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CONTENTS
Preface: The Fighter
PART 1: THE KOCH METHOD
CHAPTER 1 Under Surveillance
CHAPTER 2 The Age of Volatility Begins
CHAPTER 3 The War for Pine Bend
CHAPTER 4 The Age of Volatility Intensifies
CHAPTER 5 The War for Koch Industries
CHAPTER 6 Koch University
CHAPTER 7 The Enemies Circle
CHAPTER 8 The Secret Brotherhood of Process Owners
CHAPTER 9 Off the Rails
CHAPTER 10 The Failure
PART 2: THE BLACK BOX ECONOMY
CHAPTER 11 Rise of the Texans
CHAPTER 12 Information Asymmetries
CHAPTER 13 Attack of the Killer Electrons!
CHAPTER 14 Trading the Real World
CHAPTER 15 Seizing Georgia-Pacific
CHAPTER 16 The Dawn of the Labor Management System
CHAPTER 17 The Crash
PART 3: GOLIATH
CHAPTER 18 Solidarity
CHAPTER 19 Warming
CHAPTER 20 Hotter
CHAPTER 21 The War for America’s BTUs
CHAPTER 22 The Education of Chase Koch
CHAPTER 23 Make the IBU Great Again
CHAPTER 24 Burning
CHAPTER 25 Control
Acknowledgments
Appendix: Alphabetical Directory of Significant Characters in Kochland
Notes
Index
This book is for my mother, Victoria Brigham Leonard, who taught me to think about the other person. Thank you.
PREFACE
* * *
The Fighter
(1967–2019)
On May 18, 1981, four Wall Street bankers traveled to Wichita, Kansas. They went there to make an offer to Charles Koch, the CEO of an obscure, midsize energy company. The bankers, from Morgan Stanley, wanted to convince Koch to take his family’s company public, offering shares for sale on the New York Stock Exchange. Their deal was squarely in line with the conventional wisdom of corporate America at the time. Going public was seen as a natural progression for companies like Koch Industries, offering them access to big pools of money and promising enormous paydays for the existing team of executives. All it required from the CEO was to surrender control. Morgan Stanley, in return, would collect a small fortune in fees.
Charles Koch was forty-five years old. He had run Koch Industries since he was thirty-two, when his father died suddenly. He was trim, tall, and had an athlete’s build. He spoke quietly in meetings and seemed almost passive. The bankers laid out their plan to take Koch public. They revealed what, to most executives, at least, might have been the most significant detail: if Charles Koch agreed to the deal, he could earn $20 million overnight. The bankers seemed incredulous when they prepared a confidential memo about Koch’s reaction.
“He does not want this cash,” the memo reported.
Charles Koch calmly explained to them why their offer made no sense. His company was breathtakingly profitable. It operated in vital, deeply complex corners of the American energy industry. During the 1980s, Koch Industries was the largest purchaser and transporter of US crude oil. It owned an oil refinery. It employed teams of commodities traders who bought and sold a wildly diverse menu of raw materials and financial products, from gasoline to paper futures contracts. This might have encouraged most CEOs to take their company public. Koch Industries, however, did not want outsiders to know how much money its traders were earning. Taking the company public would expose too many of its secrets.
“Certain of [Koch’s] commodity traders are particularly worried that their high salaries, once disclosed to the public, would be used against them by their trading partners,” the memo said.
Secrecy was a strategic necessity for Koch Industries. Charles Koch did not want to surrender it. He also didn’t want to surrender control. He had a specific, clear vision of how to run his company, and he didn’t need Wall Street investors to interfere.
If the bankers expected Charles Koch to go along with the conventional wisdom of their time, then they, like so many outsiders, did not understand him. Beneath his low-key veneer, Charles Koch was, at his core, a fighter. He had unmovable ideas about how things should be, and he did not back down when challenged. When he was challenged by his own brothers for control of Koch Industries, he fought them in a bitter legal battle that lasted decades. When he was challenged by members of a powerful labor union during his first years as CEO, he fought them even as they committed an act of industrial sabotage that nearly destroyed Koch’s oil refinery. When the FBI and the US Department of Justice launched a criminal investigation into Koch Industries’ oil gathering business, Charles Koch fought them with every legal and political tool at his disposal. When a liberal Congress and President Barack Obama sought to impose regulations on the fossil fuel industry to control greenhouse gas emissions, Charles Koch fought them in ways that changed US politics.
In each of these fights, Charles Koch prevailed.
When Charles Koch dismissed the bankers in 1981, it was just a small skirmish in the larger war to control Koch Industries. After prevailing in that fight, he created a company that was true to his vision. He avoided the snares that entangled many publicly traded companies that report their financial results to investors every three months. Koch Industries didn’t have to think quarter to quarter. The company thinks year to year. An internal think tank and deal-making committee, called the development group, will sometimes think through a business deal on a timeline measured in decades. This long-term view made Koch nimble where other companies stumbled. In 2003, for example, Koch Industries bought a group of money-losing fertilizer plants when no publicly traded company was willing to take the risk. Today those plants are as profitable as a broken ATM machine that spews out cash around the clock. Unlike publicly traded companies, Koch Industries does not pay out rich dividends to investors. Charles Koch insists on reinvesting at least 90 percent of the company’s profits, fueling its constant expansion.
This strategy laid the foundation for decades of continuous growth. Koch Industries expanded continuously by purchasing other companies and branching out into new industries. It specialized in the kind of businesses that are indispensable to modern civilization but which most consumers never directly encounter. The company is embedded in the hidden infrastructure of everyday life. Millions of people use Koch’s products without ever seeing Koch’s name attached. Koch refines and distributes fossil fuels, from gasoline to jet fuel, on which the global economy is dependent. Koch is the world’s third largest producer of nitrogen fertilizer, which is the cornerstone of the modern food system. Koch makes the synthetic materials used in baby diapers, waistbands, and carpets. It makes the chemicals used for plastic bottles and pipes. It owns Georgia-Pacific, which makes the wall panels, beams, and plywood required to build homes and office buildings. It makes napkins, paper towels, stationery, newspaper, and personal hygiene products. Koch Industries owns a network of commodities trading offices in Houston, Moscow, Geneva, and elsewhere, which are the circulatory system of modern finance. Koch traders sell everything from fertilizer, to rare metals, to fuel, to abstract derivatives contracts. Koch Industries’ annual revenue is larger than that of Facebook, Goldman Sachs, and US Steel combined.
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The profits from Koch’s activities are stunning. Charles Koch and his brother David own roughly 80 percent of Koch Industries. Together the two men are worth $120 billion. Their fortune is larger than that of Amazon CEO Jeff Bezos, or Microsoft founder Bill Gates. Yet David and Charles Koch did not invent a major new product or revolutionize any industry. The Koch brothers derived their wealth through a patient, long-term strategy of seizing opportunities in complex and often opaque corners of the economic system.
This book tells the history of Koch Industries and shows how the Koch brothers’ fortune was made. In doing so, it also provides a portrait of the American economy since the 1960s. Koch’s operations span the entire landscape of the American economy. The company’s story is the story of America’s energy system, of its blue-collar factory workers, of millionaire derivatives traders, corporate lobbyists, and private equity deal makers. To examine Koch is to examine the modern American economy.
This account is based on hundreds of hours of interviews, conducted over six years, with dozens of current and former Koch Industries employees, managers, whistle-blowers, and senior executives, including Charles Koch. Also interviewed were outside regulators, prosecutors, politicians, bankers, and competitors. These verbal accounts were supplemented by internal company memos, minutes of executive meetings kept by firsthand witnesses, government documents declassified for this book, legal transcripts, regulatory filings, contemporaneous news accounts, and other documents.
Ralph Waldo Emerson famously said that an institution is the lengthened shadow of one man. This observation would seem to be particularly true of Koch Industries, which has been led by one CEO since 1967. Charles Koch’s control of the company is complete. His portrait hangs in the company’s lobby, and employees are trained with his videotaped speeches. Every employee must embrace Charles Koch’s highly detailed philosophy called Market-Based Management. But Emerson’s quote captured only half of the truth about institutions. They are shadows of people, but they are also shadows of the political and economic systems in which they exist. A large corporation in China, for example, is quite different from a large corporation based in America. The laws, culture, and economic incentives are radically different in each nation. Koch Industries, then, reflects an American system in which it grew and thrived.
When Charles Koch took control of the company, America operated under a political framework called the New Deal, which was characterized by dramatic government interventions into the private marketplace, empowered labor unions, tightly regulated energy companies, and a shackled financial industry. Charles Koch despised it. He subscribed to the philosophy of Austrian economists such as Ludwig von Mises, who believed that government intervention only created more harm than good. During Charles Koch’s career, the New Deal system fell apart. The system wasn’t replaced by a libertarian society, as Charles Koch might have wanted, but by a dysfunctional political economy characterized by selective deregulation coupled with a sprawling welfare and regulatory state. Charles Koch didn’t just operate within this political framework. He dedicated his life to transforming it. He created a political influence network that is arguably the most powerful and far-reaching operation ever run out of an American CEO’s office. Koch Industries has one of the largest, most well-funded lobbying operations in the United States. Its efforts are coupled with a nationwide army of activists and volunteers called Americans for Prosperity, along with a constellation of Koch-funded think tanks and university-based programs. Charles Koch’s political vision represents one extreme pole in the ongoing debate about the role of government in markets; a view that government should essentially protect private property and do little else. Political figures on the opposite pole believe that a robust federal government should provide a safety net and contain the power of large corporations. There is currently no political consensus in support of either view.
As the argument between these visions drags on in a stalemate, the modern American economy is one that favors giant companies over the small, and the politically connected over the independent. More than anything, it favors companies that can master complexity—the complexity of interconnected and global marketplaces, and the complexity of wide-reaching, intrusive regulatory regimes.
Charles Koch frequently derides the current political era as one of “crony capitalism,” but the company he built is perfectly suited to thrive in this environment. Koch Industries employs an army of legal experts to navigate the extensive legal intrusion of the state. A similarly large group of market analysts and traders navigate the fractured and byzantine markets of energy products. It is revealing that Koch Industries expands, almost exclusively, into businesses that are uncompetitive, dominated by monopolistic firms, and deeply intertwined with government subsidies and regulation.
To take just one example: Koch derives much of its profits from oil refineries. The entire economy depends on refined oil, but no one has built a new oil refinery in the United States since 1977. The industry is dominated by entrenched players who run aged facilities at near-full capacity, reaping profits that are among the highest in the world. A single refinery shutdown causes gasoline prices to spike across entire regions of the United States. The underlying cause of this dysfunction is a set of loopholes in the Clean Air Act, a massive set of regulations passed in 1963 (and significantly expanded in 1970) that imposed pollution controls on new refineries. The legacy oil refiners, including Koch, exploited arcane sections of the law that allowed them to expand their old facilities while avoiding clean-air standards that would apply to new facilities. This gave them an insurmountable advantage over any potential new competitor. The absence of new refineries to stoke competition and drive down prices meant that Americans paid higher prices for gasoline.
Koch Industries has applied its profits to maximum advantage. In 2018, the company’s headquarters campus in Wichita resembled a fortified kingdom. The facility was expanded in 2014, with the addition of several thousand square feet of office space in buildings arrayed at the base of the iconic Koch Tower—a large building with black windows and gleaming dark granite. The renovation also included the installation of a tall, earthen wall surrounding the north side of the campus. A local city street was diverted around the wall, at Koch’s expense, to keep passersby at a safe distance. Seldom has a company gained such deep reach into so many Americans’ lives while simultaneously walling itself away into an insular community.
Koch Industries’ employees arrive to work early, creating small traffic jams at entrances to the campus, under the watch of security guards. Many of them enter Koch Tower through an underground pedestrian tunnel, passing a series of photo collages that memorialize Koch’s history. They reach an underground lobby and an elevator bank, where the portrait of Charles Koch hangs on the wall. It is one of those composite portraits, made of countless tiny images that combine to form a larger picture. The tiny images are of Koch’s employees; the larger picture is Charles Koch. Across the lobby, employees shop at the company store, called Hot Commodities, where they can buy coffee or an audio CD relating the history of founder Fred Koch. There is a magazine rack stocked with glossy copies of the company newsletter, called Discovery, which regularly features columns by Charles Koch.
When each employee is hired, he or she undergoes a multiday training session to learn the tenets of Charles Koch’s philosophy, Market-Based Management, or MBM as they call it. Charles Koch says the philosophy is a blueprint for achieving prosperity and freedom. It is equally applicable to business ventures, personal habits, and national government. Adherence to the creed is nonnegotiable for anyone who remains at Koch Industries. Charles Koch, in one of his books, writes that an “act of conversion” is necessary for MBM to be effective. It cannot be adopted in bits and pieces. The Ten Guiding Principles of MBM are printed and hung above cubicles throughout company headquarters. When employees get free coffee in the break room, the Guiding Principles are printed on their disposable cups. The employees learn MBM’s v
ocabulary and speak a language among themselves that only they truly understand. They drop phrases like “mental models,” “experimental discovery,” and “decision rights,” that instantly convey deep meaning to insiders. The employees become more than employees; they become citizens of an institution with its own vocabulary, its own incentives, and its own goals in the world. The financial success of Koch Industries only reinforces the idea that what they are doing is right and that the tenets of MBM are indeed the key to proper living.
Because this book is the biography of an institution, not an individual, many people will come and go through its pages. Readers will meet Heather Faragher, a Koch employee who blew the whistle on systematic wrongdoing inside Koch, only to face the harshest consequences. Readers will meet Bernard Paulson, a hard-driving executive who helped Koch Industries break the back of a militant labor union. They will meet Dean Watson, a rising star at Koch Industries, who embraced the teachings of Market-Based Management but whose career collapsed under the weight of his own ambition. They will meet Philip Dubose, a Koch employee who stole oil to make his bosses happy. They will meet Steve Hammond, a warehouse worker who negotiated for workers’ rights against his bosses at Koch. And they will meet Brenden O’Neill, a striving middle-class man from Wichita who became a millionaire on Koch’s commodity trading floors. Unfortunately, many of these people will arrive and then fall away as Koch Industries moves forward and changes with the times. This is the nature of large institutions. The people in them come and go. If it is difficult to keep track of so many individuals, readers can turn to an alphabetical directory of characters at the end of the book.
There is one person, however, who is present for the entire fifty-plus-year span of this story. He resides, almost the entire time, at the pinnacle of power at Koch Industries, driving it forward, shaping it to his vision, and reaping its great rewards. Charles Koch is the author, more than anybody, of Koch Industries’ story.
Kochland Page 1
