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Merc referred to the New York Mercantile Exchange, which was also called the NYMEX for short. It was a Wall Street exchange that celebrated its hundred-year anniversary in 1982. Even though it had been around for a long time, the NYMEX was a backwater of the financial industry. The big shows on Wall Street were the exchanges where stocks and bonds were sold. On the NYMEX, people were trading products like butter, eggs, and cheese. Or, to be precise, it’s where people traded paper contracts that were based on the value of butter, eggs, and cheese. It was something called a “futures” exchange.
The futures market was very different from the oil market where Koch Industries was doing business in the late 1970s. In the oil markets, people bought and sold physical shipments of crude. In the futures markets, they bought and sold paper contracts. Futures contracts had been around for more than a century and were an integral part of the food system. Corn, pork, and soybean futures were traded on the Chicago Board of Trade. The NYMEX specialized in eggs and butter. The futures market wasn’t big—traders in the market tended to be farmers and big grain millers. They used futures contracts to limit their risk.
The owners of the NYMEX weren’t content with their sleepy corner of the financial world, and they decided to expand their business and sell contracts for new kinds of products. The NYMEX introduced the first futures contract for crude oil in 1983.
At first, the birth of oil futures contracts looked like a threat to Koch’s business model. Howell and his team spent years figuring out how to be the smartest blind men in the dark cave of the physical oil business and making the best guess as to the real price of oil. Koch Industries had gained an expertise in exploiting the opacity of oil markets and wringing the best price out of its counterparties. The new oil futures contract created something that was anathema to this business model: transparency.
When the NYMEX debuted its oil futures contract, it created a very visible price for crude oil that changed by the minute on a public exchange. Again, this wasn’t the price of real crude; it was the price for a futures contract on crude, reflecting the best guess of all market participants as to what a barrel of oil would be worth in the future. Even though the futures price wasn’t the real price, it provided everybody with a common reference point. Now, when Koch called up someone to buy oil from Koch’s tank farm in St. James, that customer could look at a screen and start haggling based on what the markets in New York were saying the price of oil was worth.
“It was the first time that there was a common, visible market signal,” Howell said. “It just kind of sucked the oxygen out of the room for that physical trading.”
Some of the older traders wanted to avoid using the futures contract for this reason; it undermined their advantage in the physical market. But there was no fighting the rise of futures. The contracts became indispensable for big companies looking to limit their risk. Airlines, for example, bought oil futures contracts to lock in future jet fuel prices. Big oil refiners bought futures contracts to lock in the price of crude in future months. The number of oil futures contracts proliferated. There were contracts to buy crude oil going out three months, six months, even a year.
Howell embraced the new market. He hung the Merc screen in his newly built trading room and urged his traders to pay attention to it. Like other oil refiners, Koch started buying and selling futures contracts on the NYMEX, in part to hedge its own risk. It wasn’t long before executives at Koch Industries realized that the birth of oil futures contracts presented them with more than just a way to cushion themselves from risk. Trading oil futures presented Koch with a chance to make money, independent of its refineries. Speculating in the futures market would become a line of business unto itself.
Koch Industries had almost inadvertently developed an expertise in trading over the years. Traders like Howell got into the business for the simple goal of “dispossession of molecules”—moving Koch’s product. In doing so, Koch Industries had become one of the world’s best traders in the physical markets for oil—the markets where real oil was bought and sold. Howell and his team realized that those skills could carry over into the newly born paper markets. And the market for paper oil futures appeared to be much larger and more profitable than the market for physical oil. Koch had been able to apply that inside information before, but now it could apply it to a massive market. Oil futures greatly magnified the power of the information that Howell and his traders were sharing around the oak table.
In the stock market, it is illegal to trade on inside information. If a CEO knows that her firm is about to buy a smaller competitor, she cannot go buy shares of that smaller firm before the news is publicly announced and the shares jump in value. The idea behind the ban on insider trading is that it makes the markets an even playing field for ordinary investors.
Futures markets are different. When regulators built the modern futures markets during the 1930s, in fact, they wanted traders to use inside information when they bought and sold futures. This way, the thinking went, the markets would quickly reflect the most accurate price possible. When traders used inside information to buy or sell contracts, their actions would quickly send price signals to everyone else.
While it was legal to use inside information in the futures markets, the power to do so was concentrating into fewer and fewer hands during the 1980s. Koch Industries was one of relatively few firms in the world that was able to ship oil by the barge load while simultaneously making bets in the futures market about what would happen when that barge load of oil arrived on shore. Koch exploited this advantage to the fullest extent. The company expanded its trading office in Houston, hiring traders who did nothing but buy and sell in the futures markets. Koch’s trading strategy was built around the high-value information that was gleaned from Koch’s refineries, pipelines, and storage tanks.
By 1985, Koch Industries had built a trading operation that was proficient in playing both the physical and futures markets for energy. Howell, however, wasn’t willing to stick around and enjoy the fruits of his efforts. His daily life as a trader was still savage and still punctuated by whippin’s. He was burned out. He retired from the trading business in 1985 and moved back home to Oklahoma, where he took up a career in politics. He would later help Koch Industries fend off legal challenges in the state related to Koch’s intentional mismeasurements.
Howell never traded oil again. But the trading system he helped build in Houston only continued to grow. The oak table was replaced by rows of cubicles, where traders sat side by side. The small trading office was traded for a larger—and then larger—office.
The age of trading was just getting underway.
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Koch Industries wasn’t the only company that understood how much money could be made in energy futures markets. Goldman Sachs, Lehman Brothers, J.P. Morgan & Co., and other Wall Street banks started trading oil futures in the early 1980s. These banks already had big trading floors for stocks and bonds, so they applied their knowledge to the commodities markets.
But even the biggest Wall Street banks were at a disadvantage when they went up against the traders at Koch Industries, British Petroleum, or Amoco. The Wall Street banks didn’t have access to inside information. Goldman Sachs didn’t own refineries or pipelines and couldn’t get a sneak peek into where markets were headed. The banks had to resort to second-rate information that was publicly available, like government reports on monthly energy supplies. It was a losing proposition.