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More on the Fall of Amaranth News

Katherine Burton and Jenny Strasburg of Bloomberg recount the fall of the Amaranth Hedge Fund, answering some questions and raising others. Some highlights:

Katherine Burton and Jenny Strasburg: Amaranth's $6.6 Billion Slide Began With Trader's Bid to Quit: "`It looked to us like the Amaranth multistrategy fund was a pure energy bet," says Edward Vasser, chief investment officer of Wolf Asset Management International LLC, a Santa Fe, New Mexico-based fund of funds. "Almost all of their profits came from their energy portfolio." He decided against investing in Amaranth.... [T]he energy bet was working for Amaranth, which had about 30 percent of its assets in the sector. The flagship fund ended the year [2005] up about 15 percent, compared with Citadel's 7 percent. In January 2006, Maounis allocated $1 billion to Hunter, who then made $300 million during the next four weeks....

The wager had been essentially the same since Hunter joined Amaranth. He was betting that the difference in prices of natural gas between winter months and summer months would widen. Winter months were represented by March delivery contracts and summer months by April contracts. He placed these trades going out until 2012, say market participants with knowledge of his positions. The spread widened to more than $2 early this year from about 40 cents when Hunter started at Amaranth in 2004.

Hunter also bet that natural-gas prices would increase while fuel and heating oils either would stay the same or fall. Arora, Hunter's former boss and the trader with the most knowledge of energy markets at Amaranth, quit in March to start his own fund. In April, Amaranth's fund climbed 13 percent, almost entirely because of energy trades.... In the first four months of the year.... Amaranth's returns approached 30 percent, they say.

Some investors were troubled by the fund's concentrated wagers. Executives of Blackstone Alternative Asset Management, the fund of hedge funds unit of New York-based Blackstone Group, went to Calgary in May to visit Hunter and afterward pulled their entire investment....

Former employees... say they were concerned... questioned Maounis and Jones... were told that the wagers weren't particularly risky because it was an arbitrage--profiting from price disparities--rather than a directional bet on natural gas.

In May, Hunter's fortunes changed. Spreads between October and January contracts, another way to wager on price differences between warmer and colder months, narrowed to $3.27 from a high of $3.64. Spreads between March and April contracts also narrowed. Hunter lost $1 billion.... Amaranth's paper profits in natural gas were significant, yet it couldn't realize all of the gains selling. Traders and hedge funds knew Amaranth was desperate to get out of its trades, so they wouldn't pay current prices....

Hunter controlled 56 percent of Amaranth's assets and accounted for 78 percent of its performance as of June 30.... Starting in May, Hunter and his team spent most of the summer flying between Calgary and Greenwich.... They conferred almost daily at 4 p.m. Eastern time, either in person or by phone or videoconference.

From June to August, the energy and commodities positions earned $1.35 billion, Maounis told clients on a Sept. 22 conference call, according to a transcript provided to Bloomberg News. Much of those gains were generated in August...

As I have said before, great kudos to Blackstone: many people will bail out after unexpectedly large losses, but few people are smart enough to bail out after unexpectedly large gains. I have to confess to some puzzlement over the statement that Amaranth "was desperate to get out of its trades" but couldn't because its counterparties "wouldn't pay current prices." The current price--the price at which you should mark to market--is the price at which you can sell, not a price at which you cannot sell.

This Bloomberg article deepens the mystery. To bet that spreads between March and April gas prices will be higher in the future than they have been in the past is not "arbitrage": arbitrage is betting that things that should converge in price will in fact do so. The disparity between March and April prices will widen only if (a) relative winter demand for natural gas continues to surge more than supply, (b) nobody finds a way to effectively and cheaply store gas produced in April until the next winter, and (c) the market recognizes (or fears) (a) and (b). That's a bet about gas demand and about gas storage technology--something that I think would be the province of energy industry engineers, rather than of a team of eight off in Calgary.

Even more disturbing: Maounis's very high opinion of a trader who had lost his previous employer $50 million in a week due to an "unprecedented and unforeseeable run-up in gas prices" and who was suing that employer for a bigger bonus.