The Senate’s Permanent Committee on Investigations is having a hearing today, to be continued July 9, on the role of speculators in natural gas markets. It’s based on the report the committee did looking into the collapse of hedge fund Amaranth last year.
Among those expected to testify are Houston’s own Vince Kaminski, a former risk management executive at Enron who is now a professor at Rice University’s Jones School of Management.
The report details the downfall of Amaranth and concludes there needs to be more oversight by the Commodities Futures Trading Commission of energy markets, particularly the over-the-counter markets.
Late in the report there’s an interesting section describing an e-mail between Amaranth’s top trader at the time, Brian Hunter, and John Arnold, the head of Houston energy hedge fund Centaurus:
By September 15, as Amaranth’s natural gas positions continued to deteriorate and its cash position weakened considerably, Amaranth began to seek a counterparty to buy its energy book. One of the counterparties Amaranth approached was Centaurus. Late on Saturday, September 16, Amaranth’s senior energy trader Brian Hunter asked John Arnold, Centaurus CEO, whether the hedge fund would like to make a bid for some of Amaranth’s positions. Early
the next morning, Mr. Arnold offered a bid after making the following observations:
“I was not in the office on Friday but I understand you were selling h/j [March/April]. The market is now loaded up on recent, bad purchases that they will probably try to be spitting out on Monday if there is a lower opening given that spread has been in free fall. In my opinion, fundamentally, that spread is still a long way from fundamental value.”
“Over the past couple years the market has put a big risk premium into that spread yet it has paid out on expiry once in ten years. We’ll be at all time high storage levels with mediocre s/d [supply and demand] and an el nino. Even though that spread has collapsed over the past 2 weeks, the only reason it’s still $1 is because of your position. Historically, that spread would be well below $1 at this point given the scenario.”
Mr. Arnold gave Mr. Hunter two price quotes for the March/April spread: 45-60 cents for the March/April 2007 spread which had closed the previous trading day at $1.15; and $1.00-$1.20 for the March/April spread in 2008 and beyond, which had closed the previous day at between $2.10 and $2.20. Mr. Hunter declined Mr. Arnold’s offer. Mr. Arnold’s prediction of the behavior of these spreads, however, turned out to be remarkably accurate. On September 21, the last day of Amaranth’s trading in the natural gas market, the March/April 2007 spread stood
at 58 cents, and the March/April spreads for 2008 and beyond ranged from $1.18 to $1.25.
After several days of frantic negotiations with several brokerages and banks, on
September 20th, Amaranth formally sold its energy book to its clearing firm, JPMorgan Chase, and Citadel, another hedge fund. To meet its margin calls and satisfy client requests, Amaranth liquidated the remainder of its $8 billion portfolio.
There was a study done based on trading data in 2002 and 2003 that says speculative traders, like hedge funds, aren’t driving prices up. The mantra I regularly hear is that speculators are “price takers, not price makers.” NYMEX has regularly made the same conclusion. But I wonder if the volume of speculative trading by banks and hedge funds has changed so much since 2002 and 2003 that those studies are no longer valid? What’s your take?