Did Amaranth cause harm?

“Brian, . . . what the hell is going on out there, rumour is you are getting even more rich!!! . . . according to the market you are brilliant!!!!!! Can do no wrong . . . ever!”

This breathless instant message, sent by a trader to Brian Hunter, top energy trader at Amaranth, encapsulates the astonishment in the markets last summer as the hedge fund was building up massive positions in the natural gas futures and swaps markets.

At one point, Amaranth held 100,000 contracts for future delivery in a single month, representing about 5 per cent of all the natural gas used in the entire US in one year; regulators define a “large trader” as holding at least 200 contracts.

The reasons behind last year’s dramatic fall of Amaranth, at one time the biggest player in natural gas derivatives in the US, will be rehashed on Monday with the release of a nine-month report by a Senate body that focuses less on the impact on Amaranth than on how its massive bets on the future direction of gas prices had a direct influence on the prices that consumers paid for gas.

The report says Amaranth spent last summer building up such a large number of positions on the New York Mercantile Exchange and on ICE, an over-the-counter electronic energy swaps platform, that when the market turned against its assumption about weather patterns, it was unable to meet margin calls and was forced to liquidate.

In building up its positions, the report alleges it engaged in “excessive speculation”, which US law attempts to guard against by requiring the futures regulator, the Commodity Futures Trading Commission, to have exchanges impose strict position limits on traders.

The trouble is, OTC markets such as ICE fall outside the CFTC’s jurisdiction. Carl Levin, lead Democratic senator on the report, says this means the law should be changed to bring platforms such as ICE under full CFTC supervision to prevent any such alleged market abuses.

But did Amaranth’s speculation cause actual harm? That will be hotly debated at a senate hearing Monday.

Since gas utilities typically plan months in advance for deliveries of gas, they use the futures markets to help lock in prices for future delivery. The report says that Amaranth drove up the difference in price between winter and summer contracts – the spread – to above average levels, and was the “predominant cause” of distorting prices for utilities.

One trader interviewed by the senate committee was quoted as saying the price spread between the October and January month futures contracts “had never done anything like this”.

“I knew Amaranth would eventually implode. It was just a question of when,” the trader was quoted as saying.

However, Amaranth disputes any link between its massive positions and causing higher gas prices to users, saying it did not “dominate” the natural gas markets. It also takes issue with the report’s claim that Amaranth moved its positions from Nymex to the largely unregulated ICE platform to avoid being subject to the “position limits” normal on fully regulated exchanges like Nymex.

Instead, the fund argues, it unwound its positions on Nymex to avoid being stuck with a commitment to deliver huge amounts of gas on the expiry of the Nymex contracts. On ICE, the contracts are only cash-settled.

The Republicans on the senate committee also took issue with the Democratic majority’s conclusions that Amaranth’s actions raised gas prices for consumers.

But they did agree with their political rivals on the broader issue: that the Amaranth saga points to the need for tighter oversight of the vast OTC markets.

Norm Coleman, ranking committee Republican, said: “The ongoing shift of energy trading to unregulated, OTC electronic exchanges undermines the CFTC’s ability to monitor and prevent excessive speculation and price manipulation”.

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