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Jet fuel scandal deals China a body blow
By Kosuke Takahashi

TOKYO - 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.

Corporate governance
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 industry."

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 examined."

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 Singapore Exchange.

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. He can be contacted at .

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Dec 7, 2004
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