Metallgesellschaft

Overall Strategy

MGRM (MG refining and marketing) is US subsidiary of MG. Strategy: fully integrate oil business in the US and develop long term customer relationships. Approach: Use forward delivery contracts (160 million barrels over ten years). Acquired Castle energy in 1989.
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Forward Delivery Contract Gain for Client Gain for MG Spot price

PFIX

Time
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Conditions for terminating contract

NYMEX futures price > fixed price MG pays 50% of price difference NYMEX futures price > exit price In both cases, situation where the client is in the money.

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Terminate Contract Futures

PFIX

1992

2002

Time
5

10 years
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Hedging forward delivery contract positions Gain/Loss

Long futures

PFIX

Spot price

MG position
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Hedge with Futures

Regular unleaded gasoline NY harbor no. 2 heavy oil West Texas Intermediate Grade Light Sweet Crude Oil on NYMEX

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Futures hedge

Short-dated futures Use roll-over hedge

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Why short dated futures?

Cost relative to physical storage? Liquidity relative to long dated market? Short dated, however, requires roll-over strategy in this scenario.

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Price

Backwardation: spot (nearby futures price) greater than deferred futures price) For example, it is the end of November

Sell Buy

Rolling Over Hedge

Maturity Spot Near (Dec.) Deferred (March)

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price
92

6/93 9/93
12/93 maturity backwardation contango backwardation

92

6/93 9/93 $19/barrel spot

12/93 $15/barrel spot

10/94
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Losses Hedging Scheme

Total 1.3 billion dollars Loss of 20-30 million dollars/month on the roll over hedge due to contango curve Main lenders: 1.9-2.1 billion dollar rescue plan

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Was the Hedging Scheme Flawed?

Let us assume the delivery contracts were a good marketing strategy. Hedge Ratio: one to one vs optimal (minimum variance, max. expected utility). Tailing the hedge. Large positions on the NYMEX Backwardation vs Contango: contango is unusual but not without precedent. Prepared for worst case scenario? Value at risk
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MG Supervisory Board: 1) liquidated derivative position 2) liquidated forward contract positions. Right Decision?
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