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David answered on
Dec 25 2021
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The Significance of Metallgesellschaft on Global Commodities Market
MettalgesellsChaft A.G (MG Corp) is a large conglomerate company that is having the
usiness related to engineering and variety of metal mining and has about fifteen subsidiaries
operating under them. They have a higher level of exposure to the global commodities market.
MG Corp had 49% stake in Castle Energy an oil exploration company in the US and had a
efiner that sold about 46 million
l of oil to MG Corp (Mello and Parsons, 1995, p. 106). MG
Corp is an active participant in the energy derivative trading. They made use of over the counter
forward contracts, options, swaps and future market for curtailing the commodity risk. They
were a large player in the global commodities market as they trade with a large amount of crude
oil, heating oil, and gasoline.
MG Refining and Marketing (MGRM) is effective in making use of various strategies to
gain more profitability. They have different strategies like “firm-fixed” program in which
MGRM will deliver the fixed quantity of oil, and the derivative contracts cover them for about
ten years (Mello and Parsons, 1995, p. 107). Next is the “firm-flexible” provides flexibility in the
delivery schedule, and the contracts cover them. MGRM always focuses on taking a long
position that will equalize the short-position to meet the supply requirement. They are trading
and supplying various energy products across the globe. They are an active participant in the
global commodities market, and hedging is one of their main business activities.
Difficulties in 1993
MGRM acts as a financial intermediary as the amount of supply obtained from the Castle
Energy was not sufficient to meet their growing demands. They offered various options to their
customers so that they will be in a position to
idge the gap between the demand and supply of
oil. They provided an option with long-term fixed price contracts to their customers that resulted
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only in one side protection and resulted in liquidity issue to the company (Mello and Parsons,
1995, p. 107). MGRM provided with an option of cash out options that the customers can buy
the oil by paying cash during the lower spot prices. All these strategies were made to get a better
competitiveness in the market. But there was a mismatch in the maturity of hedging contracts
that was creating more difficulties during 1993.
The firm fixed contract will result in the customer to receive 50% of the difference
etween the cu
ent future price and contract price multiplied by the remaining undelivered
quantity. Under the firm, flexible contract, it will be the difference between the second nearest
future price and contract price multiplied with the called deliveries. It enabled to manage the oil
price risk of the customers, but MGRM made use of the rolling stack strategy. According to this
strategy MGRM will take a long position in the stacked futures for the next month contract, and
every month there will be roll over the stack to the next month, and it downsizes the position.
The long position in the stack futures is expected to match with the short position
associated with the remaining due in the supply contract. These strategies did not work well for
MGRM, and it resulted in 55 million
l in the long position for the company in the futures
market, and a short dated swap contract over the counter stood at 154 million ba
els. The
hedging strategy of the company was poorly structured and planned as their maturity did not
match with each other. A hedging can be effective only if their position regarding value and
terms of maturity match with each other. Any mismatch in these factors will cause more risk to
the business.
It will create more liquidity crunch and causes significant volatility in the cash flow of
the company. Profit or losses arising due to the contract should be settled during the month while
the compensating profit or loss from the delivery can be recognized slowly creating more
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mismatch in the cash flow. When there was a decrease in the oil price by $0.71
l, it caused a
ealized loss of $139million while increase resulted only in $900,000. It resulted in cash deficit
of $1.17 billion during 1993 (Mello and Parsons, 1995, p. 108).
The cash flow deficit was DM 5.65 billion that was met using DM 4.4 billion and equity
issue of DM 1.21 billion. During 1993, the MG Corp was forced to sell their assets to continue
their core business activities and resulted in more layoff (Mello and Parsons, 1995, p. 109). Oil
trading of MGRM was the main reason for more trouble to the company. Short-dated futures are
another important factor that increased the overall risk and resulted in huge short-term cash
deficit. It resulted in future market losses at $1.3 billion and eventually required a negotiation
with the Bankers for $1.9 billion as their bailout. The combination of futures-long term contract
position caused more losses during 1993 due to the fall in oil price (Pi
ong, 1997, p. 544).
Metallgesellschaft Behavior Analysis
There was no prudent behavior of Metallgesellschaft in managing the risk associated with
the fluctuation in the oil price and in addressing the issues related to the cash flow deficit. The
hedge ratio was expected to be one, but it was lesser than one indicating about the poor hedging
strategy of the company. The main purpose of making use of hedging is to mitigate the risk and
to provide protection against losses, but in this case, the company faced huge loss and faced
liquidity issues due to the hedging strategies used by them. Mismatch in the maturity period will
esult in basis risks.
Basis risk arises when there is a mismatch in the hedging position and underlying asset
position. In case of oil trading basis, risks...