Hedge funds take a lashing Big losses in energy markets; traders exit By Michael Oneal Tribune staff reporter Published September 16, 2005 A tough market made worse by Hurricane Katrina is roiling the energy desks of two big Chicago-area hedge funds, causing heavy losses and costing several traders their jobs. Both Chicago-based Citadel Investment Group LLC and Ritchie Capital Management LLC in suburban Geneva have found themselves on the losing side of big trades involving natural gas and electricity, market sources say. Neither firm would comment, but Platts Commodity News, an industry trade publication, estimated the total losses at more than $250 million. Citadel, which has $12.5 billion in assets under management, lost at least $150 million, the report said. Ritchie, with $3 billion in assets, reportedly lost more than $100 million. The exact time frame of the losses wasn't clear. But sources said bad positions soured further when Katrina hit the energy infrastructure near New Orleans and heavily disrupted the markets for oil and natural gas. Scott Rose, head of energy trading at Citadel, has left the firm in the wake of the trouble. Sources said Todd Orosco and Joe Skubisz, who both traded energy at Ritchie, are departing that firm. Rose had no comment when reached at home on Thursday. A Citadel spokeswoman said he had left of his own volition. Orosco and Skubisz didn't return phone messages. Citadel's chairman and founder, Kenneth Griffin, also declined to comment on the energy situation. But in an interview early this week with Platts, Griffin said that "this year, the performance of the [energy] business has not met expectations, and I'm sure that weighed on [Rose's] mind." "We have been very successful since we launched [Citadel Energy Products]," he added. "This is one of the few times when we haven't pulled the money [to] the bottom line." Citadel and Ritchie, two of the nation's most secretive and aggressive hedge funds, are both new to the energy business. Citadel formed its operation in 2002 after the Enron scandal sent the industry into turmoil. Griffin recruited traders and managers from Enron, Aquila and other troubled trading operations. Ritchie launched its two energy related funds in 2004. To the extent that they can extract information from the highly secretive organization, investors say that Citadel's energy business has largely been profitable since it began. But like many in the natural gas market, it began encountering trouble three months ago when abnormally hot weather drove already elevated gas prices through the roof. One source close to Citadel said the prolonged price run-up disrupted any number of trades, from an arbitrage between October and January futures contracts to trades designed to take advantage of what's called the "spark spread." The spark spread is the relationship between the price of natural gas and the price of electricity produced from that gas. Typically, these two commodities trade in a particular range. But as the price of natural gas rose this summer and predictions of a mild winter began circulating through the markets, the opportunity arose to sell the commodity short--a bet that it would soon decline. To hedge their risk, traders bought electricity, which usually rises in price as generators use more expensive gas to produce it. This sort of strategy, known as spark spread arbitrage, lets the trader profit as the price spread between the two commodities eventually returns to normal. But as natural gas continued to rise abnormally through the hot summer, this trade and any others that involved shorting the commodity began to look increasingly untenable. When Katrina hit, things got exponentially worse. The most vexing part, said Eric Bolling, a trader on the New York Mercantile Exchange, was that the hurricane came on a weekend when the markets were closed. The storm changed directions toward New Orleans on Saturday night and by Sunday traders were in a panic. When the markets finally opened the price of natural gas exploded, far outpacing the move in electricity. That meant anyone short gas would sustain big losses not offset by long positions in power. "What underpins this is Katrina," Griffin told Platts. "The market really thought there was a probability that we would be oversupplied [gas] in winter, and a lot of people went short." The losses turn up the heat on Citadel and Ritchie, highfliers who have been having difficult years in 2005. Griffin said in an earlier interview with the Tribune that Katrina also ran smack into Citadel's new business in reinsurance, which sells insurance to insurance companies. But because Citadel has other, unrelated strategies that did well, it managed to exit August with a loss of less than 1 percent for the month. For the year, it is up only about 2 percent, investors said. Ritchie wouldn't comment on its returns, but SparkSpread, a Web-based publication devoted to these markets, said that the fund lost 9 percent in the latter half of the summer. Whether either fund has booked its losses is unknown. Citadel investors are signed to contracts that prevent them from pulling money out of the fund for a number of years. Market watchers said that might allow Griffin to wait out these bad trades, hoping the spreads return to normal and erase what could still be only paper losses. Citadel wouldn't comment on this speculation.