Simulating Supply
RISK 11, p.143-147, September 1998. Also in Corporate Hedging in Theory and Practice: A Metallgesellchaft Reader, C. Culp and M. Miller (Editors), RISK Books, London, England, 1999

Nicolas P.B. Bollen and Robert E. Whaley

ABSTRACT
Much has been written about Metalgesellschaft's program to guarantee long-term delivery of petroleum products af fixed prices and hedge using short-dated futures. Losses of over $1 billion at the end of 1993 resulted in a management restructuring, a reversal of all futures positions, and a vigorous debate over the merits of the program. Left out of the discussion is an analysis of the actual contracts sold by the company. In this paper, we use a detailed account of the contracts and historical price data to simulate the distribution of cash flows generated by the program if carried to completion. Our simulations indicate that while the program almost always delivers a positive terminal profit, there is a substantial probability that the project's cash balance will drop below -$1 billion prior to completion. These results indicate that the experience at Metallgesellschaft (1) did not constitute a failure of the program, and (2) could have been anticipated.