Don’t Like Where Your Bet Is Going? Cancel It

I read this article in Financial Times: Nanshan deals with Goldman Sachs halted.

China’s securities regulator has ordered a state-owned power group to cancel oil derivatives contracts it signed with a Goldman Sachs subsidiary which would have exposed the Chinese company to losses if oil prices continued to fall.

A Chinese power producing company was concerned about rising oil prices when oil price was really high (I guess because high oil price increases their cost of production). So they signed a deal with a Goldman Sachs subsidiary in Singapore called J. Aron & Co. As long as the oil price remains above ~$65 a barrel, J. Aron pays them. If the oil price goes below that, they will pay J. Aron. After they signed the deal, J. Aron has paid them $8 million. Until the oil price  came down. When it’s about their turn to pay J. Aron, the Chinese company confessed to their regulator who ruled that the deal was “unauthorized” and the contact has to be voided. They will probably return what J. Aron previously paid them, perhaps even with a small interest. I’m pretty sure if oil price remains high they will keep quiet about the “unauthorized” deal. It’s like you bought a lottery ticket, got the matching number, then have your ticket canceled because the store clerk who sold you the ticket didn’t complete his required safety training last year.

You begin to appreciate why the U.S. stock market declined less than other markets even though the U.S. is the source of the subprime mortgage problems (see previous post Crime and Punishment). At least the U.S. has a legal system that won’t allow this kind of “heads I win tails never mind” business. Southwest Airlines also entered into hedging contracts on fuel prices. In the last few years, they were able to maintain profitability while other airlines lost money because Southwest locked into a lower fuel price through hedging. After the oil price came down, Southwest started losing money because their contract price is too high. Last quarter they had their first quarterly loss in 17 years. Southwest  honors their contract. That’s how business should be conducted.

P.S. I’m looking for study mates for ECON 252. Please let me know if you are interested in studying together.

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  1. zany says

    I have been actively following your blog and thanks to you, got to learn about the econ 252 (and the game theory course). I plan to go slow (though at least one lecture a week) – let me know if you want to do it together.

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