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Experts are still divided over what went wrong in the case of Metallgesellschaft, one of Germany‟s
largest industrial concerns. This much is certain: In 1993, Metallgesellschaft had assets of $10 billion,
sales exceeding $16 billion, and equity capital of $50 million. By the end of the year, this industrial
giant was nearly bankrupt, having lost $1.3 billion in oil futures.
What makes the Metallgesellschaft case so intriguing is that the company seemed to be using
derivatives for all the right reasons. An American subsidiary of Metallgesellschaft, MG Refining and
Marketing (MGRM), had embarked on an ingenious marketing plan. The subsidiary was in the
business of selling gasoline and heating oil to distributors and retailers. To promote sales, the
company offered contracts that would lock in prices for a period of 10 years. A variety of different
contract types was offered, and the contracts had various provisions, deferments, and contingencies
built in, but the important feature was a long-term price cap. The contracts were essentially forwards.
The forward contracts were very popular, and MGRM was quite successful at selling them.
MGRM understood that the forward contracts subjected the company to oil price risk. MGRM now
had a short position in oil. If oil prices rose, the company would experience losses, as it would have to
buy oil at higher prices and sell it at the lower contracted prices to the customers. To offset this risk,
MGRM went long in exchange-traded oil futures. The long position in futures should have hedged the
short position in forwards. Unfortunately, things did not work out so nicely.
Oil prices fell in 1993. As oil prices fell, Metallgesellschaft lost money on its long futures, and had
to make cash payments as the futures were marked to market. The forwards, however, provided little
immediate cash, and their appreciation in value would not be fully realized until they matured in 10
years. Thus, Metallgesellschaft was caught in a cash crunch. Some economists argue that if
Metallgesellschaft had held on to its positions and continued to make margin payments the strategy
would have worked eventually. But time ran out. The parent company took control over the subsidiary
and liquidated its positions, thereby realizing a loss of $1.3 billion.
Other economists argue that Metallgesellschaft was not an innocent victim of unforeseeable
circumstances. They argue that MGRM had designed the entire marketing and hedging strategy just so
it could profit by speculating that historical patterns in oil prices would persist. Traditionally, oil
futures prices are lower than spot prices, so the general trend in oil futures prices is upward as the
contracts near expiration. MGRM‟s hedging plan was to repeatedly buy short-term oil futures, holding
them until just before expiration, at which point they would roll over into new short-term futures. If
the historical pattern had repeated itself, MGRM would have profited many times from the rollover
strategy. It has been alleged that the futures was the planned source of profits, while the forward
contracts with customers was the hedge against oil prices dropping.
Regardless of MGRM management‟s intent, the case teaches at least two lessons. First, it is
important to consider cash flow and timing when constructing a hedge position. Second, when a hedge
is working effectively, it will appear to be losing money when the position it is designed to offset is
showing profits. Accounting for hedges should not be independent of the position being hedged.
Askin Capital Management