entitled “Natural Gas Point of View 2000–2001.” In this report, they accurately predicted a coming disaster that would contribute to blackouts along the West Coast, the bankruptcy of major utilities, and skyrocketing costs for many consumers.I The seventh slide of the presentation concluded that in the case of a cold winter, “storage inventories will be depleted.” This blunt conclusion was the only sentence on the slide that was underlined and written in bold type.
The assessment matched what O’Neill was seeing in the markets. During the 1990s, cheap and abundant natural gas had been taken as a given in the American economy. Large new wells had been discovered, and supplies were plentiful. More power plants were built to burn the fuel, which was used as an alternative to coal and nuclear power. In the late 1980s, the price of gas spiked to $2.27,II and it hovered around that level for the decade and was trading for $2.22 in late 1999. The long years of price stagnation seemed to have convinced many consumers and producers that low volatility and cheap gas were the normal state of affairs.
In early 2000, O’Neill and his team realized that this was a deeply mistaken assumption. Koch was in a privileged position to see the coming shortage. The company didn’t just operate a huge pipeline; it also owned a huge but obscure company called IMDST,III which arranged gas storage leases for about one billion cubic feet of gas. Managing storage was a critical part of the business. As O’Neill liked to say, there wasn’t a lot you could do with gas once it was pumped out of the ground: “You either burn it, or you store it. You can’t do anything else with it.” Companies stored it by injecting it into underground storage units, and Koch saw that the inject rates were historically low. The industry was behind its historical storage levels, according to the “Natural Gas Point of View” slideshow, which stated that “More prolific injection path seems impossible with current fundamentals.”
The squirrels were not burying enough acorns, in other words, and the winter was about to hit. At the same time, there were more hungry squirrels than ever. US energy consumption was on the rise as people plugged more and more devices into their walls, from extra television sets to home computers. A historic shortage of gas appeared to be in the making. Koch Industries wasn’t the only company to see the coming storm. Traders gossiped over beer and shared tips over the phone, so it was well known in certain circles that firms like Enron were starting to put on trades betting that gas prices would rise.
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.
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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 put a premium on culture among his employees. Among the most important attributes was valuing the team over the player, and the company over the individual. There was something unseemly about the grousing of commodities traders who clamored for ever-larger bonuses. If traders got giant bonuses, it might incentivize