China Aviation Oil’s Collapse:

Singapore INC’s Challenges

Case Background
China Aviation Oil(CAO) is a Singapore based company majorly
owned by China Aviation Oil Holding Company(CAOHC)

Enjoys 100% monopoly in supply of jet fuels in China

Listed on the Singapore Exchange in 2001 and was voted as the

most transparent

Later lost $550 m in speculative oil trading

The scandal raised concern on the credibility of Singapore

China Aviation Oil’s Collapse
 China is 2nd largest consumer of Jet Aviation Fuels.

 China imports 1/3rd of the fuel of its total consumption which is 230000 barrels per
day.

 China Aviation Oil Corp Ltd established in 1993, is a multinational investment and
oil infrastructure company.

 Sole importer of Jet Aviation fuel in China.

 It has it headquarters in Singapore.

 China Aviation Oil Holding company has 75% stake in CAO, has 100% monopoly
in supply of jet fuels in China.
 Supplies to more than 100 airports and has business worth 1 billion dollars
annually.

 CAO listed itself in Singapore stock exchange in 2001.

 Huge increase in air travel volume and hence became major buyer of airlines
and aviation fuel.

 Income was subject to high volatility in oil prices.

 CAO used Oil swaps for hedging purpose.

 2003 started trading in Futures for speculative reasons.

 Chen Jiulin (CEO) was expecting a fall in the oil prices to $38 per barrel but it
went upto $55 per barrel.
 Had to pay the banks and financial institutions the earnest money
which was $5000 for 1 dollar rise in oil price barrel.

 Turned to parent company which paid $108 million to CAO.

 Parent company reduced its share from 75% to 60%.

 CAOHC approached Deutsche bank to sell it stake through block trade.

 Deutsche Bank offered 145 million CAO shares at $1.35 each,with

14% discount to market price.

 By end of November CAO received payments demands for margin

payments and settlement of Deratives trades from the following.
 Unable to secure more funds Chen made it public that
company made a loss of nearly $550 million in
Derivatives.

 The stock price fell steadily, loosing nearly 39%.

 Chen was arrested for being involved.

 Assets were not sufficient to meet the debts.

 For meeting the creditors demands and to avoid

bankruptcy CAO brought a reorganization plan.
 CAOHC planned to convert part of $118 million loans to
equity and invest additional $50 million.

 Singapore state investment agency Temasek Holdings

Pte.Ltd would invest another $50 million.

 Investment would not proceed until the creditors accept

the repayment plan.
Singapore INC’s Challenge
The scandal had raised doubts about the reputation of
Singapore which was regarded as a well-regulated
financial centre.

Singapore's Prime Minister Lee Kuan Yew (Lee), who

is also the father of modern Singapore, along with the
government and people of Singapore head worked
hard to create a corruption-free economy supported
with infrastructure and stable political and financial
system.
Singapore’s Stock Exchange’ foray
amongst the major world markets.
The Singapore Exchange had made tremendous efforts to
become an international exchange.

It received its first over seas application from Hong Kong
in 1993, and since then had accepted 176 foreign listings
by 2004, accounting for 27% of its total of 625.

Singapore provided a good alternative to Hong Kong, as

Chinese companies found it difficult to get domestic
listing due to poor market condition and regulatory
restriction.
Scandals at the Singapore Stock Exchange…
Critics say that the CAO scandal had brought into spot light the short coming
in the city-state‘ financial liberalization process, and this was not the first
scandal to happen at the Singapore stock exchange.

In November 2004, three employee from the Government of Singapore

Investment Corp, which manages Singapore’s foreign reserves were fined for
insider trading in Japanese share.

In April 2004, former finance manager with Asia Pacific Breweries was jailed
for 42 year for cheating Germany and Japanese banks of $71 million.

In 2001, Singapore- listed Asia Pulp and Paper, an Indonesian wood and pulp
conglomerate, defaulted on debts totaling $13.9 billion.

The most infamous scandal was the collapse of the UK’s Barings Bank in
1995.
Reasons for fall of Barrings bank
 Leeson – the trader was in charge of both front
office & back office

 Lack of involvement of Senior Management

 Company wanted only profits

 Improper control procedures

Someone in the Singapore government
was sleeping…..
 To attract foreign companies to list their shares on the
Singapore Exchange, the exchange had eased many
rules and regulation.

But CAO had violated major laws……

 Enterprises with overseas futures permit were only

allowed to engage in hedge transactions and they are not
allowed to engage in speculative transaction
Violations and Fraudulent non-
disclosures by CAO…..
It started speculating with 2 million barrels initially and the number
had reached 52 million barrels by the time the scandal took place.

It had exhausted its $5 mn internal trading limits back in 2003, and
also misrepresented its financial statement.

The total assets of CAO in June 2004 was $515 million and the assets-
liabilities ratio was 73%.

With Chinese companies turning to foreign markets to raise funds,

it had also raised an alarm for the creditors about the risks of
investing in Chinese firms especially the state- owned enterprises.
Conclusion
CAO adopted intrinsic value method for valuation of
options failing to include the time value method

In 2004 Chen speculated oil price will be $38 per barrel
but it shot up to $55 per barrel

Singapore Exchange(SGX) failed to enforce corporate

governance
Three main causes of the downfall were:

Speculative oil trading and undisclosed losses in 2004

Improper risk management procedure

Failure of the board to fulfill its duties

Lessons to be learnt
The strategic objectives and risk management
policy of the company must be determined at the
highest level

Senior management must be responsible for the

policies to be incorporated into daily operations

Internal and external reporting must follow best

practice with frequent and detailed disclosures
 There should be regular stress testing on strategy and risk
measurement models

 Prior to trading in new products, a formal analysis must be

conducted on the risk profile of the product
Questions……
The role of the CEO’s- whether they should aim for the
objective of profit maximization to which their
compensation is linked, or work in the interest of the
shareholders for profit maximization?

With Singapore making great strides in corporate

governance, should the companies be permitted to
engage in activities that fly under the supervisory
radar?