By: Baldev Bhinder and Joyce Fong, Blackstone and Gold

This article was originally published by Blackstone and Gold.

The current conflict in Iran is a stark reminder of how quickly physical trade can grind to a halt. Disruption in the Strait of Hormuz has triggered a domino effect, choking deliveries from the Middle East and starving Asian refineries of critical feedstock (see our earlier Force Majeure Survival Guide). A waterfall of force majeure (FM) notices has followed, with inevitable disputes over the validity of FM positions now rippling down the supply chain.

When a “prolonged FM” becomes a deadlock, termination is inevitable, and the focus shifts to the fallout. In oil trading, damages are traditionally viewed through the narrow lens of the market measure. However, in a sophisticated market, many trades are hedged. If termination leaves you with a “naked” hedge and a haemorrhaging derivative position, the million-dollar question is, can you recover those losses, or are you left to foot the bill?

Market measure: a starting point, but not the whole picture

Damages for non-performance are usually assessed by the “market measure”, being the difference between the contract price and the market price at the delivery date. A substitute purchase (if made) may evidence market price, but is not necessarily required.

While the market measure works tolerably well for unhedged deals, most commodity trades are in fact hedged (whether as exchange-traded futures or bilateral OTC instruments). If the physical leg fails, the trader may be left with an open hedge and a net gain or loss which the market measure will not capture.

Hedging is routine, but when are hedging losses recoverable?

Courts increasingly recognise that the loss from a failed physical trade may be felt across both the physical and derivative legs. The starting point is that hedging costs can, in the right case, be recovered as part of the claimant’s direct loss (and not be excluded as a consequential loss). In Addax Ltd v Arcadia Petroleum Ltd [2000] 1 Lloyd’s Rep 493, the Commercial Court observed that:

“If the direct loss to [the claimant] is that which represents their net position … it is wrong in principle to ignore part of what actually happened by describing it as either too remote or as a consequential loss. The costs of the hedging devices are an integral part of the calculation of the net position.”

Whether recovery is available in a particular case will turn on whether the specific contract categorises and excludes hedging losses as consequential loss. In broad terms, recovery of hedging losses depends on whether the claimant can show that the hedging loss forms part of its net loss resulting from the termination.

Recovery, then, often hinges on two familiar hurdles:

• Causation: Was the hedge genuinely entered into in respect of (and to manage price risk arising from) the specific physical contract that failed?
• Foreseeability: The use of hedging must have reasonably been within the parties’ contemplation when the physical contract was made. This may be self-evident in sophisticated, well-hedged markets, but cannot always be assumed.

Managing the hedge after termination: mitigate, don’t speculate

There is no general duty on the innocent party to enter into a hedge to reduce its loss. However, where a hedge is already in place, the innocent party must manage it responsibly and avoid unnecessary losses.

This usually means prompt close-out or adjustment once non-performance becomes clear, leaving the hedge open for long makes it easier to characterise the loss as driven by independent trading rather than the termination.

It is crucial that any close-out, unwind, or adjustment be driven by (and clearly tied to) the termination, as courts closely scrutinise post-termination decisions to assess if the hedge was managed responsibly. Such issues are usually decided on the basis of evidence. In this regard, contemporaneous trading records, internal approvals, and explanations often carry more weight than an expert reconstruction prepared years later.

Further, proof is often easier where the hedge is implemented through structured, exchange-recognised mechanisms (e.g., EFP/EFS/basis trades on IFAD) that generate a clear audit trail. However, where risk is managed at the book level, attribution can be harder.

Book-level (macro) hedging: issues with attribution and proof

With book-level (macro) hedging, trading desks adjust hedges against net exposure across multiple trades and delivery windows. A termination would only be one input among other movements (e.g. new trades, quantity changes, rolls), making it harder to prove that a particular hedge result was caused by the terminated contract.

Hedging loss considerations: net loss position and gains

Courts will not permit double recovery. A claimant cannot recover both market-measure damages and hedging losses if they are simply two ways of describing the same price movement. Damages must reflect the net position.

Likewise, if the hedge produces a gain following termination, it must be brought into account so that damages reflect the claimant’s net position.

Action plan for hedging losses:

In practice, disputes over hedging losses often turn on:

• contemporaneous records of the hedging strategy and its execution;
• clear documentation linking the hedge to the specific physical transaction;
• timely and well-reasoned decisions on close-out or adjustment after termination; and
• consistency between trading records, internal explanations and any expert analysis.

Claims often fail not because hedging losses are irrecoverable in principle, but because the evidential threshold is not met. That is why the earliest decisions and records after disruption matter. If an FM event is declared or termination is looming due to regional conflict, recovery can depend on what is done in the first 48 hours:

• Isolate the hedge: tag the specific derivative positions linked to the affected physical exposure.
• Document the decision: record why the hedge is being closed, trimmed, or kept open and, where relevant, the contemporaneous market conditions (for example, liquidity and bid/offer spreads).
• Check the contract: review any exclusion or clause to see whether hedging costs are excluded.