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How Koch Became An Oil Speculation Powerhouse
From Inventing Oil Derivatives To Deregulating The Market
By Lee Fang on Jun 6, 2011 at 2:42 pm

Koch Industries CEO Charles Koch
In April, ThinkProgress caused a stir when we uncovered a series of
Koch Industries corporate documents revealing the company’s role as an
oil speculator. Like many oil companies, Koch uses legitimate hedging
products to create price stability. However, the documents reveal that
Koch is also participating in the unregulated derivatives markets as a
financial player, buying and selling speculative products that are
increasingly contributing to the skyrocketing price of oil. Excessive
energy speculation today is at its highest levels ever, and even
Goldman Sachs now admits that at least $27 of the price of crude oil
is a result from reckless speculation rather than market fundamentals
of supply and demand. Many experts interviewed by ThinkProgress argue
that the figure is far higher, and out of control speculation has
doubled the current price of crude oil.
Reached for information about its trading division, Koch Industries —
America’s second largest private company — declined our request for
comment.
Writing on his political blog, an attorney working for Koch’s law firm
angrily replied to our initial investigation by claiming that Koch is
solely a bonafide hedger, meaning that it only participates in
speculative markets to reduce risk for the oil the company refines (he
also bizarrely argued that speculation has no relation to the price of
oil). The spin obscures reality: much of Koch’s oil trading business
is actually akin to a hedge fund, buying and selling financial
products based on oil with little interest in the actual delivery of
the product. In fact, Koch pioneered the risky speculation industry
that dominates the world’s oil markets today, first by inventing oil
derivatives back in the ’80s, then by working to kill off regulations.
ThinkProgress has delved into the history of Koch’s oil speculation
business and the following timeline spells out Koch’s leading role:
– October 6, 1986: First oil derivative is introduced to Wall Street
by traders at Koch. Koch Industries executive Lawrence Kitchen devised
the “first ever oil-indexed price swap between Koch Industries and
Chase Manhattan Bank.” At the time, such derivatives had been limited
to currency markets, and the shift of creating a synthetic financial
instrument based on the value of crude oil was revolutionary. For an
agreed-upon period, an oil swap is a contract where one party makes
payments based on a fixed oil price, and the other party makes
payments back based on the changing spot price of oil. In July of
2009, EnergyRisk magazine, a publication for commodity traders, posted
a piece exploring the very first oil derivatives and Koch’s role in
developing them.
– 1990-1992: Koch, along with several oil companies and Wall Street
speculators, form a coalition lobbying group to deregulate oil
speculation. A coalition called “The Energy Group” is organized to
press the Commodity Futures Trading Commission (CFTC) to allow oil
derivatives to be traded off the NYMEX or any other regulated
exchange. Participants in the coalition include Koch, Enron, Phibro (a
powerful commodity speculator firm recently sold from Citigroup to
Occidental Petroleum), J. Aron & Co (a commodity trading division of
Goldman Sachs), BP, and other companies.
– January 21, 1993. Wendy Gramm makes first major move to deregulate
oil speculation. “On the final day of the [George H.W.] Bush
administration, January 21, 1993, [CFTC chairwoman] Wendy Gramm …
approved the rule exempting key energy futures contracts from
government regulation and returned a great chunk of the energy market
to the grand old days of unregulated futures trading,” writes author
Antonia Juhasz in the book Tyranny of Oil. The move mirrored the
demands made by Koch’s lobbying coalition, The Energy Group. Gramm,
the wife of then-Sen. Phil Gramm (R-TX), leaves the Commodity Futues
Trading Commission and a month later joins the board of directors of
Enron.
– 1997: Koch continues to shift from oil refining and pipelines to
financial products. As Koch continues its embrace of selling exotic
financial products, the company pioneers the first “weather
derivatives,” essentially insurance policies sold to utility companies
that bet on future temperature and weather patterns. Although Enron
and Koch were the first to develop such financial products, hedge
funds and investment banks like Goldman Sachs later expand the weather
derivative business globally.
– December 12, 2000: Sen. Phil Gramm (R-TX), after being lobbied by
Koch and Enron, creates the infamous “Enron Loophole” vastly
deregulating the oil speculation market. On the night of December 12,
2000, Gramm attaches a 262-page amendment to the Commodities Futures
Modernization Act, which is then attached to an omnibus spending bill
that is signed into law by President Clinton before leaving office.
The Gramm amendment, which received absolutely no public scrutiny or
committee hearings, radically expands and codifies the energy
deregulation agenda began by Gramm’s wife during the first Bush
administration. The Gramm amendment allows so-called “over-the-
counter” energy derivatives not only to be traded outside of regulated
exchanges, but for private unregulated exchanges to deal in these
sorts of financial products. Thus, massive “dark” oil speculation
markets are born, including Enron’s platform for trading energy
futures, and the Intercontinental Exchange (ICE) — an online
speculation exchange founded by BP, Shell, Goldman Sachs, Morgan
Stanley, and other firms. Private e-mails reported by the New York
Times reveal that members of The Energy Group, led by lobbyists at
Enron but including at least two lobbyists from Koch and several more
from Goldman Sachs and Sempra Trading, wrote Gramm’s amendment and
pressured him to slip it into the bill.
– 2008: Rampant oil speculation spikes prices to unprecedented levels.
As academics from the Peterson Institute, the James Baker Institute at
Rice University, and others conclude, non-commercial speculators begin
to dominate the market, forcing up prices. Although the evidence was
abundant that speculators caused the massive price spikes during the
summer of 2008, regulators were toothless to act. A bipartisan
majority in the Houseoverwhelmingly passed legislation to award powers
to the CFTC to oversee rampant oil speculation, but Republican in the
Senate — acting with help from Koch lobbyists — killed the bill,
called the Energy Markets Emergency Act.
– 2009: Koch presentation to ICE boasts that Koch is on the level of
transnational big banks and can now be considered one of the world’s
top five oil speculators. The presentation, and our analysis, can be
found here. Of course, Koch is not the only large corporation engaged
in this practice. Large investors, like pension funds, hedge funds,
investment banks, and others flocked to the commodities market after
the financial crisis of 2008 and the collapse of mortgage-backed
securities.
– 2010: Koch’s Tea Party front groups and lobbyists fight financial
reforms designed to reign in the unregulated energy market. While
Americans for Prosperity, as well as other Koch fronts, decry the Wall
Street reform bill debated in Congress, Koch lobbied to water-down
provisions of the bill related to derivatives. The sweeping Dodd-Frank
reform bill contained broad new powers for the CFTC to crack down on
excessive oil speculation, while also requiring that derivative are
eventually traded on a regulated and open exchange.
– 2011: As oil speculation again hits record highs, leading to record
high oil prices, Koch’s allies in Congress fight to undermine new
reforms and allow unchecked speculation to spiral out of control. As
ThinkProgress has reported, oil speculation is currently at a record
level, which experts, and even many Republicans now agree, is causing
pain at the pump. After a furious lobbying campaign, the CFTC
postpones Dodd-Frank mandated regulations on excessive oil
speculation, known as position limits. As the CFTC grapples with how
to implement these new rules, newly elected Republicans, many with
Koch-backing, propose steep cuts to the CFTC to undercut any rules on
oil speculation.
Charles Koch, the CEO of Koch Industries who is worth a reported $22
billion, likes to call his business an example of something he
describes as the “Science of Liberty.” In reality, his company’s
deregulation crusade has contributed to rolling blackouts,
consolidation and monopolies in financial markets, and economy-
wrecking oil price spikes. In comments to the CFTC, the reform-minded
nonprofit Better Markets noted that, “the history of these markets is
a history of anti-competitive, self-interested, predatory conduct that
serves the interest of the exclusive few at the expense of the many
and the system as a whole.”
After working furiously to unleash oil speculators like Koch and
Enron, the Gramm family wasrewarded with plum jobs, including spots on
corporate boards and placements at speculator-funded think tanks.
Wendy Gramm still holds a position at the Koch-funded Mercatus Center
at George Mason University, although she hasn’t authored a paper in
years. While the Gramm family has faded somewhat from the public eye,
their actions have radically changed the global economy. Since the
Koch-Gramm-Enron deregulation bonanza, non-commercial oil speculators
have flooded the market and increased the price volatility of oil in
leaps and bounds, hurting consumers and businesses across the globe
while making a small set of oil barons and financial giants very rich.
A McClatchy investigation found: “Prior to the 1990s, speculators made
up about 30 percent of the futures market. In the latest reporting
period, the ratio on May 3 stood at 68 percent speculators to 32
percent users of oil.” The following chart illustrates the dramatic
changes in the oil speculation market following the Koch-prescribed
deregulation campaign, and how non-commercial speculators have pushed
the price of oil higher and higher:

Michael Greenberger, a former top staffer the CFTC, explained to me
that a common misperception is that oil companies are only bonafide
hedgers, meaning they only participate in the futures market to lock-
in prices for delivery of their product. With the exception of
ExxonMobil, which has explicitly stated that it does not engage in
speculation, all the major oil companies (Shell, BP, Occidental, etc)
operate like Wall Street investment banks and use their privileged
position in the oil market to make speculative bets on the price of
oil. And as the unregulated oil market has grown, investment banks
like JP Morgan and Morgan Stanley have become more like oil companies,
buying tankers, pipelines, oil containers, and other physical assets
to give them an edge while betting on oil. The Koch contango strategy
detailed by ThinkProgress is not limited to Koch Industries either —
Shell for instance is known for buying up cheap oil, storing it in
tankers, and betting on future prices as they reserve the oil from the
market.
Tyson Slocum, an expert on oil speculation at Public Citizen, has
called Koch one of the worst actors when it comes to oil speculation.
Koch, Slocum explained in an interview with ThinkProgress, is unique
because of its status as a political powerhouse as well as a
speculator with operations all over the world.