The collapse of Metallgesellschaft

Résumé du document

Metallgesellschaft AG, or MG, is a German conglomerate, owned largely by Deutsche Bank AG and the Dresdner Bank AG. In 1993, it was revealed publicly that the "Energy Group" was responsible for losses of approximately $1.9 billion.

MG Refining and Marketing or MGRM, the MG's trading subsidiary, committed to sell, at price fixed, certain amounts of petroleum every month for up to 10 years. These forward-supply contracts, representing an amount of 160 million barrels, initially proved to be very successful as it guaranteed a price over the current spot price, $4 higher than the current spot price in average.

The originality with these forward contracts was that these contracts contained an option clause which enabled the counter parties to terminate the contract early. Forward-supply contracts were negotiated in the summer 1993 when energy prices were low and falling. Energy end users saw an attractive way to lock in low energy prices for the future while MGRM saw an attractive opportunity to develop long-term profitable customer relationships that would help its long-term strategy of developing a fully-integrated oil business in the United States.

MGRM hedged this price risk with short-dated futures and OTC energy swap. It was long in the futures contracts and entered in OTC energy swap agreement to receive floating and pay fixed energy prices. MGRM bought futures for 55 million barrels and had swap position of 105 million barrels. If this hedge was successful, MGRM, by locking in a mark up of $4 per barrel on its forward-supply contracts, would have earned profits of $640 million.

Extraits

[...] Ten years can be considered as a good sample of data but when we talk about market fluctuation, the most data you have, the better. A period of ten years may not be long enough to infer long-term rollover success. Indeed, it was shown that there is past experience of shift from backwardation to contango after a long period of this first. Another point, linked to the previous one, is the use of a one to one hedge ratio. Relying on a continuous backwardation period, MGRM used this ratio strategy to protect itself and lock-in its profit margin. [...]

[...] Were there other possibilities available for MGRM? Minimum-variance hedge would have reduced funding risk but would have exposed MGRM to the risk to adjust dynamically its hedge. More, MGRM could have used same maturities for its forward and futures positions. The problem this time was the illiquid market for long-term energy futures. Finally, physical storage was one the others possibilities but was abandoned as the cost of this strategy was too high. But the main problem in MGRM was the decision by the Supervisory Board to liquidate all the entire derivative position in early 1994. [...]

[...] The maturities of the futures didn't exceed few month, and the roll over certainly occurred monthly. Moreover to maintain its one-to-one hedge, MGRM had to reduce each month its derivative position in the same value than the number of forward contracts ended. The stack and roll strategy was profitable during the backwardation period but not during a contango period. The roll over success was studied and predicted by MGRM based on data from the past 10 years. MGRM concluded that there were large chance of success and so MGRM expected gains by rolling its short-dated derivative position. [...]

[...] The collapse of Metallgesellschaft Description of the Metallgesellschaft business and its hedging operation Metallgesellschaft AG, or MG, is a German conglomerate, owned largely by Deutsche Bank AG and the Dresdner Bank AG. In 1993, it was revealed publicly that the "Energy Group" was responsible for losses of approximately $ 1.9 billion. MG Refining and Marketing or MGRM, the MG's trading subsidiary, committed to sell, at price fixed, certain amounts of petroleum every month for up to 10 years. These forwardsupply contracts, representing an amount of 160 million barrels, initially proved to be very successful as it guaranteed a price over the current spot price, higher than the current spot price in average. [...]

[...] Was the Board able enough to assess correctly the risks taking by MGRM in this program? The Supervisory Board has pleaded ignorance in the massive build-up of MGRM's forward and hedge positions. If they truly were ignorant, they weren't doing their job. If they knew of the positions and didn't understand them, they weren't doing their job. If they knew of the positions and understood them, they had confidence in the strategy and took a calculated risk. Wherever the truth lies, MGRM's Supervisory Board has to be blame for this situation. [...]