Bank of Montreal's Natural Gas Disaster: $850 Million Gone

You would think that after Amaranth blew up and lost $6 billion on natural gas, every bank and fund on the planet would have gotten the message. Natural gas is dangerous. Do not bet the house on it. But no. Just six months later, one of Canada’s oldest and biggest banks walked straight into the same wall. Chapter 28 of Torsten Dennin’s “From Tulips to Bitcoins” tells how the Bank of Montreal lost $850 million on natural gas trades and tried to cover it up.

A Bank With Two Centuries of History

Bank of Montreal, or BMO, was founded in 1817. That makes it older than Canada itself. It is the fourth largest bank in Canada. Back in the 1880s, BMO financed the first transcontinental railroad across the country. This is not some small regional player. This is a serious institution with serious history.

In 2007, BMO got a new CEO. Bill Downe took over from Tony Comper. A fresh start, a clean slate. Or so everyone thought. What Downe did not know yet was that deep inside the bank’s commodity trading desk, a disaster was already cooking.

The Star Trader

His name was David Lee. He joined BMO in his mid-twenties, coming over from Bank of New York. His specialty was natural gas options. He traded on NYMEX and over the counter. And he was good. Or at least, he looked good for a while.

BMO had actually gotten burned on natural gas before. In 2000, the bank lost $30 million CAD on natural gas futures. A small scandal at the time, forgotten quickly. You would think that experience would make them careful. It did not.

Lee handled a large chunk of his trades through a broker called Optionable. This was a tiny firm, fewer than 20 employees. BMO’s trades made up about 30% of Optionable’s total revenue. That alone should raise eyebrows. When one client is a third of your business, you will do just about anything to keep that client happy.

And here is the thing. David Lee and Optionable’s CEO Kevin Cassidy were close friends. Not just business acquaintances. Friends.

A Dangerous Size

How big was BMO’s natural gas trading operation? Fifteen to twenty times larger than Royal Bank of Canada’s. Think about that. The fourth largest bank had commodity positions that dwarfed what the number one bank was doing. That is not aggressive trading. That is reckless.

When Katrina Hit

To understand Lee’s bets, you need to understand the natural gas market at the time. Prices had been sitting around $6 to $7 per million BTU through 2004 and into early 2005. Calm, stable, nothing exciting.

Then Hurricane Katrina tore through the Gulf of Mexico in August 2005. Gas prices shot up past $15 by December. More than doubled. If you were long natural gas, you made a fortune.

But here is what happened next. The spike did not last. Prices crashed. Within a few weeks, natural gas lost about two-thirds of its value. From $15 back toward $5.

Lee’s team had bet on a price rebound. They built massive positions in call options, betting that gas would bounce back up. It did not bounce. Prices kept falling. And as prices fell, volatility dropped too. When volatility drops, call options do not just lose value slowly. They implode.

Hiding the Bodies

This is where the story goes from bad to criminal.

As the losses piled up, Lee did not report them honestly. With help from his friends at Optionable, he disguised the real damage. They falsified trading prices to make the positions look less terrible than they actually were.

When you are trading billions of dollars and your broker is helping you fake the numbers, you can hide a lot of pain for a while. But not forever.

The Unraveling

In April 2007, three directors at Optionable sold $30 million worth of their company shares. That is what people do when they know the ship is sinking. Get your money out before anyone else figures it out.

BMO brought in Deloitte to audit the trading book. What they found was ugly. The losses were between $350 million and $450 million CAD. That was the initial estimate. The real number would end up much worse.

BMO immediately cut ties with Optionable. The broker’s stock price collapsed, losing 90% of its value almost overnight. A company that had been riding high on BMO’s business was now practically worthless.

Making It Worse

Here is where BMO made a bad situation even worse. Goldman Sachs and Citadel both showed interest in taking over BMO’s troubled natural gas portfolio. These are firms that specialize in cleaning up exactly this kind of mess. They know how to unwind big positions without panicking the market.

BMO said no. They decided to handle it themselves.

And then they published their positions. Before reducing them. If you are holding a giant portfolio that you need to sell, the absolute last thing you want to do is tell the entire market what you are holding. Because now every other trader knows exactly what you need to sell. And they will front-run you. They will push prices against you before you can get out. That is exactly what happened.

The final damage was $680 million USD. That was 12% of BMO’s annual profit. The biggest trading loss in the history of Canadian banking.

The Aftermath

David Lee was fined $500,000 and banned from the banking industry. For losing $680 million and committing fraud, he paid half a million dollars. Do the math on that.

When you add up all the costs, including legal fees, the unwinding losses, and everything else, the total came to roughly $850 million USD.

BMO survived. When you are a 200-year-old bank with a diversified business, even $850 million does not kill you. But it is a stain that does not wash out.

What I Take From This

Dennin puts this chapter right after Amaranth, and I think that is deliberate. The lesson from Amaranth was obvious. Massive concentrated bets on natural gas can blow up spectacularly. And yet, just months later, BMO walked into the exact same trap.

Three things stand out to me.

First, the friendship between Lee and Cassidy. When your star trader is best friends with the broker handling most of his trades, and that broker’s revenue depends on keeping the trader happy, you have a conflict of interest so big you can see it from space. Nobody at BMO thought this was a problem?

Second, the size. Fifteen to twenty times larger than Royal Bank of Canada. That is not a hedge. That is not a managed risk. That is one trader building an empire inside a bank, and nobody asking why.

Third, the cover-up. Lee did not just make bad trades. He hid them. With outside help. For months. The fact that it took an external audit to uncover losses that big tells you something about the internal controls at BMO. Or the lack of them.

The pattern from Dennin’s book keeps repeating. A trader makes money. The bank gives them more room. The positions grow. The losses start. The trader hides them. And by the time someone finally looks, the hole is so deep that no amount of scrambling can fill it.

$850 million. From a 200-year-old bank. Because one trader had a friend at a 20-person brokerage.

Based on Chapter 28 of “From Tulips to Bitcoins” by Torsten Dennin (ISBN: 978-1-63299-227-7, River Grove Books, 2019).

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