Traders on Koch’s floor considered the rest of the world to be a herd, and not a particularly smart herd at that. There was an overwhelming amount of activity in the markets, but seemingly very little insight. When Koch cautiously branched into a new market, the traders were often surprised at how easy it was to make money there with just a little bit of forethought. “We couldn’t believe how the incumbent counterparties couldn’t see the enormous profits that existed in those markets. Even though these were very established markets . . . dominated by the large banks, or large incumbent parties, like insurance companies, et cetera. But they just looked at it fundamentally very different,” one trader said.
It turned out that most of the counterparties in the market were obsessed with the near-term horizon. On Wall Street, entire teams of traders were focused entirely on what was about to happen in the next three months. The investment culture had become trained to trade around the next set of corporate quarterly earnings; public reports that could cause major bounces for stocks or commodity prices. This near horizon was bombarded by millions of hours of attention and human brainpower, with investors jockeying to position themselves to benefit from a quick shift in the market. This left entire continents of the marketplace unexplored; terrain that Koch was quick to enter and dominate.
For example, traders at Koch would never “short” the oil market, making a bet that oil prices would drop. Making a short bet was sloppy, and the kind of thing that anybody could do. Rather than make such simple bets, Koch relied on its mastery of the world’s complicated, opaque energy markets. Koch traders tended to make “basis trades” or “spread trades” that were based on complicated price relationships between different products at different locations around the world. Koch didn’t bet that the price of gas was going up, but that the price of gas in the Midwest was going to rise relative to the price along the Gulf Coast. To make these trades, Koch used a set of tools that few other companies could use. If Koch thought there was going to be an oversupply of oil in the Gulf Coast region, for example, it might snap up leases on giant oil barges, knowing that when the oversupply hit, companies would be scrambling for extra storage space and willing to pay a premium for the leases that Koch bought on the cheap. This was a much safer way to execute the trade than simply shorting the price of oil—even if Koch was wrong about the supply glut, the downside was limited because Koch could still sell or use the barge leases and almost certainly break even.
Koch maximized the advantage of having “inside” information gleaned from its refineries and other assets. Inside information helped traders like Melissa Beckett sharpen their trading strategies as she bought and sold futures contracts for oil at her desk in Houston. When Koch’s traders made assumptions about the oil market, they could test those assumptions against the real data that was emanating from Koch’s refineries. But Koch Supply & Trading did not rely exclusively on inside information. It aggressively gathered and analyzed huge amounts of data from outside sources. It used the publicly available data that all traders used—like the federal reports that tracked the volume of crude oil being stored in the United States. This data was good, but often stale, published weekly or monthly, and rarely drilled down into specifics. So Koch found other ways to learn about the market. The Customs Service, for example, kept databases of the manifests submitted by oil tankers entering US waters, data that revealed what kind of oil the tankers carried and for whom they were carrying it. By collecting and analyzing reams of this data, Koch could reverse engineer a picture of oil shipments and flows that was granular in its specificity. Koch could learn exactly what its competitors were refining, how much they were refining, and on what day they refined it.
Koch also discovered that the National Parks Service published data showing the snow pack in the California mountains, data that Koch could analyze to determine how much water would be flowing in future months to generate power at California’s hydroelectric plants. This helped Koch predict with great accuracy the future supply of electricity and the resulting demand for natural gas.
Because weather conditions had such a big impact on electricity and natural gas demand, Koch raided the newsrooms of places like the Weather Channel to hire their best meteorologists. The weather scientists were all too happy to leave their television gigs and multiply their earning power. The meteorologists arrived at work around four thirty or five o’clock in the morning and started running their computer models that analyzed several sources of weather data around the country. If they could deliver a forecast that was one or two degrees sharper than the forecast everyone else was using, it could give Koch’s traders an edge. The company’s proprietary weather report was circulated early in the morning and updated throughout the day. The Koch meteorologists watched the local weathercasters and scoffed. The B-team players had been left behind in the television studio to forecast for the public. “I can outforecast any of those guys on TV,” one former Koch meteorologist recalled.
All of these information streams were centralized, analyzed, and then shared widely within Koch’s trading group. The purpose of gathering all of this information was to find “the gap,” as Koch’s traders called it: the gap between reality and what the market believed was reality. Koch gathered enough information to get a sharper picture of reality than its competitors. Then it placed bets that would make money when the market corrected itself, closing the gap, and came closer to the real-world conditions. When O’Neill was promoted from the oil refinery to the trading floor in late 1996, his job was to find gaps in the natural gas market. He was stunned to see how much money a person could make in this hidden niche of America’s energy industry.
* * *
On the first day he reported to work at 20 Greenway Plaza, O’Neill held the obscure job title of analyst on the Gulf Coast Basis desk. The moment he sat down at his desk, Sam Soliman’s talent sifter began to shake back and forth, testing O’Neill’s instincts. O’Neill was perpetually aware that at any moment the tap on the shoulder might come, and he’d be escorted out of a job.
O’Neill did okay at first. He seemed to have an aptitude for the business. He was trading abstract natural gas financial contracts, but he quickly learned that even this abstract business was conducted according to the Koch way. The foundation of Koch’s natural gas trading business was a 9,600-mile-long collection of pipelines that ran along the Gulf Coast and snaked through several states in the Southeast. Koch purchased these pipelines and the company that owned them, United Gas Pipe Line Company, in 1992 in a deal worth at least $100 million. The timing of the deal was no coincidence. It occurred just one year after the George H. W. Bush administration revolutionized the gas business. The deregulation of America’s natural gas business was one of those historical episodes that garnered little attention but that created sweeping changes throughout the economy. These changes gave a handful of companies the chance to make a once-in-a-generation windfall of profits.
Prior to the first Bush administration, the history of the natural gas industry wasn’t too different from the crude oil business—the government intervened in deep and distortive ways to encourage production while protecting consumers from high prices. Back in the New Deal era, Franklin Roosevelt created a legal regime, headed by the Federal Power Commission, that regulated the business from the wellhead to the kitchen gas burner. The federal government capped the price that gas drillers could charge for gas, which kept natural gas prices low for consumers. But there were toxic side effects from these price caps: by the 1970s, the price was so low that producers didn’t even bother to drill new gas wells. Predictably, new supplies dried up and gas shortages ensued. Customers turned the gas valve, and nothing came out. Even a New Deal–era government monolith like the Federal Power Commission couldn’t force producers to drill for gas if they didn’t want to.