Wednesday, May 21, 2008

Amaranth 2: Likely to unfold in Oil Futures shortly

The disconnect between demand-supply and the price of Crude Oil future points to a possibility that we might see the history of Amaranth repeating. Amaranth bet too much on Natural gas futures which collapsed from a high of 15 plus dollars to a low of 4 dollars. IMO similar thing seems to be going on in Oil speculation. Would not be surprised to see some big bulls failing.
* Interestingly, the boom in Oil price is following Bush regime over the last 8, unfortunate years I guess, which is likely to come to an end within next 4/5 months. As the markets are forward looking, I believe Oil should peak ahead of November elections.
* It is weird that US is holding 150 plus days of crude oil, 700 million barrels, in Strategic Petroleum Reserve (SPR). This SRP was created in cold war days when USSR was a threat; there is no such threat right now but I guess until Bush is in office, there will be no draw down from there :(
* Oil is scarce as an energy source for transportation but otherwise nuclear, solar, coal, natural gas in abundent quantity in the world for power plants and other energy needs. For transportation/vehicle use also, the actual demand of Gas/Petrol is going down compared to its supply and that is why there is a tremendous marging pressure for Refiners like Tesoro and WNR, Western Refineries.
In my opinion, Oil is in speculative phase; let us watch how far it goes.
By 2004-2005, the firm had shifted much of its capital to energy trading. Amaranth’s energy desk was run by a Canadian trader named Brian Hunter who placed "spread trades" in the natural gas market. Hunter had made enormous profits for the company by placing bullish bets on natural gas prices in 2005, the year Hurricane Katrina had severely impacted natural gas and oil production and refining capacity. Hoping for a repeat performance, Amaranth wagered with 8:1 leverage that the price of the March '07 and March '08 futures contracts would increase relative to the price of the April '07 and April '08 contracts (i.e., they were "long" the March contracts and "short" the April contracts).
Unfortunately for Amaranth, they did not. The spread between the March and April 2007 contracts, for example, went from US$2.49 at the end of August 2006 to US$0.58 by the end of September 2006. The price decline was catastrophic for Amaranth, resulting in a loss of US$6.5 billion.[1]. Historically, the spread in future prices for the March and April contracts have not been easily predictable. The spread is dependent on meteorological and sociopolitical events whose uncertainty makes the placing of such large bets a precarious matter.

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