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

The biggest profits were earned by breaking embargoes, of which none was more high-profile than that against the apartheid regime in South Africa. A company called Sigmoil, loosely connected to Philipp Brothers, dispatched laden tankers from New York to South Africa. In the middle of the Atlantic, the ships’ names were changed by rapid repainting, successfully confusing the hostile intelligence services in South Africa. In that atmosphere, Rich was looking for his own niche.

In early 1973, Rich heard rumours about a forthcoming Arab invasion of Israel. That war, he believed, would lead to an oil embargo and soaring prices. Rich was focused on Iranian oil, which in the event of war would be withheld. If he could accumulate and store Iranian oil, its value would rocket after the crisis erupted. Rich was able to find Iranian officials close to the Shah, the pro-Western dictator imposed on the country after a CIA coup in 1953, who were prepared to break their government’s agreement to supply oil exclusively to the Seven Sisters. Working in the shadows, Rich flew to inhospitable locations to supervise the loading of crude onto tankers destined for refineries in Spain and Israel and, more importantly, storage in Rotterdam. In exchange for selling the oil below the world price to Philipp Bros, but unbeknownst to the company’s directors, the Iranian officials, it is alleged, received ‘chocolates’ in their Swiss bank accounts. Even the corrupt, Rich always acknowledged, were clever. In New York, however, Philipp’s directors disbelieved Rich’s information about an imminent war. Fearful of the financial risks of purchasing and storing Iranian crude, they ordered the stocks to be sold. Philipp Bros’ position has always been that they had no idea what Rich was up to.

After the October invasion, as Israel fought for survival, the oil producers met and agreed to increase prices; to prevent any supplies of weapons reaching Israel, they also imposed an embargo on Holland and the USA. In the face of queues and rationing of petrol, there was fear throughout the West of economic devastation. Richard Nixon, fighting to retain his presidency in the midst of the Watergate scandal, supported Israel against what Henry Kissinger, his secretary of state, called OPEC’s ‘political blackmail’. In retaliation after Israel’s victory, the Shah, hosting a conference of OPEC producers in Tehran in December 1973, urged even higher prices than $12 a barrel. Privately, Nixon protested about the potential ‘catastrophic problems’ that would be caused by the ‘destabilising impact’ of the price increase. Iran, the Shah replied, needed to realise the maximum from its resources, which ‘might be finished in 30 years’. Whether the Shah believed his prophecy was uncertain, but OPEC’s new power was indisputable.

By then, Marc Rich and Pinky Green had quit Philipp Bros in fury to create a rival organisation. Registered in Zug, Switzerland, Rich’s new company used Philipp’s secrets and key staff to establish a network that spanned the globe, although the paper trail ended either in a shredder in his New York headquarters or in Zug, beyond the jurisdiction of America’s police and regulators. There was good reason for destroying the evidence. Rich’s growing empire was profiting by exploiting regulations introduced by President Nixon in 1973 to mitigate increasing oil prices and to encourage American companies to search for new oil. The regulations priced ‘old’ oil higher than ‘new’ oil. In common with many American oil traders, Rich relabelled ‘old’ oil as ‘new’. Unscrupulous traders, it was officially estimated, made about $2 billion from such practices between 1974 and 1978. Rich would claim that he, like his rivals, had exploited a loophole in badly drafted regulations. However, he had set himself apart from other traders by ostensibly operating from Switzerland, in order to evade American taxes. That might have been ignored if he had not planned to profit by exploiting a crisis in Iran, where oil workers were striking to topple the Shah, disrupting supplies. Oil prices in Rotterdam rose by 150 per cent, the harbinger of what would be called the second oil shock. Anticipating the shortage, Rich had again purchased oil for storage from corrupt Iranian officials. Among his customers was BP, the former owner of the Iranian oilfields, which was anxious to keep its refineries operating. BP’s reliance on Rich increased after the Shah was ousted from Tehran in January 1979 and replaced by the Islamic fundamentalist Ayatollah Khomeini. Fears of an oil embargo pushed prices further up.

On BP’s trading floor in London, Andy Hall watched Chris Moorhouse, the lead trader, regularly run up a flight of stairs to ask Bryan Sanderson, the director responsible for the supply department, to approve contracts to buy oil at increasingly higher prices. Over those weeks Rich resold oil which had cost between $1 and $2 a barrel for around $30. Resentful traders haphazardly tried to compete, and enviously asserted that Rich had paid for the oil with weapons. More seriously, Rich’s oil was occasionally exposed as substandard.

Refineries across the world relied on Iranian inspectors to certify the quality of the oil. Few realised how easy it was for Rich to disguise a tanker of low-quality crude. One tanker dispatched by Rich’s company to supply Uganda’s solitary power station carried, despite the inspector’s certificate, unusable ‘layered’ oil. After a day’s use the power station broke down, and the country’s electricity supply was cut off until another tanker arrived. Rich was aware that he was breaking the US embargo, but his profits were soaring. His good fortune was not welcomed by those queuing for petrol across America and Europe. Big Oil was accused of profiteering from rationing supplies, and Rich was in the firing line after the seizure on 4 November 1979 of 52 American diplomats in Tehran. His profiteering from America’s humiliation sparked a federal investigation into suspected tax evasion.

Rich’s success also aroused the interest of two independent oil traders: Oscar Wyatt, an American famous for running over anyone who got in his way, and John Deuss, alias ‘the Alligator’, a scarred buccaneer based in Bermuda, born 200 years too late. The son of a Ford plant manager in Amsterdam, Deuss’s early career as a car dealer had ended in bankruptcy. His next occupation was bartering oil between opportunistic producers and South Africa and Israel, both of which were excluded from normal trade by embargoes. From the profits he bought a refinery and 1,000 gasoline stations on America’s east coast. Compared to Marc Rich, Deuss and Wyatt were minnows. Rich’s skill, as they both appreciated, was obtaining oil by any means possible, brilliantly mastering the markets and insuring himself against losses by asking Andy Hall to legitimately hedge his daily trade against price fluctuations.

In 1980, Hall arrived in New York to run BP’s nascent trading operation. After BP’s expulsion from Iran and from Nigeria in 1979 for illegally trading with apartheid South Africa (exposed, according to BP’s executives, by Shell, which was eager to remove a rival), the company was seeking new sources of income. BP’s directors had noticed that as OPEC’s control over prices crumbled, BP could trade just for profit – buying and selling oil from other suppliers, and not just for its own use. After the discovery of oil in Nigeria in the mid-1950s and in the North Sea in 1969, the governments in London and Washington encouraged the oil companies to flood the market in order to undermine OPEC’s cartel. Hall, a novice trader, was given a short lesson on the art by Jeremy Brennan, the trader whom he was replacing. ‘To find out market prices,’ explained Brennan, ‘just tell them you want to buy when you want to sell, and that you want to sell when you want to buy. Keep good relations with the other majors and don’t squeeze.’ Hall decided to ignore the advice.

Conditions in America had changed. Although the country was the world’s largest energy producer if its oil, gas and coal were combined, the regulations introduced by Nixon in 1971 to encourage more exploration and keep oil prices down had proved unsuccessful. The fall of the Shah had prompted a new search for more oil and other energy sources, including nuclear power and natural gas, and energy efficiency. President Jimmy Carter encouraged the purchase of fuel-efficient cars, especially diesel engines, which used 25 per cent less gasoline, and greater energy conservation. His initiative was floundering when, on 22 September 1980, Iraq invaded Iran, starting an eight-year war. Overnight, both countries ceased supplying oil, and in anticipation of shortages, inflation and a recession, oil prices soared. The government in Saudi Arabia increased oil production to stem the emergency, and the crisis was short-lived. In 1981 Ronald Reagan, the new president, abolished price controls, and America was promised as much cheap oil as it needed. No one anticipated the turmoil this would cause. America’s oil industry was booming, and the supply gap from Iraq and Iran was filled from the North Sea and Alaska. Then, just as Saudi Arabia increased production, oil demand in the West fell. Prices tumbled, and OPEC members cheated on quotas to earn sufficient income. In retaliation against its OPEC partners Saudi Arabia flooded the market, and prices fell to $10 a barrel, undercutting oil produced in America. To save jobs in Texas, Vice President George Bush toured the Middle East, urging producers to cut production. His task was hopeless. Oil was no longer a state utility but was becoming a private business. Speculators and traders, not least Andy Hall and BP, rather than politicians and the OPEC cartel, were gradually determining prices.

The major oil companies had lost their way. The nationalisation of their assets in Iran, Saudi Arabia, Libya and Nigeria had shaken their self-confidence. Relying for supplies from dictatorships, Peter Walters of BP decided, had proven to be a mistake. Irate shareholders were demanding better profits. The oil companies began searching in the shallows of the Gulf of Mexico and in the North Sea, but refused to stray into the unknown. An offer to Walters in 1974 from the Soviet ambassador of exclusive rights to explore for oil in western Siberia had been rejected as too risky. Without experience in exploration, Walters did not understand the limitations of his strategy. The new world was unstable, and the future was unpredictable. Oil had become a cyclical business. Fearful of a financial squeeze, the American majors diversified into non-petroleum industries which would eventually include coal mining, mobile phones, high-street retailers, nuclear power, chemicals, button manufacturing and minerals. Exxon invested in the Reliant car; Occidental bought Iowa Beef Processors; Gulf considered buying Barnum & Bailey circus; BP bought a dog-food factory. Astute trading was another solution to compensate for low prices and the loss of oilfields.

To exploit the political uncertainty, Andy Hall was urged to trade aggressively. In the era before computers and screens, the market was inefficient. Traders were constantly scrambling to identify the last trade in the market and the latest price paid by rivals. In 1981, ascertaining future prices was difficult. At the beginning of the Iran crisis, experts had predicted that oil would rise beyond $40 a barrel, but instead it had remained at around $30, and sometimes lower. Politicians and OPEC’s leaders blamed London’s traders and the Rotterdam spot market. The oil companies, having bought massive quantities of oil to cover every eventuality, were dumping their stocks. The volatility of prices caused OPEC and most of the major oil companies concern, but BP seemed well-placed to profit from the new uncertainty. Unlike other traders, Hall noticed that besides the increasing amounts of oil being imported by the USA and the simplicity of trading tankers of crude oil on the daily Rotterdam spot market, there was an opportunity to speculate about future prices by using schemes devised in the financial markets. The rapid changes in prices made those profits potentially lucrative. The second oil shock had hastened the development of speculation.

The impetus for the change was BP’s discovery of oil in the North Sea. Before the discovery of the Forties field in 1970, few experts had believed that any riches would be found under the grey water. The surprise breakthrough fired a stampede, akin to a gold rush. Among the biggest reservoirs was ‘Brent’, discovered in 1971 beneath 460 feet of water, which would provide 13 per cent of Britain’s oil and 10 per cent of its gas. Developed by Shell across 10 fields and 13 platforms, the reservoirs were 9,400 feet below the sea bed, and the oil was piped 92 miles to Sullom Voe, a terminal in the Shetlands, using unique technology. In 1976 Shell’s experts estimated that production would end in the mid-1980s, and on that basis the oil companies were allowed to take the oil cheaply, without paying special taxes. But as the North Sea reserves’ true size became apparent and their productivity was extended for at least a further 35 years, the British and Norwegian governments imposed swingeing taxes just like other national oil companies, and reaped the same consequences of the oil majors refusing to search for new oil.

Initially, the North Sea produced about 24 tankers of oil every month. As production increased, a few American refineries switched to the ‘light and sweet’ North Sea crude and abandoned Saudi Arabia’s heavy ‘sour’. Although the quantities of this oil were small, their effect on the market was significant. After 1976, North Sea production was controlled by the British and Norwegian governments. To avoid oil shortages in Britain and to thwart profiteering, the government agency BNOC (British National Oil Corporation) intervened at the taxpayer’s expense to undercut OPEC prices, and directed that crude should be sold only to refineries. In the early 1980s these restrictions were breaking down, and North Sea oil was leaking onto the ‘spot market’, attracting dealers in London and New York. Although the quantities traded were small, the free market of Brent oil became the price-setter or benchmark for oil produced in North Africa, West Africa and the Middle East. The Saudis complained of chaos, but the traders loved the opportunities for speculation. BP and Shell fixed Brent prices, and using BP’s oil and information, Andy Hall began trading Brent oil aggressively. Both oil companies had to accept that the market had become opaque.

To introduce transparency into the forward, or futures, market while controlling prices, Peter Ward, Shell’s senior trader and the self-appointed guardian of the Brent market, formalised in 1984 the idea of ‘15-day Brent’. On the 15th of every month the oil majors were assigned a cargo of 600,000 barrels of Brent crude at Sullom Voe for delivery the following month. At that point, once the oil major named the day for delivery, the Dated Brent could be traded, and speculation started. Tankers carrying 600,000 barrels of oil were sold and resold 100 times before reaching a refinery. Ward believed he had created an orderly market at fixed prices. He had not anticipated that Hall and others would profit by legitimately squeezing rival traders. As the oil travelled across the North Sea, it was bought and sold by traders playing a dangerous game – buying more Dated Brent than had been sold, knowing that others had sold more than they had bought, in the expectation of eventually balancing their books. Since the quantity of Brent oil available every month was limited, Hall could profit by buying large quantities for future delivery, hoping that rival traders would eventually be compelled to buy from him at a premium price. Squeezing the market – compelling rival traders needing the oil to fulfil their own contracts to buy at his price – added uncertainty and volatility to prices. As the Dated Brent was sold to refiners, the price of the 15-day Brent rose because there was less on the market, rewarding the squeezer. In that topsy-turvy world, Hall perfected the squeeze, attracting charges of price manipulation. The squeeze, Hall knew, was not illegal. On the contrary, the British system invited speculators to buy large quantities of Brent for future delivery, despite the fact that Hall’s tactics precipitated a 15-year battle to draw a line between aggressive dealing and manipulation of the annual $30 billion trade.

As the spot market grew and prices moved depending on disruption of supplies, Hall became a substantial participant in the futures market for the sale of oil. His advantage over other traders was BP’s own information. Only BP knew how much oil would be piped from its Forties field through its own pipeline to the terminals at Hound Point. Working with Urs Rieder, a Swiss national at BP’s headquarters in London, and under the supervision of Robin Barclay, BP was not only anticipating how prices would vary, but was actually causing the market to change. That power transformed the company’s image. Buoyed by BP’s constant participation in the physical market, Hall traded uncompromisingly against smaller competitors. Leveraging the market to the hilt was not illegal, but entrepreneurial. Rieder’s move from BP to Marc Rich strengthened the relationship between Hall and the American trader. To outsiders, BP had become the Eton of traders. BP’s traders were a special breed, stamped by pedigree and lifelong friendships. Not only were they numerically astute, they were also internationalist, aware of historical, religious and cultural tensions dictating the price of oil. Among them, Hall shone as the prefect or head boy of a new school.

Hall’s casualties included Tom O’Malley, Marc Rich’s successor at Philipp Bros. Shrewd, intriguing and charismatic, O’Malley possessed an instinctive understanding of oil trading, bending rules but, unlike Rich, not breaking them. Profiting from the oil industry’s inefficiency and the market’s ignorance, he occasionally exported cargoes of oil from America’s west coast to the east coast merely to boost prices on the west coast, but he was occasionally stung by Hall’s squeeze when he was contracted to supply Brent oil in New York. To enhance his business and remove the competitor treading on his toes, O’Malley offered Hall a job. Simultaneously, Hall also received an offer from Marc Rich. At the climax of his negotiations with O’Malley, Hall asked for the terms and conditions of his employment and a company car. ‘Terms and conditions,’ snapped O’Malley, ‘is BP bullshit. You come to Philipps to become rich.’ Hall’s resignation from BP in summer 1982 was regarded as a bombshell in London. Rising stars and potential board members never left the family.

Combined, Hall and O’Malley were feared as ‘crocodiles in the water’, and became notorious for analysing markets, buying large, long positions in Brent oil, and holding out if there was insufficient volume until rivals screamed for mercy. In the Big Boys’ game, a rival trader’s scream was an invitation to squeeze harder. Philipp Bros, or Phibro, was good at squeezing, because there were large numbers of small traders – at least 50 in the US alone. To outsiders, Phibro personified the separate world inhabited by oil traders. ‘You’re ignoring the rule, “Don’t steal from thy brethren”,’ London trader Peter Gignoux complained. The British government’s remaining control over North Sea oil prices crumbled as Phibro aggressively traded primitive derivatives and futures against rival traders. The ‘plain vanilla swap’ compelled the customer either to take physical delivery of the oil or to pay to cover the loss.

For the first time, global oil prices were influenced by traders speculating as proprietors, regardless of the producers or the customers. The OPEC countries, especially Saudi Arabia, hated their game, and even Shell was displeased that their precious commodity created profiteers and casualties. In 1983 the market became murkier when Marc Rich remained in Switzerland and escaped facing criminal charges including tax evasion. Despite the scandal, Phibro and others continued to trade with him and Glencore, his corporate reincarnation in Zug. Phibro’s aggression invited retaliation. During that year, Shell took exception to Phibro squeezing Gatoil, a Lebanese oil trader based in Switzerland. Gatoil had speculated by short-selling Brent oil without owning the crude. Subsequently unable to obtain the oil to fulfil its contracts because Phibro had bought all the consignments, it defaulted on contracts worth $75 million. Refusing to bow out quietly, Gatoil reneged on the contracts and sent telexes to all its customers blaming Hall’s squeeze. Shell’s displeasure was made clear at the annual Institute of Petroleum conference in London, where every trader was warned not to attend Phibro’s party featuring Diana Ross. ‘A puerile idea to boycott our party,’ scoffed Hall, furious that the ‘clubby clique of traders around Gatoil and Shell obeyed and we were on the other side’. Shell levied a $2 million charge, and Phibro paid.

Mike Marks, the chairman of New York’s Mercantile Exchange, Nymex or the Merc, attempted to put an end to the chaos in 1983. Dairy products had been traded on Nymex since the market was established in 1872; Maine potatoes were added in 1941; and later traders could speculate on soya beans, known as ‘the crush’. Marks introduced trading of heating oil, an important fuel in America, and crude oil futures, dubbing the price spread ‘the crack’. The reference for prices was the future delivery of West Texas Intermediate (WTI, America’s light sweet crude oil) to Cushing, a small town of 8,500 people including prison inmates in the Oklahoma prairies. Several oil companies were building nine square miles of pipelines and steel container tanks in Cushing as a junction linked to ports and refineries in the Gulf of Mexico, New York and Chicago. Prices quoted on Nymex, based on those at the Cushing crossroads, rivalled those at London’s International Petroleum Exchange, trading futures in Brent and natural gas delivered in Europe. Instantly, the last vestiges Saudi Arabia’s stranglehold over world prices were removed. With the formalisation of a futures market, OPEC’s attempt to micro-manage fixed prices was replaced by market forces. The fragmented market became more efficient, but also murkier. Dictators producing oil were unwilling to succumb to regulators in New York, Washington and London. Instead of sanitising oil trading, Nymex lured reputable institutions to join a freebooting paradise trading oil across frontiers without rules. ‘I wish we were regulated,’ one trader lamented. ‘Why?’ he was asked by Peter Gignoux. ‘So I could bend the rules.’

In 1982, Phibro had faced an unusual problem. The profitable commodities business was handicapped by a lack of finance. Its solution was to buy Salomon Brothers, the Wall Street bank, and begin issuing oil warranties. Manhattan was shocked at a commodities trader owning an investment bank. Overnight, Hall and O’Malley were established as super-league players among oil traders, yet Hall was upset. ‘Traders and asset managers don’t mix,’ he announced. ‘I don’t want to be part of a bank.’ Phibro moved to Greenwich, Connecticut, to be as far from Salomon as possible, operating as a hedge fund before hedge funds became widespread.

Across Manhattan, Neal Shear, a pugnacious gold trader at Morgan Stanley, had watched Hall’s success with interest. Recruited in 1982 from J. Aron & Co., a commodities trader owned by Goldman Sachs, to start a metal-trading business to compete with his former employer, Shear envied the easy profits Hall and Rich were making. Compared to gold, he realised, oil trading was much more sophisticated and profitable. Without transaction costs or retail customers, and blessed by general ignorance about differing prices in Cushing and elsewhere in America, traders could pocket huge profits. In economists’ jargon, oil trading was ‘an inefficient market’. Shear’s business plan was original: ‘Our concept is not to be long or short but flat, to profit from transport, location, timing and quality specifications.’ Initially he wanted Morgan Stanley to copy and compete with Hall and Rich, but Louis Bernard, one of the bank’s senior partners, understood that the rapid changes in oil prices guaranteed better profits than speculating in foreign exchange. On Morgan Stanley’s model, the volatility of oil prices could be 30 per cent, while in the same period foreign exchange could move just 8 per cent. Investment bankers who had traditionally offered their clients the chance to manage risk in foreign currencies could make much more by offering them the chance to manage, protect and hedge crude prices against the risk of price changes. In 1984 Bernard hired John Shapiro, a trader at Conoco, and Nancy Kropp, a trader employed by Sun Oil, to trade crude. To ensure a constant stream of information about the market’s movements ahead of its rivals, the bank leased a few oil storage containers from Arco in Cushing. Hour by hour the traders in New York would be aware of whether there was a surplus or a shortage of WTI in Oklahoma, which determined prices on Nymex. Shapiro invented oil options, explaining the new idea to the oil industry at its annual conference in London in 1985. ‘We’re not taking speculative positions,’ he explained. ‘This is defensive, as a hedge, leaving Morgan Stanley to manage the residual risk. We’ve no desire to do an Andy Hall.’ Andy Hall had also ‘invented’ oil options, offering to the public the chance to invest in the oil trade. In the same year, by a different route, Goldman Sachs established another group of oil traders.