Amaranth Advisors Collapse: A $6B Gas Blowup

Key Takeaways

• A $9.2 billion hedge fund lost roughly $6.6 billion on natural-gas spread bets in September 2006.
• One trader's concentrated calendar-spread positions on NYMEX and ICE drove the entire loss.
• Most of the damage, about $4.6 billion, landed in a single week of forced liquidation.
• Position size beat strategy: the spreads were defensible, but the fund was far too large to exit.

Background

Amaranth Advisors was a multi-strategy hedge fund founded in 2000 by Nicholas Maounis, a former convertible-bond trader, and based in Greenwich, Connecticut. It opened with about $600 million and the ambition to run several strategies at once: convertible bonds, merger arbitrage, long-short equity, leveraged loans, and energy. For its first few years it looked like a steady, diversified shop.

Energy quietly took over. According to the academic case study by Hilary Till for the J.P. Morgan Center for Commodities, by June 30, 2006 energy trades accounted for about half of the fund's capital and generated about 75 percent of its profits. The desk that produced those gains sat far from headquarters, in Calgary, Alberta, and was run by a young star trader named Brian Hunter.

Hunter's specialty was the natural-gas futures curve. Natural gas is hard to move around the globe and expensive to store, so its price swings sharply between seasons. Hunter built large spread positions that were long winter-delivery contracts and short summer-delivery contracts, bets that would pay off if a hurricane or a cold snap drained storage and pushed winter prices far above summer prices. The strategy had an economic rationale, and in 2005, after Hurricanes Katrina and Rita spiked gas prices, it made Amaranth a fortune.

That success set the trap. Hunter's book was up roughly $2 billion by April 2006, per reporting cited in the Till case study, and the fund kept adding to the same kind of trade. By mid-2006 Amaranth was not just participating in the natural-gas market. It was the natural-gas market.

What Happened

The collapse unfolded over a few brutal weeks in late summer 2006. Natural gas prices began falling as a mild hurricane season and high storage left the market oversupplied, and the winter-versus-summer spreads Hunter had bet on began to compress instead of widen.

• September 2000: Maounis launches Amaranth with about $600 million.
• 2005: Hunter's energy desk profits surge after Hurricanes Katrina and Rita.
• Late July 2006: Amaranth's March and April 2007 contracts each represent nearly 70 percent of NYMEX volume in those contracts on July 31.
• Early August 2006: NYMEX tells Amaranth to cut its September and October positions; the fund shifts exposure to ICE.
• Late August 2006: Gas prices and spreads turn hard against the fund.
• August 31, 2006: Amaranth holds about $9.2 billion in assets under management.
• September 14, 2006: The fund loses about $560 million in a single day.
• September 18, 2006: Maounis tells investors the fund has lost an estimated 50 percent of its value since the end of August.
• September 20, 2006: Amaranth transfers its remaining energy positions to Citadel and J.P. Morgan Chase at a $2.15 billion discount.
• September 21, 2006: The natural-gas curve stabilizes; the fund's losses ultimately total about $6.6 billion.

The Senate Permanent Subcommittee on Investigations later reconstructed the trading from millions of records. It found that from the last week of August until the middle of September 2006, Amaranth's natural-gas positions lost over $2 billion in value, which forced the liquidation of the entire portfolio of what the report called "the $8 billion fund."

The price moves were extreme. The NYMEX contract for natural gas to be delivered in March 2007 had been trading far above the April 2007 contract, a spread that reached nearly $2.50 per MMBtu in July. By September that spread had fallen below 60 cents, a drop of about 75 percent, according to the Senate report. Because Amaranth held tens of thousands of these spread positions, each penny of adverse movement on 100,000 contracts swung the fund's profit or loss by about $10 million.

By the weekend of September 16 and 17, Amaranth was scrambling to hand off its book. Merrill Lynch agreed to take roughly 25 percent of the natural-gas positions for a payment of about $250 million. The fund kept bleeding, losing about $800 million more through Tuesday, September 19. On September 20 it transferred the rest to Citadel Investment Group and its clearing broker J.P. Morgan Chase at a $2.15 billion discount to the prior day's mark, with the two firms sharing the risk. The week of forced selling alone cost about $4.6 billion.

Why It Happened

The Amaranth Advisors collapse came from three reinforcing problems: extreme concentration, a strategy that looked diversified but was not, and a liquidity trap with no exit.

Start with concentration. Amaranth was not one bet among many in the gas market. It was the dominant force. The Senate subcommittee found the fund held as many as 100,000 natural-gas contracts in a single month, equal to about 5 percent of the natural gas used in the entire United States in a year. At times it controlled about 40 percent of all outstanding NYMEX contracts for the winter season, and as much as 75 percent of the contracts to deliver gas in November 2006. The Till case study notes that on July 24, 2006, Amaranth's position in the December 2007 contract was 81 percent of open interest. A firm that large cannot trade. It can only move the market, in or out.

Next, the false diversification. On paper Hunter held many different spread positions across contract months and across years out to 2010. In reality they were close cousins. Till's analysis found that two spreads, November versus October 2006 and March versus April 2007, were 93 percent correlated to the entire book. When the winter premium collapsed, almost every position lost at once. What looked like dozens of independent trades was really one giant bet on the shape of the gas curve.

Finally, the liquidity trap. A financial fund with no pipelines, storage caverns, or physical gas has a very narrow exit. The natural buyers of Amaranth's positions were physical-market players, utilities and storage operators who had taken the other side as hedges and had no reason to unwind at Amaranth's pace. Once the losses started, margin calls forced selling, the selling pushed spreads further against the fund, and the bigger losses triggered larger margin calls. The Senate report calls the move to ICE part of the problem: after NYMEX told Amaranth in August to reduce two near-expiry positions, the fund simply rebuilt the same exposure on ICE, where no position limits applied at the time. The brakes existed on one exchange and not the other.

By the Numbers

• Founding capital (Sept 2000): about $600 million; multi-strategy fund run by Nicholas Maounis. (Till case study; contemporaneous reporting)
• Assets under management, Aug 31, 2006: about $9.2 billion. (Till case study)
• Energy share of the book (mid-2006): about half of capital, roughly 75 percent of profits. (Till case study)
• NYMEX winter dominance: up to 40 percent of winter-season open interest; up to 75 percent of November 2006 delivery contracts. (Senate PSI report)
• December 2007 contract position, July 24, 2006: about 81 percent of open interest. (Senate PSI report, via Till)
• March-April 2007 spread: fell from nearly $2.50 to under $0.60 per MMBtu, about 75 percent, by September. (Senate PSI report)
• Single-day loss, Sept 14, 2006: about $560 million. (Till case study)
• Losses, late Aug to mid-Sept 2006: over $2 billion, per the Senate report. (Senate PSI report)
• Worst single week (Sept 2006): about $4.6 billion. (Till case study; contemporaneous reporting)
• Total losses: about $6.6 billion. (Till case study)
• Position transfer, Sept 20, 2006: remaining energy book sold to Citadel and J.P. Morgan Chase at a $2.15 billion discount. (Till case study)

Aftermath

Amaranth did not survive. After the September losses the fund wound down and returned what capital remained to investors, ending as the largest hedge-fund failure of its era. No criminal charges arose from the collapse itself; what followed were civil regulatory actions over how Amaranth traded earlier in 2006.

On July 25, 2007, the Commodity Futures Trading Commission charged Amaranth Advisors and Brian Hunter with attempted manipulation of natural-gas futures prices, alleging they sold large blocks of expiring NYMEX contracts during the settlement window on February 24 and April 26, 2006, to push the price down and benefit larger short swap positions held on ICE. The complaint also alleged Amaranth made false statements to NYMEX about its April 26 trading. The Federal Energy Regulatory Commission separately issued a Show Cause Order on July 26, 2007, proposing $291 million in penalties and disgorgement, including a $200 million civil penalty against Amaranth and a $30 million penalty against Hunter.

The corporate cases settled. On August 12, 2009, FERC approved an uncontested settlement in which the Amaranth entities and trader Matthew Donohoe agreed to pay $7.5 million to the U.S. Treasury and did not admit or deny the allegations; FERC noted the settlement amount reflected that the firm's assets had been "substantially diminished." That same month, a federal court entered a consent order in the CFTC matter requiring the Amaranth entities to pay a $7.5 million civil penalty and permanently enjoining them from violating the anti-manipulation provisions of the Commodity Exchange Act. The two $7.5 million figures were coordinated, not stacked.

Hunter fought on alone. In 2011 FERC's Commission affirmed a $30 million civil penalty against him under the Natural Gas Act. He appealed, and on March 15, 2013, the U.S. Court of Appeals for the D.C. Circuit vacated FERC's order in Hunter v. FERC, holding that the CFTC has exclusive jurisdiction over commodity futures contracts and that nothing in the Energy Policy Act of 2005 clearly repealed that jurisdiction. The CFTC sided with Hunter on that jurisdictional point. On September 15, 2014, Hunter settled the remaining CFTC case for $750,000 plus interest, without admitting or denying wrongdoing, and agreed to a permanent bar from trading CFTC-regulated instruments. The episode also fed the policy push to close the so-called Enron Loophole that had left ICE energy trading outside CFTC oversight.

Lessons for Investors

1. Size is its own risk. Amaranth's spread strategy was not exotic, but the fund held up to 40 percent of winter open interest. Once a position is large enough to move the market, you cannot sell without driving the price against yourself. Judge a position not only by whether the thesis is right, but by whether you could exit it in a week of panic.

2. Correlated bets are one bet. Hunter's book looked spread across many contract months and years, yet two spreads explained 93 percent of the risk. Counting the number of positions tells you nothing about diversification. Measure how your trades move together under stress, because that is the exposure that actually decides survival.

3. Liquidity disappears when you need it most. A financial fund with no physical gas had no natural buyer in a crisis. The only counterparties were hedgers with no reason to rush. Before you enter a large position, ask who is on the other side when you are forced to leave, and whether they will trade at your price or theirs.

4. A profitable strategy can still ruin you. The winter-summer spread had genuine logic and had paid off after the 2005 hurricanes. Being right about the long-run thesis does not protect you from a short-run move large enough to trigger margin calls and forced selling. Position sizing, not the idea, is what kept or killed the fund.

5. Regulatory gaps move risk, they do not remove it. When NYMEX limited Amaranth, the fund simply rebuilt the same exposure on ICE, where no limits applied. Rules that bind one venue and not another invite the risk to migrate rather than shrink. Watch where the real exposure sits, not just where the visible, regulated portion appears.

Frequently Asked Questions

What was the Amaranth Advisors collapse in simple terms? The Amaranth Advisors collapse was the September 2006 failure of a $9.2 billion hedge fund that lost about $6.6 billion in weeks on natural-gas bets. One trader, Brian Hunter, had built huge positions in gas calendar spreads that moved sharply against the fund.

Why did the Amaranth collapse happen? Amaranth held enormous, concentrated natural-gas spread positions that were long winter contracts and short summer contracts. When gas prices fell and the winter premium compressed, almost every position lost at once, and the fund was too large to exit without crushing the prices it was selling into.

How much money was lost in the Amaranth collapse? Amaranth lost about $6.6 billion in total, with roughly $4.6 billion of that in a single week of forced liquidation in September 2006, including about $560 million on September 14 alone. The fund had held about $9.2 billion in assets at the end of August.

Could an Amaranth-style collapse happen again today? Yes, in a different form. The Enron Loophole that let Amaranth trade without limits on ICE was later addressed, and futures exchanges tightened position oversight, but concentrated commodity bets, forced margin selling, and liquidity gaps remain recurring patterns.

What is the main lesson from the Amaranth collapse? Position size can matter more than the strategy itself. A defensible trade held in a size you cannot exit during a panic is not a smart bet, it is a hidden wager that the market will stay liquid exactly when it will not.

Sources

1. U.S. Senate Permanent Subcommittee on Investigations. Excessive Speculation in the Natural Gas Market (Staff Report). June 25, 2007. https://www.hsgac.senate.gov/wp-content/uploads/imo/media/doc/REPORTExcessiveSpeculationintheNaturalGasMarket.pdf
2. U.S. Commodity Futures Trading Commission. Press Release 5359-07: CFTC Charges Hedge Fund Amaranth and Its Former Head Energy Trader, Brian Hunter, with Attempted Manipulation. July 25, 2007. https://www.cftc.gov/PressRoom/PressReleases/5359-07
3. U.S. Commodity Futures Trading Commission. Press Release 5692-09: Amaranth Entities Ordered to Pay a $7.5 Million Civil Fine. August 2009. https://www.cftc.gov/PressRoom/PressReleases/5692-09
4. Federal Energy Regulatory Commission. Order Approving Uncontested Settlement, 128 FERC 61,154. August 12, 2009. https://www.ferc.gov/sites/default/files/2020-05/128FERC61154.pdf
5. Hunter v. FERC, No. 11-1477 (D.C. Cir. March 15, 2013). https://law.justia.com/cases/federal/appellate-courts/cadc/11-1477/11-1477-2013-03-15.html
6. Till, H. (2018). The Amaranth Case Study. Global Commodities Applied Research Digest, J.P. Morgan Center for Commodities, University of Colorado Denver. https://www.jpmcc-gcard.com/wp-content/uploads/2018/05/GCARD_Summer_2018_CEC_Till_Amaranth.pdf
7. Troutman. Brian Hunter Settles Natural Gas Trade Manipulation Case with CFTC. September 2014. https://www.troutmanenergyreport.com/2014/09/brian-hunter-settles-natural-gas-trade-manipulation-case-with-cftc/

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.