The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (8 page)

Ivan Glasenberg, by then Glencore’s head, had taken over from Willy Strothotte in 2002. A gregarious South African, Glasenberg was a profane, fiery character whose championship race-walking skills had nearly taken him to the Olympics as a younger man. He was also a natural-born trader.

Opportunism had always been one of his strengths. In 1980, as part of a course in business finance at the University of the Witwatersrand in Johannesburg, Glasenberg had been assigned a commodities project. He was paging through some books in a Johannesburg corporate library when he heard two men doing, of all things, an international
candle-wax trade around the corner. “I’ve got them at this price!” one of the men yelled. “What have you got?” As the second man shouted back an answer,
Glasenberg was rapt. Holy shit, he thought, the one guy sold in Brazil and the other bought in Japan. A huge international deal negotiated across three continents in a matter of seconds. He couldn’t believe it.

After graduating from Wits, Glasenberg worked as an accountant. But he couldn’t get the trading idea out of his mind. He went back to school, earned a master’s degree in international business administration from the University of Southern California, and in 1984 he joined Marc Rich & Co. as a coal trader in his native South Africa. He married, had a daughter and a son, and began learning the nuances of the business, relocating from Africa to Australia and then to Asia, where he oversaw the region’s coal operations during a time of crisis in the industry. He was a quick learner, and in 1990, he was promoted to run the company’s global coal business.

There were many challenges in the commodity trade, and one was always the need for good credit. During the 1990s, as the price of coal hit a low point in parts of the Pacific region that Glasenberg oversaw, repo men were circling coal-storage facilities, where they would seize the holdings of companies that had defaulted on their debts. Sometimes they walked away with the wrong assets.

In Australia, where the industry was particularly squeezed and repossessions were a serious threat, Glasenberg ordered employees to put ropes around their coal stockpiles with Marc Rich flags to mark them off. He fretted constantly about all the bad things that could happen to his precious assets. Each time he signed off on a coal shipment, he was tortured during the weeks it took for the cargoes to arrive intact at their destined port.

In 1991 Glasenberg, his wife, and his two children moved to a
town near Zurich, not far from the company’s headquarters in Zug. Shortly after they relocated, Marc Rich summoned Glasenberg for lunch at his house. It was a sign that he had attracted the attention of senior management.

Rich was by then in the twilight of his career. Heavily involved with real estate investing, he had delegated much of his company’s day-to-day operations to Strothotte, so even senior management had limited dealings with him. Rich was overcompensating by living hard. Over lunch at his house, Glasenberg marveled at the chance to meet the industry’s king. But despite the amicable rapport the two developed, it was clear that Rich would never be a mentor.

Two years later, after Rich’s zinc trade had gone bust, Glasenberg was part of the new generation that seized control, working closely with Strothotte, who took over after the management buyout. Over the decade that followed, Strothotte trained Glasenberg for a bigger job, and ultimately relinquished the CEO role to him in 2002. They functioned well together. When Glasenberg took over as chief, Strothotte stayed on as chairman.

As CEO, Glasenberg maintained a breakneck schedule. No matter what the weather, he rose at dawn for swims, cycling, or five-mile runs by the lake near Zug, keeping his body trim and prepared for long flights and all-nighters. His thinning, dark-brown hair was always neatly combed, his square glasses perched expertly on his clean-shaven face.

His attention to physical detail extended to the office, where his fixation with accounting kept him preoccupied with the company’s balance sheet. Between jetting around to visit Glencore’s far-flung mining, shipping, industrial processing and trading sites and conferring with his business heads over minute details of
the business, Glasenberg considered how he would navigate the next decade.

From time to time he would admonish Glencore’s division leaders not to dream too big about mergers and acquisitions. “Guys, you can’t keep bringing big fixed assets because this company can’t do it,” he’d say in one-on-one meetings, referring to the costly investments they would occasionally propose. If the division heads wanted to buy billion-dollar properties, he’d tell them, only an IPO and the permanent cash it would bring with it would make a difference. “You have to go public,” Glasenberg said again and again. “Think about it.”

Meanwhile, Glencore was stuck with relatively small-ticket items: a few hundred million dollars here, a few hundred million there. The multibillion-dollar purchases that would make Glencore more of a global contender were simply unaffordable.

Amid all this, the company’s shareholders were also draining its cash. Glencore had a tradition of hiring young and promoting from within; like Alex Beard, many of the company’s 450 or so employee shareholders were in their forties and had been with the company for more than a decade. But when partners left, as about ten had done in 2008, they expected to cash out their equity, and the more the company’s holdings grew, the more their stakes were worth.

To deal with the limited cash on hand, Glasenberg had established what he liked to describe as a financial Band-Aid: pay interest on a shareholder’s equity without allowing him to actually liquidate his holdings. But that, Glasenberg knew, was only a temporary fix.

The ratings agencies, for one, were attuned to Glencore’s situation. Throughout the fall of 2008, Standard & Poor’s and Moody’s had been asking about the stability of the company’s most senior employees, given how expensive their departure payouts were certain to be, and now the questions were becoming sharper. Glencore couldn’t risk a ratings downgrade that plunged it into “junk,” or likely-to-default, status, making borrowing much more expensive. Commodities were hurting, and miners everywhere would soon be asking public investors for additional cash before their needs grew more dire.

During a meeting with Glasenberg and his chief financial officer late one week in December, a ratings analyst had asked what Glencore would do if faced with the resignation of one of his top twenty employees and the resultant cash the departing manager would demand. “I’m not even worrying about what if,” Glasenberg told the analyst, “because it’s not happening. If you are concerned, I’ll have the partners sign a letter.”

By the following Monday, each of Glencore’s most senior officials agreed to extend their employment by at least three years.

During Glencore’s partners meeting in the spring of 2009 in Baar, Glasenberg made a pitch for what he saw as the only solution to the firm’s pressing problems, which was an IPO. He ran through the merits: a chance to raise money in the market during times of crisis; a means to take over other companies; and, not insignificantly, an opportunity to become very, very rich—but in the public eye.

Beard, who had one of the larger stakes in the company at the time, wanted to go public, never mind that it meant he was bound
to lose his low profile in the London social scene. “One of the key drivers for me is increased financial firepower,” he told the group, using a term Glasenberg had in the past, “to undertake larger-scale acquisitions.”

Glasenberg understood. It was hard to find an attractive crude-oil drill site for less than $1 billion, and as a result, Beard hadn’t even tried to present his boss with substantial takeover ideas. Realizing his goals as energy head, however, would be impossible without them.

An offering would also bring an abrupt end to decades of secrecy, however, and with it, freedom. In the more fraught parts of the world where Glencore operated, such as Zambia, the Congo, and Colombia, nongovernmental organizations would immediately home in on the company’s questionable practices and dealings with corrupt politicians. Glencore would have to hire managers for investor relations and public relations—jobs that had never existed within the company. Glasenberg didn’t know if his partners were prepared for the onslaught of publicity they were likely to get. Privately, he believed his own wife, a high-school teacher who worked with developmentally challenged students, might be shocked to learn his net worth, and joked that once the press reported it, he could no longer claim not to be able to afford the Louis Vuitton handbags she liked.

“Who’s in favor?” he asked, looking around the table.

Everyone was.

B
y 2009, the London office where Alex Beard’s lunch companion, Goran Trapp, worked for Morgan Stanley was eclipsing its U.S. arm in importance. Embarrassed by the financial crisis’s exposure of their weak spots, regulators were putting new pressure on Wall Street to rein in its risky behavior, and the UK, known for its hands-off attitude toward bank oversight, had become the finance industry’s safe haven. Commodity markets in London were thriving, and Morgan Stanley and Goldman Sachs, now chasing profits in an environment where high-stakes, high-reward trading activity was suddenly restricted, had increased their presence there.

The focus on Europe was a turnabout for Morgan Stanley, whose commodities nerve center had for years been a converted courtyard in the wealthy suburban enclave of Purchase, New York. There, inside a brutalist-style building
once used by the energy company Texaco, about seventy-five people traded both physical natural gas, crude, crops, and metals and the contracts backed by them, churning out remarkable profits. They had moved there as part of Morgan Stanley’s risk-reduction policies
after the terrorist
attacks of September 11, 2001. By 2008, they were generating revenue of $3 billion—a substantial contributor to the bank’s overall revenue of $25 billion.

Morgan Stanley wasn’t alone there. Banks everywhere were relying on commodity traders to help them survive the rout in mortgage-backed securities and the resultant setbacks in other markets. At Goldman Sachs, which reported fixed-income revenues of $3.71 billion for that year and $22 billion overall, commodities contributed more than $3 billion. Even at other banks with smaller, less profitable commodities units, the trading of raw materials was a major help. Among the top ten investment banks, commodities on average made up
14 percent of their combined total fixed-income revenue. Morgan and Goldman tended to top the list, with Barclays, JPMorgan, Bank of America, and others following behind.

Bank commodities units made money in three ways. The first was by helping corporations involved in the physical side of the commodities business to hedge their exposure to changing commodity prices. Buyers, such as Dow Chemical or Coca-Cola, used contracts like exchange-traded futures (vows to purchase a physical commodity at a preset price at a future date), options (rights, but not requirements, to buy or sell a physical commodity at a preset price at a future date), and swaps (bilateral trading agreements that allowed parties to lock in specific future prices or in exchange for ongoing cash payments) to curb the cost of big run-ups in the price of raw materials they needed to purchase. Taken together, the various contracts were known as derivatives, because they were agreements that derived their value from a relatively
simple product, like a barrel of oil, and made it more nuanced by layering on additional features, such as the right to buy or sell it later at some specific time or at some specific price. Producers, like the natural-gas driller Chesapeake Energy, faced the opposite problem: overexposure to a physical commodity whose dropping price could hurt them.

Then there were the airlines, which spent as much or more on jet fuel than they did on employee salaries and benefits. There were myriad ways to arrange a hedge, but the simplest version involved buying contracts linked to crude oil—the major commodity most closely pegged to the price of jet fuel—that gave the airline the right to buy crude in the future at a moderate price. Say, for instance, that crude-oil futures were trading at a price of $100 per barrel. Looking out on the year to come, an airline executive might believe he could handle a cost of $110 per barrel but not $120. So he’d instruct his sales trader at Morgan Stanley—a well-compensated go-between who told the actual traders what the client wanted them to do—to lock in prices of $110 per barrel twelve months into the future in an amount equal to, say, one-third of the amount of jet fuel that the airline purchased in a given year. That way, the executive got a fixed price for a portion of the commodity he would need in the coming year, protecting him against a big spike in costs. But because there was always the chance that prices would fall instead of rise, he only hedged a portion of the crude he’d actually need in order not to waste money on hedges that proved unnecessary when the commodity was cheap. It was a maddeningly difficult undertaking to time correctly, but one that was increasingly necessary, given the large swings in oil prices.

Morgan Stanley didn’t make much money on the single transaction, for which it charged a modest fee (depending on the cost of
the contract, pennies or even fractions of pennies for every dollar of market exposure the airline bought). But if Morgan arranged many such trades for many different clients, the fees from hedging jet fuel, copper, wheat, and other commodities quickly added up. It was a volume business, dependent on what an academic would call “economies of scale,” and the revenue those fees brought in was known as the client “flow” business. It was also the least sexy of the three ways banks made money in commodities.

The second way was by owning physical assets that dealt directly with raw materials. Banks over the years had tried everything from buying refineries and coal mines to running gasoline storage silos. Goldman at one point owned both Horizon Wind Energy, an operator of wind farms, and an air-polluting power plant in Linden, New Jersey. Morgan Stanley had two assets of note: TransMontaigne Partners, which handled the shipping and storage of refined-oil products, and Heidmar Inc., a tanker-ship operator. Both provided revenue that improved Morgan Stanley’s profits. But perhaps just as important, they also gave the firm in-depth knowledge of the infrastructural and regional issues in the energy business where TransMontaigne and Heidmar operated, knowledge that gave Morgan’s traders an edge when it came to buying or selling crude contracts.

The third way was both complex and highly lucrative. It was house trading, otherwise known as proprietary, or “prop” trading, a bet using internal capital that often involved using commodity contracts. A prop trade sometimes sprang from a client flow trade that required taking positions that the bank wouldn’t otherwise have wanted—for example, betting that natural-gas prices would fall at a time when most people expected them to go higher. Morgan probably would not make that trade of its own
accord, but if Chesapeake Energy wanted the bank to do it, and if no third party was willing to make the trade either, Morgan would make the negative bet in order to accommodate Chesapeake.

To avoid being stuck with a negative bet on a rising commodity, Morgan might then try to find another counterpart who would purchase its position. If it did so, it had, debatably, crossed the fine line from client flow trading into prop trading. (In the years that followed, there would be numerous arguments between banks and regulators as to what constituted a prop trade.)

Another form of prop trading was simply using Morgan Stanley’s capital to take whatever positions a trader saw fit. It was speculation, much as Pierre Andurand had done at Goldman, Bank of America, and later at Vitol and BlueGold, and as Alex Beard had done when he instructed his traders in the fall of 2008 to bet on a crude-price downward spiral. The Morgan Stanley trader would be given a bit of the bank’s money to start with, and then he or she would take their own view on a commodity to try to make a profit from it in the markets. Any gains that resulted were Morgan’s to keep—and would usually boost the bonus of the trader who generated them. And if the trader happened to bet poorly, the loss usually belonged to the bank.

Handled well, prop trading was a big moneymaker, and the banks, unsurprisingly, barreled into it. Goldman Sachs was particularly adroit. By the early 2000s, analysts estimated that prop trading accounted for at least
a quarter of Goldman’s pretax income. Later, in the opening stages of the U.S. credit crisis, a small team of traders who handled mortgage indexes for clients made nearly $
4 billion in trading profits by using Goldman’s money to bet that the housing market would crumble.

Morgan Stanley’s prop trading of mortgages had gone far less
well, resulting in a $
9 billion write-down and a wave of hasty departures, including that of the company’s president. But the commodity side was a different story.

On and off the trading desk, Jennifer Fan projects seriousness. A math prodigy who graduated from New York University with a finance degree at nineteen, she started working at Morgan Stanley as a commodity trader a year later. Conscious of her youth and inexperience, she dressed understatedly: dark pants and button-down shirts or blazers, often accented by a big, fluffy scarf wrapped around her neck, even when it wasn’t cold outside. She had a casual look reminiscent of Silicon Valley, even wearing things like gingham shirts and black slacks to hedge-fund conferences, as if to say that sitting in front of a computer all day in a high-stress job shouldn’t require a power suit. Her main accessory, other than her piercing eyes, was her luxuriously thick, dark hair that she wore straight and down.

The daughter of studious Chinese parents who had emigrated to the U.S. to attend graduate school, Fan was more comfortable talking about quantitative theory than about her personal life, which had been subsumed by her education since heading off to a special college for gifted teenagers. After school, she had spent a year at Bank of America, where she met her future husband, an oil trader named Morgan Downey, on a trip to the company’s Singapore office. Downey ran the bank’s energy desk there, and at that time had recently hired Andurand, who was on the brink of his first big score in trading.

Fan was hired at Morgan Stanley in 2004, by which time both she and Downey were dating and living in New York. John
Shapiro, Morgan’s head of commodities, a silver-haired micromanager who had helped launch the business in the 1980s, was famous for his careful selection of traders who would fit the investment bank’s collaborative, merit-driven culture. Shapiro gave Fan a choice of jobs: trading power supplies or working on the bank’s nascent index desk. She chose the latter.

To many traders, the index desk sounded dull compared to areas like crude, where an unexpected geopolitical event could put billions at risk in a flash. Copper, the red metal that was the backbone of industrial manufacturing and such a reliable predictor of economic growth when countries bought it in large quantities that it was nicknamed “Dr. Copper,” was also compelling. Even natural gas, despite the benign images it conjured of public buses and home heating, was more exciting to deal with; its contract markets were so volatile that some traders described it as the widow-maker of the commodity business.

But the trading of commodity indexes at the time was a cash cow just waiting to happen, and Morgan Stanley was playing catch-up to its rivals on Wall Street, who had spotted the opportunity many years earlier. Morgan had been particularly outflanked by Goldman, whose commodity index, the GSCI, had by the mid-2000s become a huge source of client interest. (Dow Jones, the media and index company, had paired with the insurer American International Group to create the Dow Jones–AIG index, also a popular commodity product.) So Morgan was trying to piggyback on the index fad with a more customized version of its own that took specific client needs into account. If a client called and wanted to buy the same futures contracts underlying the GSCI but with less emphasis on crude, for instance, Morgan’s index trader would go into the market and buy a basket of commodity
contracts that included less exposure to crude and more to other products that were poised to hit higher prices at that time. As with other client flow trades, the trader would charge a fee for doing so, and the more clients he or she serviced, the more money Morgan made overall.

The bank had been in the index business for a year or two by the time Jennifer Fan was hired in 2004, and indexing was generating about $50 million in revenue per year. Fan’s job would be to help convince clients that they should embrace index trading, and then to execute the trades they wanted to make.