The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders
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Authors: Kate Kelly
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First published by Portfolio / Penguin, a member of Penguin Group (USA) LLC, 2014
Copyright © 2014 by Katherine Kelly
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ISBN 978-0-698-15167-3
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For my husband, who makes everything
possible.
At BlueGold Capital Management
Pierre Andurand,
chief investment officer
Dennis Crema,
chief executive officer
Paul Feldman,
chief financial officer
Neel Patel,
trader
At Glencore International
Ivan Glasenberg,
chief executive officer
Alex Beard,
global head of oil
Marc Rich,
founder
At Morgan Stanley
John Mack,
chief executive officer
John Shapiro,
global head of commodities
Jennifer Fan,
commodity index trader
Goran Trapp,
European head of commodities
Jean Bourlot,
commodity trader
At the Commodity Futures Trading Commission
Gary Gensler,
chairman
Bart Chilton,
commissioner
Michael Dunn,
commissioner
Dan Berkovitz,
general counsel
David Meister,
director of enforcement
At Delta Air Lines
Richard Anderson,
chief executive officer
Edward Bastian,
president
Paul Jacobson,
treasurer and, later,
chief financial officer
Jon Ruggles,
vice president of fuel
At Goldman Sachs
Gary Cohn,
president and chief operating officer
Brett Olsher,
investment banker
Jeff Currie,
European cohead of commodities research
Trey Griggs,
head of U.S. energy risk management
At Xstrata
Mick Davis,
chief executive officer
Trevor Reid,
chief financial officer
Thras Moraitis,
head of strategy and corporate affairs
At the Qatar Investment Authority
Sheik Hamad bin Jassim bin Jaber Al Thani,
chief executive and prime minister of Qatar
Ahmad al-Sayed,
chief executive of Qatar Holding,
the investment arm of QIA
Other Key Players
Evgenia Slyusarenko,
Pierre Andurand’s wife
Carl Levin,
Democratic senator and chairman of the Permanent Subcommittee on Investigations
Sheik Mohammed bin Rashid Al Maktoum,
vice president of the United Arab Emirates and ruler of Dubai
Jon Corzine,
former head of Goldman Sachs and chief executive officer of MF Global
Spiro Youakim,
investment banker at Lazard
Michael Klein,
investment banker and founder of M. Klein & Co.
Tony Blair,
consultant and former UK prime minister
Ivonne Ruggles,
Jon Ruggles’s wife
Tony Ward,
cofounder of
Armajaro
T
hree and a half years ago, a colleague at CNBC turned me on to an interesting topic: natural gas hedging. There was a large driller in Oklahoma City called Chesapeake Energy that had made billions of dollars by buying and selling contracts betting on future prices of gas, he explained—perhaps even more money at times than it had made selling actual gas. Chesapeake’s chief executive, Aubrey McClendon, liked to brag about his company’s trading prowess, and some investors were becoming antsy about whether he was focused enough on his underlying business.
I flew out to Oklahoma to meet with McClendon, who was unapologetic about his gas trading activities. “If gas prices go to zero in 2011, it’s great for customers, it doesn’t bother us, it hurts our competitors,” he told me in a televised interview. “So once we get hedged, we kind of want lower gas prices.”
His sanguineness about potential price declines in his company’s central product, which was then trading at unusually low levels, amazed me, and it struck many of CNBC’s viewers as strange too. Over time, an investigation by Reuters revealed that McClendon was such an avid trader that he’d operated a hedge fund
outside of Chesapeake Energy that handled contracts connected to some of the same products the company produced. Amid this and other revelations of apparent conflicts of interest, he announced his retirement in 2013.
Meanwhile, I’d become hooked on the topic of commodity trading. I’d met a crude-oil trader at a New York–area hedge fund whose withering take on his own business—which he felt was dominated by irrational penchants for risk and a bunch of grown men with emotional issues—had made me want to learn more. I’d traveled to Nebraska to interview a corn farmer whose Tweets about crop yields and planting conditions were being watched by brokers on the Chicago Mercantile Exchange, showing both the interconnectedness of the physical farming business to its futures counterpart and the hunger with which traders searched for clues. And I’d covered the initial public offering of Glencore International, the $60 billion Swiss commodity-trading colossus founded by the longtime American fugitive Marc Rich, which made huge markets in everything from crude oil to cobalt and yet was completely unknown to the public.
As far as I could tell, commodity-contract trading was a black box. It was a business that was both massive and impactful, affecting the day-to-day prices of raw materials like crude oil and wheat, and, in turn, influencing the cost of everything from iPhones to coffee. But the whole market was scantly covered by the media and poorly understood in general. At home, successful commodity hedge-fund traders might be profiled in the newspaper, but how they bet on markets and what motivated them to make such bold moves rarely was. Overseas, commodity giants like Glencore
and its counterparts were a complete mystery—even though they dominated the markets for important products universally used.
I wanted answers. Who were these guys, and how did they work? What impact did they have on the price of physical commodities? And who was monitoring them?
This book tells you what I
found.
T
his book is the product of scores of interviews with people who buy, sell, trade, regulate, or study commodities for a living. Many of them spoke to me on the record, and their quotes appear throughout the text, either as what they said at the time of the events described, or what they have said on more recent reflection.
A number of interviewees, however, spoke on the condition that they not be named as sources. I have used their input, alongside that of named sources, to reconstruct the events of the book. The meetings, trades, thought processes, life events, and professional histories I’ve covered have in every case come from my own direct observations, relevant documents, a primary source who was involved, secondary sources who were in close proximity to the situations described, or, finally, from prior reporting that I have cited.
Not everyone agrees on the precise details of every interaction. Where documentary or other decisive evidence was not available, I solicited comments from all major parties and reflected their input in the book. The controversies that required additional context are described in further detail, often with suggestions for further reading, in the
endnotes.
THE BUBBLE
P
ierre Andurand was so comfortable with his $8 billion crude-oil position that he spent the first half of his day doing a hard-core workout with his personal trainer, casually reading the news on a Bloomberg computer terminal, and munching on lean protein and toast at his London town house. It was May 5, 2011, Osama bin Laden had just been killed, and political instability in the Middle East seemed guaranteed to raise energy prices.
Andurand made the short walk to his hedge-fund office at midday. Brent crude-oil futures, the commodity market based on petroleum drilled in Europe’s North Sea that he followed most closely, had been
hovering in the low $120s that morning, which annoyed him. He’d been betting for weeks that oil would trade higher, but prices had not obliged. Still, with the U.S. markets having only recently opened for the day and the amount of trading still a bit light, he kept a previously scheduled meeting with the author of a book series called Market Wizards in a conference room downstairs from his trading desk.
An hour or so into the meeting, Andurand got an urgent e-mail from one of his traders, who had returned from a coffee
break to find the Brent market down $2.50. That was a big move for a single afternoon in London, let alone for a fraction of an hour. The trader was baffled.
Andurand wasn’t worried. The oil market was a volatile beast, he knew, and such fluctuations weren’t unprecedented. He’d always played them to his advantage, even awakening one time from surgery to find that Brent had risen $10, just as he’d predicted. He kept chatting with the writer, telling him about his philosophy on trading and how he’d applied it at his hedge fund, BlueGold Capital Management, which had been celebrated for having predicted both the high point and the low point of the crude-oil market in 2008. It was a call that had established the firm as one of the most successful commodity hedge funds of all time.
E-mails from upstairs began flooding in. The Brent drop had widened another fraction of a dollar, then another dollar. Andurand’s team was scouring the trader chat rooms and the Internet for information that would explain the sell-off—a production hike by OPEC? A release of the U.S. Strategic Petroleum Reserve?—but there was none to be found. Meanwhile, BlueGold was losing hundreds of millions of dollars. Andurand couldn’t focus. “Why are you looking at your BlackBerry?” the writer finally asked him.
Andurand ended the meeting and rushed upstairs. His two young traders, Neel Patel and Sam Simkin, were sitting at their computers, looking anxious. Brent futures had fallen several dollars in an hour, and their downward spiral was weighing on other parts of the market too. It was a level of distress the thirty-four-year-old Andurand, who had been trading energy products daily for more than a decade, had rarely seen. He called a few other
traders to ask what was happening. He instant-messaged a few more. Nobody had a clue.
Whatever it was, it was bad for BlueGold. Andurand and his partners had used complex trades to build a position three times as large on paper as the $2.4 billion in assets they were managing, and it was set to maximize profits as crude oil prices rose. But if crude fell sharply, as it did that day, it could be disastrous for the hedge fund.
Andurand turned to his traders. “Sell a few hundred million worth!” he said. “See how the market takes it.”
Clicking their mouse buttons furiously to finalize trades on their computer screens, Patel and Simkin began selling off futures on Brent crude as well as its U.S. counterpart, the West Texas Intermediate, or WTI, oil contract, which was pegged to physical crude oil stored in Oklahoma. Although crude was always subject to its own regional supply and demand issues, jitters about the trajectory of prices tended to play out publicly in the futures markets, where hedge funds like BlueGold made bets on whether prices would stay low or high in the months and years to come.
Unloading a multibillion-dollar set of trades was extremely difficult to do without losing additional money in the process. On a calm day, sale orders comprising large numbers of contracts—each of which was linked to one thousand barrels of actual, physical petroleum—could tip other traders off to the idea that somebody had a lot to sell and prompt them to sell oil contracts themselves. The result was an even further price drop. On a rough day, a large sale could prove an even stronger depressant on prices.
BlueGold’s initial sales on May 5 seemed to worsen the markets. Brent continued falling, and the fund’s traders perceived an added drop whenever they pressed the sell button. A few hours into the rout, Brent was down $6, then $7, with little sign of settling.
But Andurand couldn’t afford to stop. He told the traders to wait twenty minutes before making additional sales, hoping that would let the market calm a bit. It was chaos in their office. Land lines and mobile phones were ringing. Competitors and friends wanted updates and gossip. Was BlueGold collapsing? they asked. Reporters had the same question. Everyone knew of Andurand’s appetite for enormous bets—and his reputation for relaxed risk management.
Brent went down, down, another dollar, another fifty cents, another dollar. BlueGold continued selling. By 7:30 that evening in London, as the U.S. markets dwindled to a close, Brent had fallen almost $10.40 per contract, a historic move.
Andurand, finally able to pause, was in a state of shock. BlueGold had managed to sell off $3 billion worth of positions, far more than he had expected they could under such duress. But the firm’s losses for the day were a half billion dollars, and it still had $5 billion invested in the markets, betting that crude-oil would rise.
Andurand’s day that May was the sort of experience that would humble any good trader. But in the world of commodity trading, where a relatively small circle of powerful players take enormous risks gambling on the future price of physical raw materials like
oil, corn, and copper, huge market moves and the resultant gains and losses are incredibly common.
“Commodity” is an overused word that in colloquial terms applies to things so widely available—toilet paper, milk, dry cleaning—that they are bought and sold almost solely on the basis of price. In the context of the global markets, physical commodities serve a crucial purpose, however: they are the basic building blocks of agriculture, industry, and commerce. The reason Brent crude oil or the widely grown grain known as number two yellow corn are called commodities—a term that brings to mind things that are easily found and not overly valuable—is that their structural, chemical makeup is the same no matter where in the North Sea they are drilled or in what field they are harvested. Like toilet paper and dry cleaning, those commodities also trade on the basis of price. But price in their case is an outgrowth of a long list of what traders call “fundamentals”: the cost of actually getting the commodity out of the earth, the cost of moving it from its source to a buyer, how many people want to buy it at a given time, how plentiful it is in other locations, and at what price, at that particular time.
Commodities may sound like an esoteric market, but everyone has heard of at least some of them. Gasoline and crude oil are important ones, and copper, which is used in the wiring of iPhones and air conditioners and
maintains a minor presence on the U.S. penny (which at this point is mostly zinc), is another. Corn, wheat, and cotton are consumed or worn by almost everyone. Other commodities, such as the element cerium, referred to as a “rare-earth” commodity because of its elusiveness, are obscure—although cerium too is put to work in mundane products like
cigarette lighters and
movie-projection bulbs.
The practice of gaming out commodity price changes through financial bets—the subject of this book—is believed to be quite old.
More than three thousand years ago, Sumerian farmers promised a portion of their harvests in exchange for silver up front. Those agreements, known to modern traders as “forwards,” were memorialized in the first written language, a body of symbols known as cuneiform.
The
trading of commodities based on future deliveries persisted for centuries, from ancient Rome to the Italian merchant cities to the
Dutch traders who exchanged tulips in the 1630s.
Commodity trading came to the U.S. with the British colonists, and was formalized by the opening of the Chicago Board of Trade in 1848, spurring a century and a half of more sophisticated virtual trading by a group of more dedicated practitioners. Eventually, commodity trading became its own dedicated niche. Farmers uncertain of the next year’s crop wanted to ensure that they had a reliable amount of income, even in a bad year, and companies dependent on a certain metal for manufacturing wanted to lock in lower prices in advance to guard against a huge price spike that could erase their profit margins. Over time, additional commodity exchanges opened in the cities that most needed them, and entire companies grew up around the need simply to hedge commodities.
During the 2000s, however, commodity trading became the new fad. Volume and volatility in the commodity contract markets exploded, propelled by a massive influx of both everyday and professional investors. In the “listed” markets, where contracts traded at places like the New York Mercantile Exchange and the IntercontinentalExchange in Atlanta, volume shot from roughly
500 million contracts per year in 2002 to nearly
2 billion contracts in 2008.
Meanwhile, in the over-the-counter market for commodity contracts, where an array of exotic financial products connected to physical commodities was traded party-to-party by phone and computer (in other words, off the exchange), the total value on paper of the trades outstanding spiked from
about $800 billion to
more than $13 trillion over roughly the same period. Suddenly, commodity contracts, once a rounding error in the world of tradable products, were all the rage.
Nonetheless, commodity investing was small compared to stocks, bonds, and currencies. Until the mid-2000s, most investors had never seriously considered adding commodities to their individual portfolios, which tended to favor simple, easily traded things like stocks and U.S. Treasury bonds. But something happened to commodities in the 2000s to change their minds: a huge increase in prices and an especially convincing sales job by Wall Street.
Between the early 2000s and the middle of 2008, before the U.S. financial crisis hit, the contracts tracked by the Goldman Sachs Commodity Index, known as the GSCI for short—the commodity equivalent of the Standard & Poor’s 500 Index—nearly tripled in price. (S&P, in fact, bought the index and added its own name to the title in 2007.) Crude oil futures rose three and a half times their earlier levels. Corn futures also tripled. Even gold, an oddball commodity because it often performs better when the stock markets fall—and in this case stocks were on fire—nearly doubled.
It was a period of easy money, and the benefits were felt all around, from state pension funds that had added commodities to their investments in order to mitigate their exposure to other, unrelated markets, to individual investors, who had dipped into commodities as a way to make money off of skyrocketing oil prices even though their gasoline was so much more expensive at the
pump. Salesmen for the GSCI and other commodity indexes argued that their products were an important way to diversify investment portfolios. An array of new securities that traded like stocks but tracked precious metals like gold and silver had made commodity investing easier for regular people than ever before, and the commodity market’s inexorable upward movement meant that they’d be crazy not to buy in.
“Wall Street did a nice job of marketing the value of having the diversification of commodities in your portfolio,” says Jeff Scott, chief investment officer of the $74 billion financial firm Wurts & Associates. “I don’t mean that sarcastically. And there is value to having certain commodities in your portfolio. Unfortunately, the return composition changed.” In other words, at a certain point the money wagon stopped rolling along.
Until 2008, there were plenty of reasons to like commodities, most important of which was the torrid pace of demand in India and China. Those economies, which were driving up the price of raw materials around the world, were widely seen as the harbingers of what the buzzier banking analysts referred to as a new “
supercycle,” a period of sustained world growth the likes of which had not been seen since World War II. There was also a prevalent theory known as “
Peak Oil” suggesting that the world’s petroleum supplies were well on their way to being tapped out—a situation that would make crude oil, the engine of so many economies, frighteningly scarce. Both hypotheses augured a continuing climb in the price of oil.
But during the second half of 2008, the belief in higher commodity prices vanished. Like stocks and bonds, commodities were roiled by the financial crisis in the U.S. The main commodity index plummeted, and crude-oil contracts sank to a fraction of
their record high of $147. Underlying their sudden drops amid volatile times in the market was a broader story line: the whole commodity craze had by then begun to fizzle.
