Long-run Risks Concerning the Oil Price Cannot Be Fully Controlled

Since the oil price is lower than it has been in a long time, many a company comes up with the idea to secure a favourable purchase price for oil for themselves on the long run by buying forward. However, there has to be someone willing to offer such forward contracts in exchange for premiums. Taking advantage of such a market gap can be both profitable but also extremely loss-making. In a current study, the Mannheim-based Centre for European Economic Research (ZEW) investigates the risk of such forward transactions. The controversial aspect of this topic becomes clearly illustrated by the example of the Metallgesellschaft, which entered into long-term delivery commitments at fixed prices at the beginning of the 90s. The company had tried to secure its forward contracts through hedging strategies, and had to face losses of 1.3 billion dollars in the end.

At that time, the case of Metallgesellschaft sparked a heated controversy among economists. For instance, the American Nobel Prize winner Merton Miller considered the idea of Metallgesellschaft as basically sound and believed that there would have been no losses if they had stuck to their strategy. However, the ZEW study clearly illustrates that the strategy of Metallgesellschaft was extremely risky and must be classified as speculative. None of the alternative options for obtaining long-run guarantees against oil price risks were fully convincing, either. According to the ZEW study, long-run risks concerning the oil price can still not be fully controlled by means of hedging instruments.

Contact

Katrin Voss, E-mail: voss@zew.de