Risk Management
The Case of Metallgesellschaft AG
Background
Metallgesellschaft AG was formerly one of the largest industrial conglomerates engaged in a wide range of activities in German. The firm had over 250 subsidiaries specializing in mining, commodity trading, engineering and financial services. In December 1993, Metallgesellschaft Refining and Marketing (MGRM), the U.S. oil marketing subsidiary of Metallgesellschaft AG, reported a huge financial derivatives-related loss of over $1.5 billion (Kuprianov, 1995).
At beginning of 1992, MGRM engaged in selling 5-year and 10-year fixed-price oil supply contracts to a number of customers. Unlike the traditional forward contacts, the firm provided customers the option that allowed customers to call for cash settlement on the full volume of outstanding deliveries if market prices for oil rose above the contracted price. More specifically, the option clauses entailed that if the front-month New York Mercantile Exchange (NYMEX) futures price exceeded the forward price, the counterparties could receive one-half of the difference between the futures price and the fixed forward price times the total volume to be delivered by the contracts. Under this condition, a large number of customers, investors and speculators who no longer in need for oil was attracted and the contacts were marketed aggressively. At November 1993, MGRM had built up long-term supply commitments of over 150 million barrels (Sundaram & Das, 2011).
“Stack-and-roll” strategy
There is no doubt that the market risk had involved under this circumstance. On one hand, if the market prices of the oil kept falling or did not rise substantially at that time, the firm could obtain the huge profits. On the other hand, MGRM’s fixed price forward delivery contracts exposed it to the risk of rising energy prices. Therefore, instead of traditional hedging strategies, the company hedged its market exposure using exchange-traded NYMEX futures contracts through
Background
Metallgesellschaft AG was formerly one of the largest industrial conglomerates engaged in a wide range of activities in German. The firm had over 250 subsidiaries specializing in mining, commodity trading, engineering and financial services. In December 1993, Metallgesellschaft Refining and Marketing (MGRM), the U.S. oil marketing subsidiary of Metallgesellschaft AG, reported a huge financial derivatives-related loss of over $1.5 billion (Kuprianov, 1995).
At beginning of 1992, MGRM engaged in selling 5-year and 10-year fixed-price oil supply contracts to a number of customers. Unlike the traditional forward contacts, the firm provided customers the option that allowed customers to call for cash settlement on the full volume of outstanding deliveries if market prices for oil rose above the contracted price. More specifically, the option clauses entailed that if the front-month New York Mercantile Exchange (NYMEX) futures price exceeded the forward price, the counterparties could receive one-half of the difference between the futures price and the fixed forward price times the total volume to be delivered by the contracts. Under this condition, a large number of customers, investors and speculators who no longer in need for oil was attracted and the contacts were marketed aggressively. At November 1993, MGRM had built up long-term supply commitments of over 150 million barrels (Sundaram & Das, 2011).
“Stack-and-roll” strategy
There is no doubt that the market risk had involved under this circumstance. On one hand, if the market prices of the oil kept falling or did not rise substantially at that time, the firm could obtain the huge profits. On the other hand, MGRM’s fixed price forward delivery contracts exposed it to the risk of rising energy prices. Therefore, instead of traditional hedging strategies, the company hedged its market exposure using exchange-traded NYMEX futures contracts through