The Energy Hedge Fund Center (EHFC), the only online community focused on energy and environmental alternative investments, observes increasing investor risk in the sector. The recent collapse of at least one energy commodity trading fund and large reported losses at other funds and banks trading energy commodities last fall continues to demonstrate that energy is a risky sector for investors. Although many energy hedge funds continue to perform significantly better than funds focused on other asset classes, EHFC Principals, Peter C. Fusaro and Dr. Gary M. Vasey continue to warn investors about the additional and often poorly understood risks involved in energy.

“ Energy trading markets have changed with more intraday price volatility caused by speed fund trading. Trying to use older trading strategies have failed some funds, we expect more blowups to come as many energy traders have not adapted to the new trading reality“ said Mr. Peter C. Fusaro.

“To some extent, due diligence has become mechanistic following pre-prepared questionnaires that were designed for more traditional investments,” reports Dr. Gary M. Vasey. “This mechanistic approach also speaks to a lack of understanding on the part of the majority of investors as to the underlying additional risks inherent in the energy industry. Energy is the hot asset class for investing but investors be warned, energy expertise is required to perform proper due diligence and to insure that effective risk mitigation is in place.”

In a recent article published by leading energy and utilities industry analysts and consultants UtiliPoint International, Inc., Dr. Vasey stated “As Peter Fusaro and I have argued in the past, energy markets are extremely risky and historical trends have broken down due to regional and/or global supply/demand tightness. There will always be blow ups in these markets and investors unfamiliar with the true risks in investing in energy will lose their money. The moral of the story for investors is simply don’t be greedy and understand and mitigate your risks. This means understanding the energy industry in some detail but it also means performing proper due diligence on the investment vehicle that you chose – especially hedge funds.”

Peter C. Fusaro and Dr. Gary M. Vasey are also the coauthors of ‘Energy and Environmental Hedge Funds – The New Investment Paradigm’ published by John Wiley (2006).

Energy-related commodities is a term that I use frequently and often prompts the questions - what do you mean? Well, I mean any non-energy commodity that has some relationship to increased demand for energy. The most obvious example is uranium used in nuclear power generation. But the fact is that a surprising number of other commodities are related to energy demand and usage.

Sugar for example can be used in the production of ethanol. Steel is used in construction of facilities in the energy industry, platinum is used in diesel engines for particulate removal and as a catalyst to reduce noxous emissions, copper is used to conduct electricity and so on....

The fact is that the boom in energy has an often significant impact on other commodities particularly copper, uranium and platinum. Consider the penchant for diesel engines in Europe and Asia (see the latest edition of Energy Hedge for more on this), the need for electric industry construction requiring a ready supply of copper and the prospect of more nuclear power stations requiring uranium!

We just got a call from an energy hedge fund commodity trader that said that a high flying energy hedge fund trading the US natural gas markets may have closed. This fund has had some hits during the past year but had over $500 mn AUM. Down 18% in September and 24% in June. They had the big name, the pedigree etc, but what they did not learn was that you can't trade at a hedge fund like you can at a big energy company or investment bank. In those places, mistakes are covered up by capital outlays.

A hedge fund is like running a small business. Mistakes can put you out of the game. It looks like a big one just bit the dust during this summer of wild gas trading markets here in the US.

Energy is a risky business and energy is still an immature financial market.

Peter Fusaro

An interesting change is underway and it has been rather quiet one While much attention has been on solar and ethanol IPOs and pre IPO in the renewable space during the past 6 months, there is about to be an upswing of new green funds Several well established hedge funds have now decided to launch new green funds this summer and fallThey are following on the success of equity plays that have panned out in their larger fund portfolios. This is a good thing. The more participation by sophisticated hedge fund managers and management will add more market liquidity to these maturing markets. Expect the rush to green to continue.

Peter Fusaro reporting from Cannes France at the GAIM 2006 Hedge Fund conference.

Our new book - Energy & Environmental Hedge Funds - The Investment Paradigm - has now been released for sale in the USA. It is available from Amazon.com.

Knowing how Washington DC works is more an art form than a science, it now seems almost certain that the US will have a mandatory greenhouse gas regime passing both houses of Congress and signed by the president in 2007 especially with Paulsen now set to go at Treasury. The real question is how much will the reduction be and how long will it last.

The debate will center on either modest reductions, than frankly can easily be met by industry, or more longer-term significant reductions. What we mean by significant is way beyond Kyoto's 5% reduction but 2012. A 20% reduction by 2015 seems doable, and 40% by 2025 inevitable if we are going to get our arms around some longer lasting and sustained impacts. The debate in DC has alredy begun.

Over the last 2-3 months, we have observed interest in commodities in Europe explode. Today Global Advisors launched two new commodity funds while other launches include an ex-Armajaro trader launching his own fund, several in France and more in Switzerland reflecting ivestor appetitie for commodity exposure.

Despite all the disinformation of the Bush Administration on climate change risk and the value of voluntary markets, the US is moving toward mandatory greenhouse gas standards. And guess what, US industry will adjust to it with not too many problems not like the EU ETS what is in chaos today. In fact, we can expect the Kyoto world of 2008 to be even more chaotic as over 160 countries try to work on developing a new market with little knowledge base or experience.

The point is that emissions trading was made in America and the experience here is deep. The latest EPA auction for SO2 allowances was dominated by Morgan Stanley and hedge funds. Hedge funds trade 35 regional emissions markets in the US and are waiting for the regulatory certainty that only the federal government can bring to the table.

The feds are coming. On April 4, bipartisanship took hold in Washington DC. It was a relapse to the days of consensual politics on greenhouse gas issues and how things used to work in DC. Senators Domenici and Bingaman, both from energy producing state New Mexico, have moved the debate forward asking industry how to construct the US carbon regime. Nothing will happen in this red and blue state year but next year the legislation will be crafted, passed and signed by Bush.

This is the contrarian play as most people are too debilitated from 6 years of propaganda to believe anything can happen in the US until after the 2008 presidential elections. They are wrong. Corporate America can not wait 5 years for action. The US will get the ball moving and it won't be Kyoto. It will beyond Kyoto. And guess what else, Canada is making noises of pulling out of Kyoto as the new government in Ottawa and the provincial government in Alberta don't want in. Then we have a North American market which is 35% of greenhouse gases, enabling agreements with the EU and Asia, and the rapid acceleration of carbon trading most likely on he NYMEX.

All opinions are from Peter C. Fusaro. More about carbon is in our publication Energy Hedge.

This past week in New York there were 3 cleantech events (Merriman, Jefferies and Ardour) in a row and all were well attended. I spoke at the third on on the new investment model for the green space which is a blurring of vc, hedge funds and private equity. But want caught my eye were that big macro hedge funds were now looking at this space.Two weeks ago at Goldman Sachs first Cleantech/Alternative Energy conference which 500 people attended, I noticed the energy hede funds were there probably to extend their presence into this new market. Now the macro funds have arrived. Lots of capital to deploy and probably not enough good investment ideas yet. But that will changes as higher energy prices continue and are sustained in coming years.

Peter C. Fusaro

Energy Hedge issue 23 conatins articles on the collapse of EU-ETS CO2 prices, E&P and the environment, a new feature article by Moncrieff Willigham Energy Advisors looking at energy markets and trends and regular features such as the briefs section, Vasey's Vista listing new fund launches and conferences, Fusaro's Focus, Commodity Corner and Cook's Viewpoint.

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