Metallgesellschaft1
In late 1993 and early 1994, MG Corporation, the US subsidiary of Germany’s
14th largest industrial firm Metallgesellschaft A.G., reported staggering losses in energy
futures and swaps in excess of $900 million.
In Summer 1993, MG Refining and Marketing (MGRM) negotiated forwardsupply contracts that committed it to supplying approximately 160 million barrels of
gasoline and heating oil to end users over the following ten years at fixed prices which
were typically three to five dollars a barrel higher than the prevailing spot prices when
the contracts were negotiated.
By the fourth quarter of 1993, MGRM held long futures positions on the NYMEX
and swap positions totaling 160 million barrels, which were virtually identical to its
forward-supply commitments. Thus, MGRM hedged its forward-supply commitments
barrel for barrel (or with a hedge ratio equal to1).
MGRM.s derivatives positions were concentrated (or stacked) in short-dated
futures and swaps that had to be rolled forward continuously to maintain the position.
This stack and roll strategy can be profitable when markets are in backwardation, but will
result in losses when markets are in contango.
What went wrong?
MGRM’s problem surfaced in late 1993 when energy spot prices tumbled and the
energy futures markets went into contango price relationship for almost the entire year of
1993. As a result, it experienced large unrealized losses on its stacked long futures and
swap positions and incurred huge margin calls. Contango also caused it to incur
substantial costs each time it rolled its derivatives positions forward.
In December 1993, MG’s Supervisory Board fired MGRM’s management and
brought in new management, which quickly made the decision to liquidate the bulk of
MGRM’s derivatives and forward delivery positions.
What were the risks facing MGRM?
In hindsight, what could MGRM have done to alleviate these problems?
What kind of evidence would you need in order to determine whether the
predicament of MGRM was due to bad luck or bad strategy?
1
This example is condensed from Franklin Edwards and Michael Canter, 1995, “The
collapse of Metallgesellshaft: Unhedgeable risks, poor hedging strategy, or just bad luck?”
The Journal of Futures Markets, 15(3), 211-264.
1