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Hedge Hogs

The Cowboy Traders Behind Wall Street's Largest Hedge Fund Disaster

Hedge Hogs by Barbara T. Dreyfuss
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Dreyfuss / HEDGE HOGS


Going All In

Day after day and month after month during the spring and summer of 2006, a brash young commodity trader named Brian Hunter invested hundreds of millions of his clients’ dollars—­money that not all of them could afford to lose—­in high-­risk bets on the price of natural gas.

Every day Hunter, tall and athletic, sat facing a bank of flickering monitors. Over and over again he’d juggled the complicated mathematical formulas in his head, called on his trading associates, and consulted the charts, graphs, and weather forecasts that filled the screens in front of him, calculating the odds. An unexpected cold winter that would cause a spike in gas prices? It had seemed likely. Stronger than expected demand, at least stronger than other traders were counting on? He thought it possible. A hurricane-­induced supply disruption? There was a good chance.

So he’d bet big. Throughout the year, he’d singlehandedly dominated the trading of natural gas. At times he’d held 50 percent or more of all the contracts for the huge natural gas market in the months ahead, betting that winter prices would rise.

But speculating on natural gas prices was risky business, and by August Brian Hunter knew he was in trouble. And billions of dollars of other people’s money were on the line.

Although it was still hot and sticky in Connecticut, where his firm was headquartered, Hunter was feverishly thinking ahead to the first chill of winter, when he had expected demand for gas to pick up, sparking price hikes and letting him make a killing.

He’d already spent large sums propping up his positions while waiting for something, anything—­a hurricane, a pipeline disruption, a delivery bottleneck—­that would push winter prices up. But there had been nothing. Indeed, if anything caused prices of gas contracts to go his way at times, it was likely Hunter’s own trading. So powerful was he that he’d created his own wave, all by himself. Now what?

Lots of other people smelled the scent of gas in the air and feared an explosion. The executives at his hedge fund, Amaranth, were getting worried, since too much of the company’s assets were tangled up in Hunter’s precarious portfolio. They were pressing him to unload a big chunk of his holdings. Usually Hunter and the handful of traders he oversaw operated out of an office in Calgary, Alberta. But for several months, wary Amaranth executives repeatedly ordered Hunter and his team of traders to fly east to Greenwich, Connecticut, so that they could more easily scrutinize their trading.

Brokers at J. P. Morgan, which handled Hunter’s trades and collected the collateral he needed for them, were alarmed at the size of his holdings too. Already in mid-­August they’d demanded that his firm post as much as $2 billion to guarantee his bets.

And down at the New York Mercantile Exchange (NYMEX) they could smell gas too. The officials at the world’s largest energy commodity exchange, not unused to watching high-­stakes gambles unfold, warned Hunter to cut back.

Although he didn’t know it at the time, Hunter had yet another problem. About fifteen hundred miles away to the southwest, his main rival, John Arnold, didn’t see things the way Hunter did. And he was ready to pounce.

Arnold was widely considered the top energy trader in the world. A wily Enron veteran, Arnold was exactly the same age as Hunter, but perhaps a bit more experienced in the high-­stakes energy trading game. He too ran and reran the numbers and analyzed the fundamentals of the natural gas market, and he didn’t believe that gas prices were likely to rise significantly with the approach of winter’s icy blast. The previous winter had been mild, Arnold knew. Natural gas supplies during the spring and summer were relatively plentiful. And the quantities of gas in storage were higher than at any time in the past half decade. So as Hunter placed bets on rising prices, Arnold was putting money behind his confident belief that winter prices would decline.

Not that either Hunter or Arnold came anywhere near an actual gas container. Nor did they come close to the network of buried pipelines, collecting stations, and pumping facilities that pushed gas from Texas, Louisiana, and the Gulf north to the energy-­hungry Midwest and Northeast. They were speculators, buying and selling paper, placing bets with brokers and on computerized exchanges, hoping to earn a profit from shifts in the price of gas. The contracts and other investments they traded represented—­somewhere in the future—­millions of cubic feet of natural gas. But they made money not when actual gas changed hands but when contracts for that gas changed hands. And make—­and lose—­money they did.

It wasn’t the first time that Hunter and Arnold clashed. They’d disagreed before on where gas prices were headed. Several times in the past twelve months, particularly on the final, crucial day of trading expiring monthly gas contracts, Hunter and Arnold faced off, with one or the other coming out ahead.

Most people think that the price of a resource such as natural gas is determined by old-­fashioned supply and demand, and to some degree it is. But more and more in the kind of speculative trading that Hunter and Arnold engaged in, other factors—­market psychology and the stratagems of traders who dominated any given day’s trading—­had a powerful impact on prices, at least over the short term. And Hunter and Arnold dominated trading that year.

In late August, there was also intense pressure on Hunter to figure out how to handle his pile of summer contracts. Just as Hunter expected winter prices to rise sharply, he also counted on summer prices to fall. Many of his investments were arranged so that he would make money if either happened. He not only bet on the price in various months but on the difference in price between summer and winter months.

But that summer prices did not go down. In fact, a heat wave that hit in the last week of July, increasing demand for electricity for air-­conditioning, along with the threat of supply disruptions from a passing tropical storm, combined to cause prices to jump 17 percent.

Even tiny changes in gas prices can have enormous impact on a trader’s profits or losses. Because of the way gas contracts are priced, if a trader holds ten thousand contracts, then just a measly 1-­cent price shift translates into a change of $1 million in the value of his holdings. And Hunter controlled much more than that. In fact, he was invested in hundreds of thousands of contracts.

All summer long Hunter had waited for prices to fall, and as each month drew to a close, he rolled his holdings forward into the next month. By the end of August he was running out of months, as his portfolio was short 56,000 September contracts. It was an enormous position.

But Hunter took a gamble. Rather than get out of his contracts at fire-­sale prices, he decided to double down on his bet. He added to his position and by August 28 had shorted 96,000 September contracts. The amount of gas they represented was about one-­quarter of all the gas used by residential consumers that entire year.

The next day, August 29, was the last trading day for September contracts. With his bosses, his bank, and NYMEX breathing down his neck, Hunter desperately planned two strategies to bail himself out.

First, he would do some more trading in September contracts, shorting even more. Perhaps he hoped that would depress prices further. He planned to let September holdings expire at the end of the day. Maybe he would do all right.

Second, he decided to place another bet—­that the difference between the September and October contract prices would widen. Usually these months traded within 7 or 8 cents of each other. But thanks in part to Hunter’s huge trading, which had helped depress September prices, the difference between the two months was now about 34 cents. He hoped the difference would widen even more the next day and he would make some money.

John Arnold, who was watching supply and demand fundamentals, sensed something else. He looked at the wide price difference that suddenly occurred between September and October gas prices on August 28 and became suspicious. There didn’t seem to be any fundamentals to justify it.

Not only that, but Arnold expected September prices to rise.

So as the final seconds ticked down before the 10:00 a.m. Eastern time start of trading on August 29, the battle lines were drawn. Hunter, from his desk in Greenwich, with vast sums at stake, wanted September prices to go down. Arnold, at his perch in Houston, was counting on them going up.

As trading kicked off, Hunter sat amidst other commodity traders who were busy buying and selling electricity, grain, metals, and oil. Behind him, looking over his shoulder, sat one of his firm’s senior managers, Rob Jones, who normally stayed in his office. He was carefully watching Hunter’s trades.

In Houston, Texas, on the eighth floor of a glass-­walled office building in the fashionable Galleria mall area, John Arnold too began trading.

At first they seemed to be testing the marketplace, trading in small amounts. Within the first ten minutes Hunter shorted just over five hundred September contracts. John Arnold bought slightly less than half that amount. Between 10:10 a.m. and 10:20 a.m. Hunter sold close to four hundred contracts; Arnold bought an almost equal number. Over the next forty minutes they made smaller trades, but Hunter always shorted, Arnold always bought.1

As the morning wore on, the size of their trades increased. Right before noon Hunter sold just over 2,500 contracts. Arnold only bought about half that number. Especially during the first couple of hours of trading, Hunter seemed to get the edge. September prices tipped down in Hunter’s favor by 10 or 20 cents. The difference between the September and October contracts widened to as much as 50 cents. For Hunter this was good news.

By early afternoon, with less than an hour to go before the end of trading, Hunter had shorted just over 15,000 September contracts. Arnold’s buying had not quite kept up with Hunter’s trading.

Although commodity investing was supposed to be anonymous, the brokers who placed many of the trades tended to talk, especially when Brian Hunter and John Arnold were facing off. “It’s the Brian and John show,” some quipped to other traders, asking which side they were on. “Can you believe how much money these guys are throwing around?” they marveled.

But then, at about 1:45 p.m., with forty-­five minutes left to the trading day, events took an ominous turn for Hunter: September contract prices began to tick up, and the price difference between September and October narrowed.

Brian Hunter had already stopped trading. He was under orders from government regulators not to trade heavily in the final half hour of exchange activity.

So he was done for the day. But not John Arnold. He was suddenly buying thousands of September contracts. As the clock ticked inexorably toward the end of the trading day, the price of September natural gas contracts moved in only one direction.

In the balance hung Hunter’s investments—­along with Amaranth’s very solvency and the fortunes of its myriad investors.
Random House Publishing Group; May 2013
320 pages; ISBN 9780679605010
Download in secure EPUB
Title: Hedge Hogs
Author: Barbara T. Dreyfuss
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