Integrated commodity risk management firm FCStone Group Inc. this week became the latest firm to get caught on the wrong side of a natural gas deal as the company said it expects to incur an additional $60 million to $80 million pre-tax bad debt provision for 2Q2009 in connection with previously reported losses by “a significant energy trading account,” for which FCStone serves as the clearing firm.

These losses, if realized, on an after-tax basis would be approximately $36-48 million, or $1.30-1.73/share in 2Q2009, according to the firm. This reserve is in addition to the $25.7 million pre-tax bad debt provision that FCStone took during fiscal 1Q2009 in connection with losses in this account along with two other domestic accounts (a renewable fuels account and a foreign exchange account) for which FCStone serves as the clearing firm or counterparty.

“FCStone got stuck in what we’re hearing was a very large natural gas trade that they cleared and allegedly weren’t able to get out of,” a New York broker told NGI. “As a result their stock cratered Wednesday. The bigger news for the natural gas community is that somebody out there is stuck in a very large position in back-month natural gas futures. I think they need natural gas prices to go up because they have been stuck in this for months.”

Natural gas futures values have fallen 70% since the front-month contract reached a high of $13.694 on July 2, 2008. On Thursday, the front month contract closed at $4.077, a $9.617 discount to last summer’s high.

FCStone CEO Pete Anderson expanded upon the details of the situation during a conference call Wednesday. “Based upon current available information, market conditions and account positions, we expect the additional bad debt provision to be adequate for the energy trading account,” he said. “However, additional changes in market conditions could cause our loss to be lower or higher than the reserve. We expect to have the majority of the account liquidated by the end of our fiscal 2009.”

FCStone Group Inc. affiliate FCStone LLC operates one of the larger independent clearing and execution platforms for exchange-traded futures and options contracts. Since the original announcement on the losses last fall, FCStone said “the extraordinary global economic turmoil has continued, with credit markets in gridlock, interest rates falling, a significant collapse and de-leveraging of the commodity markets and a wide range of settlement valuations in the commodities markets. Because of these factors, the energy trading account experienced additional losses and increased volatility.”

As a result, FCStone said it responded to these conditions by hiring a second external consulting firm with extensive asset management experience, which includes the liquidations of large energy trading portfolios. This consultant, working with NewOak Capital LLC, will provide additional oversight and management of the account. “As the tenor of the account’s portfolio shortens over time, we expect to see more liquidity in the markets for those contracts which will permit us to more aggressively liquidate positions during the balance of fiscal 2009,” FCStone said.

The company said it may recover a portion of the losses on the energy account from the owners of the account and the introducing broker of that account under a profit-sharing agreement between FCStone and the introducing broker, but no guarantee can be given as to the amount and timing of recovery that may be obtained under that agreement.

Despite the increased bad debt provision, FCStone noted that it continues to have a strong capital position and liquidity in this “unprecedented” market. It has credit lines for its operations that include $56 million in committed subordinated debt facilities available for regulatory purposes, and $250 million of committed revolving margin lines.

“We remain confident in our strong financial position and our ability to continue to execute on our strategic initiatives to grow the commodity risk management business,” said Anderson. “While we recognize the significance of this increased reserve, we would like to stress that we have strengthened our credit risk procedures throughout the organization as a result of this issue and continually strive to improve our systems and procedures. In the face of these unprecedented economic hardships, we remain confident in our operating model and continue to see strong demand for FCStone’s risk management services and products.”

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