Abstract
Metallgesellschaft AG, or MG, is a German conglomerate, owned largely by Deutsche Bank AG and the Dresdner Bank AG. In 1993, it was revealed publicly that the "Energy Group" was responsible for losses of approximately $1.9 billion.
MG Refining and Marketing or MGRM, the MG's trading subsidiary, committed to sell, at price fixed, certain amounts of petroleum every month for up to 10 years. These forward-supply contracts, representing an amount of 160 million barrels, initially proved to be very successful as it guaranteed a price over the current spot price, $4 higher than the current spot price in average.
The originality with these forward contracts was that these contracts contained an option clause which enabled the counter parties to terminate the contract early. Forward-supply contracts were negotiated in the summer 1993 when energy prices were low and falling. Energy end users saw an attractive way to lock in low energy prices for the future while MGRM saw an attractive opportunity to develop long-term profitable customer relationships that would help its long-term strategy of developing a fully-integrated oil business in the United States.
MGRM hedged this price risk with short-dated futures and OTC energy swap. It was long in the futures contracts and entered in OTC energy swap agreement to receive floating and pay fixed energy prices. MGRM bought futures for 55 million barrels and had swap position of 105 million barrels. If this hedge was successful, MGRM, by locking in a mark up of $4 per barrel on its forward-supply contracts, would have earned profits of $640 million.
