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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

Metallgesellschaft Refining & Marketing (MGRM) sold long-dated fixed-price fuel supply contracts and hedged them mainly with short-dated energy futures that were rolled forward. Which feature of this strategy most directly created the funding liquidity strain when oil prices fell sharply?

The key issue was a timing mismatch: futures losses had to be paid in cash immediately through margin calls when oil prices fell, whereas the economic gains on the long-dated fixed-price contracts would arrive only over many years, creating a severe funding liquidity strain.

  1. AFutures losses required immediate variation margin cash payments, while the offsetting gains on the fixed-price supply contracts were realised only over many yearsCorrect
  2. BThe company was unable to find counterparties willing to buy its long-dated supply contracts
  3. CExchange regulators raised initial margin to prohibit the company from rolling its futures
  4. DThe futures hedge was too small, so the company was exposed to rising oil prices

Explanation

MGRM was long short-dated futures as a hedge for short fixed-price commitments. When prices fell, daily margining forced large cash outflows, but the gains on the forward sales contracts were unrealised and spread over up to ten years. The problem was a cash-flow timing mismatch, not a lack of hedge size or direction.

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