That is some dirty pool...

[eruxiakiu]

September 29, 2006 ?€“ The natural gas market has provided a roller coaster ride of profits and losses for those investing or speculating in it. It began 2005 below $6.00 an mcf (million cubic feet). By December, the combination of an increasingly tight inventory, a rising oil market, and the devastation produced by hurricane Katrina made it soar and set a $15.75 all-time price record.
Natural gas conceived its Bull Market in September 2001, when it arose from its $1.76 base. It is an emotional market. This can be attested to by its February 2003 temporary spike above $10.00 an mcf with its following collapse to under $4.50 several months later. Similarly, in the weeks leading up to hurricane Katrina?€™s unleashing her fury, it was trading in the $8.00 range. This all changed when Katrina?€™s winds began to build and she approached the Gulf of Mexico?€™s prolific oil and gas fields, and the numerous onshore storage and processing facilities that she was destined to damage or destroy.

[eytosizarzb]

The spot price for natural gas approached $4.00 an mcf earlier this week. By so doing it broke below its $4.39 and $4.52 lows it posted in September 2003 and September 2004 respectively. How could gas trade at nearly $16.00 an mcf as recently as nine months ago, and then fall 75% in price? I believe that the surfacing of the Amaranth hedge fund collapse sheds some light on this issue.
Amaranth had earlier success in the natural gas market. They correctly anticipated its direction and accordingly positioned themselves in a bullish fashion. To their detriment, when the market reversed course they continued to maintain their existing posture and, I?€™ve read, they even increased their exposure. Finally, after suffering substantial losses, they attempted to sell their enormous hedged long positions in order to survive.
To their misfortune the apparent size of their position was known by various large traders who ?€œsmelled blood in the water?€. They watched while Amaranth worked in vain to exit their positions, and they likely increased their shorts which drove the market still lower. Amaranth?€™s plight was further exacerbated due to their need to meet forced margin calls. These latter developments increased the downward pressure on the gas market and caused Amaranth?€™s losses to swell. I believe that the depth to which natural gas plunged was a direct result of the unfolding of these events.

[exuonfgx61]

Finally, the banks and financial institutions that financed Amaranth called their loans. This forced Amaranth to sell their energy book. Interestingly, it was reportedly purchased by J.P. Morgan Chase and the Citadel Investment Group. I suspect that they were two of if not the largest shorts in the market.
With the signing of the agreement and transfer of their positions to Morgan and Citadel, Amaranth took a reported loss approaching $6 billion. Simultaneously, J.P. Morgan and Citadel were gracefully allowed to offset their enormous short positions and bank untold profits. In effect, Morgan Chase and the Citadel Group were likely let off the hook of having to repurchase their huge short positions! Further, they likely did it at a steep discount to the market. If Amaranth had not been forced into liquidating their contracts, the buying by J.P. Morgan and Citadel to close out their futures contracts would otherwise have forced the market significantly higher.

[eyepefo]

We might have expected some sort of market reaction to the thud when the Amaranth Advisers hedge fund's portfolio crashed to the floor. The fund's managers had bet heavily in the energy market, gambling that natural gas prices would rise. When that didn't happen and prices declined instead, Amaranth had to sell off its position at a loss.
The losses were initially reported as $3 billion, later corrected to $6 billion. That wasn't enough, though, to get the attention of the financial markets, which reacted not at all.
While the markets didn't respond, there was a predictable spike in calls for hedge funds to be regulated. Newspaper editorials provided the chorus as prosecutors, politicians, and bureaucrats - driven by the usual elixir of ambition and genuine concern - demanded regulatory and Congressional action.
The regulation of hedge funds has been a financial issue almost from the day the first one was dreamt up, and certainly since the Federal Reserve had to lead a rescue expedition after the implosion of Long Term Capital Management in the late 1990s.

[admin]

The LTCM collapse had some similarities to the Amaranth sinking. They both managed assets for customers wealthy enough to qualify for exemptions under Securities and Exchange Commission rules. And they both bet on the market's direction and guessed wrong.
One big difference, though, was that Amaranth lost its own money, while LTCM was a highly leveraged operation that invested, or gambled, mostly with other people's money. When the LTCM stink bomb went off, the scent carried to the halls of the Wall Street banks and investment houses that had lent it the money.
The distinction between LTCM and Amaranth is an important one when we consider regulation. Wall Street's view generally has been that if a bunch of millionaires want to get together and gamble on natural gas futures, Russian bonds, or inside straights, let 'em. If they want to borrow their gambling money in the financial markets, that is another matter.
From an economics perspective it is important that we focus hedge fund regulation on what can be, and what should be, regulated. Although the Amaranth collapse is prompting the calls for regulation, there is nothing in the regulatory rules proposed so far that would have changed anything. Amaranth would still have lost its bet and lost its money; the only difference is that we would have a government report documenting the process.
What is also significant about the Amaranth case, and which distinguishes it from LTCM beyond the leverage issue, is that it wasn't just a bunch of millionaires who lost their money. The San Diego County Employees Retirement Association pension fund, for example, had invested $175 million in Amaranth and has now lost about half of it - $85 million.