like Williams would propose the idea for some new investment. And then the questions would begin. Charles Koch’s questions were relentless, seemingly never ending, and the managers understood that they must be prepared to answer all of them. If a manager didn’t have the answers, the topic was dropped until he could return with them.

  The rhythm of corporate life at Koch Industries began to revolve around these quarterly meetings. And the rhythm beat a steady message into every manager and every employee below them down the chain: grow.

  This message would soon be felt in the farthest corners of Koch Industries, such as the bayou country in southern Louisiana, where Koch Industries was running some of its largest pipeline and oil gathering operations. The oil gathering business was still the company’s foundation, handed down from Fred Koch. In Louisiana, Koch was reaping a fortune from the oil-rich land. And the ways in which Koch was reaping this fortune would soon be discovered by one of the company’s newest hires: a young oil gauger named Phil Dubose.

  The company directives that came out of Wichita would become a daily part of Dubose’s life. And it would change him in ways that he would never be proud of. The directives also set Koch on a path that drew the attention of Kenneth Ballen and the US Senate Committee investigating oil theft on Indian land.

  * * *

  In 1968, Phil Dubose was working in a grocery store in rural Louisiana. His future didn’t look especially bright: he was in his late twenties, had no college education, and was married with three kids. He was raised in a part of Louisiana with chronically high unemployment, where many people worked intermittently and made most of their money in cash under the table. It might seem unlikely, then, that over the next twenty years Dubose would be promoted up through the ranks of Koch Industries, into the realm of senior management, where he would find himself in charge of a surprisingly large chunk of America’s energy infrastructure.

  Dubose loved hard work. His mom was a hardworking farm girl who instilled in him the religion of an honest day’s pay for a hard day’s work. His dad was an oil company manager who considered weekends to si
mply be a time when he could get work done outside the office. Dubose didn’t finish college because he was inspired to join the army in 1962 when he was newly married and just a year out of high school. President John F. Kennedy’s call for public service, combined with the Cuban Missile Crisis, convinced Dubose that he needed to enlist. He served in Vietnam, and then came back home in need of work. That’s when he landed a job as manager of a local grocery chain.

  Dubose’s life changed one day when a teenager asked if Dubose could give him more shifts at the store. Dubose told the boy that he’d allow it, but only if the kid brought his report cards to work so that Dubose could make sure his grades weren’t falling. This small decision changed the path of Dubose’s life. The kid’s father was named Don Cummings, and he was impressed to hear that a grocery store manager would care so much about his son’s grades. Cummings thanked Dubose, and then he offered him a job. Cummings said Dubose could work for him at a local oil company called Rock Island Oil. Cummings made a convincing pitch. Rock Island might sound like a tiny company, but it was owned by a conglomerate out of Wichita that was owned by the wealthy Koch family.

  Oil companies garnered a lot of respect in the Gulf Coast. The economy in most bayou towns was tied to the rice harvest, which ran in boom and bust cycles. But the oil business was different. The money was steady, and the pay was good. Dubose knew this because his father was an engineer with Superior Oil Company, which people in the area referred to, even in casual conversation, as the Superior Oil Company. In the fifties and sixties, the swamplands around Lafayette, Louisiana, were like a microcosm of the entire US oil industry. It was a place full of gushers, in other words. There were tremendous oil deposits located beneath the marshy wetlands and out in the bayous, and the landscape was covered with oil wells. Across the country, oil drilling was increasing, and the price of oil was falling slowly each year through the 1960s.

  Koch Industries hired Dubose as an oil gauger. His job would be to measure the oil in each tank before Koch collected it, and then he would pump it onto a barge and take it to one of Koch’s pipelines, where it would be shipped to a refinery. Dubose spent many of his days on the water, out on the bayou and river channels. He piloted a small barge that could navigate through just a few feet of water, an ideal craft for negotiating the marshy lands. He steered expertly through the fingerlike lanes, avoiding cypress stumps and rocks and muddy shallows. He went from oil well to oil well, collecting the crude that was held there in large tanks. After running a circuit of several tanks, he took the oil to one of Koch’s terminals, where it was fed into a pipeline or moved onto a larger barge for shipment.

  But before he could drain the tanks, Dubose had to measure just how much oil was in there. There was a regimented series of steps to taking the measurements, a kind of standardized ritual that oil gaugers around the country followed. This ritual was codified in an industry standard published by the American Petroleum Institute. These standards were voluntary, however, and Koch Industries did not follow them. Dubose said he was given a playbook for taking oil without paying for it.

  The Koch method for oil measurement followed a few simple steps. First, Dubose dropped his gauge line to see how deep the oil was. If the gauge line said it was fifteen feet and two inches, Dubose would record it as fifteen feet and one inch. Already, this meant that Dubose was getting an inch worth of oil for free. This was called “cutting the top.”

  Then he measured the “gravity” of the oil, which determined its quality. The top-dollar crude oil fell within an API measurement of gravity between 40.0 and 44.9, so Dubose fudged the numbers to push it outside of that range. This way, Koch would pay the oil producer less for the oil, even if the quality was ideal. If the oil measured 40.0, then he would record it as 39.2, for example.

  After Dubose drained the tank, he would take his final depth measurement, which was recorded to show how much oil Koch had taken. If Dubose measured that fourteen inches of oil were left, he would record it as fifteen inches. This meant he was paying for one less inch of oil than he had taken. This technique was called “bumping the bottom.”

  Dubose learned the Koch method by rote. He estimated that by using it, he could get about ten to twelve extra barrels of crude from each tank he drained. That was only a small fraction of the whole, but it was enough to ensure that he was over at the end of every month. And he knew that the extra oil added up over time, because all of his coworkers were doing the same thing.

  Dubose’s bosses measured the amount of oil that Dubose drained from each tank, and then they compared it against the amount of oil he finally delivered into Koch’s pipelines or terminals. Everybody knew that those numbers probably wouldn’t match up exactly, thanks to the slippery nature of oil. If a gauger was under, it meant that he delivered less oil into Koch’s pipelines or trucks than he gathered. If a gauger was over, on the other hand, then the opposite was true: he’d delivered more oil into Koch’s system than he had recorded gathering at the oil tanks. It was only possible to be over by mismeasurement because it was physically impossible for oil supplies to increase as they made their way through the supply chain.

  At the end of each month, Koch tabulated its oil shipments and figured out if each was over or under. The company posted the results at the branch office where Dubose worked. If a gauger was consistently under, his manager would grill him and ask what was going wrong. If a gauger was consistently over, then he had no problems.

  Dubose’s boss at the time was a manager named Doyle Barnett, who later recalled the reason for encouraging employees to be over. “You wanted to keep your company operating for sure. So, I guess I’d rather be over than short if I was the company,” Barnett said. His bias toward being over was widely shared by Koch managers across the country. Keith Langhofer, a Koch Oil manager overseeing Texas and New Mexico, would later tell federal investigators that he also encouraged his gaugers to be over.

  “I think we probably take an aggressive approach to purchasing crude oil. We certainly don’t want to be short,” Langhofer said, while under oath. If an employee came up short, then he was punished or demoted. If an employee was consistently over, the company “didn’t do anything to him,” Langhofer said.

  It was clear to Dubose that the Koch method was not the industry norm. New hires expressed shock at the company’s practices. In fact, the norm was for oil companies to be slightly under overall because it was more natural for them to lose some oil along the transportation chain rather than miraculously create oil, as Koch did. Even being slightly under, these other firms made money—oil was a profitable business, after all. The new hires at Koch either adapted, or they quit.

  Dubose adapted. He knew in the back of his mind that he was effectively stealing oil. But it was only a little bit at a time. He took comfort in the fact that measuring oil was an inexact science. No one ever got it perfect.

  “It’s a very gray area. And I think Koch saw this,” Dubose said. “They saw where they could manipulate this, because it’s such a gray area. And they took advantage of it.”

  * * *

  Koch’s oil gathering division delivered a steady flow of cash and profits into the company. This money gave Charles Koch a chance to put his management theories to the test. He encouraged his employees to look for new growth opportunities and to act like entrepreneurs. He wanted to lead by example. In his first years as head of Koch Industries, Charles Koch put together one of the most brilliant and profitable deals in the history of Koch Industries. The deal involved an oil refinery.

  Since the late 1950s, Fred Koch had owned a minority share in the Great Northern oil refinery outside of Minneapolis, near the Pine Bend Bluffs natural reserve. The other shareholders in the refinery were an oil tycoon named J. Howard Marshall II and the Great Northern Oil Company. In 1969, the refinery didn’t look like a gold mine. Competition in the sector was fierce, with new refineries being put into production monthly.

  But the Pine Bend refinery, as everyone called it, had a
secret source of profits. And this source of profits could be traced to exactly the kind of government intervention that Hayek hated most. In the 1950s, President Dwight Eisenhower capped the amount of oil that could be imported into the United States, in one of the federal government’s many ploys to protect domestic oil drillers. (Imported oil was often cheaper than domestic oil, so US drillers wanted it kept out.) But there was a loophole in that law that allowed unlimited imports from Canada. As it happened, Canada was the primary source of oil processed at the Pine Bend refinery. Pine Bend was one of only four refineries in the nation that was able to buy cheaper imported oil in unlimited quantities, giving it a huge advantage over firms that were forced to buy mostly domestic oil. The four companies who benefited from this loophole received a second advantage from the government. Thanks to a complex voucher system for oil imports, companies like Koch were able to “double dip” and exchange their voucher tickets for domestic oil in a scheme that gave them a subsidy of $1.25 per barrel. This loophole boosted profits, and Fred Koch had been happy to remain a minority shareholder and enjoy the windfall.

  In 1969, Charles Koch executed a secret plan that would increase those profits beyond anything Fred Koch could imagine. Charles approached J. Howard Marshall and convinced Marshall to sell his share in the refinery in exchange for shares in Charles Koch’s newly created firm, Koch Industries. When that secret deal closed, Charles Koch was a majority shareholder in the Pine Bend refinery. He then approached Great Northern, now a minority shareholder, and convinced that company to sell its ownership stake. By the end of the year, Koch Industries was the sole owner of the Pine Bend refinery. Charles Koch saw something in the refinery that others didn’t see.