Hedge Funds Down, Not Out in Tricky US Natgas Market

David Coolidge may still be the king of U.S. natural gas hedge fund managers but his $2 billion Velite Capital has made less than half of last year's money while one of his biggest rivals is headed for a loss in an unusually tricky year for traders.

Andy Rowe, former trader at Citigroup's Smith Barney, also has a much smaller profit to show for this year than in 2011 at SandRidge Capital, another gas-focused fund in Houston.

In Westport, Connecticut, Todd Esse, once a star gas trader at Sempra, is trying to avoid the first annual loss at his Sasco Energy Partners -- which until last year was one of the best gas funds, with four straight years of gains.

Calling prices in the $40 billion gas market correctly is never that easy, given that it's one of the most volatile commodities after electricity.

This year has been particularly arduous, investors and market sources said. After making most of their money in the first quarter with a bearish bet on gas, the three funds spent the rest of the year trying to retain those gains with varying levels of success.

The three hedge funds declined or did not respond to requests for comment. Information on their returns was gathered from investors and market sources that track their performance.

Many funds were tripped up in the last two quarters by unexpected price swings caused by dynamic weather shifts in key U.S. consuming regions, which primarily drive demand for gas used in heating and cooling.

Prices have more than doubled to almost $4 per million British thermal units since hitting ten-year lows in April.

"It's not surprising to see returns down," said Chris Kostas, senior gas analyst at Energy Security Analysis Inc in Massachusetts, which conducts independent research on energy market trends.

"It's been difficult to make any kind of money with the sideways trade we've seen for much of the year," Kostas said.

Volatility itself is often welcome by gas traders as huge moves in their favor can result in millions, even billions, of dollars of profit, like those once earned by John Arnold, the market's biggest name ever.

Arnold, who retired in May after 17 years as a trader -- seven of them at former utility Enron -- returned over 300 percent to his Houston hedge fund, Centaurus, at his peak in 2006. But position limits placed on U.S. gas futures by regulators after the 2008 financial crisis crimped his trading style, forcing the 38-year-old billionaire to close shop.

"SLAM DUNK" THAT DIDN'T QUITE WORK

So what made 2012 such hard work for hedge funds in gas?

Firstly, it was a bet that prices, like last year, would continue falling from a record supply of shale gas.

They did hit 10-year lows in April. They then rebounded sharply from mid-spring through summer on unexpected demand from utilities that decided to burn cheaper gas instead of pricier coal to help power heaters and air conditioners.

Some of the biggest price moves were also technical in nature -- counter-intuitive and against what looked like a hopelessly-oversupplied, long-term bear market. Gas funds usually base their play on fundamentals, not technicals.

Another blow for the funds was the "short October-long January" futures spread, a favorite play that didn't perform as well as thought.

With gas already in oversupply, traders braced for more inventories to flow in ahead of October while temperatures remain fairly comfortable, lessening the need for gas usage. They expected October prices to crumble and January to hold up in anticipation of colder winter weather that would widen the spread between the two months.

October prices rallied instead, swept up by the broad run-up in gas during summer due to record temperatures, and the spread narrowed.

"At the beginning of the year, people may have thought that trade was a slam dunk because the fundamentals were so overwhelmingly bearish coming out of last winter. That obviously changed," said Stefan Revielle, analyst at Credit Suisse in New York.

FEAR CAUSING MISSED OPPORTUNITIES

Funds that started the year on the right foot with their bearish positions before getting tripped, may be fearful of going against the market that just hit 13-month highs three weeks ago.

But the inclination to play it safe may have cost some to miss an opportunity to make more money as a mild start to winter has already driven prices down some 15 percent from the recent peak.

"The surplus (in supply) has shrunk, producers are raising their offers and the bulls are betting on a normal winter," said Mike Guido, managing director of energy hedge fund sales at Macquarie in New York.

The hedge funds that once shorted the market "are not willing to sell aggressively again", Guido said.

Coolidge, a two-decade veteran of the market who rose to the top of his game after the trading restrictions that stifled Arnold, gained over 20 percent in the first quarter.

The next two quarters weren't as good for him, and Velite is up just 22 percent through November versus 51 percent for the whole of last year.

SandRidge, with about $300 million under management, is up around 7 percent in the first 10 months after 4 months of losses between July and October. Last year, it rose over 14 percent.

Sasco, which manages about $600 million, gained more than 10 percent in the first quarter before hitting a rough patch. Through November, the fund is down 7 percent, compared with a 2011 gain of more than 25 percent.

In comparison, the average energy hedge fund on Hedge Fund Network, a database run by New York's eVestment Alliance, is down 1.8 percent through November.

Natural gas itself is the sixth-best performing commodity on the Thomson Reuters-Jefferies CRB index this year, with the front-month futures contract up 10 percent at near $3.30 per million British thermal units.

A DIFFERENT ERA AFTER THE BOOM YEARS

While this year's moves in gas may be surprising, they are nowhere near the peaks and valleys established during the boom years of the mid-2000 era. In 2005, the market went from a bottom of $5.71 to a record high of nearly $15.80. This year, the low was $1.90 and the peak was just $3.93.

"(Volatility) is on the low side right now, which makes it more difficult for some to trade. It loses its attractiveness," said John Kilduff, partner at Again Capital, a hedge fund based in New York and focused on energy, not particularly gas.

Kilduff said gas funds that faced the biggest challenge this year were those with a long-only bias.

"The supply glut is making it somewhat difficult in terms of being almost a one-way trade. Whatever price rise you see is short-lived and unbelievably weather dependent."

Technicals also matter as much now as fundamentals.

"Any commodity fund that concentrates on micro fundamentals will tend to miss a technical move," Macquarie's Guido said. "Fifteen years ago that was an accurate way to study the market but now the market is so big and there are so many new players and variables. It's tough to concentrate on one segment."

(Reporting By Barani Krishnan; editing by Andrew Hay)