Bad gas: BMO gamble blows up

One of Canada’s big banks has egg on its face today, admitting that it will have to write-down trading losses of $350 million to $450 million, after its Houston-based proprietary trading desk grossly miscalculated the natural gas commodity market. BMO Financial Group estimates that the losses work out to around 45 to 55 cents a share.

During a press conference on Friday morning, BMO Financial’s CEO Bill Downe said that the bank had a significant trade portfolio in energy commodities and that over the past eight weeks, it had incurred significant losses.

Downe outlined that the energy sector had been a huge money maker for the bank in 2005 and 2006, but by the end of the year, the natural gas market was dropping to historical lows. The bank’s Houston-based traders apparently decided to take a larger “market making” position in natural gas derivatives. The market was too illiquid, however, and the bank was unable to offload the commodities for a profit.

“The commodity trading losses were the result of decisions that did not adequately recognize the vulnerability of the portfolio to changes in market volatility. We are conducting a thorough review, and actions have been taken to address the current situation and reduce the likelihood of a recurrence,” Downe said.

For U.S. reporting purposes, commodity derivatives are required to be accounted for at a fair market value, the bank said during the teleconference, so it was necessary to announce the losses before its next quarterly report. The bank had no specific numbers on what the actual losses will be once it repositions the portfolio, but it assured investors that even in the most adverse conditions, the losses should be lower than the range announced today.

For holders of BMO stock, though, losses were felt immediately. As of 2:30 p.m. EDT, the stock’s value had dropped by $1.21 or 1.64% on the Toronto Stock Exchange. Still, the stock remained above $70, well above its 52-week low of $58.28.

Canadian banks were nevertheless quick to distance themselves from BMO’s misfortune. Very shortly after the announcement, CIBC issued a release that stated, “CIBC will report its second-quarter results as scheduled on May 31, 2007. To date, CIBC has experienced no material or unusual gains or losses in relation to its commodity trading activities.”

Downe has maintained that while BMO regrets the losses, fundamentally, the bank remains financially strong. “The commodity trading losses are particularly disappointing as our company continues to experience good operating momentum. We remain committed to providing the high level of service that our clients in the energy sector have come to expect from BMO Capital Markets,” he said.

A spokesperson for BMO informed Advisor.ca that all of the losses incurred were the bank’s and no investor money was used in the trades.

Natural gas has proven it can be a tough market, even during a broad-based commodity rally. A $6 billion loss in natural gas trading led to the collapse of U.S. hedge fund Amaranth Advisors in September 2006.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com