Citadel, Funds Bet $3 Billion After Amaranth Falls

Date: Monday, October 16, 2006
Author: Geoffrey Smith and Matthew Leising, Bloomberg.com

Oct. 16 (Bloomberg) -- Citadel Investment Group LLC, the $12 billion hedge fund manager, T. Boone Pickens and the Merchant Commodity fund expect natural gas to rebound from a historic losing streak.

Hedge funds amassed a $3 billion wager on rising prices in New York futures markets as gas plunged 74 percent in the past 10 months, the biggest drop of any commodity. Chicago-based Citadel added to its bet in September by taking over trades from Amaranth Advisers LLC, the hedge fund that's closing after losing $6.5 billion in the gas market.

Demand for gas, used for furnaces and power plants, will outstrip supply as production from U.S. wells declines in 2007, say the chief executive officers of energy producers Devon Energy Corp. and EOG Resources Inc. Natural gas will average $9 per million British thermal units over the next 12 months, says EOG's chief, Mark Papa, up from less than $6 last week.

``If you told me I had to go long or short today, I would go long,'' betting on higher prices, said Pickens, whose Dallas hedge fund is up 120 percent this year. Gas may reach $10 this winter if cold weather depletes inventories, he said on Oct. 11 in New York. He declined to predict when his fund might get back into the gas market after exiting earlier this year.

Natural gas may rise as high as $12 per million Btu by March, said Michael Coleman, founder of Singapore-based Aisling Analytics Pte Ltd., which runs the $386 million Merchant Commodity hedge fund.

Falling Supply

While demand for gas to run power plants is increasing in North America, supply isn't growing, said Michael Morris, chief executive of Columbus, Ohio-based American Electric Power Co., the second-biggest U.S. electricity producer. Prices fell earlier this year after the fifth-warmest winter on record and a cool summer that reduced demand for electricity to run air conditioners.

The amount of gas pumped from U.S. wells is likely to decrease 1 percent this year, and supplies from new wells are declining at a faster rate than five years ago, said David Khani, an oil and gas analyst at Friedman, Billings, Ramsey & Co. analyst in Arlington, Virginia.

Daily U.S. production of natural gas fell to a 12-year low of 49.8 billion cubic feet in 2005 because of damage to plants from hurricanes, according to the U.S. Energy Department.

``The critical part is the production capacity of natural gas wells, and that is flat at best from the past winter,'' Devon Chief Executive Larry Nichols said in a telephone interview. Prices may rise ``dramatically,'' especially if winter is colder than normal, he said. Devon, based in Oklahoma City, is the second- largest independent U.S. natural gas producer.

Amaranth's Book

Demand for natural gas will increase by 3 percent in the U.S. next year because of rising power production needed to support an expanding economy, the government forecasts.

Gas supplies are tightening worldwide. In India, generators that cost $4.4 billion to build are idle because of a shortage of natural gas on the international market. South Korea, Asia's third- largest economy, faces a shortage of liquefied natural gas until at least 2015, forcing utilities to purchase alternative oil-based fuels, the government projects.

When Citadel and Amaranth's broker, JPMorgan Chase & Co., took over trades that led to the biggest-ever hedge fund loss, they saw potential for profit in owning gas, said Jim Duncan, an energy analyst in Houston at ConocoPhillips, the third-largest U.S. oil company.

``I'm sure there are Amaranth positions that are in the money now,'' he said.

Amaranth expected prices to rise for natural gas to be delivered this winter and executed that strategy with a so-called spread trade, buying March gas and selling April futures. The seller of a futures contract has an obligation to deliver a commodity to the buyer at predetermined date at the set price.

`Wishful Thinking'

March is the last month of the so-called winter heating season, so that contract is usually more expensive. After March, furnace use drops off, and utilities replenish the inventories they tapped in winter.

Gas for this coming winter plunged as much as 30 percent in September as it became clear that supplies in underground storage would be at record levels to start this winter.

The decline in the gas market reached a ``crescendo'' as Amaranth collapsed, said Michael Rose, director of the trading desk at Angus Jackson Inc., a broker in Fort Lauderdale, Florida. ``We should be looking down here for places to buy it,'' he said. ``To think that we're going to go much lower is wishful thinking.''

2001 All Over

Hedge funds are anticipating a turnaround. The long positions held by speculators surged to a record 145,386 contracts this month, having more than tripled since the end of last year, according to data from the U.S. Commodity Futures Trading Commission. Short positions, bets on falling prices, haven't risen as fast.

The number of futures bought outnumbers those sold by 46,873 contracts as of Oct. 3, the most since 1999. Speculators started this year with an equally large bet against natural gas. Commission data don't show what firms are long or short or the timeframe for the positions.

The gas contract nearest delivery dropped 74 percent from a record $15.78 per million British thermal units last December to a low of $4.05 last month. The November contract fell 12 percent last week to $5.659 per million Btu on the New York Mercantile Exchange, and the decline may continue for now, according to traders and analysts surveyed by Bloomberg.

Twelve of 21 traders and analysts, or 57 percent, predicted prices will decline this week, according to the Oct. 13 poll. Six said gas prices will rise and three expected little change. The survey has accurately predicted the direction of prices 52 percent of the time since it started in June 2004.

Gas for November delivery climbed 29.2 cents, or 5.2 percent, to $5.951 per million Btu at 10 a.m. today on the Nymex as forecasters predicted cooler weather in the Midwest.

Pricey Gas Deposits

The surge to an all-time high last December, and the decline since then, resembles 2001. Prices climbed to a record above $10 in December 2000 only to slide more than 80 percent to $1.76 the next nine months. A four-year rally followed.

A bet on gas futures prices gets support from the rising prices seen in sales of natural-gas deposits. Oklahoma City-based Riata Energy Inc., led by Tom Ward, the former president of Chesapeake Energy Corp., agreed on Sept. 7 to pay billionaire investor Carl Icahn $1.5 billion for his oil and gas holdings. That was 10 times what Icahn spent for them in 2003.

Ward and Riata are paying the equivalent of $4.84 per million Btu for the proved reserves held by Icahn's company. That's almost two-thirds higher than ConocoPhillips paid Burlington Resources Inc. in a $36 billion deal announced Dec. 12, the day before Nymex gas futures peaked.

GE's Targets

John Schaeffer, who oversees a $2.5 billion portfolio of oil and gas fields at General Electric Co.'s financial services unit, said gas deposits are in demand.

``We're looking for investments in every gas-producing basin in the lower 48 states and the Gulf of Mexico,'' he said in an interview.

The record for U.S. gas prices was set last December as the first hint of cold weather spurred concern about shortages. Gulf of Mexico platforms and pipelines, which can fill as much as 17 percent of U.S. natural gas needs, were devastated by Hurricanes Katrina and Rita in August and September of 2005.

By the end of last winter, warm weather had hurt demand, inventories were rising and prices were sliding. Predictions the 2006 hurricane season would rival last year had helped support gas prices. No storm-related disruptions have occurred this year.

Vega's `Interest'

Papa at EOG Resources said his prediction of $9 average gas prices covers the 12 months starting in November, which the market treats as the beginning of winter. Should prices stay that strong, they would rival the record average of $8.98 for all of 2005.

Hedge fund manager Julian Barrowcliffe, who oversees the $507 million Anglian Commodity Fund at VegaPlus Capital Partners LLC in New York, said this year's swings in prices drove him from the market, and he's now looking to get back in.

``We are watching this market with interest now, waiting to see if it will get back to normal,'' he said.

To contact the reporter on this story: Geoffrey Smith in New York at gsmith15@bloomberg.net ; Matthew Leising in New York at mleising@bloomberg.net .