From Inventing Oil Derivatives To Deregulating The MarketIn 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 House overwhelmingly 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 was rewarded 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.