EBF 301
Global Finance for the Earth, Energy, and Materials Industries

Case Study 3: Metallgesellschaft (MG)

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MG was a huge, German industrial conglomerate that decided to open an energy trading office in the US in the early 90s.

The original plan was threefold:

  • Sell refined products in the forward, physical market.
  • Invest in refining capacity to produce the products.
  • Hedge the forward sales through financial derivatives.

When the strategy was first implemented in 1992, current physical prices were lower than the futures prices. So the sales contracts were set at those higher future prices. And it meant that purchasing the "near" month futures contracts would be profitable. So MG developed a strategy whereby they would cover the long-term, fixed-price sales by buying contracts in these few, near months. As each month "rolled-off," they would merely buy contracts in the next month. It was their intent to continue this process until the physical product sales contracts expired in (10) years. This strategy worked as long as the futures market was "backwardated," whereby each successive month is lower than the prior one (Lesson 3).

One of the major flaws in this approach, however, was the volume of contracts being traded since they were "loading-up" on closer month contracts. Add to that the fact that they would not get paid for the product sales for years out, and you begin to have a cash flow problem where margin calls are concerned. Their position in the Fall of 1993 was estimated to be between 160 to 180 million barrels stretched-out over the following (10) years.

In 1993, prices fell as the market received a "bearish" signal from OPEC on production quotas. This lowered futures prices and reversed the market from "backwardated" to "contango," whereby each successive month's price is higher than the prior one (Lesson 3). Faced with this position, MG management was changed and the new team was directed to close all positions. This resulted in losses on the futures purchases totalling almost ($1.5) billion USD. The had to seek bailout funds from one of their banks, and in return, had to sell-off several divisions.Today, the German industrial giant no longer exists having been bought-out by a competitor.