The recent case of China Aviation Oil's losses in derivatives trading proves that nothing can save a company when the management itself violates internal controls, risk management and corporate governance practices.

China Aviation Oil (CAO) is a Singapore-based subsidiary of China's state-owned China Aviation Oil Holding Company (CAOHC). CAO, China's main jet fuel supplier had reported in December 2004 that it had suffered losses of $550 mn by trading in oil derivatives. This incident came to light when the company announced that it had been betting on the future price of oil and in the process had suffered losses. While analysts initially assumed that the losses were in the range of $50 mn- $100 mn, they were appalled when the company revealed that the losses were at a staggering $550 mn. This news came as a shock on several grounds, one of them being that the losses are equivalent to the entire market capitalization of the company.

What is even more shocking is that CAO has clearly stated that it knew of the speculative trading losses. On investigation it was revealed that CAO began losing money on oil derivatives in the first quarter of 2004. In spite of this, it increased its purchases in oil trading with the hope that the prices would fall. Instead, oil prices rose to an all-time high in October last year. The company also stated that it had approached its parent company for help, as it did not have sufficient resources to cover its margin calls. The parent company agreed to provide an emergency loan of $100 mn. But this still proved to be insufficient to meet the margin calls.

CAO is clearly a case where nothing was done in accordance to the practices. The company violated internal controls and regulations and did not pay heed to risk management. The parent company being aware of the mounting losses and violation by the company went forward and sold the shares of its Singapore listed supplier in the market at a discounted price of $1.35 against the then price of $1.57. It sold a stake of 15% in CAO for $108 mn bringing down its stake in the company from 75% to 60%. Singapore's Securities Investors Association has said that the sale bore the hallmark of insider trading.

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