In the case of Metall Gesellschaft AG, the MRGM net exposure was short oil which was hedged using long futures, gasoline and OTC swap in oil. Since future oil market occupies the largest part of the world market, the potential to hedge long-term oil exposure in the absence of a substantial premium payment to other firms is very low. Thus, the attempt to match its clients’ contracts in time with OTC agreements would have likely reduced the MGRM’s profit margin. As a result, it used three short futures months and their swaps to hedge a long-term pricing agreement. The stack and roll strategy requires that the stack of future positions introduced to be continually rolled over from one future to another as the time elapses.
If a firm can provide its customer an innovative pricing agreement, it can be a legitimate model which can increase profits. Though, the practice of hedging long-dated oil pricing contracts is not easy as it presents MGRM with various risks. Rollover risk represents gain or loss which may occur when rolling futures contracts. In this case, since there is no level of certainty of future prices for storable commodities of several months as it can differ greatly. Funding risk includes the possibility of unrealized losses since MGRM was a long term future contracts and oil prices fell. Thus, the long-term pricing agreement did not offset funds of the oil. Credit risk occurred where the customers’ defaults on agreements due to reduced oil prices.
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Maintaining the hedge ratio to be 1:1 seemed to be a prudent approach considering the possibility of funding constraints. Additionally, spot prices are considered to be more volatile than long-term contracts. The net position losses within the contract do not show that the hedge was poorly performed a risk may result in the high volatility of the net hedge profit and loss.
