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The collapse of China Aviation Oil (Singapore) after losses of $550 million in speculative trading came about because the company lacked both a sound derivatives trading strategy and proper internal controls, according to experts in the region.
CAO, China's dominant jet fuel importer, this week filed in Singapore for court protection from creditors, after admitting to the dramatic failure of its trading adventure (IOD Dec.1,p1).
The losses are said to have been run up after the company took out large speculative positions during a period of high price volatility -- and guessed the market wrong in two crucial and massive bets this autumn.
Market players and analysts said that CAO could have prevented such huge losses, which have rendered the company technically insolvent, through the adoption of an effective trading policy and strict adherence to trading limits. The company is reported to have had three sets of risk controls to contain trading losses -- but these either didn't work or were bypassed.
CAO said that it started trading in oil derivatives on its own account in 2003. While part of this was for hedging, it also engaged in speculative activity. In October 2004, the steep rise in international oil prices as high as $55 per barrel saw CAO face significant margin calls on its open derivative positions. It was unable to meet some of these margin calls, so was forced to close the positions with some of its counterparties.
In a statement Tuesday, CAO said that losses from positions closed since Oct. 26 amounted to US$390 million, while losses from outstanding positions were estimated at US$160 million.
It declined to give details on exactly how it ran up such massive losses, pending the outcome of an investigation.
Market sources said that CAO incurred the losses by taking a...