Marc Rich, Part I: Riches in Regime Change

“I trade wherever it is legal to trade."

Sep 9

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Hi all,

This is my take on a famous commodities trader and fugitive, Marc Rich. I decided to divide the piece into two parts, the second of which will go out to premium subscribers. I wish there was a better solution since I’d like to have the entire piece in one spot. For the time being, this compromise will have to do. I hope you will enjoy the story and glean some valuable insights from Rich’s life. I plan on sending the second part tomorrow.

Fortunes are made when markets open up and old power structures crumble. This could be political (Russian oligarchs), technological (the internet and software eating the world), or geopolitical — such as when Western dominance of the oil trade ended and a free market emerged.

One of the biggest winners of the oil market’s sea change was an enterprising trader named Marc Rich. He and his family had fled Nazi persecution to America. He started as a trader at commodity trading firm Philipp Brothers before building his own trading house (today’s Glencore). Rich’s web of relationships allowed him to spot the breakdown of the oil market’s oligopoly early and he bet aggressively on higher prices. He entered long-term supply contracts, organized logistics through tankers and pipelines, and in some cases had exclusive buyers. As Byrne Hobart correctly pointed out, he was able to replicate the value creation of an integrated oil company in a synthetic and more flexible way. This way he was able to take advantage of the more volatile market and poorly positioned players.

Rich acted as the discreet middleman, dominating the crude oil trade and making a market for pariah countries including Cuban communists, Spanish fascists, Iranian islamists, and the apartheid regime in South Africa. But his greed and willingness to put profits over politics became his downfall when he was indicted by Rudy Giuliani for tax evasion and violating the Iranian boycott. While his companies settled for $200 million, at the time the largest amount in a criminal tax evasion case, Rich remained in exile in Switzerland for the rest of his life.

Key Lessons

Niche markets with strong growth prospects: Early in his career, Rich specialized in small markets where he could meet all the major players and gain an edge.
Regime change: Rich found many of his best opportunities in the volatility that followed a change in power or market structure.
Profit over politics: Rich was open to trading with anyone. What made him a highly effective middleman also led to his downfall.
Formula for riches: build relationships and gain exclusive access to information and supply. Bet big and long-term when a new secular trend becomes apparent. Replicate the capital-intensive integrated supply chain through flexible contractual relationships and bank financing.

Commodities trading was an apprenticeship business ruled by long-established family ties

Marc Rich’s father had fled pogroms in Galicia, first to Frankfurt, then in 1933 to Antwerp in Belgium where Marc was born. Upon the Nazi invasion in 1940, the family fled again. Rich remembered how his father “put us all in the car,” and “I saw the German planes. I heard the bombings.” Via a refugee camp near Casablanca, the family made its way to the US. Rich’s father rebuilt his life as an entrepreneur with ventures in jewelry, textiles, and with a banking venture in South America.

“My father,” Rich recounted, “is definitely the person who influenced me most. We fled from Belgium, and he managed to build up an important business from zero. My father had a knack for success and an uncompromising work ethic.”

Growing up as an outsider with something to prove shaped Rich’s attitude towards life, “forced emigration instilled in me a strong desire for independence,” and defeat: “You cry a little and then you move on.”

Rich dropped out of New York University in 1952 and soon joined Philipp Brothers, a commodity trading firm. The trading house had been established by two German Jewish brothers in 1901 and risen to be one of the key global traders of metals. The author of King of Oil argues that the widespread Jewish diaspora enabled efficient long-distance trade thanks to long-established community ties. This trust could compensate for the lack of available information and slow communication in the pre-internet era.

The firm followed an apprenticeship model, getting new employees acquainted with the basics of the business before making them junior traders. Rich started in the mail room, sorting through incoming telex messages. At first, he regretted his decision, calling it “postboy” work “beneath his dignity.” After the mailroom came the traffic department and the “real learning.” There he learned the inner workings of the company’s logistics: he visited the docks to supervise delivery of “merchandise and metals,” inspected the bills, checked the invoices, arranged for payment, letters of credit, and insurance.

A trader recalled Philipp Brothers as a “family business” where “your father or a family friend could get you in through the door, but then you had to prove that you were good, in fact even better than the others. There was no patronage system that would let a dud rise up through the ranks; it was all based on your own performance.” And Rich rose quickly.

Finding a niche

A first lesson from Rich’s life was the value of going deep in a niche. As a junior trader Rich traded niche metals such as tin. His first big trade was recognizing the potential of the mercury market.

In the early 1950s, mercury was traded in small quantities and used mainly for thermometers, batteries, and detonators. But mercury had important defense applications and with the Cold War heating up, Rich believed that demand would ramp up soon.

Rich “called any producer who had the slightest connection to mercury in order to buy the stuff.” He became an expert in the market and tried to know all the players. In Spain he located a mining company that would become a key supplier and a lifelong relationship.

When the US rearmed and needed mercury for batteries in walkie-talkies, metal detectors, and electronic devices, it increased its stocks of mercury by more than 50 per cent. Rich had developed his first profitable market for the firm and noted that “to see the opportunity is the most important thing as a trader.” To be a successful trader, “the analysis is more important than the relationships.” That said, relationships turned out to be very important as well.

Opportunities in regime change (Cuba)

Rich had some experience in Latin America from his father’s time establishing a bank in Bolivia. Over time, he became Philipp Brothers’ fixer, navigating politically volatile countries and Latin America in particular.

He perfected his Spanish in La Paz, Bolivia, where he sourced silver, tin, and tungsten in the wake of the 1952 revolution. But when Fidel Castro gained control of Cuba at the end of 1958, Philipp Brothers’ investment in a mine was at risk. Rich was sent to secure the substantial loan which the firm had given to pre-finance production in exchange for a long-term supply contract.

Rich spent six months in Havana negotiating a deal. His breakthrough was when he leaned into the situation: the Cubans, he realized, still needed hard currency and jobs. It was in their best interest to keep the pyrite mine going. In a show of good faith, he offered to inject additional capital. Philipp Brothers eventually recovered their entire investment and Rich would trade a variety of commodities with the embargoed Cuba for decades. He also picked up the practice of providing cash-strapped governments with capital in exchange for long-term exclusive access to valuable supply.

Illegal business

There is another account of Rich’s Cuban business, implying that Rich resolved the situation through bribes. Decades later, he was accused by the House Committee on Government Reform of running a trading firm “based largely on systematic bribes and kickbacks to corrupt local officials.” That he earned his wealth “doing business without legal, ethical, or even moral constraints.”

Judging by the people Rich did business with, he didn’t let morals interfere with trading profits. He traded with regimes shunned by the international community. And he didn’t deny paying bribes. Instead, he described them as a common practice, as a cost of doing business, paid “in order to be able to do the business at the same price as other people were willing to do the business.” It’s not hard to imagine this being true for many of the emerging markets in which he was active. His biographer wrote that “Marc Rich + Co. would never have been able to make the trades it actually completed if it had not paid bribes—really big bribes.”

It is also important to keep in mind that bribery of foreign officials was not illegal in the US until the Foreign Corrupt Practices Act of 1977. In Switzerland it remained legal until 2000 and could even be deducted from taxes as “commercially justified expenses.”

Getting the basics right: hard work and the right partner

Rich was a rising rainmaker and was made head of the Madrid office in 1964, at the age of 30. He became known for his obsession with work. A former secretary recalled meeting him at the office on Saturday when “the whole company was empty. Not a soul was there except Marc Rich.” Rich was there every Saturday, and Sundays, too. “He thinks about business 24 hours a day,” she said.

In Madrid, Rich was responsible for “the difficult regions,” what today would be called emerging markets, including South America, Africa, and the Middle East. These countries would provide ample opportunities for business as they were rich in natural resources and throwing off the shackles of colonization.

He still needed the right partner. He found it in Pincus “Pinky” Green, another refugee of the pogroms of the old world. The son of Ukrainian Jews who had escaped to Brooklyn, Green was a logistics genius (nicknamed “the Admiral”) with a photographic memory and an unrivaled awareness of the most detailed data. A colleague called him a “walking data base of freight rates,” able to generate profits by “swapping identical cargoes on the high seas to capitalize on differences in charter prices.” The two complemented each other. Marc was the visionary while Pinky “made things happen.” “It’s impossible to think of one without the other,” a friend recalled.

Oil’s regime change

The global oil market had been dominated by the “Seven Sisters,” the major integrated oil companies. Most oil was sold to these companies under long-term fixed price agreements. Only 5 per cent of oil was being traded freely. As a result, from 1948 until 1970 the price of oil showed relatively little volatility. And adjusted for inflation, oil’s price was declining despite growing demand. Industrial nations were benefiting from artificially low prices.

But signs of change were in the air. OPEC was formed in 1960 and called for nationalization of the oil fields of its member states. And the Six-Day War in 1967 saw a first, albeit ineffective, oil embargo of nations supporting Israel. Egypt’s President Nasser also disrupted Israeli shipping by cutting off the Israeli port of Eilat in the Gulf of Aqaba.

Oil and its logistics were occupying Rich’s mind. “I just thought it should be possible to trade oil despite the Seven Sisters,” Rich recalled. He added: “If I see a situation in the market and it makes sense to me, then I do something about it.”

In 1971, President Nixon abandoned the gold standard and devalued the dollar which further pressured the incomes of oil producing nations whose valuable export was priced in U.S. dollars. Oil fields were nationalized in rapid succession: Algeria and Libya in 1971, Iraq in 1972, followed by gradual nationalization of all Western concessions in Kuwait, Qatar, Abu Dhabi, and Saudi Arabia. Finally, in 1973 the Shah of Iran nationalized Iran’s oil assets. An epic regime shift was upending the global market for oil.

Careers in commodities are shaped by the respective cycles. This was true for Boone Pickens whose fortunes rose and fell with oil and gas prices. At Philipp Brothers, Rich was not a principal. He was not supposed to make directional bets on the price of the commodity. Philipp Brothers followed a credo called “Besser gut schlafen, als gut essen,” which translates to “better to sleep well than to eat well.” In other words, the firm emphasized conservative risk management. And oil was viewed as capital intensive and risky.

While Rich was not the first of the firm’s traders to get involved in crude, he would most aggressively pursue the opportunity. He saw himself as “the right person in the right place at the right time.” The disruption of the incumbent oligopoly presented tremendous opportunities:

“Suddenly the world needed a new system of bringing the oil from the producing countries to the consuming countries, so that’s exactly what I did.”

Not only that: Rich saw opportunities to place bets on crude itself. This would bring him in conflict with Philipp Brothers management and lead to one of the most important decisions of his life.

Stars: pay them or lose them

Rich and Green had developed their networks in the Middle East and in early 1973 they became aware of a desire to raise prices by OPEC to account for the devalued dollar. “I wouldn’t call it inside information, but direct information,” a trader described it. “Contrary to the other companies, we were on the spot, we were there. Contrary to them, we got all the information available in the market.”

Rich recalled they felt “the market was changing, the whole world was changing. We knew more than our competitors. Of course, I always develop relations with my customers.” It was time to take a position: to make a bet on crude, they signed a long-term contract with Persia to buy some 7.5 million barrels at $5 per barrel – a premium of $2 to the market price. And they did so without sign-off from their bosses.

Philipp Brothers was on the hook for $37.5 million without a buyer lined up. The trade violated its risk-averse philosophy and Ludwig Jesselson, the firm’s president, called up the firm’s partners to discuss how to proceed. Rich and Green were told to dump the trade, which Rich understandably found “very annoying.” They sold it to an American oil company at a small profit. “Too bad,” Rich grumbled.

Too bad indeed as in October 1973, Egypt and Syria attacked Israel in the Yom Kippur war. The Arab nations instituted another oil embargo and this time it worked. Official crude prices rose from $3 to $11.60 a barrel but traded at up to $13 on the free market. Rich’s 7.5 million barrels at $5 could have earned up to a $60 million profit.

In a second instance, Philipp Brothers management intervened when Rich and Green verbally agreed to buy an oil tanker. Rich’s aggressive style clashed with the firm’s philosophy and so did his expectations around compensation.

The enterprising pair’s oil business earned some $4–5 million in profit that year. Rich’s salary was about $70,000 and he could hope for a $100,000 bonus. He asked Jesselson for $500,000 for him and Green each, “influenced,” as he said, “by what I knew the company was making.” Jesselson offered $150,000.

Ludwig Jesselson at an informal meeting with some of the European managers of Philipp Brothers in Switzerland — Ludwig Jesselson (fourth from left) and Philipp Brothers managers in 1973

Rich felt that he had to leave. “I had been there for 20 years, I liked the company, I liked Jesselson, and I think he liked me. I always thought that the company would be my career for the rest of my life, but Jesselson got stuck on the principle.”

Rich and Green formed Marc Rich & Co. in Zug, Switzerland which had the perfect combination of political neutrality, discrete financial centers, international schools and airports, and favorable tax laws. “The only bad thing about Zug is the fog,” Rich said.

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