In the early 1990s, Metallgesellschaft AG, a German conglomerate that had evolved from a traditional metals company into a provider of risk management services, was one of Europe’s most successful businesses with approximately $15 billion in annual sales. However, that success was marred when, in December 1993, MG Refining and Marketing Inc. (MGRM), a subsidiary of Metallgesellschaft AG, revealed that it had lost $1.5 billion from trading in energy derivatives.

The tale of MGRM’s troubles starts with their marketing strategy. MGRM committed to sell to their customers set quantities of fixed-price petroleum products every month for up to 10 years. These contracts proved to be very popular. Each MGRM contract contained a sell-back option allowing MGRM’s customers to terminate the contracts early if the next-to-expire (i.e., ...