China's jet fuel import monopoly, Singapore-listed China Aviation Oil
(CAO), last week reported whopping losses to the tune of US$550 million, due largely
to speculation and unwise derivative trading. But that's only half the story.
The financial scandal has raised serious questions about the way Chinese firms
are managed, their lack of transparency, accountability and fairness, as well
as the efficiency of Singaporean financial authorities. The scandal has much
wider ramifications beyond Asian oil markets as it comes at a time when
investors worldwide are beginning to take an interest in Chinese stocks, given
the country's booming economy.
Last Tuesday, CAO, a subsidiary of state-owned Beijing-based China Aviation Oil
Holding Co (CAOHC), stunned oil traders and stock investors when it announced
that it was seeking court protection from creditors after racking up a
staggering $550 million in losses from speculative oil derivative trading. The
firm was apparently selling off call options in the hope that oil prices would
trend downwards. But the price of West Texas intermediate crude oil, an
international benchmark in oil pricing, actually hit record highs over $55 a
barrel in late October.
This is the biggest case of speculative losses to have hit Singapore since
British trader Nick Leeson was sunk by $1.4 billion of bad bets in the
derivative market that eventually brought down Barings, the United Kingdom's oldest
bank, in 1995. Trading in CAO shares has been suspended in Singapore since last
Monday and is likely to remain that way, at least in the near term. The debacle
has left the shares of more than 7,000 investors in the firm virtually worthless.
The company had been regarded as one of the most reputable and successful of
the more than 60 Chinese firms listed on the Singapore exchange.
As more details of the scandal trickle out from the Singaporean media, serious
questions are being raised about corporate governance in Chinese companies,
which in recent years have lured overseas investors hungry for a slice of the
country's economic success. It is now evident that the Chinese parent company
was informed about its Singaporean subsidiary's financial straits - amounting
to $180 million in losses - on October 10, days before it sold a 15% stake in
the subsidiary to institutional investors on October 20. But the parent did not
disclose any information about the losses during the sell-off process. This
placement, managed by Deutsche Bank's Singapore branch, reduced the parent company's shareholding in CAO from 75% to
60% and raised $108 million for it.
Selling shares under such circumstances could qualify as insider trading.
"It looks like they covered it up all the way to their parent in
China," a veteran oil trader based in Singapore told Asia Times Online on
condition of anonymity. Questions are also being raised about the internal
checking system at CAO. The Financial Times pointed out in an editorial:
"CAO had inadequate internal controls over its derivative trading since
deals were supposed to be shut down if any of the company's 10 traders assumed
a loss of more than $500,000."
Realizing the damage potential of the scandal, China is doing some heavy-duty
fire firefighting by stressing that the CAO scandal is an exception and that no
Chinese companies are flouting rules. Air China, the country's largest
international carrier, has said the losses amassed by CAO will not affect the
supply of aviation fuel to the mainland, the China Daily reported Friday. It
quoted Li Jiaxiang, chairman of Air China, as saying at a video conference in
Hong Kong, "The problem of CAO Singapore is an individual case, which will
not affect the supply mechanism or price of jet fuel for China's aviation
According to a Dow Jones report, Chinese jet fuel consumption will grow 10%
this year, to 217,000 barrels a day. CAO's jet fuel imports this year are
expected to hit 59,600 barrels a day, up nearly 40% from last year.
The scandal continues to trigger questions about the disclosure standards of
Chinese companies. Whether this scandal portends an iceberg is unclear, but for
now the onus is on China to prove that its companies follow the highest
standards in accounting and disclosure - something that even many American and
Japanese companies still haven't achieved.
Eye on Singapore
"There is a saying," the Singapore oil trader said: "If a
company loses $50 million, it's the company's problem. But if it loses $500
million, it's the system's problem." The Singapore Stock Exchange (SGX)
took swift steps to protect the market's credibility by suspending trade in CAO
stocks. The SGX has directed CAO to appoint a special auditor,
PricewaterhouseCoopers, to investigate the circumstances that led to the
losses. A criminal investigation has also been launched by Singapore's
commercial affairs department to look into the possibility of white-collar
crime at CAO.
But many wonder why the SGX and the Monetary Authority of Singapore (MAS), the
city state's central bank, had not noticed the whopping losses earlier. This
could amount to a blatant deception hurting investors. "Someone in the
Singapore government was sleeping," said an oil trader. "Losses of
this magnitude suggest the SGX and MAS failed to enforce corporate governance.
The entire SGX trading system and the MAS's supervisory role need to be
Many traders have pointed out that allowing CAO chief executive officer Chen
Jiulin to fly back to China last Wednesday was a bad decision. Chen has been
suspended from duty at CAO since the firm sought court protection from
creditors. CAO, however, promised Singaporean authorities on Monday that Chen
will would return to Singapore some time this week. "Mr Chen returned to
China on November 30 to attend to family matters. On December 1, 2004, the
company requested Mr Chen to return to Singapore to assist in the
investigations. Mr Chen has informed the company that he will return to
Singapore sometime this week," CAO said in a brief statement to the
So will CAO face charges of falsifying financial statements submitted to the
authorities in Singapore? Will it also face charges of insider trading? In
time, both the Chinese and the Singaporean governments have to sort out these
issues if they wish to restore investor confidence, something that seems to be
in pretty bad shape right now.
Kosuke Takahashi is a former staff writer at the Asahi Shimbun
and is currently a freelance correspondent based in Tokyo. He is an analyst for
RIM petroleum intelligence news service.