W
alking into the New York Mercantile Exchange for the first time was an exhilarating experience. Immortalized in the movie
Trading Places
, the sounds and energy are unmatched on Wall Street—or anywhere else in the world. While U.S. business may be run in the quiet halls of investment banks, when you walk onto the floor of the exchange, you just can’t help feeling that this is where the action is. Screaming men and women move millions of gallons of virtual crude oil from one place to another and back again. At the end of each day, when the pits are empty, the place is eerily quiet, and the floor is littered with torn trading tickets, a single, lonely LED panel displays one of the most important numbers in the global economy—the closing price of crude oil on the NYMEX.
Even a casual observer of the trading floor, after a few moments acclimating to what seems like overwhelming chaos, begins to sense an incredibly well-orchestrated dance. Whether credit for this should be given to the traders themselves or to the chaos theory that explains the harmony of motion exhibited by ants is up to debate. What’s undeniable is that when you sit and
watch the floor for any length of time, you start to understand why Wall Street rules the universe.
There’s a saying that an MBA and two bucks will get you a bus ticket. At the exchange, it’s worth even less. The floor is the realm of the self-made man—a place where education, race, gender, and religion all take a backseat to one’s ability to buy low and sell high more often than the reverse. What’s a Harvard MBA against the wisdom that comes from making or losing a BMW in five seconds? It was hard not to feel I had wasted my tuition money when a young trader summed up the esoteric topic of risk management in the best way I have ever heard by quoting Mike Tyson: “Everybody has a plan until they get punched in the face.”
A grizzled veteran, seeing me stare at the floor like a deer in the headlights, summed it all up when he whispered to me, “It’s the best business in the world—if you can figure out a way to stay in it.”
T
HE LEADERSHIP OF
Dubai showed incredible perspicacity in pushing ahead with the project of creating the Dubai Mercantile Exchange. While the region is known for its excess, the DME represents a progressive move leagues ahead of any seven-star hotel or indoor ski slope. Exchanges are the essence of capitalism. To take the essence of capitalism, drop it into the Middle East, and begin pricing
crude oil
using free-market principles is quite simply visionary.
In the context of Wall Street and Dubai, this deal was not a large one. Massive, multibillion-dollar buyouts and development projects seemed to be the norm in Dubai—and certainly no major investment bank in New York would have gotten excited over the numbers we were negotiating over. Yet somehow everyone intuitively understood that this project’s importance for the region and—though it’s hard to say without sounding grandiose—
the world
was significant.
I’ve stayed in close contact with the phenomenal teams that took over where I left off. As the launch date draws closer, a
very predictable split has emerged between the geographies/ entities that are supporting the project and those that are ambivalent or even hostile. A few large investment banks with energy trading arms have taken a predictably antagonistic attitude toward the exchange. I understand why. Price transparency is good for all—but bad for some. Specifically, it’s bad for those who have made very good livings off the lack of transparent pricing.
Without a
clear
and
accessible
reference price, intermediaries are in a powerful position to profit. Let’s say you live in a place where it is impossible to buy or import olive oil, but there is a plentiful local supply of corn oil. Let’s also assume that these are the only types of oil that exist. The producers and buyers of that corn oil won’t be exactly sure how to price the product. They can use the price of olive oil in another land as a reference. That is a
clear
price. But it’s not
accessible,
since the olive oil cannot be imported. So if you are lucky enough to establish yourself as the intermediary—helping sellers find buyers and vice versa—you can constantly work to maximize the value of your spread by convincing sellers that the price should be slightly lower and convincing buyers of the opposite.
Without a clear and accessible reference, intermediaries can have a virtual information
monopoly
—even better pricing information than the market principals (producers and consumers) themselves. Some of the groups have spent years building relationships in the Middle East sour crude market. A few of them made the same protest when the NYMEX began trading crude oil. I don’t begrudge them resistance to something that will fundamentally change how they do business in the region. However, all good things must come to an end.
Over the last two years, the public markets began to appreciate the exchange business model. Numerous buyouts, consolidations, and public offerings with earnings multiples similar to those of high-tech growth companies blew through the NASDAQ and NYSE. Some saw a bubble, though it’s important to remember
that exchanges are by their nature a limited pool of entities. Despite the attractiveness of the sector, no amount of venture capital money can guarantee the success of a start-up exchange.
I
N LATE 2006
, the NYMEX gave in to overwhelming market pressure and launched side-by-side trading—effectively pitting the open-outcry traders against the screen and setting up the final fight over which trading methodology would prevail. While most industry pundits seemed smugly confident that the speed and efficiency of electronic trading would render the pit traders extinct in months—and they are probably right—at the time of this book’s publication the final outcome has yet to be determined.
Correspondingly, in the last few years the public markets have “discovered” everything we knew about commodities exchanges. Incredible exchange IPOs with fantastic multiples and Google-like stock trajectories seem to be happening every day. NYMEX’s initial public offering was the most successful of the previous
six years
. The New York Board of Trade sold for $1.3 billion—a high-tech company multiple being applied to forward earnings. Suddenly, it is so obvious. Who wouldn’t want to invest in the entity that makes money whether prices go up or down, whether traders go broke or make money? Who wouldn’t want to own “the house”?
The public market may grant large rewards—but it also has strong demands. Exchanges that moved at their own pace for 125 years have suddenly found themselves staring down the barrel of the Jim Cramer crowd, with demands for aggressive growth into markets, scalability, and emphasis on the bottom line. Open-outcry was the low-hanging fruit. High-cost, not so scalable, antiquated, and prone to ridicule—those crazy traders and brokers running around the floor in their colored jackets just didn’t
feel
right in the new, modern world of the exchange.
But for those of us who saw them in their heyday, the move to electronic trading is bittersweet. I left Harvard Business School
loaded for bear with a copy of Milton Friedman under my arm. I believed in truth, justice, and corporate efficiency. Yes, electronic trading is more efficient—at least, for plain-vanilla front-month contracts—but there is a reason the design for the spoon hasn’t changed since the day of the caveman. It works.
The changing of the guard will, and should, happen. Computers have more horsepower, make fewer mistakes, and are morally incorruptible—but when it comes to recognizing nonlinear patterns amid volumes of constantly changing data with numerous and sometimes
emotional
variables, humans are still competitive. There’s a reason it took so long for a machine to beat Kasporov—and chess is a more mathematically
solvable
game than energy trading.
If you don’t agree, please try to write an algorithm to predict the downward or upward movement in natural gas prices resulting from a pipeline explosion in Louisiana, or the reaction of oil prices to a picture of the president holding hands with the Saudi oil minister. Energy is one of the few things we trade with
constant demand
. You can stop buying jewelry when gold prices get too high, you can stop buying Google stock when it hits six hundred dollars…but it’s hard to stop driving to work and watching TV. Until we trade elements, air (carbon credits), and water, nothing like it exists.
The DME is scheduled to trade its first contract in the second quarter of 2007. No one can predict whether the market will flourish or founder. It’s likely that, despite the fanfare, the contract will struggle in the early days as participants test out the liquidity. That is natural. Unlike some recent first-day successes, this is a brand-new contract, with little carryover from existing liquid markets.
On November 14, 2006, the Sultanate of Oman adopted the historic policy of allowing its crude oil to be priced using the daily settlement of the Oman sour crude contract at the DME. Around the same time, Oman decided to purchase an equal share of the DME, making NYMEX, Dubai, and Oman partners. Oman was,
from the beginning, the wild card. Without its support, the DME is a soccer field with players but no ball. Its commitment is a tremendous boost to the probability of the DME’s long-term success.
Both Dubai and NYMEX have a history of getting things right. If they get this one right, they will have made history.
John D’Agostino
New York City
January 2007
I
never set out to write a book about oil.
The truth is, I’ve never really seen myself as that kind of writer. My stories—the stories that turn me on enough to get me to dedicate a year of my life to their telling—usually involve brilliant young kids pulling off incredible schemes: wads of cash strapped to backs, Ferraris, and long-legged models and locales so exotic I need the Internet to help me find them on a map.
I usually leave the big geopolitical issues to the kind of writers you normally see published in the
New Yorker
and the
Atlantic Monthly
.
With
Rigged,
I actually stumbled into oil. The story I set out to write was as wild a ride as I’d ever embarked on—involving a brilliant young Ivy League kid with balls of steel who had embarked on an adventure that involved all the elements a method writer like myself lives to chronicle. But the more I researched this Ivy League kid’s tale, and the deeper I went into the world he described, the more I realized that there was a much bigger, much more important story to tell.
In real life, the kid’s name is John D’Agostino. When I first met
D’Agostino, he was a second-year student at Harvard Business School. His girlfriend introduced me to him, and I was immediately struck by his intensity; in a way, there was something almost frightening about him. He was young, matinee-idol handsome, and polished. He had a grin that was friendly and engaging, but there was also a palpable edge behind his eyes. Maybe it was just me, but I caught a hint of
American Psycho
in him, beneath the polish. Not the part that involved chopping up prostitutes in his bathroom after work, but the smoldering fierceness of a young man powered by pure ambition. Everything about D’Agostino screamed purpose, from his perfect hair, combed so severely that you could see each strand, to the perfect suit, pressed so ruthlessly that you could cut bread with the creases. I knew immediately that D’Agostino was the kind of guy I wrote stories about—but it wasn’t until six years later that I found out how right I was. D’Agostino—still with the same girlfriend—had called me out of the blue to invite me to ring the bell at the Mercantile Exchange in Lower Manhattan, where he was already a vice president at the unbelievably young age of twenty-five.
I didn’t know anything about the Merc, other than the fact that it was the trading floor that had been featured in the Eddie Murphy movie
Trading Places
. In fact, I didn’t even know that it was the place where oil was traded until D’Agostino gave me a tour of the facilities on my way to the bell-ringing ceremony. And it wasn’t until I was standing up on a platform in the center of the trading floor, staring out at this crazed mob of Brooklyn-born Italians and Jews, that my mind began to whir and I had that familiar feeling that I was witnessing something that might be worth writing about. Because the Merc wasn’t like anything I had ever seen before.
And this was where the price of oil came from? This was part of how that black juice got into my car?
After ringing the bell, I cornered D’Agostino at the bar on the top floor of the exchange and immediately made my pitch. I wanted to write a story about the Merc, about the crazy young men who made fortunes on that trading floor, then spent those
fortunes on fast cars and even faster girls. Etc., etc., etc. But D’Agostino laughed, telling me that the Merc was only the tip of the iceberg. Then his conversation shifted to Dubai—and suddenly I found myself uncovering a whole new story, one that truly blew my mind.
Right then and there, I knew I had the makings of my next book.
The problem was, John D’Agostino didn’t want me to write
Rigged
. It wasn’t just that the subject matter was controversial, involving the secret workings of a world most people had never even heard of; it was deeper than that, an intensely personal reluctance that had to do with D’Agostino’s Italian Brooklyn background and the respect he had for the people who had helped him along the way. D’Agostino was on the inside—and in D’Agostino’s world, people on the inside didn’t talk to outsiders, especially writers.
Thankfully, I can be pretty persuasive. Eventually I did manage to convince D’Agostino to let me write the book; to appease his fears, I renamed the main character David Russo. Other than obvious public figures, I have not used any real names in telling this story. For the sake of narrative, and to protect the privacy of the individuals in this story, I compressed certain time periods and altered the identity and background of certain individuals so that they would not be recognizable. Characters such as Gallo and Khaled are composites and are not meant to portray particular people.
In the end, after reading the story, D’Agostino agreed to allow his real name in this author’s note and in the afterword, which he wrote himself. I know that such an arrangement is unique in a work of nonfiction—but this is indeed a unique book.
Unique for me, as a writer, and hopefully just as unique for you, as a reader.
Ben Mezrich, Boston