China Aviation to boost trading to fuel growth

Economic growth, particularly in Asia, is boosting air cargo demand and business travel. China is the second-largest jet fuel market in the world and demand growth would continue at a fast pace even if government measures slowed the economy more, CAO Chief Executive Meng Fanqiu said.

"Even if the Chinese economy cools down, civil aviation will still maintain double digit increases," he said at the Reuters Global Energy and Climate Summit. "China is the second-biggest market for jet fuel after the US but demand is 6 times higher there, so there is a lot of potential."

The International Air Transport Association (IATA), which accounts for 93 percent of global air traffic, is forecasting about 8 percent annual growth in air traffic revenues worldwide this year to about $600 billion. Cargo revenue is seen increasing about 9 percent to $72 billion.

"The goal is to be the leader in jet fuel trading by 2014 in Asia Pacific, and to do so ... we must also explore other markets outside of China proactively and that is the main reason for us to engage in proprietary trading," he said in an interview at his office in the city state.

"Over the past two years, our jet fuel supply business to China has grown at a steady but slower rate, so the major contributor to growth (of jet fuel business volume) is proprietary trading."

This change is strategy is already beginning to show results. CAO reported a 67 percent increase to $21.5 million in net profit in the three months ended March 31 from a year earlier. Revenue in the same months more than double to $1.98 billion from $986 million a year ago.

The company's trading volumes grew by 55 percent during the quarter, with the bulk of the increase coming from deals not directly related to its core business of supplying jet fuel to Chinese airports, he said. For 2010, total volume rose 17% to 7.2 million tonnes.

"Through proprietary trading, we have diversified our sources of profit and enhanced our profitability, as compared to simply deriving a fixed margin from our supply business to the China previously," he said.

He declined to give the size of its proprietary trading business, citing competitive reasons.

The company imports over 95 percent of China's jet fuel needs, accounting for around 40 percent of the country's total demand. Its top customers include the nation's three biggest international airports.

Six years ago, the Singapore listed company stunned markets with a $550 million trading loss when it took risky bets on oil derivatives, triggering Singapore's biggest corporate scandal since the collapse of Barings Bank in 1995.

CAO was restructured and its internal controls and management practices strengthened following the debacle. Meng, who led the restructuring effort, was appointed chief executive in May 2008, after former chief executive Chen Jiulin was jailed in 2006 due to the trading scandal.

The company has instituted a slew of checks and balances to curb excessive risk-taking and avoid a similar debacle, he said.

"The Head of Risk Management reports to me, but has a separate direct reporting line to the Board, so this effectively controls risks relating to the management," said Meng.

Derivatives trades are also linked almost entirely to physical cargoes, limiting the company's net exposure, he said.

"Paper trading is primarily used for hedging for physical, so the real exposure is very small and is within the limits set by the board," he said.

CAO is 51 percent owned by the state-run China National Aviation Fuel Group Corp., the country's largest aviation transportation logistics service provider.

CAO resumed transactions in the spot market in 2009, and its trading efforts have largely been led by BP, which took a 20 percent stake in the company following its restructuring in 2005.

Under a collaborative agreement with BP, CAO's trading and risk management departments have been helmed by staff seconded from the oil major since 2005.

The two parties also set up this year a joint pool of physical jet fuel cargoes that will be sold in markets where they operate - China in the case of CAO and Australia, the Middle East, Europe and Singapore for BP. Profits from the joint account are shared between the companies.

"The advantage of this arrangement is that BP gets access to the China market while we get a presence in other markets," said Meng.

CAO has already started supplying customers in Singapore, Hong Kong, North America, Australia, the Philippines, the Middle East and Europe through term deals, spot transactions and tenders. It also started trading petrochemicals three years ago and fuel oil last year, although volumes for these two segments will remain insignificant over the next five years, Meng said.

CAO is looking to buy storage facilities to support its trading and to generate additional income from leasing them to third-parties, Meng said. It currently leases 260,000 cubic metres of storage capacity in South Korea and China.

He declined to elaborate on specific targets, but said the company is eyeing potential investments in North Asia and Singapore.

CAO has almost $58 million which could be used to fund acquisitions, according to its 2010 annual report. It can also issue more shares or tap on bank loans.

The type of funding used will depend on the nature of the project, Meng said.

Copyright Reuters, 2011