Drlondoner

oil for delivery in ten years and the value of two different dated obligations do not move in lock step. In general, spot prices are more variable than the futures prices.

This is a feature that all hedgers must deal with. Hedgers in the futures market are “speculators on the basis,” trading greater price risk for a lessor basis risk. The basis risk is the difference between the price of the instrument and the price of the underlying asset being hedged.

A rolling stack of short-dated futures initially increases the variance of cash flows. This occurs because movements in the price of oil within the month create losses or gains on the entire stack of contracts.

These losses or gains must be settled by the end of the month; while compensating gains or losses on deliveries are realized only gradually over the remaining ten years of the delivery contract. When cash flows matter, the rolling stack may be worse than no hedge at all.

There is still disagreement as to whether the marketing strategy was sound. Proponents of the strategy maintain that had MG been able to persevere, they would have made a profit in the long-term and recouped the losses on the futures through profits on the monthly sales of petroleum. However, an auditors' report commissioned by MG shareholders maintained that 59 million barrels worth of the long-term contracts had a negative value of about $12 million, so the value of these contracts could never have offset the losses, even in the long term.

...