China Grain Oils lost $17M hedging soybean oil on the CBOT — the two markets diverged

China Grain Oils was a Hong Kong-listed mainland Chinese edible oil processing company, specialising in soybean oil refining and distribution. The company sourced raw soybean oil from the domestic market, processed it, and sold it to Chinese consumers.

In early 2005, China Grain Oils purchased approximately 210,000 tonnes of crude soybean oil in the domestic market. To hedge against the risk of falling prices, the company sold short soybean oil futures on the Chicago Board of Trade (CBOT) — a standard hedging strategy for a company that owns physical inventory. The hedge assumed that CBOT prices and domestic Chinese prices would move together.

Between February and April 2005, the assumption failed catastrophically. CBOT soybean oil futures surged from 18.82 cents per pound to 24.75 cents per pound, driven by commodity fund buying. Meanwhile, domestic Chinese soybean oil prices fell sharply due to oversupply. The two markets diverged completely: the CBOT short position lost money as prices rose, while the domestic physical inventory also lost value as prices fell. The company was losing on both sides of the trade.

The total loss exceeded 130 million HKD ($17 million). China Grain Oils' stock price collapsed from 0.56 HKD to 0.267 HKD, wiping out 392 million HKD in market capitalisation. The case was dubbed 'the American version of the China Aviation Oil scandal' by Chinese financial media, and became a textbook example of basis risk — the danger that two markets assumed to move together can diverge.