Amaranth Advisors
From Invertopedia, the encyclopedia of how things fail
Amaranth Advisors was a multi-strategy hedge fund whose natural gas desk, run by Brian Hunter, came to dominate the U.S. natural gas market in 2006[1]. At times it held 40 percent of all outstanding NYMEX contracts for the coming winter[1]. When the market turned in late August and September 2006, the fund lost about $6 billion[2], sold its energy book to JPMorgan Chase and Citadel on September 20 and liquidated the rest of its $8 billion portfolio[1].
Contents
The bet
Hunter's desk bet that natural gas for the winter would stay far more expensive than gas for the summer, through spreads such as March against April 2007[1]. Hurricanes Katrina and Rita had made that kind of bet pay hugely in 2005, when energy produced about 98 percent of the domestic funds' gains and Hunter reportedly made $75 million[1].
When prices fell, the desk bought more[1]. The firm decided to ride out its losses and wait for buyers at higher prices[1].
What happened
| 2000 | Nicholas Maounis starts Amaranth as a multi-strategy fund with about $600 million. Energy trading is added in 2002.[1] |
|---|---|
| Late 2005 | After Hurricanes Katrina and Rita, energy trades drive the year's gains. Hunter reportedly makes $75 million.[1] |
| Feb – Apr 2006 | Trading on two contract expiry days that the CFTC later alleges was attempted manipulation of NYMEX natural gas futures.[3] |
| May 2006 | The energy book loses more than $1 billion in the last week of the month. A trader later says the firm could have got out "for maybe a billion dollars" but decided to ride it out.[1] |
| Jun – Jul 2006 | Instead of shrinking, the positions grow to the largest Amaranth has held.[1] |
| Early Aug 2006 | NYMEX tells Amaranth to cut two contracts. It moves the positions to ICE, an exchange with no position limits, and keeps growing.[1] |
| Aug 29, 2006 | Nearly $600 million lost in one day. Margin calls jump by $944 million the next day.[1] |
| Sep 2006 | Margin requirements pass $3 billion and the winter spreads collapse. Hunter turns down a bid from rival fund Centaurus.[1] |
| Sep 20, 2006 | Amaranth sells its energy book to JPMorgan Chase and Citadel and liquidates the rest. Total loss: about $6 billion.[1][2] |
| Jul 2007 | The CFTC sues Amaranth and Hunter, and FERC proposes $291 million in penalties and disgorgement.[3][4] |
The kill shot
The positions were bigger than the market they traded in. Once prices turned, the only way out was to sell to the traders who had been betting against them.
Amaranth held as many as 100,000 natural gas contracts in a single month, equal to about 5 percent of the gas the whole country used in a year[1]. A trader told Senate investigators it was "naïve to think that they could get out of the market with a size of 100,000 positions"[1]. The fund's own buying had held the winter spreads up, and other traders were reluctant to stand in its way[1].
In late August, with storage full and no hurricanes, the spreads began to fall, and margin calls drained the cash Amaranth would have needed to keep buying[1]. When Hunter asked Centaurus for a bid, its chief John Arnold wrote that the only reason the March/April spread was still at $1 was "because of your position"[1]. FERC said in 2007 that Amaranth's collapse was not related to the trading it alleged was manipulation[4].
Red flags ignored
- Being the market. Up to 75 percent of the open NYMEX contracts for November 2006 gas.[1]
- One desk, most of the money. By the end of May 2006 half of Amaranth's capital was in energy, at 5.21 times leverage.[2]
- A limit dodged, not obeyed. When NYMEX told it to cut positions, Amaranth moved them to an exchange with no limits.[1]
- A billion-dollar warning ignored. After losing more than $1 billion in May, the desk made its positions bigger, not smaller.[1]
The cost
About $6 billion lost, from a fund with $9.2 billion at the end of August 2006[2]. The losers included the 3M pension fund, funds of hedge funds at Goldman Sachs and Morgan Stanley, and a San Diego County retirement fund[2].
Senate investigators found that Amaranth's trading pushed up winter gas prices, so utilities and other buyers that hedged in the summer of 2006 paid more. One Georgia gas authority put the extra cost to its customers at $18 million and blamed speculation by Amaranth and others[1].
The inversion
If you are the market in a trade, you can't get out of it. Size positions to what the market can absorb on the way out, not on the way in.
What survived
The legal cases ended in settlements. Amaranth was ordered to pay a $7.5 million CFTC penalty under a 2009 consent order, and FERC announced a settlement with Amaranth entities at the same time[5]. FERC's $30 million fine on Hunter was set aside in 2013 when an appeals court ruled that the CFTC, not FERC, had jurisdiction[6]. In 2014 Hunter settled with the CFTC for $750,000 and accepted permanent bans on trading in the final settlement period of any CFTC-regulated contract and on trading natural gas during the daily close[7].
The Senate report used Amaranth as the case for closing the "Enron Loophole" that left electronic energy exchanges such as ICE outside CFTC oversight[1].
References
- ^ “Excessive Speculation in the Natural Gas Market (staff report)”. U.S. Senate Permanent Subcommittee on Investigations, June 25, 2007 (archived copy). The primary record of the collapse: Amaranth's 2000 start with about $600 million, energy trading from 2002, the 2005 hurricane profits and Hunter's reported $75 million, the $8 billion fund and 400 staff, positions of up to 100,000 contracts and 40-75 percent of open interest, the $1 billion May loss and the decision to ride it out, the move from NYMEX to ICE, the August 29 loss of nearly $600 million, margin over $3 billion, the declined Centaurus bid, the September 20 sale to JPMorgan Chase and Citadel, and the harm to gas buyers.
- ^ “Amaranth's energy portfolio was leveraged five times in May”. MarketWatch, September 25, 2006. The roughly $6 billion loss, $9.2 billion of assets at the end of August, energy leverage of 5.21 times and half of capital in energy at the end of May, the biggest loss since LTCM, the investors hit, and the sale of the energy book to JPMorgan Chase and Citadel.
- ^ “CFTC Charges Hedge Fund Amaranth and its Former Head Energy Trader, Brian Hunter, with Attempted Manipulation of the Price of Natural Gas Futures (Release 5359-07)”. Commodity Futures Trading Commission, July 25, 2007. The civil complaint alleging attempted manipulation of NYMEX natural gas futures on February 24 and April 26, 2006, and false statements to NYMEX.
- ^ “Commission Takes Preliminary Action in Two Major Market Manipulation Cases”. Federal Energy Regulatory Commission, July 26, 2007 (archived copy). FERC's show-cause order proposing $291 million in penalties and disgorgement, including $30 million for Hunter, and its statement that Amaranth's collapse was not related to the alleged manipulation.
- ^ “Amaranth Entities Ordered to Pay a $7.5 Million Civil Fine (Release 5692-09)”. Commodity Futures Trading Commission, August 12, 2009. Amaranth's consent order and $7.5 million civil penalty, and the parallel FERC settlement.
- ^ “DC Circuit: FERC Lacked Jurisdiction to Fine Amaranth Trader Hunter $30 Million”. ArentFox Schiff via The National Law Review, March 18, 2013. The D.C. Circuit's March 15, 2013 ruling that the CFTC, not FERC, had jurisdiction, ending FERC's $30 million fine.
- ^ “Federal Court Orders Brian Hunter to Pay a $750,000 Civil Fine (Release 7000-14)”. Commodity Futures Trading Commission, September 15, 2014. Hunter's consent order: $750,000 penalty, permanent bans on trading at settlement and on natural gas during the close, a registration ban, and $8.25 million in total penalties in the case.