Kochland Quotes

One of the key lessons that Charles Koch took from the Austrian economists von Mises and Hayek was that markets never stood still. The status quo never survived. Markets always build up and then tear down. It was an evolutionary process that never ended, and companies that tried to fight the process would only be devoured by the forces of change in the end.

The entire food system appeared to be one immense machine that laundered energy from fossil fuels into food calorie energy that humans could eat. At the beginning of the supply chain was the fossil fuel—gasoline used by tractors and natural gas used to make nitrogen fertilizer. The next link of the chain were farmers raising crops and animals, using the fossil fuels as they went. After that came the food processing industry, like the grain mills and slaughterhouses. Finally, there were the grocery stores and restaurants that distributed the final food products. Koch Industries planned to insert itself into every link of this chain. Charles Koch had made his company the single largest purchaser of American crude oil in the span of a decade. Now his company might be able to do the same thing with food.

Such a rich price was impossible for Purina’s management to deny. “Koch came along, and they made a huge offer for the stock,” Sumner recalled. “That’s the whole reason it was sold. People wanted to cash out. We were all led to believe that this was going to be a great thing.” Koch made one pivotal decision when it bought Purina: it financed almost the entire deal through debt. This was a stark departure from earlier deals, when Koch had used its own cash reserves to buy new businesses. It was extremely difficult to borrow hundreds of millions of dollars from one place, so Koch Industries went on a road show of sorts, convincing different groups of bankers to lend it money for the Purina deal.

Purina’s exposure to the hog business was not limited at all. The volatile markets exposed that fact. In 1998, the US hog market experienced a shock comparable to the stock market crash of 1929—a market convulsion that obliterated all the rules everyone thought applied to the business. The root of the problem could be traced to the very industrialization that created Purina Mills’ feed business in the first place. Now that hogs were raised on factory farms, the supply of animals was enormous and inflexible. Farmers were raising herds of tens or even hundreds of thousands of pigs. When prices started to fall, these industrial farms couldn’t adapt quickly. They had mortgage payments to meet on the big pig houses, and they needed to keep production high. Factory farms were a machine that wasn’t easily turned off. The flow of pigs continued into the slaughterhouses, and prices fell even further. Then everything spun out of control. Hog prices plummeted, sucking the entire business into the ground almost instantly. The price of hogs fell from about 53 cents per pound to 10 cents per pound in a matter of months. When adjusted for inflation, this was the lowest price for pigs in US history. It cost far more to raise a pig than the animal was worth. Purina Mills should have been insulated against this crisis. It only sold feed, not the hogs themselves. But with its decision in 1997 to start buying baby hogs, Purina had exposed itself to the risk of falling pork prices. Dean Watson began to discover just how large that exposure was. As one farm economist put it at the time, the rational number of hogs to own in 1998 was zero. Purina discovered this fact quickly. It bought baby hogs, and turned around to sell them to the farmers. But there were no buyers. The farmers refused to take them. “The people who we were supposed to be selling the pigs to were basically saying: ‘Sue me.’ The people we had bought the pigs from were saying: ‘You’re not getting out of my contract or I am suing you,’ ” Watson said. “All of this ownership risk that I was assured didn’t exist started to just come out of the woodwork.

strength was knowledge. Charles Koch had built an organization that learned, and learned constantly. Every transaction was a data point, every relationship was a conduit for information, every business unit a listening post. At Charles Koch’s direction, the company had filled whole rooms of its basement with computers and processing power, the ability to churn and analyze mountains of information. Koch built a company around learning.

The evidence of past mistakes was still everywhere in 2000. Koch Industries was still carrying the accumulated litter that was left behind by countless Value Creation Strategies, years of acquisitions, and rapid growth. As Koch reviewed its holdings, one executive described the corporate structure as representing a table piled high at a rummage sale, full of odds and ends that had no apparent rationale for belonging together. Koch began to unload these properties, selling off pipeline holdings like the Chase Transportation Company. It sold a chemical firm called Koch Microelectronic Service Company and closed down a new $30 million chemical plant in Bryan, Texas. Over a period of years, Koch would sell off thousands of miles of pipelines. The corporate odds and ends were discarded. The remaining businesses at Koch were restructured and streamlined. The most important division, Koch Petroleum, was renamed Flint Hills Resources and given new leaders. Other businesses were consolidated under a new, simplified structure that put them under the umbrella of a few new companies like Koch Minerals, Koch Supply & Trading, and Koch Chemical Technology Group.

The company created a new team of top executives called the business development board, whose sole job was to look for other companies to buy. This group was essentially a reincarnation of the central development group that Brad Hall had overseen in the late 1990s, but it was restructured in a way that made it larger, more influential, and capable of closing deals that were larger by an order of magnitude than anything Koch had done before. The new development group rivaled any deal-making entity on Wall Street. The team had a steady river of cash to work with thanks to the steady flow of money generated at Pine Bend and other assets. The team also made use of Koch Industries’ nearly pristine credit rating,I which made it cheap and easy to get big loans. Even this new strategy—to push for growth and limit risk with a corporate veil—rested on a deeper, more important idea. This idea was the centerpiece of Koch’s new game plan, which relied on one competitive advantage more than any other: Koch’s superior information. Koch was seen by outsiders as an energy company, but, within the firm, it was seen quite differently. Charles Koch and his lieutenants considered Koch to be an information-gathering machine that built up stores of knowledge that were deeper and sharper than its competitors’. This strategy traced back to Koch Industries’ earliest days, but with the new business development board in place, it reached the level of a fine art. Koch’s newly designed companies, like Koch Minerals, each had their own mini development teams that became like searchlights, trained on the various industries in which they operated. Whatever they saw and learned was transmitted to the central development board, which synthesized the information with knowledge that was flowing in from Koch’s other companies. The development board also undertook studies of its own, looking for new opportunities beyond the existing Koch universe.

In the futures markets, they bought and sold paper contracts. Futures contracts had been around for more than a century and were an integral part of the food system. Corn, pork, and soybean futures were traded on the Chicago Board of Trade. The NYMEX specialized in eggs and butter. The futures market wasn’t big—traders in the market tended to be farmers and big grain millers. They used futures contracts to limit their risk. The owners of the NYMEX weren’t content with their sleepy corner of the financial world, and they decided to expand their business and sell contracts for new kinds of products. The NYMEX introduced the first futures contract for crude oil in 1983. At first, the birth of oil futures contracts looked like a threat to Koch’s business model. Howell and his team spent years figuring out how to be the smartest blind men in the dark cave of the physical oil business and making the best guess as to the real price of oil. Koch Industries had gained an expertise in exploiting the opacity of oil markets and wringing the best price out of its counterparties. The new oil futures contract created something that was anathema to this business model: transparency. When the NYMEX debuted its oil futures contract, it created a very visible price for crude oil that changed by the minute on a public exchange. Again, this wasn’t the price of real crude; it was the price for a futures contract on crude, reflecting the best guess of all market participants as to what a barrel of oil would be worth in the future. Even though the futures price wasn’t the real price, it provided everybody with a common reference point. Now, when Koch called up someone to buy oil from Koch’s tank farm in St. James, that customer could look at a screen and start haggling based on what the markets in New York were saying the price of oil was worth. “It was the first time that there was a common, visible market signal,” Howell said. “It just kind of sucked the oxygen out of the room for that physical trading.

But even the biggest Wall Street banks were at a disadvantage when they went up against the traders at Koch Industries, British Petroleum, or Amoco. The Wall Street banks didn’t have access to inside information. Goldman Sachs didn’t own refineries or pipelines and couldn’t get a sneak peek into where markets were headed. The banks had to resort to second-rate information that was publicly available, like government reports on monthly energy supplies. It was a losing proposition. In the mid-1990s, the Wall Street banks came to Koch Industries, asking for help. “We kept getting approached by banks, who say, ‘Hey, Koch. You guys are so good at this physical stuff, we’d like to partner with you,’ ” recalled a former senior Koch executive who was heavily involved in trading operations. The banks came to Koch with the same pitch: the banks would handle “all this financial stuff,” while Koch handled the physical end of trading and shared information from its operations. If Koch executives were flattered by the attention from Wall Street, they didn’t show it for long. “We kind of got curious—or, suspicious is the better term,” the executive recalled. Rather than help the banks out, Koch set up a team to study why the banks were so interested in their business. Koch hired the outside consulting firm McKinsey & Company to study what was happening in commodities markets during the 1990s. McKinsey reported that the world of trading had grown even larger and more profitable than Koch Industries had suspected. As it happened, the futures contracts that Koch was trading had become the “plain vanilla” products in a rapidly booming market. Now there were more exotic, more opaque, and far more profitable financial products on the market. These products were called “derivatives.” That’s where the real money was.

After their trip to the Pink Palace, Hannan and his team agreed to buy Georgia-Pacific’s two major pulp mills. Koch Industries formed a new shell company, called Koch Cellulose LLC, which took possession of the two major pulp mills for $610 million.I This acquisition would have been among Koch’s biggest in the 1990s, but in 2003 it was just a down payment. Charles Koch favored a trading strategy that he called “experimental discovery.” It entailed making a small bet in a new market and seeing if the bet paid off. Even if a Koch trader lost money on the trade, they gained insight. If they made a profit, the bet could be expanded.

Charles Koch gained confidence from the pulp mill experiment. He was so confident that just a year after buying the pulp mills, Charles Koch was considering a plan to buy all of Georgia-Pacific outright and take the company private. Koch Industries could apply the same techniques to the entire company: 10,000 percent compliance, targeted investment, and flexible management that didn’t focus on quarterly results. But Georgia-Pacific wouldn’t come cheap. The company would cost at least three times the $4 billion Koch paid for Invista, and it would require multiple billions of dollars in debt. Charles Koch hated debt.

To make a debt-fueled deal work, private equity firms hunted for companies that were struggling, but produced a lot of cash. The equity firms then borrowed huge sums of money to take the target company private and then used the cash flow to pay down the debt. The plan was brilliant in its simplicity—the private equity firm borrowed other people’s money, then used other people’s companies to pay that money down. Once the debt was paid down, the private equity firm still owned the company itself.

The fleet Dubose oversaw initially consisted of five large barges. They each carried about 8,500 barrels of oil. Each barge had a skipper and crew who lived on the craft while it traveled from port to port. The first matter of business that Dubose focused on was keeping costs down. Fuel was the largest cost the barges incurred. Rather than let the skippers fuel up the ships when they wanted to, Dubose required them to call his office when they were running low on gas. Then he would call the local ports and find the best price for gas, sending the skipper to the best location. This helped cut costs right away. The tools from Deming helped Dubose go even further. Of all the charts he learned to make, he found that by far the most useful was called a run chart. Even decades later, he’d talk about run charts as if he were discussing a cherished family pet. “The best chart out of all of them . . . is that old-fashioned run chart. It’ll tell you where you’ve been and where you’re going,” he said. A run chart broke down all the costs that a barge would incur. It had a separate category for each cost: groceries, fuel, maintenance, ship damage, and supplies. The run chart allowed you to track these costs as they shifted from month to month, letting you see “where you’ve been and where you’re going.” Dubose was taught to look for cost spikes. The reason was simple: you figured out what caused costs to spike, and you avoided it. Then you figured out what caused costs to fall, and you replicated it.

When he was put in charge of Koch’s development group, Brooks was given one of the most important jobs at the company. The development group would be an acquisition machine. It would work full-time to identify new companies for Koch to buy and new deals in which to invest. The group would formalize Sterling Varner’s instinct to scan the market for new opportunities. The development group was a central hub to which all Koch employees could send potential deals that they’d spotted. Senior managers in every division at Koch were taught to act like scouts in the marketplace, and when they found a deal that was large enough and promising enough, they passed it up the chain of command to the development group for approval.

The machinery and supply chains that Dubose oversaw were exceedingly complicated. But the economic rules that he lived by remained relatively simple. The rules had not changed for him since he had been an oil gauger roving the backwaters of the bayou on a skiff back in the early 1970s. Dubose knew that his career still hinged on whether he was over or short. When he was an oil gauger, Dubose made sure he was over when he drained small oil tanks. Now he had to make sure he was over on a shipping network that covered many states. The reasons for this had to do with the nature of the pipeline business. Koch made its money in the transportation business by moving oil, not just by selling it. The actual value of the oil in its pipeline was of secondary importance to Koch Industries. What really mattered was ensuring that the oil was moving. When the oil was moving, Koch was paid to collect it and to deliver it. This means that Koch was somewhat protected from the volatility in prices that continued to roil markets during the 1980s.

O’Neill honed his trading strategies over the year. And he began to make one bet more than any other. He didn’t bet that gas prices were going to rise, and he didn’t bet that they were starting to fall. He just started betting that they would be volatile. He did this by snapping up options and then snapping up their underliers in the futures markets, buying them and selling them in a way that stripped out the price component of the bet. He didn’t want to bet on price. He wanted to bet that the price was going to change and change more than people expected it to. One reason he kept betting this way was because it kept making money. After the natural gas markets were deregulated, volatility started to become the norm. The sleepy days of price controls were over, and now the price could shoot up or down in minutes. That’s why, when he came into work in the early winter months of 2000, O’Neill started to get excited. He was starting to see a very large play unfolding, one that would dwarf anything he’d attempted at Koch before. All of the data that he’d amassed was pointing in one direction as the weather got colder in January and February. All of the signs were pointing toward unprecedented volatility.

only became apparent years later that Attack of the Killer Tomatoes! was prophetic in important ways. The movie captured the spirit of the age, and it documented the kind of political struggles that would eventually ruin Peace’s political career. At its core, the movie is about government incompetence and institutional decay. The tomatoes make only a few cameo appearances as they attack Californians enjoying the fruits of American middle-class life. What’s more important is the fact that the tomatoes were unleashed by incompetent government scientists working at a top-secret USDA test plot, who accidentally create a strain of lethal fruit.

In 1996, Koch Industries created a nonprofit group called the Economic Education Trust. The group did not need to disclose its donors because it was not ostensibly a lobbying or campaign finance organization. Koch funneled money through the Economic Education Trust to state and federal campaigns in Kansas and other states where it did business. In October of 1996, the Economic Education Trust gave $1.79 million to a company in suburban Washington, DC, called Triad Management Services Inc. Triad was supposedly a political consulting firm, but it had a strange business model: it offered its services for free, to Republican candidates. A US Senate report in 1998 concluded that Triad was “a corporate shell funded by a few wealthy conservative Republican activists.

The Senate report laid out a basic picture of the money trail: (1) Koch Industries supported the Economic Education Trust; (2) that trust gave cash to Triad; (3) Triad gave the cash to campaign groups like Citizens for Reform, which, in turn, (4) pumped money into elections to defeat Koch Industries’ opponents. (Koch Industries also gave at least $2,000 directly to Triad.) Triad was a new kind of campaign finance machine. It acted as a third party that didn’t directly donate money to politicians. Triad hired consultants who created attack ads for Republicans in tight races. Triad was careful in its language. It never used words like “vote for,” “support,” or “defeat” that might have triggered oversight from campaign regulators like the Federal Election Commission.

In typical Koch fashion, the company developed a specific strategy to grow, one that came complete with its own vocabulary. The framework was called the Value Creation Strategy, or VCS. Every Koch business leader was expected to create their own Value Creation Strategy. They needed to look for new companies to buy, new plants to build, and expansion projects for existing plants. This wasn’t exactly new—growth was ingrained in Koch’s DNA from the beginning, when Sterling Varner encouraged his employees to keep their eyes peeled for investment opportunities. But the VCS regimen was different. Business leaders knew that Charles Koch would cut or increase their bonus pay based on the Value Creation Strategies they delivered. Expansion was once applauded; now it would be required. This change rippled out through the ranks.

Running the fertilizer division might have seemed like an insignificant job to people outside of Koch. But Watson knew better. The fertilizer plant was an example of Koch’s strategy for “rapid prototyping,” a phrase that Watson used to describe Koch’s business experiments. Rapid prototyping was the process of trying new ventures on a small scale to see how they worked. It was the method that Koch used to branch out into different industries. Failure would be part of the process, so Koch kept its initial ventures small. Divisions like the fertilizer business were all learning laboratories.

Koch Agriculture first branched out into the beef business, and it did so in a way that gave it control from the ranch to the butcher’s counter. Koch bought cattle feedlots. Then it developed its own retail brand of beef called Spring Creek Ranch. Dean Watson oversaw a team that worked to develop a system of “identity preservation” that would allow the company to track each cow during its lifespan, allowing it over time to select which cattle had the best-tasting meat. Koch held blind taste tests of the beef it raised. Watson claimed to win nine out of ten times. Then Koch studied the grain and feed industries that supplied its feedlots. Watson worked with experts to study European farming methods because wheat farmers in Ukraine were far better at raising more grain on each acre of land than American farmers were. The Europeans had less acreage to work with, forcing them to be more efficient, and Koch learned how to replicate their methods. Koch bought a stake in a genetic engineering company to breed superyielding corn. Koch Agriculture extended into the milling and flour businesses as well. It experimented with building “micro” mills that would be nimbler than the giant mills operated by Archer Daniels Midland and Cargill. Koch worked with a start-up company that developed a “pixie dust” spray preservative that could be applied to pizza crusts, making crusts that did not need to be refrigerated. It experimented with making ethanol gasoline and corn oil. There were more abstract initiatives. Koch launched an effort to sell rain insurance to farmers who had no way to offset the risk of heavy rains. To do that, Koch hired a team of PhD statisticians to write formulas that correlated corn harvests with rain events, figuring out what a rain insurance policy should cost. At the same time, Koch’s commodity traders were buying contracts for corn and soybeans, learning more every day about those markets.

The development group that Brad Hall oversaw resembled these private equity firms in some ways. But there was a fundamental difference. Koch’s development group had patience. It thought on a timeline of ten or twenty years, not twelve to eighteen months. And, unlike virtually any other private equity firm, Koch’s group had only two shareholders to answer to: Charles and David Koch. For these reasons, Koch made acquisitions like nobody else. It tended to rush into markets when others were leaving. It tended to buy companies only when they were distressed and no one else wanted them. Koch was accustomed to the wild volatility of energy markets, so the company knew that most downturns were temporary.

Starting sometime in 1997, before Koch Industries bought the company, Purina Mills had hatched a plan to boost hog feed sales by purchasing baby pigs and then providing them to farmers to raise. The farmers agreed to feed the pigs Purina products. The company had locked in guaranteed sales, and it was easy money for a while. So Purina expanded the program. It provided more pigs under contract to big companies like Tyson Foods, selling more feed and then buying even more pigs. By the end of 1997, Purina effectively owned six million pigs, making it one of the largest hog producers in the nation. When Koch purchased the company, it missed this fact because it hadn’t looked closely enough. The deal was too hurried; growth had taken precedence over diligence. By 1998, Purina Mills was on the hook to purchase about $240 million worth of hogs that had literally zero financial value.

True knowledge results in effective action,” as Charles Koch liked to say. Pouring money into a failing business venture like Purina Mills would not change the market’s verdict. Doing so would only steer that money away from other ventures where it could be more profitably invested. It was better to let the thing die, no matter the short-term pain that might be inflicted. This was one of the principles of Market-Based Management. What good were principles if you abandoned them when tested? In late August of 1999, Koch Industries informed Purina that it would get no extra money from Wichita. Koch owed Purina nothing. Soon after, Purina failed to pay $15.75 million in interest expenses that were due. Two weeks later, it failed to pay $2.1 million in principal payments. When Purina blew through its payment dates and became delinquent, it set off a cataclysmic chain of events. The banks accelerated their payment demands rather than giving Purina more breathing room. The lenders were desperate to get whatever money they could while the firm was still solvent. The frenzy only ended on October 28, when Purina filed for bankruptcy.

Koch appeared to have structured the deal in a way that protected it from the bankers’ claims. Koch used debt that was called “non-recourse” debt, meaning that lenders could not collect the debt from Koch Industries itself—they had no recourse against the parent company. They could only collect debt against the assets of Purina Mills. But there was a way around this clause. It was called “piercing the corporate veil.” Piercing the corporate veil is one of those arcane strategies known only to a small subset of deal makers and lawyers whose careers took off during the merger boom of the 1980s and 1990s. A banker can pierce the veil by showing that nonrecourse debt was actually a sham used by a borrower to escape liability. For nonrecourse debt to be justified, the parent company needed to be truly independent from the entity borrowing the money.

It kept him on edge, and this was the key to thriving in the private equity economy. The heavy debt required ever-better performance and leaner operations. The pressure to achieve this never stopped. It was transmitted from Charles Koch, to Jim Hannan, to the cadre of executives who worked around him. Then, perhaps most importantly, it was transmitted down the chains of command to the ground level of Georgia-Pacific.

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.

Charles Koch did, this new effort carried its own slogan: “10,000 percent compliance,” meaning that employees obeyed 100 percent of all laws 100 percent of the time.II This slogan might have seemed banal, even empty, to Koch Industries employees in the beginning. There isn’t a company in America that doesn’t profess to obey the law. But the glib nature of the slogan was deceiving: it represented an entirely new way of operating. Koch Industries expanded its legal team and embedded them into the firm’s far-flung operations. Now if process owners like the managers at Pine Bend decided to release ammonia-laden water into nearby waterways, they often had to first consult with teams of Koch’s lawyers. Koch’s commodity traders consulted the legal team when devising new trading strategies. Teams of inspectors from the legal department descended on factories and threatened to shut them down if managers couldn’t prove that a valve had been properly inspected. The mandate to comply with the law was very real, and it served a strategic purpose. Koch would keep state and federal regulators off its property.

Back then, Ron Howell’s job might have seemed easy enough: he sold the gasoline and other fuels that Koch Industries produced at its refineries. As the senior vice president of supply and trading at Koch, Howell made sure that Koch’s fuel went straight from the refineries to the highest-paying customer. Gasoline was the kind of product that seemed to sell itself—there was always demand for fuel. People at Koch referred to Howell’s job as the “dispossession of molecules,” meaning that he simply had to find a home for the various fuels that Koch produced. This seemed straightforward. But Howell’s job was the kind of job that produced insomnia and ulcers. It forced him to retire when he was in his thirties before the job killed him. When he talked about oil trading, even decades later, Howell often used words like whippin’ and savage. The savagery of Howell’s average workday began when he walked into the office in Houston every morning and picked up the phone to sell the first barrel of gasoline or diesel fuel. The stomach acids started to boil the instant Howell tried to establish what might seem like a basic, simple fact: the price of oil that day. Determining the price of oil at any given minute was an arcane art practiced by a network of traders around the world. They spent their days on the phone with one another, arguing, cajoling, bluffing, and bullying. The fact is that nobody really knew the price of a barrel of oil, or gasoline, or diesel fuel. Everybody had to guess, and the person who could guess with the most precision walked away with profits that were almost limitless. The person who guessed wrong faced instant, brutal downsides in the market. There was a common misperception that the price of oil floats up and down on a global market. Every day, business commentators and journalists talked about the “price of oil” as if it were like the price of General Electric stock—a price that was determined by millions of buyers and sellers who traded on large, open exchanges. In fact, there was no global market for oil. Oil was bought and sold inside a constellation of thousands of tiny nodes where transactions and prices were totally hidden to outsiders.

There were, of course, a handful of “speculators” in the early days of the oil markets. These were people who bought oil without ever expecting to actually handle it or deliver it. They were making a bet that they could sell their contract at a higher price before the time came to load a barge. This was a dangerous game. A trader like Howell might be able to sniff out a speculator and simply refuse to buy the oil contract off his hands, putting the speculator in a desperate position because he knew he couldn’t actually take delivery of all that oil. A trader like Howell could hold out until the speculator was forced to give away the oil for pennies on the dollar when it came time to accept delivery. This was a well-known trading maneuver called “the squeeze,” and it was a pitiless tactic that could financially ruin a person in a matter of hours. Traders like Howell (and his counterparts at Chevron and Exxon) were more or less immune to the squeeze. Howell could accept delivery of the barrels of oil, maybe at a loss, but not at a catastrophic loss.

Farmland’s plants had a key advantage: they were located right next door to their customers—the farmers. This gave them an edge on transportation costs. If these plants closed, there would be a dramatic fertilizer shortage. It would be simply impossible to import all the fertilizer that midwestern farmers needed. The Farmland plants were similar to Koch’s oil refinery in Pine Bend. They were perched on exclusive real estate, giving them an advantage over their competitors. Demand wasn’t going to disappear, and it wasn’t feasible for new competitors to set up shop nearby. Perhaps most important, nobody else in the marketplace attributed this value to the Farmland plants. When Farmland put the plants up for sale, the co-op got very little interest. There were two big, publicly traded fertilizer companies that seemed like natural buyers, called Agrium and CF Industries. But these companies were also embroiled in the natural gas crisis and seemed obsessed with their quarterly losses and the near-term economics of the fertilizer business.

He was tall and thin, with a head of thick, dark hair, and spoke with exacting precision. Soliman was considered a “talent sifter,” meaning that he hired young and bright employees, put them in profoundly challenging positions, and fired the traders who couldn’t handle the challenge. This talent sifting was a vital part of Koch’s strategy to build a trading floor from scratch during the late 1990s and early 2000s.

Koch hired teams of analysts who worked alongside each trader to provide reams of data and analysis. The importance of this analysis was reflected in Koch’s pay structure—the company changed its payment structure so that profits were split between the trader and her supporting team of analysts. This put the analysts on equal footing with the traders. Melissa Beckett, who worked on several of Koch’s trading desks as both an analyst and trader, said Koch was unique in this regard. Other trading shops might consider analyst reports to be an afterthought; at Koch, those reports were the bedrock where a trade began.

While traders might have seen what was coming, it appeared that the general public did not. O’Neill saw a gap in the market in early 2000. A giant gap. The price of gas options was cheap—too cheap to account for what was apparently coming down the road. In other words, the insurance policies against a sudden price spike were not as expensive as they ought to have been. So O’Neill started snapping up the options and holding on to them, knowing that they would become more valuable. As usual, he wasn’t just making a bet that prices were going to go up. He was primarily betting that markets were about to become more volatile. He built up a large position with his natural gas options and underliers that was “long volatility,” meaning that he bet volatility would increase. He assumed that the positions would provide a good return for Koch Industries. He was wrong. He grossly underestimated the riches that the coming volatility was about to deliver. Senior executives in Koch Supply & Trading realized that they could no longer pay their traders like engineers. There was a competition for talent, and too many well-trained people were bleeding off the Koch trading floor. There was one person who seemed to resist big paydays for the traders: Charles Koch. The business failures of the 1990s impressed on Charles Koch the need for humility among his workforce. The thinking went that it was the high-flying ambition and loose planning that led to many of the business losses at Purina Mills.

Charles Koch understood now that he needed a political operation in Washington. Up until that point, he operated as if he could stay out of the miasma of the nation’s capital, staying true to his libertarian beliefs and focusing his efforts on the business in Wichita. This left Koch vulnerable. When Ken Ballen was conducting his investigation, he was contacted frequently by high-paid attorneys and experts who worked for companies like Exxon and Chevron. They defended their clients and even helped focus attention on Koch Industries. Koch had no such presence. This would change in the early 1990s.

During this decade, one of the most important features of the new Koch Industries was the impervious strength of its corporate veil—the legal barrier that separated Koch’s various divisions. Under the new structure, Koch Industries became little more than a holding company, a big investment firm that owned a lot of smaller, nominally independent firms. And those companies would be strictly segregated from one another, and from Koch central, by a thick wall designed to be legally impenetrable. The corporate veil became reflected in the vocabulary of Koch employees. They didn’t refer to the company’s subsidiaries as units or divisions, but as “companies,” reinforcing the notion that each unit was fully independent. Many of these “companies” developed their own internal systems for human resources, information technology, and other services, creating just the kind of big, redundant systems that most US corporations were striving to eliminate. These redundancies might have cost Koch money, but their value far outstripped the cost. Koch could now argue persuasively that each company division was a stand-alone company, one that could assume its own liabilities. Never again would angry creditors be able to threaten the cash reserves of Koch Industries’ central treasury, as the lawyers from Purina Mills had done. Now liability would only travel to the top of each company that Koch held.

while the world was looking elsewhere, Koch Industries built a financial trading desk that rivaled anything operated by Goldman Sachs or Lehman Brothers. Koch Industries, known for crude oil and natural gas, became a world leader in making and trading some of the most complex financial instruments in the world. Koch’s trading business was a strategic centerpiece of the company’s growth strategy over the next decade. It was also the most striking example of Koch’s ability to amass and exploit information asymmetries, learning more than everyone else and turning huge profits from this advantage. There were no markets more complex and more opaque than the trading markets born during the Bush administration, and Koch Industries mastered them.

As he watched his traders run from office to office, Howell had a pivotal realization. Every time a trader sold a barrel of oil, the transaction produced an ultravaluable by-product: information. Each sale was a price signal. And as Koch bought and sold hundreds of thousands of barrels of fuel around the world, it began to accumulate this ultravaluable information in one place. This information could then be paired with yet more ultravaluable information that only Koch Industries had access to: the huge output of price signals that were generated by Koch’s oil refineries and pipelines. These physical plants gave Koch’s traders a window into the future. Koch knew, for example, when it was about to shut down the Pine Bend refinery for repairs, or when it might be shutting down a pipeline. When this happened, Howell’s traders could start gaming the downstream effects on local energy markets—all those opaque nodes that would be affected. And they could do this before any other traders even knew it was happening. There is no way to overstate the value of this kind of inside information.

In the stock market, it is illegal to trade on inside information. If a CEO knows that her firm is about to buy a smaller competitor, she cannot go buy shares of that smaller firm before the news is publicly announced and the shares jump in value. The idea behind the ban on insider trading is that it makes the markets an even playing field for ordinary investors. Futures markets are different. When regulators built the modern futures markets during the 1930s, in fact, they wanted traders to use inside information when they bought and sold futures. This way, the thinking went, the markets would quickly reflect the most accurate price possible. When traders used inside information to buy or sell contracts, their actions would quickly send price signals to everyone else. While it was legal to use inside information in the futures markets, the power to do so was concentrating into fewer and fewer hands during the 1980s. Koch Industries was one of relatively few firms in the world that was able to ship oil by the barge load while simultaneously making bets in the futures market about what would happen when that barge load of oil arrived on shore. Koch exploited this advantage to the fullest extent.

OTC stands for “over-the-counter,” which basically meant it was a contract that wasn’t defined by the rules of an exchange. It was just a contract between two parties, tailored specifically to their needs. A futures contract, by contrast, had to meet certain criteria set by the exchanges like the Chicago Board of Trade.

The Target Company Had to Be Distressed Koch was only interested in buying companies or assets that had fallen on hard times. Part of the logic behind this was simple: distressed companies were cheaper. They could be purchased at a discount. But the company had to be distressed in the right kind of way. Ideally, the firm should to be distressed because of managerial negligence or poor decision-making. That way, Koch could reverse the poor strategies when it was the owner. The goal was to improve operations and profits at the distressed firm to boost its value. When that happened, Koch could hold on to its new profit-making machine or sell it. 2. The Deal Had to Be a Long-Term Play Koch wasn’t looking to buy and flip companies. The deal needed to make sense over the five-, ten-, or even twenty-year time frame. This played to Koch’s advantage as a private firm. It could hold an asset through the stormy weather of commodities cycles, improving the underlying investments along the way until they were worth much more. This long-term strategy would open the door to a raft of acquisitions that other firms would not consider. Publicly traded firms, and even private hedge funds, looked for deals that showed a return within one to two years. Koch would face far less competition for the deals that paid off over many years later. 3. The Target Company Had to Fit with Koch’s Core Capabilities In the new era, Koch would stick to its knitting. It would expand into new industries only if the new line of business closely resembled something Koch already did. If Koch didn’t know how to do a certain business process better than its competitors, then it would stay out of that business. New acquisitions had to build on Koch’s expertise and had to branch out from the company’s current strength.

To acquire Georgia-Pacific, we took it deep into debt—to the point where unless performance improved, Georgia-Pacific would be in violation of its loan covenants,” Charles Koch later wrote. Now debt became a virtue rather than a burden, a force that established motivation and self-sacrifice among those who carried it. Koch Industries announced its plan to take Georgia-Pacific private in mid-November of 2005. The deal made Koch the largest privately held company in the nation.III Koch would be adding fifty-five thousand new employees to its workforce of thirty-three thousand, more than doubling the company in size once again. Jim Hannan was quickly informed that his services were no longer needed at Invista. He would move to Atlanta and help Koch absorb the largest acquisition in its history.

All of these information streams were centralized, analyzed, and then shared widely within Koch’s trading group. The purpose of gathering all of this information was to find “the gap,” as Koch’s traders called it: the gap between reality and what the market believed was reality. Koch gathered enough information to get a sharper picture of reality than its competitors. Then it placed bets that would make money when the market corrected itself, closing the gap, and came closer to the real-world conditions

Ron Howell founded an obscure nonprofit group called Oklahomans for Judicial Excellence. It did something unheard of: it started grading local judges based on their fealty to free-market economic theory. The group created scorecards for state judges, measuring how well their verdicts conformed with the teachings of Hayek and von Mises. The group publicized these rankings with public opinion articles published in places like the Daily Oklahoman.

Its efforts are coupled with a nationwide army of activists and volunteers called Americans for Prosperity, along with a constellation of Koch-funded think tanks and university-based programs. Charles Koch’s political vision represents one extreme pole in the ongoing debate about the role of government in markets; a view that government should essentially protect private property and do little else.

Koch Industries would grow in a way that reflected Sterling Varner’s approach to business. Varner was “opportunistic,” in a way that Koch employees used the word, meaning that he was always looking for new deals that were connected to businesses in which he already operated. When Koch was shipping natural gas, for example, Varner pushed the company to build a specialized natural gas refinery in Medford, Oklahoma, to process the gas into liquid by-products. In this way, Koch could expand while building on the skills it already possessed. The gas refinery, or “fractionator” as they called it, became a huge moneymaker.

Charles Koch and Sterling Varner held quarterly meetings to evaluate how managers like Williams were doing in this regard. Williams was expected to report on his pipeline business and also to bring up new “high-quality investments” that he had spotted in the field.

A ritual was formed at these meetings. A manager like Williams would propose the idea for some new investment. And then the questions would begin. Charles Koch’s questions were relentless, seemingly never ending, and the managers understood that they must be prepared to answer all of them. If a manager didn’t have the answers, the topic was dropped until he could return with them. The rhythm of corporate life at Koch Industries began to revolve around these quarterly meetings. And the rhythm beat a steady message into every manager and every employee below them down the chain: grow.

The Koch method for oil measurement followed a few simple steps. First, Dubose dropped his gauge line to see how deep the oil was. If the gauge line said it was fifteen feet and two inches, Dubose would record it as fifteen feet and one inch. Already, this meant that Dubose was getting an inch worth of oil for free. This was called “cutting the top.” Then he measured the “gravity” of the oil, which determined its quality. The top-dollar crude oil fell within an API measurement of gravity between 40.0 and 44.9, so Dubose fudged the numbers to push it outside of that range. This way, Koch would pay the oil producer less for the oil, even if the quality was ideal. If the oil measured 40.0, then he would record it as 39.2, for example. After Dubose drained the tank, he would take his final depth measurement, which was recorded to show how much oil Koch had taken. If Dubose measured that fourteen inches of oil were left, he would record it as fifteen inches. This meant he was paying for one less inch of oil than he had taken. This technique was called “bumping the bottom.

Koch’s oil gathering division delivered a steady flow of cash and profits into the company. This money gave Charles Koch a chance to put his management theories to the test. He encouraged his employees to look for new growth opportunities and to act like entrepreneurs. He wanted to lead by example. In his first years as head of Koch Industries, Charles Koch put together one of the most brilliant and profitable deals in the history of Koch Industries. The deal involved an oil refinery. Since the late 1950s, Fred Koch had owned a minority share in the Great Northern oil refinery outside of Minneapolis, near the Pine Bend Bluffs natural reserve. The other shareholders in the refinery were an oil tycoon named J. Howard Marshall II and the Great Northern Oil Company. In 1969, the refinery didn’t look like a gold mine. Competition in the sector was fierce, with new refineries being put into production monthly. But the Pine Bend refinery, as everyone called it, had a secret source of profits. And this source of profits could be traced to exactly the kind of government intervention that Hayek hated most. In the 1950s, President Dwight Eisenhower capped the amount of oil that could be imported into the United States, in one of the federal government’s many ploys to protect domestic oil drillers. (Imported oil was often cheaper than domestic oil, so US drillers wanted it kept out.) But there was a loophole in that law that allowed unlimited imports from Canada. As it happened, Canada was the primary source of oil processed at the Pine Bend refinery. Pine Bend was one of only four refineries in the nation that was able to buy cheaper imported oil in unlimited quantities, giving it a huge advantage over firms that were forced to buy mostly domestic oil.

In 1969, Charles Koch executed a secret plan that would increase those profits beyond anything Fred Koch could imagine. Charles approached J. Howard Marshall and convinced Marshall to sell his share in the refinery in exchange for shares in Charles Koch’s newly created firm, Koch Industries. When that secret deal closed, Charles Koch was a majority shareholder in the Pine Bend refinery. He then approached Great Northern, now a minority shareholder, and convinced that company to sell its ownership stake. By the end of the year, Koch Industries was the sole owner of the Pine Bend refinery. Charles Koch saw something in the refinery that others didn’t see.

After everybody was settled, Paulson presented his offer. Koch would unilaterally rewrite all the work rules inside the refinery. The seniority system the union enjoyed would be gone. The rules that barred employees from doing work in different “trades” would be gone. The employee shuttle truck? Gone. The rule about a bonus payment for overtime without two hours’ notice? Gone. And then Paulson showed the union men that there would be precious little room for negotiation. These were the new rules. This was how things would work at the refinery. End of story. This might have seemed like a bluff; like a way for Paulson to start the contract negotiations with a Texas swagger. But after Christmas, and into the first frigid days of the new year, it became clear to the union that Paulson was not bluffing. He was not going to negotiate. In the eyes of the OCAW men, there was no choice as to what to do next. On January 9, 1973, at four in the afternoon, the entire unionized workforce left their stations and walked off the property grounds.

Paulson started making phone calls back to Texas, back to the oil-patch state where Paulson had friends and employees who thought the world of him. He called these old friends and asked them to come up to Minnesota to work. Shortly after the picket line was erected outside the refinery gates, Paulson arranged for helicopters to fly these workers into the refinery. The helicopters swooped in low over the refinery fences and landed on the refinery grounds to drop off his new workers from Texas and Oklahoma and other states where unions were not only rare but widely hated. Inside the main office building, Paulson converted a large room in the basement into a barracks for the new workers. On the picket line, the OCAW men watched as the helicopters passed over them, hovered, and landed inside, delivering the workers who would replace them. The picket line was becoming symbolic.

When the workers got violent, Paulson seized on their mistake. He went to court and filed a motion that would bar the OCAW from picketing in front of the refinery. Paulson’s lawyers argued that the OCAW’s property destruction and violence went far beyond the scope of legal union activity. A local district court judge agreed with the company and handed down a temporary restraining order against the union.

The sessions went on through the night. At one point, Paulson laid down on a conference table and fell asleep while waiting for the courier to return from the OCAW’s room. It was useless. Even prodding from the labor secretary could not push the two sides to an agreement. The kernel of the dispute still remained the work rules at the refinery. It was a fight over control, and neither side would budge.

Bernard Paulson and Charles Koch seemed to understand something intuitively. They understood that solidarity had its limits. The OCAW’s cohesion was unbreakable. But the OCAW would be weaker if it stood alone. In fact, it was doubtful if the OCAW would be able to stand at all if it was alone. Isolating the union would prove to be the only way to beat it. During the summer and fall of 1973, that’s exactly what happened.

Employees at the Pine Bend refinery remain unionized to this day.III But the strike of 1973 broke the union’s power. This fit into a pattern that was being played out across the United States between 1973 and 1993. Unions disbanded and broke apart. Solidarity became an artifact. The remaining unions became something like a shadow human resources department.

Oil imports nearly tripled between 1967 and 1973. With US demand for imports so strong, there was virtually no cushion of extra oil supplies on global markets to help absorb a shock to supplies. The Arab embargo kept about 4.4 million barrels of oil a day off the market: 9 percent of the total supply. For the first time in its history, the United States could not make up for the loss. The shock was unprecedented. Gasoline prices, which had hovered along at the same level year after year for decades, spiked. In some markets, crude oil prices jumped from $5.40 a barrel to $17 a barrel—a 600 percent increase in a matter of weeks.

Charles Koch aimed to build a corporation that would not only survive the brutal swings of the marketplace, but profit from them. He built a company that learned constantly from the world around it and prized information discovery above almost everything. It was a company that embraced change and hated permanence, one where every division would be up for sale all the time.

Oil that was drilled in Texas or Saudi Arabia, by contrast, was known as “sweet” crude because it had very low sulfur content. This made it a lot cheaper and easier to process—you didn’t need coker towers to take the sulfur out. So many of America’s oil refineries sprang up around the Gulf Coast because that’s where sweet crude was imported and processed. Very few firms wanted to install the kind of expensive equipment that ran at Pine Bend, but Great Northern had done so. When Paulson took over, Pine Bend was one of very fewer buyers in the upper Midwest that offered to buy Canadian crude. Because there were so few buyers, the Canadian crude piled up—there was an excess of supply. This meant that prices dropped. Koch could buy the sour oil at a price that was significantly lower than oil prices elsewhere in the United States. But the cheap Canadian crude was only half of the equation. When Koch turned around to sell the gasoline it made at Pine Bend, it sold that gasoline into a midwestern region where there were very few other refineries, causing supplies to be relatively tight and prices high. This made the economics of Pine Bend almost too good to be true.

Paulson surveyed the market and saw one large competitor. There was a pipeline company called Williams Brothers, which shipped about a hundred thousand barrels of gasoline into the Minnesota area each day. Paulson knew that it cost about 6 cents per gallon to ship the gas from the Gulf Coast, where most American refineries were located. This meant that Koch had a 6-cent advantage over Williams Brothers that it could exploit. “I said, ‘We can expand. And we can dry up Williams Brothers,’ ” Paulson recalled. The strategy worked.

Bernard Paulson was often contacted by outside business consultants who offered to help him run Koch’s refineries. These were reputable men whom Paulson knew well, and he knew that there was good reason to hire them and borrow their expertise. But hiring them would have required Paulson to show them how Koch operated. Paulson would have to show them around the banks of computers inside the Wichita headquarters. He would have to share the computer models and explain how they were created. For this reason, Paulson always turned the consultants away. “I didn’t want people to know what we were doing,” he explained. “Because we did have a method that was, I thought, unique.

Varner must have recognized quickly that Markel was exactly the kind of person that Charles Koch was searching for to fill the corporate ranks. If there is a single example of the prototypical Koch employee, it was Lynn Markel. He was born and raised on a farm outside of Dodge City, Kansas, so he was accustomed to a seven-day workweek. He attended Kansas State University and had no illusions that a college degree conferred on him anything more than the right to work hard for a living. After graduating, he became an officer in the US Air Force, where he served for four years, so he learned to think of himself as part of a larger organization and put the needs of his teammates before his own. Markel had moved to Wichita right after his stint in the air force to work as a financial controller with the Cessna Aircraft Company. Working for a large, publicly traded firm hadn’t agreed with Markel. There was a lot of bureaucracy to contend with; he wanted to be more entrepreneurial. He left Cessna and joined a large real estate firm that was expanding rapidly. But that firm went bust, and Markel landed in his current job as chief financial officer for the chain of television stations.

Like many other people at the company, Markel was struck by just how fluid, how adaptable, things were at Koch. There were about two hundred people in the company headquarters, and more were being added every day. It was a big company by Wichita standards, but it didn’t feel like a big company. It felt like an ongoing experiment. Roles changed quickly. New hires were brought in. There wasn’t a bureaucracy to stifle people or hold back new ideas.

Charles Koch loved the idea, and so did Markel. Getting rid of budgets would instantly dispose of hours’ worth of drudgery that defined a financial controller’s life. Koch invented a new set of metrics to replace budgets. And the numbers that the company focused upon were telling. Charles Koch didn’t care much about sales or costs—he cared about profits. He wanted to know how profitable any line of business was and how profitable it could be under the right management. He steered all of his managers to think this way. The key thing they needed to focus on was the return on investment, or ROI—what was the best use of Koch Industries’ money? Soon each division was writing a profit goal for the quarter, rather than a budget.

To keep things moving up and to the right, Charles Koch had an unwavering philosophy about debt. He was rigid in his belief that debt should be kept as low as possible so that interest payments didn’t eat up Koch’s cash. The reasons for this were strategic. Every downturn brought opportunities for companies that were prepared. Downturns weakened competitors and made them ripe for takeover. Downturns made assets cheaper to buy. For this reason, Markel and his team were discouraged from borrowing large sums even if banks were more than willing to lend it. “It was really based upon kind of looking forward to opportunities,” Markel recalled. “The reason you like to build up cash and not have a lot of debt is so that you can capture opportunities that you couldn’t capture if you were fully loaded in debt and had no cash.

Koch made full use of this strategy. It began to profit from market downturns by snapping up its competitors. This was most evident in Koch’s giant oil gathering and pipelines division. Roger Williams, the vice president over pipelines, oversaw an expansion funded by the cash that Charles Koch was pouring back into the company.

He said that businesses needed to fight back, and not on the terms that were laid out for them by their opponents. The business community needed to wage a long-term campaign that would change the way Americans thought about the markets and the role of government. Koch said that the campaign should have four elements: 1) Education 2) Media outreach 3) Litigation 4) Political influence

employees felt like they owned a piece of Koch Industries. Charles Koch gave them performance-based bonuses and issued them “shadow stock” contracts that paid out as the company’s value increased, but that didn’t confer actual ownership. The real shares of Koch Industires were tighly held by Charles and David Koch, and a small group of relatives and associates. The vast majority of employees embraced this culture.

It didn’t take long for Koch to grasp a truth that was well known to Farmland executives, which was that nitrogen fertilizer sales were pivotal to the company’s business model in 1995. Koch also detected a weakness in Farmland’s business model. Farmland was a co-op, meaning that it was owned by thousands of members who also sold their products through the firm. It was a uniquely midwestern form of capitalism that blended community control with industrial scale. In this way, Farmland was the opposite of Koch Industries, which was tightly held by Charles and David Koch. Farmland was owned by thousands of farm families and small business owners who shared in Farmland’s annual profits and voted on its actions. But it also hindered Farmland—decisions were influenced by its member-owners, who considered factors beyond the simple return on investment. “It was Socialism,” as Koch Agriculture president Dean Watson put it. And Koch’s traders believed that Socialism was always destined to fail.

If Koch bought the Corpus Christi plant, Paulson realized, the acquisition would open up an entirely new market for the company: the market for paraxylene and other petrochemicals. And, true to Koch’s philosophy, the market would be new but not entirely foreign. Koch knew the petrochemical business already. It could apply the expertise developed at Pine Bend to manufacturing paraxylene in Texas. On top of all of this, it appeared to Paulson and others that Sun Oil wasn’t aware of the opportunity it was missing in Corpus Christi. Sun was making and selling paraxylene but not at nearly the levels that it could. In September of 1981 Koch Industries paid $265 million in cash for the refinery, and Paulson immediately started expanding it. He more than doubled its paraxylene output. He bought a used hydrocracking tower from a refinery in Europe and had it shipped to Texas, bragging to Charles Koch that he bought the tower for 40 percent of what it would cost “off the shelf.” Koch Industries became one of the largest paraxylene producers in the United States.

A group of academics devised a new way to think about corporations, called the “agency theory.” Under this new way of thinking, a company’s CEO wasn’t in the driver’s seat—he or she would simply be the “agent” of the shareholders.

Charles Koch insists on reinvesting at least 90 percent of the company’s profits, fueling its constant expansion. This strategy laid the foundation for decades of continuous growth. Koch Industries expanded continuously by purchasing other companies and branching out into new industries. It specialized in the kind of businesses that are indispensable to modern civilization but which most consumers never directly encounter.

The first pillar of the plan to fall into place was organizational. Almost immediately, Charles Koch set about restructuring the interlocking group of companies that Fred Koch had left behind. The confusing amalgam of corporate entities—the engineering company, the oil gathering business, the pipelines, the ranches—would soon be welded into a single entity. The second pillar of Charles Koch’s plan was physical: the company would be based in a new office complex. Before Fred Koch died, the company had offices in a downtown building that was named after him. But by a stroke of coincidence, that building was scheduled to be demolished just when Fred died, torn down in order to make way for an urban renewal project. In its place, Charles Koch oversaw the construction of new headquarters, this one on the far-northeast corner of town.

Koch Industries didn’t have to think quarter to quarter. The company thinks year to year. An internal think tank and deal-making committee, called the development group, will sometimes think through a business deal on a timeline measured in decades. This long-term view made Koch nimble where other companies stumbled. In 2003, for example, Koch Industries bought a group of money-losing fertilizer plants when no publicly traded company was willing to take the risk. Today those plants are as profitable as a broken ATM machine that spews out cash around the clock.

Elroy learned how to investigate large conspiracies for the FBI during the 1980s. To break open a large conspiracy, you start at the edges. You find the most vulnerable link in the large chain of corruption, and you exploit it.

The Arizona Republic story showed that the oil companies themselves were responsible for reporting how much oil they drilled on the Indian reservations: the companies would drill wells, pump the oil, and then report to the government how much oil they had taken out of the ground. The government was not effectively double-checking the companies’ reports to verify how much oil they were actually getting from the Indian reservations. The whole thing worked on an honor system, and the Arizona Republic alleged that firms were abusing it by consistently underreporting how much oil they pumped out of the ground. The stories said that oil companies were carting off at least millions of dollars in free oil every year.

In 1988, Koch Oil had taken 142,000 barrels of oil without paying for them and cleared pure profit on each of those barrels when it sold them. In 1986 and 1987, the other years that Ballen’s team investigated, Koch was over by 240,680 and 239,206 barrels, respectively. The second-highest overage of any other company in those years was the Phillips Petroleum Company’s overage of 2,181 barrels in 1987, still just 0.009 percent of Koch’s overage that year. The set of numbers was the only clear thing that the Senate team could determine about Koch. As investigators dug further into the company, they discovered an organization that seemed built to obscure its very existence. There was a reason that no one had heard of Koch Oil, even though the company operated huge pipeline networks and two major oil refineries (one in Corpus Christi, Texas, and the other just outside of Minneapolis, Minnesota).

To take just one example: Koch derives much of its profits from oil refineries. The entire economy depends on refined oil, but no one has built a new oil refinery in the United States since 1977. The industry is dominated by entrenched players who run aged facilities at near-full capacity, reaping profits that are among the highest in the world. A single refinery shutdown causes gasoline prices to spike across entire regions of the United States. The underlying cause of this dysfunction is a set of loopholes in the Clean Air Act, a massive set of regulations passed in 1963 (and significantly expanded in 1970) that imposed pollution controls on new refineries. The legacy oil refiners, including Koch, exploited arcane sections of the law that allowed them to expand their old facilities while avoiding clean-air standards that would apply to new facilities

David Koch, one of the company’s primary owners and executives, had run for vice president on the national ticket for the Libertarian Party in 1980. Its platform had called for the abolishment of everything from the US Post Office to the Environmental Protection Agency to public schooling.

The traders at Koch and Enron now had market power. What the lawmakers didn’t take into account back then was the peculiar nature of commercial electrons and electrical power. Unlike other commodities such as corn and oil, electrons cannot be stored. They must be transmitted and used in real time as they are created. This made the electrical grid particularly vulnerable to market power. The grid had to be expertly orchestrated to match supply and demand almost perfectly: if enough electrons weren’t forced down the wires to meet demand, then the system could shudder, and blackouts could result. In other words, system reliability dictated that demand must be met in real time—buying that last megawatt of power to meet demand was a necessity rather than a luxury. The market for that last mega-watt hour was a seller’s market, and the savvy trader could exact a ransom price.

As Koch’s traders developed expertise, they branched out and traded commodities that were never priced on an open exchange. A single transaction might yield $1 million or more in profits without ever being recorded with a paper contract. One of these markets was for industrial chemicals that most people couldn’t pronounce but that they used every day. Polyvinyl chloride, for example, is used in food packaging and bottles.

The deals were too specialized for open exchanges, and they were often done one-on-one, confidentially, over the phone. Bill Koch was largely responsible for getting Koch Industries into the chemical trading business. It was a business that would become an integral part of the company. Bill came across chemical trading shortly after he graduated from MIT. He was living in Boston and looking for new companies that Koch Industries could buy with the massive amounts of cash the company was generating. In his search for new investments, Bill Koch stumbled across a chemical trader named Herbert Roskind, who ran what was basically a one-man chemical trading firm called Monocel. As a trader, Roskind was one of the few middlemen in the global market for industrial chemicals. He sold barges full of sulfur made in Louisiana to factories in Asia that needed it as an ingredient in their manufacturing plants. Roskind spent much of his day in an office in suburban Boston, working the phones to call contacts in Europe or Singapore or Houston, finding people who wanted to buy and sell giant quantities of things like chlorine, caustic soda, polyethylene, and polyvinyl chloride.

The caucus room was essentially a makeshift trading floor. Harrison and his team developed a point of view on the large, multiyear trade to which they were committing Koch Industries. They evaluated the multiyear price that Koch should pay for the IBU workers’ labor, and they treated this trade exactly as Koch treated a multiyear hedge on oil prices. They sucked in data from diverse sources like federal labor statistics, private financial services, and even other labor unions. Backed by a team of analysts with spreadsheets, they analyzed the market and figured out their view on what the true price of the labor should be. This was a technique that Koch Industries had used since at least the 1990s. Randy Pohlman, the former Koch human resources executive, said Koch’s team in the caucus room used spreadsheets to tweak and tailor the numbers even as negotiators worked next door.

Right there, on page 89, Charles Koch explains the ABC process of employee retention at Koch Industries. The A performers are a company’s competitive advantage, he explained, while the B performers are the necessary workers who keep the enterprise running. The C performers, on the other hand, do not meet expectations, and can drag the business enterprise down with them. “Focused strategies should be put in place for C-level employees to improve performance through training, development, mentoring, or role change,” Charles Koch wrote. “Employees who do not quickly respond to these efforts and continue to perform at a C level should not be retained.

Charles Koch had finally built a machine that was poised to thrive, even profit, in the midst of violent market corrections. This capability derived, in part, from something that Charles Koch called “the trading mentality.” This mentality held that it didn’t matter so much if markets were going up or down; what mattered was that the traders could see ways to exploit large shifts in the markets. During volatile times, companies and governments and competing traders were thrown off balance. Prices diverged. Supplies were interrupted. Gaps emerged between market prices and underlying values. Koch became nimble, even expert, at exploiting those gaps for its gain.

It’s difficult for outsiders to even understand the nature of a contango market. In essence, the price of oil in spot markets, which reflect the price of oil today, tends to be lower than the price of oil to be delivered in the future. This is attributable to a host of complex reasons.I In the relatively rare scenario when oil today is cheaper than oil in the future, the markets are said to be in contango, and it doesn’t tend to last very long. Usually the market reverts to its normal state of cheaper oil in the future. When the market goes into contango, it presents a whole host of ways for Koch’s traders to profit. In late 2008, the potential profits were extraordinary. The size of the contango became enormous—the gap between oil sold today and oil sold for delivery a few months out became roughly $8 a barrel. A more common level of contango would be in the range of $2 or $4 a barrel. And the gap wasn’t just wide, it was long-lasting. The markets remained in contango for several months. Koch Industries, and a handful of other giant oil producers, were able to exploit this gap in a special way. Because Koch Industries traded in both the futures markets and the physical markets, it could execute something called the “contango storage play.” One former senior trader within Koch Supply & Trading called the contango storage play a “bread-and-butter” strategy for Koch’s crude oil department. The mechanics of the contango storage play seem deceptively simple. A trader at Koch Industries buys oil in the spot markets, where it is cheap. Then, the trader sells oil for delivery in the futures markets, where oil is more expensive. When the contango gap is $8, it is easy to picture how quickly the profits pile up. The trader can buy oil for $35 and sell it for $43, almost instantly. There is a catch, however. To execute the contango storage play, the trader must be able to do something that most traders can’t do—they must be able to deliver the actual, physical oil in that future month. If a typical oil speculator—who did not own an oil refinery, storage tanks, or an oil tanker ship—tried to execute the contango storage trade, they could find themselves shut out. Executing the contango storage trade didn’t just require deep knowledge of arcane shipping markets and transportation law; it also required deep relationships in the private world of oil production.

ALEC was an umbrella group that coordinated efforts among conservative state legislators around the nation. ALEC’s mission, and its organization, was a novel innovation. State legislatures were often seen as policy backwaters. ALEC stepped into the breach by giving much-needed resources to overworked and underpaid state lawmakers. This innovation was born of necessity in 1973, when liberal politics dominated Washington. ALEC’s founder, a religious conservative activist named Paul Weyrich, felt it would be far more effective to push policy ideas on the state level. He was right.

Koch and Enron won the battle in part because they could afford ALEC’s premium membership fees. The utility companies got outbid in ALEC’s lawmaking auction. “It’s a situation where you buy a seat at the table, and then you have the opportunity to vote and drive policy,” an exasperated utility lobbyist named Tim Kichline later told the Austin American-Statesman. “We don’t have enough votes. . . . If they are going to do something we like, they don’t need our votes; and if they are going to do something we do not like, we can’t stop them.” After Koch and Enron won the fight, ALEC crafted “model bills” for electricity deregulation. In states like Mississippi and South Carolina, ALEC’s model bills were introduced almost verbatim.

The bill created a new market on which Koch’s traders could buy and sell megawatt-hours: a market called the California Power Exchange. It was basically a wholesale market where utilities bought power, thousands of megawatt-hours at a time, to meet their customers’ needs. There was a wrinkle in this exchange that would later cause calamity. The prices on the Power Exchange could float with market conditions. But the prices that utilities could charge their customers for the power they bought on the exchange were frozen. The utility companies had pressed to freeze customer rates at high levels as a way to recoup the $20 billion to $30 billion in power plant upgrades the utilities made before the new law forced them to sell those same power plants. The state agreed to freeze electricity rates—at a price that was higher than wholesale power—so the utilities would be guaranteed a comfortable profit margin for the first few years of deregulation. When everything went south later, trading companies like Enron, who were actually breaking the law, would scapegoat the rate freeze and call it a “price cap,” using it as evidence that California had created a distorted marketplace that was simply begging to be exploited. In fact, the rate freeze was not a cap at all but a floor—a guarantee that prices would be high enough for the utilities to recoup their sunk costs. It appears that virtually no one in 1998 believed that wholesale electricity prices might actually go higher in the age of deregulation.

Antrich wasn’t looking for a new trading technique when he first met with Tom Nesmith. He just wanted information. There was one critical piece missing in Koch Energy Trading’s intelligence network. Koch Industries didn’t own any power plants, so it didn’t have access to the kind of inside information that made its energy trading desks so successful. Antrich was on a quest for such information, and he tried to get it by forming information-sharing systems with utility companies that owned the plants. Antrich approached one such utility outside California: Public Service Company of New Mexico, or PNM, as most people called it. The company owned a power plant in Arizona that sold electricity into California. This meant that PNM could sell into the coveted ISO market. Antrich wanted PNM to sign a deal that would give Koch’s traders access to PNM’s inside information, such as information on plant outages, its own weather forecasts, and other data that could give Koch a head start on responding to changes in the market. In return, PNM would get access to Koch’s trading analysis, its secret in-house weather projections, and its forecasts on natural gas markets, among other things.

Over time, however, one promising strategy emerged from the tests. One simulation showed that a pipeline company might beat down the holdouts if it negotiated with all of the property owners at once, rather than buying one plot of land and then moving on to the next. This buying strategy seemed to inject a level of uncertainty into the sellers’ minds—each seller didn’t know if his or her neighbors would sell or not, which increased the pressure on them to do so. This strategy worked even better if the sellers were walled off from one another and didn’t know what price their neighbors were being offered.

Early data from the experiment suggested that it might be impossible to beat a holdout. Different strategies could undermine the holdout’s leverage, but the holdout couldn’t be eliminated. There was, however, one strategy that nearly decimated the holdout problem. The data was just astonishing on this point. The best way to destroy a holdout’s position was to make them expendable. Winn discovered this fact when his experiments divided the virtual landowners into groups and then made it clear that some of them might be cut loose if they bargained too hard. In this scenario, the pipeline company was looking to buy up land on which to build a route, but it could take alternative paths. It wasn’t necessary in this case to get all of the landowners to sell in order to build the pipeline. The company could assemble a path while excluding some landowners. This strategy created a beautiful dynamic, from the pipeline company’s point of view. It embedded competition between landowners. It made each neighbor’s bargaining power the deepest liability to his or her neighbor’s. Everybody started looking over their shoulders and worrying that they might be undercut if they held out too long for a higher price.

at Koch Industries, there was no such thing as a senior manager. Within the confines of Market-Based Management, Roos was known as a process owner, or someone who acted like they had an ownership stake in the company. The refinery at Pine Bend was divided into five groups, which were known as “profit centers.” Each profit center was like a separate piece of property owned by a boss who was responsible for everything that happened within their domain. Koch measured the financial results in each profit center, which, in turn, determined how much money would be steered toward that profit center in the future. Brian Roos was the process owner over the Utilities Profit Center, a division that included the refinery’s wastewater treatment plant, boiler house, cooling system, and other equipment that kept the cracking units running efficiently.

When process owners like Roos read Introduction to Market-Based Management, they were warned against using the nonprofit support services too much. Because services like accounting and environmental engineering were essentially “free” to people like Roos, there was a danger that those services would be overused. The pamphlet likened the nonprofit groups to government agencies that handed out free services: there was a danger that the nonprofit groups might become bloated and overly expensive. The nonprofits might therefore drag down the performance of the very profit centers that they were supposed to serve. As they grew in size and cost, the nonprofit service centers would suck resources away from the parts of the company that actually made money. “The predictable result was often a corporate overhead cost spiral,” the pamphlet said. To counter this cost spiral, Charles Koch created an internal market system: divisions such as Roos’s had to essentially pay to use the nonprofit groups.

Charles Koch seemed to make that shift effortlessly. “He goes back to his core thinking of: What’s our point of view around what’s going to happen? How long is this downturn going to take? How is that going to affect people’s buying patterns?” Jones recalled. “And how long is it going to take—given this housing crisis—to get through this deleveraging?” If Charles Koch was more confident in his company’s future, he had reason to be. The company he oversaw in 2008 was larger, more diverse, and more adaptable than it had ever been before. It was built to withstand market shocks. Some divisions were hit hard, such as Koch’s building products divisions and its carpet fiber factories. But other divisions fared much better, such as its oil refineries and trading desks. The financial pain was very real, but there never seemed to be any doubt that Koch Industries would come out the other side as a healthy and profitable enterprise.

This is how, in 1996, Steve Peace came to lead the state’s efforts to break apart the existing electricity industry and replace it with something new. Over a matter of months in 1996, he oversaw a grueling process—it would earn the nickname “the Peace Death March”—to produce a bill that was described as being as thick as a telephone book, which created the new markets for trading megawatt-hours.

Roskind and Bill Koch heard from clients that there was very strong demand in East Asia for a chemical called acetic acid, which was in tight supply. The companies that made acetic acid were aware of the supply crunch, and they were not about to let go of their product easily. This made it almost impossible to buy acetic acid at a price that would make it profitable to turn around and sell it in Asia. But a good trader knows what is happening simultaneously in different markets. Bill Koch knew that the companies that made acetic acid often used corn as a feedstock for the product. Bill Koch also knew how to get corn at a cheap price on the futures market in Chicago. So Koch Trading bought corn on the futures market and bartered it with acetic acid manufacturers for large quantities of their product. Then they sold the acetic acid at a much higher price in Asia. Roskind said he made $1 million off that single trade.

But then, during the first days of January in 2000, the West Power Clearing Model began to produce some very strange numbers. It seemed that there was a supply crunch looming in California. The state had not built a new power plant in about a decade, and demand had been rising steadily. Water reservoirs were getting low, thanks to a dry year with little rainfall. A hot summer seemed to be on the way. Demand was high and supplies were tight, which meant that prices would soon be rising. This was essentially the same analysis that Brenden O’Neill was seeing on the natural gas desk. There would be a spike in both gas and electricity prices, which were closely connected. There was a small problem, however. California’s day-ahead market on the Power Exchange had a price cap on it. This created a potential distortion in the market: the real price of power might float higher than the capped price, which would force producers to trade at a loss. There seemed to be some gaming going on in this market in response to the price caps—it looked like some utility companies were intentionally underscheduling their loads in the day-ahead market to try and evade the price caps. The traders believed that California’s new system was imperfectly deregulated because of the price caps, and they also seemed to believe that the state’s political leaders were too dumb to recognize the fact or change it. The traders weren’t sympathetic to the idea that they should abide by the price caps if the market dictated otherwise. The thinking of Enron traders was captured in recorded phone calls, later obtained by investigators, which included gems such as: “Grandma Millie, man . . . now she wants her fucking money back for all the power you’ve charged . . . jammed right up her ass for fucking two hundred fifty dollars a megawatt-hour.