|Scott E.D. Skyrm|
In 2006, energy trader
Hunter first became famous for an enormous bullish bet on natural gas prices in 2005. Had he been wrong, this story might be drastically different, but Hunter knew what he was doing, and two hurricanes later, he had made in excess of a billion dollars for Amaranth. Hunter reportedly took home between
Having a high-flying trader is good for business, and by the end of
THE WINTER AND SUMMER STRATEGY
When it came to Amaranth's natural gas trading strategy, the public line the
One reason Hunter liked the strategy so much-aside from the fact that it worked so well-was that, in his mind, it was a pretty safe bet. The typical narrow spread between the winter and summer prices would widen considerably if winter natural gas prices suddenly increased. If there was some type of weather event (hurricanes to you and me), even if it occurred in the summer, winter natural gas would generally spike higher than the summer price.
However, Hunter did have another trading strategy that worked pretty well too. It involved the idea that given enough volume, a trader could push around the market for a very short period of time. Especially right before the expiration of a futures contract. Suppose there was a massive sell-off in a futures contract at the end of the day. Now, suppose that sell-off happened on the last trading day of the
There's a name for this trading strategy-what might be better termed a manipulation strategy. It's called "banging the close." Technically, it's illegal. Those who get away with it typically hide their intentions very well and disguise their trades. However, Hunter, despite his intelligence and experience-or perhaps because of his intelligence and experience-didn't feel the need to disguise what he was doing.
Here's an example: On <chron>Feb. 23, 2006, Hunter sent a message to another Amaranth trader. "Make sure we have lots of futures to sell MoC [Market on Close] tomorrow," Hunter told him. The futures he was referring to were the
During the last 30 minutes of trading that day, Hunter gave his broker an order to sell his 3,000 contracts, but gave explicit instructions that the order was not to be executed until the last eight minutes of trading. As it turned out, during the last four minutes Hunter unloaded 99 percent of his long position, which included 78 percent of those contracts in the last 60 seconds of the trading day.
Hunter would even brag about it to other traders-at other firms, no less: "We have 4000 to sell MoC. Shhhh." The trader he'd sent that to responded and asked him why he would do that, unless he was "huge bearish" on the natural gas market. Hunter replied nonchalantly that it was "a bit of an expirment [sic]."
While his "experiment" worked, it didn't go unnoticed by Amaranth's management. On
Hunter, though, didn't take the new memo to heart, assuming he read it at all. When April rolled around, he was right back at it again. Throughout the month, Hunter built up a trading position in
Hunter expressed this concern to Amaranth's head of energy risk management: "Arnold is getting scary short into the number tomorrow. I am worried that Arnold has taken the other side of everything." In other words, Hunter was nervous that his rival was going to screw up his plan to bang the close by buying up futures contracts just as Hunter was selling them. In that case, Hunter could end up stuck short the ICE contracts just as Arnold was pushing prices higher. You see, Hunter and Arnold were energy trading rivals, and both men were competitive and liked to win on every trade.
They asked Hunter point-blank about whether Arnold was aware of what he planned to do: "Does he know [what you] are up [to] [with respect to] rolling off short?"
"Probably," Hunter acknowledged. "Arnold is the master of moving the close."
But Hunter went ahead anyway. He placed sell orders for up to 500 futures contracts, then 544, and finally 2,000. All the orders had the same explicit instruction: Do not execute the sale until eight minutes before the close. In the end, only 1,675 of the over 3,000 sell orders got sold, but Hunter still got what he wanted. The price of
This time, however, Hunter's actions didn't go unnoticed. On
The hedge fund brushed off the
In the end, though, what brought down Amaranth wasn't illegal. It wasn't even related to banging the close. What brought down Amaranth was good weather.
CLEAR SKIES AHEAD
For much of the latter half of 2005 and the beginning of 2006, weather prognosticators were talking about La Niña, a period during which sea temperatures are lower, on average, by three to five degrees Celsius. What La Niña means for the Atlantic and Gulf regions is that there is an increased probability of high-intensity storms, including hurricanes. Paired with the dire reports about increased storm activity associated with global warming, everyone was sure 2006 was going to be a devastating hurricane season. That was music to the ears of
Hunter, though, remained committed and continued his bet on a repeat of the previous year's destructive weather. He had extended his short summer/long winter position out over several years, expanding the scope of the bet into the future. In the event of any weather disaster, he'd make a fortune.
At this particular point in time, however, the markets had completely accounted for the possibility-even the probability-of a severe hurricane striking the natural gas production and distribution infrastructure of
The market finally turned in May, and natural gas prices dropped down to about
"He thinks he's bigger than the market," one natural gas trader said of Hunter at the time.
Size was the key ingredient to Hunter's strategy, as he felt that large positions could drive the market-the same idea behind banging the close. His position was concentrated, too. At one point, Amaranth controlled 75 percent of the outstanding contracts for
Hunter's positions had gotten so large that any attempt to reduce them would result in a major price decline. There was a growing problem that there were just too few buyers out there to pay for the contracts he owned if he needed to get out. "They counseled Brian to get out," one Amaranth trader recalled. "He needed to be ordered."
Hunter was told to cut back his position, but he couldn't. Everyone in the industry knew exactly what he was doing, and they knew the position he was in. He was stuck. So he did what many gamblers do-he doubled down. The logic was that if he added to his position at lower prices, his average purchase price moved lower. If he lost, he lost less; if he won, he won more. Plus, by purchasing more contracts, he was also helping to support the market and kept it from sinking lower. One rival trader said, "I knew Amaranth would eventually implode. It was just a matter of when."
By September, the price for natural gas had sunk to its lowest level in four years and Amaranth had run out of money to pledge as margin. Their only choice was to begin unloading some of their positions. On
Closing out their remaining positions would only drive prices lower and add to the already crippling losses. Their only hope was for a blisteringly cold winter, some type of surprise storm, anything-but there was nothing in the forecast.
There was a conference call on
The next day, natural gas prices continued to fall, and the prospect of getting a bridge loan and staying in business looked impossible. The firm had lost so much money that it needed to liquidate. The natural gas market continued its downward spiral, with prices hitting a new low of
With gas prices crumbling, other traders sensed blood in the water and chose to pounce.
The news media would later report that both
AFTER THE STORM
Following the Amaranth collapse,
That story doesn't quite mesh with the version told by the chairman of the FERC, who told reporters that Hunter simply left the room and never came back. "Hunter was in the middle of an interview and there was a lunch break," he explained, "and he never came back." This led to speculation all around the energy markets that
If you really want to find
Skyrm is a former trader and desk manager for
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