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COVID-19 & THE OIL MARKET: Hedging Losses

1st May 2020

Executive Summary

  1. The effects of the COVID-19 pandemic on the oil market are unprecedented. According to one estimate, oil demand could fall by more than 30 million barrels per day in April – a figure which equates to around a third of daily oil consumption. According to BP boss Bernard Looney, his industry “has been hit by supply and demand shocks on a scale never seen before”. In late April, West Texas Intermediate, the US oil price benchmark, temporarily fell below $0, heralding the novelty of a negative price for the sale of goods whereby sellers would in effect have to pay buyers to receive them.
  2. It is likely that significant volumes of litigation lie ahead. This is the first of a number of bulletins focussing on legal issues concerning the oil market, and considers the recoverability of hedging losses in the law of damages.
  3. Despite the prevalent use in the oil market of derivatives to hedge against price fluctuation, the recoverability of hedging losses has received remarkably little scrutiny by English courts.  This is likely soon to change.  This bulletin therefore seeks to summarise the law as it stands.

The situation faced

  1. Recent weeks have seen acute logistical problems in the oil industry. The drop in consumer demand has caused refineries to reduce their processing operations.  In turn, storage tanks into which arriving tankers would ordinarily discharge their cargoes lack capacity to receive them.  It has been reported that, as of 27 April, nearly 90% of the global volume of crude oil storage is full; the rest could fill up in as few as three weeks.[2] Market participants seeking to deliver/receive cargoes have encountered severe delays.
  2. This situation has produced myriad additional costs. One particular problem relates to a steep increase in freight rates.  Rather than discharging ashore, many tankers are instead being used essentially as floating storage facilities. As the number of available vessels has been depleted, there has been a corresponding spike in the freight rates for tonnage which can be chartered. The cost of hiring some tankers has almost doubled over the past week.[3]  Some oil traders are therefore finding that sales contracts agreed before the pandemic are now severely loss making, once the cost of freight is included.
  3. These conditions – of uncertainty as to the ability to deliver goods at the port of discharge and the prospect of loss-making contracts – are ripe to produce occasions when buyers either do not take delivery or else delay in taking delivery of goods. Such delays are especially problematic in oil trading for two interrelated reasons.
  4. The first reason is that sale contracts are usually not agreed at a fixed price but are instead priced at a premium above an index price reported by an agency such as Platts. The pricing will typically be based on the average of daily prices during a specified period, with the period starting some time after a fixed event such as issuance of the bill of lading following completion of loading.  Hence, the actual price can change radically between the time when the contract was agreed and the time when it came to be performed – all the more so when there has been delay in performance.
  5. The second reason has to do with the use of derivative contracts to mitigate such price fluctuations, whereby equal and opposite positions are taken in the futures or swaps markets so that any loss on the physical transaction is balanced by an equivalent gain on the paper transaction, thereby ‘locking in’ the desired profit margin. To achieve this effect, it is necessary to align the physical and paper transactions as much as possible, including as regards their pricing periods.  When there are delays in the performance of the physical contract, this can disturb the symmetry.  Where a trader has sold goods and bought futures which will mature in the month of performance, he/she may need to “roll over” the hedge into the following month, or else there will be no hedge in place to protect against any further price fluctuations until performance.  The need to roll over the hedge can cause losses on the paper transactions, independent of any market loss associated with the falling price of the physical goods.  The question is whether such hedging losses can be recovered at law.

The law

  1. It seems to be accepted by market participants that hedging losses are foreseeable – hedging strategies are almost universally used and may even be predictable, whether or not they are precisely known in any given transaction. It is significant that, when the present version of the BP GT&C came out in 2015, they differed from the 2007 version by omitting “hedging or other derivative losses” from the list of “indirect or consequential losses” that were excluded.[4]  This change has been widely understood by market participants as betokening an acceptance that hedging losses may be recovered.  Whether or not this is actually the case in law is, however, much less clear.  It may vary depending upon the parties involved in the dispute: whereas those involved in the oil trading market might treat hedging losses as not too remote to be recoverable, shipowners might not be expected to have the same background knowledge.[5]
  2. One problem is that there are very few reported cases concerned with the recoverability of hedging losses. Indeed, they are often said to be contradictory.  Statements of the law can therefore only be tentative.  It is suggested that the starting point will, however, always be the various measures for the recovery of damages prescribed by Sale of Goods Act 1979, unless the contract otherwise provides.

(a)     Hedging as part of original transaction

  1. There may be differences in result as between situations where the hedge has been entered into as part of the initial transaction; and where it has instead been entered into following breach as part of steps taken in mitigating loss. This is because Sale of Goods Act 1979 includes a number of set rules for evaluating the measure of loss for common breaches of contract, such as the failure to take delivery of goods.
  2. In that situation, section 50(3), SGA 1979 provides that “[w]here there is an available market for the goods in question the measure of damages is prima facie to be ascertained by the difference between the contract and the market or current price at the time or times when the goods ought to have been accepted …”. Whilst this is described as only a prima facie rule, the presumption in applying the ‘market measure’ has been applied rigorously, with the result that the innocent party’s actual contractual arrangements are usually ignored, even if this produces the result that it is in fact undercompensated or overcompensated.[6]
  3. One finds the ‘market measure’ reflected in two reported cases concerned with hedging transactions entered into at the time of the original transaction.

(i)    Where there is an available market

  1. The first case is Addax v Arcadia.[7] There, Addax was selling crude oil FOB to Arcadia.  Arcadia were the ones who were due to lift the oil, which was to happen by STS transfer. It was a condition of the contract that delivery aboard Arcadia’s vessel would take place 22 / 23 May.  The price payable by Arcadia was based on Platts quotation for five days after the bill of lading was issued. In breach of contract, loading did not take place in the required period and the bill of lading was issued only on 31 May. The difference between the market value of the goods when they should have been delivered and when they were actually delivered was USD 1 million.
  2. Addax was purchasing from head sellers on terms which were not back-to-back as regards the pricing period, so it hedged its exposure against price fluctuations in the period between the time when the head contract was to price, and the time when the sub contract was to price. (It had agreed a deferred pricing period for the head contract, since it speculated that the market price would fall.) Its actual loss from the late delivery under these transactions was USD 800,000.  When issuing proceedings, it claimed this sum (not USD 1 million).
  3. For their part, Arcadia argued that Addax would have suffered no loss at all if only it had agreed head contracts and sub contracts which were back-to-back as regards the pricing periods, and had not taken out any hedge. The Judge rejected that argument.  He observed that “[t]his was a commercial contract to be looked at on its own”.  If only Addax had claimed USD 1 million (rather than the lesser sum of USD 800,000) the Judge would have been prepared to award that sum in line with the ‘market measure’.  It was only if he was wrong about that, and it was instead relevant to take the actual contractual arrangements into account, that the Judge went on to observe that the hedging transactions would still need to be considered, on the basis that they were ‘part and parcel’ of the deal.  But that remark was obiter.  The decision therefore demonstrates the traditional primacy of the ‘market measure’ where there is an available market.  In such instances, it suggests that hedging losses and gains should simply be ignored.

 (ii)    Where there is no available market

  1. Where there is no available market, the assessment of damages is based on the party’s actual losses. In this situation, there is greater scope for taking hedging transactions into consideration.
  2. This was the case in The Narmada Spirit.[8] In that case, Glencore was purchasing crude oil from Transworld and it was selling to BP.  The ordinary market measure did not apply, as there was no available market.
  3. The head and sub sales had different pricing periods. Glencore therefore hedged its market exposure by selling Brent Futures. There was a problem with delivery, and the cargo was not delivered in March as planned, but the contract was not terminated.  Glencore rolled over its hedges accordingly. In May, however, Transworld made clear it would not perform the contract, after all.  So Glencore closed out its hedges and terminated the contract, realising a loss of USD8.6m – a figure which comprised USD 8 million on the hedges, and USD 600,000 by way of loss of profit based on the difference between its head and the sub contract.
  4. Glencore did not however claim that sum. Instead it claimed the higher sum of USD 11 million, being the difference between the contract price and the price which the fuel would have commanded if it had been delivered in June when the contract was finally terminated.
  5. The Judge did not award the USD 11 million claimed. Instead he awarded USD 8.6m.  He accepted that, in closing out its hedges, Glencore had established its loss, commenting “I agree with Transworld that the position as regards the hedges is not res inter alios acta, nor is it equivalent to insurance.  Hedging is on the evidence an integral part of the business by which Glencore entered into the contract for the purchase of oil, and since the losing out on an early termination established a lower loss than would otherwise have been incurred, that has to be taken into account when determining the loss.”  The decision is a surprising one and may be thought incorrect, for it prefers as the measure of damages a loss based on hedging rather than the loss which arose out of the physical contract that was broken.
  6. One important, outstanding question is whether the Judge’s remarks, which if correct point in favour of the recovery of hedging losses, can be transposed into the situation where there is an available market – notwithstanding the approach taken in Addax.

(b)     Hedging losses incurred due to steps taken in mitigation of loss

  1. Different considerations may apply where the losses in question result from hedging transactions entered into only after the breach has occurred, rather than at the time of the original transaction. There is one decision which concerns such a situation: Choil Trading SA v Sahara Energy Resources Ltd.[9]
  2. In this case, Choil was buying naphtha from Sahara, and was intending to on-sell to Petrogal. A quality defect was discovered on 28 August. Choil could not itself reject the goods, since it had purchased them on an “as is” basis. But it lost its purchaser, Petrogal, who could and did reject the goods.  The effect of being left with goods on its hands was to expose Choil to loss if the market price dropped.  It therefore began hedging to protect itself from price fluctuation. Eventually, Choil agreed a substitute on-sale contract with another party, Blue Ocean.
  3. In the meantime, the market price had risen. Hence, Choil was able to sell at a higher price to Blue Ocean than it had agreed with Petrogal – even with the quality defect.  Choil nevertheless suffered countervailing losses on its hedges. Sahara therefore argued that Choil had suffered no loss, since the price of the physical goods had actually risen.
  4. The Judge rejected that argument, holding that the hedging loss needed to be taken into account. He observed, “The damages in issue constitute the difference between the sound arrived and damaged values of the goods together with the reasonable cost of mitigation.”  He continued, “In the trade in which both parties operated, hedging was an every day occurrence.  Anyone in Choil’s position would have been expected to hedge … .  It did not require any special knowledge to realise that hedging was what Choil was likely to do.  It was regarded as a normal and necessary part of the trade.”   In the result, the Judge awarded the difference between the price paid by Blue Ocean for the physical goods (a positive figure) and the hedging position (a negative figure).
  5. This decision might therefore suggest a greater opportunity to recover hedging losses if it has occurred in the mitigation of loss. The decision nevertheless deserves caution.  Here too, there were aspects of the ‘market measure’ rule in play: Choil could not immediately sell the goods to another purchaser, so had to take out a hedge.  If, however, there had been an available market for goods at the time when the defect was discoverable, the ‘market measure’ rule would ordinarily treat  the innocent party as having promptly entered the market and sold the goods – thereby assessing the loss accordingly – irrespective of what mitigating steps it actually undertook.
  6. Finally, if hedging losses incurred when mitigating loss can be taken into account, one would expect the same to be true of hedging gains, which would have the effect of reducing the amount of the recoverable loss. In this regard, the issue of whether benefits arising in the mitigation of loss should be taken into account was considered by the Supreme Court in The New Flamenco.[10] It was held to be essentially a question of causation: the benefit to be brought into account must have been caused either by the breach of the charterparty or by a successful act of mitigation. It will be a question of fact in each case whether a hedging gain was the result of a successful act of mitigation or the result of an independent decision. Even so, that decision was expressly concerned with the situation where there was no available market; otherwise the measure of damages in that case (for the early redelivery of a cruise ship under a charterparty) would simply have been the ‘market measure’ and the benefits (of an earlier, more favourable sale) would have been obviously irrelevant.

(c)     Recovery of hedging losses – final thoughts

  1. As the above summary shows, the law relating to the recovery of hedging losses remains underdeveloped.  Depending on whether the ‘market measure’ is likely to prove favourable or unfavourable in any given case, the parties in dispute are likely to seek to apply it or else disapply it, as the case may be. One thing which cannot, however, be ignored is the need to prove the causation of the losses. Ordinarily, the innocent party will need to demonstrate that the hedging loss was due to the breach complained of.  This may not be possible where hedges are not linked to individual trades, but instead where the whole book of business is hedged, with compatible hedging requests being netted off.[11]  If greater certainty as to the recoverability of such losses were desired, express clauses would be necessary.


  1. There are extensive challenges facing the oil trading sector which are likely to give rise to substantial litigation. As with the disputes following the 2008/2009 crisis, it is likely that the issues at the forefront will focus on the various routes to escape from loss-making contracts, as well as the applicable measure of damages.  This note has sought to touch on only a few of the myriad issues that are likely to arise.


Richard Southern QC

Richard Sarll


The contents of this article, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.


[1] According to Saad Rahim, Chief Economist at Trafigura, the Geneva based trader, as reported on 13 March 2020

[2] According to Rystad Energy, a research firm, as reported on

[3] “Tanker rates boom as oil refineries turn to floating storage” 27 April 2020

[4] Compare Clause 33.1 of the 2007 BP GT&Cs with Clause 66.1 of the 2015 BP GT&Cs

[5] See The MSC Amsterdam [2007] 2 Lloyd’s Rep 622

[6] See for instance Slater v Hoyle and Smith [1920] 2 KB 11, in which the buyers were able to deliver inferior goods under their sub-contract without suffering loss, yet were still awarded damages according to the market measure.  As per Scrutton LJ “The rules of English law do not always give an exact indemnity, and in this case I think they do not.”

[7] [2000] 1 Lloyd’s Rep 493

[8] [2010] 1 Lloyd’s Rep. 91

[9] [2010] EWHC 374 (Comm)

[10] [2017] 1 WLR 2581

[11] See The MSC Amsterdam [2007] 2 Lloyd’s Rep 622