Analysis of the hedging strategy for the huge loss of Sinopec Group

Abstract

The use of crude oil futures for hedging is common for companies that use crude oil as a raw material. It helps companies to hedge against the risks associated with the volatility of crude oil prices and avoid major problems such as cash flow shortages. However, if hedging is abused, it can also have a significant impact on a company's profits. In late 2018, one of Sinopec Group's subsidiaries, United Petrochemical, mistakenly used financial derivatives to hedge, resulting in a plunge in net profit and share price for the entire group. This article analyses Sinopec Group's financial position for the three years 2017, 2018, and 2019, examines United Petrochemical's hedging strategy, and ultimately points out the reasons for and implications of its failure, with a view to providing lessons for the subsequent use of financial derivatives for hedging in related industries. The authors found that a subsidiary of Sinopec Group incurred large losses when international crude oil prices fell as it bought too many futures, causing Sinopec Group's profits to fall by more than 90% in the fourth quarter of 2018 and evaporating more than RMB 90 billion in market value in the two days the deal came to light.