SINGAPORE: For the first time in history, oil prices are now negative.
A few days before, Singapore’s largest oil trader Hin Leong applied for court protection to stave off claims in excess of US$3.85 billion (S$5.49 billion).
Press reports suggest that the home-grown company’s billionaire founder may have directed the firm to hide about US$800 million in losses over the years.
This isn’t the first time a giant in the oil industry has racked up a mountain of debt – the effects of the collapse of OW Bunker in 2014 and of the offshore downturn in 2016 still linger on today.
The current troubles of the industry provide a unique opportunity to understand the interdependence of the oil community and the impact Hin Leong’s fall-out will have outside of it.
THE CREDIT WEB
The lifecycle of oil is a capital intensive one. From the time oil exploration begins to how it is processed, shipped, stored and traded, the industry is very much dependant on financing.
The confluence of factors surrounding poor demand, low prices – owing in part to the spat between Russia and Saudi Arabia – and Hin Leong’s struggles, will mean liquidity is drying up while oil is overflowing.
This will be acutely felt by the interdependent oil companies in the industry. Oil can be bought and sold on credit terms and in today’s world of shrinking physical arbitrage opportunities, credit is sometimes more important than the price of the black gold itself.
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Oil traders are dependent on their financiers not just for purchasing oil but also to extend credit terms to their buyers to only make payment in the future.
Oil traders without sufficient banking lines, engage in credit sleeving whereby they leverage on the physical assets of a larger supplier while other traders use letter of credit (LC) agents as third parties inserted into a transaction to enable the opening of LCs to effect a purchase.
The practice of LC agents is not uncommon for Chinese oil purchasers who want to buy oil but do not have sufficient banking lines to open an LC so a third party – the LC agent – is used to open an LC on its behalf.
In back to back trades, a buyer of oil can use the LC of its own buyer as a source of funding to pay its supplier, meaning oil can be purchased by leveraging on the liquidity of other parties.
Court filings showed Hin Leong Trading, which owes about S$4 four billion, had concealed about S$800 million in losses over the years. (Photo: AFP/Roslan Rahman)
There is no lack of creative structures that companies in the oil business deploy but they have a common objective in leveraging for liquidity.
As credit gets tightened, highly leveraged oil companies will stagger – there will be difficulties in open LCs and credit terms and sleeves would be withdrawn.
Just as lenders are withdrawing credit, oil suppliers will be forced to do the same and the drying of credit will leave some companies upended in its wake.
THE SCRAMBLE FOR SECURITY
Oil can be a slippery asset if creditors are looking to lay a claim on it.
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We saw this in the aftermath of the global collapse of Danish oil bunkering giant OW Bunker in 2014 when it filed for bankruptcy just eight months after its listing in Copenhagen – partly due to losses on an estimated US$130 million credit line given by its Singapore-based arm to local company, Tankoil Marine Services.
When OW Bunker collapsed, it owed debts to numerous parties but in particular to the banks that financed it and the physical suppliers who supplied oil on its behalf to vessels. Banks and traders around the world. including in Singapore, started scrambling to take back oil or arrest vessels that the fuel was supplied to.
The banks and the physical suppliers dealing with the company’s local subsidiary were left with competing claims against vessel owners to which OW oil was supplied.
The vessel owners, faced with the threat of arrest by either group, were left with the unenviable task of deciding which party to pay to, with no assurance that an arrest be forestalled as there were competing claims for payment of the same oil.
The uncertainty resulted in unprecedented levels of litigation around the world testing the interface of maritime laws with insolvency legislation leaving vessel owners with a double exposure and some physical bunker suppliers without effective recourse.
Oil is consumed and commingled, making it notoriously difficult to lay precise claim to it. Even if you do manage to get your hands on it, what does one do with oil today?
With the pricing of oil where it is and an acute shortage in storage capacity, holding on to oil can actually be a liability.
UPSTREAM EFFECTS
Negative oil pricing might sound like good news to consumers but its effect is more detrimental than beneficial.
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Oil prices have gone through many cycles and each time it is on a downward trajectory, production is impacted alongside the massive machinery of ancillary services that support the industry.
The oil crisis will not only hurt exporting nations – regardless of what the Russians or Arabs tell you – oil producers, the contractors that build the infrastructure, rig owners and offshore support services are also looking at bleak times.
When prices dipped in 2016 – fuelled by a slowdown in the Chinese appetite for commodities and the emergence of US as a shale oil producer – the offshore market was badly exposed leaving many companies and inexperienced investors with their hands burnt.
Many offshore companies were left unable to service their loans used for capital intensive purchases of offshore support vessels.
When offshore oil production activity slowed, orders for these vessels fell and offshore companies like Swiber Holdings who were dependant on offshore oil activity had to apply for court protection.
Swiber who had issued several bonds to raise capital, were left with debts of about S$1 billion around the time it sought court protection.
The 2016 dip provided a much-needed catharsis to the offshore industry – overleveraged companies had to restructure or go under. The process culled several players and forced others to streamline their operations.
A dry-bulk ship is seen taking on bunker fuel in the Singapore Straits on December 17, 2017. REUTERS/Roslan Khasawneh/Files
More importantly banks were more sensible with their lending, resulting in less easy liquidity being sloshed about and by extension, lower chances of offshore companies now toppling over despite the headwinds.
TIME TO RE-EVALUATE HOW FINANCING IS DONE
Nevertheless, the collapse of the oil price will invariably have its casualties in the oil industry, particularly companies geared on credit.
It does however give lenders and traders an opportunity to re-examine the fundamentals of how credit is assessed and the effectiveness of security.
Hin Leong’s application for court protection while staving off astronomical claims is not particular to the oil industry.
Every year, commodity companies seek to restructure massive debts – this year alone, the high profile collapse of Agritrade with a US$1.5 billion exposure and Hontop Energy have raised concerns for banks.
In the “post-mortem” analysis, lawyers like myself are called in to examine trade structures and I am always struck as to how companies of all shapes and sizes sometimes get access to a startling amount of financing.
With banking secrecy laws keeping banks distant from each other in terms of lending activity, there is the all too familiar scenario when a group of banks meet a distressed borrower only to find out the staggering amount of money given to the debtor collectively.
This in turn, begs the question whether we are using the correct metric to assess the financial viability of companies.
Lending by the balance sheet of a company alone has repeatedly proven itself to be an inadequate metric.
Accounting practices needs to be sharpened and lenders will need to focus on what should go on or off a balance sheet particularly in the world of trade finance where the lines between trades and loans can be hard to distinguish.
A company can sell its invoices or receivables due to it and receive cash, thereby taking the receivables off its balance sheet. But sometimes such structures are not deemed “true sales” and should not be reflected on the balance sheet.
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These are not new lessons – the cautionary tales have been around with each spectacular collapse over the years. The lessons unfortunately have not been learnt.
Another metric used to determine financing relates to the underlying assets itself where banks hold on to title documents of the goods financed as security.
Here again, history has proven that in the pursuit for liquidity, the lack of title documents does not stop borrowers from moving and discharging goods.
Lenders therefore sometimes find themselves holding on to worthless pieces of paper and even the best lawyers in the world cannot do much about that.
Trade finance is fundamental to the global economy and in the present climate there is tendency for lenders to withdraw credit lines, trigger margin-calls and grab any assets they can to reduce their exposure.
In the days that follow that, a company that may have been viable at some point, can quickly spiral into a collapse. When the wheels of finance stop, the effects can easily spread to other parts of the economy wiping out confidence in the markets.
This is precisely why we have one of the most sophisticated restructuring laws in the world: to contain the contagion.
Baldev Bhinder is the Managing Director of BlackStone & Gold, a specialist energy and commodities law firm in Singapore. He can be reached at baldevbhinder@blackstonegold.com
