METALLGESELLSCHAFT

A CASE STUDY
BY:
SHEETAL SENGHANI 47
SWAPNIL TIWARI
Company profile
Metallgesellschaft AG
14 largest company in Germany
Conglomerate with interest in metal, mining and
engineering business and other 15 subsidiaries
Metallgesellschaft corporation, the U.S. subsidiaries
Trading in U.S. government bond, foreign currency,
emerging market instruments and various
commodities
MG Refining and Marketing
U.S. oil trading subsidiaries
New entrance to us market, low market share
Goal to develop a fully integrated oil businessin U.S
MG Refining and Marketing
1989 0btained a 49% stake in castle
energy, U.S oil exploration company
helped finance transformation into refiner
purchased output of refined at gauranted
margins on a long term contract
1992 -1993 signed a large number of long
term contracts with independent retailer
delivery of gasoline, heating oil and jet oil
The Deal and the strategy
MGRM structured deals with its customers to shift or eliminate some
of their oil price risk during fluctaions in oil market.
MGRM committed to sell stipulated amounts of petroleum every
month, at prices fixed at 1992 for 10 years,by September 1993, they
sold forward about 160 million barrels of oil.
These contracts contained an ~option clause, which enabled the
counter parties to terminate the contracts early if the front month New
York Mercantile Exchange (NYMEX) futures contract was greater
than the fixed price at which MGRM was selling the oil product.
If the buyer exercised this option, then MGRM had to pay in cash one-
half of the difference between the futures price and the fixed prices
multiplied by the total volume remaining to be delivered on the
contract.
ptions available to MGRM for hedging
To hedge the price volatility, a company can buy futures.
Generally very long-term (10 years) futures are not available.
Hence, it can buy short-term futures, and at the time of
maturity, the company can close the expiring futures and take a
new position in the next period. MGRM did this.
MGRM used a stacked` hedging strategy to hedge its fixed
price sale; it went long in short dated delivery month futures on
the NYMEX. At the expiry of every contract, MGRM rolled its
position forward.
MGRM went long in futures for unleaded gasoline and No.2
heating oil.
hat ent rong
1. . Market Reversal-Market went from backwardation to
contagno.
1. The size- the size of the future contracts was huge from 15-
30000avg to 55000per day.
2. Contagno effect- The ~stacked futures positions made
company to rollover it position forward at the expiration of
contract resulted in rollover loss in continues contagno market.
3. Cash Flows- Margin requirements state that if your marked-to-
market position is in too much of a loss, you have to deposit
more cash at the exchange in your account. Due to this
company had to tie up a lot of its cash in the margin
requirements as a result the cash flows were negative.
Conclusion
These types of losses are the result of a poor understanding of
the market.
Thus, it is imperative for CFs and decision-
makers to understand the nature of their position in the market,
and the consequences of market movements on the financial
position of the company. There is a need to evaluate the market
environment before taking any positions.
MGRM was initially successful in hedging its market risk,
especially when oil prices were rising. However, it failed in
assessing the funding risk of its hedge position. If the prices had
continued to rise, it would have been smooth sailing for MGRM.
F Given the contango market, MGRM should have forecasted
the downtrend in prices and suitably adjusted the contract price
to avoid losses.
Recommendation
1. Match the duration of the two contracts in
your hedging strategy
here the company was using 1-month contracts
to hedge a longer term risk
2. have appropriate controls in place so that if
your hedging strategy goes wrong, you can still
take corrective action in time and limit your
losses.
3. If you are in deep shit, communicate the same
properly and timeously to your shareholders so
that they are aware of the issue