The History of a Scandal: Metallgesellschaft Revisited with Kevin O’Reilly

[Music] Welcome to the HC Insider Podcast, a podcast dedicated to the commodities sector and the people within. I'm your host Paul Chapman. [Music] Today we're talking Metallgazell Shaft. During 1993, their US affiliate Metallgazell Shaft refining and marketing MGRM lost $1.3 billion in energy derivatives. It ultimately led to the demise of this huge German conglomerate. The events in 1993 press R2 things. Firstly, the scale of losses that can happen in commodities and have in the subsequent 30 years. And also the challenges of getting risk management right. Much ink has been spilled by academics and business school students on what happened. Today we're going to have a look at the case again and this time bringing in some new information from contacts within the commodities world who are there at the time. And also the learning that's happened in the commodities trading world over the past 30 years some things become a bit more obvious. Our guest is Kevin O'Reilly. Kevin has had a 30-year career in investment banking, sat across various functions, from sales to trading to risk management. It works as an independent consultant advising on just these kind of risks that organizations face as they look to manage their commodities exposure and profit from them. As always, you can help support the show by leaving a positive review on the platform you're listening on. And I hope you enjoy this episode. Kevin, welcome back to the show. Good to be back Paul, thanks for having me back. So I'm really excited to have this discussion. First off, we obviously were on the show last year in one of our more popular episodes talking about the the history and future of investment banks in the commodity space. Still very much a current discussion today. And I think one that we can probably update in a few months as well. And I know you've also been looking into the history of commodities and some other things as well, which hopefully we'll hear more about in the future. But we've been wanting to do this episode for a while. Looking into Mattel Gazelle-Shaft, a henceforth known as MG, which in 1993, so this is a 30th-year anniversary of it, suffered a near $2 billion loss at the time through derivatives in commodities. And much of this event press some of the future challenges. And I think is a fascinating case study of all the challenges and the opportunities prevalent in the market. It's also fair to say that this is a story that has been picked over by academics in that intervening 30 years. And actually, we can't find in our research for it, Kevin, kind of the commodities professional analysis of what happened, or at least not publicly. And we should have a word on sources and methods here. So we've obviously done a lot of research into this on what's available through the various academic case studies and court filings and so on. We've also reached into our network and had a number of discussions with individuals, some of whom were actually there at the time and were very close to the aftermath. Henceforth, known as our various deep throats and so on, and it'll become apparent why there's still sensitivity around this topic and still people not wanting to necessarily come on the record. So hopefully we're going to bring some new learning to the case and some new insight. But I think at the end, this always comes down to a question of intent. And that's the hardest thing to establish. But it's going to be quite a journey. It's a journey that we've been on. It's kind of peeling back the onion. And in this case, it seems to me that the more you discover, some of the less you understand about some of the what happened. But let's start at the start. That's a very long introduction. Mattel Gazelle Shaft in the 1980s, late 1980s, is a huge German glomerate, some 40,000 employees mainly focused in the mining and smelting of non-ferrous metals. So can you just, let's talk about the company first. So, you know, over to you, Kevin. Thank you, Paul. Mattel Gazelle Shaft was one of Germany's largest industrial companies or components, so more than a company. Based in Frankfurt, it was founded in the late 1800s as he rightly pointed out. A metal strainer and eventually, a ventral chemical supplier. And by the 1990s, it had grown into an enormous company operating in over 250 foreign offices. Like all, or like many German companies of the time, it wanted to grow and grow and grow. And the late 80s obviously, for those of us who were either in business or teams, and we're old enough to remember, was very much a commercially-led time for people. And West Germany, as it was, then was obviously the industrial engine of Europe and quite possibly the world. So, MG had a lot going on. And, you know, like all companies, they certainly didn't rest on what they were doing. In 1989, MG appointed a new CEO, an Austrian-born gentleman, Heinz Schumlerbüsch, as their new CEO. He and his management team very quickly got about developing even more aggressive business strategies to basically grow the bottom line and some diversification. Before his appointment, MG Lodge had already decided to develop a fully integrated US oil business. You know, that when we talk full integration, it's obviously exploration, extraction, refining storage and transportation, or, you know, various parts of that and various levels of commitment. This sort of reached a peak in 1989 when it purchased a 49% stake in a company called Castle Energy, which was a US oil and gas exploration company that eventually developed into an oil refiner as well. MG signed, as well as buying 49% of the company, they signed a 10-year contract to purchase Castle Energy's off-take, their production guarantee. It's refining margins. And this is pretty much where our story starts. That's where the story starts. There's one more bit of, I wouldn't put a bit of context into this as well, right? So, so, you're, we're in 1989, there, what they're about, say, have acquired this 49% stake in Castle Oil. A couple of things are pushing this at the macro level, right? Firstly, you've got the fall of the Soviet Union and the problem that MG face that Heinz Schimmelbush has inherited to some extent is that suddenly the market is getting flooded with low-cost metals from the former Soviet Union or the collapsing Soviet Union as was. So, that's pushing them to open up these other revenue lines. At the same time, you've got the opening up to derivatives, you know, of the commodities market, particularly oil markets. We've covered, we've covered in in our first episode together, right, around this time. Can you just give us a, there's a market backdrop to this as well. So, you've kind of got this 19th of 88 to 1990. You've got quite a run-up in oil prices, tied to kind of a lot of things going all the time. Can you just give us that sort of context of the oil market at that? The Soviet Union hadn't quite collapsed in 89, but it was certainly on its last legs. The Burlim Wall actually did come down towards the end of 89. You know, a lot of things are going on and interestingly enough with MG, a lot of people forget is MG had invested staggering amounts of money even today in greener technologies. So, they were actually a big leader in trying to make their metals businesses and their other businesses and indeed, as a corporate business line, more environmentally friendly. On top of it, as you rightly point out, there had been excess metal and oiling, but the trade market moves in such, so they were sort of hemorrhaging money and such the sort of the need to diversify further and engage in new strategies so on to a better word really led them to very aggressively push along these, this new business line. So, you've got rising oil prices, you've got this sort of the end, as you say, albeit 1989, it wasn't the end, but certainly had other former Soviet block countries breaking away and those then competing with Western Europe, you've got rising oil prices as well over the concern of the Gulf War. So, let's just put a pin in that because all of this ties together, I promise. So, in 1991, they've created this MG refining and marketing, so that's just called it MG RM going forwards, which is this entity in the US to essentially handle the offtake from Castle Oil and then build business lines. And they hire this chap who's key to this story, Arthur Benson. And Arthur was an oil trader from Louis Dreyfus Energy who'd had some great success and we're going to comment on this in jet fuel and had a better benefited from the Gulf War in that bet. Talked to that a little bit. Looking in a nutshell, we'd had price rises in the 80s. The price fell from sort of $35 a barrel in the mid decade towards the low teens towards that decade. The Gulf War, or Gulf War I, for those of us who are old enough to remember, obviously involved two opaque nations and caused tremendous angst and concern in the oil market. This obviously led to prices rising, fears over shortages and backwardation in the oil futures market. One thing we should remember is that oil futures market hadn't actually been around that long. The TI contract was listed in '83, the gasoline contract towards the end of '84, Brent '88. There had been a heating oil contract in existence since the late '70s. Fundamentally, there wasn't a huge amount of data to determine term structure and whether the monthly rolls were in contango or backwardation. I would assume most people listening to the podcast understand those terms, but if anybody doesn't contango is the name we give to market structure, when the forward prices are higher than the spot prices, or the further out futures prices are higher than the prompt futures prices. Backwardation is the situation where the different futures prices are lower than the prompt futures prices. If your long oil and you want to roll your position, backwardation enables you to roll your long position into a lower price. So, backwardation is the friend of the long and the enemy of the short position. Arthur Benson was a trade-ret-moody driver's energy. He had been trading jet fuel and in the wrong it was a goal for jet prices had started to rally considerably. On top of that, concerns about shortages had led to backwardation appearing in the term structure of the jet market. Prior to set out his hands in the invasion of Kuwait, my understanding and I didn't speak to Arthur personally was that he hadn't had a particularly great runner, was sort of indifferent or really hadn't got me to position. He hadn't got big profits to show for his time in the market at LDE. The goal for change is that if you talk to many of the physical oil traders at the time, most of them will tell you a story about George Bush 41 addressing everybody when the fireworks started and using the term regrettably. As he said, the deadline had expired and various traders around the world who were very smart. But what physical cargo is waterborne cargo is a Morgan Stanley guy famously hooked up satellite TV on Rufus. Their offices in London and so they had that live link and were able to act accordingly. And the price rally and the ensuing backwardation gave Arthur tremendous profits. And so when Mattel Gzelschhaft hired him to run NGRM, he was coming off the back of a big win and he was a big believer in backwardation. Big believer in backwardation and as far as we can tell, Arthur took quite a team with him to NGRM and pertinent to our discussion later on including some family members. So he comes over and again we haven't spoken to Arthur but NGRM come up with this plan. The leadership of NGRM which includes a couple of other people. Come up with this plan to create this, they're basically their big sell, right? Which is, and this is where it gets a little bit tricky but essentially the story that you're going to read if you go and Google Columbia business case on this or whichever one it is is going to be and we'll try and keep it relatively simple. Because there was actually I've discovered since some other products out there but this is the one you read about which is they say okay we're going to create at the time you've got the oil majors coming into the market really competing with the independent oil retailers, the independence and you know it's a tough time it's a time of low margin it's a time of lots of volatility and challenges for these independent oil retailers. And NGRM come along and this is completely unique completely disruptive there's nothing else out there like this product they come along and say look we'll sell you oil whatever product it might be but gasoline let's say there's some others as well there but for the next 10 years at a fixed rate. And in this contract you can also and this is going to again be important for the story you can also exercise an option to get out of it if the current spot price is higher than the price at which we've agreed to sell you oil for the next 10 years so fixed rate sales contract over 10 years naturally this product just absolutely takes off. It's a phenomenal product for these independent oil oil retailers or oil businesses who are struggling with we're trying to get supply so the physical side they've a should supply and they're also getting you know this long term hedge so suddenly MGRM I think the numbers we can find is at some point they've got a 160 million barrels worth of sales which at the time you know is an incredible amount so. Cretney of our wrong any what I've just said and then of course this gives them a massive position that they then have to hedge. Yes as you rightly point out they had quite uniquely gone to a lot of independent retailers and said we'll sell you gasoline and heating up on a term basis a good prices as we said prices had dropped to the low 20s or we'll leave lower. And a lot of these retailers couldn't before then hedge and were obviously squeezed relative to the bigger guys who had integrated businesses that could sort of inherently you know manage the the ebb and flow of the of the business and the margin cycle so MGRM as well as having this this agreement with car so I'm due to to off take 10 years worth products sort of mimic that more broadly across the US. And it wasn't actually just small retailers if you look at the bankruptcy filing you see big American corporate names there such as Chrysler energy and a few others excuse me not Chrysler energy Chrysler the car company. So as such they've they've created a a rateable 10 years short this option that they they granted for one for the better word was sort of unique they tried to be clever by saying listen you can cash out of your. Differ position if it goes in the money and will split the profit but they had created an option product where the the strike was the deferred contract they agreed but the the underlying process that determined if it was in our money was the prompt future which is not what typically happens in a you know regular American or European option and as such if if those people are quite minded that would be very very difficult to model. Because the prompt future constantly changes actual identity discussions on and so forth one of the quirks of it was that the payout could occur even if their deferred purchase was out of the money but the term structure was such that the the the prompt contract was significantly above the deferred contract so that that first of all didn't make a great lot of sense. Secondly intuitively seem quite difficult to price and third from hedging perspective certainly plays a part in in what happens and the ultimate risk management night may they walk into. Yeah and and it's kind of this and we're starting to get towards this this idea of intent but effectively and it's important to note as well this was for physical delivery all over the country as well and even if everything had gone right. That seems like that wasn't really taken into account either the basis risk in this contract as well but nonetheless it's incredibly popular and MGRM end up with a sizable substantial physical position in the US market then so okay so then we have this okay how are they going to hedge it and there's no perfect hedge for these contracts right that's just you know other than sticking it in a you know buying the physical sticking in a tank you know ideally having zero cost to carry and then you know zero cost of transport and then delivering what is ready but but they've done it because they because Arthur and team believe in that the and learn prices and now they've got a hedge it hedge they choose is a one to one which is important for later on but stack and roll so can you tell us very basically very quickly what what is a stack and roll in this context of the before I get to that we should just go into the sort of a bit more into the contract situation first of all my understanding was that MG thought the oil price would would continue to fall originally and so in the early 90s when this product was offered they wanted to create some short positions. Secondly, they were earning very significant margins relative to where say the implicit true for want to the better word futures price of oil would be three to six dollars a barrel which by any measure is a great margin but back then would have been certainly very healthy and on top of that of a three to six dollar margin on a 20 dollar commodity is a really big margin so there was an awful lot of interest in pushing this product and growing the business and by definition the exposure. As we said before the futures markets were relatively known and really the only the first three or four contracts traded and there was very little liquidity at all past six months. MG ultimately also had to engage in the OTC Swaps market and most people understand that Swaps are cash settled derivative contracts that reference some futures price so that you mimic behaviour of the future without having to deal with the complexities of physical delivery in the system. Arthur's got a 10 year short and really only has three formats of liquid futures available to him. The name stack and roll basically comes from the idea that if you were say short over 10 years 160 million barrels you may as well just buy all of those 160 million barrels at the front so you could point to people in the very crude point out to people in the very crude way. I've actually got no net barrels. The fact that my barrels at the front versus the back bleeds to all sorts of problems we're going to discuss but fundamentally the idea was that the long position is rolled every month. We stack up the length at the front and then we roll it every month and as physical deliveries are made or contracts disappear we roll a little bit less on and so forth. Given MGS belief in Arthur's belief in backwardation two things happen. One, the 160 million length at the front when rolled in a backwardated market improves economically. The price goes down effectively relative to where it was purchased. Secondly in a non-volatile, non-correlated world would and then if you'd stop your business the idea is you'd just sort of rolled you stack them rolled over 10 years the stack shrinks the rolls go on and everything closes out perfectly margins are captured and everybody's happy. The reality is that anybody who trades any commodity to crude oil knows that spreads themselves have tremendous volatility. Basis risks across different commodity products within the oil stack have tremendous volatility and as such the only way that you can employ a strategy and I want to stress that the word strategy is different from hedge. When you hedge something you lock it in you lock it down. You know what your economics are at the day whenever it expires the position, the underlying client contract and your hedge together month to market correctly exhibit no or virtually no PNL volatility that is hedged. When you can't do that you employ a risk management strategy. The term strategies is a very loose term in the sense of one man strategies and other men's gamblers on and so forth but what you would hope to do is run some sort of variance analysis that would tell you what the correct number of contracts at the front of the curve are to hold relative to the shorts at the back. We're not going to have a quantum discussion. You've had another quantum guess on and I think that would be a great actual chat to have with somebody else. Maybe there's a follow up but in a nutshell you know the correlation between tooth stochastic processes. You know the volatility of those processes and very very crudely people run simulations and you can do a bit of math and come up with a hedge before onto the bed of wood. So I've spoken to someone who has intimate knowledge of what was going on at the time. That person was saying to me that the stack and roll would work but you only needed to cover somewhere between 50 and 60% of the sales contracts to get an effective hedge. Let's come back to that because that is ultimately I feel the crux of this story and this questions that remain. But they do this this hedge, this strategy, let's call it that, this risk management strategy, a stack and roll and if you go and look at all the academic papers you can see lots of lovely graphs that I don't understand about sort of the various payoffs at different prices but essentially the whole thing sort of worked with those hedges were fine with backwardation and rising prices. The problem was and we're talking, we're very clear about the dates here, we're sort of talking the latter half of 1993 prices start falling and the market and again going to come back to this goes from backwardation into contango. So what starts happening is that the market to market on these 10 year sales contracts is great but the hedge starts hemorrhaging margin calls and money. To the tune of around 100 million dollars a month I think in November at that point plus given you've got this change in people are starting to cash out these contracts as well. So it all starts, basically this is you know those hedges start from a liquidity standpoint causing real real problems. In a nutshell we from our research and basically doing this a long time we realized that the NGNET long because they haven't effectively worked out the number of barrels they need to be on the front earths is their term short commitments. Towards the end of the year the oil market falls quite aggressively. On top of that with a market in in freefall and oil surplus growing contango returns to the market. The story of NGNET is often talked about in terms of market structure room the company but the reality is that it was ultimately their net length. So by September so the accounts or the the business year end for NGNET set 10th and 93 there are two auditors as the German order to PWC or just price for water aspect then and then the American order to for the American operations is Arthur Anderson of Inron fame. The German company or auditors have to report a 600 plus million dollar loss based this German accounting standards which did not allow for incorporating deferred you know positive margins gains whatever but had to record the losses or the market markets on the futures whereas Arthur Anderson had employed a different technique and as such you had a massive company serviced by dozens of banks with two very different financial stories. Having worked in a bank for most of my career if you have a situation where the financial story is getting very squarely and nobody can quite work it out you tend to not lend them anymore money and in fact you try and reduce your exposure and as such at the time when they needed more liquidity their liquidity was was was grained on top of that as you correctly point out they'd seem to get into a cuff-off with the CFTC and the exchange regarding the exact nature of the business that they were doing with their clients and whether or not it could have been viewed as off exchange futures trading which now gets you trip to the big house but back then would get you a fine and a slap on the wrist from my experience over the years you don't want to not that it happened to me but you simply don't want to fall foul of the CFTC. The US exchanges in general are pretty savvy people and they do keep an eye on things so MG had a very public confusing set of financials a very public spat with the exchange and the CFTC and as such their liquidity dried up the markets falling we've discussed they are away I don't even like the term hedge in the discussion of their business but they're way over hedged to use the vernacular the correct vernacular and as such things come to a head towards the end of the year when the management decide to pull the plug on the situation they fire the trading staff and they it's termed the itchy trigger finger in one of the papers we've read but essentially they look to try and to stop the hemorrhaging and as such liquidate all the futures positions very quickly this effectively locks in their $1.3 billion loss and the alarm bells sound and the chairman and the CEO who I think is still in his job at that point after bringing a seasoned investment banker to put together a rescue package. The HC insider podcast is brought to you by HC Group a retained search intelligence and advisory firm focus solely on the global energy and commodity sector with six locations across Asia, Europe and the Americas and over 50 consultants. To find out more go to our website HC Group There you can also sign up for our HCN side of content for more interviews and white papers on relevant trends and talent impacts in the commodities world. Ultimately, so Arthur and team are, or Arthur's fired and will subsequently go on to have a lawsuit about unfair dismissal and similarly happens with Heinz Schimmelbush who is somewhat, you know, goes on to have a phenomenal career and is somewhat sort of exonerated by subsequent events at least legally. So you mentioned the academic papers, so it's all done by sort of a couple days before the end of December 93. And if you read the academic papers and the backdrops those arguments, there's these kind of two big buckets of theories, which is that itchy trigger theory and then kind of just the bad hedging or poorly understood hedging. And when I was having discussions with, you know, person deeply involved in this and people, you know, the commodity trading view is neither of those are particularly right, which is the, I guess the thing that we're bringing into this discussion. But the itchy trigger theory, if I can sort of give it a brief outline and you dig in, is essentially kind of this, and this is what you'll read on Wikipedia, is at the worst possible moment when the oil prices were at their lowest, because they would subsequently, price would rise again in 94. The board get scared of what's going on here, you know, and liquidate all the positions, realizing that loss. And kind of the idea is that if only they hadn't done that, everything would have been okay. Like actually, you know, if they'd all done marked a market accounting, everything would have been fine. Now you and I in our discussions have had a lot of cold water poured on that. But that is the sort of almost the academic position. And ultimately is also the case that Arthur Benson has, which subsequently gets dismissed in his unfair dismissal cases. So there's a couple of things that you really have to think about with this situation. M.G.A. Hemorrhaging Money, the market continues to fall. We today consider credit risk liquidity risks as much as we do when we consider our position sizing. The trader will have an outright position that's read risk limit, a vague limit for his option book, or his or her, someone's hope for it. But after the, particularly after the financial crisis, focus on liquidity and credit became paramount because it was ultimately liquidity issues that forced the bankruptcy of Lehman and the problems of any number of the other banks. And it was liquidity that ultimately forced the US government to step in and buy everybody and stop the financial chaos that we live through there. We read a number of academic papers. People were very quick to jump on to the limited data set that suggested for the eight or nine years that energy futures have been in existence that most of the time they're in backwardation and even over a 12-minute period where there's backwardation in contango, backwardation wins out. So there was a lot of kudos given to the idea that the front end length would benefit from a predominantly backwardated market. Secondly, if money costs nothing, which back then it certainly didn't, we've you know we've had an entire generation of people who've just joined the financial markets who have never seen the financial catastrophe and have never seen interest rates. But back then it wasn't uncommon to have in fact if 1989, I think interest rates were 13-14 percent, although could various other people had to do things to calm inflation, which was one of the reasons why all prices at rallying the eighties, which we should imagine. Liquidity today is a big issue and so it is ridiculous to say things would have been okay if you just hung on in there and kept paying the variation margin. Obviously if you pull up a chart for the next few years prices go back up and things certainly look better. My experience over the years of whenever positions have had to be liquidated, it always seems to be the worst possible time. Interestingly enough though, that is very often because the market knows that the person liquidating has to liquidate and what they have to sell. If you look at Hammondack everybody knew he was 93 percent of the LME, copper are open. The Amaranth debacle people were very clear as to what the position was there and the Hunts, it wasn't have been clearer who owned all the silver. So all of these financial catastrophes do have various things in common. They usually end at the exchange, they usually end around issues with liquidity. So the papers talking about it should hung in there. I think our little name at best and just incorrect at worst. At the time, and we already said that and this again comes from our own discussions with people in and around at the time, you know, those academics very much had an axe to grind, you know, at least we've been told about ensuring that the idea that futures and forwards were a useful and powerful and effective tool for these markets. And the idea that any one trader or trading company could influence the market was very much against that position. So their sort of argument was that, you know, there wasn't this human action, this constant, you know, the market didn't, wasn't trading against or had no idea about the overall position, etc. which I think we're going to dispel in a little bit. The other argument at the time, so you kind of, and again, if you're, you know, you're sat doing your case study, your MBA, you're going to be writing about sort of the itchy trigger finger theory and only they've stuck in which you just poured cold water on is kind of like the bad, the imperfect hedge argument, which is essentially, you know, a combination of a poor understanding, poorest management, poor execution, and it would inevitably have led to this kind of blow up. But there's a few challenges and issues with that as well, because firstly, these were very smart people doing it as we understood. And it comes back to that question of intent, and it comes back to this question of, as you would put it out earlier on, it was, well, it wasn't simple mathematics, it was available mathematics to figure out what amount of hedge was needed to cover these term shorts. And that was something around, let's make it up either the 50% mark, not a one for one. And it's in that one for one that you get this massive hedge, this strategy, which the academics were pointing out, look at this, at any given point in the life of these contracts, they weren't such an oversized bit part of the market. And again, this is from our own discussions, as to have an effect. But what I was told was towards the end of each month, it would end up that MG's RM's position would be some 90% plus of the outstanding contracts, and everyone knew they were going to roll. And actually, that their positions alone caused the one thing they didn't want, which was contango. Well, I think the reality is that they were long anywhere, overly long anywhere between maybe 80 and even 100 million barrels. The academic papers to be fair do quickly cut none to that. They cut none quickly to the fact that some sort of variance analysis would have allowed them more effective hedge ratios. This idea that they should have kept them in the game is fanciful purely because the market will remain illogical longer than you can remain sold. And the reality is the market wasn't illogical markets do what markets do. They absorb all the information available to the oil market at the day. If somebody's 90 plus, I think it was at 1.95% of all the futures positions going into a role, then the people they have to roll, which back then of course would be open outcry and the locals and various other banks and so on and so forth are expecting this. They either roll ahead of time, which is we call that today pre-position, but back then we're allowed to do that. You perfectly entitled to take a position in a spread ahead of what you perceive to be a role. This was one of the big flaws in the commodity indices that they suffered for many years before indices sort of developed and today that it's very little issue. But back in 1993, everybody knows MGS coming to roll, it's contango time. So they're compounding their problem by their own size. Really, their activity compounds all their problems, their liquidity, their size, the so on and so forth. It's just a bad situation and the blow up that they ultimately created was really inevitable. A lot of the academic papers do then go on to focus on whether there was a speculative element. I think being sat long, effectively 80 million barrels of oil, it would be hard to defend that as ignorant. But again, unless we speak to the individuals in mode, I don't know how much of that they thought. One of the academic papers from 94 references and academic paper from 1962 by working that says that in any hedge there is a speculative element and they go on to explain this in great depth. So some of the academics want to go with well on top of that they were expressing a view. I think given how we started the discussion about backwardation in the jet fuel market and the sort of the market dynamics at the time, it would be very hard to assume that there wasn't a speculative element. And I think with the ensuing law, Sue that sort of culminated in an arbitration panel in '96, siding against Benson and 4MG, I think most people accepted that there was quite a lot of speculation going on as well. Putting a theory to you, right, is that when you look at the term shorts, and again this is from a discussion with someone who's relatively close to it, there's a lot of sort of flaws in it, which you've identified, right? One is of course that it basically assumes kind of unlimited money for all these margin calls. And it also actually ignores basis risk in terms of physical delivery. And you've got this sort of option get out clause as well for the purchaser. And there is this, you know, the sort of the third argument, which doesn't make it to many of these papers in any, and is kind of the commodity traders argument, is look, there's an element at which these long term sales contracts are the, are sort of the, the bait and switch if you'd like for a massive speculative position, which is hidden in this one to one hedging. If you, you know, and again, this is all speculation, but you say we assume that, you know, it was understood that you probably only needed 50% of the hedges on to cover those positions, but actually you could justify having a huge strategy on that they did expressing a one to one. And that was the ultimate goal of the trade if you'd like. And that was the, the idea that was where the money was to be made, you know, as opposed to these long term physical deliveries, it just the market went against it dramatically. As a result, frankly, as you pointed out of the size of the position relative to the market and everyone else figuring it out meant that it was probably never going to work, but that's sort of, and again, this is the issue of intent. And where the question remains open, like, was it, was it a bad hedge or was it actually an intentional speculative position that didn't work out? Well, I think, I think we can agree it wasn't really a hedge per se, so I would definitely say it was a very bad hedge. I think we've, we've, we've decided that it was a, a flawed risk management strategy. I wasn't there. I was still at university, although, funny if I read about the article, it's what peaked my interest in derivatives. That's a different story in another lifetime. But I think it's very hard for me to believe that anybody could put this sort of net structure in place to, you know, report up the, up the chain that this is how we were going to lock in those three to six dollar margins we talked about and not expect tremendous volatility in the, you know, in the, in the P&L statement. And let people come on and explicitly say that, I don't know, but I do think, thinking back and on my own experiences of living through some of the other financial catastrophe, because people certainly understood market structure and, you know, the volatility of different points in the curve and what couldn't, couldn't happen. Not everybody understood it, but there were definitely people who did. I like you spoke to a number of individuals who were there or they were about. And knowing these individuals, I do, I would say that the banks at the time certainly had the intellectual capacity or capital to understand how to correct model that sort of exposure. When we talk about the academics, it's actually important that we remember that it was only six years prior that we had the great stock market crash of 1987, which I guess to the younger listeners probably seems like some history. But anyway, what's important there is that the cause of one of the primary drivers of that was an academic strategy called portfolio insurance that basically nobody had accounted for the fact that the action of the strategy would collapse the market, which it isn't just that there was Alan Greenspan, there was a 10% drop the week before there was a fight with the G7s. But fundamentally, the thing that drove the start market to drop 20% and day was a strategy devised by academics that nobody thought one strategy or one activity could affect the market. So it's only five, six years later that you have a situation where call it a company, call it a strategy, call it an individual. But they embark on something that crashes the market and causes untold havoc. So it would be great to get the time machine and take the temperature of everybody involved. There are a couple of interesting situations that happen at the end of it. And one of them, a lesser known character in the story is a lady called Nancy Crock Goldey who was one of the founding members of Morgan's Community Department. She'd left Morgan by then, but had helped out in the late 80s with the ironically Deutsche Bank had trusted her to unravel the huge oil fiasco and losses at Plotner and Co. And it was to her that Deutsche Bank again turned once they had fired the CEO and the trading staff. And she spent several years along with other people and some of the people you interviewed or talked to about this, unraveling the mess. If anybody's interested, if you Google, Michelle, because I'll show you after New York Times, there's a couple of very interesting articles that talk both about her and her work and the situation that are for anybody's interested in the history of the oil market. So indeed, what happens when things go wrong? It's well worth the read. To read those academic papers, you would assume the story just ends, right? It's like, well, tell me, you know, MG board, liquidate everything and huge losses are realised and hines is let go and it's all sort of done and actually to say, within six years, MG itself has taken over by another group and no longer exists. So it was fatal to the organisation. They had to go, you know, they suddenly became beholden to banks that but bailed them out. Actually, we've discovered a bit more to the story that's probably a bit less known, ever tool, is that what they actually did, MG RM went on for the next few years to unwind this position. And they instead of liquidating everything, they actually just paired back the hedge to a correct level, around 30% of the outstanding contracts as I understand. And we were able to recover, you know, to mitigate those losses, recover money from the margins. And actually, over the next two to three years, went on to deliver the physical oil to many of those buyers of the term short. So it wasn't, you know, actually the organisation continued albeit with, yes, as you say, Nancy, in a different leadership. Actually went on to deliver and actually made some decent money out of these contracts as well. So there's a little bit of a, you know, a truncating of the story to make the point in this. But what's fascinating about this for me is that actually this is one of those cases where, you know, a lot of money was lost. And nothing, there was no, there's no, there's no fraud going on here. There's no whiff of hidden losses or anything like that, you know, this wasn't malfeasence, so to say. This was a question of, and I think it remains, we're probably a little bit closer to the answer, but remains one of intent. I think we can discard the itchy trigger theory for a variety of reasons. And I think you can probably, you know, so then comes down to sort of bad hedging or intentional strategy that went wrong. And I think when you piece it all together, you and I probably come down on the, actually, if you're going to get an A on your academic, you know, in your case study at your MBA school, arguing the strategy that went wrong or, you know, didn't include some fundamentals that now commodity traders absolutely are zeroed in on, you know, we probably come down on that side. Yeah, I mean, look, there was so many problems. I mean, even, I mean, the quality to my mind is a standout issue when you look at how people tried to defend the, it's called a strategy, it wasn't a hedge. There was no consideration about credit risk extending 10 year derivative contracts to, you know, people right across the credit spectrum was, you know, back then people didn't think about those things after 2008. That's all we thought about. On top of it, you know, just just just just as calamitous mess and we, you know, I think we've broken down the obscure option contracts that sort of paid out when they shouldn't or couldn't the perhaps lack of thought given to how they actually would would physically deliver all everywhere, although that doesn't really play a part in the ultimate bankruptcy. fundamentally that the mismanagement or whether there was a heavy speculative element or ignorance. I know because I worked with talented people in the oil market, the bag then everybody would have fundamentally understood what you should be like at the front versus short at the back. There were certainly no answers and improvements in and risk analysis at all the time, but interestingly enough if during the course of some of my research I came across the group of 30 derivative report which was published. July 1993 and it is 24 recommendations. It's 30 years old this year as well for people involved in derivatives and I read that report and I've never seen it before in my career and I would heartily recommend anybody involved in derivatives reads that report because the recommendations given then at first or if they've been followed by MG and G Woodstock exist today but secondly I think incredibly useful and actually would be relevant to what happened in 2008. So you know one of the biggest things on the first point they talked about is the role of the board. The board isn't there to be in the day-to-day management of the company. A board is there to hire the talent and to make sure the structure is in place for effective improvement risk management and you talk to the beginning of the podcast about family members being involved which are I think would certainly be a no-well wouldn't be allowed and certainly would have been a no-no in my opinion anyway but the board can be certainly faulted for not having the right structure in place the right risk management team independent oversight and really asking questions about the liquidity draw. When somebody calls you up it says hey things are going great Zenmore money the alarm bell sugaring and they clearly didn't. Yeah it is I mean and this is kind of the the whole extra hour we could go on about this right because we know what what has been put in place first you know now that would probably mitigate this and also that kind of at a time when many organizations producers retailers across the commodities world are having to build trading and marketing capabilities in order to respond to the volatility out there in order to respond to changing market conditions and to particularly to get close to their customer there's even the analogy of MG you know having put a lot of effort into cleaner production and that not really paying off because of the you know the flood from the Soviet Union, the former Soviet Union of metals. There's lots of analogies here and there's kind of that you know that Latin phrase "quist custodiate" "Ipsos custodias" right who guards the guards and you know on in MG at the group level at the border level you know who had the skill set to really understand these strategies and the risks inherent in them and that's a question I think organizations face-to-date right you know how are you how are you understanding the risks all of the risks inherent in these businesses because clearly in this case you know they did. As it pertains to liquidity you know even today I spend some time working with smaller companies and I funnely enough after our first podcast I keep getting calls somebody listen to the podcast I have a question and very often those questions are around risks which to myself a second nature because of all the years I've spent in the market and in the banks but it's it's evident to me that there is a still a genuine lack of understanding about risk management and this goes down to other consultants and consulting companies who brought in to talk to firms about risk management and exposures and so on and so forth and discussion some I helped somebody out last year with a few things and it was shocking to me how little even today so many people understand about all the things that can go wrong I guess if you work on enough in the markets you become very paranoid and see shadows when they're not but the reality is you want your risk manager to be chicken middle yeah you don't want him to be Mr. Rogers and that's that's basically the 13th man I think his race is cool well the the it's time to reason right because it does make it if you were to look at this case without the ability for us you know to meet lean on your deep deep commodity experience for 30 years in and around this this world and some of the conversation we've had externally if you're you know business school and your next role as in a management consultancy you the the learning you take from these papers is this is a bad hedge or a management misunderstanding a lack of oversight all these things what it wasn't was that fundamental piece that's sort of missing from many of these is actually mg themselves by actions of theirs in the market change the market conditions to contango and it was all about liquidity risk and other participants knowing exactly what was going on and trading against them and if you think about the challenges you know the volatility right now and you know that in covid most of those stories and most of the you know when we we're placing traders you know leadership of those organizations are asked do these people really have a grasp of liquidity risk when you're trading west power do they you know because that's where the fallout outcomes the big ultimate losses right and that's not necessarily you know that kind of somewhat goes against the academic viewpoint of efficient markets and and the word anonymous markets and you know and and and therein lies the challenge it does indeed you've got to get good people educated fearful paranoid but ultimately people who who spend their lives in the tables and and that's what it you know five years ago we didn't nobody was talking about having a pandemic you know six years ago nobody thought England would would would leave the EU two years ago nobody thought Russia would become a rogue terrorist state through its actions in in Ukraine hopefully that's not too political but we we just continue to to live in a world where where you know funky things happen and then on top of it the the level of of technological development you know the good stuff on the green side the bad stuff on more people on the planet and we still have to build more fossil fuels and all that it just makes the world ever more complex and complicated so the very minimum boards and companies have to have people insufficiently senior positions who not just can talk about what the trading arm or the risk management arm or the procurement arm is involved in but can really ask probing questions and get into the nitty gritty it's imperative if they're going to survive because blow up to keep happening we have one last year the the the the the the the the nickel blow up the chain nickel blow up on the element absolute monster you know you think the element learned less than half the number but it would have been so you know bloats will continue whether they're fraudulent or whether they're just the activities of of incompetence or naivety but it's it's a very real risk has to be guarded against yeah well I think we could carry on for a while but we'll have to leave it there I want to thank obviously you Kevin but also all those other people that have helped us understand this story a bit better and I hope that we've given some food for thought and some perhaps whilst not solved move the discussion on a bit closer to some of the essential questions about the MG case and yeah look forward to I'm sure we'll do one or two more in the future as well Kevin. Excellent I'd love to thanks for having me and good luck with the series in this year. Thank you for listening if you enjoyed this episode and want to support the show please give us a positive review on Apple podcasts or Spotify. To find out more about HC Insider and HC Group a search and advisory firm dedicated to the commodity markets visit our website at www.hcgroup.global. There you can find out more about our services and our offices around the world. There you can also find more content from interviews to insight pieces to more podcasts focused on the commodity value chains. Thanks again for listening.