The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (7 page)

Glencore credit default swaps at that time had been trading at the relatively calm level of about
€
150,000. By contrast, the swap
prices attached to the major U.S. investment banks—the cost of purchasing an insurance policy that would pay its keeper if the banks defaulted and couldn’t pay their debts—were growing vastly more expensive.

Around the time of the September partner meeting in Baar, Beard’s team received an unusual request from Morgan Stanley, long a friendly rival in the trading of commodities and their correspondent contracts. Morgan owed Glencore $125 million for a crude shipment, a bank representative explained, but the bank at that moment was hard up for cash. Could Glencore give Morgan a little grace time, the bank wondered, as Morgan tended to crises in other parts of its business?

No problem, said Beard when the matter came to his attention. He was sympathetic to Morgan’s situation.

But before long, the roles were reversed. By late October, crude prices had fallen more than 50 percent from their peak, and Glencore was battling BP and other counterparts doubting its financial health. Beard’s trader call may have calmed nerves internally, but his angry swagger, while effective in creating fear and submissiveness on his own team, had done little for the marketplace at large. Swap insurance on a piece of Glencore’s five-year debt was by then trading
for
€
900,000, an enormous price.

Beard himself was in a state of astonishment. Practically every day, it seemed, he walked into his fifth-floor Berkeley Street office in London at 8:15
A.M.
to find crude priced $2 to $3 cheaper than it had been just the day before. Working at BP during the first Persian Gulf War in the early 1990s, he’d seen large price moves in short periods of time, but with nowhere near this magnitude; the market of 2008 was moving with exponentially greater caprice.

Amid the drop-off, Beard went to lunch with Goran Trapp, a
tall, lean Swede who headed Morgan’s commodities unit in Europe. Greeting one another at a restaurant near London’s sedate Green Park, not far from Berkeley Street, they remarked on the fact that they’d never actually spent time together, despite having been in the same industry for decades. Surely they’d met at some energy-business function, they agreed, but which one, neither could say.

The conversation quickly turned to the markets. Beard, who, despite his relaxed, almost rumpled appearance, could be quite steely when annoyed, cited his frustrations with the hysteria over his company’s debt load. Glencore’s problem was based on false assumptions, he argued, something that Morgan had recently experienced and should understand firsthand.

“You aren’t going bust, and we aren’t either,” he said. The whole thing, he added, seemed a bit preposterous.

Trapp, who was a calmer, more approachable trader, considered his words. “Clearly the market has some concerns,” he replied. In the fog of crisis, he argued, trading partners made decisions based solely on their own long-term survival. That meant taking no chances, even with long-standing counterparts who had never given reason for concern before.

Beard sensed that something else was going on in his team’s dealings with BP, which he thought was going out of its way to screw Glencore. But perhaps Trapp was right on the broader point. He reminded Trapp that Glencore had been there for Morgan during its neediest hour as a barely concealed way to extract some similar loyalty.

“We’d appreciate the favor returned,” he said.

Glencore wasn’t late on any particular bill at the time, but Beard wanted to know that the bank would be flexible in trading with him.

Trapp understood, and fully intended to keep trading with Glencore as usual. Still, he couldn’t promise not to ask about the firm’s financials. At Morgan, he said, “we do the right thing. But in order for us to maintain the position we have, we need to make sure we maintain the open line,” he added, referring to the need for free-flowing communication, even if it involved sensitive financial questions about Glencore’s cash and credit lines. Morgan Stanley had to be mindful of its own risk management, after all, Trapp pointed out.

Beard agreed. It was a small price to pay to take at least one item off his team’s growing list of concerns.

Opening up their books for scrutiny, however, was something Glencore was loath to do. Insularity had been the company’s operating principle for as long as anyone could remember. Glencore had always relied on Switzerland’s lenient corporate laws to do business with unstable nations, even some that were considered enemies of the U.S. Many of the more notorious transactions had taken place during the Marc Rich era, which began in 1974 and ended twenty years later, but a few had occurred even after he left the company. In 2005, for instance,
an independent commission report on abuses under the United Nations–sponsored oil-for-food program accused the company of paying surcharges to secure Iraqi crude oil during the Saddam Hussein regime. Glencore denied the accusations, but its long-standing use of shell corporations and complex intercompany tax and trading arrangements could make it tough to unravel a given transaction—and, ultimately, even the shadiest dealings were hard to link back to Glencore in the first place.

Glencore’s willingness to do business in obscure and controversial places had also turned out to be a highly profitable business strategy. Among the European traders that handled commodities, it was one of the largest. It claimed to sell more crude than any nonintegrated oil company, its sales volume accounting for more than 3 percent of a day’s global oil consumption. It was also the largest supplier of seaborne steam coal, provided at least half the zinc and copper sold on a given day, and was a major source of sugar and exporter of grain. It operated in forty different countries in every continent but Antarctica, generating $150 billion in revenue and $400 million in profit. During the 2000s, its average return on equity was 38 percent, meaning that for every dollar of shareholder capital it held, it was generating a profit of 38 cents.

Glencore’s business blend was also unique. On the oil side, it competed with energy traders like Vitol, and in agriculture, Cargill and Louis Dreyfus. In mining, it faced off with Rio Tinto and BHP Billiton. About the only major commodity in which it lacked a significant presence was natural gas.

Glencore was founded by the Belgium-born trader Marc Rich, born Marcell David Reich in 1934. A Jew who had
fled the Nazis with his family when he was five, Rich became an American citizen as an adolescent. After dropping out of college, he had made his name as a mercury trader at Phibro, the historic commodity trading firm, founded in 1901, that now operated a hub in New York. But Rich’s real success came in the crude-oil markets during the late 1960s, when he was running Phibro’s Madrid branch, from which he oversaw parts of Africa, Latin America, and the Middle East.

Oil trading at the time was dominated by the so-called Seven
Sisters: Gulf Oil and forerunners to Exxon, Mobil, Chevron, Texaco, BP, and Royal Dutch Shell. Physical barrels were often secured months or even years ahead of time and at fixed prices, making short-term gaps hard to fill. During the Six-Day War in 1967, Egypt effectively blocked Israel from importing crude, creating the first real oil embargo. In its wake, Rich was the first to embrace a novel idea: to circumvent the Seven Sisters by offering to buy oil directly from producer nations. It was the birth of what would become known as the on-the-spot, or “spot,” market for oil, in which crude was secured and delivered far quicker than it had in the past, and would revolutionize the way business was done.

Shortly after the construction of a secret Iranian-Israeli pipeline in 1969, Rich began exporting oil from the Middle East all over the world. The experiment helped turn Phibro into a crucial international supplier.

Rich incorporated his own company in Zug, Switzerland—a larger lakeside city just south of neighboring Baar—after a pay dispute with Phibro. Building on the spot, or shorter-term, oil market Rich had launched at his old firm, and taking on numerous other commodities in addition, Marc Rich & Co. flourished under its name partner’s aggressive, innovative style of thinking, giving him godlike status in the industry. Over time, he amassed a personal fortune estimated to be
at least $1 billion, and was nicknamed “the king of oil” (which became the title of a biography published in 2010).

He also set a new, and arguably lower, industry standard by dealing extensively with rogue nations. No despot was too corrupt to do business with. Rich shipped large quantities of oil to
South Africa during apartheid, brokered sugar-for-oil deals and later traded sugar with Cuba notwithstanding U.S. sanctions, and
purchased oil from Iran during the American hostage crisis that stretched over 444 days from 1979 to 1981.

Rich, who eventually moved from Madrid to London and, later, to his wife Denise’s native New York, comforted himself with the idea that his transactions were legal under Swiss law, and that the law was the only objective standard for business. U.S. authorities, however, were far less accepting of the way he operated. In 1983, federal prosecutors indicted him on numerous charges, including racketeering, tax evasion, and trading with the enemy during the hostage crisis. Rather than facing the charges, which he considered bogus, Rich obtained Spanish citizenship and fled his Fifth Avenue apartment for the comforting slopes of Switzerland, where, by comparison, almost anything was permissible.

Amazingly, Rich’s fugitive status had little real effect on his company, which he continued operating as usual from Zug, whose charming, tree-lined shores and tasteful church spires belied the corruption of one of its richest residents. But in 1992, a large bet that one of his traders had made on zinc went uncharacteristically awry. The resultant $172 million loss damaged both the company and Rich’s standing in it.

Marc Rich & Co. stabilized, but Rich himself did not. Under duress,
Rich sold his 51 percent stake in the company to his partners the following year. Willy Strothotte, a German metals trader Rich had mentored and then fired amid a power struggle, returned to take on the chief executive role, and the company was renamed Glencore.

Rich retreated to a quieter life, eventually focusing more on real estate than commodities. His status as an outlaw carried with it great personal costs. His marriage crumbled, he drank heavily, and in 1996, one of his
three grown daughters died of cancer in a
Seattle hospital. Her mother and sisters were by her side, but her father was only able to be there by telephone, where he listened, sobbing, in her final hours. Had he flown there, he would surely have been arrested before even making it to the hospital.

In January 2001, after an intense lobbying campaign handled partly by his former wife Denise, Rich received a presidential pardon on the last day Bill Clinton was in office. He never revisited the United States. His reputation remained stained even
upon his death from a stroke, in 2013, as did those of Clinton and the lobbyists who had helped secure his pardon.

The commodity rout of 2008 was probably Glencore’s toughest period since Rich’s ill-fated zinc gamble in 1992. The company’s credit default swap, or insurance-against-default, prices had retreated from their stratospheric levels, and Glencore was bringing in nearly $5 billion in net income, an amount just shy of 2007’s. But its publicly traded bonds were still only barely above investment grade.

The landscape had also changed. Commodity prices were still at their lows, credit to help finance transactions was much harder to secure as banks grew more parsimonious about sharing their resources, and the troubles with BP and other companies had left the company more vulnerable to rivals.

All this was occurring at a time when Glencore’s need for extra cash was most pressing. Trading vast quantities of both physical and virtual commodities was a cash-intensive endeavor. Raw materials in some markets could only be bought for hard currency, and in the derivatives markets, cash was often required as collateral on trades.

Glencore was also trying to enlarge its empire. In the years following the management buyout, the company had purchased a string of new assets around the world, deepening its commitment to commodities like coal, copper, and gold. As recently as Christmas Eve of 2008—the same day Brent hit its $37 low point—the company had spent close to $300 million to purchase
a controlling interest in a distressed Congolese mining company. A couple of months later, it was
forced to sell a highly profitable coal property in Colombia to Xstrata, another mining company for which it shipped certain commodities, simply to raise enough cash to maintain its one-third investment in Xstrata, which was holding a special shareholder rights offering at the time to raise some cash of its own. The distressed deal destroyed some of the goodwill between Glencore and Xstrata, which had been closely connected for years and would attempt a merger a couple of years later.