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Metallgesellschaft: Hedging Gone Awry

Metallgesellschaft was a German oil company that sold long-term fixed-price supply contracts to customers. To hedge against risk from fluctuating oil prices, it took long positions in short-term futures contracts. However, when oil prices crashed, Metallgesellschaft faced billions in margin calls due to the strategy. Realizing gains from the contracts was long-term but losses from the hedges were immediate, creating a cash flow problem and funding crisis for the company.

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Suvendu Bishoyi
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128 views5 pages

Metallgesellschaft: Hedging Gone Awry

Metallgesellschaft was a German oil company that sold long-term fixed-price supply contracts to customers. To hedge against risk from fluctuating oil prices, it took long positions in short-term futures contracts. However, when oil prices crashed, Metallgesellschaft faced billions in margin calls due to the strategy. Realizing gains from the contracts was long-term but losses from the hedges were immediate, creating a cash flow problem and funding crisis for the company.

Uploaded by

Suvendu Bishoyi
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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METALLGESELLSCHAFT :

HEDGING GONE AWRY


OVERVIEW OF THE CASE ……

 Metallgesellschaft was a German based oil Refining &


Marketing Company.

 MG sold 5-year and 10-year fixed-price oil supply contracts


to customers at 6to 8 cents above market prices.

 MG then purchased short-term energy futures to hedge the


long-term commitments – a "stack" hedging strategy

 It hedged its exposure with long positions in short dated


futures contract that were rolling forward .
 As the oil prices crashed, leading to billion dollars of margin
call to be met in cash. The Company was faced with
temporary funds crunch.
 The member of MG who devised the strategy argued that:
 if oil prices dropped, the hedge would lose money while the
fixed-rate position increases in value;
 if oil prices rose, the hedge gains would offset the losses on
the fixed-rate position.
 MG management and bankers , disagreeing with the
strategy, decided to close out the positions to curtail
further losses. Thus, the company cashed in its positions
at a loss totaling over $1.33 billion.
WHAT WENT WRONG ?
 The problem is that when oil prices drop, the gains from
the sale of the oil are realized over the long-term, but the
losses on the hedges will be realized immediately as
margin calls come in. This creates a negative cash flow,
leading to a funding crisis .

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