This viewpoint held sway for many years, but the defections began to change things. So did a shift of personnel at the top. Sam Soliman, the previous head of trading, stepped aside to become the chief financial officer of Koch Industries when Charles Koch began overhauling the firm in the early 2000s.
A newer hire in the trading division started to change the trading culture in Soliman’s absence. His name was David Sobotka, and Koch hired him directly from Wall Street. Sobotka worked for Lehman Brothers before joining Koch in 1997. He was somewhat of an odd bird within Koch. He had matriculated from Yale, not Texas A&M, and he looked every bit the part of a Wall Street dandy. He had a boyishly handsome face with tousled, wavy hair, and clearly knew how to handle himself in a five-star world. But unlike other Ivy League grads, he managed to embed himself successfully into Koch’s management machinery, learning to talk the language of Market-Based Management. While he might have used the catchphrases of MBM, Sobotka also imported vital pieces of the Wall Street trading culture into Koch’s operations. Sobotka imposed a bonus and compensation structure that matched the norm at other trading firms. There would be no more bonuses of $25,000 for traders like O’Neill. Instead, they would get a cut of the profits they earned for the company. This was a novel thing at Koch Industries—it does not appear that Charles Koch allowed for a true profit-sharing bonus pool to exist anywhere else at the company. But the potential profits of derivatives trading demanded a change in course. Under Sobotka, the trading floor would take 14 percent of the total profit they earned. That 14 percent take would be split up among the managers, traders, and analysts, in a split that Sobotka and his leadership determined was fair.
Charles Koch never seemed comfortable with this model. But it had a dramatic effect on the traders.
* * *
It was a cold winter in 2000. Demand for electricity was strong. There wasn’t enough natural gas injected into underground storage units. Utilities were burning gas and demanding more. Suddenly, everybody in the world wanted to buy insurance against volatility. During the three short months between March and May in 2000, the price of natural gas shot up 57 percent, from $2.88 to $4.52. The markets roiled, with billions of dollars being hauled from consumers to producers in a matter of weeks. O’Neill was in the middle of it, collecting millions. Traders who had sold him options earlier in the year were calling him up seeking to buy them back. He sold when the price was right.
“We got lucky to a certain degree because it got cold early,” he recalled. “We made much more money than we probably thought we would.”
It wasn’t a straight path to riches. In July the natural gas market pulled back sharply, and prices fell. It seemed that the market was correcting itself—the run-up in March had been an aberration, an overreaction. It looked like there was a chance that O’Neill had simply gotten lucky and gotten a short-term payday. The gas price dropped 14 percent to $3.75.
Other traders in O’Neill’s group had made naked long bets, positions that counted on natural gas to keep rising. They started to unwind these positions in July out of fear that they would lose all the gains they’d achieved that year. It seemed possible that the market might sink back into a steady equilibrium. O’Neill, however, remained firm in his position. He thought of the words from his mentor, Sam Soliman, who had overseen him when O’Neill was first learning how to trade. O’Neill had often grown nervous when it appeared that the market was moving against him. But Soliman counseled patience. The Koch way wasn’t to react in the moment. It was to hold a long-term view. Soliman called this “managing to expiration,” meaning playing out a position until it expired. Short-term thinking was the death of a good trader—there were just too many wild variables that might cause a market to fall from one month to another. These variables often didn’t have any relation to the underlying reality of the market. People have a terrible habit of making bets that things will revert to a “norm.” This is the same impulse that delays the bursting of a stock market bubble: many investors convince themselves that undesirable outcomes must be unlikely because their consequences will be so painful to bear. It’s human nature.
O’Neill was not betting on a return to the norm. He was betting on volatility and sticking with his position. And almost immediately after markets dropped in July, the upheaval returned. In one month, the price of gas shot up 27 percent. Orders were piling up, and supplies were tight; customers who needed natural gas in the spot market started paying dearly to get it. During the 1970s, gas shortages caused an interruption of delivery—pipeline companies simply closed their spigots when price controls made it infeasible to deliver gas. This caused factories to shut down and lights to go out.
After the deregulation of the 1990s, it was the market that would enforce such rationing, and the main tool at the market’s disposal was the punishing power of high prices. This made perfect sense economically, but caused problems socially. Natural gas wasn’t a product that people could easily stop using when it got pricey. It was embedded in the electric and industrial base of America, so consumption remained strong and prices kept rising.
The run-up in gas prices continued for the rest of the year. In the fall, the price of gas jumped to the highest levels in years, hitting $6.31 in November, almost double the price just months before. Across the country, this volatility played out with terrible effect. It contributed to months of rolling blackouts in California, where factories ceased production, stores closed down, and auto accidents occurred when the traffic lights blinked out. In December, the price of gas hit $10.48. O’Neill cashed out of his position. He tallied the profits from his trading book. He’d earned roughly $70 million for Koch through his plays in the options market.
By contrast, the entire pipeline company of Koch Gateway, all 9,600 miles of pipe with 120 connection points to other customers, earned only $15.3 million, according to government filings. The black box economy of derivatives, once a shadow market, had far surpassed the real economy in its earnings. O’Neill said his entire trading team earned as much as $400 million of profit in one year. And that was just a single team.
* * *
After the books were closed on the year 2000, it was time for O’Neill to get his bonus. It would be his first payout under the Sobotka bonus pool regime. It would be his first taste of what other traders in the business were making, from Enron to Lehman Brothers. He knew that 14 percent of the profits would go to the floor, which would have equaled nearly $10 million. But that amount was split up among himself and others like Sobotka and Jeff Searle, a trading manager who reported to Sobotka.
One trader after another was called into Searle’s office to learn what their bonus for the year was. O’Neill’s turn came. He sat down to hear the news. He would be paid $4 million.
“We talked about how it was a life-changing number,” O’Neill said. “I was very appreciative.”
* * *
With a single paycheck, O’Neill was propelled up through the ranks of American economic life. He broke through the upper atmosphere of the middle class. He would no longer worry about making mortgage payments. He would no longer argue with his wife about cutting back to meet the monthly budget. He would no longer fret about the quality of public schools in his neighborhood. All the financial worries that had encompassed his life since he bunked in the basement with his brothers were gone.