China Aviation Oil suffers $550 million derivatives loss

The losses follow a surge in oil prices over the past few months, with the Nymex oil futures contract reaching a record high of $55.17 per barrel on October 26 compared with just $34 at the start of the year. The rise in prices left China Aviation unable to meet margin calls on its derivatives positions, forcing it to close out some trades with an aggregate loss of $390 million. The company is in the process of closing out the remaining positions, and estimates the additional losses will be around $160 million.

China Aviation began trading oil derivatives on its own account last year. In its 2003 annual report, the company stated it uses swaps, futures and options for trading and hedging, with an outstanding notional amount of more than $2 billion.

The trading losses have forced China Aviation to apply to Singapore’s High Court to protect it from claims while it hammers out a rescue package and negotiates a settlement with creditors. As part of a potential rescue deal, the firm’s parent company, China government-owned China Aviation Oil Holdings Company, has approached Temasek, the Singapore government’s investment arm, to help with the restructuring.

Temasek, which has an indirect stake of around 2% in China Aviation, has expressed an “indicative interest” in injecting $50 million into the firm, in combination with another $50 million from China Aviation Oil Holdings, the company said in a statement. This follows an emergency loan of $100 million from the parent company to meet China Aviation’s margin calls last month.

Since the losses came to light, China Aviation has suspended chief executive Chen Jiulin, and has set up a special task force to lead the restructuring. The company has also appointed PricewaterhouseCoopers to investigate the circumstances leading to the losses and the firm’s failure to make appropriate disclosure.

The first signs of trouble came on November 16, when the company announced it would exit all speculative trading positions by the end of November to “respond proactively to conditions arising in the international oil trading business”. However, China Aviation did not disclose any mark-to-market losses at that time.