The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders (9 page)

Growing up in Pittsburgh, Fan found herself in a family that was staunchly academic. Instead of watching MTV on cable like other kids in the alternative-rock heyday of the 1990s, Fan and her brother and sister did math drills at home, reviewing with their mother, a nuclear physicist, flash cards and tests designed for older students. In fifth grade, Fan and some classmates won the champion title in a math bee designed for middle-schoolers; her mother was the team’s coach. Fan’s older sister was even more precocious: she enrolled at Carnegie Mellon University at age thirteen (there were better schools out there, but she was too young to move away from her parents). “I am not the smart one in my family,” Fan says matter-of-factly. Her sister later worked at Amazon.com devising algorithms to predict how people would shop, a complex equation that had similarities to trading. She spent her free time rock-climbing.

By the time she moved to New York for college, where she received an undergraduate degree from NYU’s Stern School of Business, Fan had not yet gotten a driver’s license, but as a young commodity trader in Purchase, she had to learn to drive in order
to get from Tribeca, the trendy downtown Manhattan neighborhood where she lived, to Westchester County. In a rare occurrence for the star student, she failed the first driving test by sitting too long at a four-way intersection. On the next attempt, after a sympathetic driving instructor sneaked her onto the test site for a dry run, she passed.

She bought a blue BMW ragtop and began the half-hour commute from her apartment to Purchase. Before long she was ticketed for speeding along a tricky section of Manhattan’s West Side Highway, where the road transitioned abruptly from a 35-mile-per-hour zone to a 50-mph zone and back again. It was a rite of passage, given that other Morgan traders had also been ticketed.

Fan was one of very few women in Morgan’s commodities unit. Sitting at a five-foot desk next to her boss, a former physicist named Dan Nash, she kept busy making trades for Morgan’s clients and, in short order, trading commodity contracts in her own speculative book. She arrived at 7:30
A.M.
every morning, ate a cafeteria lunch at her desk, and stayed well after the close of trading to research trades. During afternoon lulls, she and Nash would amuse themselves by reading medical journals on the Internet and pointing out the ways in which the statistics didn’t support the recommended treatments.

“Our corner was quiet and intellectual and everybody else was raucous,” Fan says. If she took any ribbing from her coworkers, it was because she made a geek’s error, as when she conflated two members of the Bernoulli family, a seventeenth- and eighteenth-century mathematical dynasty in Switzerland that produced important theories on probability and fluid dynamics. (It was an uncle and his nephew who generated those respective ideas, not the same individual, as she had initially thought.)

The index group was a relatively bare-bones operation. It handled its entire collection of trades with a spreadsheet that Nash, who disliked the cut-and-paste bank models that other people used, had built himself. The work was labor-intensive. Replicating commodity indexes was a piecemeal process that required signing flurries of private trading contracts with clients. And Morgan was trying to compete with the more entrenched players by offering lower fees.

It worked, helped in no small part by the broader market trends at play. Commodity indexes were soaring in popularity as clients embraced the supercycle—that is, the notion that economies were in the middle of a robust, twice-a-century upswing in prices—and the idea that they could mitigate their vulnerability to price inflation by owning raw materials. Morgan benefited from that added volume. Nash added another salesman and a couple of additional traders to the team, and let Fan start trading “relative value” positions, or sets of commodity contracts where she saw potential profits from pitting the different components against one another, for the company’s benefit. She had to ask Nash for permission to make the trades, and, like Jean Bourlot at Vitol with his Singapore jet-fuel gambit, she was subjected to strict risk limits.

Late in the spring of 2005, Fan made a small bet in the U.S. gasoline market. There was plenty of gas in storage at the time, and futures contracts linked to September and October looked relatively cheap. But Fan had a theory that summer “spec” gasoline—a specified blend designed not to evaporate easily in hot conditions—might go into short supply over the summer, raising its price as the season progressed. So she bought September gas
futures and concurrently bet on a price fall by their October counterparts, hoping to benefit from an eventual price discrepancy between the final contract linked to summer and the first one of the winter season, at which point summer-blend gasoline would go out of favor. Her goal was to make about two cents a gallon, or total profits of a little over $250,000.

Months later, when Hurricane Katrina made landfall near New Orleans, she was the only trader on Morgan’s index desk who was actually in the office. It was early on Monday, August 29, and many of the energy traders had been in Purchase all weekend to be ready for a potential price spike in commodity contracts that they thought might result from hurricane damage to refineries or drill sites around the Gulf of Mexico. Nash, however, was on a long-planned family vacation and had left Fan on her own.

Initially, commodity prices fell, as the immediate damage from the storm appeared less severe than the market had feared. But things soon turned catastrophic. The death toll eventually topped 1,800. Levees around New Orleans failed, 80 percent of the city flooded, and big chunks of the roof of the Louisiana Superdome, where thousands of refugees had gone for temporary shelter, were ripped away. Meanwhile, the Gulf region’s energy infrastructure, which accounted for
a quarter of the country’s crude-oil production, was badly damaged. Fan heard that one refinery control room had an alligator in it. Gas shortages seemed inevitable, and the pipelines that fed oil tankers on coastal shores were surely compromised too.

Fan was distraught. The human impact was horrific, the market impact uncertain. Most of her clients were betting on a rise in commodity contract prices somehow, so as the market surged as bad news raised fears of crimped supplies, they would probably
make money. But Morgan, which had taken the other side of many of those trades, wasn’t in the same position. One of the few bets that actually stood to be profitable in the bank’s prop books during the storm’s aftermath was Fan’s gasoline wager.

On August 30,
gas contracts rose 20 percent as pump prices soared to $3 or even $3.50 per gallon across the country. On August 31, they rose another 6 percent, as fuel lines formed in many states. To address the shortages, President
George W. Bush vowed to tap the nation’s Strategic Petroleum Reserve, a stockpile of hundreds of millions of barrels of crude that the U.S. government drew upon in times of emergency.

Amid the drastic turn of events, Fan’s side hunch on a summer gas shortage turned into a 30-cent-per-gallon gain. The trade generated about $3 million.

Despite the performance of its occupants, the commodities building in Purchase remained a cultural backwater at Morgan. There was relatively little contact between the bankers and other traders in New York, where the firm was situated in a flashy tower near Times Square.

Morgan chief executive
John Mack, a veteran who had left the firm after a bruising boardroom battle only to be reinstated as chairman and CEO in 2005, was one of the only senior executives to visit the Purchase building regularly. Even then, it was only to use the gym on his way from home in nearby Rye to midtown Manhattan. Senior-level sightings were so rare that when Boris Shrayer, one of the top salespeople in the commodities division, was named managing director, he joked to Mack, whom he had seen frequently in the locker room, that he didn’t recognize him with his clothes on.

Mack, a Duke-educated former bond trader with Lebanese roots, could handle a blue joke or two from a subordinate. But when it came to the commodities unit’s general attitude, he was less amused. During one particular dinner with some of the commodities traders in Westchester, Mack was astonished by the group’s arrogance. Sure, they were generating billions in annual revenue, grabbing business from their competitors, buying physical assets, and trading lots of volume. But their demands for huge bonuses suggested that they thought the bank itself had nothing to do with their success, as if the Purchase trading floor was an island with no need for Morgan Stanley’s considerable resources. Mack left the dinner with a sour feeling. At some point, he thought, I’ve got to crush these people.

The key, as it turned out, would be for the commodities unit to not crush the bank first. In 2008 John Shapiro, Morgan’s head of commodities, retired. In the first half of that year, oil was peaking and the division seemed well on its way to a standout year in revenue terms. (And, to be sure, it was.) But when the market reversed that fall, a seemingly innocent crude-oil trade suddenly threatened to leave Morgan with billions of dollars in losses, and Shapiro, the godfather of the division—whose impeccable memory for detail was a source of both irritation to subordinates and, on the upside, prudent risk management—was no longer there to prevent it from happening.

The trade in question, a hedge meant to manage jet-fuel price risk for Emirates Airline, was the brainchild of Jean Bourlot, the irritable Frenchman who had fought with Andurand over the Singapore jet-fuel trade. Emirates was the official flyer of the United Arab Emirates, the tiny constellation of states east of Saudi Arabia. A government-sponsored company that had grown quickly
from its inception in the mid-1980s, it had a unique set of needs when it came to jet fuel. Emirates was a transportation hub for international flyers traveling to and from Dubai, the UAE’s financial capital, from thousands of miles away. To service those routes, Emirates operated some of the world’s biggest aircraft, including the two-deck, 525-seat Airbus A380. The airline had spent $
3.2 billion on an order for a dozen of the 777-300ER, a sleek new Boeing aircraft, as well.

By 2004, the carrier’s annual fuel bill was nearing $1 billion, overtaking personnel as its number-one cost. And unlike some of the more conservative U.S. airlines, Emirates was willing to hedge its jet risks creatively, making it a perfect target for innovative bank commodities traders.

Bourlot, the Morgan commodity trader still fuming over the China Aviation Oil Corporation trade on which he believed Andurand had stiffed him, was then a rising star at the company’s London energy-options trading desk. The same year his China Aviation trade exploded, Bourlot helped arrange a hedge for Emirates that seemed guaranteed to make it money in the crude market under anything but a wildly volatile price scenario. The only problem was that was exactly the scenario Emirates encountered.

Because the jet-fuel derivative market was relatively small, making it tough at times to get in and out of trades, airline fuel hedges typically employed a basket of contracts tied to various liquid energy commodities—usually crude, but also other contracts that were related to it, like heating oil and diesel. Bourlot’s trade involved using various options to set the expectation that crude oil would trade within a certain price band at a certain dollar amount above and below where Emirates management expected crude prices to actually be. If prices stayed in the range—which,
statistically speaking, they almost certainly would—Emirates would achieve significant cost savings on crude.

But the trade also had some other features. Emirates had layered an additional batch of commodity contracts to widen that original range. So, instead of only being price-protected in a price range that was $30 wide, a second set of options contracts locked in oil prices at a range about $50 wide (the exact prices would change every year based on the market price of crude oil, but the size of the price range remained about the same). Emirates sold put options, which represented the right to sell oil, and calls, the right to buy it, to Morgan Stanley, which in turn sold other instruments back to Emirates.