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Energy Traders Avoid Scrutiny
At one point in the summer of 2006, Hunter controlled up to 70 percent of natural gas commodities on Nymex that were scheduled to supply companies and homes in November of last year and more than 40 percent of contracts for the entire winter season, according to a report into Amaranth's activities by the Senate permanent subcommittee on investigations.
His positions were so big he could cause the price to move in the way he wanted by buying or selling massive amounts of his holdings in the last 30 minutes of trading on Nymex, a move known as "smashing the close," federal regulators say.
Nymex expressed concern over Hunter's activities and sent several warnings. Finally, in August 2006, Nymex ordered him to reduce his holdings. Hunter obeyed, but then simply replicated his positions on an unregulated commodity exchange run by Intercontinental Exchange (ICE), one of dozens in the industry, the congressional report said. And Hunter kept making trades.
Because ICE was not subject to any oversight, neither Nymex nor federal regulators could see what he was doing. Nevertheless, the volatility in gas prices that summer became so severe that even Hunter predicted it might draw official attention.
"Boy I bet you see some CFTC inquiries," Hunter wrote in an e-mail to another trader, according to the congressional report.
"Until they monitor [unregulated exchanges] no big deal," came the response.
In August, natural gas prices remained unusually high due to Amaranth's activity, according to the Senate investigation, even though adequate supplies combined with unusually warm forecasts made it apparent there would be plenty for the winter.
At the same time, many utilities across the country were locking in prices they would pay for the natural gas they would receive in the winter. They had no way of knowing what Amaranth was doing, said David Schryver, executive vice president of the American Public Gas Association.
But a few hedge funds became suspicious.
One of those, Centaurus, appeared to figure out the pattern behind Amaranth's investment strategy and positioned itself to make a profit at Amaranth's expense. On the last day of trading in August, Amaranth started selling off its gas contracts for September, but Centaurus countered by buying up Amaranth's positions. The two funds battled frantically over gas prices until the closing bell. Prices moved in the way that Centaurus had bet on.
Eventually Amaranth's losses totaled $6 billion. It lost the ability to pay back its debtors and closed its doors.
But homeowners lost out, too, because many utilities locked in prices for natural gas at just the wrong moment when gas prices were high. The ultimate cost nationwide has not been tallied, but one utility, the Municipal Gas Authority of Georgia, calculated that its 243,000 customers paid an extra $18 million in the 2006-07 winter season because of Amaranth. More than half of American homes are heated by natural gas.
The CFTC filed a civil suit this summer accusing Hunter, who is still trading natural gas, of attempting to manipulate natural gas prices in 2006. Hunter, through his spokesman, denied the charge and said he would prove his innocence in court.
"It is worth asking whether the CFTC's sudden decision to file a headline-grabbing action against Brian Hunter was politically-motivated," Brian Maddox, Hunter's spokesman, wrote in an e-mail. "The CFTC's action came after several days of hearings conducted by the [Senate] criticizing the CFTC for ineffective regulation of natural gas."
Lawmakers and even some in the industry say more oversight of commodities is needed. ICE, the unregulated exchange that hosted the debacle, has begun to share some trading information with the CFTC. But there is little agreement on how far a new law should go, or whether commodity trading can be effectively monitored.
That's in part because a significant percentage of commodity trading doesn't happen on any organized exchanges, regulated or not. They take place in private, as over-the-counter trades. It is difficult to know how many of these are occurring.
Commodities markets also have become complex with many trading futures contracts as well as financial tools called derivatives and swaps, whose value is based on the risk of futures contracts. Gathering data on these products has been a challenge for the CFTC.
The evolution of the markets has led to some tension between the CFTC and the Federal Energy Regulatory Commission, the agency that oversees the commercial use of energy resources, which is directly impacted by commodity trading. The two agencies have both gone after unscrupulous traders.
For now lawmakers are focusing on increasing the authority of the CFTC, which has a stronger relationship with the commodity exchanges.
Levin's bill would require unregulated exchanges to comply with some of the same standards that the CFTC requires of a regulated body such as Nymex. For instance, unregulated markets would have to set limits on trader positions and share trading information with the CFTC. Levin's proposal would not seek to regulate trades that occur in private. Levin hopes to attach the measure to a farm bill currently moving through the Senate.
Exchanges are wary of these moves, warning of unintended consequences. Jeff Sprecher, the chairman and chief executive of ICE, said active unregulated exchanges serve an important function in helping determine the price of a commodity. Over-regulating them could squash that activity and encourage traders to flee to the less transparent venue of over-the-counter trading.
"No one could have imagined that you would have a [commodity] energy market develop the way it did," added James Newsome, chief executive of Nymex. "The markets are changing so quickly that there is no way you could keep up with the changes from a rules standpoint."
But Dan Berkovitz, a top Levin aide, said traders "hesitate when somebody's watching. And when nobody's watching, traders will go wild."