Just days after hedge fund Amaranth Advisors LLC warned investors of significant losses due to ill-advised positions in the natural gas futures arena, the ramifications of those losses on the market — now reported to be as high as $5 billion — are slowly coming into better view. In addition, one prominent broker said that without hedge fund regulation the market will “definitely see more of these blowouts” down the road.

Gyrations in natural gas prices last week turned Amaranth into the latest hedge fund meltdown since MotherRock’s collapse a month ago. Amaranth, which managed $7.5-9.2 billion in assets and was long the natural gas market, told investors on Sept. 18 that year-to-date losses might exceed 35% of its capital due to slumping natural gas prices (see Daily GPI, Sept. 19). According to industry sources and The Wall Street Journal, Amaranth’s energy trading desk co-head Brian Hunter allegedly lost billions by betting on the future direction of natural gas prices.

“[His] role in the losses his fund expects to suffer as it unwinds its natural gas position is not yet known,” said Wall Street tabloid DealBreaker.com. It said one source believed that the Amaranth trading chief “made trades this year similar to his winning 2005 bets and got caught out when 2006 produced a much calmer hurricane season and new oil discoveries in the Gulf of Mexico.”

The New York Mercantile Exchange (Nymex) said Wednesday that Amaranth’s clearing member on the exchange was still in the clear, backing up claims by the fund to investors on Monday that it had met every margin call. “The account and carrying clearing member are in good standing,” said Nymex spokeswoman Anu Ahluwalia. “Nymex continues to actively oversee and maintain orderly markets.”

The one thing that is certain is that natural gas prices declined significantly last week. Milder temperatures throughout the country, combined with the absence of hurricanes in the Gulf of Mexico and the nation’s natural gas storage glut, brought prompt-month futures below $5 last week for the first time in two years. The October contract declined 12.2% from $5.675 to $4.982 during the week ended Sept. 15. Even more impressive, the January 2007 contract declined by 16.5% from $10.185 to $8.504. The all-important October-January spread (January premium over October) declined from $4.51 on Sept. 8 to $3.52 on Sept. 15. As of the close of business Wednesday, that spread resided closer to $3.28.

Earlier this month, technician Rich Bruskoff talked about the October-January spread. “The Oct-Jan spread recently peaked at $4.70. That compares with a low of just $1.20 back in November,” he said. Historically, that spread runs between $1-2. Bruskoff said that at $4.70, that spread was ripe for selling.

“It appears that [the Amaranth trader] talked himself into a ridiculous trade,” said Ed Kennedy, a broker with Commercial Brokerage Corp. “The position was so huge it was unmanageable. He was so big, he was literally meeting himself going out the door while coming back in the door. Yes, you can put these huge positions on in the over-the-counter market, but when you get out, someone has to take the other side going the other way. I just think he got into too big of a position that he couldn’t get out of.

“He was selling this summer and buying the winter, while selling next summer against it,” Kennedy added. “The real question is why? He pushed the summer ’06-to-winter ’07 spread way out. There was no reason for it. Evidently, when he went to get out of it, nobody wanted to take the other side of it. That is a little more than a small problem in this business.”

Brokers and traders alike said Hunter became a target because he was running over both commercial and local traders through his massive position. Nymex local Eric Bolling said it best on CNBC, according to Kennedy. “Bolling mentioned that once locals realized that [the Amaranth trader] had this huge position on that no one really wanted to take the other side of…’they all tried to help him out.’ When Bolling said ‘out,’ he made a hand gesture signaling towards the door. I think they smelled blood in the water and they went for it.”

Kennedy said the moral of the story is, “You have to have a position on that you can manage. That is just basic 101 trading knowledge.”

As for the likelihood of this occurring again, Kennedy said, “You better believe it. There is no regulation on funds, so it absolutely could happen again. We saw it with MotherRock and now Amaranth, and that is only in the last two months.

“You have position limits in the futures world, but you don’t have any position limits in the over-the-counter world. You can do anything you want. Standard & Poor’s has been trying to come up with a way to calculate the risks that these hedge funds face. They are not getting any support from the hedge funds because the funds don’t want to report to anybody…and as of now, they don’t have to. Without some sort of regulation, we will definitely see more of these blowouts. As a matter of fact, there is a rumor on the floor that there is somebody else in the same trade as Amaranth. I don’t know who it is, but the rumor is out there.”

Meanwhile, regulation of hedge funds could be on the way. Connecticut Attorney General Richard Blumenthal reiterated Tuesday his long-standing call for more oversight of hedge funds in general (see Daily GPI, Sept. 20). He said he is currently “collecting evidence and reviewing facts” concerning the large losses at Amaranth and renewed his call for “greater transparency and disclosure” in the hedge fund industry.

As for the near-term fallout, according to a Bloomberg report, Citadel Investment Group LLC is currently in talks to take over some energy trades from Amaranth, sources knowledgeable of the discussions said. A letter from Amaranth to its investors obtained by Reuters Wednesday afternoon confirmed that the fund completed negotiations to transfer its energy portfolio to “a third party,” but the name of the third party was not disclosed.

An Amaranth spokeswoman refused to comment on the latest developments.

Some market experts said they would expect natural gas futures to knee-jerk higher due to the perceived role the Amaranth crash played in plummeting prices last week. “One would be inclined to play for a short-term turnaround in natural gas, as last week’s sell-off almost had to be grossly exaggerated by an Amaranth liquidation,” said Bill Feingold, an analyst with Schaeffer’s Investment Research. “When traders are confronted with huge sellers insensitive to price, they typically get partially run over and then limp out of the way until the seller is gone. This makes the end of the sell-off the ugliest, since it becomes difficult to find bids at almost any level, but it almost makes the last buyers by far the most successful ones.”

Feingold added that stocks sensitive to natural gas should also benefit, since Amaranth’s troubles suggest that at least part of the recent sell-off was purely technical.

Looking at Amaranth itself, Feingold said it will be interesting to see what will happen with the firm. “Doubtless the convertible market is watching closely for signs of selling activity in issues in which Amaranth held large positions,” he said. “Because of Amaranth’s size, almost any issue they were involved in, they were big in. Since convertibles have done so well this year, it’s likely this will cause some investors to take some profits out of concern that a large player may be permanently exiting the market.”

Despite the shake-up caused by Amaranth on the market, the analyst said it is unlikely to have more than a relatively short-term impact on the market and funds in general. Feingold said “as shocking as the whole situation is, most things will be back on the same course they were heading within six months from now if not sooner. This is a business with very short memories.”

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