Metallgesellschaft Ag

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Case Study #1
Metallgesellschaft AG

Metallgesellschaft Refining and Marketing (MGRM), was a subsidiary of Metallgesellschaft AG in Germany. In the early 90’s, MGRM chose to being selling long term (5 and 10 year) fixed price contracts for gasoline, heating oil, and diesel fuel. These contracts were successfully marketed with MGRM contracted for 160 million barrels of oil as of Nov 1993. Due to the fact that the MGRM entered into long term commitments for fuel delivery with fixed pricing, this put MGRM as increased spot risk. For example, if fuel prices rise, the profit margin for MGRM could decrease or could turn into a loss position. As such, MGRM chose to hedge this exposure by using offsetting long positions with gasoline, heating oil, and crude oil futures on NYMEX. It’s important to note that the magnitude and complexity of contracts for MGRM made it difficult to hedge this position. One of the complicating factors for MGRM was that although these contracts had the same term, the details of delivery varied per contract. Some contracts stated monthly, and others stated longer term delivery. MGRM was also only able to hedge 55 million of the 160 million barrels through long futures on NYMEX. The remaining 105 million barrels were hedged using bilateral swaps. Due to the aforementioned issues, MGRM entered into a “stack and roll” strategy. In this case, MGRM would enter into short term (1 month) long positions for the entire exposure. At the end of each month, MGRM would swap out the 1 month position for another 1 month long position for the remaining exposure. This sounds like a reasonable hedging strategy. In this case, any changes in the value of the contracts would be offset by the hedge. However, there are additional risks to be considered before entering into a hedging program of this size. First, each futures contract would require an outflow based on the current oil price. If oil prices fall, then MGRM would be required to pay a large cash outflow...
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