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    The Metallgesellschaft Case of Oil Futures

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    Rohit Aggarwal
    Metallgesellschaft (MG) hedged its long term fixed price oil supply contracts by buying short term oil futures contracts. As oil prices fell, MG had to keep rolling over the futures contracts, locking up large sums of money in margins and incurring losses. MG's bankers refused to continue funding the hedging operations, forcing MG to close out its oil trade at a $1.1 billion loss. While MG survived, it emerged in a reduced form and the case highlighted the risks of imperfect hedges where the hedge and exposure maturities differ, as well as the opportunity costs of hedging long term exposures in futures markets.

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    The Metallgesellschaft Case of Oil Futures

    Uploaded by

    Rohit Aggarwal
    55 views1 page
    Metallgesellschaft (MG) hedged its long term fixed price oil supply contracts by buying short term oil futures contracts. As oil prices fell, MG had to keep rolling over the futures contracts, locking up large sums of money in margins and incurring losses. MG's bankers refused to continue funding the hedging operations, forcing MG to close out its oil trade at a $1.1 billion loss. While MG survived, it emerged in a reduced form and the case highlighted the risks of imperfect hedges where the hedge and exposure maturities differ, as well as the opportunity costs of hedging long term exposures in futures markets.

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    Metallgesellschaft (MG) hedged its long term fixed price oil supply contracts by buying short term oil futures contracts. As oil prices fell, MG had to keep rolling over the futures contracts, locking up large sums of money in margins and incurring losses. MG's bankers refused to continue funding the hedging operations, forcing MG to close out its oil trade at a $1.1 billion loss. While MG survived, it emerged in a reduced form and the case highlighted the risks of imperfect hedges where the hedge and exposure maturities differ, as well as the opportunity costs of hedging long term exposures in futures markets.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    55 views1 page

    The Metallgesellschaft Case of Oil Futures

    Uploaded by

    Rohit Aggarwal
    Metallgesellschaft (MG) hedged its long term fixed price oil supply contracts by buying short term oil futures contracts. As oil prices fell, MG had to keep rolling over the futures contracts, locking up large sums of money in margins and incurring losses. MG's bankers refused to continue funding the hedging operations, forcing MG to close out its oil trade at a $1.1 billion loss. While MG survived, it emerged in a reduced form and the case highlighted the risks of imperfect hedges where the hedge and exposure maturities differ, as well as the opportunity costs of hedging long term exposures in futures markets.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
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    The Metallgesellschaft Case of Oil Futures – 1995.

    MG had entered into long term fixed price contracts with buyers in the United States for supply of oil
    and oil products. Since crude prices have been notoriously volatile, MG decided to hedge its exposure to
    the price of oil by buying oil futures, while sign the long term supply contracts. The hedge was not,
    however, perfect. While the purchase in the futures market were relatively short term (there is no long
    maturity futures contract), the sales extended over a period of years. It became necessary to keep
    rolling over the futures contracts repeatedly. And, as the price of oil fell, large sums of money were
    locked up by way of margins, and there were losses at the time of rollovers. Of course, as the oil prices
    fell, the long term sale contracts were potentially more profitable and these profits would in due course,
    compensate for the losses currently incurred in the futures market.

    Meanwhile, the short term liquidity problem of the New York subsidiary of MG, which was the operating
    company for the oil trade, became serious. While the parent company was supportive when the
    temporary losses became large, MG’s bankers refused to lend money to continue the futures market
    hedge operations. They decided to close the oil trade at a one-time cost of USD 1.1 billion. MG survived
    the crisis but emerged from it n a much pruned form. Overall, the policy instituted as a conservative
    hedge ultimately became too costly to continue and sustain.

    The MG case led to a spate of suits and damage claims by the erstwhile management of MG. They
    contended that the bankers –

    a) Did not understand the hedging strategy adopted, which was basically sound and conservative,
    b) Were overhasty in their drastic surgical operation, and
    c) Damaged the reputation of the concerned executives and the interests of the shareholders.

    These contentions were broadly supported by a group of weighty American academics, the most
    prominent being Nobel Laureate Merton Miller. Others contended that there was no guarantee that the
    long term contracts would have been honored by the buyers of oil, given the falling prices, and hence it
    was best to cut the losses at some stage.

    The two risk management lessons that emerged from the MG case are –

    1) Imperfect hedges, in this case, with the maturity of the hedge significantly different from the
    maturity of the exposure, can lead to huge cash flow demands for rolling over the hedges. And
    this must be kept in mind while using imperfect hedges.
    2) The other lesson to be borne in mind is the huge opportunity cost, which hedges the forward /
    futures market can entail, particularly when the underlying exposure is long-term.

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