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Some people think they know Brian Hunter, the Canadian trader blamed for the world’s largest hedge fund failure. They consider him an overconfident Street punk, a capitalist flash-in-the-pan who imploded Amaranth Advisors LLC in September 2006 simply because greedy fund managers allowed him to bet billions that bad weather would drive up energy prices. They applaud Lady Luck for inflating Hunter’s ego to the point where he believed he could “model God,” then unleashing the mild hurricane season that reportedly destroyed his reputation along with the Connecticut-based hedge fund. These folks claim to understand Hunter’s values. They point to his winter car as if it says something bad about his DNA. The vehicle in question is rumoured to be a Bentley Arnage, which apparently handles slush better than the Calgary native’s summer ride, a Ferrari F430 Spider.
But nice cars don’t say a thing about what makes anyone tick. Hunter’s critics are wrong on the other counts, too.
At best, the Bentley shows Hunter likes options, which is not noteworthy. Trading financial ones, after all, is how he used to make a respectable living. And while the employment options of Canada’s highest-profile commodities speculator are now limited, the fall of Amaranth is not the root cause. It was actually the United States Senate that cut his career off at the knees last June, when it labelled him Consumer Enemy No. 1.
For the record, not everybody thinks Amaranth fell because Hunter is the most spectacular speculative screwball on the planet (a title he might cede anyway to the rogue French trader who was revealed in mid-January to have lost Société Générale SA US$7.2 billion). Inside hedge fund circles, many still consider the 33-year-old Canadian a market rainmaker, someone whose brain is hard-wired in such a way that it can slice and dice trading orders like an exchange computer. To this crowd, Hunter is more than just a good numbers guy who can predict migration trends of bulls and bears. He is also seen as one cool cucumber, someone who can remain calm when other market players are looking to open skyscraper windows. That ability to stay focused is what the fans say, more than anything, makes Hunter “a natural” at playing natural gas futures.
NG futures are later-date contractual obligations to deliver or receive 10,000 million British thermal units of natural gas at the Henry Hub, a pipeline junction in Louisiana. The game is played by a mishmash of speculators and commercial interests who buy and sell thousands of contracts (and options to buy or sell contracts) on a daily basis. Most never hit the Hub because obligations to deliver and receive often cancel each other out. Nevertheless, until settlement day on the New York Mercantile Exchange (NYMEX), all futures fluctuate in value due to numerous volatile factors, ranging from market fundamentals to the mood of Mother Nature.
Such price fluctuations can translate into a seriously bad trading day. In September 2006, for example, a string of Hunter’s bad days eventually cost Amaranth US$6.6 billion, which is more than the GDP of Chad. But believe it or not, Wall Street was still trying to toss big money Hunter’s way while CNBC was reporting on the fund’s fruitless efforts to survive.
That won’t surprise you after you know the whole story, which has never been reported before. For now, let’s just note that Amaranth — despite what you might have read in the business pages or on financial blogs — did not crash because a math geek placed ridiculous bets on something as unpredictable as hurricanes in the Gulf of Mexico.
Hunter’s strategy back in 2006 was based on monthly price spreads, not on an expected storm-induced jump in prices. (Such a jump could have actually hurt Amaranth’s positions at the time.) Not that Hunter is afraid of risk. He played the March–April “widow-maker” spread, where the unpredictable effect of warming weather on natural gas supply scares some traders off the market. But his overall position was hedged, highly calculated and not 100% weather-dependent. In fact, the bets Hunter made could be considered conservative when compared to what some debt traders were doing with sub-prime assets at the time.
After Amaranth was wiped off the map, there were plenty of opportunities for most of its employees. Hunter set out to launch his own commodities fund, Solengo Capital. It had no trouble attracting backers in early 2007. According to one estimate, Hunter raised US$800 million in startup capital, after putting up US$1.7 million of his own funds. That made sense to Christopher Holt, a Toronto-based finance consultant. “A number of people [who invested with Hunter] in the past may be very eager to get in again,” he explained to Reuters last March. “As ironic as it sounds, these people would have had the chance to hear Hunter’s explanation of what went wrong the last time and be assured that it won’t happen again. The guys who come back from the dead actually have a pretty high success rate.”
Then, last June, Senator Carl Levin, a Michigan Democrat and chairman of the Senate’s influential Permanent Subcommittee on Investigations (PSI), issued a report that blasted Hunter for victimizing consumers with “excessive speculation.” According to PSI investigators, massive trading by Amaranth alone created artificially high natural gas prices before the fund’s collapse in 2006. “It’s one thing when speculators gamble with their own money,” Levin said in a public statement, but it’s “another when they turn U.S. energy markets into a lottery where everybody is forced to gamble with them, betting on prices driven by aggressive trading practices.”
Shortly after the Levin report made headlines, competing U.S. market watchdogs — the Commodities Futures Trading Commission (CFTC), which regulates NYMEX trading, and the Federal Energy Regulatory Commission (FERC), which oversees real-time transactions — started falling over each other to hunt Hunter down for unethical trading. Now, a costly army of lawyers and public-relations professionals is fighting an up-mountain battle to restore the trader’s shredded reputation. They insist U.S. authorities — who have taken a lot of heat for being seen as soft on speculators — are on a witch hunt, manufacturing charges against an easy Canadian target to score political points. That argument didn’t work for Conrad Black. But this time, there appears to be more than a little politics involved.
Amaranth played the same role for natural gas consumers. But then, the positive side of market speculation has never been in doubt: it allows commercial players to transfer risk, while it also finances the production and storage of commodities, ensuring future demand can be met. What raises eyebrows these days is the use of the so-called Enron loophole — yes, that Enron. The loophole lets speculators trade look-alike NG contracts on unregulated markets that move in lockstep with regulated futures used to determine monthly settlement prices. In essence, this gives large-scale traders the power to influence the market unwatched.
The Enron loophole is actually a misnomer — it isn’t a loophole at all. Throughout most of the ’70s, ’80s and ’90s, all U.S. energy futures transactions were conducted on NYMEX under the watchful eye of the CFTC. But after extensive lobbying by Enron, U.S. lawmakers inserted a clause allowing unregulated trading into the Commodity Futures Modernization Act of 2000. Speculative activity exploded on electronic markets. According to one estimate, investment in commodity index funds alone jumped to more than US$80 billion in 2006, up from about US$15 billion in 2003. That seriously weakened the effect of NYMEX position limits, designed to keep big players from having too much influence on the market. Lately, U.S. regulators have been working on measures to rein in unregulated trading. But in Hunter’s heyday, nobody ever really knew exactly why natural gas prices moved, or if they fit with fundamentals, since nobody really knew what was going on in the unregulated markets.
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