Scott E.D. Skyrm

In 2006, energy trader Brian Hunter was a star inside Amaranth Advisors , but a series of risky and ethically challenged trades brought the Connecticut hedge fund to its knees. In Scott E.D. Skyrm's forthcoming book "Rogue Traders"-his follow-up to "The Money Noose"-the author, a former trader, takes us inside the world where betting on the weather can bring down the house.

Brian Hunter was Amaranth Advisor's rock-star energy trader. A self-described "numbers guy," he was also a family man who never missed an opportunity to talk about his two sons. But he claims to be a very private person, and if someone rings his doorbell and asks to speak to Brian Hunter , he'll tell that person himself the Brian isn't home. On top of all that, the Calgary, Canada , native is adamantly opposed to having his photograph taken.

Hunter first became famous for an enormous bullish bet on natural gas prices in 2005. Had he been wrong, this story might be drastically different, but Hunter knew what he was doing, and two hurricanes later, he had made in excess of a billion dollars for Amaranth. Hunter reportedly took home between $75 million and $125 million for himself that year. One magazine, in fact, listed him as one of the top 30 highest-paid traders of 2005.

Having a high-flying trader is good for business, and by the end of April 2006 , Amaranth's assets under management swelled from $6 billion to $8.7 billion . And that growth was entirely due to Brian Hunter .

THE WINTER AND SUMMER STRATEGY

When it came to Amaranth's natural gas trading strategy, the public line the Greenwich, Conn. , hedge fund advertised was pretty simple. They sought "to hold winter month positions and short summer month positions." In just a few quick lines, it summed up Hunter's entire strategy, and it was completely true. Hunter liked being long winter natural gas and short the summer contracts.

One reason Hunter liked the strategy so much-aside from the fact that it worked so well-was that, in his mind, it was a pretty safe bet. The typical narrow spread between the winter and summer prices would widen considerably if winter natural gas prices suddenly increased. If there was some type of weather event (hurricanes to you and me), even if it occurred in the summer, winter natural gas would generally spike higher than the summer price.

However, Hunter did have another trading strategy that worked pretty well too. It involved the idea that given enough volume, a trader could push around the market for a very short period of time. Especially right before the expiration of a futures contract. Suppose there was a massive sell-off in a futures contract at the end of the day. Now, suppose that sell-off happened on the last trading day of the New York Mercantile Exchange natural gas futures contract. The bigger the sell-off during the last few minutes of trading, the bigger the price drop.

There's a name for this trading strategy-what might be better termed a manipulation strategy. It's called "banging the close." Technically, it's illegal. Those who get away with it typically hide their intentions very well and disguise their trades. However, Hunter, despite his intelligence and experience-or perhaps because of his intelligence and experience-didn't feel the need to disguise what he was doing.

Here's an example: On <chron>Feb. 23, 2006, Hunter sent a message to another Amaranth trader. "Make sure we have lots of futures to sell MoC [Market on Close] tomorrow," Hunter told him. The futures he was referring to were the March 2006 natural gas contract, and they would expire the following day, Feb. 24 . When that next day came, Amaranth opened net short 1,700 natural gas futures contracts on the NYMEX , plus short 12,000 of similar contracts on the InterContinental Exchange . As the day progressed, Hunter steadily switched his NYMEX short to a long of 3,000 contracts, even remarking to a colleague, "I just need H to get smashed on settle, then day is done." In other words, he needed March (H) futures to get pushed down. That is, he needed to bang the close.

During the last 30 minutes of trading that day, Hunter gave his broker an order to sell his 3,000 contracts, but gave explicit instructions that the order was not to be executed until the last eight minutes of trading. As it turned out, during the last four minutes Hunter unloaded 99 percent of his long position, which included 78 percent of those contracts in the last 60 seconds of the trading day.

Hunter would even brag about it to other traders-at other firms, no less: "We have 4000 to sell MoC. Shhhh." The trader he'd sent that to responded and asked him why he would do that, unless he was "huge bearish" on the natural gas market. Hunter replied nonchalantly that it was "a bit of an expirment [sic]."

While his "experiment" worked, it didn't go unnoticed by Amaranth's management. On March 10, 2006 , Amaranth issued an internal compliance memo outlining the firm's position on trading techniques like "banging the close." In no uncertain terms, the memo stated that the firm prohibited any sort of fraudulent and manipulative practices, including engaging in "trading or apparent trading activity for the purpose of artificially causing the price of a commodity to move up or down." In other words, management knew exactly what Brian Hunter was doing, and even though they were going to pay him handsomely for the money he was making, they wanted to cover their ass in case anybody noticed.

GOING ROGUE

Hunter, though, didn't take the new memo to heart, assuming he read it at all. When April rolled around, he was right back at it again. Throughout the month, Hunter built up a trading position in May 2006 natural gas futures contracts and swaps. By April 26, 2006 , he held a position of long 3,000 NYMEX futures contracts and a short position consisting of a staggering 19,000 ICE swaps contracts. Hunter was setting up another round and getting ready to "bang the close," except for one little sticking point. Hunter was concerned the famous energy trader John D. Arnold was a buyer.

Hunter expressed this concern to Amaranth's head of energy risk management: "Arnold is getting scary short into the number tomorrow. I am worried that Arnold has taken the other side of everything." In other words, Hunter was nervous that his rival was going to screw up his plan to bang the close by buying up futures contracts just as Hunter was selling them. In that case, Hunter could end up stuck short the ICE contracts just as Arnold was pushing prices higher. You see, Hunter and Arnold were energy trading rivals, and both men were competitive and liked to win on every trade.

They asked Hunter point-blank about whether Arnold was aware of what he planned to do: "Does he know [what you] are up [to] [with respect to] rolling off short?"

"Probably," Hunter acknowledged. "Arnold is the master of moving the close."

But Hunter went ahead anyway. He placed sell orders for up to 500 futures contracts, then 544, and finally 2,000. All the orders had the same explicit instruction: Do not execute the sale until eight minutes before the close. In the end, only 1,675 of the over 3,000 sell orders got sold, but Hunter still got what he wanted. The price of NYMEX natural gas contracts dropped and his epic short position in the ICE made good money, although not the gold mine he was expecting had the balance of the contracts been sold.

This time, however, Hunter's actions didn't go unnoticed. On Aug. 2, 2006 , the compliance department of the NYMEX sent a letter to Amaranth inquiring about the firm's trading activities in the May 2006 natural gas contract.

The hedge fund brushed off the NYMEX accusations, saying, "If any of Amaranth's orders were executed in the post-close session, that was not due to Amaranth's instructions to do so." They went on to suggest that the delayed orders "perhaps occurred because a floor broker erroneously failed to comply with Amaranth's directive." In other words, the firm said they hadn't directed anyone to push orders through during the last few minutes before the close. If it did happen, it was somebody else's fault, not theirs.

In the end, though, what brought down Amaranth wasn't illegal. It wasn't even related to banging the close. What brought down Amaranth was good weather.

CLEAR SKIES AHEAD

For much of the latter half of 2005 and the beginning of 2006, weather prognosticators were talking about La Niña, a period during which sea temperatures are lower, on average, by three to five degrees Celsius. What La Niña means for the Atlantic and Gulf regions is that there is an increased probability of high-intensity storms, including hurricanes. Paired with the dire reports about increased storm activity associated with global warming, everyone was sure 2006 was going to be a devastating hurricane season. That was music to the ears of Brian Hunter . He was betting heavily that 2006 would mirror the previous two years in terms of destruction and, as a result, the same spike in natural gas prices.

By April 2006 , Hunter was up nearly $2 billion , single-handedly accounting for nearly all of Amaranth's profits for the year. Amaranth publicly announced they were up 12 percent for the year, a gain attributed singularly to energy trading. But by the beginning of May, things started to change. Other traders were covering their natural gas shorts through the June and July contract months, and at the same time, natural gas producers were pumping out as much gas as they possibly could. It was the single largest buildup of pre-winter natural gas inventory in history.

Hunter, though, remained committed and continued his bet on a repeat of the previous year's destructive weather. He had extended his short summer/long winter position out over several years, expanding the scope of the bet into the future. In the event of any weather disaster, he'd make a fortune.

At this particular point in time, however, the markets had completely accounted for the possibility-even the probability-of a severe hurricane striking the natural gas production and distribution infrastructure of the United States . By the spring of 2006, the industry had fully recovered from the previous year's destruction, and they'd learned from their mistakes. 2006 saw reserve storage holdings more than 40 percent higher than the previous five years. The market was preparing for natural disasters, unlike they'd ever done in the past. This was something new, and it was something Hunter didn't anticipate.

The market finally turned in May, and natural gas prices dropped down to about $6.00 , even trading as low as $5.88 at one point. Hunter wasn't worried, though. Or if he was, he didn't show it. He was still positioned for the year, holding fast in his bet that summer prices would fall and winter prices would soar. He held more than 100,000 NYMEX contracts, a number that constituted nearly 40 percent of the total outstanding natural gas futures contracts on the exchange.

"He thinks he's bigger than the market," one natural gas trader said of Hunter at the time.

Size was the key ingredient to Hunter's strategy, as he felt that large positions could drive the market-the same idea behind banging the close. His position was concentrated, too. At one point, Amaranth controlled 75 percent of the outstanding contracts for November 2006 . It was also reported that Amaranth controlled between 60 and 70 percent of all natural gas futures contracts for the 2006-2007 winter season.

Hunter's positions had gotten so large that any attempt to reduce them would result in a major price decline. There was a growing problem that there were just too few buyers out there to pay for the contracts he owned if he needed to get out. "They counseled Brian to get out," one Amaranth trader recalled. "He needed to be ordered."

In May 2006 , Amaranth was down more than $1 billion , a staggering figure they'd thought was impossible to hit. It was, at least according to their own calculations, more than four times more than they were supposed to be able to lose. And it was the sheer size of their position that was killing them. They were crumbling beneath the weight of their own holdings.

DOUBLING DOWN

Hunter was told to cut back his position, but he couldn't. Everyone in the industry knew exactly what he was doing, and they knew the position he was in. He was stuck. So he did what many gamblers do-he doubled down. The logic was that if he added to his position at lower prices, his average purchase price moved lower. If he lost, he lost less; if he won, he won more. Plus, by purchasing more contracts, he was also helping to support the market and kept it from sinking lower. One rival trader said, "I knew Amaranth would eventually implode. It was just a matter of when."

By September, the price for natural gas had sunk to its lowest level in four years and Amaranth had run out of money to pledge as margin. Their only choice was to begin unloading some of their positions. On Sept. 14 , Amaranth posted its single worst day ever, losing in excess of $560 million when the price dipped below $5.50 and the spread market collapsed.

Closing out their remaining positions would only drive prices lower and add to the already crippling losses. Their only hope was for a blisteringly cold winter, some type of surprise storm, anything-but there was nothing in the forecast.

There was a conference call on Monday, Sept. 18 , that included Amaranth, Goldman Sachs , NYMEX and J.P. Morgan , which had served as the source of financing for Amaranth's margin deposits. Amaranth wanted to sell their remaining position on Goldman, except there was one problem. The law provided J.P. Morgan the option of either buying the contracts in bankruptcy court or taking control of the assets themselves in the event that Amaranth defaulted. Goldman balked at the situation, and Amaranth urged J.P. Morgan to pledge that they wouldn't seek recourse in the event of bankruptcy. J.P. Morgan declined, and Goldman backed out of the deal.

The next day, natural gas prices continued to fall, and the prospect of getting a bridge loan and staying in business looked impossible. The firm had lost so much money that it needed to liquidate. The natural gas market continued its downward spiral, with prices hitting a new low of $4.35 . Amaranth's net assets were down to $3.5 billion .

With gas prices crumbling, other traders sensed blood in the water and chose to pounce. J.P. Morgan called Amaranth and offered a compromise deal: They'd agree not to seek recourse in bankruptcy court if Amaranth would allow them to purchase 50 percent of Amaranth's natural gas assets along with Citadel, the Chicago -based hedge fund. Seeing no other option, Amaranth agreed to their terms and the deal was struck.

The news media would later report that both J.P. Morgan and Citadel "made a fortune on Hunter's positions." Amaranth posted a $6.6 billion loss, with $6.5 billion of that coming in the space of a single month. It was reported that Citadel and J.P. Morgan made a profit of $1 billion each. It was also estimated that approximately $4.5 billion was made collectively by other energy traders, and it was assumed that Centaurus Energy-the firm led by John Arnold -was one of them, given that Centaurus posted a 150 percent gain that year.

AFTER THE STORM

Following the Amaranth collapse, Brian Hunter was immediately accused of violating anti-manipulation rules by the Federal Energy Regulatory Commission stemming from his "banging the close" trading in February and April of 2006. He immediately flew to his lawyer's office in New York City to voluntarily provide testimony. Hunter claimed he had no intent to deceive anyone, nor did he attempt to cover up his trades from his bosses at Amaranth. But then Hunter's attorneys noticed a FERC lawyer setting up a video camera and asked him what he was doing. "Oh, this provides superior impeachment material," the lawyer replied, and Hunter's lawyers immediately ended the interview.

That story doesn't quite mesh with the version told by the chairman of the FERC, who told reporters that Hunter simply left the room and never came back. "Hunter was in the middle of an interview and there was a lunch break," he explained, "and he never came back." This led to speculation all around the energy markets that Brian Hunter had essentially disappeared and was in hiding out in Canada .

If you really want to find Brian Hunter today, he's really not that hard to spot. The man who avoids having his picture taken is actually quite easy to find when you know what car he drives. And when you live in Calgary -where the average median income is around $30,500 , in Canadian dollars-anybody who drives a Bentley model with a list price of more than $200,000 U.S. dollars is fairly easy to spot. So the next time you're at a Starbucks in Calgary and you see a Bentley Arnage drive up, you can bet it's Brian Hunter .

Skyrm is a former trader and desk manager for Newedge and a former repo desk manager for ING Barings. He is the author of "The Money Noose: Jon Corzine and the Collapse of MF Global."