China threatens to default on oil derivatives trades

Posted Sep 12th 2009 4:10PM by Connie Madon
Filed under: International Markets, Management, Commodities, Oil, Financial Crisis

About one year after the Lehman bankruptcy, we are getting rumors of more impending bankruptcies, this time from China.

The problem started last year when the price of oil dropped from $147 to $32 per barrel. Many companies use the futures markets to hedge their buying of oil. When prices skyrocket, they get scared and buy futures contracts for future delivery to lock in a price and to be assured of getting the product. So, some companies were buying oil at the height of the market last year. Companies that place hedges usually leave them on until delivery. What happened was that when the price of oil collapsed, these companies were still holding high-priced contracts. They saw the price plummet and took horrendous losses.

Usually such deals are struck in Hong Kong or Singapore. Apparently these deals were not made on listed exchanges. When commodities are traded on a listed exchange, all margin monies must be paid by noon the next day, usually via bank wires. If the margin is not met, the house automatically sells out the account. This keeps losses from growing too large.

If banks had been forced to use clearinghouses, these same rules would have been in effect, and chances are we would not have had the financial meltdown that occurred last year.

This is what happened to some Chinese companies. They lost millions of dollars in the oil market last year. Now, the Wall Street Journal (subscription required) reports that the companies are in such dire straits that they may default on their losses. China Eastern Airlines (NYSE: CEA), Air China Ltd. (OTC: AICF) and China Ocean Shipping sent letters to a handful of banks, including Citigroup (NYSE C), Deutsche Bank (NYSE DB), Goldman Sachs Group (NYSE GS), JPMorgan Chase (NYSE JPM), and Morgan Stanley (NYSE MS). The letters warned that the companies had the right to default.

Cases such as these usually go to arbitration. However the Chinese have stated that they reserve the right to overrule any judgments set out by arbitration.

These cases bear watching. We haven't had defaults since last year. Now, out of left field we see this happening. What is also strange is that these deals have been left hanging for the almost a year. You can bet that if these three are still open, that there many more still out there.

This is a reminder that the big banks still have losses that they are hiding. Who knows? China may default on these deals.

Do you believe that the Chinese companies will default on their trades?

Tags: AICF, Air China, CEA, China Eastern Airlines, China Ocean Shipping, inthenews, oil futures

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Reader Comments (Page 1 of 1)

9-12-2009 @ 5:34PM

ij70 said...

Very interesting situation.

I read yesterday that Mr. Obama put new three years import tariffs on Chinese made tires, 35% first year, 30% second year, 25% third year.

Now I read that Chinese companies threatening to default on some deals and this threat appeared suddenly, almost out of nowhere. One start to wonder if these two issues are related...

9-12-2009 @ 9:23PM

william lindblad said...

May be something, may be nothing. In the past I have made mention of some potentials out there, those that more in the direct financial front. As I really don't know and can only suspect - we shall all have to wait and see.
For the record - trade, tariff's, etc. have been going on for more than 100 years and retaliatory moves, gestures and postures - are old hat. The McKinley trade and tariff was the first major legislation by the U.S. in this area. Enacted in the 1880's and was widely amended shortly thereafter. Conditions change and so do laws. Before it we had the warehouse act which was essentially worthless. Protective tariff's don't work in a free trade world.
Laissez faire anyone?

9-13-2009 @ 5:02AM

Scott said...

Yes, just like the U.S. is going to do when all countries try and cash in their treasury bonds we will have no choice in this world economy but to say sorry we are keeping the commodities your countries bought with but your paper is no longer being honored because we are BANKRUPT and can no longer pay!!!!!!! tough shit china, japan and so on!