Traders Tales ...

Phibro Unveiled (Part I)

Phibro and its head, Andrew Hall, have been getting a lot of unwanted attention lately.
In this first article of a two-part series, we provide a background to Phibro, and its
enigmatic leader, Andrew Hall. In the second, we will review some of the main physical and
financial trading strategies used by the firm based on public records since the late 1980s.
By Carlos Blanco
PHIBRO, CURRENTLY A wholly owned name appeared in the headlines of the major financial newspapers
but independently run subsidiary of and websites. The reason was that Andrew Hall was entitled to a
Citigroup, is one of the largest traders US$100 million bonus. There was one small problem: Citigroup had
in the physical and financial crude oil previously received US$45 billion from the federal government to stay
markets. The firm operates largely alive. If Citigroup had not been rescued by the Federal Government,
as an internal hedge fund with a the firm would have probably gone bankrupt, and therefore Hall
small employee count, and Phibro’s would have had to wait in line with other creditors in order to get
managers are compensated largely on his bonus.
the profits they generate for the firm. But before we look at the present of Phibro, we are going to back
Even though the company has been to the origins of the firm.
highly profitable for decades, Phibro
has managed to stay under the radar Phibro’s Origins
until recently. In July 2009, Phibro’s Phibro was founded by the Philipp Brothers, two Jewish German
immigrants, in the early 1900s. The firm grew organically and by the
1970s it was one of the largest metals, energy as well as agricultural
products traders worldwide
In the 1970s, oil trading became one of its main profit centres as
Phibro took advantage of the high volatility in oil prices as a result
of geopolitical tension in the Middle East. Phibro was also involved
in a series of scandals as some of its traders ignored the 1973-74 oil
embargo and bought crude oil from Iran and Iraq to sell it at a large
profit in world markets. One of the heads of the firm back then was
Mark Rich, also known as ‘the Matador’, because of his killer instinct.
Rich eventually left Phibro to found Glencore International in 1974,

Phibro Energy’s history is tightly linked to the

enigmatic and charismatic Andrew Hall
and was later linked to firms that did not comply with US embargoes
in countries like South Africa during the Apartheid era , as well as with
Cuba and Libya.
In 1981, Phibro bought out Salomon Brothers and the combined
entity was originally named Phibro-Salomon, Inc. Phibro’s
competitive advantage back then was believed to be its in-depth
knowledge of physical crude oil and refined products markets
worldwide, as well as its ability to think ‘out-of-the-box’ and
anticipate market moves. Phibro’s traders seemed to have a superior
knowledge of the fundamental drivers of inter-temporal, inter-
product and geographical price differentials.
While Salomon’s traders were making a killing in the fixed income
markets in the years following the acquisition, Phibro’s traders had
a weak performance as commodity prices tumbled as a response
to the monetary policy of the federal reserve to fight inflation and
a general glut in production. Even though Phibro had the stronger
balance sheet, Salomon’s traders eventually came out on top and
the Phibro name was later dropped.
After Salomon’s reverse takeover, Phibro became Phibro Energy,
and its size was drastically reduced. In the mid 1980s a payment

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scheme that gave Phibro’s traders a

substantial amount of the unit’s profits
was negotiated.
The firm owned physical assets such
as refineries and provided creative risk
management solutions to clients. For
example, in September 1985 Phibro
Energy, then a unit of Salomon Inc.,
announced the first public issue of
‘warrants’ (options) on crude oil on
record.
Phibro Energy’s history is tightly
linked to the enigmatic and charismatic
Andrew Hall. There are mixed records
about his early years in the industry, but
it appears that Hall started his career “We’re trying to find anomalies where something
at BP at age 17, and got scholarships
to go to Oxford University, where he
is sold too cheaply in relation to its relative value ...
graduated with a degree in Chemistry, Then we lock in the discrepancy through hedging.”
and also Insead, where he received an
MBA (and won the Henry Ford Prize as 1990 was a particularly good year for Phibro making US$492 million
the top student of his class). While in profits.
BP, he worked in London and New York Phibro Energy was one of pioneers in unlocking the value of ‘real
from 1973 to 1979 in various positions. options’ in crude oil and refined products – physical and derivatives
He joined Phibro in 1982 as a crude oil markets. Those strategies ranged from cargo arbitrage based on
trader in London. profiting from geographic differential and diversion options to
He quickly moved up in Phibro and storage plays taking advantage of the shape of the forward curve
and its relation with spot markets. In the next part
Figure 1: Citigroup’s Commodity Trading Results & VaR of this article, we will explore those strategies in
more depth.
Phibro Energy had a diversified strategy involving
exploration and production, operation of refineries,
as well as physical and financial crude oil and
refined product trading. In the early 1990s Phibro
was the 4th largest independent refiner in the
United States and it is estimated that 30% of their
revenues came from refinery margins. One of the
most publicised projects that the firm was involved
in was a joint venture in the Soviet Union known as
‘White Nights’, because of the Siberian summers,
that eventually went sour.
Source: Citigroup Annual Reports
In a rare interview given by Hall back then, he
summarized his trading philosophy as: “We’re
became its President in the mid 1980s. trying to find anomalies where something is sold too cheaply in
In 1991, he was named Chairman relation to its relative value ... Then we lock in the discrepancy
and CEO and also joined the Board of through hedging.”
Salomon Inc. By then, he was already A common theme in Phibro’s trading strategy is to look for
one of the highest paid traders in opportunities with option-like asymmetric risk and return profiles.
Salomon Inc., joining the higher According to Hall, “We like trades where there’s lots of upside and
echelons of the firm with traders like limited downside.”
John Meriwhether. One of the key differences between Phibro and other market
Under Hall’s direction, Phibro moved players is the size of Phibro’s bets, as well as their ability to hold
away from Salomon Inc.’s other on to positions for months or even years, even when markets were
businesses and successfully operated as turning against them. Having Citigroup’s deep pockets behind them
an independent profit centre. Between provided the necessary support for long-term plays.
1986 to 1990 the firm contributed over That same year Phibro had one of its rare large losses. After oil
US$1 billion to Salomon’s bottom line. prices plummeted after first Gulf War, there were rumours that the

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firm lost nearly US$200 million in wrong-way bets and had an overall was negotiated before the cut-off date
loss for the year of US$34 million. Salomon’s management allowed of February 11th 2009. Andrew Hall
Hall to continue running Phibro Energy, but with a substantially may agree to be compensated partially
reduced staff and limiting the scope to the operations to crude oil in Citigroup’s stock, but it is unlikely
trading. The refineries and oil production in Russia were removed that he will agree to a pay cut.
from Hall’s control. Looking forward, Phibro’s days within
Throughout most of the 1990s, Phibro kept a low profile as an Citigroup look numbered. Many critics
independent proprietary trading group earning large risk-adjusted believe that an energy hedge-fund
returns as part of Salomon Inc. should not be part of a government
In 1992, Salomon was involved in a series of high profile scandals partly owned bank. Higher levels of
as some of its top traders were caught attempting to manipulate disclosure and increased scrutiny on
the US treasury bond market. Salomon’s
Chairman resigned and Warren Buffet took ... new regulatory constraints on energy speculative
over Salomon in the interim. trading, combined with increased competition from
In 1998, Salomon’s proprietary desks other investments banks, will make it difficult for Phibro
suffered serious losses. It appears that
Andrew Hall was an outspoken critic of
to enjoy the consistency achieved in recent years
Salomon’s strategies back then, but he was not able to prevent the pay levels do not appear particularly
firm from betting the house – and losing. appealing to Andrew Hall and Phibro’s
In 1998, Traveler’s Group purchased Salomon Inc., to create traders. In addition, new regulatory
Salomon Smith Barney. Then Travelers merged with Citicorp later constraints on energy speculative
that year to create the behemoth Citigroup. trading, combined with increased
One of Citigroup’s early decisions was to sell or close-out many of competition from other investments
the Salomon large proprietary trading desks. The liquidation of the banks, will make it difficult for Phibro
proprietary desk positions is believed to be one of the drivers behind to enjoy the consistency achieved in
the liquidity crisis of the summer of 1998 that led to the fall of Long recent years. •
Term Capital Management. Citigroup also eventually dropped the In our next article, we will explore in
Salomon and Travelers names, but kept Phibro as an independent greater depth some of the main physical
proprietary trading group. and financial trading strategies pursued
Phibro managed to maintain a deal with Citigroup by which the by Phibro in the last few years.
firm enjoyed inexpensive financing as well as a strong credit rating to
support its trading positions, as well as a very generous profit-sharing
Carlos Blanco is Managing Director
arrangement. Even though Andrew Hall could have easily started his
of Black Swan Risk Advisors, LLC, a firm
own hedge fund or similar, the deal with Citigroup was as lucrative
providing risk advisory and financial
as the profit sharing arrangements of most hedge funds, and Hall did engineering services to assist in the
not have to risk his own capital. design, development and validation
In the period between 2002 and 2008, Citigroup reported over of trading, optimization and hedging
US$3 billion in profits from Commodity Trading* while taking strategies for energy, commodity and
relatively low risk (see Figure 1 for Trading Results and Value at Risk financial services firms worldwide.
numbers.) Phibro also managed to maintain independence from He is also the Managing Director of
Citigroup efforts to merge the unit into the asset management arm. NQuantX, LLC, a financial engineering
The only reference to Phibro in Citigroup’s annual reports is in the firm that develops customized
footnotes of the breakdown of the trading profit and losses of the software to design and implement
bank. The footnote has not changed in the last 5 years, and briefly hedging programmes for energy and
mentions that commodity trading results, which accidentally happen commodity firms. He is a lecturer on
to be a substantial percentage of Citigroup’s profits, ‘primarily risk management at the University
includes the results of Phibro LLC, which trades crude oil, refined oil of California, Berkeley and conducts
products, natural gas, and other commodities.’ several courses on energy derivatives
Going back to the ‘excessive compensation’ issue, it turns out that hedging, pricing and risk management
Hall’s bonus will be exempt from review from the pay czar because it as well as credit and counterparty risk
management for the Oxford-Princeton
References Programme.
“President of Phibro Is Promoted to Chief.” Cowan, Alison L. BusinessWeek. December 5, 1991 E: carlos@blackswanrisk.com
“Will Phibro’s Daddy Squash Its Ambitions?” BusinessWeek, March 25, 1991 The author would like to thank Chris
“Salomon to Absorb Its Phibro Energy Unit”. New York Times. December 3, 1992 Mammarelli for his extensive contribution
“Trader Hits Jackpot in Oil: As Commodity Boom Roars On Mr. Hall Bet Early On Market Shift; to this article.
Buoying Citigroup.” Davis, Ann ( 2008) February 28; Page A1 www.blackswanrisk.com

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