Amaranth Autopsy: The Views of the Senate Permanent Subcommittee on Investigations on Excessive Speculation in the Natural Gas Market

Michael Giberson

“I think there are a significant amount of people who call themselves hedge-fund managers who have been very lucky because they were able to ride the market wave.” — Daniel A. Strachman, author of The Fundamentals of Hedge Fund Management

In mid-2006, that lucky group included a number of employees of Amaranth Advisors LLC. By September of 2006, Amaranth had fallen apart.

The primary message I get from reading the U.S. Senate Permanent Subcommittee on Investigation’s recently released report on the Amaranth blow-up, Excessive Speculation in the Natural Gas Market, is this: in 2005 the fund took some chances, got lucky, and made around $2 billion in gas markets; in 2006 they used that money and more to take additional chances, were not lucky, and lost about $6 billion. (While I’m certain a great deal of skill was deployed in the Amaranth efforts, the fundamental drivers of both the 2005 gains and 2006 losses were weather-related: the hurricane-related gas price spikes in late 2005, the mild 2005-2006 winter, and the relatively calm 2006 hurricane season.)

The report strains to make the Amaranth case support conclusions that the Permanent Subcommittee had earlier reached in a June 2006 report, The Role of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat: to wit, that the CFTC’s authority to oversee exchanges like NYMEX should be extended to electronic exchanges such as the Intercontinental Exchange (ICE). In addition, the Permanent Subcommittee wants to beef up the CFTC staff.

The amount of strain involved in using the Amaranth case in this manner is inadvertently revealed in the minority staff statement – a one-page addendum tacked onto the 134-page subcommittee report. The minority statement emphasizes support for the policy conclusions while expressing doubts about several findings in the report. Fortunately, in the minority staff’s view, one need not accept the report’s conclusions about facts in order to support the report’s conclusions about policies.

Despite the report’s bulk, the evidence for various assertions seems thin. For example, the report often asserts that Amaranth’s trading practices increased market volatility, but it offers the merest of anecdotes in support of those assertions. The report is 135 pages and the appendices total 345 pages. The appendices mostly chart the degree to which Amaranth was a large holder of various gas market contracts traded on NYMEX and ICE. Nowhere in the 480 pages is there a chart showing volatility of prices in the NYMEX or ICE markets. Instead we are treated to quotes from unhappy market participants saying that volatility was a problem, Amaranth’s own claims to its investors that volatility was up, and the mention of an industry seminar offered in early 2007 “with panelists offering a variety of trading strategies to try to deal with the extreme price volatility in the market.” Apparently a trader at the conference presented “a chart showing volatile natural gas prices in 2006,” but the Permanent Subcommittee couldn’t find a chart showing volatility to include in the report.

According to the report, “The trading records examined by the Subcommittee disclosed that from early 2006 until its September collapse, Amaranth dominated trading in the U.S. natural gas financial markets.” They dominated trading until they collapsed? I guess “domination” isn’t all that it is cracked up to be.

NOTES: The flower pictured above is Amaranthus retroflexus, also known as Common Amaranth or as Redroot Pigweed. The picture was obtained from the Wikimedia Commons.

According to Wikipedia, the name of the genus Amaranthus comes from the Greek word amarantos, the “one that does not wither.”

The Strachman quote at the beginning of the post comes from this Washington Post article, discussed here yesterday. We’ve discussed Amaranth here before, see this link.

ADDENDUM: The Houston Chronicle ran a story about the report on June 26. Related stories also showed up in the New York Times and Wall Street Journal, but are not available free online. The Washington Post carried a story on the hearings that accompanied release of the report.