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 pipeline 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.