Metallgeshellschaft

MetallGeshellschaft AG is the fourteenth largest German corporation specializing in metals and oils; a conglomerate with 15 major subsidiaries. MG Refining and Marketing (MGRM) was a trading subsidiary in the “Energy Group”, in charge of refining and marketing products in the US, with over 65% of stock owned by institutional investors including banks. In the early 1994 Metallgesellshaft AG, was on the verge of bankruptcy. The trading strategy of the company had led to an outstanding loss of 1 billion USD.

1. Situation:

In 1992, Metallgesellschaft Refining and Marketing (MGRM) tried to set up a strategy meant to be highly profitable: the company planned to sell determined amounts of petroleum products every month for ten years, at fixed prices (that were higher than the current market price). MGRM then purchased short-term energy futures to hedge the long-term commitments - a "stack" hedging strategy.

This strategy failed because it didn’t take into consideration one problem: when oil prices drop, the benefits from the sale of oil are realised in the long-term, but the losses from the energy futures will be realised immediately. Thus, when oil prices dropped, the company faced a cash flow crisis

More precisely, Metallgesellshaft AG (MG) owned 51 %ЁOf MGRM Metallgesellshaft Refining and Marketing, MGRM in the late 1991 offered 5 to 10 years heating oil and gasoline fixed price contracts to its clients. This offer was 210 basis point over the market price with maturity up to one year. Those contracts had therefore known good craze from the investors. Following the settlement of those contracts MGRM was committed to deliver 20 millions barrels in October 1992 and 210 millions barrels in December 1993. MGRM tried to hedge their long term exposure to customer using a long position in short-term futures and forwards.

2. Hedging