Metallgesellschaft

Overall Strategy  MGRM (MG refining and marketing) is US subsidiary of MG.

 Strategy: fully integrate oil business in the US and develop long term customer relationships.

 Approach: Use forward delivery contracts (160 million barrels over ten years). Acquired Castle energy in 1989.

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P FIX Forward Delivery Contract Gain for Client N. Takezawa (ICU) Spring 2001 Gain for MG Spot price Time 3

Conditions for terminating contract  NYMEX futures price > fixed price  MG pays 50% of price difference  NYMEX futures price > exit price  In both cases, situation where the client is in the money.

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Terminate Contract Futures P FIX 1992 10 years N. Takezawa (ICU) Spring 2001 2002 Time 5

Gain/Loss Hedging forward delivery contract positions Long futures P FIX Spot price N. Takezawa (ICU) Spring 2001 MG position 6

Hedge with Futures  Regular unleaded gasoline  NY harbor no. 2 heavy oil  West Texas Intermediate Grade Light  Sweet Crude Oil on NYMEX N. Takezawa (ICU) Spring 2001 7

Futures hedge  Short-dated futures  Use roll-over hedge N. Takezawa (ICU) Spring 2001 8

Why short dated futures?

 Cost relative to physical storage?

 Liquidity relative to long dated market?

 Short dated, however, requires roll-over strategy in this scenario.

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Price Backwardation: spot (nearby futures price) greater than deferred futures price) For example, it is the end of November Sell Buy Rolling Over Hedge Spot Near (Dec.) Deferred (March) N. Takezawa (ICU) Spring 2001 Maturity 10

price backwardation contango 92 6/93 9/93 12/93 maturity backwardation 92 6/93 $19/barrel spot 9/93 12/93 $15/barrel spot N. Takezawa (ICU) Spring 2001 10/94 11

Losses Hedging Scheme  Total 1.3 billion dollars  Loss of 20-30 million dollars/month on the roll over hedge due to contango curve  Main lenders: 1.9-2.1 billion dollar rescue plan N. Takezawa (ICU) Spring 2001 12

Was the Hedging Scheme Flawed?

 Let us assume the delivery contracts were a good marketing strategy.

 Hedge Ratio: one to one vs optimal (minimum variance, max. expected utility). Tailing the hedge.

 Large positions on the NYMEX  Backwardation vs Contango: contango is unusual but not without precedent. Prepared for worst case scenario? Value at risk N. Takezawa (ICU) Spring 2001 13

MG Supervisory Board: 1) liquidated derivative position 2) liquidated forward contract positions.

Right Decision?

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