The Squeeze: Oil, Money and Greed in the 21st Century

As the gold market deteriorated in 1981, J. Aron & Co., a conservatively managed precious metals dealer, had been sold to Goldman Sachs for $30 million, although the rumoured price was $100 million. Goldman Sachs’s partners had only agreed to buy what one called a ‘risk-averse pig-in-a-poke’ because they assumed that Phibro’s purchase of Salomon’s must be clever, and Aron would give them additional international experience to earn a slice of the commodities trade. Three years later, 30 Aron metal traders were ordered to start trading oil. Under the leadership of Steve Hendel, Charlie Tuke and Steve Semlitz, they were to rival Morgan Stanley. Among their new ventures was speculating in heating oil contracts. By offsetting any order to buy or sell heating oil for future delivery, the bank earned its profit on the arbitrage regardless of future prices. ‘Arbing on the difference in price’ depended on whether the speculator took a bearish or bullish view, but the risk was taken by the customer. The bank’s books were nearly always balanced. Whenever an order to buy was booked, the bank’s traders made sure that the order for the future was fulfilled by finding a supplier. In those early days, neither Goldman Sachs nor Morgan Stanley were proprietary traders betting on the price, and they were blessed that British banks were either too sleepy or too small to compete.

In 1985, to profit from the ‘cash and carry possibilities’ of heating oil and crude, Goldman Sachs’s traders also acquired storage containers in Cushing and New York. The two American investment banks had become players in physical and paper oil. Oil prices, they realised, were determined not only by demand, but also by supply and international events. In that jigsaw, they traded only if they had the edge. Recognising that accurate prediction of prices was impossible, the traders did not bet on prices going in a particular direction, but traded on the volatility itself as Brent fell from $30 a barrel in December 1985 to $9 in August 1986. Fast and furious, dealers traded huge volumes even to earn just half a cent on a barrel. The watershed in their trading – before computer models had eradicated the club atmosphere – was the formal introduction of derivatives (‘Contracts for Difference’), allowing traders to own huge ‘paper’ positions to influence the market. Bankers, oil traders, the oil companies and the OPEC producers were plotting against each other to master and manipulate the market. The trade in futures, or ‘paper barrels’, was as much a banking business as an oil trader’s speciality.

1986 was the beginning of oil’s Goldilocks years. Survivors of the crash were destined to earn fortunes because of the volatility of prices. Regardless of whether these went up or down, the traders could profit. During the boom in the 1970s, oil prices had soared fivefold, and pundits had predicted $100 a barrel. In the mid-1980s, Sheikh Ahmed Zaki Yamani, the Saudi oil minister, became worried that high prices would encourage the West to search for alternative sources of energy. In that event, he anticipated, the floor for oil prices would be $18. Others including Matt Simmons, a Houston banker, predicted a crash. ‘Stay alive till ’85’ became the mantra of groups characterised by Simmons as ‘insular and unreliable’ for failing to understand the effect of the growing excess capacity. Contrary to their expectation, oil prices had fallen despite the Iran-Iraq war. Falling prices appealed to President Reagan. According to rumours, in 1985 he urged King Fahd of Saudi Arabia to flood the world with oil in order to destroy the Soviet economy; at the same time, Margaret Thatcher ended BNOC’s monopoly in the North Sea, deregulating prices of Brent oil. During December 1985, Simmons’s pessimistic forecast began to materialise. Prices were falling from $36 as Saudi Arabia flooded the world with oil, and they fell further as unexpected surpluses of oil from Alaska, the North Sea and Nigeria were dumped on the market. Traders in the speculative Brent market played for huge profits as prices seesawed. The value of 44 to 50 tankers carrying 600,000 barrels of crude oil every month from the North Sea terminals to refineries assumed global importance among the 50 players – oil companies, banks and traders. All crude oil in the world beyond America was priced in relation to Dated Brent, the benchmark of oil prices. Two traders fixing a future price for oil produced in Nigeria would base their contract on the price of Brent on the material day in the future. By squeezing the price of Dated Brent, traders could directly influence the price of crude sold by Nigeria, or Russia, or Algeria. Fortunes could also be made by manipulating the market prices of other oils across the globe based on Brent.

In that hectic atmosphere, a group of traders regularly met at the Maharajah curry house off Shaftesbury Avenue in central London to agree joint ventures to reduce risk and decide what price they would bid for Brent. In the era before the computerisation of the markets, the traders, unable to know at an instant the price of oil elsewhere in the world, relied on gossip and trust, knowing that rivals would pick their pockets whenever possible. The atmosphere in the curry restaurant was akin to a club where ‘everyone was prepared to screw but not kill’. Over 50 per cent of the trading market was governed by self-interest rather than laws. ‘Can you break a law when laws don’t exist?’ asked one club member rhetorically. Unscrupulous traders seeking to achieve the desired price on a Dubai contract would try to squeeze the price of Brent oil on that day. Shrewd traders noticing a rival taking up a perilous position would step aside to avoid a crash. The unfortunates who screamed ‘help’ could expect assistance, but at a price. The hostility was not tarnished by malice. Those meeting in the restaurant were deal junkies playing for pennies on each barrel, and at the end of the day they jumped into their Porsches to party and celebrate all night with Charlie Tuke before starting to trade at 6 o’clock the following morning. Among the reasons to celebrate was the crash of Japanese trading companies in London. In previous years, their traders had been paid commission on turnover and not profits, and were thus keen to accept any contract. Those traders were known as ‘Japanese condoms’ because they would be left holding all the contracts. As oil prices fell in the mid-1980s, the Japanese traders had been forced to pay huge sums to the London traders before their companies closed. ‘Hara-kiri all round,’ toasted the profiteers.

Falling oil prices in early 1986 terrified the Saudi rulers. President Reagan had lifted all controls, allowing supply and demand to determine oil prices. Many predicted huge rises, but instead prices began falling from $26 a barrel in January. By April they were $11. America’s high-cost producers could not compete in the new markets. Domestic production in Texas and California collapsed. Across the country, oil wells were mothballed, dismantled and closed. Laden by huge debts, property prices across the oil regions fell by 30 per cent, followed by bankruptcies and a smashed economy. Hardened oil men grieved about ‘the dark days’. In spring 1986, US vice president Bush flew to Saudi Arabia to plead with King Fahd to stop flooding the market.

OPEC’s first attempt to stabilise prices by cutting production in early May 1986 by two million barrels a day temporarily restored prices to $15. Any OPEC country which broke the rules, Yamani warned, would be punished. OPEC reduced output by another million barrels to 15.8 million barrels a day. Traditionalists believed that Saudi Arabia’s bid to control prices would succeed. Prices rose to $17 on 19 May, but secret sales of Saudi crude to sustain the country’s expenditure exposed Yamani’s political weakness as prices tumbled again to $12. OPEC had lost control. The industry was in chaos. In July prices fell below $10. British prime minister Margaret Thatcher refused a Saudi request to cut production in the North Sea. Her reasons were not political but were intended purely to raise taxes, regardless of the fact that the price collapse was causing havoc in Texas’s oil industry and the American economy. Bush’s plea had been too late. By August that year the customarily riotous Margarita lunches in Houston had dried up, sales of Rolex watches ceased, 500,000 jobs disappeared, bankruptcies proliferated, and Texas was devastated. In the darkest days, oil was $7 a barrel. In October Yamani was fired by the king, and Saudi Arabia cut production from nine million barrels a day to about 4.8 million.

Fearful of continuing low prices, the oil majors’ enthusiasm for exploration and improved production evaporated. Less glamorous, but nevertheless critical to the future, the profits from refining oil began a long, permanent decline. Convinced that low prices would last for years, the major oil companies sharply reduced their investment. ‘It’s the end of the party,’ said Peter Gignoux, noting that the world could no longer rely on the Seven Sisters as guaranteed oil suppliers. Liberated from that responsibility, the major oil companies resorted to skulduggery to reduce their taxes. By churning trades of oil to reduce Brent prices to absurdly low rates, they could reap lucrative tax advantages from the 15-day market. In 1986 Transnor, a Bermudan company, claimed to be a victim of a squeeze over Brent oil orchestrated by Exxon, BP and other oil majors. To seek relief, its directors litigated against the companies in America.

The oil companies became alarmed. The Brent trade was an unregulated international business, not subject to American or British laws. Squeezing Transnor was part of the game to manipulate prices and secure tax advantages. The companies’ initial ploy in the American court was to persuade the judge that 15-day Brent was similar to ‘a forward contract’ used by farmers to secure guaranteed prices for their crops, and was therefore not subject to the Commodities Futures Trading Commission (CFTC), the American regulator.

Created by Congress in 1974 ‘to protect market users and the public from fraud, manipulation and abusive practices’ in the commodities trade, the CFTC initially supervised 13 commodity exchanges with staff recruited from Congress, especially the agricultural committees. Political favourites, some with limited experience, were appointed commissioners to supervise those monitoring the markets. Relying on the traders’ reports submitted to Nymex as its primary tool to identify suspicious price movements, the agency was deprived of adequate funding by Congress, undermining its prestige from the outset. After 1984, as the trade of contracts tripled and the trade in options multiplied tenfold, the 600 staff struggled with an inadequate computer system and a falling budget to identify market manipulation and excessive speculation in 25 commodities, the value of which was growing towards $5.4 trillion a month. That bureaucracy was anathema to Exxon and BP. The oil majors adamantly denied the agency’s authority over their business.

Transnor argued the opposite. Its agreement to buy Brent oil, the company argued, was a speculative or hedging ‘futures contract’, which was subject to American law and the CFTC. In 1990 Judge William Conner found in favour of Transnor, ruling that trading Brent was illegal in America. The oil majors were dismayed. Oil traders, they argued, were big enough to look after themselves without a regulator’s protection. To persuade the US government of their cause, they stopped trading with American companies and lobbied the director of the CFTC in Washington to reverse the judge’s ruling. The CFTC, a lackadaisical regulator caring primarily for farmers and agricultural contracts, had never experienced the pressure of oil lobbyists. Within days the companies declared victory. Fifteen-day Brent was declared to be a ‘forward contract’ and beyond regulation. The oil companies could administer their own ‘justice’, especially when they fell victim to a squeeze of Brent oil orchestrated by John Deuss, the sole owner of Transworld.

Transworld was based in Bermuda, with trading offices in London and Houston, and Deuss’s micro-management stimulated the sentiment among his traders that the only compensation for suffering his obnoxious manner was the unique lessons in oil trading he could provide. Oil spikes, Deuss believed, occurred once every decade, and in the intervening years traders should tread water, manipulating the market with squeezes. The best squeezes, he boasted, passed unnoticed.

During 1986, Deuss decided to execute a monster squeeze on the Brent market. Mike Loya, Transworld’s manager in London, was delegated to mastermind the purchase of more oil than was actually produced in the North Sea. In that speculative market, the cargo of a tanker carrying 600,000 barrels of North Sea oil was normally sold and resold a hundred times before it reached a refinery. If prices were falling, traders who bought at higher prices were exposed to losses, while those selling short would expect to profit. Starting in a small way, Deuss and his traders in London bought increasing amounts of 15-day Brent every month. Seeing that by tightening the market they were pushing prices upwards and earning extra dollars, they became bolder. Summer 1987 was the self-styled ‘Eureka Moment’. To allow maintenance work, monthly oil production had been reduced to 32 cargoes. Traders at Shell, Exxon and BP had as usual sold 15-day cargoes, expecting to buy back at the end of the period any oil they needed for their refineries. Now, however, their offers were ignored. Mike Loya, the traders noticed, had bought over 40 cargoes, so owned more oil than the fields produced. And having bought everything, Loya was not selling. Transworld’s squeeze was felt in London and New York. Prices rose and the protests grew. The oil majors needed Brent to produce specific lubricants which were unobtainable from other North Sea crudes. Without that oil, the refineries could not operate. Contractually bound to supply Brent, they were compelled to pay Transworld an extra $2 a barrel, earning Deuss $10 million profit for one month’s work. Unexpectedly, the majors then suffered a second blow. Because of the complexities of oil trading, while 15-day Brent prices increased, Dated Brent prices fell. That fall directly cut the prices of oil produced in West Africa and the Gulf, so the producers lost money on supplying it to other refineries. Deuss’s squeeze had caused chaos. ‘Very painful,’ admitted BP’s senior trader, suspecting that the squeeze had been profitably shadowed by Goldman Sachs and Marc Rich.

After Loya’s summer coup, Transworld’s traders earned more profits from smaller squeezes until, in December 1987, Deuss believed he had the information to strike a spectacular bonanza. Focused on an audacious coup against the oil companies, he was convinced by the golden fable that no regulator, stock exchange or even country could control the oil market. Like every trader, Deuss nurtured his OPEC contacts, and few were more important than Mana Said al Otaiba, the oil minister of the UAE, who was also a co-owner with Deuss of a refinery in Pennsylvania. Al Otaiba convinced Deuss that in order to force up oil prices, OPEC would agree at its meeting in January 1988 to significantly cut production. If OPEC’s production fell, Brent prices would rise.

‘Buy Brent,’ Deuss ordered. Transworld’s traders in London bought 41 out of 42 Brent cargoes for $425 million, but prices barely moved. No other traders appeared to believe that OPEC would cut production. Then prices began to fall. ‘Buy more,’ Deuss ordered, to shore up his position. To achieve a squeeze, he simultaneously also bought Brent oil from rival traders for delivery in the same period. Those traders, unaware of Deuss’s plot, had expected to buy those cargoes from BP and Shell once they were produced. In the common usage, the traders were ‘short’ – selling oil without owning it. As the moment of delivery approached, Deuss demanded delivery of the oil. The unsuspecting traders discovered that no oil was available. Deuss expected to hear screams appealing for mercy. The traders faced two options: either pay Deuss a penalty for defaulting on their contracts, or buy their cargoes from Deuss in order to resell them to him, inevitably suffering a hefty loss. But instead of hearing screams, Deuss became perplexed by the ‘shorts” silence. Unknown to him, Peter Ward, Shell’s trader, had agreed with Exxon to sabotage the squeeze by producing extra oil. ‘Deuss is a buccaneer,’ Ward declared. ‘Let’s teach him a lesson.’ There was, he decided, a fine line between combat trading and corrupt trading.

To embarrass Deuss, a Shell trader gave the details of the failing squeeze to the London Oil Report and BBC television. ‘Everyone’s ganging up against him,’ noticed Axel Busch, the Oil Report’s editor. ‘It’s become a free for all.’ Deuss calculated the cost. Not only could he not afford to pay for the 41 cargoes he had bought, but the storage costs if he did take delivery would be crippling. Urged by his staff to continue buying up to 60 cargoes, Deuss blinked. Unable to bear the risk, he retreated. Summoning his London manager out of an Italian restaurant, he ordered, ‘Sell everything.’ Within minutes, the first six cargoes were sold. Competitors smelled Deuss’s panic. With 35 cargoes remaining, prices collapsed. Transworld lost $600 million. Deuss could pay his debts only by selling his oil refinery. ‘He’s been bagged,’ laughed Peter Gignoux. It was the end of an era. In 1988 the International Petroleum Exchange in London opened a regulated market to trade Brent futures. Refiners could hedge their exposure to prices. Some believed that the squeeze and manipulation had finally been curtailed. But the traders and the oil majors knew that humiliating one buccaneer had not legitimised the trade. The odds, Andy Hall knew, and the potential profits, had only increased.

FOUR The Casualty

Shell’s directors congratulated themselves on scoring a hit against those disrupting the Brent oil trade. There was a shared pride among the company’s long-time employees about their company’s probity and purpose. Built by Dutch engineers and Scottish accountants, nothing was decided in haste. Decisions were taken only after all the circumstances and consequences had been considered and the benefit to the value chain was irrefutable. Although BP might produce more oil, Shell earned higher profits.

Reared on that tradition, Chris Fay was bullish. With 23 years’ experience in Nigeria, Malaysia and Scandinavia, Fay had become the chairman of Shell’s operations in Britain. Shell’s ten oil-producing fields in the North Sea and others under development were his responsibility. Among the problems he inherited in 1993 was the fate of Brent Spar, a platform in the North Sea used to load crude onto tankers. Erected in 1976, the 65,000-ton, 462-foot-high structure had been decommissioned in 1991, and by 1994 was no longer safe. Dismantling it was a problem. There was no suitable British inshore site, while dismantling at sea would cost $69 million. Shell’s engineers had considered 13 options offered by different organisations, and Fay had discussed the alternatives with Tim Eggar, the Conservative minister for energy. With the government’s public approval, Fay confirmed on 27 February 1995 that the platform would be towed 150 miles into the Atlantic and, using explosives to detonate the ballast tanks, would be sunk in 6,600 feet of water. The cost would be $18 million. The only downside of the apparently uncomplicated process was that the metal, alongside innumerable shipwrecks on the sea bed, would take 4,000 years to disintegrate. Neither Fay nor Eggar was concerned. Over a hundred similar structures had been dumped by American oil companies in the sea without protest, creating artificial reefs off Texas and Louisiana. ‘This is a good example of deep-sea disposal,’ claimed Eggar, anticipating that the Brent Spar’s disposal would be followed by that of 400 other North Sea structures.

Two months later, at lunchtime on 30 April 1995, four Greenpeace activists jumped from the Greenpeace ship Moby Dick and occupied the derelict Brent Spar. The rig, announced Greenpeace, was filled with 5,500 tons of toxic oil which would escape and contaminate the sea and kill marine life if it was sunk. Media organisations around the world were offered film of the occupation, with close-ups of Shell’s staff aiming high-pressure water hoses at the protestors. Any viewer who doubted that Shell was the aggressor was reminded by Greenpeace about the company’s poor environmental record. In March 1978 the Amoco Cadiz, a tanker carrying a cargo of 220,000 tons of oil, broke up in the English Channel, contaminating the French coastline. Shell owned the oil and was blamed for the disaster, a tenuous link motivated by anger at Shell’s refusal to boycott South Africa during the apartheid era and by its supply of oil to Rhodesia’s rebellious white settlers despite international sanctions after they declared independence in 1965. The accumulated anger against Shell took Fay and his co-directors in London and The Hague by surprise, especially the accusation that Shell was untrustworthy. Taking the lead from Lo van Wachem, the former chairman of Shell’s committee of managing directors, who remained on the board of directors, Shell had already declared its ambition to lead the industry in the protection of the environment. In advertisements and meetings, directors mentioned the possibility of withdrawing from some activities to avoid gambling with the company’s reputation. This commitment had been disparaged by Greenpeace. To gain sympathisers, the environmental movement was intent on entrenching its disagreements with the oil companies.

Fay and his executives knew that Greenpeace’s allegations were untrue: the platform contained no more than 50 tons of harmless sludge and sand. Greenpeace, they were convinced, had invented the toxic danger as part of its long campaign that mankind should stop using fossil fuels. The battle lines had been drawn after Shell’s spokesmen, in common with Exxon’s and BP’s, had dismissed any link between fossil fuel and damage to the environment. Convinced that the truth would neutralise the Brent Spar protest, Fay appeared on television. But, unprepared for Greenpeace’s counter-allegation that Shell was deliberately concealing internal reports describing the toxic inventory, he visibly reeled, fatally damaging Shell’s image. His personal misfortune reflected Shell’s inherent weaknesses, especially its governance.

The historic division of the Anglo-Dutch company had never been resolved. In 1907 Henry Deterding, a mercurial Dutchman who had gambled with oilfields, investing in Russia, Mexico, Venezuela and California, had negotiated the merger between his own company, Royal Dutch, and Shell Transport, a British company, on advantageous terms giving the Dutch 60 per cent of Royal Dutch Shell. The company’s management, however, had remained divided. Two boards of directors – one Dutch and the other British – met once a month for a day ‘in conference’. Each meeting was meticulously prepared, but serious discussions among the 30 people in the room – 20 directors and 10 officials – were rare. Each director could normally speak only once during these meetings which, remarkably, lacked any formal status. After the ‘conference’ the two national boards separated and made decisions based on the conference’s discussion. Aware that the company had become renowned during the 1970s as a vast colossus employing eccentric people enjoying a unique culture, van Wachem, a self-righteous, abrasive chairman, had imposed some reforms while acknowledging that Shell’s dismaying history had inflamed Greenpeace’s protest. Henry Deterding, infatuated with Hitler, had negotiated without consulting his directors to guarantee oil supplies to Nazi Germany, and in 1936 he retired to live in Germany. After the war, to remove the concentration of authority in one man, the company had created a committee of managing directors with limited powers to influence Shell’s directors. That barely affected the inscrutable aura of an aloof international group of interlinked but autonomous companies immersed in engineering, trade and diplomacy.

As the friends of presidents and kings, Shell’s chairmen did not merely control oilfields, but sought influence over governments. Supported by a planning department to project the corporation’s power, Shell’s country chairmen in Brunei, Qatar, Nigeria and across the Middle East wielded authority akin to that of a sovereign. Yet beyond public view, Shell’s employees worked in a non-hierarchical, teamlike atmosphere, exalting technology and engineers who, in the interests of the industry and Shell’s reputation, occasionally donated their patents and expertise for the industry’s common good. That collaborative attitude was proudly contrasted with Exxon’s. Unlike the American directors, whose principal task was to earn profits for their shareholders, Shell had proudly enjoyed its status during the 1980s as a defensive stock – shares which remained a safe investment even in the worst economic recession. Shareholders were tolerated as a necessary evil, and modern management techniques were disdained, emphasising the company’s increasing dysfunctionality. ‘I’m not saying we enjoyed it,’ said van Wachem about the 1986 collapse in oil prices, ‘but there was no panic.’ With more than $9 billion in cash on the balance sheet, van Wachem’s strategic task appeared uncontroversial. Shell owned Europe’s biggest and most profitable refining and marketing operation, and Shell Oil was the most successful discoverer of new oil in the USA. Nevertheless, van Wachem’s poor investment decisions, combined with a fatal explosion at a refinery at Norco, Louisiana, in 1988, had hit Shell’s profits. In 1990 they fell by 48 per cent in the US, and net income in 1991 collapsed by 98 per cent, from $1.04 billion to $20 million, far worse than its rivals. Shell’s poor finances had compelled the sale of oilfields to Tullow and Cairn, two independent companies, and making 15 per cent of the American workforce redundant.