Thursday, September 3, 2009

Is an Oil Derivatives Default Crisis Just Ahead?

There are facts and speculation that when mixed together sound like a witches brew of trouble in the not too distant future for the markets and economy.

Here are the facts:

This past weekend China announced that State Owned Enterprises (SOEs) will be allowed to default on commodity derivative contracts.

A Reuters report cited 6 foreign banks [This would be non-Chinese banks] that received letters indicating that the Chinese State Owned Enterprises would be given the green light to default on their derivatives.

In another Reuters story, we learn that a

...source, whose bank did not receive a letter, said that Air China, China Eastern and shipping giant COSCO -- among the Chinese companies that have reported huge derivatives losses since last year -- had issued almost identical notices to banks.

"If it's in the name of the government, the impact will be very negative," said the source, who declined to be named.
Here's where the speculation starts:

What do Air China, China Eastern and COSCO have in common? They are all major users of oil. If they are underwater in derivatives, it is likely to be oil derivatives.

Further speculation:

Among the major oil derivatives traders are the usual suspects: Goldman Sachs, UBS and JP Morgan. These are big dollar sized derivatives. One web site speculates, repeat speculates (not fact) that a hit to Goldman under this scenario could be $15 billion range. What's Goldman, UBS and JP Morgan saying about all this. Reuters asked them:

Spokespersons at Goldman Sachs (GS.N) and UBS (UBSN.VX) declined comment, and media officials at Morgan Stanley (MS.N) and JPMorgan (JPM.N) were not immediately available for comment. All are major global providers of commodity risk management.
Is something going on?

I participated in a conference call, pen and pad press briefing by a top Treasury official, yesterday. If there was a major problem, he would know. But, there didn't seem to be anything unusual surrounding the call. It was a briefing before the start of the G-20 meeting in London. The time of the conference call was changed, outside of that there was nothing unusual. The official did not seem particularly spooked. The call in fact was so boring that I didn't even mention it here at EPJ. Though the official: A. may be a better actor than I give him credit for, or B. he is clueless.

Oil derivatives crisis or not, it's a dangerous time to be randomly dabbling in the market. There is no Fed money printing and we are headed into a period of the year that is known to be treacherous. Long side trading should be done with extreme caution.

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