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.
* * *
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.
* * *
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.
In spite of all this help, fracking never turned a profit. It was a marginal industry populated by dreamers and wildcatters who were promising big returns, kept alive by welfare benefits.
This changed quickly in 2009. Business and government partnerships figured out how to make the fracking process ever cheaper. Then, the price spike of 2008 made fracking competitive. After that, the industry gained steam and a self-reinforcing momentum. Banks started to give loans to frackers, from Pennsylvania to North Dakota, and these frackers turned their eye to new reservoirs of fossil fuel.
Brad Urban and his team canvassed the industry. Koch’s traders bought oil supplies and quizzed the drillers. By doing so, they discovered the next horizon for the fracking business. It was something called tight oil. This was crude oil trapped in porous rock. Tight oil tended to be extremely “light” crude, meaning that it had low sulfur content, which differentiated it from heavy-sulfur oil of the kind that was imported from overseas.
As it happened, Koch’s refinery in Corpus Christi specialized in refining light crude. It also happened to be that one of the biggest deposits of light, tight oil was in located in southern Texas, near Corpus Christi’s backyard. Oil drillers told Koch about an area called the Eagle Ford Shale, a crescent of land that curved from southwest Texas up through the big empty space between San Antonio and Corpus Christi.
Koch started to gather estimates of how much oil might be retrievable through fracking in Eagle Ford. The region produced about fifty-five thousand barrels a day before the frackers arrived. It might produce as much as a hundred thousand barrels a day—maybe two hundred thousand—when new wells were installed. Before long, people were talking about five hundred thousand barrels a day.I Urban’s team hired an outside geologist to study the land and try to triangulate the truth between the boasts of various wildcat drillers. The team at Flint Hills came to believe that a flow of at least two hundred thousand barrels a day was realistic.