In the summer of 2005, hotshot Amaranth Advisors LLC trader Brian Hunter spied a bargain.
Natural gas supplies nationally were plentiful, gas production was unusually high, and by midsummer storage facilities were brimming with the stuff. Prices were low, hovering between $6 and $8 per MMBtu. Since investors didn’t expect any reason for prices to shoot up, nobody was very interested in options that gave them the right to buy natural gas well above that. The options were going for bargain-basement prices. So Hunter swooped in, scooping up millions of dollars of options on the cheap.
Energy was a growing colossus in Amaranth, and by August 2005 energy investments were tying up 36 percent of Amaranth’s money. Hunter was taking a huge gamble when he bought up his millions of dollars of options. He would profit only if natural gas prices rose dramatically. And that didn’t seem likely to happen.
Then Mother Nature came roaring in to Hunter’s rescue.
On the evening of August 25, 2005, Hurricane Katrina struck. It hit the Florida coast between Miami and Fort Lauderdale first. Torrential rain, twelve inches or more, pelted the coast, and winds roared to 80 miles an hour. About a dozen people died, more than a million people lost power, and flooding was extensive.
Then, after crossing Florida, the storm surged into the Gulf of Mexico and strengthened. In the Gulf, it was classified a Category 5 storm, the most powerful. The damage to oil and gas operations in the Gulf was extensive. Four days later, the storm slammed into Louisiana, with sustained winds of 125 mph. New Orleans was devastated.
Hurricane Rita came next. One month later, it too tore through the Gulf and ripped through Louisiana and Texas. The major delivery point for natural gas, the Henry Hub, was underwater. Repair crews couldn’t get to it because roads were flooded and covered by downed trees and power lines.
For Brian Hunter and Amaranth, the storms were welcome news. Katrina and Rita caused major damage to oil pipelines and rigs in the Gulf, which would affect natural gas prices. More than 450 pipelines were damaged. Drilling platforms—113 of them— were destroyed. There were close to 150 oil spills, six involving more than a thousand barrels of oil. Gas production dropped from slightly over 1.6 trillion cubic feet per month before the hurricanes to 1.4 trillion cubic feet immediately after.
Natural gas prices rocketed up. In June, the futures contract for the next month was selling for about $6. On October 25, a month after Rita struck, the price reached $14.33. Prices then went on a roller-coaster ride, falling, then peaking in mid-December at $15.38, then falling again to a little more than $6.
The undulating prices made a fortune for Hunter. His options to buy gas paid off handsomely when prices rose. But even his minor holdings—short positions he took as a hedge if prices fell—made money. “There were some fairly random occurrences after Katrina and Rita that also made money for Brian,” says a former Amaranth employee. “Both his long positions, and where he was short as hedges. Where he was short, by chance he was locked into gas in areas where prices collapsed.” Whether it was because of luck or cunning, Brian Hunter could do no wrong.
The effect of Hunter’s trading on Amaranth was dramatic. While the firm lost money for the first six months of 2005—down almost 1 percent—it gained more than 5 percent in August. In September, it was up an additional 7.5 percent.
After months of shaky results, the firm turned itself around. It closed the year up almost 15 percent after fees. And it was all because of Hunter’s investments. The energy book was responsible for 98 percent of Amaranth’s earnings.
Employees—down to the secretaries and limo driver—started calculating their bonuses. Because of Hunter’s profits, the firm had earned money to divvy up at the end of the year. The largest bonus by far went to Hunter, with the farm-country boy from Calgary netting a bonus of $113 million.
Everyone at Amaranth was making money because of Hunter. Wall Street was abuzz. Some traders were envious; others not yet invested in energy wondered if they should get in on it. A few were dubious about Hunter’s trading. They warned that players betting a huge pile of chips could reap a windfall but could also be wiped out. More than anything else, however, there was disbelief that a guy as young and inexperienced as Hunter could make such a killing.
In its monthly newsletter to investors, Amaranth celebrated the destruction wrought by Katrina and noted that even though “sister Hurricane Rita did not have the same catastrophic impact,” it did enough damage to keep gas prices up.
Hunter's rival John Arnold at the hedge fund Centaurus had been contemplating the upcoming hurricane season too, assessing where prices were headed. He thought there was a good chance they would rise, and he placed his bets. One large set of trades he negotiated was with oil producer British Petroleum, whose traders were worried prices might decline. When the hurricanes hit, Arnold made money, lots of it.
Arnold also expected prices to quickly drop from their hurricane-sparked highs, say other traders. So he started to short gas prices. But he was too early. Prices remained high, and Arnold ran into trouble. As he lost money, brokers demanded he pay more collateral on his trades. Arnold struggled to meet their demands.
But Arnold was willing to take the pain because he believed in his analysis. “When he feels he really understands the supply and demand, although his timing may be off, he’s willing to ride through his analysis,” says a fellow gas trader. “And if he’s timed it wrong, even on large size, and he has a 30 percent drawdown in a two-week period, he’s willing to live through it, whatever the short-term event is. And he’s had investors that are willing to ride through that short-term pain with him.”
Finally, in the second half of December, prices dropped, and Arnold ended up with blockbuster returns. His fund was up 160 percent for the year. By the end of the year it was managing $1.5 billion.
Bo Collins at MotherRock also was having a good year. His firm was up 23 percent.
A few weeks after the hurricanes passed through and Hunter scored big, Amaranth’s Calgary office was finally ready to open. Calgary, a major oil and gas center, wasn’t an inappropriate place for Hunter to be, and Amaranth had several other offices abroad. But it took months to arrange, as business was booming in Calgary and office space and staff were hard to find. By October 2005 everything was finally ready, and Hunter and his family, after living for four years in the New York/Connecticut area, moved back to Calgary, near his parents and other family. He already owned two and a half acres in a suburb west of Calgary, bought when Maounis had hired him, although it would take some time yet to build a house.
Initially he was the firm’s only employee in the office. Later on, he hired several traders to work with him. There was an electricity trader who invested in California and Rocky Mountain power, and a trader of propane, ethane, and butane—natural gas liquids. Several others worked with Hunter on natural gas. There was administrative staff. But there were never any risk management people sitting in the office, talking with the traders and evaluating the trades. That was still done from Greenwich by David Chasman, who was the primary risk manager for the natural gas portfolio. When Hunter had been working in Greenwich he sat three or four seats down from Chasman.
Chasman—short, portly, and opinionated—had earned his PhD from MIT in physical chemistry. He had previously worked as a risk manager at San Diego–based Sempra Energy Trading, which specialized in trading and marketing natural gas and other energy commodities. Chasman’s job there was similar to what he did at Amaranth—working with natural gas traders to determine the value of their portfolios and monitor the risk of their positions. Another guy brought in by Chasman, Karl Koster, devised the computer system that tracked their holdings.
Chasman reported to Rob Jones, the head of risk management. The tall, soft-spoken Jones had an air of the academic about him. He had joined Paloma in 1989 to manage an international arbitrage portfolio and worked with Maounis during his last four years at Paloma. Prior to that, he had worked at Goldman Sachs with Fischer Black, developing arbitrage strategies and techniques to limit portfolio risks. He was well known in his field. Indeed, he helped conduct a study for the New York Stock Exchange evaluating market risks brought to light during the 1987 stock market crash. However, he had no experience in energy trading, with its acute volatility and high risks.
Chasman believed in Hunter. He told Maounis Hunter was the best commodity trader he had ever seen. “He has a very strong understanding of the underlying trading instruments and a good grasp of market supply-and-demand fundamentals,” he later testified. Chasman was responsible for monitoring Hunter’s trades, evaluating his portfolio, and assessing what would happen if prices didn’t go his way. He calculated the value-at-risk of Hunter’s holdings. Chasman was hired to be a tough watchdog over Hunter and his team, but other traders say they seemed more like friends.
When Hunter was in Greenwich, Chasman could follow his exchange trading in real time, questioning his strategies, making suggestions, warning about pitfalls. Chasman could easily hear about over-the-counter trades. When Hunter moved to Calgary, there was no computer system at the firm’s Greenwich headquarters capable of viewing Hunter’s trades in real time.
Hunter provided Chasman information on his trades, although sometimes there was a wait on details. Their interaction—give-and-take about the markets, discussions about strategy—was now more difficult. Chasman later told government officials he recognized a need for risk personnel “on the ground” in Calgary. But no one was sent, or hired, to work out of the Calgary office. Instead, the firm relied on email, instant messaging, and phone calls to keep abreast of what was happening there. Hunter and his traders spoke to Chasman and his guys daily, frequently more often. But the Federal Energy Regulatory Commission later charged that the lack of on-the-scene risk managers significantly hurt the firm’s ability to constantly monitor exactly how risky its investments were.
As 2005 wound down, Arora’s misgivings about his role at Amaranth and about Hunter grew. He acknowledged that Hunter had turned around Amaranth’s losing year, resulting in double-digit profits. And he thought Hunter had some good investment strategies going into the hurricane season. But the size of Hunter’s positions was growing. They weren’t yet a danger to the firm, but they were larger than anything Arora would have put on. And while Hunter’s main bet on prices rising had paid off after the hurricanes, a colleague remembers Arora pointing out that the trades easily could have gone the other way if the weather had been different.
Other things were bothering Arora too. Nothing had come of his talk with Maounis about setting up a separate commodity fund. Now, with the firm’s attention focused on Hunter’s trading, Arora was certain it was not going to happen.
Although he didn’t have any say about Hunter’s trades, Arora generally was called in by management to speak with investors about the complete energy portfolio. He was the face of the energy desk. Even if both Hunter and Arora were in the room with investors, Arora usually did most of the talking. He was the more seasoned portfolio manager, more at ease expounding on micro and macro issues. But discussing the entire energy desk bothered Arora. While he understood his book of business, knew his strategies and the size of his positions, he had no control over what Hunter was doing.
He had been thinking for some time about starting his own firm. Now his interest in it grew more serious.
The Amaranth Christmas party at a nearby hotel was festive that year, an elaborate celebration that featured Russian caviar, quail foie gras, and sixteen musicians. Along with its annual Christmas card, the firm sent out little gasoline pumps.
But beneath the smiles and gaiety at the party, tension was starting to build. Capital allocations were cut for some portfolio managers and traders in order to funnel more money to Hunter. The other traders had not necessarily lost money; some just had longer-term investment strategies, which would take a while to pay off. Some employees with profits as high as 15 percent for the year found their capital reduced by as much as 25 percent. There was significant dissatisfaction. After bonuses were paid out, a number of people left the firm.
Twelve hundred miles away in New Orleans, Christmas 2005 was grim. The hurricanes that had given Hunter his financial bonanza and Amaranth the means to celebrate so extravagantly had left more than eighteen hundred people dead and thousands without jobs and homes. For the residents of New Orleans, still putting up shingles and siding instead of Christmas lights, the storm that destroyed oil rigs and gas pipelines only meant loss of jobs, collapsed houses, and financial ruin.
At the start of 2006 money was rolling into the firm, both from Hunter’s dramatic investment profits and from investors eager to ride the gravy train. By the end of January, the firm was managing close to $8 billion.
Hunter personally was managing between $2 billion and $3 billion. And because he needed to put up only a small amount of cash to place a trade, he was directing many billions more. It was a huge amount of money for anyone to oversee, let alone a thirty-one-year-old trader who had been at his firm less than two years. Profits seemed to spew from his trading screen like it was an ATM run wild. He was raking in more than half of all the firm’s earnings.
Maounis was earning so much money from Hunter’s profits and the 1.5 percent management fee that “he didn’t want to be bothered with other things at the firm. Now he just wanted to sit on the desk,” says a trader. He would lean back in his chair on the trading floor, put his feet up on the desk in front of him, and joke that he was going to get rich enough to own the Yankees.
Maounis “had the real-time profit-and-loss [report of Amaranth] screen up on his computer, and he knew constantly how much he was earning,” recalls another employee. “We joked about how many thousands of dollars he was making as he read every letter of the Wall Street Journal.”
When he came back to the Greenwich office periodically, Hunter’s manner was the same as before. He was polite and respectful to the senior managers. He still walked with the usual slouch that made him look shorter than his six feet four inches, and he dressed as always, in jeans, sneakers, and hockey jersey. But he started talking about earning a bonus of $500 million. Then $1 billion.
In Calgary, Hunter put together what would be called “Team Hunter.” Eventually as many as seven people were working with him there. Hunter surrounded himself with guys his age, several of whom he knew from school or previous jobs. They included Shane Lee, from his days at TransCanada Pipelines, and his university buddy and fellow Canadian Matthew Donohoe.
Hunter was the nucleus of the group and planned the natural gas investment strategies. He preferred the cerebral aspects of the game. “I never enjoyed the trading, I liked the design,” he said later. “Most of my models would be option-based models and scenario models.” He didn’t like implementing his stratagems—the technical aspects of trading—saying later it wasn’t his strength.
Donohoe executed most of the trades that Hunter devised. Hunter considered him good at the nitty-gritty aspects of trading, which required good people skills—getting to know the strengths of various brokers and being able to negotiate complex deals with other traders—along with the agility to process electronic trades.
The Calgary group operated out of what Hunter called an “office in a box.” Amaranth leased a couple of small rooms on the tenth floor of Bankers Hall that were part of a ready-made office suite run by a private company. The offices shared receptionists, telephone answering services, mail delivery, conference rooms, and a kitchen area with other businesses. Dozens of other company off-shoots or small firms also worked on the floor, many involved with the oil and gas industry.
Amaranth leased a corner office—a larger room about fifteen feet square and a smaller side office about ten feet by six. Traders were wedged in tightly in the larger room. Hunter faced a wall, and at his back sat Donohoe.
Arrayed in front of Hunter were five computer screens. One displayed real-time trading on global markets for a variety of investments, including currencies, stocks, and bonds. On another screen, Hunter tracked U.S., Canadian, and European government weather forecasts, which drew on vast quantities of data churned through by giant supercomputers. A third screen was open to the IntercontinentalExchange, showing trading volume and prices on a multitude of contracts. Hunter also watched a fourth open to the Bloomberg service providing real-time price information on futures and options traded on the floor of NYMEX. Finally, Hunter also had open an instant-messaging screen, where he kept in contact with as many as fifty different people. They included his Amaranth colleagues, brokers, and traders. He was always messaging someone—a broker who wanted to get his bid or offer on a trade, Donohoe or another Amaranth trader who wanted his advice or direction, outside traders who were speculating on how prices would move or were wondering what Hunter was trading.
Hunter’s communications with traders outside the firm were somewhat unusual. He speculated about what other competitors were up to and who was responsible for prices moving in a certain way. He even talked about his own trading. Bo Collins and John Arnold didn’t do that. They used instant messaging and emails mainly for perfunctory communication with brokers, getting prices and giving directions, and generally were circumspect about their trading.
Hunter and his team were feeling pretty good about themselves. They had made their firm, their investors, and themselves a fortune the previous year. Hunter was back in his hometown, among friends and relatives. He was building his planned $2 million house with its stunning view of the Rockies. He tooled around town in his Bentley and his Ferrari. He enjoyed fine cigars after meals at high-end restaurants.
Hunter’s team gloated over how well things were going, how they were exerting their muscle on the market. They referenced favorite jokes often, in instant messages and conversations. One stemmed from Hunter’s baby son acting like a “muscle man.” When Hunter’s son was an infant just starting on solid food, Hunter asked Donohoe to babysit. Donohoe tried to feed the baby spinach, but he refused to eat it. “Don’t you want to grow up big and strong like your dad?” he asked the baby as he kept offering him the spoon. But instead of eating or crying, Hunter’s son flexed his arms and legs and grunted, sounding more like a tough guy than a baby. So, anytime they could, Hunter and Donohoe threw references to that into their conversations and instant messages. They joked about “flexing” and wrote “rrrrrrrrrrrrrrrrrrrrrrrrrrrrrr” to each other when they were happy with how their trading was going.
Flush from his stunning success following the hurricanes in the fall and newly ensconced in his Calgary trading room, Brian Hunter began to plan for the year ahead. January 2006 was turning out to be the warmest January on record for the United States, with an average temperature of 39.5 degrees—8.5 degrees higher than the mean temperature for the previous 110 years. Even the coldest regions of the country, including the northern plains and the Midwest, experienced record-high temperatures. Outdoor ice rinks in Wisconsin closed, and Super Bowl event planners worried that the mild weather in Detroit would melt the two-hundred-foot snow slide they were constructing as part of the pregame Motown Winter Blast.
Although Hurricanes Katrina and Rita had destroyed or closed down significant infrastructure and natural-gas supply that past summer, the warm winter weather kept gas in storage, mitigating the storms’ impact. Hunter, along with his team of traders, believed gas supplies would remain plentiful and demand low all that current winter and into the summer of 2006. “We thought that a price up-side potential for the next several months was muted by all this extra storage,” was how Hunter put it later. “The summer prices couldn’t go up in crazy amounts.”
But Amaranth’s traders anticipated a changed scenario the following winter, in 2007. They predicted that the natural gas supply would be tight and demand strong. If the winter of 2007 turned out to be very cold, then gas supplies could get very low, even run out. Their view seemed to be supported by the activity of other traders, such as a major Texas utility that was hedging massively. If there’s only enough gas to heat 80 percent of homes, Hunter liked to say, “what will the other 20 percent pay to keep their families warm?” In such a scenario prices would “skyrocket.”
With this overall view of supply and demand, Hunter started placing his bets in early 2006. Initially he focused on trades that would make money if that winter continued to be warm all the way into the spring, causing a glut of gas. He shorted gas for March, and by the end of January had shorted 40,000 contracts. As the weeks wore on and the mild weather continued, he switched from shorting March to shorting April contracts. Hunter expected the resulting gas excess to carry all the way into the upcoming fall, 2006. That would cause autumn prices to be lower than other traders probably expected. So he began to work on November gas contracts too, shorting more than 25,000.
While lower than expected prices might carry into November, Hunter believed that by January 2007 cold weather would return and supply would be tight, forcing gas prices up. So he started buying January contracts, more than 25,000 of them. By buying and selling the same number of contracts in this way, he created a spread position between November and January, betting that January 2007 prices would be much higher than November 2006 prices.
These positions were huge. By the end of February, Hunter alone was responsible for 70 percent of all the November contracts shorted on NYMEX. He had bought 60 percent of all January 2007 NYMEX contracts. His holdings would grow even larger in the months to come.
Also in February, he bought thousands of contracts for other winter 2007 months, particularly February and March, and he shorted other fall months. On top of that, he started to trade the “widow maker” spread for 2008, buying thousands of March 2008 contracts and shorting April. That trade was a gamble that winter 2008 would see high gas prices extending into March, then falling in April.
He also expected that the high winter prices of 2007 would cause average prices that year to be higher than for calendar 2010. He bought contracts that would pay off if that happened.
Hunter was dealing with tens of thousands of contracts. (By comparison, a small steel hardening company, one that relied heavily on natural gas for its operations, used less than one contract worth of gas a month.) The value of these holdings and the potential profit as prices moved was huge. One contract represented 10,000 MMBtus, so if the price of gas was $8 per MMBtu, then one contract was worth $80,000, and ten thousand contracts would be worth $800 million. A change of just 1 cent would mean $1 million more in profit or loss. With contracts for the upcoming winter in the $9 to $10 range per MMBtu that February, Hunter was trading billions of dollars’ worth of gas.
Hunter faced few limits from regulators on his trading. ICE was exempt from any government regulation and didn’t impose any limits on trading. NYMEX was regulated by the CFTC, but that agency, which set firm limits on what traders of wheat, corn, and other farm products could hold, did not do so for most energy trading on NYMEX. Instead, it allowed NYMEX to set loose guidelines, called “accountability levels,” for what a trader could hold of one month’s contract or for all months combined. The only firm limit set by NYMEX, under CFTC guidance, was on how many expiring contracts a trader could hold during its last three trading days: one thousand. But traders did not have much trouble getting permission to exceed these limits. Indeed, in September 2005, Amaranth’s limit for such trading was raised to twenty-five hundred. If traders exceeded these limits, they received a warning letter after each of the first two violations. If it continued, they could be fined or lose trading privileges.
Other than that, Hunter was subject only to the less strict NYMEX accountability levels. Traders weren’t forbidden to exceed them. Some did so occasionally; others exceeded them daily. When traders did that, NYMEX reviewed the situation, assessing the overall size of the market, whether a contract was near expiration, and a trader’s other holdings. Frequently, rather than require a trader to cut back positions, they agreed the trader could exceed the accountability levels. At the time, NYMEX allowed a net position of twelve thousand (adding up all the long futures contracts and subtracting all the short contracts) in one month’s contract, and a net position of twelve thousand for all months combined.
As Hunter bought and sold over the following months, he rarely changed his strategy; he just kept adding to his positions. It was a very different trading style from that used by most other gas traders. Usually a trader just picks and chooses some positions he believes are really good, then waits to see if he is correct. John Arnold “puts on two or three big positions a year,” Bo Collins later told a reporter. “He has discipline that other traders don’t have and is aware when there are just no good trades around. He won’t overtrade.” But Hunter seemed to believe every trade he did was a good one. Furthermore, he had no plan for when to exit them, cashing out and taking his profits. Until he did so, any profits were only on paper.
“You have to know why you think the price will change and when, and then get out when it does,” says a longtime successful commodity trader. “But he had a Master of the Universe, ‘I’m always right’ mentality. Other traders will take off all their risk for a time, get out of their positions, in order to reflect or take profit. You must say to yourself, ‘If the portfolio is X, what would I get out at? Would it be a $1 billion profit?’ ”
Maounis seems never to have pressed Hunter on that. “They had no idea how much it would give them in profits,” says the same trader. “They just knew, or thought they knew, it would keep going up. The idea that you can speculate and always be right is a crazy idea.”
As the size of Hunter’s positions soared in February, his cautious colleague Harry Arora grew even more worried. He saw the daily profit-and-loss reports. Hunter’s profits and losses could change by tens of millions of dollars from day to day. On February 24, for example, he was up $45 million; for that whole week he earned $163 million. Arora knew Hunter’s holdings must be huge. So he decided to open up Hunter’s spreadsheets and take a look at his book.
Arora was very troubled by what he saw there. Hunter’s holdings were very large, and they were concentrated in only a few ideas. Diversification didn’t guarantee he wouldn’t lose money, but it was generally considered safer than going all in on one strategy. But Hunter loved winter/summer spreads and March against April. Hunter’s strategy wasn’t necessarily wrong, thought Arora. But his size and concentration were.
Arora went to Jones to express his concerns over the size of Hunter’s positions. A little while later he also brought it up with Maounis. “They reacted positively and told me that they appreciated my input,” Arora later said.
“Harry has a good nose for smelling danger,” says an analyst who knows him. “Harry saw that what Hunter was doing was so risky that it was dangerous.”
But Hunter was minting money. “Most people were just amazed at how much money he was making,” remembers a former Amaranth trader. “You don’t want to kill the goose that lays the golden eggs. It was good for everyone when he was making money.”
Other traders, back-office staff, and executives could see Hunter’s profit-and-loss statements and could guess at the amounts of money he traded. Some could see his spreadsheets. Other portfolio managers raised an eyebrow as they watched the volatility in his book. But there was little incentive to say anything. Everybody could see their bonuses growing. If Hunter was trading outsize positions, he was also earning outsize profits—he earned the firm $320 million in February. He must know what he’s doing, people told themselves.
“Human nature is such that when someone is making a lot of money, you don’t question them,” says another Amaranth trader.
Nothing was done about Arora’s concerns.
From the Book, "HEDGE HOGS" by Barbara T. Dreyfuss. Copyright © 2013 by Barbara Dreyfuss. Reprinted by arrangement with Random House, an imprint of The Random House Publishing Group, a division of Random House, Inc. All rights reserved.