The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (5 page)

Andurand’s job by that time was purely to speculate. He was given about $100 million to trade crude and other energy products, markets with which he was now well acquainted. Certain crude-oil futures were in “backwardation,” or a situation in which the futures prices were lower than the current prices, but he thought that scenario temporary. He was spending much of his money on crude-oil calls dated multiple years into the future at significantly higher prices.

At Vitol Andurand worked with a team, but nobody really bothered him. Unlike many of his colleagues, who were focused on hedging Vitol’s physical exposure as it moved crude and refined products from one location to another, he had moved beyond the more tailored deal-by-deal protective trades and was focused on the more esoteric art of predicting what other traders
might do in the global commodity contract markets. Quantitative analysis that he’d learned at university helped him understand the history behind the market’s moves, but knowledge of the energy industry’s fundamental drivers, as well as the groupthink that helped push around prices, was crucial as well. Andurand was honing his skill for putting all those components together and coming up with a strategy for making money. And he was soon doubling his capital every year.

He also benefited from a number of built-in advantages. Not only did Vitol do business in numerous individual physical energy markets around the world, creating the data bank that helped inform Andurand and his colleagues’ individual trades, it had massive scale as well. Its experiences in the petroleum markets were more than just anecdotal. Vitol was handling one of the single-biggest shares of the trading of oil in global markets—
up to 10 percent of active, or “open,” contracts in oil in the New York Mercantile Exchange market alone, by some estimates. Those details helped Vitol’s contract traders make significant profits.

Having now mastered the art of physical hedging and gotten quite good at speculative trading, Andurand was getting bored again. It was as if all those built-in advantages made trading too easy—or perhaps, given that he wanted even more autonomy over his work to generate fast profits, not easy enough. In 2007 Andurand approached his superiors about the idea of opening his own hedge fund within Vitol. He knew it was a long shot. Domiciled in Switzerland, where the market regulation was looser and the tax rates lower, Vitol was extremely secretive. So asking it to open up its books to potential investors, just so that Andurand could make trades he was already paid handsomely to make without the glare of outside investors, was asking a pretty big favor.

Predictably, Andurand’s bosses said no. They were not interested in the asset-management business, they told him. But they presented him with some parting gifts: an attractive bonus check and the assurance of a good recommendation to potential investors, should he ever need it.

Andurand resigned from Vitol in May 2007 and decided to take some time off. He wanted to have some fun. Stressful days in the oil markets had distracted him from keeping fit, normally a priority. Any time his weight crept up past 220 pounds, he knew he was overeating and it was time for a change.

Andurand had married his girlfriend from Singapore, but things hadn’t worked out, and now that he was divorced, he wanted to meet some new women. So for the next four months, he made it his mission to run, weight train, go on dates, travel, and find his way back to an equilibrium from which he could start a new business.

About a month into Andurand’s sabbatical, he had an unexpected caller: Dennis Crema, who had managed all the gasoline trading at Vitol. An American whose first exposure to the oil business had been working on a tanker in the Long Island Sound in his early twenties, Crema had been an impressive trader in his own right at the Swiss firm—about as successful, in fact, as Andurand had been. Crema was also older, and after years of working in the physical trading business in the U.S. and London, he had landed a job as, effectively, the head trader at Vitol, a very senior position that reported directly to the company’s president and chief executive officer.

Crema proposed to join Andurand as CEO of his new hedge fund, playing the senior statesman role to Andurand’s head trader. He had a long list of contacts in the investment business,
he argued, and could help the fledgling fund attract new capital. He would also help Andurand figure out how to approach the markets and to interface with brokerage firms on Wall Street, which provided crucial funding and trading assistance.

“I was very flattered at the time,” says Andurand. “He was a very successful trader at Vitol.” So he accepted.

Their fund, BlueGold Capital Management, started trading in February 2008 with $120 million in capital and half a dozen employees. February was the very month when the market for mortgages tied to high-risk borrowers, known as “subprime” loans, started to flatline, signaling the beginning of the U.S. credit crisis. Those investors who had seen the drop coming were already positioned for a flurry of late payments or defaults by home-loan recipients and had bought vast quantities of insurance policies that would pay out if the loans went bad.

But commodities markets were still humming. Chinese manufacturing had by now become the engine of world consumer-goods production. In India, a massive and young population was consuming more services and products. Those two countries alone were on pace to grow their economies at an annual rate of
close to 10 percent apiece, according to statistics published by the International Monetary Fund—levels that the U.S., whose economy grew by a few percentage points per year, had not seen since the early 1980s.

Crude oil would be the key to their growth. Already that winter, electricity shortages were hampering parts of the developing economies around the world. In China,
the most severe winter weather in fifty years had damaged power sources throughout the country,
and
poor government planning in South Africa had spurred power outages that affected the entire continental region.

Amid all the demand and lack of supply, there was also an overarching fear of “
Peak Oil,” a 1950s theory now experiencing a renaissance, which held that the availability of global oil was soon to be maxed out, after which global supplies would be on an ever-diminishing decline. Believers in Peak Oil felt that crude oil was certain to grow more expensive.

The Peak Oil theory had some weaknesses, given the promising advancements in drilling that were being made in such hard-to-reach areas as deep ocean water in the Gulf of Mexico and the Arctic Circle. If the technology to tap those reserves could be harnessed, there would be plenty of crude oil yet. But those facts didn’t prevent the market’s jitters from driving crude prices up, and Andurand, who had by now been expecting price hikes for several years, also saw every indication that crude would continue on the same trajectory. Brent crude contracts, the commodity product he traded most frequently, were in the low $90s at the time. But if the demand and supply factors then present persisted, followed by a strong dose of scaremongering over Peak Oil, he thought the futures markets could go absolutely haywire, taking crude levels to $200 a barrel.

So, just weeks after BlueGold’s inception, Andurand began slowly purchasing Brent contracts, betting that prices would rise dramatically to anywhere from $100 to $130. The calls were pegged to future dates as far out as two and a half years.

Andurand was already taking enormous risk, but he went a step further. In order to juice his potential returns on investment, he used complex market contracts that provided extra exposure to triple the size of his bet.

Brent crude began getting more expensive. And since Andurand’s aggressive trades were winning in the short term, his assets under management were going up. By May, BlueGold was managing $500 million, an impressive rise from where it had started three months before. With the added exposure from the contracts he bought, Andurand was in fact managing a portfolio with market investments worth $1.5 billion on paper.

Suddenly BlueGold was becoming a big deal in London. Bankers who had refused to do business with the firm just a few months before were calling the office, multiple times a day. New investors were making inquiries. To the fund’s junior staff, working at BlueGold felt like the hot new gig.

BlueGold reflected Andurand’s lavish but quiet style, operating more like a library than a testosterone-fueled trading floor. On a standard day, he would only make three or four trades, building larger positions over time. In between those trades, he researched the oil markets or spoke to friends about what they were seeing and doing. Working at that slow pace, it took him several months to piece together a large position of between 10,000 and 15,000 individual contracts, in this case mostly options, or the right to buy crude at levels considerably higher in the Brent crude market.

And Brent continued moving up. By the end of May, the contract had ripped through the once-significant $100 mark and was trading above $120. BlueGold was now managing $700 million. Some of the options it had bought moved up a remarkable $27 in a total of fourteen trading sessions, the firm noted in an investor letter, shifting one of the essential oil markets from “backwardation,” where future prices were predicted to be lower than the current ones, to what traders call “contango,” in which future prices were expected to be higher. (The latter, which was thought
to be a bastardized version of the nineteenth-century stock-trading term “continuation,” meaning to keep a short-term hold on a trading account from one finalization date to the next, was exotic compared to its less imaginative opposite.)

The trade was a huge score. Around the office, though, there were no high fives or champagne popping. Andurand was waiting for things to turn.

By the early summer of 2008, Brent futures were trading at stratospheric prices. Meanwhile, the U.S. markets were in distress. Bear Stearns had collapsed into JPMorgan Chase’s arms, Lehman Brothers was flirting with failure, and housing in the U.S. was tumbling downward. No matter how great the demand out of China, the breathless pace of commodities prices would have to slow.

BlueGold’s partners told investors their optimism had cooled. After crude oil hit $135, Andurand and Crema wrote in an investor letter, the fund had sold off some of the positions it had taken when betting that crude would trade much higher in the longer term, and focused those bets more on the immediate future. BlueGold was now effectively betting that the price of crude would stay high for the next few months, but fall sharply in the coming few years.

Andurand was nervous. Every day he’d get up and pore through the overnight market reports, searching for clues. Mornings were typically slow in London’s commodity markets, so he had plenty of time to bum around his Knightsbridge apartment and worry. There was a lot of noise about the broad market’s movements, mushrooming crises in the banking and mortgage sectors, and stubbornly high crude futures, which had become the source of much hand-wringing in the U.S., where members of Congress
were convening hearings almost weekly to address the public’s outrage over ballooning costs of gas and other products.

But there was little a newspaper could tell Andurand that would ultimately change his thinking. For all his research, he traded essentially on gut instinct. It was clear to him that things had recently shifted, and that the price of crude and refined products would be depressed by the global tumult. He thought all this would bear out in the coming months; he just wasn’t sure when.

The rest of the market appeared equally torn. As a result, oil prices fluctuated multiple dollars per day, in huge moves at a time. The argument for higher prices was that geopolitical issues—threats of a possible
nuclear weapon in Iran, or labor strikes in Nigeria—would crimp the production of oil, leading to sticker shock for the supplies that were available. The case for lower prices was that the U.S. credit crisis was worsening, dampening orders and spending in other continents and ultimately risking oversupply of crude.

Longtime market watchers were stumped by the mixed messages, and some even argued to reporters that the oil market was broken. “
This whole industry has been absolutely turned on its head,” an energy analyst told the
New York Times
. Price moves that had once taken five years, the
Times
pointed out, were now taking far less time—such as the $60 upswing that had occurred over the prior twelve months. Overall, prices had been climbing for seven straight years, the
Times
added—a trend unheard of since oil drilling began in the 1850s.