METALLGESELLSCHAFT

Thank you and now I will continue with Metalgesellschaft case, later on I will abbreviate its name to MG

Before to move on, I would like to introduce some background info about this company

Establish 1881, MG was one of Germany's largest industrial conglomerates engaged in a wide range of
activities from mining and engineering to trading and financial services.

It all started in German. In 1993, the company released that there is a derivative related loss in its
petroleum subsidiary - Metallgesellschaft Refining and Marketing (MGRM) which is later called MGRM
for short. The losses were estimated to be over $1.5B and is considered as the largest derivative loss
ever at that time and brought MG to the blink of bankruptcy.. So what did happen to MG?

In the 1991, MGRM took a short position in a long-term forward contract to supply large quantities of
around 150M barrels oil products such as gasoline and fuel oil to many customers with a fixed price per
month up to 10 years. To prevent the increasing of oil price which causes losses on those forward
commitment, the company hedged its exposure by taking a long position in short-term NYMEX oil
futures. This is also known as stack-and-roll hedging strategy.

To describe this process in brief. Imaging, at the beginning of the month, the company entered into
short-term future contracts to purchase 150M barrels of oil and then after a short period of time – let’s
just say one month later and right before expiration, the MG the company closed those positions out
which is roll and then entered into a new stack. And in this way, the company keep doing that month to
month with this stack and roll.

Notice that if the oil prices or the oil spot prices are increasing gently then the short position is losing
money on the forwards, however they are hedged by the profit that are made on the long position in
the futures. So generally, this strategy is relied on the continuation of the backwardation in the future
markets where the future price is above the spot price. But what exactly happened to MGRM

-Falling

In the 1993 the oil prices dropped and the future market shifted from backwardation to the contango
where the forward price is greater than the spot price. And then these long position on the short-term
futures are being rolled over with losses. But the thing here is:

The gains from the short position on selling oil are realized over long-term but the losses on the hedge
would be realized immediately so it means only the losses was realized which resulted in the margin call.
The cost of rolling in the futures or the long position was about $88 million and in order to cover these
costs and maintain the cashflows MGRM had to obtain funding from its parent organization MG. Due to
lack of understanding and communication between injuries and parent. MG closed the position in the
attempt to diminish further losses. In December 1993, MGRM was forced to cashed out its position and
incurring a loss of over $1.5 billion.

This is all about the MG case which represents the loss from future contracts. Next one, my friend Duy
will continue with the case of options.