Introduction
The Metallgesellschaft case became one of the first and now one of the most infamous
examples of derivatives malpractice, due to the fact that it lost a reported $1.3 billion
(Edwards, 1995) based on a hedging strategy which it developed. The strategy nearly
brought the conservative German blue chip firm to bankruptcy in 1993/1994 due to the
actions of its US subsidiary MG Refining and Marketing (MGRM). MGRM established a
strategic business goal of becoming a major trading and distribution business in the North
American energy market. Through its president Arthur Benson, MGRM believed that it
was uniquely positioned, due to its financial resources, to fill a gap in the market that
would provide independent retailers with long term insurance coverage against large price
fluctuations in gasoline and heating oil. It would do this by charging a fee of usually $3-5
per barrel of oil over the spot price on the day the contract was agreed (Edwards, 1995).
By the end of 1993 MGRM had committed to supplying 160million barrels of product
over the next 10 years to retailers. This was achieved by giving retailers the option of three
different contracts from which to choose from (Verleger, 1999)
I. “Firm Fixed” contract where the buyer had to take delivery of a specified volume of
product each month at a fixed price for a period ranging between 5-10years
II. “Firm Flexible” contract where the buyer had to take delivery of a volume of product
over a 10 year period with no specific volume at a certain time and could take up to 20%
of the volume in any given year.
III. “Guaranteed Margin” contracts guaranteed retailers a fixed profit margin.
These contracts were similar to what most other competitors offered at the time except for
3 distinct differences. Both contracts I and II (Verleger, 1999)
1) Imposed a 5-10 year obligation on MGRM where normally the contracts previously
offered would last a few months to a year at most.
2) Contracts offered no release if the government increased standards that increased the
cost of production
3) Customers on these contracts were given the option to terminate the contract at their
discretion, where they could “Cash Out” and receive a payment from MGRM if prices on
the NYMEX exceed a specified threshold.
Because of these contractual obligations and the long term nature of the contracts, MGRM
needed to engage in hedging activities. MGRM had to be prepared for customers
