Over the weekend of April 19th, many Oil and Gas bankers in Singapore must have had an upset stomach as they digested the shocking news that Hin Leong, one of the largest oil trading houses in the region, was effectively insolvent. The owner, the ex-billionaire OK Lim, had admitted that he had cooked the books and that Hin Leong’s true liabilities of $4,000m against assets of approximately $750m. In Singlish, Hin Leong is effectively a “gone case”. The 3 main Singapore local banks are on the hit for a combined total of $600M and HSBC by itself is on the hit for $600M. To make it even more dramatic, this announcement was made by Mr. Lim while he was on a conference call with the company’s network of banks who were assembled to discuss whether to offer Hin Leong a debt moratorium, or in other words giving the company a lifeline . Most bankers who heard Mr Lim’s confession were left in a state of shock and awe.
First a quick summary of the facts:
- A) Hin Leong trades about S$20,000m worth of oil and oil products in one year
- B) Banks lent Hin Leong S$4,000m in the form of commodity financing loans or Letters of Credit for the purchase of oil and oil products.
- C) A Hin Leong affliate, Universal Terminals, has storage capacity of approximately 14m barrels of oil.
- D) Hin Leong owns a lot of VLCC Tankers
- E) OK Lim is a well known gambler
- F) This sector has witnessed some spectacular bankruptcies such as OW Bunker’s bankruptcy in 2014. Bunker trading has a reputation as a shady business with shady operators.
Together, A, B, C, D , E and F is a recipe for disaster.
First some background. Let’s say in January, when an oil trader buys a cargo of oil, its called a cargo of oil based on the standard VLCC cargo of 2 million barrels, the amount for the purchase is probably about USD$90M based on the price of oil at $45 per barrel in a world before Covid19 aka #CCPVirus. If this VLCC was loaded in Houston, Texas, the 13,253 nautical mile trip to Singapore will take approximately 2 months. The seller, let’s say for argument sake is that firm headed by that female CEO, yes Occidental Petroleum, is not going offer any credit terms whatsoever to the buyer. The title to the oil changes from Occidental to the buyer as the oil passes through the main flange of the oil tanker. From the sellers point of view, its a done deal and they want to be paid.
Here is where the oil bankers step in, and for argument sake, lets call it HSBC. They issue a document called a Letter of Credit or LC to the buyer’s bank, let’s call it JP Morgan, which constitutes an irrevocable undertaking by HSBC to remit to JP Morgan in favour of Occidental Petroleum $90M once they have received the original documents detailing the transfer of oil from Occidental to the trader. This could take several days. So from Occidental’s point of view, their payment is guaranteed by HSBC and not by the trader, who could be some fly-by-night outfit. The risk of non-payment is borne by HSBC and not by Occidental. So far, so good, and the VLCC sets sail from Corpus Christi, destination Singapore.
Now, to recap, an Oil Trader buys a cargo of oil from a producer, the payment is $90M and the payment risk is borne by the oil trader’s bank, in our case HSBC. At the heart of the issue is what makes the bank so confident of this transaction is that so long the oil is in the VLCC, the title to the oil actually belongs to the bank and not to the trader. So from the bank’s point of view, they will usually demand some form of collateral from the trader, maybe a 10% deposit or about $9M and finance the 90%, by issuing a $90M LC. The oil then arrives in Singapore, where the trader gets the banks permission to store the oil in its oil storage facility. The bank agrees and the LC is now converted to a loan, maybe a 180 day loan, once again secured on the value of the oil.
Ok here is where things mess up. What happens if the oil trader secretly decides to sell the oil stored in the oil storage terminal without telling the bank?
This form of financing, called Inventory or Stock Financing has this weakness. Usually in the case of financing of industrial metals, like Copper, the Warehouse party is an independent party to the buyer and will only allow stocks to be taken out upon the explicit instruction of the bank.
It is a basic error in risk judgement for any banker to allow an oil trader, or any commodity trader, to store inventory FINANCED BY THE BANK in the warehouse of an affiliated party.
And that is most likely what happened in the case of Hin Leong. The oil which was bought was most likely stored in Universal Terminals, an entity linked to Hin Leong. The oil actually belonged to the banks, who financed the purchase transaction. But Hin Leong’s owner, would have on-sold the oil to get much needed cash to cover other bad debts and ordered the tank operator in Universal Terminals to pump the oil to a ship.
The financing bank is left issuing a loan against NOTHING.
So at heart, bank’s suffer when they do not hire experienced risk professionals to vet through transaction deals and protect the bank’s interest. Either the risk officers are happy for the 9 to 5 paycheck without raising a fuss or they have had the experience of being shouted down by the powerful commercial folk in the bank. In the latter case, the bank usually defer to the Oil and Gas banker, who is in for the short haul, gets the commission on the financing transaction and jets off when things go bad. The job of risk management in a bank is to cost a bank $1 a year so that they will prevent the bank the $100 loss that comes once every 5 to 10 years. But most of the time, some short sighted bankers see risk management as a cost without understanding the benefit. The following applies to those banks.
These banks deserve their losses, well and proper. Actually any bank which defers to their glorified Relationship Managers against the protestations of a proper risk analyst, deserve their losses, well and proper. Any bank that does not have a proper trained risk analyst, adequately compensated, is doomed to sustain the $100 loss that can wipe out an entire year’s worth of earnings.
ISSUE NO 2 – Deloitte
The second issue has to do with Deloitte. Deloitte Audit has some serious issues in South East Asia.
Didn’t Deloitte in Malaysia look the Malaysian Cabinet in the eye and said 1MDB was not a fraud case when even a junior auditor who was simultaneously high, drunk and slipping in and out of consciousness could point it out. And now, the Singapore Deloitte office has decided to join their Malaysian counterparts infamy by not uncovering what appears to be an elementary case of accounting fraud when all the risk indicators should be bright red – high turnover, low profit margin, multiple banking relationships, affiliated subsidiaries, poor accounting controls, family run business AND exposed to a highly volatile markets, which had a recent history of large bankruptcies like OW Bunker .
As they say in Malaysia: MAMPUS!
For the record, of the 4 big audit firms in South East Asia, only PWC and Ernst and Young (EY) have any value in my opinion. The Malaysian offices of both these firms told 1MDB to go fly kites and refused to audit their financial statements. Their reputation is intact.
ISSUE NO 3 – OK LIM’s misreading of the oil market.
Over the weekend of the 8th of March, Saudi Arabia decided to launch an oil price war. When markets opened for trading on Monday, 9th of March, WTI collapsed by about $10 to $30 a barrel. At that time, two very important elderly readers (related to the author) sought our opinion on what the price of oil would be. We said cooly, it was going to drop below $20 a barrel. And as of today, WTI prices are $10 a barrel and there is probably little hope that prices could touch $20 a barrel anytime soon.
But OK Lim had misread the market, thinking that the Coronavirus could be beaten. We actually saw the following a) Collapse in global air travel , b) Collapse in motor gasoline demand and c) Massive overproduction. To be honest a) and b) and c) were blatantly obvious to any right headed oil analyst. One way that this was obvious was to look at the stock prices of oil companies over the last 1 year. They were trading horribly in the 4th quarter and only managed a short gasp of air in the first 2 months of the year when the financial markets were going crazy and Dow Jones 30,000 was just one or two trading days away. The last point is actually quite important. Some of the best money managers say that the best reading of the economy could be found in the “bowels of the stock market”.
OK Lim however was on the wrong side of this development. He believed that oil prices would recover and probably nobody in his company would want to challenge the opinion, seeing that he had lost his mind by agreeing to do the accounting fraud.
There is some truth in the markets ability to make sector predictions, because in the case of the oil market, its doom was quite evident since last year and the stock prices reflected its doom. The oil sector has been a downturn ever since 2017. ExxonMobil which used to be trading at $90 a share a couple of years ago is now $40 a share. Occidental, which used to be trading at $80 , is now $12. I kid you not, some folks actually said that oil could crash to $2. Our view is that oil will be under $20 until May before recovering in June. The Covid-19 situation is beginning to end.
Actually, if Hin Leong’s owner, OK Lim did not do accounting fraud, he could actually be earning a risk free reward of up to $70M a month by just renting out his sprawling 14M barrel of oil facility for about $5 per barrel. The key thing now is storage, and Hin Leong had a lot of storage in the form of Universal Terminals. Pity, though because once you do this thing called fraud once, it usually has a habit of biting you back and leaving the fraudster with NOTHING.