Oil company must pay

Posted: 21st August 2012

Industrial chimneyAn oil company that lost more than US$166 million after entering into derivative contracts designed to protect it from sharp increases in oil prices has failed to convince the Court of Appeal that it did not have the capacity to enter into the transactions.

Ceylon Petroleum Corporation (CPC), which imports oil products worth about $US2 billion into Sir Lanka annually, was established by the Ceylon Petroleum Corporation Act 1961 and argued that, as a creature of statute, it did not have the power or capacity to enter into the derivative contracts.

However, in upholding Standard Chartered Bank’s rights under the contracts, the Court of Appeal has ruled that CPC did have the capacity to enter into the transactions which were ‘incidental or conducive’ to its express statutory objectives.

Lord Justice Moore-Bick said that CPC had entered into the contracts in an attempt to iron out peaks in the price of oil and did well out of them whilst prices remained high. However, contrary to many industry forecasts, the onset of the credit crunch resulted in a collapse in oil prices in July and August 2008.

Standard Chartered Bank launched proceedings after CPC ceased paying out under two contracts but was faced by CPC’s arguments that it had not had the statutory power or capacity to enter into transactions which included speculative elements.

Ruling against CPC the judge, sitting with Lords Justice Rix and Rimer, said that it mattered not whether the contracts were primarily speculative or designed to ‘hedge’ the company’s position in the market place. The judge said CPC’s ‘public status’ did not mean that it lacked capacity to utilise increasingly sophisticated tools used by oil traders to mitigate the risks they take amidst ‘the vagaries of the oil market’.

He observed: ‘It may be that, in retrospect, with the catastrophic credit crunch which overtook western economies in the autumn of 2008 following the collapse of Lehman Brothers, the downside risk undertaken by CPC in its transactions looks imprudent, especially compared to the limited opportunity for gain on the upside.

‘That, however, is the wisdom of hindsight. If we were all as wise as hindsight teaches us to be, we would always prosper, but history relates a different lesson’.

The judge concluded: ‘These transactions were in our judgment within the capacity of CPC and are binding on it. We would therefore dismiss the appeal.’